-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F2yiLcgqsTbrdoVs2UoO86HN8QTyVHX/7h8f5aOqr1mCPYLiPSP/Kc8nIH2O/3wx unRRYlzxYReeAuFnMK8LGQ== 0000927016-98-001306.txt : 19980401 0000927016-98-001306.hdr.sgml : 19980401 ACCESSION NUMBER: 0000927016-98-001306 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PHYSICIANS QUALITY CARE INC CENTRAL INDEX KEY: 0000947569 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-OFFICES & CLINICS OF DOCTORS OF MEDICINE [8011] IRS NUMBER: 043267297 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-26137 FILM NUMBER: 98581858 BUSINESS ADDRESS: STREET 1: 950 WINTER STREET CITY: WALTHAM STATE: MA ZIP: 02154 BUSINESS PHONE: 6178905560 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ____________ FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 ------------------------------------ OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission file number 333-26137 --------- Physicians Quality Care, Inc. ------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 04-3267297 ---------- ------------ (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 950 Winter Street, Suite 2410, Waltham, MA 02154 - -------------------------------------------- ------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (781) 890-5560 ---------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: NONE 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____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. [_] The aggregate value of voting common stock held by nonaffiliates of the registrant was approximately $76,224,048, based on the Company's most recent arms-length sale of the Common Stock of the Company on February 13, 1998. There is no public market for the Registrant's voting Common Stock. Number of shares outstanding of the registrant's common stock as of March 23, 1998: 26,146,844 shares of Class A Common Stock, $.01 par value, 2,809,296 shares of Class B-1 Common Stock, $.01 par value, 1,790,704 shares of Class B-2 Common Stock, $.01 par value, and 7,692,309 shares of Class C Common Stock, $.01 par value. PART I The Business section and other parts of this Annual Report on Form 10-K contain forward-looking statements that involve risks or uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Future Operating Results." ITEM 1. BUSINESS. Physicians Quality Care, Inc., a Delaware corporation ("PQC" or the "Company"), was incorporated in March 1995, and provides practice management services for multi-specialty medical practice groups. The Company's objective is to establish networks of primary and specialty care physicians and related diagnostic and therapeutic support services which can provide comprehensive healthcare services in targeted geographic areas. PQC's strategy has four central elements: (i) developing economies of scale in support services for physician practices (i.e., administrative, billing and clerical staff) and managed care contracts and geographic penetration by affiliating with large numbers of qualified physicians in targeted geographic areas; (ii) assisting the affiliated practices in providing cost-effective healthcare to special populations; (iii) building comprehensive local healthcare networks by developing contractual or strategic relationships with providers of ancillary services such as home healthcare and weight and health management; and (iv) improving the financial performance of affiliated physician's practices by seeking to maximize the value of each physician encounter. To date, the Company has focused upon developing its presence in western Massachusetts, northern Connecticut, Maryland and Atlanta. The Company believes that once the Company has developed a large base of affiliated physicians its strategy will enable the Company to generate increased demand for the services and capabilities of its affiliated physicians, treat patients in lower cost settings and negotiate favorable managed care contracts. The Company intends to achieve growth through the recruitment of additional physicians, the expansion of managed care relationships and the development of contractual or strategic relationships with providers of ancillary services. The core of PQC's proposed integrated healthcare delivery system is its affiliation with groups of physicians who enter into long-term management agreements with the Company. The Company assumes responsibility for non-medical aspects of an affiliated physician's practice and focuses its efforts on seeking to increase revenues and improve operating margins, implementing management information systems and negotiating managed care contracts. The physicians remain responsible for, among other things, the medical, professional and ethical aspects of their practices. By affiliating with the Company, physicians have increased opportunity to access capital, continue to participate in the profitability of their individual practices and, through stock ownership, share a financial interest in the overall performance of the Company. Industry Overview - ----------------- Traditionally, health insurance plans reimbursed providers on a fee-for- service basis, a system that offered very little incentive for efficiency. In recent years, the healthcare industry has undergone significant changes as both the private and public sectors seek to slow spending growth. Since the early 1980s, much of the healthcare coverage in the U.S. has shifted to managed care systems which offer cost savings in exchange for limiting the utilization of services. Moreover, there has been a shift to prepaid insurance plans that offer comprehensive healthcare services to enrollees and pay providers a fixed, prepaid monthly premium. The most prevalent of these prepaid health insurance alternatives is the health maintenance organization ("HMO"). To remain competitive, HMOs and other similar payors seek to align themselves with the most cost- and service-effective providers, generally channeling patient volume to such providers. In the managed care environment, doctors must contract or affiliate with leading insurers or healthcare networks in their practice area. The third-party payors rely on primary care physicians to play a "gatekeeping" role and to make important medical decisions for the patient. Many payors look to share the risk of providing services through capitation arrangements which provide for fixed payments for patient care over a specified period of time. In general, capitated contracts pay a flat dollar amount per enrollee in exchange for the physician's obligation to provide or arrange for the provision of a broad range of healthcare services (including inpatient care) to the enrollee. A significant difference between a capitated contract and traditional managed care contracts is that the physician is sometimes responsible for both professional physician services and many other healthcare services, e.g., hospital, laboratory, nursing home and home health. The physician is not only the "gatekeeper" for enrollees, but is also financially at risk for over-utilization and for the actuarial risk that certain patients may consume significantly more healthcare resources than average for patients of similar age and sex (such patients being referred to as "high risk patients"). Although physicians often purchase reinsurance to cover some of the actuarial risk associated with high risk patients, such insurance typically does not apply with respect to the risk of over-utilization until a relatively high level of aggregate claims has been experienced. If over- utilization occurs with respect to a given physician's enrollees (or if the physician's panel of enrollees includes a disproportionate share of high risk patients not covered by reinsurance), the physician typically is penalized by failing to receive some or all of the physician's compensation under the contract that is contingent upon the attainment of negotiated financial targets, or the physician may be required to reimburse the payor for excess costs. In addition, a physician may be liable for over-utilization by other physicians in the same "risk pool" and for utilization of ancillary, inpatient hospital and other services when the physician has agreed contractually to manage the use of those services. Under this payment system, primary care physicians have important economic incentives to reduce costs by ensuring the efficient utilization of other providers of care, shifting care to outpatient settings where feasible, monitoring the progress of patients throughout the course of treatment and encouraging preventive healthcare. -2- In this environment, physicians are facing reimbursement pressures, greater administrative burdens, increasing financial responsibility for the risk of patient care, and a shift in demand from specialty to primary care. In addition, legislative changes have substantially limited a physician's ability to maintain an ownership interest in entities that provide ancillary services such as outpatient laboratories, infusion centers and diagnostic and rehabilitation facilities. These factors have all contributed to a moderation, if not reduction, in the growth of many physicians' incomes. With greater oversight by third-party payors, physicians are also facing a decrease in control over medical decisions and the administration of their practices. In response to these changes in the marketplace, many physicians are joining together to maintain clinical autonomy, create greater negotiating leverage vis-a-vis HMOs and other third party payors and reduce escalating administrative costs. Physicians also are increasingly abandoning traditional private practice which typically has higher operating costs and little purchasing power with suppliers and must spread overhead over a relatively small revenue base in favor of affiliations with larger organizations. Three basic groups have emerged as managers of physician practices each of which encompasses several variations in format: hospitals, which may employ physicians directly or provide support through a management services organization ("MSO"); insurance companies, which may employ physicians directly through HMOs or may provide management services through an affiliated MSO; and independent, investor-owned physician practice management companies. Company Strategy - ---------------- The Company believes that physician practice management companies ("PPMs"), such as PQC, offer physicians significant advantages over other alternatives in the industry consolidation. PPMs provide physicians with improved practice management and an opportunity to participate in the growth of the PPM through stock ownership while maintaining control over medical decisions. The physician market is currently highly fragmented, and PPMs and other organizations providing physicians with management alternatives have thus far captured only a small portion of this potential market. In addition, the Company believes that because physicians can serve as gatekeepers for patient care, they can exercise direct control over healthcare spending and should be in a position to share in the savings generated by the cost containment practices they adopt. For a fee or a percentage of the group's earnings, a PPM provides physician groups with administrative and practice management services that are needed for a physician group to realize these cost savings and to seek to optimize contractual relationships with managed care organizations, thus retaining some or most of the cost savings so generated. The central elements of the Company's strategy are to develop long-term affiliations with physicians, focus on cost effective healthcare delivery to special populations, and build comprehensive local healthcare networks. To date, the Company has focused upon developing a network of affiliated physicians. The Company believes that its strategy will enable the -3- Company to generate increased demand for the services and capabilities of its affiliated physicians, treat patients in lower cost settings and negotiate favorable managed care contracts. Develop long-term affiliations with physicians. PQC seeks to affiliate with physicians in solo or group practices by entering into contractual arrangements pursuant to which PQC, or a professional corporation or professional association affiliated with PQC, assumes management of non-medical aspects of the practices (an "Affiliated Group"). Upon affiliation, PQC seeks to provide the physicians with, among other things, increased opportunity to access capital, management experience, improved information systems and increased opportunity to participate in favorable managed care contracts. The Company intends to assist affiliated physicians in improving clinical outcomes and seeks to keep medical costs down by merging physicians into Affiliated Groups. The Company's structure allows physicians to continue to practice in their existing locations with no disruption to patient flow patterns while providing access to coordinated ancillary services. By affiliating with PQC, physicians, through the revenue sharing provisions of their employment agreements and the Services Agreements between the Affiliated Group and PQC, continue to participate in the profitability of their individual practices and, through stock ownership, share a financial interest in the overall performance of the Company. Physicians constitute a majority of the Board of the Directors of PQC and all local advisory boards, which control such decisions as clinical protocols and utilization review, payor relations and the addition of ancillary services. Balance of primary care physicians and specialists. PQC believes that a successful system should be balanced between primary care physicians and specialists to provide efficient coordination and utilization of the appropriate levels of care, and PQC intends to seek to develop this balance in the physician groups with which it affiliates. Of the 185 physicians affiliated with the Company at December 31, 1997, 128 are engaged in primary care practices and 57 are engaged in specialist practices. The Company believes the industry trend toward integrated delivery systems will result in an increasing demand for primary care physicians because a higher degree of coordination of care and risk-sharing will be required than that which can be achieved in a system controlled by specialists. The Company's strategy is to have the primary care physician serve as the central manager in the patient system and to develop effective coordination between specialists and the primary care physicians within its network. Focus on special populations. PQC believes that the management of healthcare costs for certain populations provides significant opportunities that are not being addressed in the marketplace. The Company believes that special populations, including the elderly, the disabled and those with debilitating chronic or high-cost, complex diseases represent a minority of the population but account for a disproportionately high percentage of the healthcare costs in the United States due to the significantly greater need of such patients for medical care compared to the population as a whole. The Company believes that a significant portion of these costs can be avoided with effective case management, use of information systems, and coordinated use of the full continuum of healthcare. At present, a relatively -4- small percentage of these patients are enrolled under capitated contracts. However, the Company believes that the cost pressures that fostered the development of managed care for other segments of the population should have an even more significant impact on the rapid development of managed care for such patients. Through affiliation with physicians and academic experts who specialize in geriatrics and medical conditions that disproportionately affect these population segments, effective use of case management techniques designed specifically for such populations, and management information systems, the Company believes that its affiliated physicians should be able to manage cost effectively the risks of providing care to these populations on a capitated basis. Improved medical quality and performance. Over time, the Company intends that its affiliated physicians will devise medical protocols and the Company will perform outcome analyses, such that the most effective medical practices in each network can be shared across physician groups. The Company is in the process of establishing a quality assurance program that will incorporate peer review, self-critiquing mechanisms, patient satisfaction surveys, continuing medical staff development and regular continuing medical education seminars. Once a large base of affiliated physicians at Affiliated Groups is established, medical directors of each local care network will participate in the Company's National Medical Advisory Board that will meet regularly to establish and review medical standards, policies and procedures for all physicians affiliated with the Company. Affiliation Structure - --------------------- General affiliation model. Although the details of each affiliation transaction may differ, the Company has developed a general affiliation model designed to capture the benefits of integration while preserving significant physician autonomy (the "General Affiliation Model"). In the General Affiliation Model, physicians initially affiliating with the Company in each geographic area who will become stockholders of the Company transfer their practices by mergers or asset sales to an Affiliated Group, a professional corporation ("PC") or professional association ("PA") permitted to practice medicine under applicable law. These physicians, along with other physicians in that geographic area who subsequently become part of an Affiliated Group and become stockholders of the Company (the "Stockholder Physicians"), execute an Employment Agreement with the Affiliated Group at the time that they transfer their practice assets. The Affiliated Group, in turn, enters into a Services Agreement, generally for periods up to 40 years, with the Company pursuant to which the Company agrees to provide the physicians in the Affiliated Group with comprehensive management services in exchange for a fee. As consideration for transferring their practices to and becoming employed by the Affiliated Group, Stockholder Physicians receive shares of the Company's Class A Common Stock, $.01 par value per share (the "Class A Common Stock"), and in some cases cash, the amount of which is negotiated on an individual basis between each Stockholder Physician and the Company. Physicians who are not stockholders of the Company may also be employed by the Affiliated Group. -5- The factors that the Company considers in selecting a physician or a physician group for affiliation include the location of the practice, whether the practice can be successfully integrated into an Affiliated Group, the ability of the Company to assist the physician to increase billings and control costs, the size of the practices, the compensation sought by the physician or physician group, the nature of the physician's practice and the reputation of the physician in the medical community. All of the outstanding capital stock of each Affiliated Group is held by a Stockholder Physician designated by the Company (the "Affiliated Group Stockholder"). At the time of the affiliation, the Affiliated Group Stockholder enters into an agreement (the "Designation Agreement") with the Company and the Affiliated Group pursuant to which he or she agrees to consult with the Company in voting the stock of the Affiliated Group, agrees to transfer the stock of the Affiliated Group without consideration to another licensed physician at the direction of the Company and agrees to pay over to the Company any dividend or distribution on the stock received from the Affiliated Group. The Designation Agreement also provides that the stock of the Affiliated Group is automatically transferred at the direction of the Company in the event that the Affiliated Group Stockholder attempts to transfer it to a third party. The Designation Agreement provides, however, that the Affiliated Group Stockholder is not required to consult with the Company as to matters requiring the exercise of professional medical judgment. The Employment Agreements contain certain restrictive covenants, including covenants relating to noncompetition, confidentiality and nonsolicitation of employees. Pursuant to these restrictive covenants, the Stockholder Physicians agree, during the term of the employment agreement and for a one year period thereafter, not to establish, operate or provide medical services in a specified geographic region, subject to certain limited exceptions. In addition, the Stockholder Physicians agree during the employment agreement and for a two year period thereafter not to provide certain other services related to the practice of medicine in the geographic region and not to solicit any employee or patients of the Affiliated Group. Under current state laws and judicial decisions that restrict the enforcement of non-competition agreements against physicians on public policy grounds, the Company has no or limited ability to enforce the covenants not to compete. Each Employment Agreement generally is terminable by the Affiliated Group with respect to any individual Stockholder Physician upon the death or disability of such Stockholder Physician or upon the occurrence of certain events that either interfere with the ability of such Stockholder Physician to practice medicine or significantly diminish the value of such Stockholder Physician's affiliation to the Affiliated Group. Each Stockholder Physician may terminate his or her Employment Agreement under certain circumstances, including without cause upon six months notice to the Affiliated Group. The Employment Agreements also contain terms permitting or requiring a Stockholder Physician upon termination after certain material breaches of the Affiliated Group's or the Company's obligations under the employment agreement or the Services Agreement between PQC and the Affiliated Group, to repurchase from the Affiliated Group the restrictive covenants and his or her practice assets (i.e., office and examination equipment, in certain cases the lease for premises at which the physician practices, patient lists and -6- records, and third party payor contracts) upon termination of employment. The terms of such repurchase provision may not permit the Company to fully recover its affiliation payments to the physician or reflect the cost of affiliation transactions at the time of termination. To date, no Stockholder Physician has terminated an employment agreement or repurchased any practice assets. Pursuant to the Services Agreement, the Company provides (or arranges for the provision of) a comprehensive package of services to the Affiliated Group and its physicians, including offices and facilities, equipment, nursing and other non-physician professional support, administrative personnel, information systems, comprehensive professional liability insurance and general management and financial advisory services. The Company, on behalf of the physicians in the Affiliated Group, supervises the billing of all patients, insurance companies and third-party payors and negotiates all contracts and relationships with payors. The physicians remain responsible for, among other things, the medical, professional and ethical aspects of their practices. Generally under a Services Agreement, revenue from patient care is used to pay practice expenses and a fee to PQC for its services and to fund one or more pools from which physician compensation is paid (each a "Compensation Pool"). The basis for such allocation is negotiated separately with each group of affiliating physicians. Because compensation of Stockholder Physicians is a function of many factors including the financial performance of such physicians, neither the Company nor an Affiliated Group can guarantee that a Stockholder Physician will receive any minimum level of compensation, and the Stockholder Physicians are not entitled to any compensation other than their allocated share of the Compensation Pool. The Compensation Pool is initially allocated to the Stockholder Physicians until each physician has received a pre-agreed draw. Any amount remaining in the Compensation Pool is allocated among the Stockholder Physicians as determined by a Compensation Committee appointed by the Physicians. The Company believes that its General Affiliation Model offers a number of advantages. For example, physicians remain in their pre-affiliation locations, offering their patients the continuity and convenience of decentralized offices. At the same time, laboratory and administrative services generally are provided on a centralized basis, allowing the Affiliated Groups to achieve economies of scale in purchasing and other administrative efficiencies. Moreover, the Company believes that as it completes its initial affiliation transactions in particular geographic markets, Affiliated Groups will provide it with both a visible business presence and a corporate framework for securing additional affiliations with physicians in those markets. The Company also believes that the decision making structure that it establishes in connection with each Affiliated Group facilitates information sharing and cooperation between the affiliated physicians and the Company. Each Affiliated Group maintains its own policy making structure, including a Joint Policy Board and a Medical Advisory Board. The Joint Policy Board is charged with, among other things, developing certain management and -7- administrative policies for the Affiliated Group, approving operating and capital expenditure budgets, establishing fee schedules for services provided by the Affiliated Group, approving the establishment of managed care contracts and determining of the number and type of physicians required for the operation of the Affiliated Group. Certain decisions that may have a material impact upon the business, results of operation or financial condition of the Affiliated Group must also be approved by the Affiliated Group Stockholder. The current Joint Policy Boards are comprised of: the President of the Affiliated Group (selected by the Affiliated Group Stockholder from physicians nominated by the Stockholder Physicians), and an equal number of members selected by the Company and the physician stockholders. The Medical Advisory Board, which is responsible for providing medical input on managed care contracting by the Affiliated Group and leading the development and dissemination of medical protocols among the physicians, consists of the Medical Director of the Affiliated Group (selected by the Affiliated Group Stockholder from physicians nominated by the Stockholder Physicians) and other physicians elected by the Stockholder Physicians. Although the Affiliated Groups in the Springfield, Massachusetts area and the greater Baltimore-Annapolis, Maryland generally track the General Affiliation Model, the Company may depart to some extent or significantly from it or pursue an altogether different approach in completing future physician affiliations. The Springfield Affiliated Group. The Company has entered into affiliation transactions with nine medical practices located in western Massachusetts, consisting at December 31, 1997 of a total of 42 physicians, 35 of whom are stockholders in the Company (the "Springfield Stockholder Physicians") and 7 of whom are employed by the Springfield Affiliated Group as employees (the "Springfield Affiliated Group"). Twenty-nine of the physicians are engaged in primary care practices, including two physicians with pediatric practices. Thirteen of the physicians are engaged in specialist practices, including pulmonology, cardiology, oncology/hematology, infectious disease, rheumatology and gastroenterology. Consistent with the General Affiliation Model, the Springfield Stockholder Physicians, or the professional corporations and other entities with whom they were affiliated, merged or sold their practice assets to the Springfield Affiliated Group in exchange for an aggregate of approximately 3,164,738 shares of Class A Common Stock of the Company and approximately $4.1 million in cash. The 29 initial Stockholder Physicians entered into a three-year employment agreement with the Springfield Affiliated Group, pursuant to which each physician also received options to purchase 2,500 shares of Class A Common Stock of PQC at an exercise price of $2.50 per share. The options expire on the earlier of termination of employment or three years from commencement of employment. The Physicians who subsequently affiliated with the Springfield Affiliated Group entered into ten-year employment agreements with the Springfield Affiliated Group. Four of these Springfield Physician Stockholders each received options to purchase 37,500 shares of Class A Common Stock at an exercise price of $1.00 per share which options are subject to certain vesting conditions. Up to an additional $2.15 million, payable in Class A Common Stock at $2.50 per share, was -8- available to be paid to certain physicians if certain revenue goals were met. During 1997, $2.1 million of additional consideration was accrued based upon the achievements of these goals and will be paid during 1998. The Springfield Affiliated Group in turn entered into a 40-year services agreement with the Company pursuant to which the Company (on behalf of the Springfield Affiliated Group) agreed to provide management services to the Springfield Affiliated Group physicians. Under the Employment Agreements with the twenty-nine initial Springfield Stockholder Physicians, revenues from patient care remaining after payment of operating expenses, including expenses of the Springfield Affiliated Group ("Gross Margin") are allocated first between the Springfield Affiliated Group's Compensation Pool (the "Springfield Compensation Pool") and the Springfield Affiliated Group in a 95%/5% proportion until 95% of the base compensation of the Springfield Stockholder Physicians is achieved, then to payment of certain non-operating expenses, and then 80% to the Springfield Affiliated Group and 20% to the Springfield Compensation Pool until the Springfield Affiliated Group has been allocated $1.5 million, with any remaining Gross Margin being divided evenly between the Springfield Affiliated Group and the Springfield Compensation Pool. Under the Employment Agreements with the Springfield Stockholder Physicians who subsequently affiliated with the Springfield Affiliate Group any Gross Margin attributable to these physicians are allocated between the Springfield Compensation