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 MARCH 31, 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.
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(Exact name of registrant as specified in its charter)
Delaware 65-0642485
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7289 Garden Road, Suite 200, Riviera Beach, Florida 33404
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(Address of principal executive offices) (Zip Code)
(561) 845-1850
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(Registrant's telephone number, including area code)
Not Applicable
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(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 25,163,605 shares of common stock, $.01 par value,
outstanding as of May 11, 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
March 31, 2001 (Unaudited) and December 31, 2000 3
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2001 and 2000 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2001 and 2000 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-29
Item 3. Quantitative and Qualitative Disclosures about Market Risk 29
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 31
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, December 31,
ASSETS 2001 2000
--------- ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 4,147 $ 2,418
Accounts receivable, net 77,060 70,939
Inventories 1,507 1,406
Other current assets 11,272 11,446
--------- ---------
Total current assets 93,986 86,209
--------- ---------
PROPERTY AND EQUIPMENT, NET 23,840 23,580
--------- ---------
OTHER ASSETS:
Goodwill, net 189,709 177,263
Identifiable intangibles, net 266,008 268,627
Other 6,440 6,487
--------- ---------
Total other assets 462,157 452,377
--------- ---------
TOTAL ASSETS $ 579,983 $ 562,166
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 41,018 $ 35,712
Current portion of long-term debt 1,076 1,055
Other current liabilities 10,389 8,627
--------- ---------
Total current liabilities 52,483 45,394
--------- ---------
LONG-TERM LIABILITIES:
Revolving loan 201,999 197,216
Long-term debt 3,349 3,476
Other liabilities 8,743 2,369
Deferred tax liability 62,746 64,046
--------- ---------
Total liabilities 329,320 312,501
--------- ---------
STOCKHOLDERS' EQUITY:
Common stock 249 247
Additional paid-in capital 189,979 188,050
Accumulate other comprehensive loss (4,174) --
Retained earnings 64,609 61,368
--------- ---------
Total stockholders' equity 250,663 249,665
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 579,983 $ 562,166
========= =========
The accompanying notes are an integral part of these
unaudited financial statements.
3
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
------------------------
2001 2000
-------- --------
NET REVENUES:
Net patient service revenue $ 91,724 $ 68,888
Net management service revenue 7,021 6,155
-------- --------
Total net revenues 98,745 75,043
-------- --------
OPERATING COSTS AND EXPENSES:
Cost of services 48,432 36,950
Selling, general and administrative expenses 17,218 13,141
Provision for doubtful accounts 10,658 7,103
Amortization expense 4,526 3,837
Merger-related charges 7,103 --
-------- --------
Total operating costs and expenses 87,937 61,031
-------- --------
INCOME FROM OPERATIONS 10,808 14,012
-------- --------
OTHER INCOME (EXPENSE):
Interest expense (4,742) (3,418)
Other, net 24 63
-------- --------
Total other expense (4,718) (3,355)
-------- --------
INCOME BEFORE INCOME TAXES 6,090 10,657
PROVISION FOR INCOME TAXES 2,849 4,559
-------- --------
NET INCOME 3,241 6,098
Accretion of redeemable preferred stock -- (34)
-------- --------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 3,241 $ 6,064
======== ========
BASIC EARNINGS PER COMMON SHARE:
Basic earnings per common share $ 0.13 $ 0.27
======== ========
Basic weighted average shares outstanding 24,809 22,275
======== ========
DILUTED EARNINGS PER COMMON SHARE:
Diluted earnings per common share $ 0.12 $ 0.27
======== ========
Diluted weighted average shares outstanding 25,983 22,825
======== ========
The accompanying notes are an integral part of these
unaudited financial statements.
4
AMERIPATH, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
March 31,
-------------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,241 $ 6,098
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization 6,128 5,007
Loss on disposal of assets (12) (5)
Deferred income taxes (1,300) (500)
Provision for doubtful accounts 10,658 7,103
Merger-related charges 7,103 --
Changes in assets and liabilities (net of effects of acquisitions):
Increase in accounts receivable (16,780) (10,265)
(Increase) / decrease in inventories (101) 281
Decrease in other current assets 62 123
(Increase) / decrease in other assets (76) 137
Increase in accounts payable and accrued expenses 4,271 4,039
Pooling merger-related charges paid (1,528) --
-------- --------
Net cash provided by operating activities 11,666 12,018
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (2,069) (1,567)
Merger-related charges paid (97) (213)
Cash paid for acquisitions and acquisition costs, net of cash acquired (236) (407)
Payments of contingent notes (13,401) (12,036)
-------- --------
Net cash used in investing activities (15,803) (14,223)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options and warrants 1,109 106
Debt issuance costs -- (4)
Principal payments on long-term debt (26) (106)
Net borrowings under revolving loan 4,783 1,200
-------- --------
Net cash provided by financing activities 5,866 1,196
-------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,729 (1,009)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,418 1,713
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,147 $ 704
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 4,508 $ 3,454
Income taxes $ 401 $ 1,834
Contingent stock issued $ 822 --
The accompanying notes are an integral part of these
unaudited financial statements.
5
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 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 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 financial position or results of
operations.
In June 1998, the 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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(Continued)
In September 2000, the Financial Accounting Standards Board 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 the financial
conditions or results of operations of the Company.
NOTE 2 - ACQUISITIONS
There were no acquisitions made in the first quarter of 2001.
The accompanying financial statements include the results of operations of the
Company's 2000 acquisitions from the date acquired through March 31, 2000. The
allocation of the purchase price of some of the 2000 acquisitions 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 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 three months ended March 31, 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 three months ended March 31, 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
three months ended March 31, 2001, since there were no acquisitions made during
the first three months of 2001. These amounts are in thousands, except per share
amounts.
Pro Forma (Unaudited)
Three Months Ended
March 31,
2000
---------------------
Net revenues $ 81,147
========
Net income attributable to common stockholders $ 7,406
========
Diluted earnings per common share $ 0.28
========
7
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(Continued)
NOTE 3 - INTANGIBLE ASSETS
Intangible assets and the related accumulated amortization and amortization
periods are set forth below (dollars in thousands):
March 31, 2001
Amortization Periods
(Years)
----------------------
March 31, December 31, Weighted
2001 2000 Range Average
---------- ---------- ----- --------
Hospital contracts $ 211,738 $ 211,738 25-40 32.3
Physician client lists 71,447 71,447 10-30 20.6
Laboratory contracts 4,543 4,543 10 10.0
Management service agreement 11,379 11,214 25 25.0
---------- ----------
299,107 298,942
Accumulated amortization (33,099) (30,315)
---------- ----------
Identifiable intangibles, net $ 266,008 $ 268,627
========== ==========
Goodwill $ 207,419 $ 193,231 10-35 30.6
Accumulated amortization (17,710) (15,968)
---------- ----------
Goodwill, net $ 189,709 $ 177,263
========== ==========
The weighted average amortization period for identifiable intangible assets and
goodwill is 29.6 years.
