/FIRST AND FINAL ADD -- DATH008 -- US Oncology Earnings/ Financial
Discussion Introduction The following discussion should be read in
conjunction with the financial information appearing elsewhere in
this release and our filings with the Securities and Exchange
Commission, in particular the "Forward Looking Statements and Risk
Factors" included therein. General We provide comprehensive
services to our network of affiliated practices, made up of more
than 875 affiliated physicians in over 470 sites, with the mission
of expanding access to and improving the quality of cancer care in
local communities. The services we offer include: -- Medical
Oncology Services. We purchase and manage specialty oncology
pharmaceuticals for our affiliated practices. Annually, we are
responsible for purchasing, delivering and managing more than $1.0
billion of pharmaceuticals through a network of 45 licensed
pharmacies, 145 pharmacists and 278 pharmacy technicians. Under our
physician practice management arrangements, we act as the exclusive
manager and administrator of all day-to-day non-medical business
functions connected with our affiliated practices. As such, we are
responsible for billing and collecting for medical oncology
services, physician recruiting, data management, accounting,
systems, and capital allocation to facilitate growth in practice
operations. -- Cancer Center Services. We develop and manage
comprehensive, community-based cancer centers, which integrate all
aspects of outpatient cancer care, from laboratory and radiology
diagnostic capabilities to chemotherapy and radiation therapy as
well as radiation therapy. As of February 25, 2004, we have
developed and operate 78 integrated community-based cancer centers
and manage over one million square feet of medical office space. We
also have installed and manage 23 positron emission tomography
(PET) systems. -- Cancer Research Services. We facilitate a broad
range of cancer research and development activities through our
network. We contract with pharmaceutical and biotechnology firms to
provide a comprehensive range of services relating to clinical
trials. We currently supervise 50 clinical trials, supported by our
network of approximately 470 participating physicians in more than
165 research locations. During 2003, we enrolled over 3,300 new
patients in research studies. We provide these services through two
business models: the physician practice management (PPM) model,
under which we provide all of the above services under a single
contract with one fee based on overall performance; and the service
line model, under which practices contract with the company to
purchase only the pharmaceutical aspects of Medical Oncology
Services and/or Cancer Research Services, each under a separate
contract, with a separate fee methodology for each service. Most of
our revenues (91.1 % during 2003) are derived under the PPM model.
Our Strategy Our mission is to increase access to and advance the
delivery of high- quality cancer care in America. We do this by
empowering physicians, offering them a complete set of services
designed to enable them to provide cancer patients with a full
continuum of care, including professional medical services,
chemotherapy infusion, radiation oncology, diagnostic services,
access to clinical trials, patient education and other services,
primarily in a community setting. We believe that in today's
marketplace, particularly in light of recent reductions in Medicare
reimbursement and continued pressures on overall reimbursement, the
most successful oncology practices will be those that have a
preeminent position in their local market, that are diversified
beyond medical oncology and that have implemented efficient
management. We believe that our services help practices to attain
these characteristics. We intend to intensify our development
efforts and to continue to offer practices and physicians the
opportunity to take advantage of our services through a
comprehensive strategic alliance, encompassing all of the
management services we offer. We believe that our comprehensive
management solution is the best one for most practices. We
previously offered our PPM affiliated practices the option to move
to a less comprehensive, lower cost "service line" option, and
those practices generally have remained on the PPM model. For
medical oncologists who do not wish to obtain comprehensive
management services such as billing and collection and cancer
center diversification opportunities, we offer pharmaceutical
management service as a stand-alone option under our "service line"
structure. Under our pharmaceutical service line offering, we
manage all aspects of the pharmaceutical operations of the
practice, but do not provide other business office services and do
not provide services outside of medical oncology. We also offer our
Cancer Research Services to our pharmaceutical customers under the
service line structure. We no longer offer Cancer Center Services
under the service line model. During the last several years, we
have worked to enhance the platform upon which we expect to build.
Our model conversions and disaffiliations have stabilized our
network to align ours and our affiliated practices' incentives and
better ensure that our economic arrangements are sustainable, as
well as eliminating the distraction of underperforming practices
and assets. Economic Models Most of our revenues (91.1% during
2003) are derived under the PPM model. Under the PPM model, we
provide all of our services to a physician practice under a single
management agreement under which we are appointed the sole and
exclusive business manager, responsible for all of the non-clinical
aspects of the physicians' practice. Our PPM agreements are
long-term agreements (generally with initial terms of 25 to 40
years) and cannot be terminated unilaterally without cause.
Physicians joining the PPM practices are required to enter into
employment or noncompetition agreements with the practice. Prior to
2002, we generally paid consideration to physicians in physician
groups in exchange for the group's selling us operating assets and
entering into such long-term contracts or joining with an already
affiliated group. Historically, we also have helped affiliated
groups expand by recruiting individual physicians without buying
assets or paying consideration for service agreements. During 2002
and 2003, our PPM business expanded solely through such recruitment
(rather than new affiliations involving the purchase of assets and
payment of consideration.) We intend to continue to expand our
business, both by recruiting new physicians and by affiliating with
new groups. We will pay consideration for operating assets of
groups and may, under some circumstances, pay other consideration.
Under most of our PPM agreements, we are compensated under the
"earnings model." Under that model, we are reimbursed for all
expenses we incur in connection with managing a practice, and paid
an additional fee based upon a percentage of the practice's
earnings before income taxes, subject to certain adjustments. 66.7%
of our revenue during 2003 was derived from practices that, as of
December 31, 2003, were operating under agreements on the earnings
model. The remainder of our PPM agreements are under the net
revenue model described below or, in some states, provide for a
fixed management fee. 6.8% of our 2003 revenue was derived under
the service line model. Under our service line agreements, fees
include payment for pharmaceuticals and supplies used by the group,
reimbursement for certain pharmacy related expenses and payment for
the other services we provide. Rates for our services typically are
based on the level of services required by the practice.
