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9-Nov-2009
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements, related notes, and other financial information thereto included elsewhere in this report. References to "fiscal year" refer to the period from January 1 to December 31 of the indicated year. Unless otherwise noted, references to EBITDA and the combined period have the meaning set forth under "Discussion of Non-GAAP Information." In addition, see "Forward-Looking Statements and Risk Factors" included in our Annual Report on Form 10-K, filed with the SEC on March 12, 2009, and subsequent filings.
Business Overview
Our mission is to enable physicians to provide the right treatment, at the right time, for the right patient. We strive to expand and improve patient access to high quality, integrated and advanced cancer care by working closely with physicians, manufacturers and payers to improve the safety, efficiency and effectiveness of the cancer care delivery system. To realize our mission of enhancing patient access to advanced care, we must maintain a dual emphasis on cost containment and quality improvement. Pursuit of this mission involves strategic initiatives at both the local level, where cancer care is delivered to patients, and at the national level to address the needs of commercial and governmental payers, pharmaceutical manufacturers and other industry customers. As of September 30, 2009, our network included:
• 1,310 affiliated physicians
• 493 sites of service
• 81 comprehensive cancer centers and 17 facilities providing radiation therapy only
• A research network currently managing 78 active clinical trials
• A pharmaceutical distribution business currently distributing $2.2 billion annually in oncology pharmaceuticals
We provide our services through four operating segments; medical oncology services, cancer center services, pharmaceutical services and research/other services. Each of our operating segments is described in greater detail below.
We provide practice management services to practices under comprehensive services agreements in both our medical oncology and cancer center services segments. Our management services are intended to support affiliated physicians in providing high quality, integrated and advanced cancer care. Both medical oncology and cancer center services may be provided under the same arrangement to provide comprehensive practice management services with the differentiation between these segments relating to the nature of cancer care being supported. Medical oncology services typically relate to the support of physicians who provide chemotherapy and drug administration, while cancer center services typically relate to physicians performing radiation treatments and diagnostic radiology.
Our practice management services are designed to encompass all non-clinical aspects of managing an oncology practice and assist affiliated practices develop and execute long-term strategies for their success. We believe our fee arrangements, which are typically based on a percentage of the affiliated practice's earnings, effectively align our interests and long-term objectives with those of our comprehensively managed practices. We work with affiliated groups to improve practice performance through optimizing reimbursement, implementing Lean Six-Sigma operating processes, providing customized electronic medical records and information systems, and obtaining nationally-negotiated supply arrangements. We also assist in recruiting additional physicians into our groups, including physicians from established practices and newly qualified oncologists. Each year approximately 50 oncologists are recruited to join one of our affiliated groups. We believe that a substantial portion of newly qualified oncologists that enter private practice join groups that are affiliated with us. We also assist affiliated groups in strengthening their market position in an increasingly competitive environment through the development of relationship-building programs targeted to referring physicians, and through local and national branding campaigns that communicate the benefits of being a member of our network.
We work with practices to establish budgets, determine goals, set strategic direction and assess the viability of capital projects or other initiatives to position them for long-term growth. Our network technology infrastructure provides a common platform that facilitates collaboration among physicians, including virtual tumor boards where challenging cases and treatments can be discussed among peers. In addition, this infrastructure allows for the accumulation of financial information that can be used to establish key performance metrics, benchmark practice results, identify opportunities to enhance performance and develop best operating practices. We also provide a voice in Washington, D.C. for our affiliated practices and advocate on their behalf, and on behalf of their patients, with state agencies and lawmakers.
In addition, our management services are designed to encompass all non-clinical aspects of managing an oncology practice, allowing affiliated physicians to spend more time providing care to patients. These services include accounting, billing and collection, personnel management, payroll, benefits administration, risk management and compliance.
Operating Challenges and Strategic Responses
The economics of healthcare and the aging American population mean that pressures to increase the effectiveness of care while reducing the cost of delivery will continue. We work with physicians, manufacturers and payers to address these issues. In 2008, we launched Innovent Oncology, a service specifically designed to bring physicians and payers together to provide the highest clinical quality while better managing the total cost of care through evidence-based treatment protocols and patient support services. In 2009, we continue to expand this offering designed to address the fundamental pressures on the cancer care delivery system in America.
We expect that the demand for professional management of physician groups will continue. We recently began packaging key services such as Oncology Pharmaceutical Services ("OPS"), Innovent Oncology, iKnowMed and Research into a targeted physician services offering under which physician practices are able to purchase one or more of these key services. This offering is intended to complement the comprehensive services model ("CSA") and address the needs of mid-size practices (five to fifteen physicians). It is available as a suite of services customized to each practice's priorities.