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 quarter ended March 31, 2001 with
respect to the merger-related reserves is as follows:
Balance Statement of Balance
December 31, Operations March 31,
2000 Charges Payments 2001
------------ ------------ -------- ---------
Transaction costs $1,726 $2,863 $(1,189) $ 3,400
Employee termination costs 1,417 4,240 (400) 5,257
Lease commitments 2,128 -- (36) 2,092
Other exit costs 263 -- -- 263
------ ------ -------- -------
Total 5,534 $7,103 $(1,625) 11,012
====== ========
Less: portion included in
current liabilities (3,165) (6,443)
------ -------
Total included in other
liabilities $2,369 $4,569
====== ======
8
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(Continued)
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
March 31, 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 our
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 March 31, 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
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 ("SFAS") No. 128, "Earnings Per Share." Basic
earnings per share, which excludes the effects of any dilutive
9
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(Continued)
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
March 31,
----------------------
2001 2000
------- -------
Earnings Per Common Share:
Net income $ 3,241 $ 6,064
======= =======
Basic earnings per common share $ 0.13 $ 0.27
======= =======
Diluted earnings per common share $ 0.12 $ 0.27
======= =======
Basic weighted average shares outstanding 24,809 22,275
Effect of dilutive stock options and warrants 1,174 550
------- -------
Diluted weighted average shares outstanding 25,983 22,825
======= =======
Options to purchase 84,629 shares and 764,805 shares of common stock which were
outstanding at March 31, 2001 and 2000, respectively, have been excluded from
the calculation of diluted earnings per share for the respective years because
their effect would be anti-dilutive. In addition, 395,471 shares of Preferred
Stock were excluded from the calculation of diluted earnings per share for the
three months ended March 31, 2000 because their effect would be anti-dilutive.
Warrants to purchase 38,867 shares for the three months ended March 31, 2000,
were excluded from the calculation of diluted earnings per share because their
effect would be anti-dilutive.
NOTE 8 - LONG TERM DEBT
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 will also be required to pay an amendment fee of up to
30 basis points to those lenders which consented to the amendment. The amendment
fee will be 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
10
AMERIPATH, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -
(Continued)
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 and 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 LOSS
The Company includes changes in the fair value of certain derivative financial
instruments which qualify for hedge accounting in comprehensive income. For the
three months ended March 31, 2001, comprehensive loss was approximately
$900,000. This includes a transition adjustment recorded on January 1, 2001 of
$3.0 million (net of tax of $2.0 million). The difference between net income and
comprehensive loss for the three months ended March 31, 2001, is as follows (in
thousands):
Net income $ 3,241
Change in fair value of derivative financial instruments,
net of tax of $2,753 (4,174)
-------
Comprehensive loss $ 933
=======
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 described in the summary of accounting
policies. The Company evaluates performance based on revenue and income before
amortization of intangibles, merger-related 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 months
ended March 31 for the business segments and corporate.
Owned 2001 2000
----- --------- ---------
Net patient service revenue $ 91,724 $ 68,888
Operating income 27,326 21,462
Segment assets 275,800 162,885
Managed
-------
Net management service revenue $ 7,021 $ 6,155
Operating income 1,129 1,006
Segment assets 20,208 15,053
Corporate
---------
Operating loss $ (6,018) $ (4,619)
Segment assets 313,796 339,940
Elimination of intercompany accounts (29,821) (27,571)
NOTE 12 - SUBSEQUENT EVENTS
Subsequent to March 31, 2001, the Company paid approximately $8.1 million on
contingent notes issued in connection with previous acquisitions as additional
purchase price.
11
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company is a leading national provider of cancer diagnostics, genomic, and
related information services. Since the first quarter of 1996, the Company has
completed the acquisition of 49 physician practices (the "Practices") located in
21 states. These practices are either directly owned by the Company or managed
by the Company through one of its subsidiaries. This includes the acquisition of
Pathology Consultants of America, Inc., d/b/a Inform DX ("Inform DX"). The
Inform DX transaction was accounted for as a pooling of interests and therefore
all prior year information has been restated to reflect the acquisition of
Inform DX. As a result of the Inform DX acquisition, the Company now manages
several practices through which it derives management fees. The Company's 419
pathologists provide medical diagnostic services in outpatient laboratories
owned, operated and managed by the Company, hospitals, and outpatient ambulatory
surgery centers. Of these pathologists, 413 are board certified in anatomic and
clinical pathology, and 190 are also board certified in a subspecialty of
anatomic pathology, including dermatopathology (study of diseases of the skin),
hematopathology (study of diseases of the blood) and cytopathology (study of
abnormalities of the cells).
Under the management or equity model, the Company acquires certain assets of and
operates pathology practices under long-term service agreements with affiliated
physician groups (the "Managed Practices"). The Company provides facilities and
equipment as well as administrative and technical support for the affiliated
physician groups under service agreements. Through its ownership or employment
model, the Company acquires a controlling equity interest in the pathology
practice (the "Owned Practices").
As of March 31, 2001, the Company and the Managed Practices had contracts with a
total of 237 hospitals to manage their clinical pathology and other laboratories
and provide professional pathology services. The majority of these hospital
contracts are exclusive provider relationships of the Company and the Managed
Practices. The Company and the Managed Practices also have 42 licensed
outpatient laboratories.
The Company manages and controls all of the non-medical functions of the
practices, including: (i) recruiting, training, employing and managing the
technical and support staff of the practices; (ii) developing, equipping and
staffing laboratory facilities; (iii) establishing and maintaining courier
services to transport specimens; (iv) negotiating and maintaining contracts with
hospitals, national clinical laboratories and managed care organizations and
other payors; (v) 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; and (vi) with respect to the Company's ownership and operation of
anatomic pathology laboratories, providing slide preparation and other technical
services. The Company is not licensed to practice medicine.
The Company has commenced its transition to becoming a fully integrated
healthcare diagnostic information provider, which includes the Company's
development of new ways to generate additional revenues through leveraging the
Company's personnel, technology and resources. Two examples of such endeavors
(one with Genomics Collaborative, Inc. and one with Ampersand Medical of
Chicago) are described below. Although the Company believes that such new
endeavors are promising, there can be no assurance that they will be profitable.
During the second quarter of 2000, the Company 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 the
Company's 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 the Company's operations during 2000. The
Company is 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
12
potential liability of the Company. On September 15, 2000, the Company made a
$1.0 million investment in GCI in exchange for 333,333 shares of Series D
Preferred Stock, par value $0.01.
On March 27, 2001, the Company announced an agreement with Ampersand Medical of
Chicago ("Ampersand") which illustrates another example of leveraging the
Company's existing resources. In this alliance, AmeriPath will be performing
clinical trial work for Ampersand's 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. The Company
will be paid on a fee-for-service basis for each clinical trial we conduct. The
agreement also calls for the Company to assist Ampersand with the development of
associated products and tests. The Company would receive equity in Ampersand for
the developmental work and would be entitled to royalty payments based on future
sales of these products and tests. AmeriPath is particularly excited about the
prospects for 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.
Net Revenues
AmeriPath derives its net revenue primarily from the operations of the 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.
Net patient revenues. The majority of services furnished by the Company's
pathologists are anatomic pathology diagnostic services. Medicare reimbursement
for these services represented approximately 22% of the Company's cash
collections at March 31, 2001 and 2000. The Company typically bills 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:
o Medicare and Medicaid reimbursements at annually established rates;
o payments from managed care organizations at discounted fee-for-service
rates;
o negotiated reimbursement rates with national clinical laboratories and
other third party payors; and
o other discounts and allowances.