Realignment of Net Revenue ModelPractices 24.4% of our 2003 revenue
was derived from practices that, as of December 31, 2003, were
operating under agreements under our "net revenue model." Under the
net revenue model, our fee consists of a fixed amount, plus a
percentage of net revenues, plus, if certain performance criteria
are met, a performance fee. Under these agreements, once we have
been reimbursed for expenses, the practice is entitled to retain a
fixed portion of revenues before any additional service fee is paid
to us. The effect of this priority of payments is that we bear a
disproportionate share of increasing practice costs, since if there
are insufficient funds to pay both our fee and the fixed amount to
be retained by the practice, the entire amount of the shortfall
reduces our management fee. Rapidly increasing pharmaceutical costs
have increased practice revenues and thus the amounts retained by
physicians. At the same time, rising costs have eroded margins,
leaving less available to pay our management fees. The net revenue
model does not appropriately align ours and our practices' economic
incentives, in that the parties do not have similar motivation to
control costs or efficiently utilize capital. For this reason, we
have been seeking to convert netrevenue model practices to the
earnings model since the beginning of 2001. In some cases, net
revenue model practices have converted instead to the service line
model or disaffiliated entirely. 56.3% of our 2000 revenue was
derived from net revenue model practices, while only 24.4% of our
2003 revenue was derived from practices under the net revenue model
as of December 31, 2003. We no longer enter into new affiliations
under the net revenue model. Since December 31, 2003, and through
February 25, 2004, we have converted three practices under the net
revenue model, representing 6.2% of our 2003 revenue, to the
earnings model. We will continue to attempt to convert the
remaining net revenue model practices. Conversions and
disaffiliations havehelped to stabilize our operating platform. The
percentage of Field EBITDA that we retained as management fees (not
including reimbursement for practice expenses) declined from 42% in
1999 to 38% in 2000 and 35% in 2001. With the implementation of our
realignment strategy, the percentage of Field EBITDA has been
steady, at 34% in both 2002 and 2003. Since announcing our
initiative to convert practices away from the net revenue model in
November 2000, we have recorded charges of $251.3 million relating
to impairment of net revenue model practices resulting either from
termination of those agreements or the determination that their
carrying values were not recoverable. As of December 31, 2003, only
one net revenue model service agreement, with a carrying value of
$22.5 million was reflected on our balance sheet. The table below
summarizes our transitional activities in (i) converting net
revenue model practices to the earnings model, (ii) converting PPM
practices to the service line model; (iii) adding new service line
practices and (iv) terminating affiliations with PPM practices: Jan
1. - Feb. 25, 2004 2003 Practices Physicians Practices Physicians
Conversions from net revenue to earnings model 3 42 1 8 Conversions
from PPM model to service line model --- --- 2 27 New service line
model affiliations 2 3 9 45 Disaffiliations 2 2 3 62(A) 2002
Practices Physicians Conversions from net revenue to earnings model
5 59 Conversions from PPM model to service line model 3 23 New
service line model affiliations 3 23 Disaffiliations 4 23 (A) 39 of
these physicians were a group of diagnostic radiologists that we
disaffiliated with because their non-oncology practice was not
consistent with our overall strategy. Not reflected in the table is
a practice comprising four physicians that converted from the
service line model to the earnings model PPM during 2003. Key
Operating Trends and Market Conditions During 2003, the most
important event relative to our business wasthe enactment of the
Medicare Modernization Act of 2003. The new law will significantly
reduce Medicare reimbursement for outpatient oncology services in
2005 and beyond. We view this as both a challenge and an
opportunity. We will need to continue to deliver substantial value
to our physician practices. As the reimbursement reductions impact
our affiliated physician groups, they may increasingly scrutinize
the level of fees paid to us. On the other hand, the services we
provide permit physiciansto address the financial pressures caused
by reimbursement reform, by implementing effective management and
diversifying their services beyond medical oncology. Against the
backdrop of reduced government reimbursement, pharmaceutical costs
continue torise. For the last several years, pharmaceutical costs
have represented a higher percentage of revenue than the previous
year. This trend shows no signs of abating. As new, single source
therapies continue to be introduced, we would expect pharmaceutical
costs to continue to rise. We must continue to adopt strategies to
mitigate this increase, particularly in light of reduced
reimbursement. The new basis for reimbursement for pharmaceuticals
under Medicare may also create challenges for us in our attempt to
continue to obtain market-differentiated pricing for drugs. We also
continue to see other practice expenses, particularly for qualified
technical and clinical personnel, rise at a rate faster than
inflation. Our liquidity remains strong. As of December 31, 2003,
we had $124.5 million in cash and cash equivalents and $268.2
million of indebtedness outstanding. Cash flow remained strong
during 2003 at $231.3 million, and we anticipate that we will
generate adequate cash from operations to fund capital expenditures
in the near term. The leasing facility we used to finance many of
our cancer centers matures in June 2004. As of February 25, 2004,
the outstanding balance on that facility was $69.5 million. Other
than a potential payment on the leasing facility at maturity, we
currently have no other material contractual cash commitments
outside of the course of operations upcoming during 2004. Critical
Accounting Policies and Estimates Our discussion and analysis of
our financial condition and results of operations are based upon
our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States (GAAP). The preparation of these financial statements
requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an
ongoing basis, we evaluate these estimates, including those related
to service agreements, accounts receivable, intangible assets,
income taxes, and contingencies and litigation. We base our
estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. These
estimates form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from those estimates under
different assumptions or conditions. Management believes the
following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its consolidated
financial statements. Revenue Our consolidated financial statements
include only the results of US Oncology, Inc. and its wholly owned
subsidiaries. We do not include the results of our affiliated
practices (and the amounts they retain for physician compensation),
since we have determined that our relationships with the practices
under our service agreements do not warrant consolidation under the
applicable accounting rules. However, we do include all practice
expenses (other than physician compensation) of our PPM practices
in our financial statements, since we are legally obligated for
these costs under our service agreements. This policy means that
trends in, and effects of, the compensation levels of our
affiliated physicians are not readily apparent from our statements
of operations and comprehensive income. However, as our discussion
regarding conversions from the net revenue model emphasizes, the
relationship between net patient revenue and our revenue is
important in understanding our business. For this reason, we
include information regarding net patient revenue and amounts
retained by physicians in this report and in the notes to our
consolidated financial statements. We record net patient revenue
for services to patients at the time those services are rendered,
based upon established or negotiated charges, reduced by
management's judgment as to allowances for accounts that may be
uncollectible. When final settlements of the charges are
determined, we report adjustments for any differences between
actual amounts received and our estimated adjustments and
allowances. These adjustments can result in decreased net patient
revenues due to a number of factors, such as changes in