Our Strategy
Our mission is to enable physicians to provide the right treatment, at the right time, for the right patient. We strive to expand and improve patient access to high quality, integrated and advanced cancer care by working closely with physicians, manufacturers and payers to improve the safety, efficiency and effectiveness of the cancer care delivery system. We know that to realize our mission of enhancing patient access to advanced care, we must maintain a dual emphasis on cost containment and quality improvement. Pursuit of this mission involves strategic initiatives at both the local level, where cancer care is delivered to patients, and at the national level to address the needs of commercial and governmental payers, pharmaceutical manufacturers and other industry customers.
We believe declining reimbursement and increasing operating costs have resulted in a trend toward professional management of physician groups. Since our inception, we have worked with local physician groups to enable affiliated practices to offer state of the art care to cancer patients in outpatient settings, including professional medical services, chemotherapy infusion, radiation oncology services, access to clinical trials, laboratory services, diagnostic radiology, pharmacy services and patient education. In addition, we work with affiliated groups to improve practice performance through optimizing reimbursement, implementing Lean Six-Sigma operating processes, recruiting physicians, providing customized electronic medical records and information systems, and obtaining nationally negotiated supply arrangements. We also assist affiliated groups in strengthening their market position in an increasingly competitive environment through the development of relationship-building programs targeted to referring physicians, and through local and national branding campaigns that communicate the benefits of being a member of our network. We have also developed other tools for physicians such as the Oncology Portal which was just launched during the third quarter. The portal is a web-based cancer care community to provide oncologists and clinicians a platform to collaborate, share best practices and gain industry insight and education.
As of September 30, 2009, we were affiliated with 1,310 physicians operating in 493 locations, including 98 radiation oncology facilities, in 39 states. Our affiliated physicians care for approximately 720,000 patients annually, which we believe is the largest for-profit cancer care network in the United States. We will continue to work with existing affiliated physicians, and seek to enter into new affiliations, to increase the financial strength of network practice and support their clinical initiatives.
It is that sizable physician and patient population that allows us to realize volume efficiencies for the network and a variety of additional industry customers. We provide oncologists with a broad range of innovative products and services through two economic models: a comprehensive services model, under which we provide all of our practice management products and services under a single contract with one fee typically based on the practice's financial performance, and our targeted physician services model, under which physicians purchase a narrower suite of services based on the types of services required by the practice. We expect our services will increasingly be offered through targeted arrangements where a subset of our comprehensive services, including supplying oncology pharmaceuticals, disease management, electronic medical records and research can be obtained separately on a fee for service basis. These targeted arrangements are designed to meet the needs of oncology practices that may not be well-suited for a comprehensive management arrangement but still value a narrower scope of our services.
In addition to assisting physicians in addressing the challenges in their local markets, we will continue to use the insight gained from working with these practices to assist payers and pharmaceutical manufacturers improve patient access to high quality cancer care and the effectiveness of the care delivery system.
Our reimbursement expertise helps providers, payers and manufacturers realize cost efficiency and predictability in a largely unpredictable field of medicine. Innovent Oncology addresses the payer's need to avoid the unnecessary costs of care while ensuring the highest level of clinical quality. Innovent Oncology offers a comprehensive solution to the key cost drivers in cancer care: variable treatments, debilitating side effects that lead to emergency room visits and hospitalizations between treatments, and futile treatment at the end of life.
We also work with pharmaceutical manufacturers in the development and commercialization of oncology pharmaceuticals. The US Oncology Research Network provides pharmaceutical manufacturers with a centrally managed and efficient system for the clinical development of new therapies from Phase I through IV. This research network is led by industry-leading cancer experts in all major tumor types and offers access to an unparalleled national sampling of patients. In addition, AccessMed® provides patient financial assistance and product support services to assist pharmaceutical manufacturers commercialize their products while our Healthcare Informatics business collects and analyzes data to provide significant insight into drug performance and patient outcomes for ongoing product development and evaluation.
Physician Relationship Models
Comprehensive Service Agreements
Under our comprehensive services model ("CSA"), we own or lease all of the real and personal property used by our affiliated practices. In addition, we generally manage the non-medical business operations of our affiliated practices and facilitate communication with our affiliated physicians. Each management agreement contemplates a policy board consisting of representatives from the affiliated physician practice and us. Each board's responsibilities include strategic planning, decision-making and preparation of an annual budget for that practice. While both we and the affiliated practice have an equal vote in matters before the policy board, the practice physicians are solely responsible for all medical decisions, including the hiring and termination of physicians. We are responsible for all non-medical decisions, including facilities management and information systems management.