In recent years, there has been a shift away from traditional indemnity
insurance plans to managed care as employers and other payors move their
participants into lower cost plans. The Company benefits more from patients
covered by Medicare and traditional indemnity insurance than managed care
organizations and national clinical laboratories, which contract directly under
capitated agreements with managed care organizations to provide clinical as well
as anatomic pathology services. The Company also contracts with national
clinical laboratories and is attempting to increase the number of such contracts
to increase test volume. Since the majority of the Company's operating costs --
principally the compensation of physicians and non-physician technical personnel
-- are relatively fixed, increases in volume, whether from indemnity or
non-indemnity plans, enhance the Company's profitability. Historically, net
patient service revenue from capitated contracts has represented an
insignificant amount of total net patient service revenue.
Virtually all of the Company's net patient service revenue is derived from the
Practices' charging for services on a fee-for-service basis. Accordingly, the
Company assumes 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 AmeriPath
to borrow funds to meet its current obligations or may otherwise have a material
adverse effect on AmeriPath's 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, AmeriPath bills non-Medicare patients according to a
fee schedule for what is referred to as clinical
13
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 billing charges and "Part A" fees, and in
the future the Company may sustain substantial decreases in these payments.
Medicare calculates and reimburses fees for all physician services ("Part B"
fees), including anatomic pathology services, based on a methodology known as
the resource-based relative value system ("RBRVS"), which Medicare began phasing
in since 1992 and had fully implemented by 1997. 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 AmeriPath.
The Medicare Part B fee schedule payment for each service is determined by
multiplying the total relative value units ("RVUs") established for the service
by a Geographic Practice Cost Index ("GPCI"). The sum of this value is
multiplied by a statutory 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 expense RVU (expense related to performing the
service) and malpractice RVU (malpractice costs associated with the service).
The Balanced Budget Act of 1997 ("BBA") added coverage for an annual screening
pap smear for Medicare beneficiaries who are at high risk of developing cervical
or vaginal cancer and for beneficiaries of childbearing age effective January 1,
1998, as well as coverage for annual prostate cancer screening, including a
prostate-specific antigen blood test, for beneficiaries over age 50, effective
January 1, 2000. Although most women of childbearing age and men under age 65
are not Medicare beneficiaries, the addition of Medicare coverage for these
tests could provide additional revenues for the Company. With the BBA, Congress
merged the three existing conversion factors into one for all types of services
provided resulting in a single conversion factor.
In July 1999, HCFA announced several proposed rule changes, and issued a final
rule on November 2, 1999 that impacts payment for pathology services. The
changes include: (a) the implementation of resource-based malpractice relative
value units ("RVUs"), which should not significantly change reimbursement; and
(b) the 1997 regulations required HCFA to develop a methodology for
resource-based practice expense RVUs for each physician service beginning in
1998. The BBA provided for a four-year transition period. HCFA has established,
and is proposing, a new methodology for computing resource-based practice
expense that uses available practice expense data. In the November 2, 1999 final
rule, an interim solution was developed which created a separate practice
expense pool for all services with zero work RVUs. As published in the final
rule, certain reimbursement codes were removed from the zero work RVU pool. The
impact of these procedures from the zero work pool varies by procedure and
geographic region. The impact of the changes for pathology revenue were
estimated by HCFA to be 8%, however, the magnitude of the impact that Medicare
has on AmeriPath depends upon the mix of Medicare and non-Medicare services. For
those outpatient facilities that AmeriPath bills globally, the average
percentage increase is 16.6% for a common CPT code 88305. On August 10, 2000,
the Final Update to the 2000 Medicare Physician Fee Schedule Database was
published by HFCA. The changes included increases to various codes including CPT
code 88305. Increases vary by region and averaged 5.7%.
In addition, HCFA announced that it will cease the direct payment by Medicare
for the technical component of inpatient physician pathology services to an
outside independent laboratory on the basis that it believes that the cost of
the technical component for inpatient services is already included in the
payment to hospitals under the hospital inpatient prospective payment system.
Implementation of this change was scheduled to commence January 1, 2001.
Congress, however, recently "grandfathered" certain existing hospital-lab
arrangements. HCFA has increased the physician fee schedule conversion factor
from $36.61 to $38.26 in 2001.
Due to the implementation of the hospital outpatient prospective payment system
("PPS"), effective as of January 1, 2001, independent pathology laboratories
providing services to hospital outpatients generally will no longer be able to
bill Medicare for the technical component ("TC") of those services. Rather, they
will need to bill the hospital for the TC. The hospital will be reimbursed as
part of the new Ambulatory Payment Classification ("APC") payment system. This
change will require new billing arrangements to be
14
made with the hospitals which may result in an increase in the amount of time
necessary for collections and reduction in the amounts paid. The actual change
in revenue has not been determined due to current negotiations in progress with
the hospitals. There can be no assurance that these changes will not have an
adverse effect on the Company.
As indicated above, a significant portion of AmeriPath's net patient service
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 services under these programs could have a material adverse effect on
AmeriPath's financial position and results of operations.
The impact of legislative changes on AmeriPath's 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 conversion
factors (budget neutrality adjustments) which are published in November of each
year. Management continuously monitors changes in legislation impacting
reimbursement.
In prior years, AmeriPath has been able to mitigate the impact of reductions in
Medicare reimbursement rates for anatomic pathology services through the
achievement of economies of scale and the introduction of alternative
technologies that are not dependent upon reimbursement through the RBRVS system.
Despite any offsets, the recent substantial modifications to the physician fee
schedule, along with additional adjustments by Medicare, could have an effect on
the 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 have a negative impact on
the average unit reimbursement.
Net management service revenue. Net management service revenue is based on a
predetermined percentage of net operating income of the practices managed by the
Company 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.
The underlying calculation of net management service revenue is net physician
group revenue less amounts retained by the physician groups (" 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 debt represents
management's estimate of potential credit issues associated with amounts due
from patients, commercial insurers, and other third party payors. Physician
Group Retainage is the net physician group revenue less practice expenses and
management fee charged by the Company in accordance with the terms of the
service agreement.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2001 AND 2000
Changes in the results of operations between the three month periods ended March
31, 2001 and 2000 are due primarily to the various acquisitions which were
consummated by the Company subsequent to March 31, 2000. References to "same
store" means practices at which the Company provided services for the entire
period for which the amount is calculated and the entire prior comparable
period, including acquired hospital contracts and expanded ancillary testing
services added to existing practices. During the first three months of 2001, the
Company completed no acquisitions.