reimbursement rates by payors or a deterioration in the financial
condition of payors or patients which decreases their ability to
pay. Our estimate may, at times, lag in taking into account
reductions in reimbursement. We are ensuring that our estimate will
take into account recent Medicare reductions. However, to the
extent there is a significant and uniform decrease in other payors'
reimbursement, our estimate may not reflect fully such decrease on
a timely basis. We calculate our revenue by reducing net patient
revenue by the amount retained by the practices, primarily for
physician compensation. We recognize service fees as revenue when
the fees are earned and deemed realizable based upon our agreements
with the practices, taking into account the priority of payments
for amounts retained by net revenue model practices. The amount
retained by practices is also subject to the foregoing estimates,
since it is based upon our estimates of revenue and earnings of the
practice. Accounts Receivable To the extent we are legally
permitted to do so, we purchase from our PPM affiliated practices
the accounts receivable those practicesgenerate by treating
patients. We purchase the accounts for their net realizable value,
which in management's judgment is our estimate of the amount that
we can collect, taking into account contractual agreements that
would reduce the amount payable and allowances for accounts that
may otherwise be uncollectible. If we determine that accounts are
uncollectible after we have purchased them from a practice, our
contracts require the practice to reimburse us for the additional
uncollectible amount. However, such a reimbursement to us would
also reduce the practice's revenue for the applicable period, since
we base net patient revenue on the same estimates we use to
determine the purchase price for accounts receivable. Such a
reduction would reducephysician compensation and, because our
management fees are partly based upon practice revenues, would also
reduce our future service fees. Typically, the impact of these
adjustments on our fees is not significant. Reimbursement rates
relating to health care accounts receivable, particularly
governmental receivables, are complex and change frequently, and
could in the future adversely impact our ability to collect
accounts receivable and the accuracy of our estimates. Depreciation
Our property and equipment are stated at cost. Depreciation of
property and equipment is provided using the straight-line method
over the estimated useful lives of (a) three to ten years for
computers and software, equipment, and furniture and fixtures, (b)
the lesser of ten years or the remaining lease term for leasehold
improvements and (c) twenty-five years for buildings. Interest
costs incurred during the construction of major capital additions,
primarily cancer centers, are capitalized. These lives reflect
management's best estimate of the respective assets' useful lives
and subsequent changes in operating plans or technology could
result in future impairment charges to these assets. Amortization
Relating to Service Agreements Our balance sheet includes
intangible assets related to our service agreements under the PPM
model. These intangible assets consist of the costs of purchasing
the rights to manage our PPM practices. We did not record any
additional intangible assets on our balance sheet in respect of
service agreements during 2002 or 2003. We amortize these assets
over 25 years. Amortization of service agreements is included in
our income statement in the line item "Depreciation and
amortization." We recognized amortization expense relating to
service agreements of $17.1 million in 2002 and $13.3 million in
2003. The reduction in amortization was caused by impairments of
intangible assets described below. Impairment of Assets The
carrying values of our fixed assets are reviewed for impairment
when events or changes in circumstances indicate their recorded
cost may not be recoverable. If the review indicates that the
undiscounted cash flows from operations of the related fixed assets
over the remaining useful life are expected to be less than the
recorded amount of the assets, our carrying value of the asset will
be reduced to its estimated fair value using expected cash flows on
a discounted basis. Impairment analysis is highly subjective.
Assumptions regarding future growth ratesand operating expense
levels as a percentage of revenue can have significant effects on
the expected future cash flows and ultimate impairment analysis. As
a result of such analysis, we recorded a charge of $27.6 million
during the fourth quarter of 2002 to reflect our estimation that
certain of our cancer center assets had become impaired. There was
no such impairment charge during 2003. Our balance sheet includes
intangible assets related to our service agreements, which reflect
our costs of purchasing the rights to manage our affiliated
practices. During each period, we review the carrying value of our
service agreements, particularly when changes in circumstances
suggest that the amount reflected on our balance sheet may not be
recoverable.In this review, we deem the amount of a service
agreement asset to be unrecoverable if we anticipate that the
undiscounted cash flows from the relevant service agreement over
its remaining life will be less than the amount on the balance
sheet. If in management's judgment the carrying value of a service
agreement is not recoverable, we reduce the value of that asset on
our books to equal our estimate of discounted future cash flows
from that service agreement. In estimating future cash flows,
management considers past performance as well as known trends that
are likely to affect future performance. As disclosed in "Forward
Looking Statements and Risk Factors," there are a number of factors
we cannot accurately predict that could impact practiceperformance
and that could cause our assessment of cash flows to be incorrect.
In addition, we have to make judgments about the timing and amounts
of those reductions, which are known as impairment charges, and
those reductions also reduce our income. In the same fashion, when
we determine that termination of a service agreement is likely, we
reduce the carrying value of certain assets related to that service
agreement to reflect our judgment of reductions in the value of
those assets. In doing so, we take into account amounts we
anticipate recovering in connection with that termination as part
of our estimation of future cash flows to be realized from the
related assets. Amounts we may deem recoverable in connection with
a termination include estimates of amounts a practice will pay us
to buy its operating assets and working capital and, in some cases,
may include liquidated damages or termination fees. Because
contract terminations are negotiated transactions, these estimates
are subject to uncertainties and third party behavior, which we may
not accurately predict. We do not have the right to unilaterally
terminate our service agreements without cause, and we will not
terminate an agreement (absent cause) unless we are able to
negotiate an acceptable settlement of the agreement. Sometimes we
may change our determination as to whether or not we are likely to
terminate an agreement due to changes in circumstances. We
periodically assess those agreements that we have determined are
likely to be terminated to verify that such termination is still
likely. In addition, at the time an agreement is terminated, we
recognize a charge, if necessary, to eliminate any remaining
carrying value for that agreement and certain related assets from
our balance sheet. Since the fourth quarter of 2000, we have
recorded charges of $251.3 million relating to the impairment of
service agreements, either as a result of our economic analysis or
termination of the agreement. These charges have reduced net income
(or increased net loss) in the periods in which termination became
likely or the asset otherwise became impaired. However, the
reduction in value of service agreements reflected on our balance
sheet also has the effect of reducing amortization expense relating
to service agreements going forward. From time to time, the
Financial Accounting Standards Board, the Securities and Exchange
Commission and other regulatory bodies seek to change accounting
rules, including rules applicable to our business and financial
statements. We cannot assure you that future changes in accounting
rules would not require us to make restatements. Discussion of
Non-GAAP Information In this release, we use certain measurements
of our performance that are not calculated in accordance with GAAP.
