UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-22313
AMERIPATH, INC.
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 65-0642485
--------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7289 Garden Road, Suite 200, Riviera Beach, Florida 33404
--------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(561) 845-1850
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
--------------------------------------------------------------------------------
(Former name, former address and formal fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The registrant had 30,066,261 shares of common stock, $.01 par value,
outstanding as of November 9, 2001.
AMERIPATH, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of
September 30, 2001 and December 31, 2000 (Unaudited) 3
Condensed Consolidated Statements of Operations for
the Three and Nine Months Ended September 30, 2001
and 2000 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 2001 and 2000
(Unaudited) 5
Notes to Condensed Consolidated Financial Statements
(Unaudited) 6-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-35
Item 3. Quantitative and Qualitative Disclosures about Market Risk 36
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
September 30, December 31,
ASSETS 2001 2000
------------- ------------
CURRENT ASSETS:
Cash and cash equivalents $ 4,657 $ 2,418
Accounts receivable, net 81,341 70,939
Inventories 1,201 1,406
Other current assets 9,964 11,446
-------- --------
Total current assets 97,163 86,209
-------- --------
PROPERTY AND EQUIPMENT, NET 24,427 23,580
-------- --------
OTHER ASSETS:
Goodwill, net 201,015 177,263
Identifiable intangibles, net 263,714 268,627
Other 6,996 6,487
-------- --------
Total other assets 471,725 452,377
-------- --------
TOTAL ASSETS $593,315 $562,166
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 50,122 $ 35,712
Current portion of long-term debt 800 1,055
Other current liabilities 7,374 8,627
-------- --------
Total current liabilities 58,296 45,394
-------- --------
LONG-TERM LIABILITIES:
Revolving loan 194,000 197,216
Long-term debt 2,879 3,476
Other liabilities 8,946 2,369
Deferred tax liability 60,146 64,046
-------- --------
Total liabilities 324,267 312,501
-------- --------
STOCKHOLDERS' EQUITY:
Common stock 253 247
Additional paid-in capital 192,117 188,050
Accumulated other comprehensive loss (5,946) --
Retained earnings 82,624 61,368
-------- --------
Total stockholders' equity 269,048 249,665
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $593,315 $562,166
======== ========
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
3
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
-------- -------- -------- ---------
NET REVENUES:
Net patient service revenue $ 97,555 $79,650 $286,614 $222,910
Net management service revenue 8,503 6,871 23,241 19,588
-------- ------- -------- --------
Total net revenues 106,058 86,521 309,855 242,498
-------- ------- -------- --------
OPERATING COSTS AND EXPENSES:
COST OF SERVICES:
Net patient service revenue 45,165 37,465 132,942 104,493
Net management service revenue 5,756 4,950 15,801 13,698
-------- ------- -------- --------
Total cost of services 50,921 42,415 148,743 118,191
Selling, general and administrative expenses 18,089 15,234 53,475 42,660
Provision for doubtful accounts 12,617 8,868 35,823 24,320
Amortization expense 4,677 4,043 13,857 11,777
Asset impairment and related charges -- -- -- 5,245
Merger-related charges -- -- 7,103 --
-------- ------- -------- --------
Total operating costs and expenses 86,304 70,560 259,001 202,193
-------- ------- -------- --------
INCOME FROM OPERATIONS 19,754 15,961 50,854 40,305
-------- ------- -------- --------
OTHER INCOME (EXPENSE):
Interest expense (4,443) (3,657) (13,880) (10,633)
Other, net (74) 91 70 204
-------- ------- -------- --------
Total other expense (4,517) (3,566) (13,810) (10,429)
-------- ------- -------- --------
INCOME BEFORE INCOME TAXES 15,237 12,395 37,044 29,876
PROVISION FOR INCOME TAXES 6,369 5,159 15,788 13,570
-------- ------- -------- --------
NET INCOME 8,868 7,236 21,256 16,306
Induced conversion and accretion of redeemable
preferred stock -- -- -- (1,604)
-------- ------- -------- --------
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS $ 8,868 $ 7,236 $ 21,256 $ 14,702
======== ======= ======== ========
BASIC EARNINGS PER COMMON SHARE:
Basic earnings per common share $ 0.35 $ 0.30 $ 0.85 $ 0.64
======== ======= ======== ========
Basic weighted average shares outstanding 25,277 24,176 25,061 23,109
======== ======= ======== ========
DILUTED EARNINGS PER COMMON SHARE:
Diluted earnings per common share $ 0.34 $ 0.29 $ 0.81 $ 0.62
======== ======= ======== ========
Diluted weighted average shares outstanding 26,390 25,001 26,147 23,720
======== ======= ======== ========
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
4
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
------------------------------
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 21,256 $ 16,306
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 19,012 15,449
Loss on disposal of assets 120 19
Deferred income tax provision (3,900) (2,650)
Provision for doubtful accounts 35,823 24,320
Asset impairment and related charges -- 5,245
Merger-related charges 7,103 --
Changes in assets and liabilities (net of effects of acquisitions):
Increase in accounts receivable (46,456) (32,094)
Decrease in inventories 205 113
Decrease in other current assets 1,446 99
Increase in other assets (757) (137)
Increase in accounts payable and accrued expenses 11,270 3,767
Pooling merger-related charges paid (5,001) --
-------- --------
Net cash provided by operating activities 40,121 30,437
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (6,323) (6,635)
Investment in Genomics Collaborative, Inc. -- (1,000)
Merger-related charges paid (542) (1,344)
Cash paid for acquisitions and acquisition costs, net of cash acquired (465) (14,927)
Payments of contingent notes (29,721) (21,672)
-------- --------
Net cash used in investing activities (37,051) (45,578)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and warrants 3,251 822
Debt issuance costs (94) (70)
Principal payments on long-term debt (772) (407)
Net (payments) / borrowings under revolving loan (3,216) 18,921
-------- --------
Net cash (used in) / provided by financing activities (831) 19,266
-------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 2,239 4,125
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,418 1,713
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,657 $ 5,838
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Contingent stock issued (non-cash) $ 822 --
Cash paid during the period for:
Interest $ 14,011 $ 10,598
Income taxes $ 12,666 $ 18,046
The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
5
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements, which
include the accounts of AmeriPath, Inc. and its subsidiaries (collectively,
"AmeriPath" or the "Company"), have been prepared in accordance with accounting
principles generally accepted in the United States ("GAAP") for interim
financial reporting and the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, the financial statements do not include all of the
information and notes required by GAAP for complete financial statements. In
the opinion of management, such interim financial statements contain all
adjustments (consisting of normal recurring items) considered necessary for a
fair presentation of the Company's financial position, results of operations and
cash flows for the interim periods presented. The results of operations and
cash flows for any interim periods are not necessarily indicative of results
which may be reported for the full year. On November 30, 2000, the Company
acquired Pathology Consultants of America, Inc., d/b/a Inform DX ("Inform DX").
In connection with the acquisition, the Company issued approximately 2.6 million
shares of common stock in exchange for all the outstanding common stock of
Inform DX. In addition, the Company assumed certain obligations to issue shares
of common stock pursuant to outstanding Inform DX stock options and warrants.
This transaction was accounted for as a pooling of interests. All prior year
information has been restated to reflect the acquisition of Inform DX.
The accompanying unaudited interim condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements, and the notes thereto, included in the Company's Annual Report on
Form 10-K, as amended, for the year ended December 31, 2000, as filed with the
Securities and Exchange Commission.
In order to maintain consistency and comparability between periods presented,
certain amounts have been reclassified in order to conform with the financial
statement presentation of the current period.
Recent Accounting Pronouncements
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements, which
provided the staff's views in applying GAAP to selected revenue recognition
issues. In June 2000, SAB 101 was amended by SAB 101B, which delayed the
implementation of SAB 101 until no later than the fourth fiscal quarter of
fiscal years beginning after December 15, 1999. The Company adopted SAB 101 in
the fourth quarter of 2000. The adoption of the provisions of SAB 101 did not
have a material impact on the Company's consolidated results of operations, cash
flows or financial position.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS 133") and in June 1999, the FASB
issued Statement of Financial Accounting Standards No. 137 "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133," which delayed the effective date the Company is
required to adopt SFAS 133 until its fiscal year 2001. In June 2000, the FASB
issued Statement of Financial Accounting Standards No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - an Amendment to
FASB Statement No. 133." This statement amended certain provisions of SFAS 133.
SFAS 133 requires the Company to recognize all derivatives on the balance sheet
at fair value. Derivatives that are not hedges must be adjusted to fair value
through income. If the derivative is a hedge, depending on the nature of the
hedge, changes in the fair value of derivatives will either be offset against
the change in fair value of the hedged assets, liabilities, or firm commitments
through earnings or recognized in other comprehensive income until the hedged
item is recognized in earnings. The ineffective portion of a derivative's change
in fair value will be immediately recognized in earnings. The Company does not
enter into derivative financial instruments for trading purposes. The adoption
of SFAS 133 did not result in a cumulative effect adjustment being recorded to
net income for the change in accounting. However, the Company recorded a
transition adjustment of approximately $3.0 million (net of tax of $2.0 million)
in accumulated other comprehensive loss on January 1, 2001. See Notes 9 and 10
to the unaudited condensed consolidated financial statements.
6
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
In September 2000, the FASB issued Statement of Financial Accounting Standards
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 140"). SFAS 140 is a replacement of
Statement of Financial Accounting Standards No. 125. SFAS 140 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishment of liabilities occurring after March 31, 2001. The
Company has evaluated this standard and has concluded that the provisions of
SFAS 140 will not have a significant effect on its consolidated results of
operations, cash flows or financial position.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" ("SFAS 141"). SFAS 141 requires the purchase
method of accounting for business combinations initiated after June 30, 2001 and
eliminates the pooling-of-interests method. The Company does not believe that
the adoption of SFAS 141 will have a significant impact on its financial
statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which is effective
January 1, 2002. SFAS 142 requires, among other things, the discontinuance of
goodwill amortization. In addition, the standard includes provisions for the
reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments of goodwill. SFAS 142 also requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption. The
Company is currently assessing, but has not yet determined, the impact of SFAS
142 on its consolidated results of operations, cash flows or financial position.
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
143, "Accounting for Obligations associated with the Retirement of Long-Lived
Assets." SFAS No. 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, and early adoption is
permitted. The Company is currently assessing the new standard and has not yet
determined the impact on its consolidated results of operations, cash flows or
financial position.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." This
statement addresses financial accounting and reporting for the impairment or
disposal of long-lived assets. This statement supersedes FASB Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and the accounting and reporting provision of
Accounting Principle Board Opinion No. 30, "Reporting the Results of Operations-
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions," for the disposal of
a "segment of a business" (as previously defined in that Opinion). This
statement also amends Accounting Research Bulletin No. 51, "Consolidated
Financial Statements" to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. SFAS No. 144 is
effective for the fiscal years beginning after December 15, 2001, and early
adoption is permitted. The Company is currently assessing the new standard and
has not yet determined the impact on its consolidated results of operations,
cash flows, or financial position.
NOTE 2 - ACQUISITIONS
There were no acquisitions made in the first nine months of 2001.
The accompanying unaudited condensed consolidated financial statements for the
nine months ended September 30, 2000 include the results of operations of the
Company's 2000 acquisitions from the dates acquired through September 30, 2000.
The allocation of the purchase prices of some of the acquisitions occurring in
the latter half of 2000 are preliminary, while the Company continues to obtain
the information necessary to determine the fair value of the assets acquired and
liabilities assumed. When the Company
7
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
obtains such final information, management believes that adjustments, if any,
will not be material in relation to the consolidated financial statements. The
following unaudited pro forma information presents the consolidated results of
the Company's operations and the results of operations of the acquisitions for
the nine months ended September 30, 2000, after giving effect to amortization of
goodwill and identifiable intangible assets, interest expense on debt incurred
in connection with these acquisitions, and the reduced level of certain specific
operating expenses (primarily compensation and related expenses attributable to
former owners) as if the acquisitions had been consummated on January 1, 2000.
Such unaudited pro forma information is based on historical financial
information with respect to the acquisitions and does not include operational or
other changes which might have been effected by the Company.
The unaudited pro forma information for the nine months ended September 30, 2000
presented below is for illustrative information purposes only and is not
indicative of results which would have been achieved or results which may be
achieved in the future. There is no pro forma information presented for the
nine months ended September 30, 2001, since there were no acquisitions made
during the first nine months of 2001. These amounts are in thousands, except per
share amounts.
Pro Forma (Unaudited)
Nine Months Ended
September 30,
2000
----------------------
Net revenues $267,721
========
Net income attributable to common stockholders $ 16,627
========
Diluted earnings per common share $ 0.65
========
NOTE 3 - INTANGIBLE ASSETS
Intangible assets and the related accumulated amortization and amortization
periods are set forth below (dollars in thousands):
September 30, 2001
Amortization Periods
(Years)
-----------------------------
September 30, December 31, Weighted
2001 2000 Range Average
------------- ------------ ---------- ---------
Hospital contracts $211,738 $211,738 25-40 31.5
Physician client lists 74,778 71,447 10-30 19.7
Laboratory contracts 4,543 4,543 10 10.0
Management service agreements 11,379 11,214 25 25.0
-------- --------
302,438 298,942
Accumulated amortization (38,724) (30,315)
-------- --------
Identifiable intangibles, net $263,714 $268,627
======== ========
Goodwill $222,430 $193,231 10-35 29.3
Accumulated amortization (21,415) (15,968)
-------- --------
Goodwill, net $201,015 $177,263
======== ========
The weighted average amortization period for identifiable intangible assets and
goodwill is 27.6 years.