15
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
March 31,
---------------------
2001 2000
------ ------
NET REVENUES 100.0% 100.0%
------ ------
OPERATING COSTS AND EXPENSES:
Cost of services 49.0% 49.2%
Selling, general and administrative expenses 17.4% 17.5%
Provision for doubtful accounts 10.8% 9.5%
Amortization expense 4.6% 5.1%
Merger-related charges 7.2% --
------ ------
Total operating costs and expenses 89.0% 81.3%
------ ------
INCOME FROM OPERATIONS 11.0% 18.7%
------ ------
Interest expense and other, net 4.8% 4.5%
------ ------
INCOME BEFORE INCOME TAXES 6.2% 14.2%
PROVISION FOR INCOME TAXES 2.9% 6.1%
------ ------
NET INCOME 3.3% 8.1%
====== ======
Net Revenues
Net revenues increased by $23.7 million, or 31.6%, from $75.0 million for the
three months ended March 31, 2000, to $98.7 million for the three months ended
March 31, 2001. Same store net revenue increased $11.3 million or 15% from $75.0
million for the three months ended March 31, 2000 to $86.3 million for the three
months ended March 31, 2001, including approximately $1.2 million related to the
increase in Medicare reimbursement. Same store outpatient revenue increased $6.6
million, or 23%, same store hospital revenue increased $3.7 million, or 9%, and
same store management service revenue increased $900,000, or 14%, compared to
the same period of the prior year. The remaining increase in revenue of $12.4
million resulted from the operations of laboratories acquired during the year
2000.
During the three months ended March 31, 2001, approximately $7.2 million, or 7%,
of the Company's net revenue was attributable to contracts with national labs
including Quest Diagnostics ("Quest") and Laboratory Corporation of America
Holdings ("LabCorp"). Effective December 31, 2000, Quest terminated AmeriPath's
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 AmeriPath discontinued
its Quest work in San Antonio. These decisions by Quest and/or LabCorp to
discontinue or redirect pathology services, at any or all of its practices, or
the Company's decision to discontinue processing work from the national labs,
could have a material adverse effect on AmeriPath's financial position and
results of operations.
In addition, approximately $12.9 million, or 13%, of the Company's net revenue
is derived from 27 hospitals operated by HCA-The Healthcare Company ("HCA"),
formerly known as Columbia/HCA Healthcare Corporation. Generally, these
contracts and other hospital contracts have remaining terms of less than five
years and contain renewal provisions. Some of the contracts also contain clauses
that allow for termination by either party with relatively short notice. HCA has
been under government investigation for some time and is evaluating its
operating strategies; including the sale, spin-off or closure of certain
16
hospitals. Closures and/or sales of HCA hospitals and/or terminations of one or
more of these contracts could have a material adverse effect on the Company's
financial position and results of operations.
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 $11.5 million, or 31.1%, from $36.9 million for the three months ended March
31, 2000 to $48.4 million for the same period in 2001. Cost of services, as a
percentage of net revenues, decreased slightly from 49.2% for the three months
ended March 31, 2000 to 49.0% in the comparable period of 2001. Gross margin
increased from 50.8% in the three months ended March 31, 2000 to 51.0% in 2001.
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. As a percentage of consolidated net revenues, selling,
general and administrative expenses decreased from 17.5% for the three months
ended March 31, 2000 to 17.4% for the same period of 2001, as the Company
continues to implement measures to better control these costs and continued to
spread these costs over a larger revenue base. One of the Company's objectives
is to decrease these costs as a percentage of net revenues, however, these
costs, as a percentage of net revenue, may increase as the Company continues to
invest in marketing, information systems and billing operations.
Selling, general and administrative expenses increased by $4.1 million, or
31.0%, from $13.1 million for the three months ended March 31, 2000 to $17.2
million for the comparable period of 2001. Of this increase, approximately $1
million was attributable to the increase in billing and collection costs and
approximately $600,000 attributable to the acquisitions the Company completed
after March 31, 2000. The remaining increase was due primarily to increased
staffing levels in marketing, human resources, accounting and salary increases
effected during the fourth quarter of 2000, and costs incurred to expand the
Company's administrative support infrastructure and to enhance the Company's
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 the Company's
penetration in the urology, gastroenterology and oncology markets. The Company's
objective is to achieve annual same practice net revenue growth in excess of
10%, however, there can be no assurance that the Company will achieve this
objective.
Provision for Doubtful Accounts
The provision for doubtful accounts increased by $3.6 million, or 50.0%, from
$7.1 million for the three months ended March 31, 2000, to $10.7 million for the
same period in 2001. The provision for doubtful accounts as a percentage of net
revenues was 9.5% and 10.8% for the three month periods ended March 31, 2000 and
2001, respectively. This increase was principally driven by price increases
implemented earlier in the year.
Provision for estimated third-party payor settlements and adjustments are
estimated in the period the related services are rendered and adjusted in future
periods as final settlements are determined. The provision and the related
allowance are adjusted periodically, based upon an evaluation of historical
collection experience with specific payors for particular services, anticipated
collection levels with specific payors for new services, industry reimbursement
trends, and other relevant factors.
Amortization Expense
Amortization expense increased by $689,000, or 17.9%, from $3.8 million for the
three months ended March 31, 2000, to $4.5 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 after March 31, 2000, and payments made on the contingent
notes, as well as a
17
reduction in the weighted average amortization periods from 31 to 30 years.
Amortization expense is expected to increase in the future as a result of
additional identifiable intangible assets and goodwill arising from future
acquisitions, and any payments required to be made pursuant to the contingent
notes issued in connection with acquisitions.
The Company continually evaluates whether events or circumstances have occurred
that may warrant revisions to the carrying values of its 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 the
Company's goodwill or other identifiable intangible assets could have a material
adverse effect on the Company's consolidated financial position and results of
operations. Such impairment would be recorded as a charge to operating profit
and reduction in intangible assets.
Merger-related Charges
The merger-related charges of $7.1 million for the three months ended March 31,
2001 relate to AmeriPath's 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. AmeriPath effectively closed the
Nashville office March 31, 2001 and based on its current plans expects to
complete the integration of the New York and Pennsylvania operations by the end
of July 2001. The restructuring of the combined operations of AmeriPath and
Inform DX are expected to result in potential annual operating synergies of up
to $5 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,
AmeriPath expects the acquisition of Inform DX to be nominally dilutive for the
first six months and accretive for the year 2001.
Income from Operations and Net Income
Income from operations decreased $3.2 million, or 22.9%, from $14.0 million for
the three months ended March 31, 2000, to $10.8 million in the same period of
2001. Without the merger-related charges, income from operations would have
increased by $3.9 million, or 27.8%, to $17.9 million.
Net income for the three months ended March 31, 2001 was $3.2 million, a
decrease of $2.8 million, or 46.6%, over the same period in 2000. Diluted
earnings per share for the three months ended March 31, 2001 decreased to $0.12
from $0.27 for the comparable period of 2000, based on 26.0 million and 22.8
million weighted average shares outstanding, respectively. Diluted earnings per
share would have been $0.30 without the merger-related charge.