These non-GAAP measures are derived from relevant items in our GAAP
financials. A reconciliation of each non-GAAP measure to our income
statement is included in this report. Management believes that the
non-GAAPmeasures we use are useful to investors, since they can
provide investors with additional information that is not directly
available in a GAAP presentation. In all events, these non- GAAP
measures are not intended to be a substitute for GAAP measures,and
investors are advised to review such non-GAAP measures in
conjunction with GAAP information provided by us. The following is
a discussion of these non- GAAP measures. "Net operating revenue"
is our revenue, plus amounts retained by our affiliated physicians.
We believe net operating revenue is useful to investors as an
indicator of the overall performance of our network, since it
includes the total revenue of all of our PPM practices and other
business lines, without taking into account what portion of that is
retained as physician compensation. In addition, by comparing
trends in net operating revenue to trends in our revenue, investors
are able to assess the impact of trends in physician compensation
on our overall performance. "Net Patient Revenue" is the net
revenue of our affiliated practices under the PPM model for
services rendered to patients by those affiliated practices. Net
patient revenue is the largest component (92.1% in 2003) of net
operating revenue. It is a useful measure because it gives
investors a sense of the overall operations of our PPM network in
which we are responsible for billing and collecting such amounts.
"EBITDA" is earnings before interest, taxes, depreciation and
amortization, loss on early extinguishment of debt, and impairment,
restructuring and other charges. EBITDA also excludes a loss on
sale of assets during 2003. We believe EBITDA is a commonly applied
measurement of financial performance. We believe EBITDA is useful
to investors because it gives a measure of operational performance
without taking into account items that we do not believe relate
directly to operations -- such as depreciation and amortization,
which are typically based on predetermined asset lives, and thus
not indicativeof operational performance, or that are subject to
variations that are not caused by operational performance -- such
as tax rates or interest rates. We exclude impairment charges
during 2002 because they are non-cash charges, which relate
primarily toour repositioning during the last several years and to
net-revenue model practices, which we do not believe are indicative
of the ongoing performance of the business. Likewise, the loss on
sale of assets during 2003 is a non-cash item, incurred as part of
our overall repositioning strategy. Restructuring and other charges
are excluded from EBITDA because we do not believe they reflect
ongoing business performance. EBITDA is a key tool used by
management in assessing our business performance both asa whole and
with respect to individual sites or product lines. "Field EBITDA"
is EBITDA plus physician compensation and corporate and
administrative expenses. Like net operating revenue, Field EBITDA
provides an indication of our overall network operation
performance, without taking into account the effect of physician
compensation. Corporate general and administrative expenses are
included because they are not indicative of field performance. The
remaining exclusions are discussed above in the definition of
EBITDA. Results of Operations We were affiliated (including under
the service line structure) with the following number of physicians
by specialty as of December 31, 2003 and 2002: December 31, 2003
2002 Medical oncologists 743 685 Radiation oncologists 117 120
Diagnostic radiologists/other oncologists 37 79 897 884 The
following table sets forth sources of the growth of the number of
physicians affiliated with us: Year Ended December 31, 2003 2002
Affiliated physicians, beginning of period 884 868 Physician
practice affiliations 45 23 Recruited physicians 79 73 Physician
practice separations (62) (23) Retiring/Other (49) (57) Affiliated
physicians, end of period 897 884 In 2003 and 2002, all new
practice affiliations were under the service line. The following
table sets forth the number of cancer centers and PET systems
managed by us as of February 25, 2004 and December 31, 2003 and
2002: February 25, December 31, 2004 2003 2002 Cancer Centers,
beginning of period 78 79 77 Cancer Centers opened 1 4 5 Cancer
Centers closed (1) (1) (2) Cancer Centers disaffiliated --- (4) (1)
Cancer Centers, end of period 78 78 79 PET Systems 23 21 16 The
following table sets forth the key operating statistics as a
measure of the volume of services provided by our PPM practices:
Year Ended December 31, 2003 2002 Medical oncology visits 2,415,212
2,405,377 Radiation treatments 644,639 658,368 PET scans 20,052
12,777 New patients enrolled in research studies 3,388 3,202 The
following table sets forth the percentages of revenue represented
by certain items reflected in our Consolidated Income Statement.
The following information should be read in conjunction with our
consolidated financial statements and notes thereto. Year Ended
December 31, 2003 2002 Revenue 100.0% 100.0% Operating expenses:
Pharmaceuticals and supplies 57.4 52.5 Field compensation and
benefits 18.220.6 Other field costs 10.1 11.7 General and
administrative 3.5 3.8 Impairment, restructuring and other charges,
net 0.1 9.1 Depreciation and amortization 3.8 4.4 Income (loss)
from operations 6.9 (2.1) Interest expense, net (1.0) (1.3) Loss on
early extinguishment of debt ---(0.8) Income (loss) before income
taxes 5.9 (4.2) Income tax benefit (provision) (2.3) 1.4 Net income
(loss) 3.6% (2.8)% 2003 Compared to 2002 Net Operating Revenue. Net
operating revenue includes two components -- net patient revenue
and our other revenue: The following table shows the components of
our net operating revenue for the years ended December 31, 2003 and
2002 (in thousands): Year Ended December 31, 2003 2002 Net patient
revenue $2,301,202 $2,042,885 Other revenue 198,740 83,361 Net
operating revenue $2,499,942 $2,126,246 Net Patient Revenue. Under
our PPM model, we are responsible for billing and collecting all
practice revenues. We disclose "netpatient revenue" to give you a
sense of the size and operating trends of the business which we
manage. Net patient revenue comprises all of the revenues for which
we bill and collect for affiliated practices under the PPM model.
We collect all of thereceivables, control cash management functions
and are responsible for paying all expenses at our PPM practices.
We retain all the amounts we collect in respect of practice
receivables. On a monthly basis, we calculate what portion of
revenues our practices are entitled to retain by subtracting our
accrued fees and accrued practice expenses from accrued revenues.