8
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
NOTE 4 - MERGER-RELATED CHARGES
In connection with the Inform DX merger and other previous acquisitions, the
Company has recorded reserves for transaction costs, employee-related costs
(including severance agreement payouts) and various exit costs associated with
the consolidation of certain operations, including the elimination of duplicate
facilities and certain exit and restructuring costs. During the first quarter
of 2001, the Company recorded merger-related costs totaling $7.1 million related
to the Inform DX merger. As part of the Inform DX acquisition, the Company is
closing or consolidating certain facilities.
A reconciliation of the activity for the nine months ended September 30, 2001
with respect to the merger-related charges is as follows:
Balance Statement of Balance
December 31, Operations September 30,
2000 Charges Payments 2001
------------- ------------- -------- -------------
Transaction costs $ 1,726 $2,863 $(3,113) $ 1,476
Employee termination costs
1,417 4,240 (2,109) 3,548
Lease commitments 2,128 -- (321) 1,807
Other exit costs 263 -- -- 263
------- ------ ------- -------
Total 5,534 $7,103 $(5,543) 7,094
====== =======
Less: portion included in
current liabilities (3,165) (4,094)
------- -------
Total included in other
liabilities $ 2,369 $ 3,000
======= =======
NOTE 5 - MARKETABLE SECURITIES
The Company accounts for investments in certain debt and equity securities under
the provisions of Statement of Financial Accounting Standards No. 115 ("SFAS No.
115"), "Accounting for Certain Debt and Equity Securities". Under SFAS No. 115,
the Company must classify its debt and marketable equity securities in one of
three categories: trading, available-for-sale, or held-to-maturity.
In September 2000, the Company made a $1 million investment in Genomics
Collaborative, Inc ("GCI") for which it received 333,333 shares of Series D
Preferred Stock, par value $0.01. The shares of GCI Series D Preferred Stock
are convertible into shares of GCI common stock on a one-for-one basis and are
redeemable after 2005 at $3.00 per share at the option of the holder. GCI is a
privately held, start-up company, which has a history of operating losses. As
of September 30, 2001, it appears that GCI has sufficient cash to fund
operations for the next twelve months. In the event that they are unable to
become profitable and/or raise additional funding, it could result in an
impairment of the Company's investment. This available for sale security is
recorded at its estimated fair value, which approximates cost, and is classified
as other assets on the Company's balance sheet. At September 30, 2001, there
were no unrealized gains or losses associated with this investment.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
Liability Insurance -- The Company is insured with respect to general liability
on an occurrence basis and medical malpractice risks on a claims made basis. The
Company records an estimate of its liabilities for claims incurred but not
reported. Such liabilities are not discounted. Effective July 1, 2000, the
Company changed its medical malpractice carrier and the Company is currently in
a dispute with its former insurance carrier on an issue related to the
applicability of surplus insurance coverage. The Company believes that an
9
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
unfavorable resolution, if any, of such dispute would not have a material
adverse effect on the Company's financial position or results of operations.
Healthcare Regulatory Environment and Reliance on Government Programs -- The
healthcare industry in general, and the services that the Company provides, are
subject to extensive federal and state laws and regulations. Additionally, a
significant portion of the Company's net revenue is from payments by government-
sponsored health care programs, principally Medicare and Medicaid, and is
subject to audit and adjustments by applicable regulatory agencies. Failure to
comply with any of these laws or regulations, the results of increased
regulatory audits and adjustments, or changes in the interpretation of the
coding of services or the amounts payable for the Company's services under these
programs could have a material adverse effect on the Company's financial
position and results of operations. The Company's operations are continuously
subject to review and inspection by regulatory authorities.
Internal Revenue Service Examination -- The Internal Revenue Service ("IRS")
conducted an examination of the Company's federal income tax returns for the tax
years ended December 31, 1996 and 1997 and concluded that no changes to the tax
reported needed to be made. Although the Company believes it is in compliance
with all applicable IRS rules and regulations, if the IRS should determine the
Company is not in compliance in any other years, it could have a material
adverse effect on the Company's financial position and results of operations.
Employment Agreements - The Company has entered into employment agreements with
certain of its management employees, which include, among other terms,
noncompetition provisions and salary continuation benefits.
NOTE 7 - EARNINGS PER SHARE
Earnings per share is computed and presented in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share." Basic earnings
per share, which excludes the effects of any dilutive common equivalent shares
that may be outstanding, such as shares issuable upon the exercise of stock
options and warrants, is computed by dividing income attributable to common
stockholders by the weighted average number of common shares outstanding for the
respective periods. Diluted earnings per share gives effect to the potential
dilution that could occur upon the exercise of certain stock options and
warrants that were outstanding at various times during the respective periods
presented. The dilutive effects of stock options and warrants are calculated
using the treasury stock method.
Basic and diluted earnings per share for the respective periods are set forth in
the table below (amounts in thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2001 2000 2001 2000
-------- ------- -------- ---------
Earnings Per Common Share:
Net income attributable to common
stockholders $ 8,868 $ 7,236 $21,256 $14,702
======= ======= ======= =======
Basic earnings per common share $ 0.35 $ 0.30 $ 0.85 $ 0.64
======= ======= ======= =======
Diluted earnings per common share $ 0.34 $ 0.29 $ 0.81 $ 0.62
======= ======= ======= =======
Basic weighted average shares outstanding 25,277 24,176 25,061 23,109
Effect of dilutive stock options and warrants 1,113 825 1,086 611
------- ------- ------- -------
Diluted weighted average shares outstanding 26,390 25,001 26,147 23,720
======= ======= ======= =======
10
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
Options to purchase 77,238 and 212,859 shares of common stock that were
outstanding for the quarter and nine months ended September 30, 2001,
respectively, and options to purchase 436,026 and 699,826 shares of common stock
that were outstanding for the quarter and nine months ended September 30, 2000,
respectively, have been excluded from the calculation of diluted earnings per
share for each period because their effect would be anti-dilutive. Warrants to
purchase 38,867 shares for the three and nine months ended September 30, 2000,
were excluded from the calculation of diluted earnings per share because their
effect would be anti-dilutive.
NOTE 8 - LONG TERM DEBT
On June 11, 2001 the Company increased committed funding from $230 million to
$282.5 million under its existing credit facility. Citicorp, USA, Inc.
committed $37.5 million and agreed to serve as documentation agent for the
credit facility. Credit Suisse First Boston committed $15 million.
On March 29, 2001, the Company and its lenders executed an amendment ("Amendment
No. 3") to its Credit Facility, dated December 16, 1999, which excluded an
additional $5.4 million, or $28.3 million in total, of charges from its covenant
calculations. In addition, Amendment No. 3 (i) increased the Company's
borrowing rate by 37.5 basis points; (ii) requires the Company to use a minimum
of 30% equity for all acquisitions; (iii) requires the Company to use no more
than 20% of consideration for acquisitions in the form of contingent notes and;
(iv) requires lender approval of all acquisitions with a purchase price greater
than $10 million. The Company paid an amendment fee of up to 30 basis points to
those lenders which consented to the amendment. The amendment fee was
approximately $600,000. The amendment is not expected to have an adverse effect
on the Company's operations or strategies.
NOTE 9 - INTEREST RATE RISK MANAGEMENT
The Company utilizes interest rate swap contracts to effectively convert a
portion of its floating-rate obligations to fixed-rate obligations. Under SFAS
133, the Company accounts for its interest rate swap contracts as cash flow
hedges whereby the fair value of the related interest rate swap agreement is
reflected in other comprehensive loss with the corresponding liability being
recorded as a component of other liabilities on the condensed consolidated
balance sheet. The Company has no ineffectiveness with regard to its interest
rate swap contracts as each interest rate swap agreement meets the criteria for
accounting under the short-cut method as defined in SFAS 133 for cash flow
hedges of debt instruments. The Company uses derivative financial instruments to
reduce interest rate volatility and associated risks arising from the floating
rate structure of its Credit Facility. Such derivative financial instruments
are not held or issued for trading purposes. The Company is required by the
terms of its Credit Facility to keep some form of interest rate protection in
place. The effectiveness of the strategies will be monitored, measuring the
intended benefit or cost of protection against the actual market conditions.
NOTE 10 - COMPREHENSIVE INCOME
The Company includes changes in the fair value of certain derivative financial
instruments which qualify for hedge accounting in comprehensive income. For the
nine months ended September 30, 2001, comprehensive income was approximately
$15.3 million. This includes a transition adjustment recorded on January 1,
2001 of $3.0 million (net of tax of $2.0 million). The composition of
comprehensive income for the nine months ended September 30, 2001, is as follows
(in thousands):
Net income $21,256
Change in fair value of derivative financial
instruments, net of tax of $4,271 (5,946)
-------
Comprehensive income $15,310
=======
11
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (Continued)
NOTE 11 - SEGMENT REPORTING
The Company has two reportable segments, Owned and Managed practices. The
segments were determined based on the type of service and customer. Owned
practices provide anatomic pathology services to hospitals and referring
physicians, while under the management relationships the Company provides
management services to the affiliated physician groups. The accounting policies
of the segments are the same as those of the Company. The Company evaluates
performance based on revenue and income before amortization of intangibles,
merger-related charges, asset impairment charges, interest expense, other income
and expense and income taxes ("Operating Income"). In addition to the business
segments above, the Company evaluates certain corporate expenses which are not
allocated to the business segments.
The following is a summary of the financial information for the three and nine
months ended September 30 for the business segments and corporate.
Owned Three months ended September 30, Nine months ended September 30,
----- -------------------------------- -------------------------------
2001 2000 2001 2000
----------- -------- ----------- ----------
Net patient service revenue $97,555 $79,650 $286,614 $222,910
Operating income 29,312 24,063 87,126 69,998
Segment assets 335,328 233,447
Managed Three months ended September 30, Nine months ended September 30,
------- -------------------------------- -------------------------------
2001 2000 2001 2000
----------- -------- ----------- ----------
Net management service revenue $8,503 $6,871 $23,241 $ 19,588
Operating income 1,128 1,951 3,409 3,372
Segment assets 21,403 18,075
Corporate Three months ended September 30, Nine months ended September 30,
--------- -------------------------------- -------------------------------
2001 2000 2001 2000
----------- -------- ----------- ----------
Operating loss $(6,009) $(6,010) $(18,721) $(16,043)
Segment assets 266,432 322,446
Elimination of intercompany accounts (29,848) (28,429)
NOTE 12 - SUBSEQUENT EVENTS
Subsequent to September 30, 2001, the Company paid approximately $1.9 million on
contingent notes issued in connection with previous acquisitions as additional
purchase price.
On October 29, 2001, the Company closed a public offering of 4,743,750 shares of
common stock (which included 618,750 shares purchased by the underwriters
pursuant to their over-allotment option) at a price of $26.00 per share. Salomon
Smith Barney acted as book-running manager, and Credit Suisse First Boston, U.S.
Bancorp Piper Jaffray, and Wachovia Securities were co-managers, of the
underwriting group for the offering. The net proceeds of approximately $117
million were used to repay indebtedness under the Company's credit facility.
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
We are one of the leading national providers of anatomic pathology services. The
424 pathologists in our owned and managed practices as of September 30, 2001
provide medical diagnostic services in outpatient laboratories owned, operated
and managed by us, in hospitals, and in ambulatory surgery centers. Under our
ownership or employment model, we acquire a controlling equity (i.e., voting)
interest or have a controlling financial interest in pathology practices. We
refer to these practices as our owned practices. Under our management or equity
model, we acquire certain assets of, and operate pathology practices under long-
term management services agreements with, pathology practices. We refer to these
practices as our managed practices. Under the management services agreements,
we provide facilities and equipment as well as administrative and technical
support for the managed practices. As of September 30, 2001, we had seven
managed practices, employing 68 physicians. When we refer to "practices"
generally, we mean our owned and managed practices as a group.
As of September 30, 2001, our practices had contracts or business relationships
with a total of 237 hospitals pursuant to which we manage their clinical
pathology and other laboratories and provide professional pathology services.
The majority of these hospital contracts and relationships are exclusive
provider relationships. We also have 42 licensed outpatient laboratories.
Generally, we manage and control all of the non-medical functions of the
practices, including:
. recruiting, training, employing and managing the technical and support
staff;
. developing, equipping and staffing laboratory facilities;
. establishing and maintaining courier services to transport specimens;
. negotiating and maintaining contracts with hospitals, national clinical
laboratories and managed care organizations and other payors;
. providing financial reporting and administration, clerical, purchasing,
payroll, billing and collection, information systems, sales and
marketing, risk management, employee benefits, legal, tax and accounting
services;
. maintaining compliance with applicable laws, rules and regulations; and
. with respect to our ownership and operation of outpatient anatomic
pathology laboratories, providing slide preparation and other technical
services.
Acquisitions
Since the first quarter of 1996, we have completed the acquisition of 49
physician practices located in 21 states. These acquisitions include the
acquisition of Inform DX, during the fourth quarter of 2000. We accounted for
the Inform DX transaction as a pooling of interests and, therefore, we have
restated all historical information to reflect the acquisition of Inform DX. As
a result of the Inform DX acquisition, we now have managed practices from which
we derive management fees. Prior to the Inform DX transaction, we only had owned
practices.
There were no acquisitions in the first nine months of 2001. While we regularly
explore additional acquisition opportunities and are in various stages of
discussions with a number of acquisition candidates, we currently have no
specific agreements or commitments with any third party regarding any potential
acquisition.