Interest Expense
Interest expense increased by $1.3 million, or 38.7%, from $3.4 million for the
three months ended March 31, 2000, to $4.7 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 March 31, 2001. For the three
months ended March 31, 2001, average indebtedness outstanding was $207.3
million, compared to average indebtedness of $170.8 million outstanding in the
same period of 2000. The Company's effective interest rate was 9.2% and 8.0% for
the three month periods ended March 31, 2001 and 2000, respectively. Although
there have seen some declines in interest rates in the first quarter of 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 42.8% and 46.8% for the three
month period ended March 31, 2000 and 2001, respectively. Generally, the
effective tax rate is higher than AmeriPath's statutory rates primarily due to
the non-deductibility of the goodwill amortization and section 481(a)
adjustments (cash to accrual) related to the Company's acquisitions. In
addition, for the three-month period ended March 31, 2001 the Company had
non-deductible merger-related charges, which further increased the effective tax
18
rate. The effective tax rate for the three-month period ended March 31, 2001,
excluding these items would have been approximately 41.5%.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2001, the Company had working capital of approximately $41.5
million, an increase of $0.7 million from the working capital of $40.8 million
at December 31, 2000. The increase in working capital was due primarily to
increases in net accounts receivable of $6.1 million and cash and cash
equivalents of $1.7 million offset by an increase in accounts payable and
accrued expenses of $7.1 million.
For the three month periods ended March 31, 2000 and 2001, cash flows from
operations were $12.0 million, 16% of net revenue, and $11.7 million, 12% of net
revenue, respectively. Excluding pooling merger-related charges paid for Inform
DX of $1.5 million, cash flow from operations would have been $13.2 million. For
the three months ended March 31, 2001, cash flow from operations and borrowings
under the Company's Credit Facility were used to make contingent note payments
of $13.4 million and acquire $2.1 million of property and equipment.
At March 31, 2001, the Company had $28.0 million available under its 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 $230
million in the form of a revolving loan that may be used for working capital
purposes and to fund acquisitions. As of March 31, 2001, $202.0 million was
outstanding under the revolving loan with an annual effective interest rate of
8.65%.
In May 2000, the Company entered into three interest rate swaps transactions
with an effective date of October 5, 2000, variable maturity dates, and a
combined notional amount of $105 million. See Item 3. - Quantitative and
Qualitative Disclosures About Market Risk for details on these new 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. The Company uses derivative
financial instruments to reduce interest rate volatility and associated risks
arising from the floating rate structure of its credit facility and they 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. At March
31, 2001, the Company believes that it is in compliance with the covenants of
the credit facility.
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 will also be required to pay an amendment fee of up to
30 basis points to those lenders which consented to the amendment. The amendment
fee will be approximately $600,000.The amendment is not expected to have an
adverse effect on the Company's operations or strategies.
The Company expects to continue to use its credit facility to fund acquisitions
and for working capital. The Company anticipates that funds generated by
operations and funds available under the 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
payments under the contingent notes issued in connection with acquisitions
become due, the Company believes that the incremental cash generated from
operations would exceed the cash required to satisfy the Company's payment, if
any, of the contingent obligations in any one year period. Such payments, if
any, will result in a corresponding increase in goodwill and the related amount
of amortization thereof in periods following the payment. Funds generated from
operations and funds available under the credit facility may not be sufficient
to implement the Company's longer-term growth strategy. The Company 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
19
securities. No assurances can be given that the Company 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 the Company
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 for the year ended
December 31, 2000), 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 as "may," "should," "believe," "expect," "anticipate" and similar
expressions.
In addition to the risks and uncertainties identified elsewhere herein and in
other documents filed by the Company with the Securities and Exchange
Commission, the following factors should be carefully considered when evaluating
the Company's business and future prospects: general economic conditions;
competition and changes in competitive factors; the extent of success of the
Company's operating initiatives and growth strategies (including without
limitation, the Company's continuing efforts to (i) achieve continuing
improvements in performance of its current operations, by reason of various
synergies, marketing efforts, revenue growth, cost savings or otherwise, (ii)
transition into becoming a fully integrated healthcare diagnostic information
provider, including the Company's efforts to develop, and the Company's
investment in, new products, services, technologies and related alliances, such
as the alliance with Genomics Collaborative, Inc. (iii) acquire or develop
additional pathology practices (as further described below), and (iv) develop
and expand its managed care and national clinical lab contracts); federal and
state healthcare regulation (and compliance); reimbursement rates under
government-sponsored and third party healthcare programs and the payments
received under such programs; changes in coding; changes in technology;
dependence upon pathologists and contracts; the ability to attract, motivate,
and retain pathologists; labor and technology costs; marketing and promotional
efforts; the availability of pathology practices in appropriate locations that
the Company is able to acquire on suitable terms or develop; the successful
completion and integration of acquisitions (and achievement of planned or
expected synergies); access to sufficient amounts of capital on satisfactory
terms; and tax laws. In addition, the Company's strategy to penetrate and
develop new markets involves a number of risks and challenges and there can be
no assurance that the healthcare regulations of the new states in which the
Company enters and other factors will not have a material adverse effect on the
Company. The factors which may influence the Company's success in each targeted
market in connection with this strategy include: the selection of appropriate
qualified practices; negotiation, execution and consummation of definitive
acquisition, affiliation, management and/or employment agreements; the economic
stability of each targeted market; compliance with state, local and federal
healthcare and/or other laws and regulations in each targeted market (including
health, safety, waste disposal and zoning laws); compliance with applicable
licensing approval procedures; restrictions under labor and employment laws,
especially non-competition covenants. Past performance is not necessarily
indicative of future results.
RISK FACTORS
You should carefully consider each of the following risks and all of the other
information set forth in this Form 10Q. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not
presently known to us or that we currently believe to be immaterial may also
adversely affect our business.
20
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 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 under such jurisdiction's laws and could
be required to restructure our contractual and other arrangements.
Alternatively, some of our existing contracts could be found to be illegal and
unenforceable. In addition, expansion of our operations to other "corporate
practice" states may require structural and organizational modification to the
form of relationship that we currently have with physicians, affiliated
practices and/or hospitals. Such results or the inability to successfully
restructure contractual arrangements could have a material adverse effect on our
business, financial condition and results of operations.
We could be hurt by future interpretation or implementation of federal
anti-kickback laws.
The federal anti-kickback law and regulations prohibit any knowing and willful
offer, payment, solicitation and receipt of any form of remuneration, either
directly or indirectly, in return for, or to induce the referral of an
individual for a service for which payment may be made by Medicare and Medicaid
or certain other federal health care programs, or the purchasing, leasing,
ordering or arranging for, or recommending the purchase, lease or order of, any
service or item for which payment may be made by Medicare, Medicaid or certain
other federal health care programs. Violations of federal anti-kickback law are
punishable by monetary fines, civil and criminal penalties and exclusion from
participation in Medicare, Medicaid and other federal health care programs.
Several states have similar laws.
The federal government has published regulations that provide "safe-harbors"
that protect business transactions that meet enumerated requirements from
prosecution under the federal anti-kickback law. The failure to meet the
requirements of a safe harbor does not necessarily mean that a transaction
violates the anti-kickback law. While arrangements that we enter into with
physicians and third parties may not satisfy all requirements under applicable
safe harbors, 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 however, that the federal government might investigate
arrangements which do not satisfy the safe harbors. If our arrangements with
physicians and third parties were found to be illegal, we would be subject to
civil and criminal penalties, including exclusion from the participation in
government payor programs, which could materially adversely affect our business,
financial condition and results of operations.