During the nine months ended September 30, 2009 and 2008, 80.7% and 80.9% of our revenue, respectively, was derived from CSAs. Under most of our comprehensive service agreements, or CSAs, we are compensated under the earnings model. Under the earnings model, we account for all expenses that we incur in connection with managing a practice, including rent, pharmaceutical expenses and salaries and benefits of non-physician employees of the practices, and are paid a management fee based on a percentage of the practice's earnings before income taxes, subject to certain adjustments. Our other CSAs are on a fixed management fee basis, as required by some states.
Targeted Physician Services
Our services are increasingly being offered through targeted arrangements where a subset of the services offered through our comprehensive management agreements are provided separately to oncologists on a fee-for-service basis. Targeted physician services represented 15.5% and 16.1% of our revenue during the nine months ended September 30, 2009 and 2008, respectively, which was primarily fees for payment for pharmaceuticals and supplies used by the practice and reimbursement for certain pharmacy-related expenses. A smaller portion of our revenue from targeted arrangements was payment for billing,
collection and reimbursement support service and payment for the other services we provide. Rates for our services typically are based on the level of services desired by the practice.
Forward-Looking Statements and Risk Factors
The following statements are or may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995: (i) certain
statements, including possible or assumed future results of operations contained
in "Management's Discussion and Analysis of Financial Condition and Results of
Operations," (ii) any statements contained herein regarding the prospects for
any of our businesses or services and our development activities relating to
physician affiliations and cancer centers; (iii) any statements preceded by,
followed by or that include the words "believes", "expects", "anticipates",
"intends", "estimates", "plans," "projects" or similar expressions; and
(iv) other statements contained herein regarding matters that are not historical
facts.
Our business and results of operations are subject to risks and uncertainties, many of which are beyond management's ability to control or predict. Because of these risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements, and investors are cautioned not to place undue reliance on such statements, which speak only as of the date thereof. Such risks and uncertainties include the impact of a recession in the U.S. or global economy, the possibility of healthcare reform in the United States and its impact on cancer care specifically, the Company's reliance on pharmaceuticals for the majority of its revenues, the Company's ability to maintain favorable pharmaceutical pricing and favorable relationships with pharmaceutical manufacturers and other vendors, concentration of pharmaceutical purchasing and favorable pricing with a limited number of vendors, prescription drug reimbursement, such as reimbursement for ESAs, and other reimbursement under Medicare (including reimbursement for radiation and diagnostic services), reimbursement for medical services by non-governmental payers and cost-containment efforts by such payers, including whether such payers adopt coverage guidelines regarding ESAs or pharmaceutical reimbursement methodologies that are similar to Medicare coverage, other changes in the manner patient care is reimbursed or administered, continued migration to generic alternatives for branded pharmaceuticals, the impact of increasing unemployment (which may result in a larger population of uninsured and under insured patients), the decisions of employers to increase the financial responsibility of individuals under health insurance programs afforded to their employees, the Company's ability to service its substantial indebtedness and comply with related covenants in debt agreements, the Company's ability to fund its operations through operating cash flow or utilization of its credit facility or its ability to obtain additional financing on acceptable terms, the instability of capital and credit markets, including the potential that certain financial institutions may be unable to honor existing financing commitments, the Company's ability to implement strategic initiatives, the Company's ability to maintain good relationships with existing practices and expand into new markets and development of existing markets, modifications to, and renegotiation of, existing economic arrangements, the Company's ability to complete cancer centers and PET facilities currently in development and its ability to recover investments in cancer centers, government regulation, investigation and enforcement, increases in the cost of providing cancer treatment services and the operations of the Company's affiliated physician practices, and potential impairments that could result from declining market valuations.
Please refer to our filings with the SEC, including our Annual Report on Form 10-K, filed with the SEC on March 12, 2009, and subsequent filings with the SEC, for a more extensive discussion of factors that could cause actual results to differ materially from our expectations.
The cautionary statements contained or referred to in this report should be considered in connection with any written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We do not undertake any obligation to release any revisions to or to update publicly any forward-looking statements to reflect events or circumstances after the date thereof or to reflect the occurrence of unanticipated events.
Reimbursement Matters
Pharmaceutical Reimbursement under Medicare
Erythropoiesis-stimulating agents ("ESAs") are drugs used for the treatment of anemia, which is a condition that occurs when the level of healthy red blood cells in the body becomes too low, thus inhibiting the blood's ability to carry oxygen. Many cancer patients suffer from anemia either as a result of their disease or as a result of the treatments they receive for their cancer. ESAs have historically been used by oncologists to treat anemia. ESAs are administered to increase levels of healthy red blood cells as an alternative to blood transfusions.