We pay practices this remainder in cash, which they use primarily
for physician compensation. These amounts we remit to physician
groupsare excluded from our revenue, since they are not part of our
fees. By paying physicians on a cash basis for accrued amounts we
finance their working capital. Net patient revenue is recorded when
services are rendered based on established or negotiated charges
reduced by contractual adjustments and allowances for doubtful
accounts. Differences between estimated contractual adjustments and
final settlements are reported in the period when final settlements
are determined. Other Revenue. Our other revenues are primarily
derived in three areas: -- Service line fees. In the medical
oncology services area under our service line agreements, we bill
practices on a monthly basis for services rendered. These revenues
include payment for all of the pharmaceutical agents used by the
practice for which we must pay the pharmaceutical manufacturers,
and a service fee for the comprehensive pharmaceutical management
services we provide. -- GPO and data fees. We receive fees from
pharmaceutical companies for acting as a group purchasing
organization (GPO) for our affiliated practices, as well as for
providing informational and other services to pharmaceutical
companies. GPO fees are typically based upon the volume of drugs
purchased by the practices. Fees for other services include amounts
paid for data we collect and compile and fees paid to us for
assistance in launching new products. -- Research fees. We receive
fees for research services from pharmaceutical and biotechnology
companies. These fees are separately negotiated for each study and
typically include some management fee, as well as per patient
accrual fees and fees for achieving various study milestones. Net
operating revenue is reduced by amounts retained by the practices
under our service agreements to arrive at the amount we report as
revenue in our financial statements. Net operating revenue
increased from $2,126.2 millionin 2002 to $2,499.9 million in 2003,
an increase of $373.7 million, or 17.6%. Same practice net
operating revenue (which excludes the results of practices with
which we disaffiliated since January 1, 2002) increased from
$2,031.8 million in 2002 to $2,486.7 million in 2003, an increase
of $454.9 million, or 22.4%. The following table shows net
operating revenue by segment for the year ended December 31, 2003
and 2002 (in thousands): Year Ended Year Ended December 31,
December 31, 2003 2002 Medical oncology services $2,123,203
$1,758,626 Cancer center services 317,588 304,477 Other 59,151
63,143 $2,499,942 $2,126,246 Medical oncology net operating revenue
increased from $1,759 million in 2002 to $2,123 million in 2003, an
increase of 20.7%. The increase in medical oncology net operating
revenue is attributed to an increased in pharmaceutical revenues,
as well as the addition of 124 physicians. Cancer center net
operating revenue increased from $304.5 million to $317.6 million,
an increase of 4.3%. Cancer center revenue increased as a result of
the addition of 23 IMRTs, the opening of four cancer centers and an
increase in PET scans of 56.9% over prior year. Growth of the
cancer center net operating revenue was partially offset by the
closing of one cancer center in 2003 and two cancer centers in
2002. Radiation treatments per day decreased from 2,592 to 2,538,
while same store radiation treatments per day increased from 2,496
to 2,502. PET scans increased from 12,777 in 2002 to 20,052 in
2003, an increase of 56.9%, which was attributable to an increase
in same-facility PET scans per day of 29.1% and the addition of
four PET systems during 2002 and five during 2003. Currently 93.9%
of our net operating revenue is derived under the PPM model.
Revenue. Our revenue is net operating revenue, less the amount of
net operating revenue retained by our affiliated practices under
PPM service agreements. The following presents the amounts included
in the determination of our revenue (in thousands): Year Ended
December 31, 2003 2002 Net operating revenue $2,499,942 $2,126,246
Amounts retained by practices (534,217) (477,345) Revenue
$1,965,725 $1,648,901 Amounts retained by practices increased from
$477.3 million in 2002 to $534.2 million in 2003, an increase of
$56.9 million, or 11.9%. Such increase in amounts retained by
practices is directly attributable to the growth in net patient
revenue combined with the increase in profitability of affiliated
practices. Amounts retained by practices as a percentage of net
operating revenue decreased from 22.5% to 21.4% in 2003, as a
result of our realignment of net revenue model practices throughout
2002 and 2003. Revenue increased from $1,648.9 million in 2002 to
$1,965.7 million in 2003, an increase of $316.8 million, or 19.2%.
Revenue growth was primarily caused by increases in revenues
attributable to pharmaceuticals and the addition of physicians. The
following table shows our revenue by segment for the years ended
December 31, 2003 and 2002 (in thousands): Year Ended Year Ended
December 31, December 31, 2003 2002 Medical oncology services
$1,683,854 $1,382,412 Cancer center services 224,136 208,195 Other
57,735 58,294 $1,965,725 $1,648,901 Medicare is the practices'
largest payor. During 2003, approximately 41% and 3%, of the
practices' net patient revenue was derived from Medicare and
Medicaid payments respectively and 41% and 2%, respectively, was so
derived in the previous year. This percentage varies among
practices. Medicare and Medicaid generally reimburse at lower rates
than commercial payors, so this percentage increase adversely
affects our margins. No other single payor accounted for more than
10% of our revenues in 2003 and 2002. Texas Oncology, P.A., an
affiliated oncology practice with locations throughout Texas under
the earnings model, is our largest oncology group, accounting for
approximately 25% of our revenues in 2003 and 2002. No other
practice accounts for more than 10% of our revenue. Pharmaceuticals
and Supplies. Pharmaceuticals and supplies expense, which includes
drugs, medications and other supplies used by the practices,
increased from $866.4 million in 2002 to $1,128.5 million in 2003,
an increase of $262.2 million, or 30.3%. As a percentage of
revenue, pharmaceuticals and supplies increased from 52.5% in 2002
to 57.4% in 2003. The increase was primarily attributableto an
increase in the percentage of our revenue attributable to
pharmaceuticals as a result of increased use of supportive care
drugs and utilization of more expensive chemotherapy agents. Such
increases were partially offset by more favorable drug pricing with
respect to certain drugs. As long as pharmaceuticals continue to
become a larger part of our revenue mix as a result of changing
usage patterns (rather than growth of our business), we believe
that our overall margins will continue to be adversely impacted. In
addition, the pharmacy service line is a lower-margin business than
our PPM model. We believe the service line model reduces risk in
certain respects, since our compensation is not directly based on
physician reimbursement and capital requirements are lower.