The Department of Health and Human Services Office of the Inspector General
issues advisory opinions that provide advice on whether proposed business
arrangements violate the anti-kickback statute. In Advisory Opinion 99-13, the
OIG opined that when prices for laboratory services for non-governmental
patients are discounted below Medicare reimbursable rate, the anti-kickback
statute may be implicated. The OIG found prices discounted below the laboratory
supplier's costs to be particularly problematic. In the same opinion, OIG
suggests that a laboratory may be excluded from federal health care programs if
it charges Medicare or Medicaid amounts substantially in excess of discounted
charges to the physician. In the
21
OIG's opinion, charges are likely excessive if the profit margin for Medicare
business exceeds profit margin for non-federally reimbursed business.
The OIG also has addressed physician practice management arrangements in an
advisory opinion. In Advisory Opinion 98-4, the OIG found that management fees
based on a percentage of practice revenues may violate the anti-kickback
statute. Although these advisory opinions only apply to the parties who request
them, in the event that we our found to have arrangements that are inconsistent
with the OIG's opinions, the OIG might take the position that the arrangements
violate the anti-kickback law. Any such finding could have a material adverse
impact on us.
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 referral 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 a physician has a financial relationship. Financial
relationship includes both investment interests in an entity and compensation
arrangements with an entity. If an arrangement is covered by the Stark Law, all
of the requirements of the Stark Law exception must be satisfied. Many states
also have laws that are similar to the Stark Law. These statutes and regulations
generally apply to services reimbursed by both governmental and private payors.
Violations of these laws may result in prohibition of payment for services
rendered, loss of licenses as well as fines and criminal penalties. In addition,
violation of the Stark Law may result in exclusion from Medicare and Medicaid.
State statutes and regulations affecting the referral of patients to health care
providers range from statutes and regulations that are substantially the same as
the federal laws and the safe harbor regulations to a requirement that
physicians or other health care professionals disclose to patients any financial
relationship the physicians or health care professionals have with a health care
provider that is being recommended to the patients. These 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. Adverse judicial or
administrative interpretations of any of these laws could have a material
adverse effect on our business, financial condition and results of operations.
In addition, expansion of our operations to new jurisdictions, or new
interpretations of laws in 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
have a material adverse effect on our business, financial condition and results
of operations.
We have financial relationships with our physicians, as defined by the federal
Stark Law, in the form of compensation arrangements, ownership of our shares,
contingent promissory notes issued by us in connection with acquisitions, or a
combination of the above. We believe that such existing compensation
arrangements are structured to comply with an applicable Stark Law exception. We
also believe that the ownership of our shares by physicians should fall within
the publicly traded stock exception to the Stark Law's definition of financial
relationship. However, certain physician-owned shares do have transfer
restrictions and, as a result, the government could take the position that all
of the requirements of this exception are not met. The contingent notes held by
some physicians do not meet an exception to the Stark Law's definition of
financial relationship. In either case, however, we believe that our current
operations comply with the Stark law because physicians affiliated with us
ordinarily do not make referrals and in any event have been instructed, and are
believed to be following such instructions, not to make referrals to us. To the
extent physicians affiliated with us may make a referral to us and a financial
relationship exists between us and the referring physician through either the
ownership of our shares or contingent notes, the government might take the
position that the arrangement does not comply with the federal Stark Law. Any
such finding may have a material adverse impact on our business, financial
conditions or results from operations.
22
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 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 target geographic
markets. We believe that we are in compliance with these laws and intend to
comply with any state and federal laws that may affect our development of
integrated health care delivery networks. Nevertheless, a review of our business
by courts or regulatory authorities could adversely affect our business,
financial condition or results from operations.
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
criminal provisions, which 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.
HIPAA also provided broad prosecutorial subpoena authority and authorized
property forfeiture upon conviction of a federal health care offense.
Significantly, the HIPAA provisions apply not only to federal programs, but also
to private health benefit programs as well. 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. Although we are unaware
of any current violations of HIPAA, the government may in the future seek
penalties against us for violations of HIPAA, which could have a material
adverse effect on business, financial condition or results from operations.
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
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. 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 our current obligations or may otherwise have a material
adverse effect on our business, financial condition and results of operations.
We rely upon reimbursement from government programs for a significant portion of
our revenues, and if reimbursement rates from government programs decline, it
could have a material adverse effect on our business.
We derive approximately 20% of our collections 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 change in reimbursement regulations, policies, practices, interpretations or
statutes that places limitations on reimbursement amounts, or changes in
reimbursement coding, or practices could materially and adversely affect our
business, financial condition and results of operations. Increasing budgetary
pressures at both the federal and state level 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 also
could result in payment reductions. Although governmental payment reductions
have not materially affected us in the past, it is possible that such changes in
the future could have a material adverse effect on our business, financial
condition and results of operations. In addition, Medicare, Medicaid and other
government sponsored health care programs are increasingly shifting to some form
of managed care. Some states have recently enacted legislation to require that
all Medicaid patients be converted to managed care organizations, and similar
legislation may be enacted in other states, which could result in reduced
payments to us for such patients. In addition, a state-legislated shift in a
Medicaid plan to managed care could cause the loss of some, or all, Medicaid
business for us in
23
that state if we were not selected 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,
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.
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 to the extent that we have
relationships with the hospitals being investigated.
Significant media and public attention has been focused on the health care
industry due to ongoing federal and state investigations reportedly related to
certain referral and billing practices, laboratory and home health care services
and physician ownership and joint ventures involving hospitals. Most notably,
HCA is under investigation with respect to such practices. We operate
laboratories on behalf of and have numerous contractual agreements with
hospitals, including 28 pathology service contracts with HCA hospitals as of
March 31, 2001. The government's ongoing investigation of HCA could result in a
governmental investigation of one or more of our operations that have
arrangements with HCA. In addition, the OIG and the Department of Justice have
initiated hospital laboratory billing review projects in certain states and are
expected to extend such projects to additional states, including states in which
we operate hospital laboratories. These projects increase the likelihood of
governmental investigations of laboratories owned and operated by us. 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 have other
effects which could materially and adversely affect us, including termination or
amendment of one or more of our contracts or the sale of hospitals potentially
disrupting the performance of services under such contracts. In addition, in
certain instances indemnity insurers and other non-governmental payors have
sought repayment from providers, including laboratories, for alleged
overpayments.
There has been a heightened scrutiny of Medicare and Medicaid billing practices
in recent years, which may increase our possibility of being subject to costly
investigations.
Payors periodically reevaluate the services they reimburse. 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 have an adverse affect on our revenues and earnings.
Moreover, the federal government has become more aggressive in examining
laboratory billing and seeking repayments and penalties as the result of
improper billing for services (e.g., the billing codes used), regardless of
whether carriers had furnished clear guidance on this subject. 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. Although the
scope of this initiative could expand, it is not possible to predict whether or
in what direction the expansion might occur. We believe that our practices are
proper and do not include any allegedly improper practices now being examined.
However, the government could broaden its initiative to focus on the type of
services furnished by us and, if this were to happen, we might be required to
repay money.
Furthermore, HIPAA and Operation Restore Trust have strengthened the powers of
the OIG and increased the funding for Medicare and Medicaid audits and
investigations. As a result, the OIG is currently 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 such an
investigation, we could be required to change coding practices or repay amounts
paid for incorrect practices either of which could have a material adverse
effect on our business, financial condition and results from operations.