On July 30, 2007, Centers for Medicare & Medicaid Services ("CMS") issued a national coverage decision ("NCD") establishing criteria for reimbursement by Medicare for ESA usage which led to a significant decline in utilization of these drugs by oncologists, including those affiliated with US Oncology. In addition, the Oncology Drug Advisory Committee of the FDA ("ODAC") met on March 13, 2008, to further consider the use of ESAs in oncology. Based upon the ODAC findings, on July 30, 2008, the FDA published a final new label for the ESA drugs Aranesp and Procrit. Unlike the NCD from CMS, which governs reimbursement (rather than prescribing) for Medicare beneficiaries only, the label indication directs appropriate physician prescribing and applies to all patients and payers.
The FDA also mandated implementation of a Risk Evaluation and Mitigation Strategy ("REMS") for ESAs. A proposed REMS for ESAs was filed by ESA manufacturers with the FDA in August 2008, but is not yet final or publicly available. The REMS is expected to focus on future ESA prescribing guidelines and may require additional patient consent, education requirements, medication guides and physician registration procedures. The length of time required for the FDA to approve the REMS and for manufacturers to implement the new program is uncertain and it presently remains under discussion between the manufacturers and the FDA. Once implemented, the REMS will outline additional, if any, procedural steps that will be required for qualified physicians to prescribe ESAs for their patients. The REMS is expected to become effective in late 2009 or early 2010. We believe a possible impact of the REMS could be further reductions in ESA utilization, which could be significant. Because the use of ESAs relates to specific clinical determinations and the Company does not make clinical decisions for affiliated physicians, analysis of the financial impact of these restrictions is a complex process. As a result, there is inherent uncertainty in making an estimate or range of estimates as to the ultimate financial impact on the Company. Factors that could significantly affect the financial impact on the Company include ongoing clinical interpretations of coverage restrictions and risks related to ESA use.
The decline in ESA usage has had a significant adverse affect on the Company's results of operations, and, particularly, its Medical Oncology Services and Pharmaceutical Services segments. Operating income attributable to ESAs administered by our network of affiliated physicians decreased by $0.8 million and $9.0 million during the three and nine months ended September 30, 2009, respectively, from the comparable periods ended September 30, 2008. The operating income reflects results from our Medical Oncology Services segment which relate primarily to the administration of ESAs by practices receiving comprehensive management services and from our Pharmaceutical Services segment which includes purchases by physicians affiliated under the OPS model, as well as distribution and group purchasing fees received from manufacturers for pharmaceuticals purchased by physicians affiliated under either of these arrangements.
Decreasing financial performance of affiliated practices as a result of declining ESA usage also affects their relationship with the Company and, in some instances, has led to increased pressure to amend the terms of their management services agreements. In addition, reduced utilization of ESAs may adversely impact the Company's ability to continue to receive favorable pricing from ESA manufacturers. Decreased financial performance may also adversely impact the Company's ability to obtain acceptable credit terms from pharmaceutical manufacturers, including manufacturers of products other than ESAs.
We expect continued payer scrutiny of the side effects of supportive care products and other drugs that represent significant costs to payers. Such scrutiny by payers or additional scientific data could lead to future restrictions on usage or reimbursement for other pharmaceuticals as a result of payer or FDA action or reductions in usage as a result of the independent determination of oncologists practicing in our network. Any such reduction could have an adverse effect on our business. In our evidence-based medicine initiative, affiliated physicians continually review emerging scientific information to develop clinical pathways for use in oncology and remain engaged with payers in determining optimal usage for all pharmaceuticals.
Reimbursement for Physician Services
Medicare reimbursement for physician services is based on a fee schedule, which establishes payment for a given service, in relation to actual resources used in providing the service, through the application of relative value units ("RVUs"). The resources used are converted into a dollar amount of reimbursement through a conversion factor, which is updated annually by CMS, based on a formula.
On October 30, 2009, CMS announced final changes to policies and payment rates for services to be furnished during 2010 by physicians and nonphysician practitioners who are paid under the Medicare physician fee schedule. Under the statutory formula, the conversion factor for 2010 is estimated to decrease by 21.2% unless Congress again enacts superseding
legislation. Congress and the Administration are considering possible actions to prevent that decrease. In addition, CMS projects that changes to policies and payment rates for 2010 would result in a 1% decrease (6% decrease in 2013 under 4-year phase-in) in overall payments to the specialty of hematology/oncology and a 1% decrease (5% decrease in 2013) in overall payments to the specialty of radiation oncology. Under the provisions, if Congress fails to act to avert the scheduled 21.2% cut pursuant to the current Sustainable Growth Rate ("SGR") formula for setting aggregate Physician Fee Schedule spending, EBITDA would be reduced by approximately $16 million. We expect that Congress, as in previous years, will enact legislation to avert a 21.2% SGR reduction. If such legislation is enacted, we currently estimate the impact to 2010 EBITDA of changes to CMS policies and payment rates will be approximately $1 million to $2 . . .
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