13
Business Collaborations
We have commenced our transition to becoming a fully integrated healthcare
diagnostic information provider. As part of this transition, we have entered
into business collaborations intended to generate additional revenues through
leveraging our personnel, technology and resources. Two examples of such
endeavors (one with Genomics Collaborative, Inc. and one with Molecular
Diagnostics, Inc. ("Molecular Diagnostics" (f/k/a Ampersand Medical of
Chicago)) are described below. Although we believe such new endeavors are
promising, there can be no assurance that they will be profitable.
During the third quarter of 2000, we formed an alliance with Genomics
Collaborative, Inc. ("GCI") to provide fresh frozen samples from normal,
diseased, and cancerous tissue to GCI for subsequent sale to researchers in
industry and academic laboratories who are working to discover genes associated
with more common disease categories, such as heart disease, hypertension,
diabetes, osteoporosis, depression, dementia, asthma, and cancer, with a special
focus on breast, colon, and prostate tumors. This alliance utilizes our national
network of hospitals, physicians, and pathologists and GCI's capabilities in
large scale DNA tissue analysis and handling, tied together by proprietary
information systems and bioinformatics. The financial results of the alliance
with GCI were not material to our operations during 2000 or for the nine months
ended September 30, 2001. We are working with GCI to develop procedures to
comply with informed consent requirements and other regulations regarding the
taking and processing of specimens from donors and related records. Failure to
comply with such regulations could result in adverse consequences including
potential liability to us. On September 15, 2000, we made a $1.0 million
investment in GCI in exchange for 333,333 shares of Series D Preferred Stock,
par value $0.01. GCI is a privately held, start-up company, which has a history
of operating losses. As of September 30, 2001, it appears that GCI has
sufficient cash to fund operations for the next twelve months. In the event that
they are unable to become profitable and/or raise additional funding, it could
result in an impairment of the Company's investment. At September 30, 2001,
there were no unrealized gains or losses associated with this investment.
On March 27, 2001, we announced an agreement with Molecular Diagnostics which
illustrates another example of leveraging our existing resources. In this
alliance, we will be performing clinical trial work for Molecular Diagnostics'
cytology platform that utilizes proteomic biomarkers to help pathologists and
cytologists identify abnormal and cancerous cells in pap smears and other body
fluids, such as sputum and urine. We will be paid on a fee-for-service basis for
each clinical trial we conduct. The agreement also calls for us to assist
Molecular Diagnostics with the development of associated products and tests. We
would receive equity in Molecular Diagnostics for the developmental work and
would be entitled to royalty payments based on future sales of these products
and tests. One of the Molecular Diagnostics products we are currently evaluating
is a new test for human papilloma virus or HPV, which causes over 99% of all
cervical dysplasia and cancer. This new test involves the application of genomic
and proteomic markers directed against the specific oncogenes and oncoproteins
of HPV that are directly responsible for the virus' ability to cause cancer.
Preliminary studies indicate superior performance of these markers compared to
currently available tests. However, there can be no assurance that such tests or
such markers will be successful or become commercially viable.
Sources of Net Revenue
We derive our net revenue primarily from the operations of our owned and managed
practices. Net revenue was comprised of net patient service revenue from our
owned practices and net management service revenue from our managed practices.
The percent of our net revenue from outpatient and inpatient pathology and
management services is presented below. The type and mix of business among these
three categories, which can change from period to period as a result of new
acquisitions and other factors, may change our ratio of operating costs to net
revenue, particularly the provision for doubtful accounts as discussed below in
our results of operations.
14
Three Months Nine Months
------------------- -------------------
Ended September 30, Ended September 30,
------------------- -------------------
2001 2000 2001 2000
---- ---- ---- ----
Revenue Type
Outpatient............... 46% 46% 45% 42%
Inpatient................ 46% 46% 47% 50%
Management service
revenues................ 8% 8% 8% 8%
Net patient revenues
The majority of services furnished by our pathologists are anatomic pathology
diagnostic services. We typically bill government programs, principally Medicare
and Medicaid, indemnity insurance companies, managed care organizations,
national clinical laboratories, physicians and patients. Net patient revenue
differs from amounts billed for services due to:
. Medicare and Medicaid reimbursements at annually established rates;
. payments from managed care organizations at discounted fee-for-service
rates;
. negotiated reimbursement rates with national clinical laboratories and
other third-party payors; and
. other discounts and allowances.
The national clinical laboratories contract directly under capitated agreements
with managed care organizations to provide clinical as well as anatomic
pathology services. We, in turn, subcontract with national clinical laboratories
to provide anatomic pathology services at a discounted fee-for-service rate and
are attempting to increase the number of such subcontracts to increase test
volume. Since the majority of our operating costs -- principally the
compensation of physicians and non-physician technical personnel -- are
relatively fixed, increases in test volume generally enhance our profitability.
Historically, net patient service revenue from capitated contracts has
represented an insignificant amount of total net patient service revenue.
However, we may be required to enter into more capitated arrangements in order
to compete effectively for managed care contracts in the future.
Virtually all of our net patient service revenue is derived from our practices'
charging for services on a fee-for-service basis. Accordingly, we assume the
financial risk related to collection, including potential uncollectability of
accounts, long collection cycles for accounts receivable and delays in
reimbursement by third-party payors, such as governmental programs, private
insurance plans and managed care organizations. Increases in write-offs of
doubtful accounts, delays in receiving payments or potential retroactive
adjustments and penalties resulting from audits by payors may require us to
borrow funds to meet current obligations or may otherwise have a material
adverse effect on our financial condition and results of operations.
In addition to services billed on a fee-for-service basis, the hospital-based
pathologists have supervision and oversight responsibility for their roles as
Medical Directors of the hospitals' clinical, microbiology and blood banking
operations. For this role, we bill non-Medicare patients according to a fee
schedule for what is referred to as clinical professional component charges. For
Medicare patients, the pathologist is typically paid a director's fee or a "Part
A" fee by the hospital. Hospitals and third-party payors are continuing to
increase pressure to reduce the payment of these clinical professional component
charges and "Part A" fees, and in the future we may sustain substantial
decreases in these payments.
Approximately 22% of our collections from owned practices in the nine months
ended September 30, 2001 was from government-sponsored health care programs,
principally Medicare and Medicaid, and is subject to audit and adjustments by
applicable regulatory agencies. Failure to comply with any of these laws or
regulations, the results of increased regulatory audits and adjustments, or
changes in the interpretation of the coding of services or the amounts payable
for services under these programs could have a material adverse effect on our
financial position and results of operations.
15
The impact of legislative changes on our results of operations will depend upon
several factors, including the mix of inpatient and outpatient pathology
services, the amount of Medicare business, and changes in reimbursement levels
which are published in November of each year. Management continuously monitors
changes in legislation impacting reimbursement.
In prior years, we have been able to mitigate the impact of reductions in
Medicare reimbursement rates for anatomic pathology services through the
achievement of economies of scale and production efficiencies. Despite any
offsets, the recent substantial modifications to the physician fee schedule,
along with additional adjustments by Medicare, could have a material adverse
effect on average unit reimbursement in the future. In addition, other third-
party payors could adjust their reimbursement based on changes to the Medicare
fee schedule. Any reductions made by other payors could also have a material
negative impact on average unit reimbursement.
Net management service revenue
Net management service revenue is based on a predetermined percentage of
operating income of the managed practices, before physician group retainage,
plus reimbursement of certain practice expenses as defined in each management
service agreement. Management fees are recognized at the time the physician
group revenue is recorded by the physician group.
Generally, net management service revenue equates to net physician group revenue
less amounts retained by the physician groups, which we refer to as physician
group retainage. Net physician group revenue is equal to billed charges reduced
by provisions for bad debt and contractual adjustments. Contractual adjustments
represent the difference between amounts billed and amounts reimbursable by
commercial insurers and other third-party payors pursuant to their respective
contracts with the physician group. The provision for bad debts represents
management's estimate of potential credit issues associated with amounts due
from patients, commercial insurers, and other third-party payors. Net physician
group revenue, which underlies our management service revenue, is subject to the
same legislative and regulatory factors discussed above with respect to net
patient revenue.
Medicare Reimbursement
Since 1992 the Centers for Medicare and Medicaid Services ("CMS") (formerly
known as the Health Care Financing Administration, or "HCFA") has paid for
physician's services under section 1848 of the Social Security Act. CMS
calculates and reimburses fees for all physician services ("Part B" fees),
including anatomic pathology services, based on a fee schedule methodology known
as the resource-based relative value system ("RBRVS"). The RBRVS initially was
phased in over a four year period. Subsequently, CMS proposed changes in the
computation of the malpractice portion and practice expense portion of the total
relative value units ("RVUs"). Although these changes have changed reimbursement
to some extent, they are not expected to have a material impact on the Company's
revenues. Overall, anatomic pathology reimbursement rates declined during the
fee schedule phase-in period, despite an increase in payment rates for certain
pathology services performed by us.
The Medicare Part B fee schedule payment for each service is determined by
multiplying the RVUs established for the service by a Geographic Practice Cost
Index ("GPCI"). The sum of this value is multiplied by a conversion factor. The
number of RVUs assigned to each service is in turn calculated by adding three
separate components: work RVU (intensity of work), practice exposure RVU
(expense related to performing the service) and malpractice RVU (malpractice
costs associated with the service).
CMS annually reviews both the RVUs and the conversion factor in conjunction with
its budgeting process. The resulting payment schedule is published each year in
the Federal Register typically in November. The blended payment rates for
services provided by AmeriPath to Medicare patients, based on our values and
locations of services, increased on average by 6.8% from 2000 to 2001. However,
there can be no assurance that we will receive similar increases in the future,
and it is possible that our blended rates may decrease at some point in the
future.
16
A final rule published in the Federal Register on November 1, 2001 indicates
that the conversion factor used in the Medicare Physician Fee Schedule will be
reduced by 5.4%. The RVUs will also be changing in 2002, with certain services
getting an increase in RVUs, while others are decreased. The Company estimates
the overall impact to be neutral for 2002.
In 1999, CMS announced that it would cease the direct payment by Medicare for
the technical component of inpatient physician pathology services to an outside
independent laboratory because they concluded payment for the technical
component is included already in the payment to hospitals under the hospital
inpatient prospective payment system. Implementation of this change commenced
January 1, 2001. Under these rules, independent pathology laboratories would be
required to bill the hospital directly for technical services on hospital
Medicare inpatients. Congress, however, "grandfathered," for a period of two
years, certain existing hospital-lab arrangements in effect before July 22,
1999. Effective January 2001, hospital arrangements that were not grandfathered
are not reimbursed by Medicare for the technical component. Upon expiration of
the two years, the grandfather provision is scheduled to expire.
Additionally, with the implementation of the hospital outpatient prospective
payment system ("PPS") during 2000, independent pathology laboratories providing
technical services to Medicare hospital outpatients generally are no longer able
to bill Medicare for the technical component ("TC") of those services. Rather,
they need to bill the hospital for the TC. The hospital is reimbursed as part of
the new Ambulatory Payment Classification ("APC") payment system. Laboratories
providing these services now need to contract directly with hospitals for
reimbursement. As the amount paid to hospitals for the most common pathology
services is less than the technical component under the RBRVS, it is likely that
those laboratories will incur substantial reductions in reimbursement under PPS.
However, services provided by us which are subject to PPS are not material to
our total net revenue.
Recent Developments
We used the net proceeds of our recently completed public stock offering to
repay a portion of the outstanding indebtedness under our credit facility. In
addition, we intend to put in place $200 million of new debt facilities and
repay the remaining balance of our existing credit facility. The refinancing
will result in the termination of three interest rate swaps with a combined
notional amount of $105 million and the write-off of associated unamortized debt
costs of approximately $1.7 million. The termination of these interest rate
swaps would result in a special charge, after tax, of approximately $5.9
million. The write-off of the unamortized debt costs will result in an
extraordinary charge, net of tax, of approximately $1.0 million. These estimates
are based on information as of September 30, 2001 and actual charges could
increase or decrease based upon the fair value of the swaps at the time of
termination. We expect to complete this refinancing during the fourth quarter of
2001 and we anticipate that we will be able to lower our effective interest rate
as well as obtain greater flexibility to pursue our strategic objectives,
including further acquisitions. However, there can be no assurance that we can
obtain this financing on terms acceptable to us.
During the third quarter of 2001, two pathologists in our Birmingham, Alabama
practice terminated their employment with us and opened their own pathology
laboratory. As a result, we no longer have an operating laboratory in Alabama.
We have implemented a strategy to retain our Alabama customers and service them
through other AmeriPath facilities. If we are unable to retain these customers
we could incur a non-cash asset impairment charge, which would not exceed $3.9
million in the aggregate, and possibly a charge for other related non-recurring
costs. If such charges are necessary, depending upon the magnitude of the
charges, we may have to seek a waiver from our lenders to avoid violating a
covenant under our existing credit facility.
Results Of Operations
Changes in the results of operations when comparing the three and nine month
periods ended September 30, 2001 to the three and nine months periods ended
September 30, 2000 are due primarily to the various acquisitions we consummated
during 2000, many of which were consummated late in the year. References to
"same store" means practices at which we provided services during the entire
period for which the amount is calculated and the entire period comparable
period, including acquired hospital contracts and
17
relationships and expanded ancillary testing services added to existing
practices. During the first nine months of 2001, we completed no acquisitions.