Pool and the Springfield Affiliated Group in a 80%/20% proportion until the physicians receive 80% of their base compensation, and then to payment of certain non-operating expenses attributable to the Springfield Affiliated Group, with any remaining Gross Margin being divided evenly between the Springfield Compensation Pool and the Springfield Affiliated Group. The allocation of Gross Margin to the Springfield Compensation Pool is calculated separately for each fiscal period. If the Gross Margin for any such period is negative, such negative amount constitutes an operating expense in the next fiscal period. Pursuant to the Springfield Services Agreement, all amounts allocated to the Springfield Affiliated Group in any fiscal period are remitted to the Company. On March 1, 1999, the Springfield Affiliated Group (on behalf of the Company) or a majority of the Springfield Shareholder Physicians may amend the financial arrangements, effective as of August 30, 1999, such that the economic terms of the Springfield Stockholder Physicians' employment agreements, taken as a whole (and giving effect to any payments or other compensation received by the Springfield Stockholder Physicians in connection with their affiliation), are adjusted to reflect the terms being entered into by independent third parties for similar affiliation and employment relationships at that time. The Flagship Affiliated Group. On December 11, 1996, pursuant to affiliation transactions with the Company, 15 existing professional practices located in the greater Baltimore-Annapolis, Maryland area, consisting of a total of 55 physicians, transferred their practice assets to and became employed by Flagship Health P.A., a Maryland professional association (the "Flagship Affiliated Group"). In exchange for such affiliation, the physicians received a combination of approximately $2.7 million in cash and 6,842,675 shares of -9- Class A Common Stock (the "Initial Flagship Affiliation"). On December 1, 1997, Clinical Associates, P.A., a Maryland professional association ("Clinical Associates"), which also had practices in the Baltimore area, was combined with the Flagship Affiliated Group. The stockholders of Clinical Associates received approximately $3.0 million in cash and 4,800,000 shares of Class A Common Stock. As of December 31, 1997, the Flagship Affiliated Group employed 143 physicians and 16 non-physician medical professional, of which 113 are stockholders of the Company and employees of the Flagship Affiliated Group (the "Flagship Stockholder Physicians") and 30 are employees of the Flagship Affiliated Group. Of the physicians employed by the Flagship Affiliated Group, 99 are primary care or pediatric physicians and 44 are specialists. The specialist practices include pulmonology, cardiology, oncology/hematology, infectious disease, rheumatology, gastroenterology, neurology, dermatology, endocrinology, immunology, neurology, psychiatry, obstetrics/gynecology, ophthalmology, orthopedics, otolaryngology, plastic surgery, urology, general surgery and vascular surgery. The Flagship Affiliated Group leases 28 practice locations in Maryland, some of which are leased from the Flagship Stockholder Physicians. In order to effectuate the Flagship Affiliation, the Flagship Stockholder Physicians, or the professional associations, business corporations and limited liability partnerships with whom they were affiliated, transferred their practice assets to the Flagship Affiliated Group by merger or by sale of assets. The Company entered into a 40-year management services agreement with the Flagship Affiliated Group (the "Flagship Services Agreement"), which entered into Employment Agreements with each Flagship Stockholder Physician. In addition, the Company entered into an agreement with the Flagship Affiliated Group pursuant to which the Company agreed to grant options to purchase, subject to certain conditions, up to 400,000 shares of Class A Common Stock to the Flagship Stockholder Physicians. Pursuant to the Flagship Services Agreement and the Employment Agreements with the Flagship Stockholder Physicians who initially affiliated with the Flagship Affiliated Group (the "Initial Flagship Affiliated Physicians"), revenues from patient services remaining after payment of third- party operating expenses ("Net Margin") is allocated between the Flagship Stockholder Physicians' Compensation Pool (the "Initial Flagship Compensation Pool") and reimbursement of the Company's direct expenses relating to the Flagship Affiliated Group, based on a ratio of such budgeted compensation to such budgeted expenses. Once both the Company's direct expenses and the aggregate base physician compensation have been fully satisfied, any remaining Net Margin will be divided evenly between the Company and the Initial Flagship Compensation Pool. The method for determining PQC's management fee and the compensation of the Clinical Associates physicians differs from the model used in the Springfield Affiliated Group and with the original Flagship physicians. Instead of a sharing of gross margin after practice expenses, PQC is entitled to a percentage of billings, net of uncollectible amounts and discounts ("Net Adjusted Billings"). The revenue splitting arrangements for the Clinical -10- Associates physicians differ based upon whether the revenue is derived from an existing specialist practice, a primary care practice, future specialist practices and the practices of physicians without established practices. Except as provided below, Net Adjusted Billings in excess of baseline Net Adjusted Billings reflecting the historical level billings for such physician subject to reductions for changes in practice patterns ("Specialist Net Adjusted Billings") from specialist (a specialist being a physician at least 80% of whose billings are derived from a specialist practice) practices with respect to any fiscal year will be allocated 35% to PQC and 65% to an account established with respect to the Clinical Associates physicians and any future physicians included in the same compensation arrangements (the "Account") until $3 million has been allocated between the Account and PQC; and any remaining Specialist Billings will be allocated 20% to PQC and 80% to the Account. Net Adjusted Billings by primary care, OB/GYN physicians and physicians (whether primary care or specialist) added to the compensation arrangements in the future in excess of the agreed upon baseline Net Adjusted Billings will be allocated 20% to PQC and 80% to the Account. With respect to any physician recruited to join Flagship who does not have a practice that is merged into Flagship (and to certain physicians currently affiliated with Clinical Associates ), 20% of the Incremented Amount shall be allocated to PQC. "Incremented Amount" means the excess, if any, of Net Adjusted Billings attributable to such physician over an amount equal to twice the average compensation of physicians with a similar practice in the Baltimore metropolitan area as reported by a standardized reporting source. Any Net Adjusted Billings attributable to such physician less (A) the amounts allocated to PQC and (B) the compensation payable to the physician under the physician's employment agreement shall be allocated to the Account. Any revenue not included in Net Adjusted Billings will be allocated to the Compensation Pool to offset practice expenses, provided that if the ratio of practice expenses to practice revenue declines below historical levels, revenues not included in Net Adjusted Billings will be allocated equally to PQC and the Account. Net Margin from centralized laboratory services (which for this purpose shall mean revenue from laboratory ancillary services less (i) direct expenses of such laboratory ancillary services and (ii) an allocation of Flagship overhead) attributable to the Clinical Associate physicians will be allocated 80% to PQC and 20% to the Account. Net Margin from incremental non-laboratory ancillary services will be allocated 50% to PQC and 50% to the Account together with the current Flagship Compensation Pool. The amount allocated to the Account is first used to pay the practice expenses of the physicians whose compensation is paid through the Account. Any remaining amount in the Account with respect to any fiscal year will be distributed to the Clinical Associates physicians as their sole source of compensation. The allocation of such compensation among the physicians is determined by a committee elected by, or pursuant to a formula approved by, the Clinical Associates physicians. PQC expects to consider restructuring the compensation arrangements with respect to the initial Flagship Affiliated Physicians to determine whether to merge the two compensation arrangements. In the event that PQC elects to modify the compensation arrangements of the -11- Initial Flagship Physicians in this manner, PQC will guarantee for a two year period (commencing on the date of such merger) that the compensation of the Clinical Associates physicians under the combined compensation distribution system is not less than the baseline compensation that such physicians would have received if the compensation distribution systems are not merged. Until June 1, 1998, the Clinical Associate physicians have the right to elect to receive up to an additional 2,000,000 shares of Common Stock as consideration for their affiliation with the Flagship Affiliated Group. If the Clinical Associate physicians elect in their sole discretion to receive such additional Common Stock, the compensation arrangements set forth above will be amended, so that an aggregate of $760,000 of Net Adjusted Billings (or such proportionately reduced amount if less than 2,000,000 shares of Common Stock shares are elected) that would otherwise be allocated to the Account with respect to each fiscal year shall instead be allocated to PQC. The Agreements between PQC and the Clinical Associated Physicians include a provision that penalizes PQC if certain revenue targets described below are not met. Until there is no Shortfall (as defined below) or PQC completes a public offering of the Company Common Stock at a price to the public of $9.00 or more per share, the amount that would have been allocated to PQC pursuant to the Services Agreement will be reduced by the Adjustment Amount and the amount that is allocated to the Account will be increased by the Adjustment Amount. "Shortfall" means the difference between $3.0 million and the aggregate increase in Net Adjusted Billings over baseline Net Adjusted Billing by the specialist physicians in Clinical Associates or who are subsequently added to the practice. The "Adjustment Amount" is 45% of any Shortfall. Consequently, unless Net Adjusted Billing increases by $3.0 million over historical levels, and Adjustment Amount will be due. PQC has agreed with the stockholders of Clinical Associates that neither PQC nor Flagship will merge with or into, become a subsidiary of, or sell Flagship or all or substantially all of PQC's assets to, or grants governance participation to, a Baltimore Health Care Entity without the approval of a majority of the members of the Management Committee. A Baltimore Health Care Entity means any hospital, medical group or other organization that principally conducts its business in and derives its revenues from the delivery of healthcare services in Maryland. In the event that PQC or any of its affiliates propose the establishment of an independent provider association ("IPA") network in the Maryland Area, PQC is required to obtain the approval of the Joint Policy Board with respect to the structure, governance and financial arrangements of the IPA network, including whether the Physicians in the Flagship Affiliated Group will participate in such IPA network. PQC will be entitled to a fee of up to 10% of the aggregate revenue of the IPA network, which fee PQC shall not be required to share with the physicians employed by the Flagship Affiliated Group. Any residual profits of the IPA network (in excess of the 10% fee) that are retained by PQC shall be allocated 50% to PQC and 50% to the physicians in the Flagship Affiliated Group. -12- In the event that prior to December 1, 2001, PQC has not completed an underwritten initial public offering, the Clinical Associates physicians shall have the right, within 45 days thereafter, to require PQC to repurchase the Common Stock issued in the affiliation transaction with Clinical Associates at a purchase price of $3.00 per share. PQC shall have the right to pay the purchase price by a five (5) year non-interest bearing note. The principal payable with respect to such note shall be reduced by the amount, if any, that the Clinical Associates physicians' compensation between the issue date of the note and its maturity exceeds the base compensation with respect to the Clinical Associates physicians during that period. Atlanta IPA Affiliates. The Company has acquired a 50% interest in two related physician network management companies in Atlanta, Georgia. The two entities, TLC Management Company, Inc. ("TLC") and Total Quality Practice Management, Inc. ("Total Quality"), manage payor contracting for a 350-physician network in Georgia. The network currently serves approximately 4,500 covered lives. PQC's investment totals $5 million. The Company believes that the Atlanta market is attractive for the Company as it is a relatively unconsolidated physician practice market and global capitation arrangements are expected to become a more significant market factor. Future Affiliation Transactions. The Company's current primary focus is on expanding the Springfield Affiliated Group and the Flagship Affiliated Group, and developing additional Affiliated Groups in the eastern United States. The Company will determine which geographic markets to enter in the future based upon consideration of the following factors (among others): (i) population and economic profile, (ii) level of managed care penetration and effectiveness of providers in coping with the managed care environment, (iii) physician practice density, specialty composition, and average group size, (iv) receptivity of the medical community to the Company's management philosophy, (v) local competition in the physician practice management business and (vi) commercial and Medicare reimbursement rates. The Company also regularly considers the addition of physicians on an employee, rather than a Stockholder Physician, basis. Governmental Regulation - ----------------------- As a participant in the healthcare industry, the Company's operations and relationships, and the business and activities of its affiliated physicians, will be subject to extensive and increasing regulation by a number of governmental entities at the federal, state and local levels and by fiscal intermediates appointed by various payors and other private brokers. The Company will also be subject to laws and regulations relating to business corporations in general. Because of the uniqueness of the structure of the relationship with the physician groups, many aspects of the Company's business operations have not been the subject of state or federal regulatory interpretation, and there can be no assurance that a review of the business of the Company or its affiliated physicians by courts or regulatory authorities will not result in a determination that could adversely affect the operations of the Company or the -13- affiliated physicians. In addition, there can be no assurance that the healthcare regulatory environment will not change so as to restrict the Company's or the affiliated physicians' existing operations or their expansion. Prohibition on Corporate Practice of Medicine. The laws of most states, including Massachusetts and Maryland, prohibit business corporations such as the Company from practicing medicine or employing physicians to do so. The contractual relationships the Company has entered into with the Affiliated Groups attempt to comply with these laws. Because there is very limited judicial or regulatory interpretation of the scope of the corporate practice of medicine prohibition in most states, however, there can be no assurance that the Company's contractual arrangements will be found to comply with such laws. Any determination that the contractual relationships violate such laws could have a material adverse effect on the Company, and there can be no assurance that the Company would be able to restructure its arrangements on favorable terms or at all. The Massachusetts Board of Registration in Medicine (the "BRM") has proposed regulations that, if promulgated as proposed, might prohibit physicians licensed within the Commonwealth of Massachusetts from entering into management contracts with proprietary business entities unless a majority of the governing board of those business entities are licensed physicians and certain other conditions are met. The BRM also indicated that it may seek to limit significantly the extent to which proprietary business entities may have control or consultation rights with respect to medical decisions or business decisions that may affect patient care, such as the amount of time each physician spends with a patient. Extensive commentary has been filed in opposition to the proposed regulations, and it is not known when or in what form final regulations will be promulgated. The final regulations may have a material adverse effect on the Company's relationship with the Springfield Affiliated Group and its ability to operate in Massachusetts as currently contemplated. Comparable regulations have not been proposed in Maryland, but there can be no assurance that such regulations will not be proposed or adopted. Restrictions on Referrals and Fee-Splitting. In addition to prohibiting the practice of medicine, numerous states prohibit entities such as the Company from engaging in certain healthcare-related activities such as fee-splitting with physicians or from making referrals to entities in which the referring physician has an ownership interest. For example, Maryland has enacted legislation that significantly restricts patient referrals for certain services, and requires disclosure of ownership in businesses to which patients are referred and places other regulations on healthcare providers. The Company has structured its arrangements with the practices in the Flagship Affiliation to fit within the group practice exemption contained in the Maryland act; however, investments or contractual relationships with businesses not specifically operated by the Flagship Affiliated Group would, in some cases, be prohibited. The Company believes it is likely that other states will adopt similar legislation. Accordingly, expansion of the operations of the Company to certain jurisdictions may require it to comply with such jurisdictions' regulations which could lead to structural and organizational -14- modifications of the Company's anticipated form of relationships with physician groups. Such changes, if any, could have an adverse effect on the Company. Certain provisions of the Social Security Act, commonly referred to as the "Anti-kickback Statute," prohibit the offer or receipt of any form of remuneration in return for the referral of Medicare or state health program (such as Medicaid) patients, or in return for the recommendation, arrangement, purchase, lease, or order of items or services that are covered by Medicare or state health programs. The Anti-kickback Statute is broad in scope and has been broadly interpreted by courts in many jurisdictions. Read literally, the statute places at risk many customary business arrangements, potentially subjecting such arrangements to lengthy, expensive investigations and prosecutions initiated by federal and state governmental officials. Many states have adopted similar prohibitions against payments intended to induce referrals of state health program and other third-party payor patients. While the Company has attempted to structure its contractual relationships so as to comply with the Anti-kickback Statute, there can be no assurance that such relationships do in fact comply with the Anti-kickback Statute given the broad wording of the statute. While the federal government has promulgated or proposed various "safe harbor" exceptions to the Anti-kickback Statute, the Company does not expect its operations to fit within any of the safe harbors. Violation of the Anti-kickback Statute is a felony, punishable by fines up to $25,000 per violation and imprisonment for up to five years. In addition, the Department of Health and Human Services may impose civil penalties excluding violators from participation in Medicare or state health programs. Significant prohibitions against physician referrals were enacted by Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions, commonly known as "Stark II," amended prior physician self-referral legislation known as "Stark I" by dramatically enlarging the field of physician-owned or physician-interested entities to which the referral prohibitions apply. Stark II prohibits, subject to certain exemptions, a physician or a member of his or her immediate family from referring Medicare or state health program patients for "designated health services" to an entity in which the physician has an ownership or investment interest or with which the physician has entered into a compensation arrangement including the physician's own group practice. The designated health services include radiology and other diagnostic services, radiation therapy services, physical and occupational therapy services, durable medical equipment, parenteral and enteral nutrients, equipment, and supplies, prosthetics, orthotics, outpatient prescription drugs, home health services, and inpatient and outpatient hospital services. The penalties for violating Stark II include a prohibition on payment by these government programs for services rendered pursuant to such references and civil penalties of as much as $15,000 for each violative referral and $100,000 for participation in a "circumvention scheme." In addition, the provider may be disqualified from participating in the Medicare and state health care programs based on the submission of a false claim or participation in a circumventive scheme. The Company has attempted to structure its activities in compliance with Stark I and Stark II. However, the Stark legislation is broad and the Stark I regulations are complex and do not provide clear guidance on how Stark II will be interpreted. A finding that the Company or its Affiliated Groups has violated Stark could have -15- a material adverse effect on the Company. In addition, future regulations or clarification of the existing regulations could require the Company to modify the form of its relationships with physician groups and may limit the Company's ability to implement fully its plan for integrated care. Prohibition on False Claims. There are also state and federal civil and criminal statutes imposing substantial penalties, including civil and criminal fines and imprisonment, on healthcare providers who fraudulently or wrongfully bill governmental or other third-party payors for healthcare services. The federal law prohibiting false billings allows a private person to bring a civil action in the name of the United States government for violations of its provisions. There can be no assurance that the Company's activities will not be challenged or scrutinized by governmental authorities. Moreover, technical Medicare and other reimbursement rules affect the structure of physician billing arrangements. Regulatory authorities might challenge the billing arrangements with the Affiliated Groups and, in such event, the Company may have to modify its relationship with physician groups. Noncompliance with such regulations may adversely affect the operation of the Company and subject the Company and Affiliated Groups to lost reimbursement, penalties and additional costs. Direct Provision of Healthcare Services. The Company plans to develop a network of integrated healthcare services (other than acute care) in the future, depending on market conditions. If the Company determines that it is advantageous to provide such services through a wholly-owned subsidiary or other controlled relationship, it is possible that one or more subsidiaries or affiliates of the Company could become licensed providers of healthcare services. Any such provider would have to comply with applicable regulatory requirements. In addition, the direct provision of healthcare services by a subsidiary or affiliate might increase the risk to the Company of regulatory or other investigation or litigation. Healthcare Reform. A portion of the revenues of the Company's Affiliated Groups is derived from payments made by governmental sponsored healthcare programs (principally, Medicare and Medicaid). Government revenue sources are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, determinations by fiscal intermediaries, and government funding restrictions, all of which may materially decrease the rates of payment and cash flow to physicians and other healthcare providers. The federal Medicare program adopted a system of reimbursement of physician services, known as the resource based relative value scale schedule ("RBRVS"), which took effect in 1992 and is expected to be fully implemented by December 31, 1996. The Company expects that the RBRVS fee schedule and other future changes in Medicare reimbursement will, in some cases, result in a reduction from historical levels in the per patient Medicare revenue received by certain of the Affiliated Groups with which the Company may contract, which in turn may result in a decrease in revenues to the Company. In addition to current regulation, the United States Congress has considered various types of healthcare reform, including comprehensive revisions to the current healthcare -16- system. It is uncertain what legislative proposals will be adopted in the future, if any, or what actions federal or state legislatures or third party payors may take in anticipation of or in response to any healthcare reform proposals or legislation. Healthcare reform legislation adopted by Congress could result in lower payment levels for the services of physicians managed by the Company and lower profitability of the Affiliated Groups, which could have a material adverse effect on the operations of the Company. Insurance Laws. Laws in all states regulate the business of insurance and the operation of HMOs. Many states also regulate the establishment and operation of networks of healthcare providers. While these laws do not generally apply to the hiring and contracting of physicians by other healthcare providers, there can be no assurance that regulatory authorities of the states in which the Company operates would not apply these laws to require licensure of the Company's operations as an insurer, as an HMO or as a provider network. Antitrust Laws. Because the affiliated practice groups are not subsidiaries of the Company and thus remain separate legal entities for antitrust purposes, they may be deemed competitors subject to a range of antitrust laws which prohibit anti-competitive conduct, including price fixing, concerted refusals to deal and division of market. The Company intends to comply with such state and federal laws as they may affect its development of integrated healthcare delivery networks, but there is no assurance that the review of the Company's business by courts or regulatory authorities will not result in a determination that could adversely affect the operation of the Company and its affiliated physician groups. Competition - ----------- The Company faces competition for both the recruitment and retention of affiliated physicians. The market for affiliation with physicians is highly competitive, and the Company expects this competition to increase. The Company competes for physician affiliations with many other entities, some of whom have substantially greater resources, greater name recognition and a longer operating history than the Company and some of whom offer alternative affiliation strategies which the Company may not be able to offer. The provision of physician practice management services is a highly competitive business in which the Company will compete for contracts with several national and many regional and local providers of such services. Certain of the Company's competitors will have access to substantially greater resources than the Company. Although the nature of the competition may vary, competition is generally based on cost and quality of care. There can be no assurance that PQC will be able to compete effectively, that additional competitors will not enter the market, or that such competition will not make it more difficult to acquire the assets of multi-speciality clinics on terms beneficial to PQC. -17- Employees - --------- As of December 31, 1997, the Company had 43 employees and the Affiliated Groups had 1,037 employees, including 198 physicians. ITEM 2. PROPERTIES. The Company leases a 6,358 square foot facility in Waltham, Massachusetts for its headquarters and also leases office space in Springfield, Massachusetts and Baltimore, Maryland. The Springfield Affiliated Group leases approximately 46,000 square feet at 13 practice locations and the Flagship Affiliated Group leases approximately 197,000 square feet at 41 practice locations. The facilities leased by the Company and its Affiliated Groups are sufficient for its current operations. ITEM 3. LEGAL PROCEEDINGS. On June 12, 1997, Jay N. Greenberg, a founder and former executive vice president of the Company, filed a complaint against the Company in Massachusetts state court seeking damages of $1.4 million and a declaratory judgment that 843,750 of the shares registered in Mr. Greenberg's name (out of 1,012,500 shares of Class A Common Stock originally granted to Mr. Greenberg) have "vested" under this Employment Agreement. The complaint involves a dispute over whether an amendment in December 1996 to Mr. Greenberg's Employment Agreement is valid and whether Mr. Greenberg resigned or was terminated in January 1997. The Company maintains that the amendment was fraudulently induced based upon a commitment by Mr. Greenberg for long-term employment with the Company and that Mr. Greenberg resigned in January 1997. Under such facts Mr. Greenberg is entitled to have no more than 450,000 shares of Class A Common Stock vest (and, depending upon counterclaims that may be brought by the Company, possibly fewer) and is entitled to no severance payment. Mr. Greenberg claims that 843,750 shares of Class A Common Stock have vested and that his employment was terminated in January 1997 by the Company entitling him to severance payments of $440,000. The Company is not able to predict the outcome of this litigation. No other claims are pending against the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders of the Company, through solicitation of proxies or otherwise, during the last quarter of the year ended December 31, 1997. -18- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company did not issue or sell any equity securities during the quarter ended December 31, 1997 that were not registered under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data for the Company should be read in conjunction with the financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10K. The selected financial data of the Company for the period from March 20, 1995 (inception) through December 31, 1995 and for the years ended December 31, 1996 and December 31, 1997, have been derived from financial statements of the Company which have been audited by Ernst & Young LLP, independent auditors. -19-