However, to the extent we add additional service line practices
under the pharmacy service line, we would expect our overall
margins to be adversely impacted. The Medicare Modernization Act is
expected to lower pharmaceutical margins. The new reimbursement
methodology under that act may also make certain of our strategies,
such as obtaining favorable pricing from pharmaceutical
manufacturers, more difficult to sustain. General and
Administrative. General and administrative expenses increased from
$63.2 million in 2002 to $68.4 million in 2003, an increase of $5.2
million, or 8.2%. We incurred strategic planning and lobbying costs
of approximately $2.1 million in 2003 in connection with the
Medicare legislation. We anticipate incurring additional general
and administrative costs during early 2004, as we add additional
resources in our sales and marketing areas to strengthen our
business development. As a percentage of revenue, general and
administrative costs decreased from 3.8% in 2002 to 3.5% in 2003.
Other. Our other operational costs in the field increased as a
result of expansion of services and inflation, partially offset by
our efficiency enhancements. In addition, Field Compensation and
Benefits costs have risen as a result of increases in compensation
rates to address shortages of certain key personnel such as
oncology nurses and radiation and radiology physicists,
dosimetrists and technicians. We expect this shortage will continue
to make recruitment efforts difficult and make it difficult for us
to contain these costs in the future. These other costs decreased
as a percentage of revenue because revenues (and expenses)
attributable to pharmaceuticals are increasing at a more rapid rate
than these expenses and other aspects of our business. However, we
have been successful at controlling overall non-drug costs.
Expenses other than pharmaceuticals and supplies as a percentage of
revenue decreased from 40.5% in 2002 to 35.6% in 2003 as a result
of our cost containment efforts both in the field and at the
corporate level. Overall, we experienced slightly lower operating
margins from 2002 to 2003, with EBITDA as a percentage of revenue,
decreasing from 11.3% in 2002 to 10.7% in 2003. Such decrease is
attributable to the growth in pharmaceuticals as a percentage of
our revenue and related pharmaceutical expenses and, to a lesser
extent, the growth in affiliated practices under the service line
model. The table below presents information about reported segments
for the years ended December 31, 2003 and 2002 (in thousands): Year
ended 2003: Unallocated General Medical Cancer Administrative
Oncology Center Expenses and Services Services Other Charges Total
Net operating revenue $2,123,203 $317,588 $59,151 $--- $2,499,942
Amounts retained by affiliated practices (439,349) (93,452) (1,416)
--- (534,217) Revenue 1,683,854 224,136 57,735 --- 1,965,725
Operating expenses (1,483,215) (182,894) (95,082) (70,093)
(1,831,284) Income (loss) from operations 200,639 41,242 (37,347)
(70,093) 134,441 Depreciation and amortization 114 29,335 44,629
--- 74,078 Impairment, restructuring and other charges --- --- ---
1,6521,652 EBITDA $200,753 $70,577 $7,282 $(68,441) $210,171 Year
ended 2002: Unallocated General Medical Cancer Administrative
Oncology Center Expenses and Services Services Other Charges Total
Net operating revenue $1,758,626 $304,477 $63,143 $--- $2,126,246
Amounts retained by affiliated practices (376,214) (96,282) (4,849)
--- (477,345) Revenue 1,382,412 208,195 58,294 --- 1,648,901
Operating expenses (1,204,072) (164,245) (102,367) (213,289)
(1,683,973) Income (loss) from operations 178,340 43,950 (44,073)
(213,289) (35,072) Depreciation and amortization 190 19,889 51,780
--- 71,859 Impairment, restructuring and other charges --- --- ---
150,060 150,060 EBITDA $178,530 $63,839 $7,707 $(63,229) $186,847
EBITDA in Medical Oncology increased primarily as a result of
growth in revenue. Medical Oncology EBITDA margin decreased from
10.2% in 2002 to 9.5% in 2003, primarily as a result of increased
use of lower-margin drugs. EBITDA in Cancer Center Services
increased primarily as a result of growth in revenue. Cancer Center
Services EBITDA margin increased from 21.0% in 2002 to 22.2% in
2003. Impairment, Restructuring and Other Charges. During 2003, we
recognized restructuring and other charges of $1.7 million, net;
and during 2002, we recognized impairment, restructuring and other
charges of $150.1 million, net as follows (in thousands): Year
Ended December 31, 2003 2002 Impairment charges $--- $135,147
Restructuring charges 900 3,825 Other charges 752 11,088 Total
$1,652 $150,060 The following is a detailed description of the
charges during 2003 and 2002 (in thousands): Year Ended December
31, 2003 2002 Impairment charges Write-off of service agreements
$--- $113,197 Impairment of cancer center fixed assets --- 27,603
Gain on sale of practice assets --- (5,653) Restructuring charges
Personnel reduction costs 900 2,381 Consulting costs for
implementing service line --- 1,444 Other charges Write-off of an
affiliate receivable --- 11,088 Other 752 --- $1,652 $150,060
Impairment Charges During 2002, we recognized (a) a non-cash pretax
charge of $5.2 million in the fourth quarter related to impairment
of a service agreement under which we had significantly reduced the
scope of our services during the year, based upon our analysis of
future cash flows under likely future scenarios for that agreement;
(b) a non-cash, pretax charge of $68.3 million during the third
quarter comprising (i) a $13.0 million charge related to a PPM
service agreement that was terminated in connection with conversion
to the service line model, (ii) a $51.0 million charge related to
three net revenue model service agreements that became impaired
during the third quarter based upon our analysis of projected cash
flows under those agreements, taking into account developments in
those markets during the third quarter and (iii) a $4.3 million
charge related to a group of physicians under a net revenue model
service agreement with which we disaffiliated during the third
quarter; and (c) a non-cash, pretax charge of $39.7 million during
the second quarter comprising (i) a $33.8 million charge related to
a net revenue model service agreement that became impaired during
the second quarter based upon our analysis of projected cash flows
under that agreement, taking into account developments in that
market during the second quarter and (ii) a $5.9 million charge
related to two PPM service agreements that were terminated in
connection with conversions to the service line model. During the
fourth quarter of 2002, we recognized a charge of $27.6 million
related to impairment of fixed assets. This charge was based on our
estimate of future cash flows from our cancer center assets, taking
into account developments during the fourth quarter of 2002. All of
the impaired cancer centers were at practices that had been on the
net revenue model at the outset of center development. In assessing
likely future performance, we make estimates of the likelihood and
impact of possible operational improvements, as well as looking at
existing performance. If we have made a determination to dispose of
a center, our valuation is based upon the value of that
disposition. In making estimates regarding possible improvements in
performance, we take into consideration the economic arrangement
with the practice, as well as certain qualitative considerations
regarding the continued growth prospects of the practice, internal
practice management, and our relationship with the practice. The
$5.6 million net gain on sale of practice assets during 2002
consisted of a $3.6 million net gain on sale of practice assets
during the third quarter comprising (a) net proceeds of $4.9
million paid by converting and disaffiliating physicians; (b) a
$0.3 million net recovery of working capital assets, partially
offset by a $1.1 million net charge arising from our accelerating
consideration that would have been due to physicians in the future
in connection with those transactions; and (c) a $2.0 million net
gain on sale of practice assets during the second quarter. During
that quarter, we terminated a service agreement as it related to
certain radiology sites and sold the related assets, including the
rightto future revenues attributable to radiology technical fee
revenue at those sites, in exchange for delivery to us of 1.1
million shares of our common stock. In connection with that sale,
we also recognized a write-off of a receivable of $0.6 million due
from the physicians and made a cash payment to the buyer of $0.6
million to reflect purchase price adjustments during the third
quarter. The transaction resulted in a $3.9 million gain based on
the market price of our Common Stock as of the date of the
termination. This gain was partially offset by a $1.9 million net
impairment of working capital assets relating to service line
conversions, disaffiliations and potential disaffiliations.