Percentage Of Net Revenue
The following table sets forth, for the periods indicated, certain consolidated
financial data as a percentage of net revenue (billings net of contractual and
other allowances):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2001 2000 2001 2000
------ ------- ------ ------
NET REVENUES 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
OPERATING COSTS AND EXPENSES:
Cost of services 48.0% 49.0% 48.0% 48.7%
Selling, general and administrative
expenses 17.1% 17.6% 17.3% 17.6%
Provision for doubtful accounts 11.9% 10.2% 11.6% 10.0%
Amortization expense 4.4% 4.8% 4.4% 4.9%
Merger-related charges -- -- 2.3% --
Asset impairment and related charges -- -- -- 2.2%
----- ----- ----- -----
Total operating costs and expenses 81.4% 81.6% 83.6% 83.4%
----- ----- ----- -----
INCOME FROM OPERATIONS 18.6% 18.4% 16.4% 16.6%
Interest expense and other income, net 4.2% 4.1% 4.4% 4.3%
----- ----- ----- -----
INCOME BEFORE INCOME TAXES 14.4% 14.3% 12.0% 12.3%
PROVISION FOR INCOME TAXES 6.0% 5.9% 5.1% 5.6%
----- ----- ----- -----
NET INCOME 8.4% 8.4% 6.9% 6.7%
Induced conversion and accretion of
redeemable preferred stock -- -- -- 0.6%
----- ----- ----- -----
NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS 8.4% 8.4% 6.9% 6.1%
===== ===== ===== =====
Three Months Ended September 30, 2001 and 2000
Net Revenues
Net revenues increased by $19.6 million, or 22.6%, from $86.5 million for the
three months ended September 30, 2000 to $106.1 million for the three months
ended September 30, 2001. Same store net revenue increased $11.8 million, or
14%, from $85.8 million for the three months ended September 30, 2000 to $97.6
million for the three months ended September 30, 2001, including approximately
$1.4 million related to the increase in Medicare reimbursement. Same store
outpatient revenue increased $6.0 million, or 16%, same store hospital revenue
increased $4.2 million, or 10%, and same store management service revenue
increased $1.6 million, or 24%, compared to the same period of the prior year.
The remaining increase in revenue of $7.8 million resulted from the operations
of laboratories acquired during the year 2000. Our objective is to achieve
annual same store net revenue growth in excess of 10%; however, there can be no
assurance that we will achieve this objective.
Cost of Services
Cost of services consists principally of the compensation and fringe benefits of
pathologists, licensed technicians and support personnel, laboratory supplies,
shipping and distribution costs and facility costs.
Cost of services increased by $8.5 million, or 20.1%, from $42.4 million for the
three months ended September 30, 2000 to $50.9 million for the same period in
2001. The increase in cost of services can be attributed primarily to the
increase in net revenues (approximately $5.7 million) and the practices
acquired in late 2000 (approximately $2.8 million). Cost of services as a
percentage of net revenues decreased slightly
18
from 49.0% for the three months ended September 30, 2000 to 48.0% in the
comparable period of 2001. Gross margin increased from 51.0% in the three months
ended September 30, 2000 to 52.0% for the same period in 2001. Because a
substantial portion of our net revenues come from third-party payors, it is
often difficult to compensate for cost increases through price increases.
Selling, General and Administrative Expenses
The cost of corporate support, sales and marketing, and billing and collections
comprise the majority of what is classified as selling, general and
administrative expenses ("SG&A").
As a percentage of consolidated net revenues, SG&A decreased from 17.6% for the
three months ended September 30, 2000 to 17.1% for the same period of 2001. SG&A
increased by $2.9 million, or 18.7%, from $15.2 million for the three months
ended September 30, 2000 to $18.1 million for the comparable period of 2001. Of
this increase, approximately $1.1 million is attributable to an increase in
billing and collection costs and approximately $1.1 million is attributable to
an increase in sales and marketing expenses. The remaining increase was due
primarily to increased staffing levels in marketing, human resources and
accounting, salary increases effected during the fourth quarter of 2000, and
costs incurred to expand our administrative support infrastructure and to
enhance our information systems support services. The increase in marketing
costs includes the cost of additional marketing personnel to cover new markets
for dermatopathology, marketing literature, and products to expand our
penetration in the urology, gastroenterology and oncology markets.
One of our objectives is to decrease these costs as a percentage of net
revenues; however, these costs, as a percentage of net revenue, may increase as
we continue to invest in marketing, information systems and billing operations.
During 2001, we have made significant investments in sales and marketing focused
on achieving our goal for same store revenue growth. Therefore we do not expect
any significant reduction in the ratio of SG&A to net revenue for the remainder
of 2001.
Provision for Doubtful Accounts
Our provision for doubtful accounts can be affected by our mix of revenue from
outpatient, inpatient, and management services. The provision for doubtful
accounts for outpatient revenue, including revenue from national labs, is
approximately 4% and for inpatient revenue is approximately 17%. Management
service revenue generally does not have a provision for doubtful accounts. The
provision for doubtful accounts as a percentage of net revenue is higher for
inpatient services than for outpatient services due primarily to a larger
concentration of indigent and private pay patients, more difficulties gathering
complete and accurate billing information, and longer billing and collection
cycles for inpatient services. If our revenue from hospital-based services
increases as a percentage of our total net revenues, our provision for doubtful
accounts as a percentage of total net revenues may increase.
Our provision for doubtful accounts increased by $3.8 million, or 42.3%, from
$8.8 million for the three months ended September 30, 2000 to $12.6 million for
the same period in 2001. The provision for doubtful accounts as a percentage of
net revenues was 10.2% and 11.9% for the three month periods ended September 30,
2000 and 2001, respectively. This increase was driven principally by three
factors: conservative reserve practices as same store revenue accelerates;
extended account aging in some practices where billing systems have been
standardized, and increased hospital clinical professional component billing,
which generally has a higher bad debt ratio.
Amortization Expense
Our acquisitions completed since 1996 resulted in significant increases in net
identifiable intangible assets and goodwill. Net identifiable intangible assets
are recorded at fair value on the date of acquisition and are amortized over
periods ranging from 10 to 40 years. We amortize goodwill on a straight-line
basis over periods ranging from 10 to 35 years. We cannot assure you that we
will ever realize the value of intangible assets.
19
Amortization expense increased by $634,000, or 15.7%, from $4.1 million for the
three months ended September 30, 2000 to $4.7 million for the same period of
2001. The increase is attributable to the amortization of goodwill and other
identifiable intangible assets recorded in connection with anatomic pathology
practices acquired in late 2000, payments made on contingent notes, and a
reduction in the weighted average amortization periods from 30 to 28 years.
We continually evaluate whether events or circumstances have occurred that may
warrant revisions to the carrying values of our goodwill and other identifiable
intangible assets, or to the estimated useful lives assigned to such assets. Any
significant impairment recorded on the carrying values of our goodwill or other
identifiable intangible assets could materially harm results of operations. Such
impairment would be recorded as a charge to operating profit and reduction in
intangible assets.
Income from Operations
Income from operations increased $3.8 million, or 23.8%, from $16.0 million for
the three months ended September 30, 2000 to $19.8 million in the same period of
2001.
Interest Expense
Interest expense increased by $786,000, or 21.5%, from $3.6 million for the
three months ended September 30, 2000 to $4.4 million for the same period in
2001. The majority of this increase was attributable to the higher average
amount of debt outstanding during the three months ended September 30, 2001. For
the three months ended September 30, 2001, average indebtedness outstanding was
$204.0 million compared to average indebtedness of $177.4 million outstanding in
the same period of 2000. Our effective interest rate was 8.7% and 8.3% for the
three-month periods ended September 30, 2001 and 2000, respectively. Although
there have been some declines in interest rates in 2001, $105 million of the
credit facility is hedged with an interest rate swap which is at a fixed rate of
approximately 10%, while the remaining balance of the credit facility floats
with LIBOR.
Provision for Income Taxes
The effective income tax rate was approximately 41.6% and 41.8% for the three-
month periods ended September 30, 2000 and 2001, respectively. Generally, the
effective tax rate is higher than our statutory rates primarily due to the non-
deductibility of the goodwill amortization related to our acquisitions.
Net Income Attributable to Common Stockholders
Net income attributable to common stockholders for the three months ended
September 30, 2001 was $8.9 million, an increase of $1.7 million, or 22.5%, over
the same period in 2000. Diluted earnings per share for the three months ended
September 30, 2001 increased to $0.34 from $0.29 for the comparable period of
2000, based on 26.4 million and 25.0 million weighted average shares
outstanding, respectively.
Nine Months Ended September 30, 2001 and 2000
Net Revenues
Net revenues increased by $67.4 million, or 27.8%, from $242.5 million for the
nine months ended September 30, 2000 to $309.9 million for the nine months ended
September 30, 2001. Same store net revenue increased $34.9 million, or 15%, from
$235.6 million for the nine months ended September 30, 2000 to $270.5 million
for the nine months ended September 30, 2001, including approximately $3.8
million related to the increase in Medicare reimbursement. Same store outpatient
revenue increased $21.2 million, or 22%, same store hospital revenue increased
$10.1 million, or 8%, and same store management service revenue increased $3.6
million, or 19%, compared to the same period of the prior year. The remaining
increase in revenue of $32.5 million resulted from the operations of
laboratories acquired during the year 2000.
20
During the nine months ended September 30, 2001, approximately $22.8 million, or
7%, of our net revenue was attributable to contracts with national laboratories
including Quest Diagnostics ("Quest") and Laboratory Corporation of America
Holdings ("LabCorp"). Effective December 31, 2000, Quest terminated our
pathology contract in South Florida. In 2000, this contract accounted for
approximately $1.5 million of net patient service revenue. This contract
termination resulted in a $3.3 million asset impairment charge in the fourth
quarter of 2000. In addition, during the fourth quarter of 2000, we discontinued
our Quest work in San Antonio. Decisions by Quest or LabCorp to discontinue or
redirect pathology services, at any or all of its practices, or our decision to
discontinue processing work from the national laboratories, could materially
harm our financial position and results of operations.
In addition, during the nine months ended September 30, 2001, approximately
$37.1 million, or 12%, of our net revenue was derived from 28 hospitals operated
by HCA -- The Healthcare Company ("HCA"), formerly known as Columbia/HCA
Healthcare Corporation. Generally, any contracts or relationships we may have
with these and other hospitals are short-term and allow for termination by
either party with relatively short notice. HCA has been under government
investigation for some time, and we believe that HCA is evaluating its operating
strategies, including the possible sale, spin-off or closure of certain
hospitals. Closures or sales of HCA hospitals or terminations or non-renewals of
one or more of our contracts or relationships with HCA hospitals could have a
material adverse effect on our financial position and results of operations.
Cost of Services
Cost of services increased by $30.5 million, or 25.9%, from $118.2 million for
the nine months ended September 30, 2000 to $148.7 million for the same period
in 2001. The increase in cost of services can be attributed primarily to the
increase in net revenues (approximately $17.3 million) and the practices
acquired in 2000 (approximately $13.2 million). Cost of services as a percentage
of net revenues decreased slightly from 48.7% for the nine months ended
September 30, 2000 to 48.0% in the comparable period of 2001. Gross margin
increased from 51.3% in the nine months ended September 30, 2000 to 52.0% for
the same period in 2001. Because a substantial portion of our net revenues come
from third-party payors, it is often difficult to compensate for cost increases
through price increases.
Selling, General and Administrative Expenses
As a percentage of consolidated net revenues, SG&A decreased from 17.6% for the
nine months ended September 30, 2000 to 17.3% for the same period of 2001. SG&A
increased by $10.8 million, or 25.4%, from $42.7 million for the nine months
ended September 30, 2000 to $53.5 million for the comparable period of 2001. Of
this increase, approximately $3.2 million is attributable to an increase in
billing and collection costs, approximately $4.2 million is attributable to an
increase in sales and marketing expenses and approximately $2.7 million is
attributable to the acquisitions we completed in 2000. The remaining increase
was due primarily to increased staffing levels in marketing, human resources and
accounting, salary increases effected during the fourth quarter of 2000, and
costs incurred to expand our administrative support infrastructure and to
enhance our information systems support services. The increase in marketing
costs includes the cost of additional marketing personnel to cover new markets
for dermatopathology, marketing literature, and products to expand our
penetration in the urology, gastroenterology and oncology markets.
Provision for Doubtful Accounts
Our provision for doubtful accounts increased by $11.5 million, or 47.3%, from
$24.3 million for the nine months ended September 30, 2000 to $35.8 million for
the same period in 2001. The provision for doubtful accounts as a percentage of
net revenues was 10.0% and 11.6% for the nine month periods ended September 30,
2000 and 2001, respectively. This increase was driven principally by three
factors: conservative reserve practices as same store revenue accelerates;
extended account aging in some practices where billing systems have been
standardized, and increased hospital clinical professional component billing,
which generally has a higher bad debt ratio.
21
Amortization Expense
Amortization expense increased by $2.1 million, or 17.7%, from $11.8 million for
the nine months ended September 30, 2000 to $13.9 million for the same period of
2001. The increase is attributable to the amortization of goodwill and other
identifiable intangible assets recorded in connection with anatomic pathology
practices acquired in 2000, payments made on contingent notes, and a reduction
in the weighted average amortization periods from 30 to 28 years.
Merger-related Charges
The merger-related charges of $7.1 million for the nine months ended September
30, 2001 relate to our acquisition of Inform DX and include transaction costs
and costs related to the closing of the Inform DX corporate office in Nashville
and the consolidation or closing of the overlapping operations of Inform DX in
New York and Pennsylvania. We effectively closed the Nashville office on March
31, 2001 and by the end of the third quarter we had completed most of the
integration of the New York and Pennsylvania operations. The restructuring of
the combined operations of AmeriPath and Inform DX are expected to result in
potential annual operating synergies of up to $6.0 million. Since the majority
of the positive effect of such savings on operations will not begin to be
realized until the second half of 2001, we believe the acquisition of Inform DX
has been nominally dilutive for the first nine months of 2001; we expect it to
be accretive for the year 2001.