PQC ------------------------------------------------------ PERIOD FROM MARCH 20, 1995 YEAR ENDED YEAR ENDED (INCEPTION) TO DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1996 1997 ------------------------------------------------------ (in thousands, except per share data) STATEMENT OF OPERATING DATA: Net patient service revenue $ - $ 6,027 $ 46,037 Retained by physicians - 2,195 15,596 ------- -------- -------- Management fee revenue - 3,832 30,441 Nonphysician salaries and benefits - 1,816 13,865 Other practice expenses - 1,822 12,721 General corporate expenses 2,062 4,666 7,329 Depreciation and amortization 6 280 2,164 Provision for bad debt - 214 1,106 ------- -------- -------- Operating income (loss) (2,068) (4,968) (6,743) Other, net 18 (13) 238 ------- -------- -------- Income (loss) before taxes (2,050) (4,981) (6,506) Income taxes (benefit) 32 78 (795) ------- -------- -------- Net income (loss) (2,082) (5,059) (5,710) ======= ======== ======== Net loss available to common stock (2,082) (19,496) (12,389) Net income (loss) per common share-basic $ (0.27) $ (1.81) $ (0.41) Weighted average common shares and common share equivalents outstanding 7,706 10,786 30,336
PQC ------------------------- DECEMBER 31, 1995 1996 1997 ------------------------- (in thousands) BALANCE SHEET DATA: Cash and cash equivalents $3,480 $ 136 $ 8,782 Net current assets 2,651 (860) 12,493 Total assets 4,363 34,790 73,411 Total current liabilities 850 2,776 2,113 Long-term obligations 1,410 521 746 Class A Common Stock, subject to put - 31,851 54,474 Total stockholders' equity (deficiency) 2,104 (358) 16,077
During 1997, the Company adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128") which requires the restatement of earnings per share calculations for all years presented. The adoption of SFAS 128 did not impact the Company's earnings per share calculation for 1995 and 1996. -20- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Overview - -------- The Company affiliates with and operates multi-specialty medical practice groups. The first physician affiliation took place on August 30, 1996, with 32 physicians in the Springfield, Massachusetts and Enfield, Connecticut area. On December 11, 1996, PQC consummated the affiliation with the Flagship Affiliated Group, which consisted of 59 physicians in Baltimore and Annapolis, Maryland. In connection with the affiliation transactions, the assets and liabilities of the physician practices were transferred to newly formed PCs or PAs affiliated with the Company. Additional physicians have been subsequently added to the Affiliated Groups. PQC is working with these groups of physicians to improve operating practices and to obtain managed care contracts. On October 24, 1997, the Company also acquired a 50% interest in TLC and a 50% interest in Total Quality. Both companies are located in Atlanta, Georgia. As of December 31, 1997, the Company had affiliations or IPA arrangements with the following physicians:
Affiliated Physicians ---------------------------- Maryland Massachusetts Georgia ---------- ------------- ------- Primary Care: 99 29 0 Specialist: 44 13 0 Total: 143(1) 42 0
IPA Physicians -------------- Maryland Massachusetts Georgia(2) ---------- ------------- ------- Total: 0 0 350 - -----------------
(1) Includes 16 non-physician medical professionals. (2) Reflects number of physicians in IPA network in which the Company has a 50% interest. The Company's Fee under Service Agreements. For a discussion of the fee and expense allocation arrangement between the Company and each Affiliated Group, see "Item 1. Business - Affiliation Structure." Under the Company's contractual arrangements with its Affiliated Groups, the Company can improve its management fee revenues by increasing the patient care revenue of its Affiliated Groups, whether through improved billing and operating efficiency, additional patient encounters or increased capitated revenues, and controlling the expenses of Affiliated Groups. To the extent that patient revenue increases at a greater rate than practice expenses, -21- PQC's management fee will increase. Conversely, if PQC is not able to control practice expenses or assist the Affiliated Groups in increasing patient care revenue, PQC will earn no or only a limited management fee. Under the arrangements with the physicians formerly associated with Clinical Associates (which became effective on December 1, 1997) PQC earns a fee based, in part, upon increases in billings, net of bad debts and discounts, above historical levels, and a reduction in the percentage of revenue needed to pay practice expenses. While this structure causes PQC's management fee not to be as dependent upon controlling practice expenses, PQC believes that both increased revenues and controlling costs will continue to be important factors to its management fee growth as increased billings depend upon affiliated physicians being motivated by competitive levels of compensation. The Company's and its Affiliated Groups' revenues are derived from governmental programs, managed care payors and traditional fee-for-service arrangements. The following table sets forth the approximate percentage of the revenues received by the practices that were affiliated with the Company at December 31, 1997 during the year ended December 31, 1997: Fee for Service Contracts 48.0% Medicare 35.0% Capitated Managed Care Contracts 12.0% Medicaid 5.0% ------ 100%
Results of Operations - --------------------- Year Ended December 31, 1996 Compared to Period From March 20, 1995 (Inception) to Year Ended December 31, 1995 From inception (March 20, 1995) through August 30, 1996, the Company was primarily in a development and start up phase. The first affiliation with 32 Springfield, Massachusetts physicians was completed on August 30, 1996. Prior to this date the Company had no revenues. On December 11, 1996, the Company affiliated with 59 physicians in the greater Baltimore-Annapolis, Maryland area. In connection with the affiliation transactions, the assets and liabilities of the physician practices were transferred to newly formed PCs and PAs affiliated with the Company. The assets and liabilities of the Springfield, Massachusetts physicians were transferred to Medical Care Partners, P.C. ("MCP") and the physicians became employees of MCP. The assets and liabilities of the December 11, 1996 affiliation were transferred to Flagship Health I, P.A. ("Flagship I") and the physicians became employees of Flagship I. The increase in revenues of $6.0 million was more than offset by increases in operating expenses. The affiliation transactions resulted in the addition of physician salaries and benefits, non-physician salaries and benefits, other practice expenses, provision for bad -22- debt and depreciation and amortization. Prior to the completion of the first affiliation transaction the Company incurred general corporate home office expense only. Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 During January and February 1997, the Company affiliated with 6 physicians in the Springfield, Massachusetts area. The assets and liabilities of the Springfield physicians were transferred to MCP and the physicians became employees of MCP. On December 1, 1997, the Company entered into an affiliation agreement with a physician practice consisting of 58 physicians located in the Baltimore/Annapolis, Maryland area. The assets and liabilities of the Baltimore/Annapolis physicians were transferred to Flagship Health II, P.A. ("Flagship II") and the physicians became employees of Flagship II. The completion of the Springfield and Baltimore area affiliations resulted in the Company having net revenues of approximately $46.0 million for the year ended December 31, 1997 compared to approximately $6.0 million for the year ended December 31, 1996. The increase in revenues was primarily due to both the number and dates of affiliation of the Springfield and Baltimore physicians. The revenues for 1996 were generated from 32 physicians from August 30, 1996 through December 31, 1996 and one month of revenues from Flagship I physicians. The revenues for 1997 consisted of a full year of revenues from both MCP and Flagship I physicians as well as one month's revenues generated by the 58 Flagship II physicians. The source of revenue in 1997 remained largely unchanged from 1996, with fee for service payments and Medicare accounting for approximately 83% of revenue. Although the Company is seeking to increase its participation in capitated managed care contracts, such agreements only amounted for approximately 12.0% of revenue in 1997. During the year ended December 31, 1997 as compared to the year ended December 31, 1996, the amounts retained by physician groups, which represents physician salaries and benefits increased approximately $13.4 million. The increase is primarily due to the same factors which caused the increase in revenues, namely that 1997 consisted of a fully year of operations for MCP and Flagship I as compared to four months of operations and one month of operations during 1996 for MCP and Flagship I, respectively. In addition, the affiliation of Flagship II on December 1, 1997 resulted in an increase of approximately $900,000 as compared with 1996. As a percentage of net patient service revenues amounts retained by physician groups decreased from 36.4% in 1996 to 33.8% in 1997. This decrease was primarily due to variances in the fee and expenses allocation arrangements between the Company and each Affiliated Group. See "Item 1. Business-Affiliation Structure." During the year ended December 31, 1997 as compared to the year ended December 31, 1996, nonphysician salaries and benefits, which represents salaries and benefits for staff engaged in the physicians' practice increased approximately $12.0 million. Other practice expenses in 1997, which represent primarily all non-salary and benefits expenses of physicians' practices, increased approximately $10.9 million and provision for bad debt increased approximately $891,000. These increases in physician affiliation expenses resulted -23- primarily from the same reasons stated above for the increase in net patient service revenues and amounts retained by physician groups; namely that 1997 consisting of a full year of operations for MCP and Flagship I as compared with a partial year operations in 1996 and the addition of Flagship II during 1997. General corporate expenses consist of all costs except depreciation and amortization of the Company's corporate home office and regional operations. The increase in general corporate expenses of approximately $2.7 million for the year ended December 31, 1997 as compared to the year ended December 31, 1996 was primarily due to the increase in home office and corporate regional operations staff and related expenses to support the Company's growth. However, corporate expenses increased at a slower rate than overall revenue, declining from 77.4% of net patient service revenue in 1996 to 15.9% in 1997. Depreciation and amortization expense consists primarily of amortization of intangibles associated with affiliated practices. The increases of approximately $1.9 million from the year ended December 31, 1997 as compared to the year ended December 31, 1996 was due to the increase in intangible assets acquired as practice affiliations were completed, as well as 1997 consisting of a full years depreciation and amortization for MCP and Flagship I as compared to a partial year of depreciation and amortization during 1996. On October 24, 1997, the Company acquired a 50% interest in TLC and a 50% interest in Total Quality. The Company has accounted for the transaction using the equity method of accounting for investments in common stock. For the year ended December 31, 1997, the net loss in investment was approximately $98,000. The Company made no such investments in 1996. The increase in interest income of approximately $407,000 for the year ended December 31, 1997 as compared to the year ended December 31, 1996 was primarily due to a significant increase in the purchase of the Company's Class B and Class C Common Stock by institutional investors during the year ended December 31, 1997 as compared to the year ended December 31, 1996. Proceeds from the issuance of common stock to institutional investors, net of issuance costs were approximately $25.8 million for the year ended December 31, 1997 as compared to approximately $8.0 million for the year ended December 31, 1996. Liquidity and Capital Resources - ------------------------------- The Company's principal requirements for capital are payments to physicians in connection with affiliation transactions with the Company and its Affiliated Groups, transaction costs associated with such affiliation transactions, working capital requirements for its Affiliated Groups and the funding of operating losses. The Company anticipates that its liquidity and capital resource requirements will be similar on a long-term and short-term basis. Due to its start-up status, the Company has incurred significant operating losses to date and does not have operating cash flow to fund growth or further losses. The Company's -24- principal sources of capital to date have been the issuance of Class B and Class C Common Stock to contain institutional investors, issuances of Class A Common Stock to Physician Stockholders, other issuances of Class A Common Stock to private investors, borrowing under a Credit Agreement with Bankers Trust Company (which terminated on January 31, 1998) and cash generated by the operations of the Affiliated Groups. During 1997 and 1996, the Company paid aggregate consideration of approximately $23.6 and $29.5 million, respectively, in connection with affiliation transactions. Of such amount, approximately $7.8 million in 1997 and $5.9 in 1996 was paid in cash and approximately $15.8 million in 1997 and $23.6 in 1996 was paid in Class A Common Stock. The majority of such payments were accounted for as an addition to intangible assets, which represented $26.1 million of the Company's total assets of $73.4 million at December 31, 1997. As of December 31, 1997, intangible assets net of amortization costs, represent approximately $57.3 million of the Company's total assets of approximately $73.4 million. The Company is amortizing the intangible assets over 25 years. Of the Company Common Stock outstanding at December 31, 1997, 18,157,982 shares of Class A Common Stock are subject to a put option which provides for the put of the shares back to the Company at fair value upon the death or disability of the holder. In addition, 1,029,749 of such shares are also subject to a fair value put option back to the Company at the later of the shareholder's retirement from the Company or June 1998. Consequently, these 18,157,982 shares of Class A Common Stock have been recorded at fair value outside of permanent equity in the accompanying balance sheet. Under the Company's stockholder agreements, the holders of an aggregate of 15,471,063 shares of Class A Common Stock, the Company may repurchase such shares for fair value if the shareholder's termination of employment with the Company is without cause or is by resignation, and for the lower of cost or fair value if termination is with cause. The terms of such repurchase provision may not permit the Company to fully recover its affiliation payments to the physician or reflect the cost of affiliation transactions at the time of termination. To date, no Stockholder Physician has terminated an employment agreement or repurchased any practice assets. All of the above put and call provisions expire on the closing of a public offering of the Company's common stock which results in net proceeds to the Company of at least $50.0 million and which meets certain other criteria. In addition to the previously discussed put options, the Flagship II physicians have the right to require the Company to repurchase (in the form of a five year non-interest bearing note) 4.8 million shares of Class A Common Stock issued in the Flagship II affiliation at a purchase price of $3.00 per share if the Company has not completed an underwritten initial public offering prior to December 1, 2001. Because the Company's shares are subject to a number of restrictions in the stockholders' agreements and will not trade until the occurrence of such an offering, the Company believes it is a nonpublic entity for compensation accounting purposes and, accordingly, has not recorded any compensation expense for these puts and calls. Working capital existing at the date of affiliation has generally been retained in the practices. Therefore, additional working capital investment is generally only required to the -25- extent billing processing is slowed during payor administrative changes after an affiliation and also to fund growth of revenues. The Company and its affiliated entities had total net accounts receivable of $5.4 million and $11.9 million at December 31, 1996 and 1997, respectively. The Company currently anticipates that its and the Affiliated Group's capital expenditures during 1998 will be approximately $2.5 million. The Company has executed a contract with HMO and Company that obligates the Company to purchase $1.1 million worth of equipment and licenses pertaining to practice management systems. The term of the contract is five years. Impact of Year 2000 - ------------------- The Company is aware of issues associated with the programming code in existing computer systems as the year 2000 approaches. The "Year 2000" problem is pervasive and complex, as virtually every computer operation will be affected in the same way by the rollover of the two digit year value to 00. The issue is whether computer systems will properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate enormous data or cause a system to fall. The Company is utilizing both internal and external resources to identify, correct or reprogram, and test its systems for Year 2000 compliance. It is currently anticipated that all reprogramming efforts will be completed by July 31, 1999, allowing adequate time for testing. A preliminary assessment has indicted that some of the Company's older personal computers and ancillary software programs may not be Year 2000 compatible. The Company intends to either replace or modify these computers and programs. The cost of this replacement is not expected to be material as the shelf life of the Company's personal computers is three to five years. The present financial systems are all Year 2000 compliant. The practice management system is 80% compliant and the Company plans to move to a newer version of the software which is 100% compliant as part of it's reprogramming efforts which will be completed by July 31, 1999. This upgrade is provided under the Company's current software maintenance agreement with its software vendor. All new software purchased will be 100% compliant. The Company is also obtaining confirmations from the Company's primary vendors that plans are already in place to address processing of transactions in the Year 2000. However, there can be no assurance that the systems of other companies on which the Company's systems rely also will be converted in a timely fashion or that any such failure to convert by another company would not have an adverse effect on the Company's systems. Management is in the process of completing the assessment of the Year 2000 compliance costs. However, based on currently available information (excluding the possible impact of vendor systems which management currently is not in a position to evaluate) as noted above, -26- management does not believe that these costs will have a material effect on the Company's earnings. Factors Affecting Future Operating Results - ------------------------------------------ Lack of Operating History; History of Operating Losses The Company's historical financial condition and results of operations may not be indicative of the Company's results of operations and financial condition for future periods. The Company has incurred losses of each of its fiscal years through 1997. The Company expects to incur operating losses for at least the immediate future and to fund such operating losses through the issuance of additional equity and debt securities. See "-- Need for Substantial Additional Capital." There can be no assurance that the Company will achieve or maintain profitability. Need for Substantial Additional Capital The Company will require substantial capital resources to obtain the necessary scale to become profitable and to fulfill its business plan. Additional funds will be required to fund the acquisition, integration, operation and expansion of affiliated practices, capital expenditures including the development of the information systems to manage such practices, operating losses and general corporate purposes. The Company has no committed external sources of capital. Without the consent of the director elected by the stockholders of the Class B-1 Common Stock (the "Class B-1 Director"), the director elected by the stockholders of the Class B-2 Common Stock (the "Class B-2 Director," and together with the Class B-1 Director the "Class B Directors") and the directors elected by the holders of Class C Common Stock (the "Class C Directors"), the Company may not obtain additional financing through external borrowings or the issuance of additional securities. The issuance of additional capital stock could have an adverse effect on the value of the shares of common stock held by the then existing stockholders. There can be no assurance that the Class B Directors and Class C Directors will approve such capital raising activities or that the Company will be able to raise additional capital when needed on satisfactory terms or at all. The failure to obtain additional financing when needed and on appropriate terms could have a material adverse effect on the Company. Risk that Future Affiliation Transactions Will Not Be Consummated; Costs of Affiliation Transactions There can be no assurance that any future affiliation transactions will be consummated. In consummating future affiliation transactions, the Company will rely upon certain representations, warranties and indemnities made by sellers with respect to the affiliation transaction, as well as its own due diligence investigation. There can be no assurance that such representations and warranties will be true and correct, that the Company's due diligence -27- will uncover all material adverse facts relating to the operations and financial condition of the affiliated medical practices or that all of the conditions to the Company's obligations to consummate these future affiliations will be satisfied. Any material misrepresentations could have a material adverse effect on the Company's financial condition and results of operations. The Company has incurred approximately $2.9 million and $567,000 during 1996 and 1997, respectively, in accounting, legal and other costs in developing its affiliation structure and completing its initial affiliation transactions. The Company's ability to enter into affiliation transactions with a significant number of physicians and to achieve positive cash flow will be adversely affected unless it is able to reduce the expenses associated with future transactions. There can be no assurance that the Company will be able to reduce transaction costs on a per affiliated physician basis in the future. Dependence upon Affiliated Medical Practices Although the Company does not and will not employ physicians or control the medical aspects of the practices of the physicians employed by the Springfield Affiliated Group, the Flagship Affiliated Group or similar Affiliated Groups, the Company's revenue and profitability are directly dependent on the revenue generated by the operation and performance of and referrals among the affiliated medical practices. The compensation to the Company under its Services Agreements with the Affiliated Groups is based upon a percentage of the profits or revenues generated by the Affiliated Groups' practices with a substantial portion of the profits or revenues being allocated to the physicians until threshold levels of income or revenues, based upon the physicians' historical compensation or billings, are achieved. Accordingly, the performance of affiliated physicians affects the Company's profitability and the success of the Company depends, in part, upon an increase in net revenues from the practice of affiliated physicians compared to historical levels. The inability of the Company's Affiliated Groups to attract and retain patients, to manage patient care effectively and to generate sufficient revenue or a material decrease in the revenues of the Affiliated Groups would have a material adverse effect on the financial performance of the Company. To the extent that the physicians affiliated with the Company are concentrated in a limited number of target markets, as is currently the case in western Massachusetts and Maryland, deterioration in the economies of such markets could have a material adverse effect upon the Company. Risks Related to Expansion of Operations Integration Risks. The Company has completed affiliation transactions with the Springfield Affiliated Group and the Flagship Affiliated Group, and is seeking to enter into Affiliations with additional physicians. In the Springfield and Greater Baltimore-Annapolis areas and in other potential affiliation markets, the Company is integrating physician practice groups that have previously operated independently. The Company is still in the process of integrating its affiliated practices. The Company may encounter difficulties in integrating the operations of such physician practice groups and the benefits expected from such affiliations -28- may not be realized. Any delays or unexpected costs incurred in connection with integrating such operations could have an adverse effect on the Company's business, operating results or financial condition. While each Affiliation conforms to PQC's overall business plan, the profitability, location and culture of the physician practices that have been combined into Affiliated Groups are different in some respects. PQC's management faces a significant challenge in its efforts to integrate and expand the business of the Affiliated Groups. The need for management to focus upon such integration and future Affiliations may limit resources available for the day- to-day management of the Company's business. While management of the Company believes that the combination of these practices will serve to strengthen the Company, there can be no assurance that management's efforts to integrate the operations of the Company will be successful. The profitability of the Company is largely dependent on its ability to develop and integrate networks of physicians from the affiliated practices, to manage and control costs and to realize economies of scale. There can be no assurances that there will not be substantial costs associated with such activities or that there will not be other material adverse effects on the financial results of the Company as a result of these integration and affiliation activities. The Company intends to continue to pursue an aggressive growth strategy through affiliations and internal development for the foreseeable future. The Company's ability to pursue new growth opportunities successfully will depend on many factors, including, among others, the Company's ability to identify suitable growth opportunities and successfully integrate affiliated or acquired businesses and practices. There can be no assurance that the Company will anticipate all of the changing demands that expanding operations will impose on its management, management information systems and physician network. Any failure by the Company to adapt its systems and procedures to those changing demands could have a material adverse effect on the operating results and financial condition of the Company. Need to Hire and Retain Additional Physicians The success of the Company is dependent upon its ability to affiliate with a significant number of qualified physicians and the willingness of such affiliated physicians to maintain and enhance the productivity of their practices following affiliation with PQC. The market for affiliation with physicians is highly competitive, and the Company expects this competition to increase. The Company competes for physician affiliations with many other entities, some of which have substantially greater resources, greater name recognition and a longer operating history than the Company and some of which offer alternative affiliation strategies which the Company may not be able to offer. In addition, under current law the Company has no or only limited ability to enforce restrictive covenants in the employment agreements with the physicians with whom the Company affiliates. The Company is subject to the risk that physicians who receive affiliation payments may discontinue such affiliation with the Company, resulting in a significant loss to the Company and a decrease in the patient base associated with such affiliated physicians. There can be no assurance that PQC will be able to -29- attract and retain a sufficient number of qualified physicians. If the Company were unable to affiliate with and retain a sufficient number of physicians, the Company's operating results and financial condition would be materially adversely affected. A material increase in costs of affiliations could also adversely affect PQC and its stockholders. Risk of Inability to Manage Expanding Operations The Company is seeking to expand its operations rapidly, which, if successful, will create significant demands on the