Restructuring Charges During the fourth quarter of 2003, we
recognized restructuring charges of $0.9 million relating to
personnel reductions, of which $0.6 million was paid in 2003. In
connection with our focus on internal operations and cost
structure, management commenced an initiative to further centralize
certain accounting and financial reporting functions at our
corporate headquarters in Houston, Texas, resulting in charges for
personnel reduction costs of $2.4 million in 2002, all of which was
paid in 2002. During 2002, we also recognized restructuring charges
of $1.4 million in consulting fees related to its introduction of
the service line model. Other Charges During 2003, we recognized a
net charge of $0.8 million consisting of a $1.8 million loss on the
sale of a cancer center partially offset by a gain of $1.0 million
relating to lower than expected losses resulting from the
bankruptcy of one of our insurance carriers. During the third
quarter of 2002, we recognized an $11.1 million write-off of an
$11.1 million receivable due to us from one of our affiliated
practices. In the course of our PPM activities, we advance amounts
to physician groups and retain fees based upon our estimates of
practice performance. Subsequent events and related adjustments may
result in the creation of a receivable with respect to certain
amounts advanced. During the third quarter of 2002, we made the
determination that such amounts owed by physician practices to us
had become uncollectible due to, among other things, the age of the
receivable and circumstances relating to practice operations.
Interest. Net interest expense decreased from $21.3 million in 2002
to $19.5 in 2003, a decrease of $1.8 million or 8.5%. As a
percentage of revenue, net interest expense decreased from 1.3% in
2002 to 1.0% in 2003. On February 1, 2002, we refinanced our
indebtedness by issuing $175 million in 9.625% Senior Subordinated
Notes due 2012, repaying in full our existing Senior Secured Notes
and terminating our existing credit facility. Our previously
existing $100 million Senior Secured Notes bore interest at a fixed
rate of 8.42% and would have required a $20 million repayment of
principal in each of the years 2002 through 2006. Higher levels of
debt during 2002, as compared to 2003, contributed to the decrease
in interest expense. Income Taxes. For 2003, we recognized a tax
provision of $44.3 million, resulting in an effective tax rate of
38.5% compared to a tax benefit of $24.1 million in 2002, resulting
in an effective tax rate of 34.4% for the sameprior year period.
The tax benefit is a result of the impairment and restructuring
charges discussed above. The effective tax rate in 2002 reflects
management's estimate of the limited extent to which we will be
able to deduct the impairment, restructuring and other charges at
the state level. Loss on Early Extinguishment of Debt. During the
first quarter of 2002, we recorded a loss of $13.6 million, before
income taxes of $5.2 million, in connection with the early
extinguishment of our $100 million Senior Secured Notes due 2006
and our existing credit facility. The loss consisted of payment of
a prepayment penalty of $11.7 million on the Senior Secured Notes
and a write-off of unamortized deferred financing costs of $1.9
million related to the terminated debt agreements. Net Income (Net
Loss). Net income increased from a loss of $(45.9) million, or
$(0.47) per diluted share, in 2002 to net income of $70.7 million,
or $0.77 per share, in 2003, an increase of $116.6 million.
Included in netincome for 2002 are pre-tax impairment,
restructuring and other charges of $150.1 million and a pre-tax
loss on early extinguishment of debt of $13.6 million. Excluding
the loss on early extinguishment of debt and the impairment,
restructuring and other charges, net income for 2002 would have
been $58.1 million, which represents earnings per share of $0.59.
Liquidity and Capital Resources As of December 31, 2003, we had net
working capital of $148.6 million, including cash and cash
equivalents of $124.5 million. We had current liabilities of $397.8
million, including $79.7 million in current maturities of long-term
debt, and $188.4 million of long-term indebtedness. During 2003, we
generated $231.3 million in net operating cash flow, invested $87.6
million, net and used cash from financing activities in the amount
of $94.2 million. As of February 25, 2004, we had cash and cash
equivalents of approximately $150 million. Cash Flows From
Operating Activities During 2003, we generated $231.3 million in
cash flows from operating activities as compared to $150.1 million
in 2002. The increase in cash flow is attributable to (i) advance
purchases of certain pharmaceutical products during 2002 in order
to obtain favorable pricing, (ii) differences in timing of
recognition of tax benefits associated with our model transitional
activity in 2003, and (iii) timing of certain working capital
payments. In addition our increase in cash flows is attributable to
an increase in amounts due to affiliates arising from the timing of
distribution of certain pharmaceutical rebates and payment of
certain management fee rebates to physician practices. Such amounts
were earned in respect of 2003, but will not be paid until 2004.