Income from Operations
Income from operations increased $10.6 million, or 26.2%, from $40.3 million for
the nine months ended September 30, 2000 to $50.9 million in the same period of
2001. Without giving effect to asset impairment charges of $5.2 million in 2000
and merger-related charges of $7.1 million in 2001, income from operations
increased by $12.4 million, or 27.2%, from $45.6 million in the nine months
ended September 30, 2000 to $58.0 million in the same period of 2001.
Interest Expense
Interest expense increased by $3.3 million, or 30.5%, from $10.6 million for the
nine months ended September 30, 2000 to $13.9 million for the same period in
2001. The majority of this increase was attributable to the higher average
amount of debt outstanding during the nine months ended September 30, 2001. For
the nine months ended September 30, 2001, average indebtedness outstanding was
$207.4 million compared to average indebtedness of $174.0 million outstanding in
the same period of 2000. Our effective interest rate was 8.8% and 8.2% for the
nine-month periods ended September 30, 2001 and 2000, respectively. Although
there have been some declines in interest rates in 2001, $105 million of the
credit facility is hedged with an interest rate swap which is at a fixed rate of
roughly 10%, while the remaining balance of the credit facility floats with
LIBOR.
Provision for Income Taxes
The effective income tax rate was approximately 45.4% and 42.6% for the nine-
month periods ended September 30, 2000 and 2001, respectively. Generally, the
effective tax rate is higher than our statutory rates primarily due to the non-
deductibility of the goodwill amortization related to our acquisitions. In
addition to non-deductible goodwill amortization, we had non-deductible asset
impairment charges and merger-related charges for the nine-month periods ended
September 30, 2000 and 2001, respectively, which further increased the effective
tax rate. The effective tax rate for the nine-month periods ended September 30,
2000 and 2001 excluding these items would have been approximately 42.3% and
41.7%, respectively.
Net Income Attributable to Common Stockholders
Net income attributable to common stockholders for the nine months ended
September 30, 2001 was $21.3 million, an increase of $6.6 million, or 44.6%,
over the same period in 2000. Without giving effect to asset impairment charges
of $5.2 million and a $1.6 million charge for the induced conversion of
redeemable preferred stock in 2000, and the merger-related charges of $7.1
million in 2001, net income increased by
22
$5.4 million, or 27.1%, from $20.3 million in the nine months ended September
30, 2000 to $25.7 million in the same period of 2001. Diluted earnings per share
for the nine months ended September 30, 2001 increased to $0.81 from $0.62 for
the comparable period of 2000, based on 26.1 million and 23.7 million weighted
average shares outstanding, respectively. Diluted earnings per share was $0.98
and $0.85 for the nine months ended September 30, 2001 and 2000, respectively,
without giving effect to any special charges.
Liquidity And Capital Resources
At September 30, 2001, we had working capital of approximately $38.9 million, a
decrease of $1.9 million from the working capital of $40.8 million at December
31, 2000. The decrease in working capital was due primarily to increases in
accounts payable and accrued expenses of $14.4 million offset in part by an
increase in net accounts receivable of $10.4 million.
For the nine month periods ended September 30, 2001 and 2000, cash flows from
operations were $40.1 million, 12.9% of net revenue, and $30.4 million, 12.6% of
net revenue, respectively. Excluding pooling merger-related charges paid for
Inform DX of $5.0 million, cash flow from operations for the 2001 period would
have been $45.1 million, or 14.6% of net revenue. For the nine months ended
September 30, 2001, cash flow from operations and borrowings under our credit
facility were used to make contingent note payments of $29.7 million and acquire
$6.3 million of property and equipment.
During 2000, we amended our credit facility to allow $22.9 million of special
charges to be excluded from the credit facility's covenant computations. On
March 29, 2001, we further amended our credit facility to exclude an additional
$5.4 million, or $28.3 million in total, of special charges from its covenant
calculations. In addition, the March 2001 amendment (1) increased our borrowing
rate by 37.5 basis points; (2) requires us to use a minimum of 30% equity for
all acquisitions; (3) requires us to use no more than 20% of consideration for
acquisitions in the form of contingent notes; and (4) requires lender approval
of all acquisitions with a purchase price greater than $10.0 million. We paid an
amendment fee to those lenders who consented to the amendment of approximately
$600,000.
On June 11, 2001 we increased committed funding from $230.0 million to $282.5
million under our credit facility. Citicorp, USA, Inc. committed $37.5 million
and agreed to serve as documentation agent for the Credit Facility. Credit
Suisse First Boston committed $15.0 million.
At September 30, 2001, we had $88.5 million available under our credit facility
with a syndicate of banks led by Fleet National Bank (formerly BankBoston,
N.A.). The amended facility provides for borrowings of up to $282.5 million in
the form of a revolving loan that may be used for working capital purposes and
to fund acquisitions. As of September 30, 2001, $194.0 million was outstanding
under the revolving loan with an annual effective interest rate of 8.21%.
In May 2000, we entered into three interest rate swaps transactions with an
effective date of October 5, 2000, various maturity dates, and a combined
notional amount of $105 million. See Item 3. - Quantitative and Qualitative
Disclosures About Market Risk for details on these swap agreements. These
interest rate swap transactions involve the exchange of floating for fixed rate
interest payments over the life of the agreement without the exchange of the
underlying principal amounts. The differential to be paid or received is
accrued and is recognized as an adjustment to interest expense. These
agreements are indexed to 30 day LIBOR. We use derivative financial instruments
to reduce interest rate volatility and associated risks arising from the
floating rate structure of our credit facility and they are not held or issued
for trading purposes. We are required by the terms of our credit facility to
keep some form of interest rate protection in place. At September 30, 2001, we
believe that we are in compliance with the covenants of the credit facility.
In connection with our acquisitions, we generally agree to pay a base purchase
price plus additional contingent purchase price consideration to the sellers of
the practices. The additional payments are generally contingent upon the
achievement of stipulated levels of operating earnings by the acquired practices
over periods of three to five years from the date of the acquisition, and are
not contingent on the continued employment of the sellers of the practices. In
certain cases, the payments are contingent upon other factors such as the
retention of certain hospital contracts or relationships for periods ranging
from
23
three to five years. The amount of the payments cannot be determined until
the achievement of the operating earnings levels or other factors during the
terms of the respective agreements. As of December 31, 2000, if the maximum
specified levels of operating earnings for each acquired practice are achieved,
we would make aggregate maximum payments, including principal and interest, of
approximately $198.4 million over the next three to five years. At the mid-point
level, the aggregate principal and interest would be approximately $89.7 million
over the next three to five years. A lesser amount or no payments at all would
be made if the stipulated levels of operating earnings specified in each
agreement are not met. During the nine months ended September 30, 2001, we made
contingent note payments aggregating $29.7 million.
Historically, our capital expenditures have been primarily for laboratory
equipment, information technology equipment and leasehold improvements. Total
capital expenditures were $6.3 million for the first nine months of 2001. During
the first nine months of 2001, capital expenditures included approximately $3.0
million related to information technology, $1.7 million for laboratory equipment
and $1.6 million for various other capital assets.
Planned capital expenditures for 2001 are estimated to be $6.5 million to $7.0
million, with priority being given to a new billing system at our consolidated
billing office in Fort Lauderdale and enhancements in financial and lab
information systems. Historically, we have funded our capital expenditures with
cash flows from operations. For the first nine months of 2001, capital
expenditures were approximately 2.0% of net revenue. We are consolidating and
integrating our financial information, billing and collection systems, which may
result in an increase in capital expenditures as a percentage of net revenue. We
believe, however, that such information systems enhancements may result in cost
savings that will enable us to continue to fund capital expenditures with cash
flows from operations.
We expect to continue to use our credit facility (or a replacement credit
facility) to fund acquisitions and for working capital. We anticipate that funds
generated by operations and funds available under our credit facility (or a
replacement credit facility) will be sufficient to meet working capital
requirements and contingent note obligations, and to finance capital
expenditures over the next 12 months. Further, in the event additional payments
under the contingent notes issued in connection with acquisitions become due, we
believe that the incremental cash generated from operations would exceed the
cash required to satisfy our payment, if any, of the contingent obligations in
any one year period. Such payments, if any, will result in a corresponding
increase in goodwill in periods following the payment. Funds generated from
operations and funds available under the credit facility (or a replacement
credit facility) may not be sufficient to implement our longer-term growth
strategy. We may be required to seek additional financing through additional
increases in the credit facility, to negotiate credit facilities with other
banks or institutions or to seek additional capital through private placements
or public offerings of equity or debt securities. No assurances can be given
that we will be able to extend or increase the existing credit facility, secure
additional bank borrowings or complete additional debt or equity financings on
terms favorable to us or at all.
Qualification Of Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements made
pursuant to the safe harbor provisions of the Securities Litigation Reform Act
of 1995. Statements contained anywhere in this Form 10-Q that are not limited
to historical information are considered forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, including, without limitation, statements
regarding the Company's expectations, beliefs, intentions, plans or strategies
regarding the future. These forward-looking statements are based largely on the
Company's expectations which are subject to a number of known and unknown risks,
uncertainties and other factors discussed in this report and in other documents
filed by the Company with the Securities and Exchange Commission (including,
without limitation, the Company's Annual Report on Form 10-K, as amended, for
the year ended December 31, 2000 and the Company's Quarterly Reports on Form 10-
Q for the quarters ended March 31, 2001 and June 30, 2001), which may cause
actual results to be materially different from those anticipated, expressed or
implied by the forward-looking statements. All forward-looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward-looking statements to reflect future events or circumstances. Forward-
looking statements are sometimes indicated by words such
24
as "may," "should," "believe," "expect," "anticipate" and similar expressions.
Past performance is not necessarily indicative of future results.
Risk Factors
Any investment in our company involves a high degree of risk. You should
carefully consider each of the following risks and all of the other information
set forth in this Form 10-Q. If any of the following risks actually occur, our
business prospects, financial condition and results of operations could be
materially adversely affected and the trading price of our common stock could
decline. In any such case, you could lose all or part of your investment in our
company.
Our business could be materially harmed by future interpretation or
implementation of state laws regarding prohibitions on the corporate practice of
medicine.
We acquire or affiliate with physician practices located in many states across
the country. However, the laws of many states prohibit business corporations,
including AmeriPath and its subsidiaries, from owning corporations that employ
physicians, or from exercising control over the medical judgments or decisions
of physicians. These laws and their interpretations vary from state to state and
are enforced by both the courts and regulatory authorities, each with broad
discretion. The manner in which we operate each practice is determined primarily
by the corporate practice of medicine restrictions of the state in which the
practice is located and other applicable regulations.
We believe that we are currently in material compliance with the corporate
practice of medicine laws in each of the states in which we operate.
Nevertheless, it is possible that regulatory authorities or other parties may
assert that we are engaged in the unauthorized corporate practice of medicine.
If such a claim were successfully asserted in any jurisdiction, we could be
subject to civil and criminal penalties, which could exclude us from
participating in Medicare, Medicaid and other governmental health care programs,
or we could be required to restructure our contractual and other arrangements.
Any restructuring of our contractual and other arrangements with physician
practices could result in lower revenues from such practices, increased expenses
in the operation of such practices and reduced influence over the business
decisions of such practices. Alternatively, some of our existing contracts could
be found to be illegal and unenforceable, which could result in the termination
of those contracts and an associated loss of revenue. In addition, expansion of
our operations to other corporate practice states may require structural and
organizational modification to the form of relationships that we currently have
with physicians, affiliated practices and hospitals. Such modifications could
result in less profitable relationships with physicians, affiliated practices
and hospitals, less influence over the business decisions of physicians and
affiliated practices and failure to achieve our growth objectives.
We could be hurt by future interpretation or implementation of federal and state
anti-kickback laws.
Federal anti-kickback laws and regulations prohibit the offer, payment,
solicitation and receipt of any form of remuneration in exchange for referrals
of products or services for which payment may be made by Medicare, Medicaid or
other federal health care programs. Violations of federal anti-kickback laws are
punishable by monetary fines, civil and criminal penalties and exclusion from
participation in Medicare, Medicaid and other governmental health care programs.
Several states have similar laws. While we believe our operations are in
material compliance with applicable Medicare and fraud and abuse laws, including
the anti-kickback law, there is a risk that government authorities might take a
contrary position or might investigate our arrangements with physicians and
third parties, particularly those arrangements that do not satisfy the
compliance safe harbors provided under the relevant regulations or that are
similar to arrangements found to be problematic in advisory opinions of the
Department of Health and Human Services Office of Inspector General (OIG). For
example, the OIG has addressed physician practice management arrangements in an
advisory opinion and found that management fees based on a percentage of
practice revenues may violate the federal anti-kickback statute. While we
believe our fee arrangements can be distinguished from those addressed in the
opinion, government authorities may disagree. Such occurrences, regardless of
their outcome, could damage our reputation and adversely affect important
business relationships that we have with third parties, including physicians,
hospitals and private payors. If our arrangements with physicians and third
parties were found to be illegal, we could be subject to civil and criminal
penalties, including fines and possible exclusion from participation in
government payor programs. Significant fines could cause liquidity problems and
adversely affect our results of operations.
25
Exclusion from participation in government payor programs, which represented 19%
of our collections from owned practices in 2000, would eliminate an important
source of revenue and could materially adversely affect our business. In
addition, some of our existing contracts could be found to be illegal and
unenforceable, which could result in the termination of those contracts and an
associated loss of revenue.
Our business could be harmed by future interpretation or implementation of the
federal Stark Law and other state and federal anti-referral laws.