Company's administrative, operational and financial personnel and systems. There can be no assurance that the Company's systems, procedures, controls and staffing will be adequate to support the proposed expansion of the Company's operations. The Company's future operating results will substantially depend on the ability of its officers and key employees to integrate the management of the Affiliated Groups, to implement and improve operational, financial control and reporting systems and to manage changing business conditions. Dependence Upon the Growth of Numbers of Covered Lives The Company is also largely dependent on the continued increase in the number of covered lives under managed care and capitated contracts. This growth may come from affiliation with additional physicians, increased enrollment with managed care payors currently contracting with the Affiliated Groups and additional agreements with managed care payors. A decline in covered lives or an inability to increase the number of covered lives under contractual arrangement with managed care or capitated payors could have a material adverse effect on the operating results and financial condition of the Company. Potential Regulatory Restraints Upon the Company's Operations The healthcare industry is subject to extensive federal and state regulation. Changes in the regulations or interpretations of existing regulations could have a material adverse effect on the Company's business, financial condition and results of operations. Risks of Capitated Contracts The physician groups with which the Company is affiliated and proposes to affiliate are parties to certain capitated contracts with third party payors, such as insurance companies. The Company intends to seek to expand the capitated patient base of its Affiliated Groups, particularly for Medicare enrollees. In general, risk contracts pay a flat dollar amount per enrollee in exchange for the physician's obligation to provide or arrange for the provision of a broad range of healthcare services (including in-patient care) to the enrollee. A significant difference between a full risk capitated contract and traditional managed care contracts is that the physician is sometimes responsible for both professional physician services and many other healthcare services, e.g., hospital, laboratory, nursing home and home health. The physician is not only the "gatekeeper" for enrollees, but is also financially at risk for -30- over-utilization and for the actuarial risk that certain patients may consume significantly more healthcare resources than average for patients of similar age and sex (such patients are referred to herein as "high risk patients"). While physicians often purchase reinsurance to cover some of the actuarial risk associated with high risk patients, such insurance typically does not apply with respect to the risk of over-utilization until a relatively high level of aggregate claims has been experienced and therefore does not completely protect against any capitation risk assumed. If over-utilization occurs with respect to a given physician's enrollees (or the physician's panel of enrollees includes a disproportionate share of high risk patients not covered by reinsurance), the physician is typically penalized by failing to receive some or all of the physician's compensation under the contract that is contingent upon the attainment of negotiated financial targets, or the physician may be required to reimburse the payor for excess costs. In addition, a physician may be liable for over-utilization by other physicians in the same "risk pool" and for utilization of ancillary, in-patient hospital and other services when the physician has agreed contractually to manage the use of those services. Neither the Company nor the Affiliated Groups currently maintain any reinsurance arrangement and, to date, the Affiliated Groups have not experienced losses from participation in risk pools or incurred any material penalties or obligations with respect to excess costs under capitated contracts. The Company is pursuing a strategy of seeking increased participation in capitated contracts for all of its affiliated physicians. As the percentage of the Company's revenues derived from capitated contracts increases, the risk of the Company experiencing losses under capitated contracts increases. As the revenues from capitated contracts became of increasing importance to PQC and its Affiliated Groups, the Company will review the financial attractiveness of reinsurance arrangements. Medical providers, such as the Affiliated Groups, are experiencing increasing pricing pressure in negotiating capitated contracts while facing increased demands on the quality of their services. If these trends continue, the costs of providing physician services could increase while the level of reimbursement could grow at a lower rate or decrease. Because the Company's financial results are dependent upon the profitability of such capitated contracts, the Company's results will reflect the financial risk associated with such capitated contracts. Liabilities or insufficient revenues under capitated and other risk-sharing arrangements could have a material adverse effect on the Company. Risks of Changes in Payment for Medical Services The profitability of the Company may be adversely affected by Medicare and Medicaid regulations, cost containment decisions of third party payors and other payment factors over which PQC and its Affiliated Groups have no control. The federal Medicare program has undergone significant legislative and regulatory changes in the reimbursement and fraud and abuse areas, including the adoption of RBRVS schedule for physician compensation under Medicare, which may have a negative impact on PQC's revenue. Efforts to control the cost of healthcare services are increasing. PQC's Affiliated Groups contract -31- with provider networks, managed care organization and other organized healthcare systems, which often provided fixed fee schedules or capitation payment arrangements which are lower than standard charges. Future profitability in the changing healthcare environment, with differing methods of payment for medical services, is likely to be affected significantly by management of healthcare costs, pricing of services and agreements with payors. Because PQC derives its revenues from the revenues generated by its affiliated physician groups, further reductions in payment to physicians generally or other changes in payment for healthcare services could have an adverse effect on the Company. Exposure to Professional Liability; Liability Insurance In recent years, physicians, hospitals and other participants in the healthcare industry have become subject to an increasing number of lawsuits alleging medical malpractice, negligent credentialing of physicians, and related legal theories. Many of these lawsuits involve large claims and substantial defense costs. There can be no assurance that the Company will not become involved in such litigation in the future. Through its management of practice locations and provision of non-physician healthcare personnel, the Company could be named in actions involving care rendered to patients by physicians or other practitioners employed by Affiliated Groups. In addition, to the extent that affiliated physicians are subject to such claims, the physicians may need to devote time to defending such claims, adversely affecting their financial performance for the Company, and potentially having an adverse effect upon their reputations and client base. The Company and the Affiliated Groups maintain professional and general liability insurance, which is currently maintained at $1 million per occurrence and $3 million annually for each affiliated physician. Nevertheless, certain types of risks and liabilities are not covered by insurance, and there can be no assurance that the limits of coverage will be adequate to cover losses in all instances. Certain Federal Income Tax Considerations Physician groups which operated as PCs in Springfield prior to affiliating with the Company were merged into the Springfield Affiliated Group, with stockholders of each PC receiving shares of Class A Common Stock of the Company and cash in exchange for their capital stock in the PC. Physician groups which operated as PAs in the greater Baltimore-Annapolis area prior to affiliating with the Company were similarly merged into the Flagship Affiliated Group, with stockholders of each PA receiving shares of Class A Common Stock of the Company and cash in exchange for their capital stock in the PA. Each such merger is intended to qualify as a "reorganization" under Section 368(a) of the Internal Revenue Code of 1986, as amended (the "Code"), in which case no gain or loss would generally be recognized by the PC or PA or the stockholders (other than as cash received) of the PC or PA. The Company has not sought or obtained a ruling from the Internal Revenue Service or an opinion of counsel with respect to the tax treatment of the mergers of PCs or PAs into the Springfield or Flagship Affiliated Groups. The Company does not believe that the Internal Revenue Service is issuing rulings at this time on transactions using the Company's affiliation structure. If a merger were not to so qualify, the exchange of shares -32- would be taxable to the stockholders of the PC or PA, and the consideration (net of asset basis) issued in connection with the merger would be taxable to the Affiliated Group into which such PC or PA was merged. Because of such tax liability, failure of a merger or mergers to qualify as tax-free reorganizations could have a material adverse effect on the applicable Affiliated Group and the Company. Also, the inability to structure future Affiliations on a tax deferred basis may adversely affect the Company's ability to attract additional physicians. New Management; Dependence on Key Personnel The current management structure and the senior management team of the Company have been in place for a relatively short time. The Company's future success depends, in large part, on the continued service of Jerilyn P. Asher, the Chief Executive Officer, and on PQC's ability to continue to attract, motivate and retain highly qualified senior management and employees. The Company has an employment agreement with Ms. Asher. The Company does not maintain key person life insurance with respect to Ms. Asher. As a development stage company, PQC has experienced some turnover in staff, including two of the founding officers. The Company and one of the departed founders are currently in a dispute concerning the vesting of approximately 400,000 shares of Class A Common Stock granted to the founder and the founder's right to severance payments of approximately $440,000. Although the Company has entered into employment agreements with certain of its other executives that contain covenants not to compete with the Company, there can be no assurance that the Company will be able to retain such key executives or its senior managers and employees. The inability to hire and retain qualified personnel or the loss of the services of personnel could have a material adverse effect upon the Company's business and future business prospects. Risk of the Unavailability of the Equity Facility The remaining amount under the Class B and Class C Stock Purchase Agreement (the "Equity Facility') with certain institutional inventors ("Institutional Investors") is only available with the consent of the Institutional Investors and there can be no assurance that the Institutional Investors will be willing to provide additional capital when needed by the Company. The Equity Facility also restricts the sources of capital available to the Company without the consent of the Institutional Investors. Except for the Equity Facility, the Company has no committed external sources of capital. Except with the consent of the director elected by the Institutional Investors, the Company may not obtain additional financing through external borrowings or the issuance of additional securities. The Institutional Investors also have received warrants to purchase a substantial number of shares of Class A Common Stock. These warrants are exercisable at $2.50 or $3.25 per share, which exercise price may be substantially below the fair market value of the Class A Common Stock at the time of exercise. Any additional equity issuance could have an adverse effect on the value of the shares of Class A Common Stock held by the then existing stockholders. -33- Risks from Put and Other Rights Held by Certain Stockholders Each physician and management stockholder who is a party to the Stockholders Agreement, dated as of August 30, 1996 (the "Stockholder's Agreement"), has the right to require PQC to purchase the Common Stock owned by such stockholder at fair market value upon their death or disability. Pursuant to the Stockholders Agreement, fair market value, as determined by the Board of Directors, reflects an arms-length private sale. In determining the fair market value, the Board is to consider recent arms-length sales by the Company and the stockholders, as well as other factors considered relevant. While the Stockholders Agreement does not limit the Board's discretion, such other factors may include changes, since the last arms-length sale, in the Company's financial conditions or prospects and any valuation studies conducted by management of the Company or independent valuation experts. Under the Stockholder Agreement, the Board is not permitted to discount the fair market value of the Common Stock to reflect the fact that the Common Stock being sold constitutes less than a majority of the outstanding shares. The put option is only triggered by death or disability (and in a few instances retirement) and will terminate upon the completion of a public offering which results in at least $50.0 million in gross revenues to the Company and which meets certain other criteria. The physician affiliated with Clinical Associates have the right to require the Company to repurchase their Common Stock at $3.00 per share (in the form of a five year, non-interest bearing note) in the event that the Company has not completed an underwritten initial public offering within four years. The exercise of such right could have a material adverse effect upon the Company. To the extent that the "put options" are likely to be exercised, the Company expects to fund such repurchases from working capital, the Equity Facility or other sources. Amortization of Intangible Assets In connection with its Affiliations, the Company has recorded, and is expected to continue to record, a significant amount of intangible assets as the consideration paid to physicians exceeds the value of the practice assets. At December 31, 1997, the Company had intangible assets of approximately $57.3 million reflected on its balance sheet as long-term affiliation agreements. The Company amortizes such intangible assets over a 25 year period. See the Notes to the Company's Financial Statements. The amortization of these intangible assets, while not affecting the Company's cash flow, has an ongoing negative impact upon the Company's earnings. During the year ended December 31, 1997, amortization of intangible assets contributed approximately $1,292,000 to the Company's net loss of $5.7 million. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. Not applicable. -34- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. All financial statements required to be filed hereunder are filed as Appendix A, are listed under Item 14(a) and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. There have been no disagreements on accounting and financial disclosure matters. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The executive officers and directors of the Company and their ages as of December 31, 1997 are as follows:
NAME AGE POSITION - ---------------------------- --- ----------------------------------------- Jerilyn P. Asher 55 Chief Executive Officer and Chairman of the Board Alphonse Calvanese, M.D. 46 Director Leslie Fang, M.D.(1) 52 Director Ira Fine, M.D. 49 Director Dana Frank, M.D. 47 President and Director Arlan F. Fuller, Jr., M.D. 52 Executive Vice President, Medical Affairs and Director Stephen G. Pagliuca 42 Director Marc Wolpow 39 Director Timothy T. Weglicki 46 Director Samantha J. Trotman 30 Chief Financial Officer
- ---------------- (1) Member of the Compensation Committee. There are currently three vacancies on the Board. Directors, Executive Officers and Other Key Employees ----------------------------------------------------- Jerilyn P. Asher is a founder of the Company and has served as Chief Executive Officer and as Chairman of the Board since its inception. She has over eighteen years of experience as a healthcare executive in both the public and private sectors, with broad-based responsibilities for all aspects of constituency building with physicians and payors, business -35- development, finance, operations, sales, marketing and federal and state healthcare regulation. From 1994 to 1995, Ms. Asher served as President and a member of the Board of Directors of Abbey Healthcare Group Incorporated ("Abbey"), a home healthcare provider. Ms. Asher was a founder and served as President, Chief Executive Officer and Chairman of the Board of Directors from 1988 to 1995 and Executive Vice President from 1985 to 1988 of Protocare, Inc., a leading regional provider of home healthcare products and services. From 1978 to 1984, Ms. Asher served as Executive Director of United Cerebral Palsy of Western Massachusetts, Inc., a multi-service agency providing direct care services to persons of all ages with multiple disabilities. Alphonse Calvanese, M.D. has been a member of the Board of Directors of the Company since November 1996 and President of the Springfield Affiliated Group since August 1996. He has been in the private practice of medicine since 1981. He received his B.S. from the University of Massachusetts and his M.D. from Tufts Medical School. He completed his internship and residency at Baystate Medical Center. Leslie Fang, M.D. has served as a member of the Board of Directors of the Company and a member of the Board's compensation committee since its inception. Dr. Fang has been Associate Director of the Hemodialysis Unit, Massachusetts General Hospital since 1980 and an Assistant Professor of Medicine at Harvard University Medical School since 1983. He is also Director of the Charles River Plaza Dialysis Unit and a nationally recognized expert in the field of nephrology. Dr. Fang received his B.S., M.S. and Ph.D. in physiology and biophysics from the University of Illinois and his M.D. from Harvard University Medical School. He completed his internship and residency at Massachusetts General Hospital. Ira Fine, M.D. has been a member of the Board of Directors of the Company since November 1996. He has been in the private practice of medicine for 16 years and has been the Chief, Division of Rheumatology at Sinai Hospital since 1988 and St. Joseph Medical Center in Baltimore since 1992. He is the Chairman of the Board of The Physician Group. He is also an Assistant Professor of Medicine at the University of Maryland School of Medicine and an Assistant Professor of Medicine at the Johns Hopkins University School of Medicine. He received his B.S. from the Virginia Polytechnic Institute and his M.D. from University of Maryland School of Medicine. He completed his internship at University of Maryland Hospital/Baltimore Veterans Administration Hospital, his residency at University of Maryland Hospital and a fellowship in rheumatology at the Johns Hopkins University School of Medicine. Dana Frank, M.D. has been President of the Company since March 1997 and the Flagship Affiliated Group since December 1996 and has served as a member of the Board of Directors of the Company since November 1996. He has been in the private practice of medicine since 1981 and is President of Park Medical Associates, P.A. He is an Assistant Professor at the Johns Hopkins University School of Medicine and has been a Consulting Internist and Headache Specialist at the Johns Hopkins University School of Medicine since 1981. He has also served on the Johns Hopkins Hospital Medical Board. He received his A.B. -36- from Brown University and his M.D. from George Washington University. He completed his internship and residency at Johns Hopkins Hospital. Arlan F. Fuller, Jr., M.D. has served as Executive Vice President of Medical Affairs and a member of the Board of Directors of the Company since its inception. He also co-chairs the Company's National Medical Advisory Board, and is responsible for organizing and directing the company's clinical systems. Dr. Fuller has been an Associate Professor of Obstetrics and Gynecology at Harvard University Medical School since 1987 and has been the Director of the Gynecologic Oncology Service of Massachusetts General Hospital since 1985. Dr. Fuller maintains a practice in gynecologic surgery and gynecologic oncology at the Massachusetts General Hospital and is affiliated with the North Shore Cancer and Medical Centers in Peabody and Salem, Massachusetts. In 1988, Dr. Fuller was a founder and served as President of Massachusetts General Physicians Corporation, the first organized physician group at the Massachusetts General Hospital and a forerunner to the Massachusetts General Physicians Organization, which manages group practices at the Massachusetts General Hospital. Previously, Dr. Fuller was a member of the Board of Trustees of Partners Community Healthcare, Inc., the primary care network and integrated health system which includes the Massachusetts General Hospital and Brigham and Women's Hospital. Dr. Fuller received his undergraduate degree from Bowdoin College and his M.D. from Harvard University Medical School. He completed his internship at Massachusetts General Hospital, his residencies at the former Boston Hospital for Women (now the Brigham and Women's Hospital) and a fellowship in gynecological oncology at Sloan-Kettering Memorial Cancer Center. Stephen G. Pagliuca has been a member of the Board of Directors of the Company since August 1996. He has been with Bain Capital, Inc., where he is a Managing Director, since 1989, and has actively invested in the medical and information industries. Prior to joining Bain Capital, Inc., he was a partner at Bain & Company, where he managed client relationships in the healthcare and information services industries, including assisting clients in developing acquisition strategies. He is chairman of the board of PhysioControl Corporation and Dade International, Inc. and a director of Vivra, Inc., Coram Healthcare, Gartner Group, Executone, Medical Specialities Group and Wesley-Jessen. Marc Wolpow has been a member of the Board of Directors of the Company since August 1996. He joined Bain Capital, Inc. in 1990 and has been a Managing Director since 1993. Previously he was a member of the corporate finance department of Drexel Burnham Lampert, Inc. He is a director of American Pad & Paper Corp., Miltex Instruments, Inc., Professional Services Industries, Inc., Paper Acquisition Corp. and Waters Corp. Timothy T. Weglicki has been a member of the Board of Directors of the Company since June 1997. Mr. Weglicki has been a principal with ABS Partners II, L.L.C., the general partner of ABS Capital Partners II, L.P., a private equity fund, and related entities since December 1993. Prior to joining ABS Partners, he was a Managing Director of Alex Brown & Sons, Inc., where he established and headed its Capital Markets Group and prior thereto -37- headed the Firm's Equity Division, Corporate Finance Department, and Health Care Investment Banking Group. Mr. Weglicki holds an M.B.A. from the Wharton Graduate School of Business and a B.A. from the John Hopkins University. He is a director of Eldertrust, VitalCom, Inc. and several privately held companies. Samantha J. Trotman has served as Chief Financial Officer since December 1996. She is responsible for all financial functions and physician affiliation activities. She is also a member of the senior management team. Ms. Trotman joined PQC from Bain Capital, where she was a senior associate. While at Bain Capital, she managed and completed over a dozen transactions with combined value of approximately $500 million, including the $30 million capital commitment to the Company. Prior to joining Bain Capital, Ms. Trotman was an analyst with Wasserstein Perella, a leading mergers and acquisitions advisory firm. Ms. Trotman holds a BA in Engineering from Cambridge University, England, an MA and Meng also from Cambridge and an MBA from Harvard Business School. Ann M. Keehn served as Vice President of Finance from February 1997 to February 1998. Prior to joining PQC, Ms. Keehn was Director, Health Services Management Consulting for John Snow, Inc. ("JSI"), an international health care consulting firm. During her eight years with JSI, Ms. Keehn provided management consulting services to a wide array of health care provider organizations including integrated delivery systems, physician practices, community health centers, and hospitals. Consulting engagement areas included strategic planning, affiliation strategies, financial management under capitation arrangements, and operational effectiveness. From 1988 to 1995, Ms. Keehn served as the chief financial officer and interim chief executive officer for Acton Medical Associates, a primary group practice affiliated with Harvard Pilgrim (formerly Harvard Community Health Plan). Ms. Keehn has also held financial positions with Children's Hospital and Brigham and Women's Hospital in Boston. Ms. Keehn worked for Price Waterhouse from 1978 to 1981. She is a certified public accountant and a member of the Massachusetts Society of CPAs. Ms. Keehn received her BA in Accounting from Kansas State University and her Masters in Business Administration from the University of Texas. ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth compensation earned by (i) the Company's Chief Executive Officer and (ii) the other executive officer of the Company whose compensation was greater than $100,000 in the year ended December 31, 1997 (collectively, the "Named Executive Officers"): -38- SUMMARY COMPENSATION TABLE
Long-Term Compensation Annual Compensation Awards (1) --------------------- -------------- Securities All Other Underlying Compensation Name and Principal Position Year Salary ($) Bonus ($) Options (#) ($) - ----------------------------- ---- ------------ ---------- ----------- ------------ Jerilyn P. Asher............. 1997 250,000 -- -- 7,996 (2) Chief Executive Officer 1996 250,000 -- -- 9,647 (3) Dana Frank................... 1997 220,325 (4) -- 300,000 -- President 1996 118,075 -- -- -- Samantha J. Trotman.......... 1997 125,000 -- 400,000 -- Chief Financial Officer 1996 4,808 (5) -- -- --
- ---------------- (1) The Company did not grant any restricted stock or stock appreciation rights during the year ended December 31, 1997. (2) Represents $7,200 paid in connection with an automobile allowance and $796 of compensatory group life insurance premiums paid by the Company. (3) Represents $7,200 paid in connection with an automobile allowance and $2,447 of compensatory group life insurance premiums paid by the Company. (4) Includes $120,325 paid as salary for Dr. Frank's patient care practice. (5) Amount based on annual salary of $125,000 from December 16, 1996. Employment Agreements --------------------- The Company is a party to an employment agreement with Jerilyn P. Asher pursuant to which Ms. Asher serves as Chief Executive Officer of the Company for the three-year period ending June 21, 1998. The term of the agreement will be automatically extended for successive one-year terms, unless the Company notifies Ms. Asher to the contrary at least 90 days prior to the expiration of the then current term. For her services, Ms. Asher is entitled to an initial base salary of $250,000 per year (subject to periodic increases as determined by the Board) and is eligible to receive bonuses under the Company's management incentive program, if such a program is adopted, in an amount up to 100% of her base pay based upon individual and Company performance. Pursuant to an amendment to the employment agreement dated August 30, 1996, Ms. Asher waived the right to receive any unpaid amounts of base salary and bonus to which she was entitled and had not received as of August 1, 1996. Ms. Asher is also entitled to receive other benefits available to the Company's senior management generally. Pursuant to a stock restriction agreement executed as of the date of -39- the employment agreement, the Company issued 4,162,500 shares of Series A Common Stock to Ms. Asher at a purchase price of $.01 per share, 346,875 of which remain subject to vesting if Ms. Asher maintains her employment with the Company until June 1998, which vesting will be accelerated in the event of a Change in Control. A Change in Control is defined to include a person or group becoming the beneficial owner of 50% or more of the outstanding voting securities of the Company, certain changes to the composition of the Board of Directors, certain mergers and a liquidation of the Company. A percentage of the vested shares (50% in the case of termination for cause and 35% in the case of voluntary termination) are subject to the Company's repurchase rights in certain circumstances, including termination of Ms. Asher for "cause" or Ms. Asher's voluntary resignation, at the fair market value at the time of repurchase. The Company may terminate Ms. Asher's employment at any time without cause and upon 10 days' written notice with cause. Ms. Asher may terminate her employment for any reason upon 90 days' written notice. If Ms. Asher's employment is terminated by the Company without cause, or if Ms. Asher terminates her employment for good reason, the Company must pay Ms. Asher an amount equal to two times her annual salary. Cause, for purposes of the termination provisions, means willful and continued failure to perform her duties, willful engagement in misconduct materially injurious to the Company or her conviction for a felony, fraud or embezzlement of the Company's property. In addition, the Company must also make such payment if Ms. Asher's employment is terminated at any time within 24 months after a "Change in Control" for any reason other than (i) death or disability, (ii) by the Company for Cause or (iii) by Ms. Asher other than for Good Reason. During the term of the agreement, the Company must nominate Ms. Asher to and Ms. Asher will be eligible to serve on the Board of Directors. Ms. Asher also agreed to standard non-competition and non-disclosure terms with the Company. The Company is also party to an employment agreement with Arlan F. Fuller, pursuant to which Dr. Fuller serves as Executive Vice President, Medical Information Systems and Academic Development of the Company for the three-year period ending June 20, 1998. The term of the agreement will be automatically extended for successive one-year terms, unless the Company notifies Dr. Fuller to the contrary at least 90 days prior to the expiration of the then current term. Dr. Fuller was required to devote 40% of his time to the Company and, for such services, was entitled to an initial base salary of $175,000 per year (subject to periodic increases as determined by the Board). Dr. Fuller reduced his base annual salary to $50,000 beginning in December 1996. Pursuant to a stock restriction agreement executed as of the date of the employment agreement, the Company issued 618,750 shares of Common Stock to Dr. Fuller at a purchase price of $.01 per share. These shares are subject to vesting based on individual performance and duration of employment, which vesting will be accelerated in the event of a "Change in Control." The Company may terminate Dr. Fuller's employment at any time with cause and upon 60 days' notice without cause. Dr. Fuller may terminate his employment for any reason upon 60 days' written notice. -40- During the term of the agreement, the Company must nominate Dr. Fuller to and Dr. Fuller will be eligible to serve on the Board of Directors. Dr. Fuller also agreed to standard non-competition and non-disclosure terms with the Company. Options Grants Table - -------------------- The following sets forth, as to the Named Executive Officers, information concerning stock options granted in the year ended December 31, 1997. OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION FOR INDIVIDUAL GRANTS OPTION TERM(1) ----------------------------------------------------------------- --------------------- NUMBER OF % OF TOTAL SECURITIES OPTIONS UNDERLYING GRANTED TO EXERCISE OPTION EMPLOYEES IN PRICE EXPIRATION NAME GRANTED (#) FISCAL YEAR ($/SH)(2) DATE(3) 5% 10% - ---------------- ------------- ------------- ---------- ----------- ------- --------- Jerilyn Asher... -- -- -- -- -- -- Dana Frank...... 300,000(4) 13.8% $2.50 4/23/07 471,671 1,195,307 Samantha Trotman 400,000(5) 18.3% 2.50 1/1/07 628,895 1,593,742