Our accounts receivable daysoutstanding as of December 31, 2003,
decreased to 46 days from 48 days as of December 31, 2002 and from
50 days as of December 31, 2001. Cash Flows from Investing
Activities During 2003 and 2002, we expended $89.2 million and
$59.1 million in capital expenditures. During 2003 and 2002, we
expended $62.4 million and $34.1 million, respectively, on the
development and construction of cancer centers and PET systems.
Expected capital expenditures on cancer center and PET system
development for 2003 are below forecasted amounts due to our focus
on transitional activity. Maintenance capital expenditures were
$26.8 million and $25.0 million in 2003 and 2002, respectively. For
all of 2004, we anticipate expending a total of approximately
$30-$35 million on maintenance capital expenditures and
approximately $60-70 million on development of new cancer centers
and PET system installations. In addition to these capital
expenditures, we have financed, and will in the future finance,
most of our PET systems investments and a portion of our cancer
center investments through operating leases. Cash Flows from
Financing Activities During 2003, we used cash from financing
activities of $94.2 million as compared to cash used of $19.1
million in 2002. Such decrease in cash used is primarily attributed
to the expenditure of $87.5 million to repurchase 10.2 million
shares of our Common Stock during 2003. We currently expect that
our principal use of funds in the near future will be in connection
with thepurchase of medical equipment, investment in information
systems and the acquisition or lease of real estate for the
development of integrated cancer centers and PET systems. In
addition, we anticipate that from time to time we will make
significant purchases of pharmaceuticals in excess of normal
patterns to take advantage of available volume discounts and
rebates. Although we expect to fund our capital needs during 2004
with our available cash and cash generated from operations, in the
future, wemay have to incur additional debt or issue additional
debt or equity securities from time to time. Capital available for
health care companies, whether raised through the issuance of debt
or equity securities, is quite limited. As a result, we may be
unable to obtain sufficient financing on terms satisfactory to
management or at all. On February 1, 2002, we entered into a
five-year $100 million syndicated revolving credit facility and
terminated our existing syndicated revolving credit facility.
Proceeds under that credit facility may be used to finance the
development of cancer centers and new PET systems, to provide
working capital or for other general business purposes. No amounts
have been borrowed under that facility. Our credit facilitybears
interest at a variable rate that floats with a referenced interest
rate. Therefore, to the extent we have amounts outstanding under
the credit facility in the future, we would be exposed to interest
rate risk under our credit facility. On February 1, 2002, we issued
$175 million in 9.625% Senior Subordinated Notes due 2012 to
various institutional investors in a private offering under Rule
144A under the Securities Act of 1933. The notes were subsequently
exchanged for substantially identical notes in an offering
registered under the Securities Act of 1933. The notes are
unsecured, bear interest at 9.625% annually and mature in February
2012. Payments under those notes are subordinated in substantially
all respects to payments under our new credit facility and certain
other debt. We used the proceeds from the Senior Subordinated Notes
to repay in full our existing $100 million in Senior Secured Notes
due 2006, including a prepayment penalty of $11.7 million due as a
result of our repayment of the notes before their scheduled
maturity. We also used proceeds from the Senior Subordinated Notes
to pay fees and related expenses of $4.8 million associated with
issuing those notes and to pay fees and related expenses of $2.7
million in connection with the new credit facility. During the
first quarter of 2002, we recognized the prepayment penalty of
$11.7 million and a write-off of unamortized deferred financing
costs related to the terminated debt agreements of $1.9 million,
which wererecorded as a loss on early extinguishment of debt during
the first quarter of 2002. We entered into a leasing facility in
December 1997, which we have used to finance the acquisition and
development of cancer centers. Since December 31, 2002, the lease
has been classified as indebtedness on our financial statements
since we have guaranteed 100% of the residual value of the
properties in the lease since that date. As of December 31, 2003,
we had $70.2 million outstanding under the facility and no further
amounts are available under that facility. The annual cost of the
lease is approximately $2.9 million, based on interest rates in
effect as of December 31, 2003. The lease matures in June 2004 and
is therefore classified as a current maturity in our balance sheet.
We can renew the lease with lender consent, but have not yet
determined whether we will seek consent or repay or refinance the
lease. Cash reserves and availability under our revolving credit
facility are more than adequate to satisfy our obligations at
maturity. Because the lease payment floats with a referenced
interest rate, we are also exposed to interest rate risk under the
lease. A 1% increase in the referenced rate would result in an
increase in lease payments of $0.7 million annually. Borrowings
under the revolving credit facility and advances under the leasing
facility bear interest at a rate equal to a rate based on prime
rate or the London Interbank Offered Rate, based on a defined
formula. The credit facility, leasing facility and Senior
Subordinated Notes contain affirmative and negative covenants,
including the maintenance of certain financial ratios, restrictions
on sales, leases or other dispositions of property, restrictions on
other indebtedness and prohibitions on the payment of dividends.
Events of default under our credit facility, leasing facility and
Senior Subordinated Notes include cross-defaults to all material
indebtedness, including each of those financings. Substantially all
of our assets, including certain real property, are pledged as
security under the credit facility and the guarantee obligations of
our leasing facility. We are currently in compliance with covenants
under our leasing facility, revolving credit facility and Senior
Subordinated Notes, with no borrowings currently outstanding under
the revolving credit facility. We have relied primarily on cash
flows from our operations to fund working capital and capital
expenditures for our fixed assets. The following summarizes our
contractual obligations in respect of our indebtedness and
noncancelable leases at December 31, 2003, and the effect such
obligations are expected to have on our liquidity and cash flow in
future periods (based on interest rates in effect as of December
31, 2003, in millions): Obligation After 2004 2005 2006 2007 2008
2009 Principal maturities of long-term indebtedness, including
capital lease obligations 79.7 6.2 4.9 1.8 0.1 175.5 Non-cancelable
operating leases 44.3 35.7 29.5 25.7 18.9 67.7 In addition, we are
obligated to pay $6.4 million under pending construction contracts,
which we would expect to pay during 2004, depending on the progress
of construction projects. PRNewswire-FirstCall -- Feb. 26 END FIRST
AND FINAL ADD DATASOURCE: US Oncology, Inc. Web site:
http://www.usoncology.com/
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