We are also subject to federal and state statutes and regulations banning
payments for referrals of patients and referrals by physicians to health care
providers with whom the physicians have a financial relationship. The federal
Stark Law applies to Medicare and Medicaid and prohibits a physician from
referring patients for certain services, including laboratory services, to an
entity with which the physician has a financial relationship. Financial
relationship includes both investment interests in an entity and compensation
arrangements with an entity. The state laws and regulations vary significantly
from state to state, are often vague and, in many cases, have not been
interpreted by courts or regulatory agencies. These state laws and regulations
generally apply to services reimbursed by both governmental and private payors.
Violations of these federal and state laws and regulations may result in
prohibition of payment for services rendered, loss of licenses, fines, criminal
penalties and exclusion from governmental and private payor programs. We have
financial relationships with our physicians, as defined by the federal Stark
Law, in the form of compensation arrangements, ownership of our common stock and
contingent promissory notes issued by us in connection with acquisitions. While
we believe that our financial relationships with physicians and referral
practices are in material compliance with applicable laws and regulations,
government authorities might take a contrary position or prohibited referrals
may occur. We cannot be certain that physicians who own our capital stock or
hold contingent promissory notes will not violate these laws or that we will
have knowledge of the identity of all beneficial owners of our capital stock. If
our financial relationships with physicians were found to be illegal, or if
prohibited referrals were found to have been made, we could be subject to civil
and criminal penalties, including fines, exclusion from participation in
government and private payor programs and requirements to refund amounts
previously received from government and private payors. In addition, expansion
of our operations to new jurisdictions, or new interpretations of laws in our
existing jurisdictions, could require structural and organizational
modifications of our relationships with physicians to comply with that
jurisdiction's laws. Such structural and organizational modifications could
result in lower profitability and failure to achieve our growth objectives.
Our business could be materially harmed by future interpretation or
implementation of state laws regarding prohibitions on fee-splitting.
Many states prohibit the splitting or sharing of fees between physicians and
non-physicians. These laws vary from state to state and are enforced by courts
and regulatory agencies, each with broad discretion. Some states have
interpreted management agreements between entities and physicians as unlawful
fee-splitting. We believe our arrangements with physicians comply in all
material respects with the fee-splitting laws of the states in which we operate.
Nevertheless, it is possible regulatory authorities or other parties could claim
we are engaged in fee-splitting. If such a claim were successfully asserted in
any jurisdiction, our pathologists could be subject to civil and criminal
penalties and we could be required to restructure our contractual and other
arrangements. Any restructuring of our contractual and other arrangements with
physician practices could result in lower revenues from such practices,
increased expenses in the operation of such practices and reduced influence over
the business decisions of such practices. Alternatively, some of our existing
contracts could be found to be illegal and unenforceable, which could result in
the termination of those contracts and an associated loss of revenue. In
addition, expansion of our operations to other states with fee-splitting
prohibitions may require structural and organizational modification to the form
of relationships that we currently have with physicians, affiliated practices
and hospitals. Any modifications could result in less profitable relationships
with physicians, affiliated practices and hospitals, less influence over the
business decisions of physicians and affiliated practices and failure to achieve
our growth objectives.
We could be hurt by future interpretation or implementation of state and federal
anti-trust laws.
In connection with the corporate practice of medicine laws, the physician
practices with which we are affiliated in some states are organized as separate
legal entities. As such, the physician practice entities may be deemed to be
persons separate both from us and from each other under the antitrust laws and,
accordingly, subject to a
26
wide range of laws that prohibit anti-competitive conduct among separate legal
entities. In addition, we are seeking to acquire or affiliate with established
and reputable practices in our new geographic markets. While we believe that we
are in material compliance with these laws and intend to comply with any laws
that may apply to our development of integrated health care delivery networks,
courts or regulatory authorities could nevertheless take a contrary position or
investigate our business practices. If our business practices were found to
violate these laws, we could be required to pay substantial fines, penalties and
damage awards, or we could be required to restructure our business in a manner
that would materially reduce our profitability or impede our growth.
Our business could be harmed by future interpretation or implementation of the
Health Care Insurance Portability and Accountability Act.
The Health Care Insurance Portability and Accountability Act, or HIPAA, created
provisions that impose criminal penalties for fraud against any health care
benefit program, for theft or embezzlement involving health care and for false
statements in connection with the payment of any health benefits. The HIPAA
provisions apply not only to federal programs, but also to private health
benefit programs. HIPAA also broadened the authority of the OIG to exclude
participants from federal health care programs. Because of the uncertainties as
to how the HIPAA provisions will be enforced, we are currently unable to predict
their ultimate impact on us. Compliance with HIPAA could cause us to modify our
business operations in a manner that would increase our operating costs or
impede our growth. In addition, although we are unaware of any current
violations of HIPAA, if we were found to be in violation of HIPAA, the
government could seek penalties against us or seek to exclude us from
participation in government payor programs. Significant fines could cause
liquidity problems and adversely affect our results of operations. Exclusion
from participation in government payor programs, which represented 22% of our
collections from owned practices in the first nine months of 2001, would
eliminate an important source of revenue and could materially adversely affect
our business.
Federal and state regulation of the privacy, security and transmission of health
information could restrict our operations, impede the implementation of our
business strategies or cause us to incur significant costs.
The privacy, security and transmission of health information is subject to
federal and state laws and regulations, including HIPAA. Some of our operations
will be subject to HIPAA and its regulations. Because HIPAA's privacy
regulations do not supercede state laws that are more stringent, we will have to
comply both with the federal privacy regulations under HIPAA and with any state
privacy laws that are more stringent than HIPAA. Our operations that are subject
to HIPAA must be in compliance with HIPAA's regulations by April 2003. Another
set of regulations issued under HIPAA establish uniform standards relating to
data reporting, formatting, and coding that covered entities must use when
conducting certain transactions involving health information. The compliance
date for these regulations is October 2002. A third set of regulations, which
have not yet been finalized, will establish minimum security requirements to
protect health information. The HIPAA regulations could result in significant
financial obligations for us and will pose increased regulatory risk. The
privacy regulations could limit our use and disclosure of patient health
information and could impede the implementation of some of our business
strategies, such as our genomics initiatives. For example, the Department of
Health and Human Services, or HHS, has indicated that cells and tissues are not
protected health information, but that analyses of them are protected. HHS has
stated that if a person provides cells to a researcher and tells the researcher
that the cells are an identified individual's cancer cells, that accompanying
statement is protected health information. At this time, we are unable to
determine the full impact of the HIPAA regulations on our business and our
business strategies or the total cost of complying with the regulations, but the
impact and the cost could be significant. Many states have enacted, or indicated
an intention to enact, privacy laws similar to HIPAA. These state laws could
also restrict our operations, impede the implementation of our business
strategies or cause us to incur significant compliance costs. In addition,
failure to comply with federal or state privacy laws and regulations could
subject us to civil or criminal penalties.
We charge our clients on a fee-for-service basis, so we incur financial risk
related to collections as well as potentially long collection cycles when
seeking reimbursement from third-party payors.
Substantially all of our net revenues are derived from our practices' charging
for services on a fee-for-service basis. Accordingly, we assume the financial
risk related to collection, including the potential uncollectability of
27
accounts, long collection cycles for accounts receivable and delays attendant to
reimbursement by third-party payors, such as governmental programs, private
insurance plans and managed care organizations. Our provision for doubtful
accounts for the nine months ended September 30, 2001 was 11.6% of net revenues,
with net revenues from inpatient services having a provision for doubtful
accounts of approximately 17%. If our revenue from hospital-based services
increases as a percentage of our total net revenues, our provision for doubtful
accounts as a percentage of total net revenues may increase. Increases in write-
offs of doubtful accounts, delays in receiving payments or potential retroactive
adjustments and penalties resulting from audits by payors may adversely affect
our operating cash flow and liquidity, require us to borrow funds to meet our
current obligations, reduce our profitability, impede our growth or otherwise
materially adversely affect our business.
We rely upon reimbursement from government programs for a significant portion of
our collections, and therefore our business would be harmed if reimbursement
rates from government programs decline.
We derived 22% of our collections from owned practices in the first nine months
of 2001 from payments made by government sponsored health care programs,
principally Medicare and Medicaid. These programs are subject to substantial
regulation by federal and state governments. Any changes in reimbursement
regulations, policies, practices, interpretations or statutes that place
limitations on reimbursement amounts or change reimbursement coding practices
could materially harm our business by reducing revenues and lowering
profitability. Increasing budgetary pressures at both the federal and state
levels and concerns over escalating costs of health care have led, and may
continue to lead, to significant reductions in health care reimbursements. State
concerns over the growth in Medicaid expenditures also could result in
significant payment reductions. Since these programs generally reimburse on a
fee schedule basis, rather than a charge-related basis, we generally cannot
increase net revenue by increasing the amount charged for services provided. As
a result, cost increases may not be able to be recovered from government payors.
In addition, Medicare, Medicaid and other government health care programs are
increasingly shifting to forms of managed care, which generally offer lower
reimbursement rates. Some states have enacted legislation to require that all
Medicaid patients be transitioned to managed care organizations, which could
result in reduced payments to us for such patients. Similar legislation may be
enacted in other states. In addition, a state-legislated shift of Medicaid
patients to a managed care organization could cause us to lose some or all
Medicaid business in that state if we were not selected by the managed care
organization as a participating provider. Additionally, funds received under all
health care reimbursement programs are subject to audit with respect to the
proper billing for physician services and, accordingly, repayments and
retroactive adjustments of revenue from these programs could occur. We expect
that there will continue to be proposals to reduce or limit Medicare and
Medicaid reimbursements.
The continued growth of managed care may have a material adverse effect on our
business.
The number of individuals covered under managed care contracts or other similar
arrangements has grown over the past several years and may continue to grow in
the future and a substantial portion of our net revenue is from reimbursement
from managed care organizations. Entities providing managed care coverage have
been successful in reducing payments for medical services in numerous ways,
including entering into arrangements under which payments to a service provider
are capitated, limiting testing to specified procedures, denying payment for
services performed without prior authorization and refusing to increase fees for
specified services. These trends reduce revenues, increase the cost of doing
business and limit the ability to pass cost increases on to customers. The
continued growth of the managed care industry and increased efforts to reduce
payments to medical care providers could materially harm our business.
There has been an increasing number of state and federal investigations of
hospitals and hospital laboratories, which may increase the likelihood of
investigations of our business practices.
Significant media and public attention has been focused on the health care
industry due to ongoing federal and state investigations reportedly related to
referral and billing practices, laboratory and home health care services and
physician ownership and joint ventures involving hospitals. Most notably, HCA-
The Healthcare Company, or HCA, is reportedly under investigation with respect
to such practices. We provide medical director services for numerous hospital
laboratories, including 28 HCA hospital laboratories as of September 30, 2001.
Therefore, the government's ongoing investigation of HCA or other hospital
operators could result in governmental investigations of one or more of our
operations. In addition, the OIG and the Department of
28
Justice have initiated hospital laboratory billing review projects in certain
states, including some in which we operate, and are expected to extend such
projects to additional states, including states in which we operate. These
projects further increase the likelihood of governmental investigations of
laboratories that we own or operate. Although we monitor our billing practices
and hospital arrangements for compliance with prevailing industry practices
under applicable laws, such laws are complex and constantly evolving, and it is
possible that governmental investigators may take positions that are
inconsistent with our practices or industry practices. The government's
investigations of entities with which we contract may materially harm our
business, including termination or amendment of one or more of our contracts or
the sale of hospitals, potentially disrupting the performance of services under
our contracts. In addition, some indemnity insurers and other non-governmental
payors have sought repayment from providers, including laboratories, for alleged
overpayments.
The heightened scrutiny of Medicare and Medicaid billing practices in recent
years may increase the possibility that we will become subject to costly and
time consuming lawsuits and investigations.
Payors periodically reevaluate the services for which they provide
reimbursement. In some cases, government payors such as Medicare also may seek
to recoup payments previously made for services determined not to be
reimbursable. Any such action by payors would adversely affect our revenues and
earnings. In addition, under the federal False Claims Act, any person convicted
of submitting false or fraudulent claims to the government may be required to
make significant payments, including damages and penalties in addition to
repayments of amounts not properly billed, and may be excluded from
participating in Medicare, Medicaid and other government health care programs.
Many states have similar false claims laws. The federal government has become
more aggressive in examining laboratory billing practices and seeking repayments
and penalties allegedly resulting from improper billing for services, such as
using an improper billing code for a test to realize higher reimbursement. While
the primary focus of this initiative has been on hospital laboratories and on
routine clinical chemistry tests, which comprise only a portion of our revenues,
the scope of this initiative could expand and it is not possible to predict
whether or in what direction the expansion might occur. In addition, recent
government enforcement efforts have asserted poor quality of care as the basis
for a false claims action. Private insurers may also bring actions under false
claims laws and, in some circumstances, private whistleblowers may bring false
claim suits on behalf of the government. While we believe that our practices are
proper and do not include any allegedly improper practices now being examined,
the government could take a contrary position or could investigate our
practices. Furthermore, HIPAA and the joint federal and state anti-fraud
initiative commenced in 1995 called Operation Restore Trust have strengthened
the powers of the OIG and increased funding for Medicare and Medicaid audits and
investigations. As a result, the OIG is expanding the scope of its health care
audits and investigations. Federal and state audits and inspections, whether on
a scheduled or unannounced basis, are conducted from time to time at our
facilities. If a negative finding is made as a result of any such investigation,
we could be required to change coding practices, repay amounts paid for
incorrect practices, pay substantial penalties or cease participating in
Medicare, Medicaid and other government health care programs.
In August 2001, we received two letters from the Civil Division of the U.S.