- ---------------- (1) Amounts represent hypothetical gains that could be achieved for respective options if exercised at the end of the option term. These gains are based on assumed rates of stock price appreciation of 5% and 10%, compounded annually from the date the respective options were granted to their expiration date. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise. Actual gains, if any, on stock option exercises will depend on the future performance of the Common Stock, the option holder's continued employment through the option period and the date on which the options are exercised. (2) The exercise price is equal to the fair market value of the Company's Common Stock on the date of grant. (3) The expiration date of an option is the tenth anniversary of the date on which the option was originally granted. (4) Of these stock options, 100,000 stock options vest immediately and the remaining stock options vest in two equal annual installments commencing on the first anniversary of the date on which the option was originally granted. Of these options 120,000 are intended to qualify as incentive stock options and the remainder are non-statutory stock options. The vesting of these stock options is accelerated in the event of a change in control of the Company. (5) These stock options vest in three annual installments of 150,000, 125,000 and 125,000 shares commencing on the first anniversary of the date on which the option was originally granted. Of these options 120,000 are intended to qualify as incentive stock options and the remainder are non-statutory stock options. The vesting of these stock options is accelerated in the event of a change in control of the Company. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The following table sets forth the number of shares of capital stock of the Company beneficially owned as of January 1, 1998 by (i) each owner who is known by the Company to beneficially own 5% or more of any class of voting stock, (ii) each of the Company's directors, (iii) each of the Company's Named Executive Officers and (iv) all directors and executive officers as a group. Except as otherwise indicated, the named owner has sole voting and investment power with respect to all shares beneficially owned. -41-
Class A Common Stock(2) Class B Common Stock(2) ------------------------- -------------------------- Number Percentage Number Percentage Name and Address of of Class of of Class of Beneficial Owner Shares Outstanding Shares Outstanding - -------------------------------------- ---------- ----------- ---------- ----------- Bain Capital Funds.................... -- -- 11,015,000(3) 100.0% c/o Bain Capital, Inc. Two Copley Plaza Boston, Massachusetts 02116 Goldman Sachs Funds................... -- -- -- -- c/o Goldman Sachs & Co. 85 Broad Street New York, NY 10004 ABS Capital Partners, II, L.P. Funds.. -- -- -- -- One South Street Baltimore, MD 21201 Offshore Health Industries, Inc. ..... 1,582,500(7) 6.1% -- -- Two Park Plaza Boston, MA 02116 Jerilyn P. Asher...................... 4,318,748(8) 16.8% -- -- Arlan F. Fuller, Jr., M.D. ........... 618,750 2.4% -- -- Samantha J. Trotman................... 150,000(9) * 1,729,016(10) 15.7% Alphonse F. Calvanese, M.D............ 313,007(11) * -- -- Leslie Fang, M.D. .................... -- -- -- -- Ira Fine, M.D. ....................... 113,316 * -- -- Dana Frank, M.D....................... 272,904(12) * -- -- Stephen G. Pagliuca(13)............... -- -- 11,015,000(3) 100.0% Marc Wolpow(13)....................... -- -- 11,015,000(3) 100.0% Timothy T. Weglicki................... -- -- -- -- All directors and executive officers as a group (10 persons) (32,115,577 (15) shares of 83.9% assuming conversion of Class B Common Stock into Class A Common Stock) 5,786,725 22.2% - ---------------------
*Less than 1%
Class C Common Total Stock(2) Common Stock(1)(2) --------------------------- ------------------------- Number of Percentage of Name and Address Number Percentage Common Common of Beneficial Owner of Shares of Class Stock Stock - -------------------------------------- ----------- ----------- ---------- ----------- Bain Capital Funds.................... 3,076,924(4)(5) 33.3% 14,091,924 30.7% c/o Bain Capital, Inc. Two Copley Plaza Boston, Massachusetts 02116 Goldman Sachs Funds................... 3,076,924(4)(5) 33.3% 3,076,924 7.8% c/o Goldman Sachs & Co. 85 Broad Street New York, NY 10004 ABS Capital Partners, II,............. 9,160,004(6) 74.6% 9,160,004 21.5% L.P. Funds One South Street Baltimore, MD 21201 Offshore Health -- -- 1,582,500 4.1% Industries, Inc. Two Park Plaza Boston, MA 02116 Jerilyn P. Asher...................... -- -- 4,318,748 11.4% Arlan F. Fuller, Jr., M.D. ........... -- -- 618,750 1.6% Samantha J. Trotman................... -- -- 1,879,016 4.8% Alphonse F. Calvanese, M.D. .......... -- -- 313,007 * Leslie Fang, M.D. .................... -- -- -- * Ira Fine, M.D. ....................... -- -- 113,316 * Dana Frank, M.D. ..................... -- -- 272,904 * Stephen G. Pagliuca................... 3,076,924(4)(5) 33.3% 14,091,924 30.7% Marc Wolpow........................... 3,076,924(4)(5) 33.3% 14,091,924 30.7% Timothy T. Weglicki................... 9,160,004(14) 74.6% 9,160,004 21.5% All directors and executive officers as a group (10 persons) (32,115,577 (15) shares of 83.9% assuming conversion of Class B Common Stock into Class A Common Stock)
- --------------------- *Less than 1% -42- (1) Reflects the percentage of shares of Class A, Class B and Class C Common Stock. The Class B and Class C Common Stock of the Company are convertible at the option of the holder into Class A Common Stock. (2) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of the Company's capital stock subject to options or warrants held by that person that are exercisable on or before March 1, 1998 are deemed outstanding. Such shares, however, are not deemed outstanding for purposes of computing the ownership of each other person. (3) Includes warrants to purchase 6,415,000 shares of Class B Common Stock. (4) Does not include 6,153,846 shares of Class C Common Stock or warrants to purchase 6,153,846 shares of Class C Common Stock which other Institutional Investors are entitled to purchase pursuant to the Equity Facility. (5) Includes warrants to purchase 1,538,462 shares of Class C Common Stock. (6) Includes warrants to purchase 4,580,002 shares of Class C Common Stock. (7) Includes warrants to purchase 332,500 shares of Class A Common Stock. (8) Includes warrants to purchase 52,082 shares of Class A Common Stock. (9) Consists of options to purchase shares of Class A Common Stock. (10) Includes an aggregate of 722,059 shares of Class B Common Stock and 1,006,957 shares of Class B Common Stock issuable upon outstanding warrants held by BCIP Associates and BCIP Trust Associates. Ms. Trotman is a general partner of BCIP Associates and BCIP Trust Associates. As such, Ms. Trotman may be deemed to own beneficially shares owned by BCIP Associates and BCIP Trust Associates, although Ms. Trotman disclaims beneficial ownership of any such shares. (11) Includes options to purchase 100,625 shares of Class A Common Stock. (12) Includes options to purchase 100,000 shares of Class A Common Stock. (13) Includes an aggregate of 4,600,000 shares of Class B Common Stock beneficially owned by the institutional investors affiliated with Bain Capital (11,015,000 shares on a fully diluted basis) and 1,538,426 shares of Class C Common Stock (3,076,924 on a fully diluted basis). Each of Mr. Pagliuca and Mr. Wolpow is a Managing Director of Bain Capital, which manages each of the institutional investors. Bain Capital is a limited partner in the partnership which is the general partner of Bain Capital Fund V, L.P. and Bain Capital Fund V-B, L.P., and a general partner of BCIP Associates and BCIP Trust Associates. As such, Messrs. Pagliuca and Wolpow may be deemed to own beneficially shares owned by such institutional investors, although each of Mr. Pagliuca and Mr. Wolpow disclaims beneficial ownership of any such shares. (14) Includes 4,580,002 shares of Class C Common Stock (9,160,004 shares of Class C Common Stock on a fully diluted basis) beneficially owned by ABS Capital Partners II, L.P. Mr. Weglicki is a managing member of ABS Partners II, L.L.C., which manages ABS Capital Partners II, L.P. As such Mr. Weglicki may be deemed to own beneficially shares owned by ABS Capital Partners II, L.P., although Mr. Weglicki disclaims beneficial ownership of such shares. (15) See notes (1), (3), (4), (5) and (8)-(14) above. -43- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Through June 20, 1997, pursuant to the Equity Facility, the institutional investors affiliated with Bain Capital purchased an aggregate of 4,600,000 shares of Class B Common Stock and warrants exercisable for 6,415,000 shares of Class B Common Stock for an aggregate purchase price of $11,500,000. On June 23, 1997, the Company issued 7,692,309 shares of Class C Common Stock and Warrants to purchase 7,692,309 shares of Class C Common Stock to the Institutional Investors for an aggregate consideration of $25 million. In connection with the Equity Financing, the Company entered into a Management Agreement dated as of August 30, 1996 with BCPV, pursuant to which the Company will pay BCPV (or an affiliate designated by BCPV) a management fee of $750,000 per year, plus 1% of any financings from parties other than affiliates of Bain Capital, for services including advice in connection with financings and financial, managerial and operational advice in connection with day-to-day operations (the "Management Agreement"). The Company is also obligated to pay certain expenses, not to exceed $250,000 per year without the Company's consent, of BCPV, Bain Capital and the Institutional Investors in connection with the Management Agreement. Each of Stephen G. Pagliuca and Marc Wolpow is a Director of the Company, a limited partner of BCPV, which is the general partner of Bain Capital Fund V, L.P. and Bain Capital Fund V-B, L.P., and a general partner of BCIP Associates, L.P. and BCIP Trust Associates, L.P., and a Managing Director of Bain Capital, which manages each of the Institutional Investors. Alphonse Calvanese, M.D., is a director of the Company and transferred his practice to the Springfield Affiliated Group for which he received his allocable portion of the $11.8 million total consideration paid to the physicians who transferred their practices to the Springfield Affiliated Group. Ira Fine, M.D. and Dana Frank, M.D., each a Director of the Company, are members of medical practice groups which transferred their practice assets to the Flagship Affiliated Group in the Flagship Affiliation. Upon consummation of the Flagship Affiliation, Dr. Fine received his allocable share of the total consideration of $566,580 payable to his existing practice group, and Dr. Frank received his allocable share of the total consideration of $3,647,064 payable to his existing practice group. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The following documents are included: 1. The following financial statements (and related notes) of the Company are included: -44- Page Report of Independent Accountants.................................................. 1 Balance Sheets at December 31, 1997 and 1996....................................... 2 Statements of Operations for the Years Ended December 31, 1997 and 1996...................................................................... 3 Statements of Stockholders' Equity for the Years Ended December 31, 1997 and 1996......................................................... 4 Statements of Cash Flows for the Years Ended December 31, 1997 and 1996...................................................................... 5 Notes to the Financial Statements.................................................. 6
2. The schedule listed below and the Report of Independent Accountants on financial statement schedule are filed as part of this Annual Report on Form 10-K: All schedules are omitted as the information required is inapplicable or the information is presented in the financial statements or the related notes. 3. The Exhibits listed in the Exhibit Index immediately preceding the Exhibits filed as a part of this Annual Report on Form 10-K. (b) The following current report on Form 8-K was filed by the Company during the last quarter of the year ended December 31, 1997. 1. Current Report on Form 8-K dated December 2, 1997, filed with the Securities and Exchange Commission on December 16, 1997, relating to the closing of the merger between Clinical and Flagship pursuant to which Clinical became affiliated with PQC. There are no trademarks mentioned in this Annual Report on Form 10-K. -45- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. PHYSICIANS QUALITY CARE, INC. By: /s/ Samantha J. Trotman ------------------------------------------ Samantha J. Trotman Chief Financial Officer and Vice President Date: March 31, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - ----------------------------------- ----------------------------------- -------------- /s/ Jerilyn P. Asher Chief Executive Officer, Secretary March 31, 1998 - ----------------------------------- and Chairman of the Board Jerilyn P. Asher (Principal Executive Officer) /s/ Samantha J. Trotman Chief Financial Officer and Vice March 31, 1998 - ----------------------------------- President (Principal Financial and Samantha J. Trotman Accounting Officer) /s/ Dana Frank, M.D. President and Director March 31, 1998 - ----------------------------------- Dana Frank, M.D. /s/ Arlan F. Fuller, Jr., M.D. Executive Vice President, Medical March 31, 1998 - ----------------------------------- Affairs and Director Arlan F. Fuller, Jr., M.D. /s/ Alphonse Calvanese, M.D. Director March 31, 1998 - ----------------------------------- Alphonse Calvanese, M.D.
-46- /s/ Leslie Fang, M.D. Director March 31, 1998 - ----------------------------------- Leslie Fang, M.D. Director March __, 1998 - ----------------------------------- Stephen G. Pagliuca /s/ Mark Wolpow Director March 31, 1998 - ----------------------------------- Mark Wolpow /s/ Ira Fine, M.D. Director March 31, 1998 - ----------------------------------- Ira Fine, M.D. /s/ Timothy T. Weglicki Director March 31, 1998 - ----------------------------------- Timothy T. Weglicki
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. Subsequent to the filing of this Annual Report on Form 10-K a proxy statement will be sent to security holders. -47- APPENDIX A ---------- Physicians Quality Care, Inc. AUDITED FINANCIAL STATEMENTS Years ended December 31, 1997 and 1996 CONTENTS Report of Independent Auditors.................................... 1 Audited Financial Statements Balance Sheets.................................................... 2 Statements of Operations.......................................... 3 Statements of Stockholders' Equity and Common Stock Subject to Put............................................. 4 Statements of Cash Flows.......................................... 5 Notes to Financial Statements..................................... 6 Report of Independent Auditors The Board of Directors Physicians Quality Care, Inc. We have audited the accompanying balance sheets of Physicians Quality Care, Inc. (the Company) as of December 31, 1997 and 1996, and the related statements of operations, stockholders' equity and common stock subject to put, and cash flows for the period from March 20, 1995 (inception) to December 31, 1995 and the years ended December 31, 1996 and 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Physicians Quality Care, Inc. as of December 31, 1997 and 1996 and the results of its operations and its cash flows for the period from March 20, 1995 (inception) to December 31, 1995, and the years ended December 31, 1996 and 1997, in conformity with generally accepted accounting principles. Boston, Massachusetts March 13, 1998 1 Physicians Quality Care, Inc. Balance Sheets
December 31 1997 1996 --------------------------------- ASSETS Current assets: Cash and cash equivalents $ 8,782,019 $ 136,926 Prepaid expenses 35,175 58,776 Due from affiliated physician practices 5,719,421 1,694,687 Other current assets 69,868 25,380 -------------------------------------- Total current assets 14,606,483 1,915,769 Investment in long-term affiliation agreements, less accumulated amortization of $1,394,987 and $198,634 in 1997 and 1996, respectively 57,340,059 32,401,305 Property and equipment, net 1,327,860 214,008 Other assets 136,181 258,491 -------------------------------------- Total assets $ 73,410,583 $ 34,789,573 ====================================== December 31 1997 1996 -------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable $ 1,218,766 $ 1,217,630 Accrued compensation 266,138 218,893 Accrued expenses 628,433 1,053,892 Income taxes payable 69,708 Note payable 200,000 Current portion of capital lease obligations 15,685 -------------------------------------- Total current liabilities 2,113,337 2,775,808 Capital lease obligations, less current maturities 55,867 Deferred taxes 746,062 464,877 Commitments and contingencies Common stock, subject to put, 18,157,982 and 12,740,589 shares authorized, issued and outstanding at December 31, 1997 and 1996, respectively 54,473,947 31,851,473 Stockholders' equity (deficit): Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued Class A common stock, $.01 par value, 75,000,000 shares authorized, 8,505,208 and 7,236,033 shares issued and 7,492,708 and 6,223,533 outstanding at December 31, 1997 and 1996, respectively 85,052 72,360 Class B-1 common stock, $.01 par value, 15,267,915 shares authorized, 2,809,296 and 2,442,866 shares issued and outstanding at December 31, 1997 and 1996, respectively 28,093 24,429 Class B-2 common stock, $.01 par value, 9,732,085 shares authorized, 1,790,704 and 1,557,134 shares issued and outstanding at December 31, 1997 and 1996, respectively 17,907 15,571 Class C common stock, $.01 par value, 13,846,155 shares authorized, 7,692,309 shares issued and outstanding at December 31, 1997 76,923 Additional paid-in capital 49,846,913 21,117,622 Accumulated deficit (33,967,526) (21,578,309) Less treasury stock, at cost, 1,012,500 shares (10,125) (10,125) -------------------------------------- Total stockholders' equity (deficit) 16,077,237 (358,452) -------------------------------------- Total liabilities and stockholders' equity $ 73,410,583 $ 34,789,573 ====================================== See accompanying notes.
2 Statements of Operations
PERIOD FROM MARCH 20 YEAR ENDED YEAR ENDED 1995 (INCEPTION) DECEMBER 31 DECEMBER 31 TO DECEMBER 31 1997 1996 1995 ---------------------------------------------------------- Net patient service revenue $ 46,037,234 $ 6,026,452 Less: amounts retained by physician groups (15,596,162) (2,194,571) ---------------------------------------------------------- Management fee revenue 30,441,072 3,831,881 Operating expenses: Nonphysician salaries and benefits 13,864,792 1,816,309 Other practice expenses 12,721,065 1,822,262 Corporate and regional expenses 7,329,132 4,666,334 $ 2,061,737 Depreciation and amortization 2,163,866 280,490 6,704 Provision for bad debts 1,105,616 214,404 Total expenses 37,184,471 8,799,799 2,068,441 ---------------------------------------------------------- Operating loss (6,743,399) (4,967,918) (2,068,441) Other income (expense): Interest income 498,095 91,104 108,177 Interest expense (161,938) (104,255) (90,000) Loss of investment in subsidiary (98,269) ---------------------------------------------------------- 237,888 (13,151) 18,177 Loss before income taxes (6,505,511) (4,981,069) (2,050,264) Income tax (benefit)/provision (795,281) 78,128 32,000 ---------------------------------------------------------- Net loss $ (5,710,230) $ (5,059,197) $(2,082,264) ========================================================== Net loss available to common stock $(12,389,217) $(19,496,045) $(2,082,264) ========================================================== Net loss per common share basic $(0.41) $(1.81) $(0.27) ==========================================================
See accompanying notes. 3 Physicians Quality Care, Inc. Statements of Stockholders' Equity and Common Stock Subject to Put Period from March 20, 1995 (inception) to December 31, 1995, and year ended December 31, 1996 and December 31, 1997
Common Stock Class A Common Stock ------------------------------------------------------------------- Shares Amount Shares Amount ------------------------------------------------------------------- Issuance of common stock 7,706,250 $ 77,063 Issuance of convertible preferred stock, net of issuance cost of $98,153 Issuance of warrants Loan to stockholders Net loss ------------------------------------------------------------------- Balance at December 31, 1995 7,706,250 77,063 Purchase of treasury shares Recapitalization in connection with restatement of Charter (7,706,250) (77,063) 7,706,250 $ 77,063 Reclassification of common stock in connection with recapitalization (5,897,914) (58,980) Accretion of common stock subject to put to fair value Issuance of Class A common stock upon conversion of Series A convertible preferred stock 1,666,151 16,662 Issuance of Class A common stock 10,604,221 106,041 Reclassification of common stock subject to put (6,842,675) (68,426) Issuance of Class B-1 and B-2 common stock for cash, net of issuance costs of $2,051,095 Payment received from stockholder Net loss ------------------------------------------------------------------- Balance at December 31, 1996 - - 7,236,033 72,360 Issuance of Class A common stock, net of issuance cost $108,475 6,686,568 66,866 Reclassification of common stock subject to put to fair value (5,417,393) (54,174) Issuance of Class B-1 and B-2 common stock for cash Accretion of common stock subject to put to fair value Issuance of Class C common stock for cash net of issuance cost of $742,088 Options issued at below fair value in connection with affiliation Net loss ------------------------------------------------------------------- Balance at December 31, 1997 - - 8,505,208 $ 85,052 =================================================================== Class B-1 Common Stock Class B-2 Common Stock --------------------------------------------------------------------- Shares Amount Shares Amount --------------------------------------------------------------------- Issuance of common stock Issuance of convertible preferred stock, net of issuance cost of $98,153 Issuance of warrants Loan to stockholders Net loss --------------------------------------------------------------------- Balance at December 31, 1995 Purchase of treasury shares Recapitalization in connection with restatement of Charter Reclassification of common stock in connection with recapitalization Accretion of common stock subject to put to fair value Issuance of Class A common stock upon conversion of Series A convertible preferred stock Issuance of Class A common stock Reclassification of common stock subject to put Issuance of Class B-1 and B-2 common stock for cash, net of issuance costs of $2,051,095 2,442,866 $24,429 1,557,134 $15,571 Payment received from stockholder Net loss --------------------------------------------------------------------- Balance at December 31, 1996 2,442,866 24,429 1,557,134 15,571 Issuance of Class A common stock, net of issuance cost $108,475 Reclassification of common stock subject to put to fair value Issuance of Class B-1 and B-2 common stock for cash 366,430 3,664 233,570 2,336 Accretion of common stock subject to put to fair value Issuance of Class C common stock for cash net of issuance cost of $742,088 Options issued at below fair value in connection with affiliation Net loss --------------------------------------------------------------------- Balance at December 31, 1997 2,809,296 $28,093 1,790,704 $17,907 ===================================================================== Class C Series A Convertible Common Stock Preferred Stock Treasury Stock Additional ---------------------------------------------------------------------- Pain-in Shares Amount Shares Amount Shares Amount Capital --------------------------------------------------------------------------------------- Issuance of common stock Issuance of convertible preferred stock, net of issuance cost of $98,153 1,666,151 $ 3,750,609 Issuance of warrants $ 420,000 Loan to stockholders Net loss --------------------------------------------------------------------------------------- Balance at December 31, 1995 1,666,151 3,750,609 420,000 Purchase of treasury shares (1,012,500) $(10,125) Recapitalization in connection with restatement of Charter Reclassification of common stock in connection with recapitalization (248,958) Accretion of common stock subject to put to fair value Issuance of Class A common stock upon conversion of Series A convertible preferred stock (1,666,151) (3,750,609) 3,733,947 Issuance of Class A common stock 26,341,989 Reclassification of common stock subject to put (17,038,261) Issuance of Class B-1 and B-2 common stock for cash, net of issuance costs of $2,051,095 7,908,905 Payment received from stockholder Net loss ---------------------------------------------------------------------------------------- Balance at December 31, 1996 - - (1,012,500) (10,125) 21,117,622 Issuance of Class A common stock, net of issuance cost $108,475 18,718,611 Reclassification of common stock subject to put to fair value (15,889,309) Issuance of Class B-1 and B-2 common stock for cash 1,494,000 Accretion of common stock subject to put to fair value Issuance of Class C common stock for cash net of issuance cost of $742,088 7,692,309 $76,923 24,180,989 Options issued at below fair value in connection with affiliation 225,000 Net loss ---------------------------------------------------------------------------------------- Balance at December 31, 1997 7,692,309 76,923 - $ - (1,012,500) $(10,125) $ 49,846,913 ========================================================================================= Common Additional Total Stock Paid-in Accumulated Due from Stockholders' Subject Capital Deficit Stockholders Equity to Put -------------------------------------------------------------------------------------- Issuance of common stock $ 77,063 Issuance of convertible preferred stock, net of issuance cost of $98,153 3,750,609 Issuance of warrants $ 420,000 420,000 Loan to stockholders $(61,875) (61,875) Net loss $ (2,082,264) (2,082,264) -------------------------------------------------------------------------------------- Balance at December 31, 1995 420,000 (2,082,264) (61,875) 2,103,533 Purchase of treasury shares 10,125 Recapitalization in connection with restatement of Charter Reclassification of common stock in connection with recapitalization (248,958) (307,938) $ 307,938 Accretion of common stock subject to put to fair value (14,436,848) (14,436,848) 14,436,848 Issuance of Class A common stock upon conversion of Series A convertible preferred stock 3,733,947 Issuance of Class A common stock 26,341,989 26,448,030 Reclassification of common stock subject to put (17,038,261) (17,106,687) 17,106,687 Issuance of Class B-1 and B-2 common stock for cash, net of issuance costs of $2,051,095 7,908,905 7,948,905 Payment received from stockholder 51,750 51,750 Net loss (5,059,197) (5,059,197) -------------------------------------------------------------------------------------- Balance at December 31, 1996 21,117,622 (21,578,309) (358,452) 31,851,473 Issuance of Class A common stock, net of issuance cost $108,475 18,718,611 18,785,477 Reclassification of common stock subject to put to fair value (15,889,309) (15,943,483) 15,943,483 Issuance of Class B-1 and B-2 common stock for cash 1,494,000 1,500,000 Accretion of common stock subject to put to fair value (6,678,987) (6,678,987) 6,678,991 Issuance of Class C common stock for cash net of issuance cost of $742,088 24,180,989 24,257,912 Options issued at below fair value in connection with affiliation 225,000 225,000 Net loss (5,710,230) (5,710,230) -------------------------------------------------------------------------------------- Balance at December 31, 1997 $ 49,846,913 $ (33,967,526) $ - $ 16,077,237 $54,473,947 ====================================================================================== See accompanying notes.