We are dependent on hospital contracts for a significant portion of our
revenues, which are short term and can easily be terminated.
24
Our hospital contracts typically have terms of one to five years from their date
of execution and automatically renew for additional terms of one year unless
otherwise terminated by either party. The contracts generally provide that the
hospital may terminate the agreement prior to the expiration of the initial or
any renewal term. Loss of any particular hospital contract would not only result
in a loss of net revenue to us under that contract, but may also result in a
loss of outpatient net revenue that may be derived from our relationship with
the hospital and its medical staff. Continuing consolidation in the hospital
industry may result in fewer hospitals or fewer laboratories as hospitals move
to combine their operations. As of March 31, 2001, our practices had contracts
with 237 hospitals, of which the majority are exclusive, and 28 of which are
executed with HCA. Such contracts with hospitals may be terminated or may not be
renewed in the future.
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 expect to
continue to pursue growth through the acquisition and development of
laboratories. 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. In addition, since we are a bigger company, the amount that acquired
businesses contribute to our revenue and profits will likely be smaller on a
percentage basis. We also 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. Further, the
businesses we acquire may not perform well enough to justify our investment. If
we are unable to make additional acquisitions on suitable terms, we may not meet
our growth expectations.
Our future growth will depend on our ability to secure adequate capital
resources and to effectively integrate newly acquired practices.
In addition to acquisitions of and affiliations with practices, we intend to
continue to grow through internal expansion. We derive our net revenue from the
net revenue of our practices. Our growth strategy requires: (i) capital
investment; (ii) compliance with present or future laws and regulations that may
differ from those to which we are currently subject; (iii) further development
of our corporate management and operational, financial and accounting resources
to accommodate and manage growth; and (iv) the ability to expand our physician
and employee base and to train, motivate and manage employees. Failure to meet
these requirements could limit our growth potential and may have a material
adverse effect on our business, financial condition and results of operations.
Although we are taking steps to manage our growth, we cannot assure you that we
will be able to do so efficiently or that our growth rate will continue in the
future.
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 have a material adverse effect on the
integration of additional practices and on our financial condition and results
of operations. We cannot assure you that we will be able to maintain or
establish payor and customer relationships, convert management information
systems or integrate new practices into our combined network.
The integration of additional practices typically requires the implementation
and centralization of purchasing, accounting, human resources, management
information systems, cash management and other systems, which may be difficult,
costly and time-consuming. Our operating results 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. Future affiliations could have a
material adverse effect on our business, financial condition and results of
operations, particularly during the period immediately following completion of
such affiliations.
We may inherit significant liabilities from practices that we acquire.
We perform due diligence investigations with respect to potential liabilities of
acquired and affiliated practices and obtain indemnification with respect to
liabilities from the sellers of such practices. Nevertheless, undiscovered
claims may subsequently arise and liabilities for which we become responsible
25
may be material or may exceed either the limitations of any applicable
indemnification provisions or the financial resources of the indemnifying
parties. Furthermore, through our corporate compliance program, we regularly
review each practice's compliance with federal and state health care laws and
regulations and revise, as appropriate, the operations, policies and procedures
of our practices to conform to our policies and procedures and applicable law.
While we believe that the operations of our practices prior to their acquisition
were generally in compliance with such laws and regulations, we cannot assure
you that the prior operations of such practices were in full compliance with
such laws, as such laws may ultimately be interpreted. Moreover, although we
maintain an active compliance program, it is possible that the government might
challenge some of our current practices as not being in full compliance with
such laws. A violation of such laws by a practice could result in civil and
criminal penalties, exclusion of the physician, the practice or us from
participation in Medicare and Medicaid programs and/or loss of a physician's
license to practice medicine.
We have significant contingent liabilities payable to many of the sellers of
practices that we recently acquired.
In connection with our practice acquisitions, we typically agree to pay to
sellers of the practices additional consideration in the form of debt
obligations, payment of which is contingent upon the practice achieving certain
specified profitability criteria over periods ranging from three to five years
from the date of acquisition. The principal amount and accrued interest of the
contingent amount to be paid 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. Lesser amounts of cash would be paid if the
maximum financial criteria are not met. Although we believe that we will be able
to make such cash payments from internally generated funds or proceeds of future
borrowings, we cannot assure you that we will be able to do so. Payments of
these contingent amounts will affect our earnings per share and may cause
volatility in the market price of our common stock. We expect to continue to use
contingent notes as partial consideration for acquisitions and affiliations.
While we believe that the contingent notes do not violate federal or state
"anti-kickback" or "self-referral" statutes, it is nevertheless possible that
such arrangements may get challenged by regulatory authorities seeking to
enforce such laws.
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
$266.0 million at March 31, 2001, representing approximately 45.9% 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 $189.7 million at March 31,
2001, representing approximately 32.7% of our total assets. We amortize goodwill
on a straight-line basis over periods ranging from 15 to 35 years. 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. We cannot assure you that we will ever realize the value of our
intangible assets. Any future determination requiring the write off of a
significant portion of unamortized intangible assets could have a material
adverse effect on our business, financial condition and results of operations.
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. While our
practices have been able to recruit (principally through practice acquisitions)
and retain pathologists, we cannot assure you that we or our practices will be
able to continue to do so successfully or on terms similar to our current
arrangements. The relationship between the pathologists and their respective
local medical communities is important to the operation and continued
profitability of each practice. Loss of one of our pathologists could lead to
the loss of hospital contracts or other sources of revenue that depend on our
continuing relationship with that pathologist. In the event that
26
a significant number of pathologists terminate their relationships with our
practices or become unable or unwilling to continue their employment, or in the
event non-compete agreements with a number of physicians were terminated or
determined to be invalid or unenforceable, our business, financial condition and
results from operation could be materially and adversely affected.
Proposals to reform the health care industry may have a material adverse effect
on our business.
Federal and state governments have recently focused 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. Some of the
proposals under consideration, or others that may be introduced, could, if
adopted, have a material adverse effect on our business, financial condition and
results of operations.
Competition from other providers of pathology services may adversely affect our
business.
Our services include the provision of physician practice management services to
pathology practices and the provision of pathology and cytology diagnostic
services. Competition may result 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
pathology physician practice management companies that may enter our markets,
some of which may have greater financial and other resources than us.
We compete with several companies, and such competition can reasonably be
expected to increase. In addition, companies in other health care segments, such
as hospitals, national clinical laboratories, third party payors, and health
maintenance organizations, many of which have greater financial resources than
us, may become competition in the employment and management of pathology
practices. We compete for acquisitions and affiliations on the basis of our
reputation, management experience, status and resources as a public company and
our focus on anatomic pathology. We cannot assure you that we will be able to
compete effectively, and it is possible that additional competitors will enter
our markets and make it more difficult for us to acquire or affiliate with
practices on favorable terms.
We may be subject to significant professional liability claims and we cannot
assure you that our insurance coverage limits will be sufficient to cover such
claims.