Department of Justice ("DOJ") requesting information regarding billing practices
and documentation of gross descriptions on skin biopsy reports. We are providing
documentation to the DOJ regarding the tests that are the subjects of its
requests for information. While we currently do not believe there is any basis
for the DOJ to pursue any significant enforcement action against us with respect
to these tests, no assurances can be given regarding the ultimate outcome of the
investigation. Requests for information such as these are often the result of a
qui tam, or whistleblower, action filed by a private party. If this information
request is the result of a qui tam action and if the DOJ decides not to pursue
an action against us, the private party could still proceed with the action.
Defending a qui tam lawsuit, even where there is little or no merit to the
allegations, can be expensive and time consuming.
We derive a significant portion of our revenues from short-term hospital
contracts and hospital relationships that can easily be terminated.
Many of our hospital contracts provide that the hospital or we may terminate the
agreement prior to the expiration of the initial or any renewal term with
relatively short notice and without cause. We also have business relationships
with hospitals that are not subject to written contracts and that may be
terminated by the hospitals at any time. Loss of any particular hospital
contract or relationship would not only result in a loss of
29
net revenue to us under that contract or relationship, but may also result in a
loss of outpatient net revenue that may be derived from our association with the
hospital and its medical staff. Any such loss could also result in an impairment
of the value of the assets we have acquired or may acquire, requiring
substantial charges to earnings. For example, during the fourth quarter of 2000,
we were unsuccessful in retaining a contract to perform pathology services for a
hospital in South Florida. Based upon the remaining projected cash flow from
this hospital network, we determined that the intangible assets were impaired
and recorded a pre-tax non-cash charge of approximately $1.0 million. This
hospital contract accounted for approximately $800,000 of net revenue during
2000. Continuing consolidation in the hospital industry may result in fewer
hospitals or fewer laboratories as hospitals move to combine their operations.
Our contracts and relationships with hospitals may be terminated or, in the case
of contracts, may not be renewed as their current terms expire.
Our business strategy emphasizes growth, which places significant demands on our
financial, operational and management resources and creates the risk of failing
to meet the growth expectations of investors.
Our growth strategy includes efforts to acquire and develop new practices,
develop and expand managed care and national clinical laboratory contracts and
develop new products, services, technologies and related alliances with third
parties. The pursuit of this growth strategy consumes capital resources, thereby
creating the financial risk that we will not realize an adequate return on this
investment. In addition, our growth may involve the acquisition of companies,
the development of products or services or the creation of strategic alliances
in areas in which we do not currently operate. This would require our management
to develop expertise in new areas, manage new business relationships and attract
new types of customers. The success of our growth strategy also depends on our
ability to expand our physician and employee base and to train, motivate and
manage employees. The success or failure of our growth strategy is difficult to
predict. The failure to achieve our stated growth objectives or the growth
expectations of investors could disappoint investors and harm our stock price.
We may not be able to implement our growth strategy successfully or to manage
our expanded operations effectively and profitably.
We are pursuing business opportunities in new markets, such as genomics, which
adds uncertainty to our future results of operations and could divert financial
and management resources away from our core business.
As we pursue business opportunities in new markets, such as genomics, we
anticipate that significant investments and costs will be related to, and future
revenue may be derived from, products, services and alliances that do not exist
today or have not been marketed in sufficient quantities to measure accurately
market acceptance. Similarly, operating costs associated with new business
endeavors are difficult to predict with accuracy, thereby adding further
uncertainty to our future results of operations. We may experience difficulties
that could delay or prevent the successful development and introduction of new
products and services and such products and services may not achieve market
acceptance. Any failure by us to pursue new business opportunities successfully
could result in financial losses and could inhibit our anticipated growth. In
addition, the pursuit of new business endeavors could divert financial and
management resources away from our core business.
Ethical, social and legal issues concerning genomic research and testing may
result in regulations restricting the use of genomic testing or reduce the
demand for genomic testing products, which could impede our ability to achieve
our growth objectives.
Ethical, social and legal concerns about genomic testing and genomic research
could result in regulations restricting our or our customers' activities or in
only limited demand for those products. For example, the potential availability
of testing for some genomic predispositions to illness has raised issues
regarding the use and confidentiality of information obtained from this testing.
Some states in the United States have enacted legislation restricting the use of
information from some genomic testing, and the United States Congress and some
foreign governments are considering similar legislation. The United States Food
and Drug Administration, or FDA, has subjected the commercialization of certain
elements of genomic testing to limited regulation. The federal Centers for
Disease Control and Prevention has published notice of its intent to revise the
regulations under the Clinical Laboratory Improvements Amendments, or CLIA, to
specifically recognize and regulate a genomic testing specialty. The Department
of Health and Human Services' Secretary's Advisory Committee on Genetic Testing
advises the Department of Health and Human Services as to various issues
30
raised by the development and use of genomic testing and has published
preliminary recommendations for increased participation on the part of the FDA
and increased regulation of genomic testing under CLIA. As a result of these
activities, it is likely that genomic testing will be subject to heightened
regulatory standards. Restrictions on our or our customers' use of genomic
information or testing products could impede our ability to broaden the range of
testing services we offer and to penetrate the genomic and genomic testing
markets. If we are unable to make acquisitions in the future, our rate of growth
will slow.
Much of our historical growth has come from acquisitions, and we continue to
pursue growth through the acquisition and development of laboratories and
physician practices. However, we may be unable to continue to identify and
complete suitable acquisitions at prices we are willing to pay or to obtain the
necessary financing on acceptable terms. In addition, as we become a bigger
company, the amount that acquired businesses contribute to our revenue and
profits will likely be smaller on a percentage basis. We compete with other
companies to identify and complete suitable acquisitions. We expect this
competition to intensify, making it more difficult to acquire suitable companies
on favorable terms. For example, we may be unable to accurately and consistently
identify physician practices whose pathologists have strong professional
reputations in their local medical communities. Further, we may acquire
physician practices whose pathologists' individual marketing and other sales
efforts do not produce a profitable customer base. As a result, the businesses
we acquire may not perform well enough to justify our investment. Our
flexibility in structuring acquisitions is inhibited by restrictive covenants in
our current credit facility. For example, our credit facility requires us to use
no less than 30% equity and no more than 20% contingent notes as part of the
purchase price for any acquisition and requires us to obtain lender consent for
any acquisition with a purchase price greater than $10 million. These
limitations may impede our ability to complete acquisitions. If we are unable to
make additional acquisitions on suitable terms, we may not meet our growth
expectations.
We may raise additional capital, which could be difficult to obtain at
attractive prices and which could cause us to engage in financing transactions
that adversely affect our stock price.
We need capital for both internal growth and the acquisition and integration of
new practices, products and services. Therefore, we may raise additional capital
through public or private offerings of equity securities or debt financings. Our
issuance of additional equity securities could cause dilution to holders of our
common stock and may adversely affect the market price of our common stock. The
incurrence of additional debt could increase our interest expense and other debt
service obligations and could result in the imposition of covenants that
restrict our operational and financial flexibility. Additional capital may not
be available to us on commercially reasonable terms or at all. The failure to
raise additional needed capital could impede the implementation of our operating
and growth strategies.
The success of our growth strategy depends on our ability to adapt to new
markets and effectively integrate newly acquired practices.
Our expansion into new markets will require us to maintain and establish payor
and customer relationships and to convert the patient tracking and financial
reporting systems of new practices to our systems. Significant delays or
expenses with regard to this process could materially harm the integration of
additional practices and our profitability. The integration of additional
practices also requires the implementation and centralization of purchasing,
accounting, sales and marketing, payroll, human resources, management
information systems, cash management, risk management and other systems, which
may be difficult, costly and time-consuming. Accordingly, our operating results,
particularly in fiscal quarters immediately following a new practice
affiliation, may be adversely affected while we attempt to complete the
integration process. We may encounter significant unanticipated costs or other
problems associated with the future integration of practices into our combined
network of affiliated practices. Our expansion into new markets may require us
to comply with present or future laws and regulations that may differ from those
to which we are currently subject. Failure to meet these requirements could
materially impede our growth objectives or materially harm our business.
We may inherit significant liabilities from practices that we have acquired or
acquire in the future.
We perform due diligence investigations with respect to potential liabilities of
acquired and affiliated practices and typically obtain indemnification with
respect to liabilities from the sellers of such practices. Nevertheless,
31
undiscovered claims may arise and liabilities for which we become responsible
may be material and may exceed either the limitations of any applicable
indemnification provisions or the financial resources of the indemnifying
parties. Claims or liabilities of acquired and affiliated practices may include
matters involving compliance with laws, including health care laws. While we
believe, based on our due diligence investigations, that the operations of our
practices prior to their acquisition were generally in compliance with
applicable health care laws, it is nevertheless possible that such practices
were not in full compliance with such laws and that we will become accountable
for their non-compliance. We have, from time to time, identified certain past
practices of acquired physician groups that do not conform to our standards. A
violation of applicable health care laws by a practice, whether or not the
violation occurred prior to our acquisition of the practice, could result in
civil and criminal penalties, exclusion of the physician, the practice or us
from participation in Medicare and Medicaid programs and loss of a physician's
license to practice medicine. Significant fines and other penalties could cause
liquidity problems and adversely affect our results of operations. Exclusion
from participation in government payor programs, which represented 22% of our
collections from owned practices in the first nine months of 2001, would
eliminate an important source of revenue and could materially harm our business.
We have significant contingent liabilities payable to many of the sellers of
practices that we have acquired.
In connection with our practice acquisitions, we typically agree to pay the
sellers additional consideration in the form of contingent debt obligations,
payment of which depends upon the practice achieving specified profitability
criteria over periods ranging from three to five years after the acquisition.
The amount of these contingent payments cannot be determined until the
contingency periods terminate and achievement of the profitability criteria is
determined. As of December 31, 2000, if the maximum criteria for the contingency
payments with respect to all prior acquisitions were achieved, we would be
obligated to make payments, including principal and interest, of approximately
$198.4 million over the next three to five years. This amount could increase
significantly as we continue selectively to acquire new practices. Lesser
amounts would be paid if the maximum criteria are not met. Although we believe
we will be able to make such payments from internally generated funds or
proceeds of future borrowings, it is possible that such payments could cause
significant liquidity problems for us. We continue to use contingent notes as
partial consideration for acquisitions and affiliations.
We have recorded a significant amount of intangible assets, which may never be
realized.
Our acquisitions have resulted in significant increases in net identifiable
intangible assets and goodwill. Net identifiable intangible assets, which
include hospital contracts, physician client lists, management service
agreements and laboratory contracts acquired in acquisitions were approximately
$263.7 million at September 30, 2001, representing approximately 44.4% of our
total assets. Net identifiable intangible assets are recorded at fair value on
the date of acquisition and are being amortized over periods ranging from 10 to
40 years. Goodwill, which relates to the excess of cost over the fair value of
net assets of businesses acquired, was approximately $201.0 million at September
30, 2001, representing approximately 33.8% of our total assets. On an ongoing
basis, we make an evaluation to determine whether events and circumstances
indicate that all or a portion of the carrying value of intangible assets may no
longer be recoverable, in which case an additional charge to earnings may be
necessary. For example, during the fiscal year ended December 31, 2000, we
recorded asset impairment charges to intangible assets in the amount of $9.6
million. We may not ever realize the full value of our intangible assets. Any
future determination requiring the write-off of a significant portion of
intangible assets could materially harm our results of operations for the period
in which the write-off occurs, which could adversely affect our stock price.
Our business is highly dependent on the recruitment and retention of qualified
pathologists.
Our business is dependent upon recruiting and retaining pathologists,
particularly those with subspecialties, such as dermatopathology,
hematopathology, immunopathology and cytopathology. While we have been able to
recruit, principally through practice acquisitions, and retain pathologists, we
may be unable to continue to do so in the future as competition for the services
of pathologists increases. In addition, we may have to modify the economic terms
of our relationships with pathologists in order to enhance our recruitment and
retention efforts. Because it may not be possible to recover increased costs
through price increases, this could materially harm our profitability. The
relationship between the pathologists and their respective local medical
32
communities is important to the operation and continued profitability of each
practice. Loss of one of our pathologists for any reason could lead to the loss
of hospital contracts or other sources of revenue that depend on our continuing
relationship with that pathologist. Our revenues and earnings could be adversely
affected if a significant number of pathologists terminate their relationships
with our practices or become unable or unwilling to continue their employment,
or if a number of our non-competition agreements with physicians are terminated
or determined to be invalid or unenforceable. For example, the two pathologists
in our Birmingham, Alabama practice recently terminated their employment with us
and opened their own pathology lab. As a result, we no longer have an operating
lab in Alabama. We have implemented a strategy to retain our Alabama customers
and service them through other AmeriPath facilities. If we are unable to retain
these customers, we could incur a non-cash asset impairment charge of up to $3.9
million, and possibly a charge for other related non-recurring costs. If such
charges are necessary, depending upon the magnitude of the charges, we may have
to seek a waiver from our lenders to avoid violating a covenant under our credit
facility.
Enactment of proposals to reform the health care industry may restrict our
existing operations, impose additional requirements on us, limit our expansion
or increase our costs of regulatory compliance.
Federal and state governments periodically focus significant attention on health
care reform. It is not possible to predict which, if any, proposal will be
adopted. It is possible that the health care regulatory environment will change
so as to restrict our existing operations, impose additional requirements on us
or limit our expansion. Costs of compliance with changes in government
regulations may not be subject to recovery through price increases.
Competition from other providers of pathology services may materially harm our
business.