4 Physicians Quality Care, Inc. Statements of Cash Flows
PERIOD FROM MARCH 20 1995 (INCEPTION) TO DECEMBER 31 DECEMBER 31 1997 1996 1995 -------------------------------------------------------- OPERATING ACTIVITIES Net loss $(5,710,230) $(5,059,197) $(2,082,264) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,163,866 280,490 6,704 Interest accretion on convertible promissory note 90,000 90,000 Changes in operating assets and liabilities, net of effects of business acquisitions: Increase in due from affiliated physician practices (6,121,758) (2,522,221) (Increase) decrease in prepaid expenses and other assets (614,070) 11,402 (335,853) Increase (decrease) in accounts payable, accrued compensation and accrued expenses 540,064 1,672,530 817,885 Increase (decrease) in income taxes payable (69,708) 37,708 32,000 ----------------------------------------------------------- Net cash used in operating activities (9,811,836) (5,489,288) (1,471,528) INVESTING ACTIVITIES Purchase of property and equipment (1,657,453) (120,218) (97,350) Cash paid for affiliation related costs (1,016,096) (1,839,274) Cash paid for affiliations (7,277,412) (5,880,974) ----------------------------------------------------------- Net cash used in investing activities (9,950,961) (7,840,466) (97,350) FINANCING ACTIVITIES Proceeds from issuance of common stock, net of issuance costs 28,599,906 8,309,655 15,188 Net proceeds from issuance of convertible preferred stock 3,750,609 Proceeds from issuance of warrants 420,000 Proceeds from bridge financing 1,000,000 (Payment to) proceeds from note payable (200,000) 200,000 Proceeds from convertible promissory note 1,320,000 Proceeds from repayment of shareholder loan 51,750 (Increase) decrease in deferred financing costs 79,536 438,942 (457,138) Payments on capital lease obligations (71,552) (13,448) Net cash provided by financing activities 28,407,890 9,986,899 5,048,659 ----------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 8,645,093 (3,342,855) 3,479,781 Cash and cash equivalents at beginning of period 136,926 3,479,781 ----------------------------------------------------------- Cash and cash equivalents at end of period $ 8,782,019 $ 136,926 $ 3,479,781 ===========================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest was $119,000, $14,000 and $0 for the years ended December 31, 1997, 1996 and 1995, respectively. Cash paid for income taxes was $230,000, $32,000 and $0 for the years ended December 31, 1997, 1996 and 1995, respectively. During 1997 and 1996 $15,943,000 and $23,587,000, respectively was paid in connection with affiliations in the form of Class A common stock. During 1996, the Company converted a bridge loan and a promissory note payable totalling $2,500,000 into shares of Class A common stock. See accompanying notes. 5 Physicians Quality Care, Inc. Notes to Financial Statements December 31, 1997 1. BUSINESS AND ORGANIZATION Formed in March 1995, Physicians Quality Care, Inc. (PQC or the Company) provides complete practice management for multi-specialty medical practice groups. The Company's objective is to establish and manage networks of specialty and primary care physicians and related diagnostic and therapeutic support services which can provide comprehensive health care services in targeted geographic areas. During 1996 and 1997, the Company completed affiliations with physician practices in Springfield, Massachusetts, and in the Baltimore/Annapolis, Maryland area. Prior to August 30, 1996, the Company's operations consisted primarily of seeking affiliations with physician practices and negotiating the terms of the affiliations and management agreements with such physician practices. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The Company enters into long-term affiliation arrangements with physician practices, and through mergers and asset purchases, the assets and liabilities of the physician practices are transferred to a professional corporation affiliated with the Company. Each affiliated group has a nine member joint Policy Board that is responsible for final decisions related to management and administrative policies for the overall operations of the affiliated group including decisions regarding; scope of services, patient acceptance policies and procedures, pricing of services, negotiation and execution of contracts and approval of operating and capital budgets. Four members of the Joint Policy Board are appointed by the Company and four members are appointed by the affiliated group. The President, who is the ninth member of the Joint Policy Board, is appointed by the Company; however, the Company may only select the President from three physicians nominated by physicians employed by the affiliated group. Therefore, the Company cannot exercise exclusive authority over the decision making process of the Joint Policy Board. Accordingly, for financial reporting purposes, the Company does not consolidate the operating results and accounts of the physician practices. For display purposes, the Company has presented the physician practice revenues and amounts retained by the physician practices in the accompanying statements of operations to arrive at the Company's management fee revenue. See further discussion below. NET PATIENT SERVICE REVENUE Net patient service revenue represents the revenue of the physician practices reported at the estimated realizable amounts from patients, third-party payors and others for services rendered, net of contractual and other adjustments. During 1996 and 1997, respectively, the Company estimates that approximately 40% and 35% of net patient service revenue was received under government-sponsored healthcare programs (principally, the Medicare and Medicaid programs). 6 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company has agreements with various Health Maintenance Organizations (HMOs) to provide medical services to subscribing participants. Under these agreements, the Company receives monthly capitation payments based on the number of each HMO's participants. MANAGEMENT FEE REVENUE Management fee revenue represents net patient service revenue less amounts retained by physician practices. The amounts retained by physician practices represents amounts paid to the physicians pursuant to the service agreements between the Company and the physician practices. Physician baseline compensation is determined based on an agreed-upon percentage (80% to 95%) of the physicians' historic compensation levels, but is subject to reduction if physician practice net revenues are insufficient to cover the baseline compensation for two of the physician groups. The amounts allocated to the Company and to the physician groups are determined based on a percentage of physician group revenue in excess of physician baseline compensation and reimbursement of practice expenses (hereafter referred to as net profits). The net profits for one of the Company's Affiliated Groups are first allocated to the Company up to 5% of the net profits. Net profits remaining after the first allocation are then allocated 80% to the Company and 20% to the physician groups up to $1.5 million. Net profits remaining after the second allocation are then allocated equally between the Company and the physician groups. The net profits for the Other Affiliated Group are allocated equally between the Company and the physician groups. The following details the amounts retained by physician groups and the management fee revenue for the year ended December 31, 1997 and 1996:
1997 1996 ---------------------------------------- Amounts Retained by Physician Groups: Excess net profits subject to allocation $ 759,041 $ 241,143 Less amount allocated to the Company (568,302) (136,957) ---------------------------------------- Amount allocated to physician groups 190,739 104,186 Physician baseline compensation 15,405,423 2,090,385 ----------------------------------------- $15,596,162 $2,194,571 ======================================== Management Fee Revenue: Amount allocated to Company $568,302 $136,957 Reimbursement of practices expenses 29,872,770 3,694,924 ----------------------------------------- $30,441,072 $3,831,881 ========================================
7 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Under the service agreements, the Company provides each physician practice with a comprehensive package of services, including office and facilities, equipment, nursing and other non-physician professional support, administrative support, information systems, comprehensive professional liability insurance, and general management and financial advisory services. The Company also bills all patients, insurance companies and third-party payors and negotiates all contracts and relationships with payors. CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value. PROPERTY AND EQUIPMENT Property and equipment is carried at cost. Depreciation is calculated using the straight-line method over the useful lives of the assets. PROFESSIONAL LIABILITY INSURANCE The Company has obtained professional liability coverage for the Physician Practices through commercial insurance carriers on either a claims-made or occurrence basis. The Company has purchased additional insurance to cover the tail portion of the claims made policies. Management believes that there are no claims that may result in a loss in excess of amounts covered by its existing insurance. INVESTMENT IN LONG TERM AFFILIATION AGREEMENTS The cost of the long-term affiliation agreements in excess of the underlying equity of the affiliated groups is being amortized on a straight-line basis over 25 years. STOCK COMPENSATION ARRANGEMENTS As permitted under SFAS 123 the Company accounts for its stock compensation arrangements under the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). Because the exercise price of options granted during 1997, 1996 and 1995 equals the fair value of the underlying stock at date of grant, no compensation expense is required under APB 25. 8 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company has adopted disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). These provisions require the Company to disclose pro forma net income and earnings per share amounts as if compensation expense related to grants of stock options were recognized based on new fair value accounting rules. NET LOSS PER COMMON SHARE In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 "Earnings per Share" (SFAS 128), which establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. This Statement is effective for financial statements issued for both interim and annual periods ending after December 15, 1997 and requires restatement of all prior period EPS data. The Company has applied this standard in 1997 and has restated EPS for 1995 and 1996. Basic net loss per share of common stock is computed by dividing the net loss available to common stock by the weighted-average number of common shares outstanding during each period presented. Diluted loss per share is not presented because the effect would be antidilutive. RISKS AND UNCERTAINTIES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 9 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PENDING ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components. SFAS No. 131 establishes standards for public companies to report information about operating segments in financial statements, and supersedes SFAS No. 14, Financial Reporting for Segments of an Business Enterprise, but retains the requirements to report information about major customers. SFAS No. 130 and SFAS No. 131 are effective for the Company in 1998. The Company does not believe the adoption of these Statements will have a significant effect on its financial statements. In November 1997, the Financial Accounting Standards Board's Emerging Issues Task Force reached a consensus on its Issue 97-2, Consolidation of Physician Practice Entities which is effective for the Company for its 1998 annual financial statements. The Company is currently evaluating the guidance contained in the consensus as it affects its current model for its affiliation structures. However, management does not believe implementation of the consensus guidance will materially affect the financial position or its net results of operations. RECLASSIFICATION Certain amounts in the financial statements have been reclassed for the basis of presenting corresponding items in the comparative financial statements. 3. AFFILIATIONS Springfield On January 1, 1997, the Company entered into long-term affiliation arrangements with 2 physician practices (5 physicians) located in Western Massachusetts (the Springfield Affiliation). On August 30, 1996, the Company entered into long- term affiliation arrangements with 7 physician practices (32 physicians) located in Western Massachusetts (the Springfield Affiliation). In connection with these transactions, the assets and liabilities of the physician practices were transferred to a professional corporation affiliated with the Company, Medical Care Partners, P.C. (MCP) and the physicians became employees of MCP. The aggregate consideration paid to the physicians for the 1997 affiliation was approximately $2.5 million, of which $831,000 10 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 3. AFFILIATIONS (CONTINUED) was paid in cash, $1.4 million was paid by the issuance of 572,493 shares of Class A common stock, and $225,000 was paid by the issuance of options to purchase shares of common stock at below fair value. The aggregate consideration paid to the physicians for the 1996 affiliation was approximately $9.7 million, of which $3.2 million was paid in cash and $6.5 million was paid by the issuance of 2,592,245 shares of Class A common stock. Up to an additional $2.15 million, payable in Class A common stock, was available to be paid to certain physicians if revenue goals were met. During 1997, $2.1 million of additional consideration was accrued based on the achievement of these goals and will be paid during 1998. In addition, 29 physicians each received 2,500 options to purchase common stock at an exercise price equal to fair value. Baltimore On December 1, 1997, the Company entered into a long-term affiliation arrangement with a physician practice (58 physicians) located in the Baltimore/Annapolis, Maryland area (the Flagship II Affiliation). In connection with this transaction, the assets and liabilities of the physician practices were transferred to a newly formed professional corporation affiliated with the Company, Flagship Health II, P.A. (Flagship II) and the physicians became employees of Flagship II. The aggregate consideration paid to the physicians for the affiliation was approximately $17.4 million, of which $3 million was paid in cash and $14.4 million was paid by the issuance of 4,800,000 shares of Class A common stock. On December 11, 1996, the Company entered into long-term affiliation arrangements with 15 physician practices (59 physicians) located in the Baltimore/Annapolis, Maryland area. In connection with this transaction, the assets and liabilities of the physician practices were transferred to a newly formed professional corporation affiliated with the Company, Flagship Health I, P.A. (Flagship I) and the physicians became employees of Flagship I. The aggregate consideration paid to the physicians for the affiliation was approximately $19.8 million, of which $2.7 million was paid in cash and $17.1 million was paid by the issuance of 6,842,675 shares of Class A common stock. During 1997, the Company issued 44,900 shares of Class A common stock to the Flagship I physicians totalling $112,000 for the settlement of working capital adjustments. As described in Note 2, the Company does not consolidate the operating results or accounts of the affiliated physician practices for financial reporting purposes. Accordingly, its investments in these long-term affiliation agreements are accounted for in a manner similar to that used in the application of the equity method of accounting. Therefore, the costs of the long-term affiliation agreements in excess of the underlying equity of affiliated groups is accounted for as an intangible asset and amortized on a straight-line basis over 25 years. 11 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 3. AFFILIATIONS (CONTINUED) The allocation of the costs of the 1997 and 1996 affiliations were as follows:
1997 AFFILIATIONS ------------------------------------------ SPRINGFIELD FLAGSHIP II ------------------------------------------ Cash $30,000 Fixed assets 21,000 $1,171,000 Other current assets 150,000 4,100,000 Intangibles 2,327,000 15,795,000 Accounts payable (12,000) (905,000) Other liabilities (29,000) (2,762,000) ------------------------------------------ 2,487,000 17,399,000 Other affiliation costs 115,000 461,000 ------------------------------------------ Investment in long-term affiliation agreements $2,602,000 $17,860,000 ========================================== 1996 AFFILIATIONS ------------------------------------------- SPRINGFIELD FLAGSHIP I ------------------------------------------ Cash $336,000 $443,000 Fixed assets 317,000 955,000 Other current assets 1,346,000 4,260,000 Intangibles 9,037,000 16,371,000 Accounts payable (190,000) (677,000) Other liabilities (1,138,000) (1,592,000) ------------------------------------------ 9,708,000 19,760,000 Other affiliation costs 1,238,000 1,711,000 ------------------------------------------ Investment in long-term affiliation agreements $10,946,000 $21,471,000 ==========================================
4. ACQUISITIONS On October 24, 1997, the Company acquired a 50% interest in TLC Management Company, a medical management company and a 50 % interest in Total Quality Practice Management, Inc., a practice management company providing Medicare risk management services. Both companies are based in Atlanta, GA. Total aggregate consideration was $4 million paid in cash and an obligation to issue a $1 million letter of credit. As of December 31, 1997, the letter of credit has not been issued. The Company has accounted for the transaction using the equity method of accounting for investments in common stock. For the year ended December 31, 1997, the net loss in investment was $98,269. 12 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 5. PROPERTY AND EQUIPMENT Property and equipment consist of the following:
DECEMBER 31 1997 1996 --------------------------------- Equipment $1,504,452 $132,163 Furniture and fixtures 10,863 34,110 Office equipment 32,753 20,509 Leasehold improvements - 85,000 --------------------------------- 1,548,068 271,782 Less accumulated depreciation (220,208) (57,774) --------------------------------- $1,327,860 $214,008 =================================
Depreciation expense was $543,591, $81,853 and $6,704 for years ended December 31, 1997, 1996 and for the period from inception to December 31, 1995, respectively. 6. TRANSACTIONS WITH RELATED PARTIES The amounts due under the service agreements with the affiliated practices represent management fee revenue due the Company net of nonphysician salaries and benefits and other practice related expenses paid by the Company on behalf of the affiliated practices. The amounts due as a result of working capital and other adjustments at date of affiliation, represent post closing adjustments provided for as part of the affiliation agreements. The corresponding credits were reflected as a reduction in the cost of the long-term affiliation agreements. Because of the nature of the Company's arrangements with the affiliated physician groups, substantially all transactions included in net patient service revenues and amounts retained by physician groups in the accompanying financial statements are viewed as related-party transactions. 13 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 6. TRANSACTIONS WITH RELATED PARTIES (CONTINUED) The following summarizes the amounts due from related parties:
DECEMBER 31 1997 1996 ------------------------------------- Due under Service agreements: Flagship I & II $3,164,696 $69,774 MCP 2,219,318 520,596 Working capital and other adjustments at date of affiliation: Flagship I & II 72,000 506,702 MCP 263,407 597,615 -------------------------------------- $5,719,421 $1,694,687 ======================================
During the year ended December 31, 1996, the Company entered into affiliation transactions with three of its directors who are physicians. The physicians received 498,602 shares of Class A common stock, 2,500 options to acquire Class A common stock, with an exercise price of $2.50 per share and cash in the amount of $315,000 as consideration for the affiliations. On August 30, 1996, the Company entered into a Management Agreement with Bain Capital Partners V, L.P. (Bain), an affiliate of the Company's Institutional Investors (see Note 6). Pursuant to the Management Agreement, the Company has agreed to pay Bain a management fee of $750,000, plus 1% of any financings from parties other than affiliates of Bain, for services including advice in connection with financings and financial, managerial and operational advice in connection with day-to-day operations. The Company is also obligated to pay certain expenses, not to exceed $100,000 per year without the Company's consent, of Bain and its affiliates in connection with the Management Agreement. 7. LEASES The Company and its affiliates maintain operating leases for property and certain office equipment. The property leases contain renewal options and escalation clauses and require payments of certain utilities and taxes over established base amounts. Operating lease expense amounted to $3,136,822, $535,479 and $14,679 for the years ended December 31, 1997 and 1996 and the period from inception to December 31, 1995, respectively. Future minimum lease payments under noncancelable capital and operating leases follow. All amounts, excluding approximately $162,000 in 1998, are the obligations of the Company's affiliated groups.
OPERATING LEASES ---------------- 1998 $ 4,349,000 1999 3,932,000 2000 3,721,000 2001 3,081,000 2002 2,417,000 Thereafter 2,673,000 ___________ $20,173,000 ===========
14 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 8. STOCKHOLDERS' EQUITY Preferred Stock - --------------- During June 1995, the Company issued 1,666,151 shares of Series A Convertible Preferred Stock (Preferred Stock), par value $.01, that was converted to Class A common stock on a one-for-one basis in connection with the recapitalization discussed below. Warrants to purchase 416,538 shares of Common Stock at $2.40 per share were issued upon the closing of the sale of the Preferred Stock. Warrants to purchase an additional 416,538 shares of common stock were required to be issued to the holders of the Preferred Stock in the event that the Company did not complete an initial public offering on or before June 30, 1996. Accordingly, on August 30, 1996, the Company issued an additional 416,538 warrants at $2.40 per share. A total value of $300,000 were assigned to these warrants. In connection with the recapitalization, the Company authorized 10 million shares of $.01 par value preferred stock. Common Stock - ------------ The Company has four classes of common stock; Class A, Class B-1, Class B-2 and Class C. The primary difference between these four classes is voting rights. Holders of Class A, Class B-1, Class B-2 and Class C common shares are entitled to elect two, one, two and one members of the Company's Board of Directors, respectively. The remaining seven directors are elected collectively by the holders of Class A, Class B-1, Class B-2 and Class C common shares, with each share having a single vote. During the period from March 20, 1995 (inception) to December 31, 1995, the Company issued 7,706,250 shares of $.01 par value common stock to its founders in exchange for cash of $15,188 and notes of $61,875. During the year ended December 31, 1996, 1,012,500 shares of common stock were reacquired by the Company at a cost of $10,125 in the form of cancellation of a like amount of a note due from the shareholder. These shares are subject to certain restrictions which lapse in August 1998. Effective August 30, 1996, the Company recapitalized. All shares of then-existing common stock were canceled and replaced with Class A common shares. On August 30, 1996, 402,301 of Class A common shares were issued in connection with the conversion of a bridge loan. The bridge loan, in the amount of $1.0 million, (1) was outstanding during July and August 1996; (2) bore interest at 10.25% and (3) was convertible into Class A common shares at a conversion rate of $2.50 per share. Warrants to purchase 201,150 shares of common stock at $5.00 per share were issued in connection with the bridge loan. 15 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 8. STOCKHOLDERS' EQUITY (CONTINUED) During August 1996, 625,000 shares of Class A common stock were issued in connection with the conversion of a promissory note. In connection with the Springfield Affiliation described in Note 3, on August 30, 1996, the Company issued 1,587,863 Class B-1 common shares, 1,012,137 Class B-2 common shares and warrants to purchase 3,750,500 shares of Class B common stock at $2.50 per share to the Institutional Investors in exchange for cash proceeds of $6.5 million, which after issuance costs of approximately $1.4 million, netted to approximately $5.1 million. In connection with the Baltimore Affiliation described in Note 3, on December 11, 1996, the Company issued 855,003 Class B-1 common shares, 544,997 Class B-2 common shares and warrants to purchase 1,799,000 shares of Class B common stock at $2.50 per share to the Institutional Investors in exchange for cash proceeds of $3.5 million, which after issuance costs of approximately $640,000, netted to approximately $2.9 million. In April 1997, the Company issued 366,430 Class B-1 common shares, 233,570 Class B-2 common shares and warrants to purchase 865,500 shares of Class B common stock at $2.50 per share to the Institutional Investors in exchange for cash proceeds of $1.5 million. Subject to certain conditions, the Institutional Investors are required to purchase up to 8,000,000 additional shares of Class B common stock, together with warrants to purchase up to 7,450,500 shares of Class B common stock, for aggregate consideration of $20,000,000. These shares may be sold no later than December 31, 1999. In connection with the Flagship II Affiliation described in Note 3, on June 30, 1997, the Company issued 7,692,309 Class C common shares, at $3.25 per share to the Institutional Investors in exchange for cash proceeds of $25 million, which after issuance costs of approximately $700k, netted to approximately $24.3 million. 16 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 8. STOCKHOLDERS' EQUITY (CONTINUED) Puts and Calls - -------------- Of the Company's outstanding common stock, 18,157,982 shares as of December 31, 1997 are subject to a put option which provides for the put of the shares back to the Company at fair value upon the death of the holder. In addition, 1,029,749 of such shares are also subject to a fair value put option back to the Company at the later of the shareholder's retirement from the Company or June, 1998. Consequently, common shares have been recorded at fair value outside of permanent equity in the accompanying balance sheet. Under shareholder agreements as of December 31, 1997, the Company has the right to purchase 15,471,063 shares of common stock for fair value if the shareholder's termination from the Company is without cause or is by resignation, and for the lower of cost or fair value if termination is with cause. All of the above put and call provisions expire on the date of a Qualified Public Offering (QPO), defined as a public offering of the Company's common stock with proceeds to the Company of at least $50 million. In addition to the previously discussed put options, the Flagship II physicians have the right to require the Company to repurchase (in the form of a five year non-interest bearing note) 4.8 million shares of Class A common stock issued in the Flagship II affiliation (note 3) at a purchase price of $3.00 per share if the Company has not completed an underwritten initial public offering prior to December 1, 2001. Because the Company's shares are subject to a number of restrictions in the shareholders' agreements and will not trade until the occurrence of a QPO, the Company believes it is a nonpublic entity for compensation accounting purposes and, accordingly, has not recorded any compensation expense for these puts and calls. As noted above, at the date of the QPO, the put and call provisions of the shareholder agreements will expire. 17 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 8. STOCKHOLDERS' EQUITY (CONTINUED) Warrants - -------- At December 31, 1997, warrants to purchase shares of Class A, Class B and Class C common stock were outstanding as follows:
NUMBER OF SHARES PRICE PER SHARE EXPIRATION DATE - ------------------------------------------------------------------- 20,000 $2.40 2000 201,150 5.00 2003 416,538 2.40 2000 416,538 2.40 2001 6,415,000 2.50 2003 50,000 3.00 2003 7,692,309 3.25 2004
Shares Reserved for Future Issuance - ----------------------------------- At December 31, 1997, the Company has reserved 24,865,381 shares of Common Stock for future issuance for the following purposes: Equity incentive plan 2,710,795 Warrants 15,211,535 ----------- 17,922,330 =========== 18 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 9. Earnings Per Share The following table sets forth the computation of basic earnings per share:
1997 1996 1995 --------------------------------------------------------- Numerator: Net loss $ (5,710,230) $ (5,059,197) $(2,082,264) Accretion of common stock subject to put to fair value (6,678,987) (14,436,848) --------------------------------------------------------- Numerator for basic earnings per share-income available to common stockholders (12,389,217) (19,496,045) (2,082,264) Denominator for basic earnings per share - weighted-average shares 30,335,607 10,785,605 7,706,250 --------------------------------------------------------- Basic earnings per share $ (0.41) $ (1.81) $ (0.27) =========================================================
The effect of options (Note 9) and warrants (Note 7) are not considered, as it would be anti-dilutive for the years presented. At December 31, 1997, these securities, if converted, could potentially dilute basic earnings per common share in the future. 10. Employee Compensation Plans Equity Incentive Plan - --------------------- The Company's 1995 Equity Incentive Plan provides the opportunity for employees, consultants, officers and directors to be granted options to purchase, receive awards or make direct purchases of up to 3.5 million shares of the Company's common stock. Options granted under the Plan may be "Incentive Stock Options" or "Nonqualified Options" under the applicable provisions of the Internal Revenue Code. Incentive Stock Options are granted at the fair market value of the Company's common stock at the date of the grant as determined by the Board of Directors. Incentive Stock Options granted to employees who own more than 10% of the voting power of all classes of stock will be granted at 110% of the fair market value of the Company's common stock at the date of the grant. Nonqualified options may be granted at amounts up to the fair market value of the Company's common stock on the date of the grant, as determined by the Board of Directors. 19 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 10. EMPLOYEE COMPENSATION PLANS (CONTINUED) Pro forma information regarding net income and earnings per share, as if the Company had used the fair value method of SFAS 123 to account for stock options issued under its equity incentive plan is presented below. The fair value for these options was estimated at the date of grant using the "minimum value method" prescribed by SFAS 123. The following weighted-average assumptions were used to determine the fair value for 1997, 1996 and 1995, respectively: a risk- free interest rate of 6.08%, 6.2% and 6.0%, an expected dividend yield of 0% each year, and a weighted-average expected life of the options of six years.