Our business entails an inherent risk of claims of physician professional
liability for acts or omissions of our physicians and laboratory personnel. We
and our physicians periodically become involved as defendants in medical
malpractice lawsuits, some of which are currently ongoing, and are subject to
the attendant risk of substantial damage awards. Generally, we have consolidated
our physician professional liability insurance coverages with the St. Paul Fire
and Marine Insurance Company, whereby each of the pathologists is insured under
claims-made policies with primary limits of $1.0 million per occurrence and $5.0
million in the annual aggregate, and share with us in surplus coverage of up to
$20.0 million in the aggregate. The policy also provides "prior acts" coverage
for each of our physicians with respect to our practices prior to their
acquisition by us. Further, we have provided reserves for incurred but not
reported claims in connection with our claims-made policies. The terms of the
purchase agreements relating to each practice acquisition contain certain
limited rights of indemnification from the sellers of the practices. While we
believe that we have adequate professional liability insurance coverage, we can
give no assurances that a future claim or claims will not be successful and, if
successful, will not exceed the limits of available insurance coverage or that
such coverage will continue to be available at acceptable costs or on favorable
terms. In addition, our insurance does not cover all potential liabilities
arising from governmental fines and penalties, indemnification agreements and
certain other uninsurable losses. A malpractice claim asserted against us, a
management subsidiary, a practice subsidiary, an affiliated practice or an
affiliated physician could, in the event of an adverse outcome exceeding limits
of available insurance coverage, have a material adverse effect on our business,
financial condition and results of operations.
The continued growth of managed care may have a material adverse effect on our
business.
27
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. 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 specified services unless
prior authorization for such services has been obtained and refusing to increase
fees for specified services. The continued growth of the managed care industry
and its continued success in reducing payments to medical service providers
could have a material adverse effect on our business, financial condition and
results of operation.
We could be damaged by the loss of our key personnel.
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 Chief
Medical Officer. The loss of service of any of these persons could have a
material adverse effect on our business, financial condition and results of
operations.
Because of the complex nature of our billing and reimbursement arrangements, we
may be at a greater risk of Internal Revenue Service Examinations.
The Internal Revenue Service, or IRS, conducted an examination of our 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 we
believe that we are in compliance with all applicable IRS rules and regulations,
if the IRS should determine that we are not in compliance in any other years, it
could have a material adverse effect on the our financial position and results
of operations.
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, our common stock, which trades on the Nasdaq
national market, has traded from a low of $8 per share to a high of $26 15/16
per share for the year ended December 31, 2000. We believe that various factors,
such as legislative and regulatory developments, 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.
Anti-Takeover provisions in our charter documents could make it more difficult
for a third party to acquire us.
Certain provisions of our Amended and Restated Certificate of Incorporation,
Amended and Restated Bylaws and Preferred Share Purchase Rights Plan may be
deemed to have anti-takeover effects and may delay, defer or prevent a takeover
attempt that a stockholder might consider in its best interest. Any of these
anti-takeover provisions could lower the value of our common stock.
The Company's business strategy emphasizes growth, which places significant
demands on the Company's financial, operational and management resources and
creates the risk of failing to meet the growth expectations of investors.
The Company's growth strategy includes efforts to acquire and develop new
practices, develop and expand managed care and national clinical lab 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 the Company will not realize an
adequate return on this investment. In addition, the Company's growth may
involve the acquisition of companies, the development of products or services or
the creation of strategic alliances in areas in which the Company does not
currently operate.
28
This would require the Company's management to develop expertise in new areas,
manage new business relationships and attract new types of customers. The
success or failure of the Company's growth strategies is difficult to predict.
The failure to achieve the Company's stated growth objectives or the growth
expectations of investors could disappoint investors and harm the Company's
stock price. There can be no assurance that the Company will be able to
implement its growth strategy successfully or manage its expanded operations
effectively and profitably.
The Company is pursuing a strategy of becoming a fully integrated healthcare
diagnostic information provider, which adds uncertainty to future results of
operations and could divert financial and management resources away from the
Company's core business.
As the Company pursues its transition into becoming a fully integrated
healthcare diagnostic information provider, the Company anticipates that
significant amounts of 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, post-transition
operating costs are difficult to predict with accuracy, thereby adding further
uncertainty to the Company's future results of operations. The Company may
experience difficulties that could delay or prevent the successful development
and introduction of new healthcare diagnostic information products and services
and such products and services may not achieve market acceptance. Any failure by
the Company to complete this transition in a timely and cost-efficient manner
could result in financial losses and could inhibit the Company's anticipated
growth. In addition, the pursuit of this transition could divert financial and
management resources away from the Company's core business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated principally with changes in
interest rates. Interest rate exposure is principally limited to the revolving
loan of $202.0 million at March 31, 2001.
In May 2000, the Company entered into three interest rate swaps transactions
with an effective date of October 5, 2000, variable 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 10/07/04
$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 2.0%. 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 since October 1998 and the current interest rate environment. Beginning
in October 2000, these higher fixed rates will increase the Company's annual
interest cost by approximately $2.7 million. In addition, further tightening of
interest rates by the Federal Reserve will increase the Company's interest cost
on the outstanding balance of the credit facility not subject to interest rate
protection. All of the Company's 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. The
Company uses derivative financial instruments to reduce interest rate volatility
and associated risks arising from the floating rate structure of its credit
facility and 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.
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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. 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 claims, there can be no assurance that the Company's
medical malpractice insurance coverage will be adequate to cover any such
liability. The Company may also, from time to time, be involved with legal
actions related to the acquisition of and affiliation with physician practices,
the prior conduct of such practices, or the employment (and restriction on
competition of) physicians. 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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
There were no shares of Common Stock issued in the first three months of 2001 or
through the date of this report.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.47 Amendment No. 3, dated March 29, 2001, to the Amended and
Restated Credit Agreement dated as of December 16, 1999, among
AmeriPath, Inc., certain of its subsidiaries, Fleet National
Bank (formerly BankBoston N.A.) and certain other lenders
(Incorporated by reference to the exhibit referenced and filed
with AmeriPath Form 8-K, dated March 29, 2001, filed on April
6, 2001.)
(b) Reports on Form 8-K
A Current Report on Form 8-K, dated February 27, 2001, was
filed by the Company with the Securities and Exchange
Commission on March 6, 2001, reporting that on February 27,
2001, the Company held a conference call for investors and
analysts to discuss the Company's financial results for the
fourth quarter and year ended December 31, 2000. During the
call, certain information was provided regarding the Company's
estimated 2001 financial ratios.
A Current Report on Form 8-K, dated March 29, 2001, was filed
by the Company with the Securities and Exchange Commission on
April 6, 2001, reporting that on March 29, 2001, the Company
and its lenders executed an amendment to the Credit Facility
("Amendment No. 3"), which excludes an additional $5.4
million, or $28.3 million in total for all three amendments to
the Credit Facility, 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 will also be required to pay an amendment fee of
up to 30 basis points to those lenders which consented to the
amendment. The maximum amount of the amendment fee would be
$700,000.
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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: May 15, 2001 By: /s/ JAMES C. NEW
------------------------------------
James C. New
Chairman and Chief Executive Officer
Date: May 15, 2001 By: /s/ GREGORY A. MARSH
------------------------------------
Gregory A. Marsh
Vice President and
Chief Financial Officer
31