Health care companies such as hospitals, national clinical laboratories, third-
party payors and health maintenance organizations may compete with us in the
employment of pathologists and the management of pathology practices. We also
expect to experience increasing competition in the provision of pathology and
cytology diagnostic services from other anatomic pathology practices, companies
in other health care industry segments, such as other hospital-based
specialties, national clinical laboratories, large physician group practices or
other pathology physician practice management companies. Some of our competitors
may have greater financial and other resources than we, which could further
intensify competition. Increasing competition may erode our customer base,
reduce our sources of revenue, cause us to reduce prices or enter into a greater
number of capitated contracts in which we take on greater pricing risks or
increase our marketing and other costs of doing business. Increasing competition
may also impede our growth objectives by making it more difficult or more
expensive for us to acquire or affiliate with additional pathology practices.
We are subject to significant professional or other liability claims, and we
cannot assure you that insurance coverage will be available or sufficient to
cover such claims.
Our business entails an inherent risk of claims of physician professional
liability or other liability for acts or omissions of our physicians and
laboratory personnel or of hospital employees who are under the supervision of
our hospital-based pathologists. We and our physicians periodically become
involved as defendants in medical malpractice and other lawsuits, some of which
are currently ongoing, and are subject to the attendant risk of substantial
damage awards. While we believe that we have a prudent risk management program,
including professional liability and general liability insurance coverage as
well as agreements from third parties, such as hospitals and national clinical
laboratories, to indemnify or insure us, it is possible that pending or future
claims will not be covered by or will exceed the limits of our risk management
program, including the limits of our insurance coverage or applicable
indemnification provisions, or that third parties will fail or otherwise be
unable to comply with their obligations to us. While we believe this practice is
routine, in a number of pending claims our insurers have reserved their rights
to deny coverage. In addition, we are currently in a dispute with our former
medical malpractice carrier on an issue related to the applicability of excess
insurance coverage. If we do not prevail, a gap of several months in our excess
insurance coverage may exist for a period in which significant claims have been
made. It is also possible that the costs of our insurance coverage will rise
causing us either to incur additional costs or to further limit the amount of
coverage we have. In addition, our insurance does not cover all potential
liabilities arising from governmental fines and penalties, indemnification
agreements and certain other uninsurable losses. For example, from time to time
we agree to indemnify third parties, such as hospitals and national clinical
laboratories, for various claims that may not be
33
covered by insurance. As a result, we may become responsible for substantial
damage awards that are uninsured. We are currently subject to indemnity claims
which, if determined adversely to us, could result in substantial uninsured
losses.
We depend on certain key executives, the loss of whom could disrupt our
operations, cause us to incur additional expenses and impede our ability to
expand our operations.
Our success is dependent upon the efforts and abilities of our key management
personnel, particularly James C. New, our Chairman and Chief Executive Officer,
Brian C. Carr, our President, Gregory A. Marsh, our Vice President and Chief
Financial Officer, Alan Levin, M.D., our Chief Operating Officer and Dennis M.
Smith, Jr., M.D., our Executive Vice President of Genomic Strategies and Medical
Director. It would be costly, time consuming and difficult to find suitable
replacements for these individuals. The need to find replacements combined with
the temporary loss of these key services could also materially disrupt our
operations and impede our growth by diverting management attention away from our
core business and growth strategies.
We depend on numerous complex information systems and any failure to
successfully maintain those systems or implement new systems could materially
harm our operations.
We depend upon numerous information systems to provide operational and financial
information on our practices, provide test reporting to physicians and handle
our complex billing operations. We currently have several major information
technology initiatives underway, including the integration of information from
our practices. No assurance can be given that we will be able to enhance
existing and/or implement new information systems that can integrate
successfully the disparate operational and financial information systems of our
practices. In addition to their integral role in helping our practices realize
operating efficiencies, such new systems are critical to developing and
implementing a comprehensive enterprise-wide management information database. To
develop such an integrated network, we must continue to invest in and administer
sophisticated management information systems. We may experience unanticipated
delays, complications and expenses in implementing, integrating and operating
such systems. Furthermore, our information systems may require modifications,
improvements or replacements as we expand and as new technologies become
available. Such modifications, improvements or replacements may require
substantial expenditures and may require interruptions in operations during
periods of implementation. Moreover, implementation of such systems is subject
to the availability of information technology and skilled personnel to assist us
in creating and implementing the systems. The failure to successfully implement
and maintain operation, financial, test reports, billing and physician practice
information systems could substantially impede the implementation of our
operating and growth strategies and the realization of expected operating
efficiencies.
Failure to timely or accurately bill for our services may have a substantial
negative impact on our revenues, cash flow and bad debt expense.
Billing for laboratory testing services is complicated. The industry practice of
performing tests in advance of payment and without certainty as to the outcome
of the billing process may have a substantial negative impact on our revenues,
cash flow and bad debt expense. We bill various payors, such as patients,
insurance companies, Medicare, Medicaid, and national clinical laboratories, all
of which have different billing requirements. In addition, the billing
information requirements of the various payors have become increasingly
stringent, typically conditioning reimbursement to us on the provision of proper
medical necessity and diagnosis codes by the requisitioning client. This
complexity may increase our bad debt expense, due primarily to several non-
credit related issues such as missing or incorrect billing information on test
requisitions.
Among many other factors complicating our billing are:
. disputes between payors as to which party is responsible for
payment;
. disparity in coverage among various payors; and
. the difficulty of adherence to specific compliance requirements,
diagnosis coding and procedures mandated by various payors.
The complexity of laboratory billing also tends to cause delays in our cash
collections. Confirming incorrect or missing billing information generally slows
down the billing process and increases the aging of accounts
34
receivable. We assume the financial risk related to collection, including the
potential uncollectability of accounts and delays due to incorrect and missing
information and the other complex factors identified above.
Disruption in New York City and in U.S. commercial activities generally
following the September 2001 terrorist attacks on the U.S. adversely impacted
and may continue to adversely impact our results of operations and could
adversely impact our ability to raise capital or our future growth.
The operations of our laboratories have been and may continue to be harmed by
the recent terrorist attacks on the U.S. For example, transportation systems and
couriers that we rely upon to receive and process specimens have been and may
continue to be disrupted, thereby causing a decrease in testing volumes and
revenues. In addition, we may experience a rise in operating costs, such as
costs for transportation, courier services, insurance and security. In
particular, the operations of our laboratory in New York City may be harmed as a
result of the terrorist attacks on New York City. We also may experience delays
in receiving payments from payors that have been affected by the attacks, which,
in turn, would harm our cash flow. The U.S. economy in general may be adversely
affected by the terrorist attacks or by any related outbreak of hostilities. Any
such economic downturn could adversely impact our results of operations, impair
our ability to raise capital or impede our ability to continue growing our
business.
Our stock price is volatile and the value of your investment may decrease for
various reasons, including reasons that are unrelated to the performance of our
business.
There has been significant volatility in the market price of securities of
health care companies that often has been unrelated to the operating performance
of such companies. In fact, since January 1, 2000, our common stock, which
trades on the Nasdaq National Market, has traded from a low of $7.00 per share
to a high of $37.16 per share. We believe that various factors, such as
legislative and regulatory developments, investigations by regulatory bodies or
third-party payors, quarterly variations in our actual or anticipated results of
operations, lower revenues or earnings than those anticipated by securities
analysts, the overall economy and the financial markets could cause the price of
our common stock to fluctuate substantially. For example, in the fourth quarter
of 1998, our stock price declined significantly as a result of an announcement
by the government of its intent to seek recovery of amounts allegedly improperly
reimbursed to us under Medicare. Although the claim was resolved to our
satisfaction and resulted only in a small fine, similar investigations may be
announced having the same effect on the market price of our stock. In addition,
securities class action claims have been brought against companies whose stock
prices have been volatile. Several such suits were brought against us as a
result of the decline in our stock price described above. This kind of
litigation could be very costly and could divert our management's attention and
resources. Any adverse determination in this type of litigation could also
subject us to significant liabilities, any or all of which could materially harm
our liquidity and capital resources.
Certain provisions of our charter, by-laws and Delaware law may delay or prevent
a change of control of our company.
Our corporate documents and Delaware law contain provisions that may enable our
board of directors or management to resist a change of control of our company.
These provisions include a staggered board of directors, limitations on persons
authorized to call a special meeting of stockholders and advance notice
procedures required for stockholders to make nominations of candidates for
election as directors or to bring matters before an annual meeting of
stockholders. We also have a rights plan designed to make it more costly and
more difficult to gain control of our company. These anti-takeover defenses
could discourage, delay or prevent a change of control. These provisions could
also discourage proxy contests and make it more difficult for you and other
stockholders to elect directors and cause us to take other corporate actions. In
addition, the existence of these provisions, together with Delaware law, might
hinder or delay an attempted takeover other than through negotiations with our
board of directors.
35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to market risk associated principally with changes in interest
rates. Interest rate exposure is principally limited to our revolving loan of
$194.0 million at September 30, 2001.
In May 2000, we entered into three interest rate swaps transactions with an
effective date of October 5, 2000, various maturity dates, and a combined
notional amount of $105 million. These interest rate swap transactions involve
the exchange of floating for fixed rate interest payments over the life of the
agreement without the exchange of the underlying principal amounts. The
differential to be paid or received is accrued and is recognized as an
adjustment to interest expense. These agreements are indexed to 30 day LIBOR.
The following table summarizes the terms of the swaps:
Notional Amount(in millions) Fixed Rate Term in Months Maturity
$45.0 6.760% 48 10/05/04
$30.0 7.612% 36 10/06/03
$30.0 7.626% 48 10/05/04
The fixed rates do not include the credit spread, which is currently 2.375%. The
fixed rates under the new agreements are approximately 2.6% higher than the
prior agreements reflecting the numerous interest rate increases by the Federal
Reserve between October 1998 and October 2000. In addition, further changes in
interest rates by the Federal Reserve may increase or decrease our interest cost
on the outstanding balance of the credit facility not subject to interest rate
protection. All of our swap transactions involve the exchange of floating for
fixed rate interest payments over the life of the agreement without the exchange
of the underlying principal amounts. The differential to be paid or received is
accrued and is recognized as an adjustment to interest expense. We use
derivative financial instruments to reduce interest rate volatility and
associated risks arising from the floating rate structure of our credit facility
and they are not held or issued for trading purposes. We are required by the
terms of our credit facility to keep some form of interest rate protection in
place.
36
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During the ordinary course of business, the Company has become and may in the
future become subject to pending and threatened legal actions and proceedings.
The Company may have liability with respect to its employees and its
pathologists as well as with respect to hospital employees who are under the
supervision of the hospital based pathologists. The majority of the pending
legal proceedings involve claims of medical malpractice. Most of these relate
to cytology services. These claims are generally covered by insurance. The
Company also has become, and may in the future become, subject to claims under
agreements to indemnify third parties, such as hospitals and national clinical
laboratories, which may not be covered by insurance. Based upon investigations
conducted to date, the Company believes the outcome of such pending legal
actions and proceedings, individually or in the aggregate, will not have a
material adverse effect on the Company's financial condition, results of
operations or liquidity. If the Company is ultimately found liable under these
medical malpractice or other claims, there can be no assurance that the
Company's medical malpractice or general liability insurance coverage will be
available or adequate to cover any such liability. While we believe this
practice is routine, in a number of pending claims our insurers have reserved
their right to deny coverage. The Company is also, from time to time, involved
with legal actions related to the acquisition of and affiliation with physician
practices, the prior conduct of such practices, the employment (and restriction
on competition) of physicians, or the employment of non-physician personnel or
actions of employees of hospitals for which the Company provides pathology
services. There can be no assurance any costs or liabilities for which the
Company becomes responsible in connection with such claims or actions will not
be material or will not exceed the limitations of any applicable indemnification
provisions or the financial resources of the indemnifying parties.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Form of Indemnification Agreement entered into by the Company
with each of its directors and with each of the following
executive officers: Alan Levin, M.D.; Gregory A. Marsh; James E.
Billington; and Stephen V. Fuller
10.2 Amendment No. 1 to the AmeriPath, Inc. 2001 Stock Option Plan
(b) Reports on Form 8-K
A Current Report on Form 8-K, dated August 8, 2001, was filed by the
Company with the Securities and Exchange Commission on August 8, 2001,
reporting the appointment of Haywood D. Cochrane, Jr. to its Board of
Directors, expanding the size of the Board of Directors from six to
seven.
A Current Report on Form 8-K, dated September 17, 2001, was filed by
the Company with the Securities and Exchange Commission on September
18, 2001, reporting that the Company filed with the SEC a registration
statement on Form S-3 to register 4,743,750 shares of its common stock
to be issued and sold in an underwritten public offering.
A Current Report on Form 8-K, dated September 21, 2001, was filed by
the Company with the Securities and Exchange Commission on September
24, 2001, reporting that that as a result of the tragic events that
occurred in New York City, Washington, D.C., and near Pittsburgh,
Pennsylvania on September 11, 2001, the Company expects net revenue to
be negatively impacted resulting in an EPS shortfall for the third
quarter and the year of approximately $.02 to $.04 per share from our
previous guidance.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERIPATH, INC.
Date: November 13, 2001 By: /s/ JAMES C. NEW
-----------------
James C. New
Chairman and Chief Executive Officer
Date: November 13, 2001 By: /s/ GREGORY A. MARSH
---------------------
Gregory A. Marsh
Vice President and
Chief Financial Officer
38
Exhibit Index
Exhibit
Number Description
------ -----------
10.1 Form of Indemnification Agreement entered into by the Company with
each of its directors and with each of the following executive
officers: Alan Levin, M.D.; Gregory A. Marsh; James E. Billington;
and Stephen V. Fuller
10.2 Amendment No. 1 to the Ameripath, Inc. 2001 Stock Option Plan