1997 1996 1995 ---------------------------------------------------------- Pro forma net income $(13,379,027) $(19,541,921) $(2,084,340) Pro forma basic earnings per share $ (0.44) $ (1.81) $ (0.27)
A summary of the Company's stock option activity and related information is as follows:
PERIOD FROM MARCH 20 1995 YEAR ENDED YEAR ENDED (INCEPTION) TO DECEMBER 31, DECEMBER 31, 1997 DECEMBER 31, 1996 1995 ------------------------------------------------------------------------------------------------------ WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE EXERCISE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES PRICE ------------------------------------------------------------------------------------------------------ Outstanding at beginning of period 811,012 $ 0.95 476,086 $ 0.10 Granted 2,181,033 2.69 346,676 2.12 476,086 $0.10 Exercised (90,375) (0.04) Forfeited (190,875) (1.97) (11,750) (0.08) ------------------------------------ -------------------------------------- Outstanding at end of period 2,710,795 $ 2.25 811,012 $ 0.95 476,086 $0.10 =================== ================= =============== Exercisable at period end 600,099 140,487 -- Weighted-average fair value =================== ================== =============== of options granted during period $0.85 $ 0.69 $ 0.02
20 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 10. EMPLOYEE COMPENSATION PLANS (CONTINUED) The following table summarizes information about stock options outstanding at December 31, 1997:
Weighted-Average Remaining Life EXERCISE PRICE OPTIONS OUTSTANDING Options Exercisable (Years) - ------------------------------------------------------------------------------------------ $ 0.01 241,586 152,557 7.4 0.25 91,000 40,500 7.0 0.85 109,676 27,669 8.1 1.00 150,000 150,000 9.0 2.50 1,311,000 229,373 9.2 3.00 316,533 0 9.8 3.25 491,000 0 8.5
All options granted vest ratable over a range of three to four years. Profit Sharing Plan - ------------------- The Board of Directors of the Company approved the adoption of a qualified 401(k) profit sharing plan (the Plan) for all employees meeting certain eligibility requirements. Under the Plan, the participants may make contributions to the Plan of up to 15% of their compensation, up to the Internal Revenue Service limitation. Effective December 1, 1996, the Company may make discretionary contributions to the Plan as determined by the Board of Directors. Contributions for the year ended December 31, 1997 and 1996, respectively, were approximately $528,000 and $86,000. Money Purchase Pension Plan - --------------------------- The Board of Directors of the Company approved the adoption of a qualified money purchase pension plan for the employees of MCP. Effective August 30, 1996, the Company may provide a contribution on wages up to the Social Security limitation and up to 9.27% on wages in excess of the Social Security limitation. The Company contributed approximately $518,000 and $187,000 to the money purchase pension plan in 1997 and 1996, respectively. 21 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 11. Income Taxes The Company consolidates the affiliated physician practices for Federal and State income tax purposes. Significant components of the provision for income taxes are as follows:
YEAR ENDED DECEMBER 31 1997 1996 ----------------------------------- Current: Federal $22,057 State $ 111,123 56,071 ----------------------------------- 111,123 78,128 Deferred: Federal (770,443) State (135,961) ----------------------------------- (906,404) ----------------------------------- Total (benefit) expense $(795,281) $78,128 ===================================
The components of the Company's deferred income taxes are as follows:
DECEMBER 31 1997 1996 Deferred tax liabilities: Adjustment of cash basis practices to accrual basis $(1,475,782) $(1,073,048) Fixed assets differences (514,408) 85,360 --------------------------------- Total deferred tax liabilities (1,990,190) (987,688) Deferred tax assets: Net operating loss carryover 3,660,488 1,783,956 Other accrued liabilities 194,225 98,529 Other (charitable contribution carryover) 9,617 Capitalized start-up costs 498,410 664,547 Allowance for doubtful accounts 282,122 85,763 --------------------------------- 4,644,862 2,632,795 Less valuation allowance (3,400,734) (2,109,984) --------------------------------- Net deferred tax assets 1,244,128 522,811 --------------------------------- Net deferred tax assets (liabilities) $ (746,062) $ (464,877) =================================
22 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 11. INCOME TAXES (CONTINUED) The difference between the provision for income taxes and the amount computed by applying the statutory federal income tax rate is as follows:
YEAR ENDED DECEMBER 31 1997 1996 ---------------------------------------------------------------- Federal taxes at statutory rates $(2,211,874) 34% $(1,721,439) 35% Add (deduct): State income taxes, net of federal benefit (300,555) 4.6 (209,474) 4.3 Change in valuation allowance attributable to operations 1,290,750 (19.8) 1,999,182 (40.6) Goodwill 402,404 6.2 Other 23,994 (0.4) 9,859 (0.2) ---------------------------------------------------------------- $ (795,281) 12.2% $ 78,128 (1.5)% =================================================================
At December 31, 1997, the Company had net operating loss carryforwards for federal income tax purposes of approximately $9,151,000 which expire through the year 2012. The utilization of net operating losses may be subject to limitation under the change in stock ownership rules of the Internal Revenue Code. For financial reporting purposes, a valuation allowance of approximately $3,400,734 has been recognized to offset the deferred tax assets, including these carryforwards, since uncertainty exist with respect to future realization of such carryforwards. The 1997 increase in the valuation allowance of $1,290,750 is comprised of an increase in the allowance of $2,197,154 relating to the creation of deferred tax assets in the current period that may not be realized in future periods, and a decrease of $906,404 relating to the utilization of a portion of these deferred tax assets to offset acquired deferred tax liabilities unable to be offset by preacquisition deferred tax assets. 23 Physicians Quality Care, Inc. Notes to Financial Statements (continued) 12. CONTINGENCY On June 12, 1997, Jay N. Greenberg, a founder and former executive vice president of the Company, filed a complaint against the Company in Massachusetts state court seeking damages of $1.4 million and a declaratory judgement that 843,750 of the shares registered in Mr. Greenberg's name (out of 1,012,500 shares of class A Common Stock originally granted to Mr. Greenberg) have "vested" under his employment agreement. The complaint involves a dispute over whether an amendment in December 1996 to Mr. Greenberg's employment agreement is valid and whether Mr. Greenberg resigned or was terminated in January 1997. The Company maintains that the amendment was fraudulently induced based upon a commitment by Mr. Greenberg for long-term employment with the Company and that Mr. Greenberg resigned in January 1997. Under such facts, Mr. Greenberg is entitled to have no more than 450,000 shares of Class A Common Stock (and, depending upon counterclaims that may be brought by the Company, possibly fewer) and is entitled to no severance payment. Mr. Greenberg claims that 843,750 shares of Class A Common Stock have vested and that his employment was terminated in January 1997 by the Company entitling him to severance payments of $440,000. While the Company is not able to predict the outcome of this litigation, it does not believe its ultimate resolution will materially affect either the Company's financial position or its results of operations. 13. SUBSEQUENT EVENT In February 1998 the Company entered into affiliation arrangements with 2 physicians located in the Baltimore/Annapolis, Maryland area. The aggregate total consideration paid to the physicians in connection with the affiliation was approximately $1.5 million, payable in a combination of cash and common stock. 24 EXHIBIT INDEX -------------
Exhibit No. Description Page - ----------- ------------------------------------------------------------ ---- 3.1(1) -- Restated Certificate of Incorporation of the Registrant (as amended on June 23, 1997) 3.2(1) -- Amended and Restated By-Laws of the Registrant (as amended on June 19, 1997) 4.1(1) -- Specimen certificate for shares of Class A Common Stock 4.2(1) -- Amended and Restated Class B Common Stock and Warrant Purchase Agreement dated June 20, 1997, between the Registrant and each of the Institutional Investors 4.3(1) -- Stockholders Agreement, dated August 30, 1996 (the "Stockholders Agreement"), among the Registrant, the Institutional Investors, each Management Stockholder from time to time party thereto, each Physician Stockholder from time to time party thereto and other existing stockholders from time to time party thereto 4.4 -- Waiver of Rights and Amendment Under Stockholders Agreement 4.5 -- Amendment No. 2 to the Stockholders Agreement 4.6(1) -- Stockholders Agreement dated August 9, 1996 between the Registrant and certain Springfield Stockholder Physicians 4.7(1) -- Registration Rights Agreement dated August 9, 1996, by and among the Registrant and certain Springfield Stockholder Physicians 10.1(1) -- 1995 Equity Incentive Plan 10.2(1) -- Management Agreement dated August 30, 1996, between the Registrant and Bain Capital Partners V, L.P., a Delaware limited partnership (the "Management Agreement") 10.3(1) -- Lease dated November 1995 between Shorenstein Management, Inc. as trustee for SRI Two Realty Trust and the Registrant 10.4(1) -- Lease dated December 9, 1996 between Steven M. Roberts, trustee of Northernedge/Plant One Realty Trust and the Registrant
1 10.5(1) -- Maryland Full-Service Office Lease of Camden Yards North Warehouse dated October 12, 1995, by and between the Maryland Stadium Authority and the Registrant 10.6(1) -- Form of Merger Agreement dated December 11, 1996, among the Registrant, the Flagship Affiliated Group and certain of the Flagship Stockholder Physicians and their practices 10.7(1) -- Form of Asset Purchase Agreement dated December 11, 1996, among the Registrant, the Flagship Affiliated Group and certain of the Flagship Stockholder Physicians and their practices 10.8(1) -- Form of Affiliated Agreement dated December 11, 1996, among the Registrant, the Flagship Affiliated Group and certain of the Flagship Stockholder Physicians 10.9(1) -- Services Agreement dated December 11, 1996, between the Registrant and the Flagship Affiliated Group (the "Flagship Service Agreement") 10.10(1) -- Form of Employment Agreement dated December 11, 1996, between the Flagship Affiliated Group and each Flagship Stockholder Physician 10.11(1) -- Form of Shareholder Designation and Stock Transfer Agreement dated December 11, 1996, among the Registrant, the Flagship Affiliated Group and the Flagship Affiliated Group Stockholder, Laura M. Mumford, M.D. 10.12(1) -- Form of Merger Agreement among the Registrant, the Springfield Affiliated Group and the Springfield Stockholder Physicians and their practices 10.13(1) -- Form of Asset Purchase Agreement among the Registrant, the Springfield Affiliated Group and certain Springfield Stockholder Physicians 10.14(1) -- Form of Employment Agreement between the Springfield Affiliated Group and certain Springfield Stockholder Physicians, including General Terms and Conditions of Employment for the Springfield Affiliated Group and Form of Addendum thereto relating to the Springfield Stockholder Physicians 2 10.15(1) -- Form of Affiliation Agreement dated August 30, 1996, among the Registrant, the Springfield Affiliated Group and the Springfield Stockholder Physicians 10.16 -- Services Agreement dated August 30, 1996, among the Registrant and the Springfield Affiliated Group 10.17(1) -- Shareholder Designation and Stock Transfer Agreement dated August 9, 1996, among the Registrant, the Springfield Affiliated Group and the Springfield Affiliated Group Stockholder, Jay Ungar, M.D. 10.18(1) -- Credit Agreement dated January 16, 1997 among the Registrant, Banker's Trust Company, as Agent, and various lending institutions *10.19(1) -- Employment Agreement dated June 21, 1995 between the Registrant and Jerilyn P. Asher, as amended in January 1996 and on August 30, 1996 *10.20(1) -- Employment Agreement dated June 21, 1995 between the Registrant and Arlan F. Fuller, M.D., as amended in January 1996 10.21(1) -- Office Building Lease dated March 18, 1997, by and between Harbor Court Associates and the Registrant 10.22 -- Amended and Restated Services Agreement dated July 1997, among Flagship Health II, P.A. ("Flagship II") and the Registrant 10.23 -- Agreement dated July 31, 1997 by and among the Registrant, Flagship, Flagship II and the Stockholders and Optionholders of Clinical Associates, P.A. 10.24 -- Merger Agreement dated July 31, 1997, between the Registrant, Flagship II, Clinical Associates and the Stockholders and Optionholders of Clinical Associates 10.25 -- Amendment to the Management Agreement, dated April 18, 1997 21.1 -- Subsidiaries of the Registrant 27 -- Financial Data Schedule ___________ (*) Management contract or compensatory plan or arrangement filed as an exhibit to this Form pursuant to Item 14(c) of Form 10-K. (1) Incorporated herein by reference from the Company's Registration Statement on Form S-1 (File No. 333-26137). 3 EX-4.4 2 WAIVER OF RIGHTS AND AGREEMENT Exhibit 4.4 ----------- EXECUTION COPY -------------- WAIVER OF RIGHTS AND AMENDMENT UNDER STOCKHOLDERS AGREEMENT This Waiver of Rights and Amendment under Stockholders Agreement ("Waiver of Rights") is made and entered into as of December 11, 1996, by and among Physicians Quality Care, Inc., a Delaware corporation (the "Company"), and each of the undersigned parties (the "Majority Stockholders"). Capitalized terms not defined herein shall have the meanings set forth in the Stockholders Agreement (as hereinafter defined). WHEREAS, the Company and the Majority Stockholders, along with certain other holders of the Company's securities, are parties to a Stockholders Agreement dated as of August 30, 1996, as amended and in effect from time to time (the "Stockholders Agreement"); WHEREAS, the Majority Stockholders collectively hold a majority of all Shares currently outstanding and subject to the Stockholders Agreement and collectively hold a majority of the Non-Bain Investor Shares currently outstanding and subject to the Stockholders Agreement; WHEREAS, each of the physicians listed on Exhibit A (the "Non-Retiree --------- Flagship Physicians") are becoming parties to the Stockholders Agreement for all purposes by executing an Instrument of Joinder to Stockholders Agreement dated as of even date herewith; and WHEREAS, pursuant to the provisions of Section 12.2 of the Stockholders Agreement, the Company and the Majority Stockholders desire to waive certain of the Company's rights under the Stockholders Agreement as set forth below. NOW, THEREFORE, the parties to this Waiver of Rights agree as follows: 1. As applied to each of the Non-Retiree Flagship Physicians, Section 5.1.1. of the Stockholders Agreement is hereby amended to read in its entirety as follows: 5.1.1. Termination by the Company Without Cause. If such ---------------------------------------- termination is the result of termination of such holder's employment by the Company, its Subsidiaries or any Affiliate thereof without Cause or as a result of the death or Disability (as defined in such holder's written employment agreement with the Company, its Subsidiary or its Affiliate, as applicable (the "Employment Agreement")) of such holder, the Company (or its designee), upon written notice delivered within 90 days of termination, may purchase all or any portion of the Shares, Warrants and Options then held by the applicable Call Stockholder Group at a price equal to the Fair Market Value of such securities; provided, however, that upon termination of the employment -------- ------- by the Company, its Subsidiary or any Affiliate thereof of a holder of Physician Shares as a result of a Disability of such Physician Stockholder, the Company shall have no right to purchase all or any portion of the Shares, Warrants and Options then held by the applicable Call Stockholder Group for such period of time, if any, as such Physician Stockholder is in all respects a Qualified Holder with a Total Disability, as hereafter defined. 5.1.1.1. It shall be the responsibility of such Physician Stockholder or his/her legal guardian, if any, to notify the Company in writing within 30 days of termination of employment as a result of Total Disability that such Physician Stockholder should be considered a Qualified Holder with a Total Disability and the failure of the Physician Stockholder or his/her legal guardian to do so in a timely manner shall be determinative of the matter. Following said notice, the Physician Stockholder (in the case of seeking such qualification pursuant to Section 5.1.1.3(d)(i), upon the Company's request, or in the case of seeking such qualification pursuant to Section 5.1.1.3(d)(ii), upon the request of the NMA Board (as defined below in Section 5.1.1.3(d)(ii)) shall submit to the examination and testing of up to three physicians selected by the Company or the NMA Board, respectively. In order for the Physician Stockholder to be medically certified as having a Total Disability hereunder pursuant to Section 5.1.1.3(d)(i), each of the physicians so selected must conclude that the Physician Stockholder has a Total Disability in accordance with Section 5.1.1.3(d)(i) hereof. In the case of Physician Stockholders who qualify as Totally Disabled hereunder pursuant to Section 5.1.1.3(d)(i), the Company may require the Physician Stockholder to be recertified quarterly thereafter by up to three physicians and the Physician Stockholder shall be recertified only by unanimous determination of the physicians selected by the Company. In the case of Physician Stockholders who qualify as Totally Disabled hereunder pursuant to Section 5.1.1.3(d)(ii), the NMA Board may require the Physician Stockholder to be examined by a physician from time to time as the NMA Board determines appropriate but in no event more frequently than annually. If the Physician Stockholder shall fail to submit to any medical examination or testing requested by the Company or the NMA Board hereunder, the Physician Stockholder shall cease to be a Qualified Holder with a Total Disability. 5.1.1.2. A Physician Stockholder shall notify the Company in writing immediately if the Physician Stockholder ceases, in any respect, to be a Qualified Holder with a Total Disability in accordance with Section 5.1.1.3(c) hereof. Any Physician Stockholder who is determined to be a Qualified Holder with a Total Disability hereunder shall no longer qualify as such in the event that the Physician Stockholder ceases to meet in full all of the criteria set forth in Section 5.1.1.3(c) hereof. The date on which the Company determines, and provides notice of such determination to the Physician Stockholder, that such Physician Stockholder ceases to be a Qualified Holder with a Total Disability shall be the "Disqualification Date". In the event a Physician Stockholder ceases to be certified or recertified as having a Total Disability or otherwise ceases to be a Qualified Holder with a Total Disability, the Physician Stockholder shall be treated for purposes of this Agreement as being terminated for Cause as of the Disqualification Date. 5.1.1.3. Definitions. For purposes of this Agreement, the ----------- following definitions shall apply: (a) "Basic Activities of Daily Living" shall mean bathing, dressing, toileting, continence, eating and the ability to move from a sitting to a lying position and vice versa. (b) "Cognitive Impairment" shall mean confusion or disorientation resulting from a deterioration or loss of intellectual capacity as a result of Alzheimer's disease, senility or other irreversible dementia, which deterioration or loss is capable of being diagnosed, and is diagnosed, by standardized testing or instruments. (c) A "Qualified Holder with a Total Disability" shall mean a Physician Stockholder who (i) is Totally Disabled in accordance with Section 5.1.1.3 (d) hereof; (ii) is in compliance with and intends to remain in compliance with all of his/her obligations under the Employment Agreement (including without limitation the restrictive covenants), excluding only the Physician Stockholder's obligation to provide services thereunder; and (iii) is not working in any capacity, with or without compensation, whether as an employee, partner, independent contractor or otherwise. (d) A Physician Stockholder shall be certified as having a "Total Disability" by a physician selected by the Company hereunder only if (i) the Physician Stockholder (A) is unable to perform three or more of the Basic Activities of Daily Living without substantial human physical assistance and/or constant supervision or is suffering from a Cognitive Impairment and (B) is unable to work in any capacity, or (ii) in the event that (after having been examined in accordance with the requirements of and followed the procedures set forth in Section 5.1.1.1 above) the Physician Stockholder fails to be certified as having a Total Disability pursuant to Section 5.1.1.3(d)(i), (A) the Physician Stockholder appeals to the National Medical Advisory Board of the Company (the "NMA Board"), and the NMA Board (by vote of the majority of all its members) certifies in its sole discretion that the Physician Stockholder is permanently disabled and is not able to contribute meaningfully as a member of the medical profession, and that such determination will not unfairly and adversely affect the other physician employees of the Company or its Subsidiaries or Affiliates and (B) the NMA Board (by vote of the majority of all its members) has not subsequently revoked such certification. 2. MISCELLANEOUS. 2.1. Authority; Effect. Each party hereto represents and warrants to ----------------- and agrees with each other party that the execution and delivery of this Waiver of Rights and the consummation of the transactions contemplated hereby have been duly authorized on behalf of such party and do not violate any agreement or other instrument applicable to such party or by which its assets are bound. Except to the extent specifically amended hereby, the provisions of the Stockholders Agreement shall remain unmodified and the provisions of the Stockholders Agreement are hereby confirmed as being in full force and effect. This Waiver of Rights does not, and shall not be construed to, give rise to the creation of a partnership among any of the parties hereto, or to constitute any of such parties members of a joint venture or other association. 2.2. Notices. Notices and other communications provided for in this ------- Waiver of Rights shall be given as directed in Section 14.2 of the Stockholders Agreement. 2.3. Binding Effect, etc. This Waiver of Rights constitutes the entire ------------------- agreement of the parties with respect to its subject matter, supersedes all prior or contemporaneous oral or written agreements or discussions with respect to such subject matter, and shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, representatives, successors and assigns. 2.4. Descriptive Headings. The descriptive headings of this Waiver of -------------------- Rights are for convenience of reference only, are not to be considered a part hereof and shall not be construed to define or limit any of the terms or provisions hereof. 2.5. Counterparts. This Waiver of Rights may be executed in multiple ------------ counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one instrument. 2.6. Severability. If in any judicial proceedings a court shall refuse ------------ to enforce any provision of this Waiver of Rights, then such unenforceable provision shall be deemed eliminated from this Waiver of Rights for the purpose of such proceedings to the extent necessary to permit the remaining provisions to be enforced. To the full extent, however, that the provisions of any applicable law may be waived, they are hereby waived to the end that this Waiver of Rights be deemed to be valid and binding agreement enforceable in accordance with its terms, and in the event that any provision hereof shall be found to be invalid or unenforceable, such provision shall be construed by limiting it so as to be valid and enforceable to the maximum extent consistent with and possible under applicable law. 2.7. Governing Law. Except to the extent that any provision of this ------------- Waiver of Rights is contrary to any mandatory provision of the General Corporation Law of the State of Delaware (in which case such mandatory statutory provision shall apply), this Waiver of Rights shall be governed by and construed in accordance with the domestic substantive laws of The Commonwealth of Massachusetts without giving effect to any choice or conflict of laws provision or rule that would cause the application of the domestic substantive laws of any other jurisdiction. [Balance of this page intentionally left blank.] IN WITNESS WHEREOF, each of the undersigned has duly executed this Waiver of Rights (or caused this Waiver of Rights to be executed on its behalf by its officer or representative thereunto duly authorized) under seal as of the date first above written. THE COMPANY: PHYSICIANS QUALITY CARE, INC. By: /s/ Jerilyn P. Asher --------------------------------------------- Name: Jerilyn P. Asher Title: Chief Executive Officer and President MAJORITY STOCKHOLDERS: BAIN CAPITAL FUND V, L.P. By Bain Capital Partners V, L.P., a Delaware limited partnership, its general partner By Bain Capital Investors V, Inc., its general partner By /s/ -------------------------------------------------- Title: Managing Director BAIN CAPITAL FUND V-B, L.P. By Bain Capital Partners V, L.P., a Delaware limited partnership, its general partner By Bain Capital Investors V, Inc., its general partner By /s/ ---------------------------------------------------- Title: Managing Director BCIP Associates By /s/ -------------------------------------------------- Title: a general partner BCIP TRUST ASSOCIATES, L.P. By /s/ ----------------------------------------------- Title: a general partner /s/ Jerilyn P. Asher ------------------------------------------------ Jerilyn P. Asher, as an individual /s/ Jay Greenberg ----------------------------------------------- Jay Greenberg, as an individual /s/ Arlan Fuller, Jr., M.D. ---------------------------------------------- Arlan Fuller, Jr., M.D., as an individual /s/ Thomas M. Zizic, M.D. -------------------------------------------- Thomas M. Zizic, M.D., as an individual Exhibit A -- Non-Retiree Flagship Physicians - -------------------------------------------- Charles S. Angell, M.D. John Aucott, M.D. David C. Barnes, M.D. Nancy K. Barnett, M.D. Barbara L. Bean, M.D. Marshall S. Bedine, M.D. Richard Berg, M.D. Peter C. Belitsos, M.D. Lauren L. Bogue, M.D. Joyce Burd, M.D. Nicholas Capozzoli, M.D. Michael R. Clemmens, M.D. Enser W. Cole, III, M.D. Alan M. Davick, M.D. Timothy F. Doran, M.D. Barbara A. Duffy, M.D. Ira Fine, M.D. Dwight N. Fortier, M.D. Dana H. Frank, M.D. Allen M. Friedman, M.D. Neil Friedman, M.D. Peter R. Graze, M.D. Andre Gvozden, M.D. Faith Hackett, M.D. Dennis L. Headings, M.D. Katherine S. Koch, M.D. S. David Krimins, M.D. Timothy L. Krohe, M.D. Alan M. Lake, M.D. Marshall A. Levine, M.D. Samuel M. Libber, M.D. Ann C. Massey, M.D. Susan M. Molinaro, M.D. Laura Mumford, M.D. Mary M. Newman, M.D. Alan Rosen, M.D. Saul D. Roskes, M.D. Michael Rudikoff, M.D. Peter Schilder, M.D. Jeffrey Schmidlein, M.D. Kenneth C. Schuberth, M.D. Eric J. Seifter, M.D. Stuart Selonick, M.D. Stanley P. Watkins, M.D. Stanley R. Weimer, M.D. Julia Wen, M.D. Milan Wister, M.D. Robert A. Wood, M.D. EX-4.5 3 AMENDMENT NO.2 TO STOCKHOLDER'S AGREEMENT EXHIBIT 4.5 Execution Copy AMENDMENT NO. 2 TO STOCKHOLDERS AGREEMENT This Amendment No. 2 to the Stockholders Agreement (the "Amendment") is made and entered into as of June 23, 1997 by and among Physicians Quality Care, Inc., a Delaware corporation (the "Company"), the Bain Initial Investors, ABS Capital Partners II, L.P., a Delaware limited partnership, Russell Roy, Steve Schuh, Stanley Blaylock, Dick Franyo, Christopher Camut, Terry Hyman, Brent Milner, Kathy Coffey, Mark Klausner, Michael Singer, Stuart Smith and Gary Lessing (collectively, the "Capital Investors"), GS Capital Partners II, L.P., Goldman, Sachs & Co. Verwaltungs GmbH, GS Capital Partners II Offshore, L.P. and The Goldman Sachs Group, L.P. (collectively, the "Goldman Initial Investors") and the Class A Common Stockholders listed on the signature page hereof ( the "Class A Holders"). Capitalized terms not defined herein shall have the meanings set forth in the Stockholders Agreement (as hereinafter defined). WHEREAS, the Company, the Bain Initial Investors and the Non-Bain Majority Stockholders along with certain other holders of the Company's Securities, are parties to a Stockholders Agreement dated as of August 30, 1996, as amended on December 31, 1996 and as amended and in effect from time to time (the "Stockholders Agreement"); WHEREAS, the undersigned Stockholders of the Company collectively hold a majority of all Shares currently outstanding; WHEREAS, the Class A Holders collectively hold a majority of Non-Bain Investor Shares currently outstanding and subject to the Stockholders Agreement; WHEREAS, the Capital Investors, the Goldman Initial Investors and the Bain Investors are purchasing shares of Class C Common Stock of the Company pursuant to an Amended and Restated Class B and Class C Common Stock and Warrant Purchase Agreement dated the date hereof and as a condition thereto have required certain amendments to the Stockholders Agreement; NOW, THEREFORE, the parties agree as follows: 1. Section 1 of the Stockholders Agreement is hereby amended and restated in its entirety as follows: "1. DEFINITIONS. For purposes of this Agreement: 1.1. Certain Definitions. The following terms shall have the following ------------------- meanings: 1.1.1 "Affiliate" shall mean, with respect to any specified Person, any --------- Person that, directly or indirectly, through one or more intermediaries, controls, is controlled by or is under common control with, the Person specified including effective control by virtue of a contractual relationship such as a management agreement or a stockholder transfer or designation or similar agreement other than a management or similar agreement which does not, alone or together with related agreements, result in control of such Person. 1.1.2. "Affiliated Fund" shall mean any limited partnership or other --------------- Person formed for the purpose of investing in other companies or businesses and for which (a) any general partner of any Investor or any of its Affiliates has the right to direct the voting of shares of corporations in which such limited partnership or other Person invests or (b) any general partner of an Investor or an Investor or any of their respective Affiliates provides management services. 1.1.3. "Bain Investor" shall mean (i) any Bain Initial Investor and ------------- (ii) any Affiliated Fund of a Bain Investor which, from time to time, acquires Shares or Warrants and becomes party to this Agreement by executing and delivering to the Company an instrument in form satisfactory to the Company pursuant to which such stockholder agrees to be bound by the terms of this Agreement to the same extent as a Bain Initial Investor. 1.14. "Board" shall mean the Board of Directors of the Company. ----- 1.1.5. "Capital Investor" shall mean (i) ABS Capital Partners II, L.P., a ---------------- Delaware limited partnership, Russell Roy, Steve Schuh, Stanley Blaylock, Dick Franyo, Christopher Camut, Terry Hyman, Brent Milner, Kathy Coffey, Mark Klausner, Michael Singer, Stuart Smith and Gary Lessing and (ii) any Affiliated Fund of a Capital Investor which, from time to time, acquires Shares or Warrants and becomes party to this Agreement by executing and delivering to the Company an instrument in form satisfactory to the Company pursuant to which such stockholder agrees to be bound by the terms of this Agreement to the same extent as the Capital Investor. 1.1.6. "Cause" shall mean, (a) in the context of termination of the ----- employment of any Management Stockholders, any of the following events or conditions: (i) such person's significant failure to perform (other than by reason of disability) his or her duties and responsibilities to the Company and its Affiliates which failure causes material injury to the Company and is not cured within fourteen (14) days after written notice by the Company to such person, (ii) any act of fraud, embezzlement or other material dishonesty, (iii) conviction of, or plea of nolo contendere to, any felony -2- or any other crime involving fraud, dishonesty or moral turpitude, or (iv) conduct which causes criminal or material civil liabilities to the Company, its Subsidiaries or Affiliates thereof; and (b) shall mean, in the context of a Physician, any of the following events or conditions: (i) fraud or dishonesty with respect to the Company, its Affiliates or their employees, patients or visitors; (ii) suspension or termination from Medicare, Medicaid or any third- party reimbursement program, for cause other than by reason of the fact of employment by the Company or its Affiliates; (iii) ceases to be licensed to practice medicine without restriction under the laws of any state in which the Physician is licensed; (iv) ceases to maintain a current and valid Federal Drug Enforcement Agency license; or (v) conviction of, or plea of nolo contendere to, any felony or any other crime involving fraud, dishonesty or moral turpitude, (vi) conduct causes criminal or material civil liabilities to the Company, its Subsidiaries or Affiliates thereof or (vii) breach of noncompetition agreement with the Company or any of its Subsidiaries or Affiliates thereof. 1.1.7. "Class A Director" shall have the meaning set forth in the ---------------- Company's Restated Certificate of Incorporation. 1.1.8. "Class C Common" shall mean the Class C Common Stock, $.01 par -------------- value per share of the Company. 1.1.9. "Common Stock" shall mean the Class A Common, the Class B Common ------------ and the Class C Common of the Company. 1.1.10. "Common Stock Director" shall have the meaning set forth in --------------------- the Company's Restated Certificate of Incorporation. 1.1.11. "Cost" shall mean, in the context of the Cost of securities ---- subject to the provisions of Section 5, (i) in the case of Shares, the amount (in the form of subscription price or exercise price or otherwise) paid to the Company upon issuance of such Shares and (ii) in the case of Warrants or Options, an amount equal to the value of the consideration paid therefor as determined by the Board; in each case adjusted appropriately to take account of any stock splits, stock dividends, conversions or consolidations of stock or substantially similar reorganizations of the Company's capital stock. 1.1.12. "Effective Time" shall mean August 30, 1996. -------------- 1.1.13. "Exchange Act" shall mean the Securities Exchange Act of 1934, as ------------ amended. 1.1.14. "Executive" shall mean Jerilyn Asher or Jay Greenberg. --------- -3- 1.1.15. "Fair Market Value" shall mean, as of any date, the fair value of ----------------- any Share as of the applicable date, as determined pursuant to Section 5.5. 1.1.16. "Goldman Investors" shall mean (i) the Goldman Initial Investor ----------------- and (ii) any Affiliated Fund of a Goldman Investor which, from time to time, acquires Shares or Warrants and becomes party to this Agreement by executing and delivering to the Company an instrument in form satisfactory to the Company pursuant to which such stockholder agrees to be bound by the terms of this Agreement to the same extent as the Goldman Investors. 1.1.17. "Investors" shall mean the Bain Investors, the Capital Investor --------- and the Goldman Investors. 1.1.18. "Investor Initial Shares" shall mean with respect to each Investor ----------------------- all Shares originally issued to such Investor. 1.1.19. "Investor Majority Holders" shall mean, as of any date, the ------------------------- holders of a majority of the Investor Shares outstanding on such date. 1.1.20. "Investor Shares" shall mean all Shares issued to (or issued upon --------------- conversion of or otherwise with respect to Shares, Warrants or Options issued to) or held by the Investors whenever issued. 1.1.21. "Majority Stockholders" shall mean, as of any date, the --------------------- holders of a majority of the Shares outstanding on such date. 1.1.22. "Management Majority Holders" shall mean, as of any date, the --------------------------- holders of a majority of the Management Shares outstanding on such date. 1.1.23. "Management Shares" shall mean all Shares issued to (or issued ----------------- upon conversion of or otherwise with respect to Shares issued to) or held by the Management Stockholders, whenever issued, including without limitation all Shares issued pursuant to the exercise of any Warrants or Options, whenever issued; provided, however, that for purposes of this Agreement Management Shares shall not include Shares issued upon exercise of Options (i) outstanding on the Effective Time (ii) which are exercisable as of the Effective Time or on or prior to December 31, 1997, (iii) which Shares shall not exceed 303,057 in the aggregate and (iv) are held by such Management Stockholders listed on Schedule A hereto in the amounts specified therein. 1.1.24. "Management Stockholder" shall mean any officer or employee ---------------------- of the Company or any of its subsidiaries who, from time to time, acquires Shares or Options and becomes party to this Agreement by executing and delivering to the Company an instrument in form satisfactory to the Company and -4- the Investors pursuant to which such stockholder agrees to be bound by the terms of this Agreement applicable to Management Stockholders. 1.1.25. "Members of the Immediate Family" shall mean, with respect to any ------------------------------- individual, each spouse, parent, brother, sister or child of such individual, each spouse of any such Person, each child of any of the aforementioned Persons, each trust created solely for the benefit of one or more of the aforementioned Persons and each custodian or guardian of any property of one or more of the aforementioned Persons in his capacity as such custodian or guardian. 1.1.26. "Non-Investor Options" shall mean all Options held by any -------------------- Stockholder other than Options held by Investors. 1.1.27. "Non-Investor Shares" shall mean all Shares other than Investor ------------------- Shares, whenever issued. 1.1.28. "Non-Investor Warrants" shall mean all Warrants held by --------------------- Stockholders other than Warrants held by Investors. 1.1.29. "Options" shall mean any options to subscribe for, purchase or ------- otherwise acquire Shares, including, without limitation, any and all options issued pursuant to the Company's Equity Incentive Plan or any similar plan. 1.1.30. "Permitted Transferee" shall mean as to each Management Share -------------------- and Physician Share, a transferee of such Management Share or Physician Share in compliance with Section 4.1 or 4.2. 1.1.31. "Person" shall mean any individual, partnership, corporation, ------ company, association, trust, joint venture, unincorporated organization or other entity, or any government, governmental department or agency or political subdivision thereof. 1.1.32. "Physician Shares" shall mean Shares, Warrants or Options issued ---------------- pursuant to the acquisition by an Affiliate of the Company of group practices of certain physicians which are held by Persons who become parties to this Agreement by executing and delivering to the Company an instrument in form satisfactory to the Company and the Investors pursuant to which such stockholder agrees to be bound by the terms of this Agreement applicable to Physician Stockholders. 1.1.33. "Prime Rate" shall mean the rate of interest as announced from ---------- time to time by Fleet Bank, at its principal office in Boston, Massachusetts as its prime lending rate, the Prime Rate to change when and if such prime lending rate changes. -5- 1.1.34. "Public Event" shall mean any transaction or other event ------------ (including, without limitation, a merger with a public company) after or in connection with which shares of common stock of the Company or any successor are registered under the Securities Act or listed on a "national securities exchange" as defined in the Exchange Act or the subject of price quotation through the National Association of Securities Dealers' Automated Quotation System. 1.1.35. "Public Offering" shall mean the closing of an offering of Shares --------------- registered under the Securities Act of Shares of the Company. 1.1.36. "Qualified Public Offering" shall mean the closing of a Public ------------------------- Offering with (i) the net proceeds of the sale of such Shares by the Company and any stockholder of the Company to equal or exceed $50,000,000 provided that the Investors shall have sold or shall be permitted to sell fifty percent (50%) of the Shares then held by the Investors and the net proceeds of the sale thereof to or the net proceeds of the sale thereof which would be permitted to be sold by the (A) Capital Investor shall equal or exceed seventy-five percent of the total amount invested in capital stock of the Company by the Capital Investors up to $15,000,000, (B) the net proceeds of the sale thereof to the Bain Investors shall equal or exceed seventy-five percent of the total amount invested in capital stock of the Company by the Bain Investors up to $15,000,000 and (C) the net proceeds of the sale thereof to the Goldman Investors shall equal or exceed seventy-five percent of the total amount invested in capital stock of the Company by the Goldman Investors up to $15,000,000 and (ii) subject to a firm commitment underwriting conducted by a nationally recognized underwriter acceptable to a majority of the Class B Directors and Class C Directors, voting together as a single class. 1.1.37. "Securities Act" shall mean the Securities Act of 1933, as -------------- amended, and the rules and regulations of the Securities and Exchange Commission promulgated thereunder, all as from time to time in effect. 1.1.38. "Shares" shall mean shares of Common Stock of the Company. ------ 1.1.39. "Transfer" shall mean to sell, assign, pledge, grant a -------- participation interest in, encumber, or otherwise dispose of any Shares to any other Person whether directly, indirectly, voluntarily, involuntarily, by operation of law, pursuant to judicial process (including, without limitation, divorce decree) or otherwise. 1.1.40. "Underlying Shares" shall mean the (i) Shares issuable upon ----------------- exercise of any Option or Warrant, (ii) without duplication, any Shares issued upon the conversion of such Shares referred to in clause (i) above and (iii) any Shares issued or issuable with respect to the securities referred to in clauses (i) or (ii) above by way of stock dividend or stock split or in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization. For purposes of this Agreement, any Person who holds Options or -6- Warrants shall be deemed to be the holder of the Underlying Shares obtainable upon exercise of the Options or Warrants in connection with the transfer thereof or otherwise regardless of any restriction or limitation on the exercise of the Options or Warrants; provided, however, that such Underlying Shares shall not be deemed to be outstanding for purposes of this Agreement until they are actually issued. As to any particular Underlying Shares, such shares shall cease to be Underlying Shares when they have been (a) registered under the Securities Act and disposed of in accordance with the registration statement covering them or (b) distributed to the public through a broker, dealer or market maker pursuant to Rule 144 under the Securities Act or any similar provision then in force as the requirements of which may be modified by Rule 701 ("Rule 144"), in each case in compliance with any applicable provisions of this Agreement. 1.1.41. "Warrants" shall mean any warrants to subscribe for, purchase or -------- otherwise acquire Shares, including, without limitation, any and all warrants issued pursuant to the Purchase Agreement." 2. Section 1.3 is amended to replace the term " Registrable Bain Investor Securities" with "Registrable Investor Securities" wherever it appears. 3. Section 2 is amended and restated in its entirety as follows: "TERMINATION OF PRIOR STOCKHOLDERS AGREEMENT AND REGISTRATION RIGHTS AGREEMENT AND AGREEMENT OF FUTURE STOCKHOLDERS. 2.1. Termination of Prior Agreements. By the execution and ------------------------------- delivery hereof by certain parties hereto, the Stockholders Voting Agreement dated June 30, 1995 among the Company, Jerilyn Asher, Nancy Kelley and The Investor (as defined therein), the Registration Rights Agreement dated as of June 30, 1995 among the Company and the Purchasers named therein and any agreement pursuant to which any Stockholder hereto is a party which provides for the right to register any securities of the Company under the Securities Act and related rights are terminated and superseded by this Agreement. 2.2. Future Stockholders. The Company agrees not to issue ------------------- any shares of capital stock (or any securities convertible, exchangeable or exercisable into shares of capital stock) to any person that is not a party to this Agreement, unless such Person agrees to be subject to the provisions of this Agreement and shall be bound by and subject to the terms hereof, unless the Board, including a majority of -7- the Class B and Class C Directors, approves the exclusion of such Person from being a party hereto." 4. Section 3.1 is amended to add the following at the end of the first paragraph: "Each holder of Class C Common hereby agrees to cast all votes to which such holder is entitled in respect of Class C Common now or hereinafter owned by such holder, whether at any annual or special meeting of stockholders, by written consent or otherwise to (i) elect as a Class C Director of the Company any one individual who is designated to serve on the Board by the Capital Investors and (ii) in the event that and from and after such time as the Goldman Investors have purchased all of the Class C Common allocated to the Goldman Investors as set forth in Exhibit A-2 to the Amended and Restated Class B and Class C Common Stock and Warrant Purchase Agreement dated the date hereof,elect as a Class C Director of the Company any one individual who is designated to serve on the Board by the Goldman Investors. Unless and until the Goldman Investors have purchased the shares contemplated in (ii) above, the additional Class C Director shall remain unfilled and there shall be a vacancy in the Board. 5. Sections 3.1, 3.5, 4, 5.4, 6, 7, (other than the last sentence under Section 7.1.1(b)), and 9 are amended to replace the term "Bain Investors" with "Investors" wherever it appears. 6. Sections 7, 8, 9 and 10 are amended to replace the term "Bain Investor Shares" with "Investor Shares" wherever it appears. 7. Section 3.4 is amended by deleting the first sentence thereof and replacing it with the following: "The Company agrees to permit the Bain Investors to have two representatives, the Capital Investor to have two representatives and the Goldman Investor to have two representatives attend meetings of the Board of Directors of the Company." 8. Section 3.5 is amended (i) to replace the term "Bain Investor Initial Shares" with "Investor Initial Shares" and (ii) to replace "30%" with "15% subject to adjustment for stock splits, reclassifications, and other similar transactions." 9. Section 6 is amended (i) to replace the term "Proposed Bain Investor Seller" with "Proposed Investor Seller" wherever it appears and (ii) replace the term "Bain Investor Majority Holders" with "Investor Majority Holders" wherever it appears. 10. Section 6.3 is amended and restated as follows: -8- "Further Assurances. Each Participating Seller shall, whether in his ------------------ capacity as a Participating Seller, stockholder, officer or director of the Company, or otherwise, take or cause to be taken all such actions as may be reasonably requested in order expeditiously to consummate each Sale pursuant to Section 6.1. Each such Participating Seller agrees (i) to vote all Shares with respect to which he holds power to vote in favor of any proposal to stockholders in connection with the Sale which is approved by the holders of a majority of the outstanding Shares entitled to vote with respect to such matter and (ii) to execute and deliver such agreements as may be necessary for the Participating Seller to be subject to the same terms and conditions with respect to the Sale as apply to the Proposed Investor Seller, including without limitation, an agreement by such Participating Seller to be subject to such purchase price escrow or adjustment provisions as may apply to Stockholders generally and to be liable in respect of any individual representations, warranties, agreements and indemnities to be given by selling Stockholders in the Sale." 11. Section 7 is amended to add in the first sentence after "Shares", in each case, the term "or Warrants." 12. Section 8 is amended to replace the term "Initial Bain Investor" with "Investor" wherever it appears. 13. Section 9 is amended (i) to replace the term "Registrable Bain Investor Securities" with "Registrable Investor Securities" wherever it appears and to delete Section 9.1.3 in its entirety. 14. Section 9.1.1 is amended by deleting clause (ii) to the proviso and inserting in lieu thereof: "(ii) the number of Shares offered for the account of the Investors pursuant to Section 9.2.1 shall only be reduced in accordance with the terms of Section 9.2.1." 15. Section 9.2.1 is amended to delete the term "twenty-five percent (25%)" and replace it with "fifteen percent (15%)." 16. Section 9.2.1 is amended to add the following sentences to the end of the first paragraph: "Whenever the Company proposes to register any shares of its Common Stock pursuant to a request for registration under this Section 9.2, the Company shall furnish each Investor prompt written notice of its intent to do so. Upon the request of any Investor given by notice to the Company within twenty (20) days after the effectiveness of such -9- notice from the Company, the Company will use its reasonable best efforts to cause to be included in such registration all of the Shares which such Investor requests to be included therein. Neither the Company nor any Person other than an Investor shall be permitted to register any Shares in connection with a registration requested pursuant to this Section 9.2 unless all Shares which have been requested by the Investors to be included in the registration statement have been so included. If the Investors are advised in writing in good faith by any managing underwriter of the securities being offered pursuant to a Public Offering under this Section 9.2 that the number of Shares so offered by the Investors and the Initiating Holders is greater than the number of such shares which can be included in such Public Offering, the number of shares offered by the Investors and the Initiating Holders may be reduced pro rata (based upon the number of Shares offered for the accounts of such Investor) to a number of Shares deemed satisfactory by such managing underwriter; provided, -------- however, that in the event that the number of Shares offered for the ------- account of an Investor are reduced more than 20%, such registration shall not be included in the calculation of registration under Section 9.2.4. 17. Section 9.3 is amended by replacing "30 " with "60". 18. Section 9.3 is amended by adding the following paragraph immediately following paragraph (h): "(i) The Company shall pay all expenses of the holders of Shares participating in any Public Offering pursuant to Section 9.1 or 9.2 (including the fees and expenses payable to a Qualified Independent Underwriter (as such term is defined in Conduct Rule 2720 of the National Association of Securities Dealers, Inc.'s By-laws) other than underwriting discounts and commissions, if any, applicable transfer taxes, if any, and fees and charges of attorneys or other advisors retained by the holders of Shares to advise it in connection with such Public Offering; provided, that the Company shall be required to pay the expenses of one counsel to the Investors for each Class of Common Stock retained by any such holders in connection with the Public Offering." 19. Section 9.5 is amended as follows: (i) by deleting "the Bain Investors" and inserting, following "selected by" and prior to "an," the following phrase: "holders of a majority of the Investor Shares participating in the public offering." -10- 20. Section 9.6 is amended to add: (i) immediately following "Each " in the first sentence, "of the Company and" and (ii) immediately after "Transfer," "or issue, as the case may be." 21. Section 12.2 is amended to replace the term "Non-Bain Investor Stockholders" with "Non-Investor Stockholders" wherever it appears and to replace the term "Non-Bain Investor Majority Holders" with "Non-Investor Majority Holders" wherever it appears. 22. Section 12.2 is amended: by adding the following at the end of the first sentence: "; provided, further, however, that no such amendment, -------- ------- modification, extension, termination or waiver which affects the rights of the Investors will be effective unless and until the consent of the Investor Majority Holders have been obtained." 23. Section 14.2 is amended to add the following: If to the Capital Investors, to them at: ABS Capital Partners II, L.P. 1 South Street Baltimore, MD 21202 Attn: Timothy T. Weglicki If to the Goldman Investors, to them at: GS Capital Partners II, L.P. 85 Broad Street New York, New York 10004 Attn: Joseph Gleberman IN WITNESS WHEREOF, each of the undersigned has duly executed this Amendment (or caused this Amendment to be executed on its behalf by its officer or representative thereunto duly authorized) under seal as of the date first above written. Physicians Quality Care, Inc. By /s/ ---------------------------- Title: -11- Bain Capital Fund V, L.P. By Bain Capital Partners V, L.P., a Delaware limited partnership, its general partner By Bain Capital Investors V, Inc., its general partner By /s/ ---------------------------- Title: Managing Director Bain Capital Fund V-B, L.P. By Bain Capital Partners V, L.P., a Delaware limited partnership, its general partner By Bain Capital Investors V, Inc., its general partner By /s/ ------------------------------ Title: Managing Director BCIP Associates By /s/ ------------------------------ Title: a general partner BCIP Trust Associates, L.P. By /s/ ------------------------------ Title: a general partner -12- ABS Capital Partners II, L.P. By ABS Partners II, L.L.C., its General Partner By /s/ ------------------------------ Title: Managing Director: /s/ Russell Ray --------------------------------- Russell Ray 115 Longwood Road Baltimore, MD 21210 /s/ Steve Schuh --------------------------------- Steve Schuh 729 Skywater Road Gibson Island, MD 21056 /s/ Stanley Blaylock --------------------------------- Stanley Blaylock 1505 Heather Hill Lane Hunt Valley, MD 21030 /s/ Dick Franyo --------------------------------- Dick Franyo 925 Drohomer Place Baltimore, MD 21210 /s/ Christopher Camut --------------------------------- Christopher Camut 4405 Bedford Place Baltimore, MD 21218 -13- /s/ Terry Hyman --------------------------------- Terry Hyman 3131 O Street, N.W. Washington, D.C. 20007 /s/ Brent Milner --------------------------------- Brent Milner 5505 St. Alban's Way Baltimore, MD 21212 /s/ Kathy Coffey --------------------------------- Kathy Coffey 1800 Broadway, #301 San Francisco, CA 94109 /s/ Mark Klausner --------------------------------- Mark Klausner 7105 Charles Spring Way Towson, MD 21204 --------------------------------- Michael Singer 3048 Jackson Street San Francisco, CA 94111 /s/ Stuart Smith --------------------------------- Stuart Smith 7834 Ellenham Road Ruxton, MD 21204 --------------------------------- Gary Lessing 10 Queensdale Place London, England W11 4SQ -14- GS CAPITAL PARTNERS II, L.P. By: GS Advisors, L.P. Its General Partner By: GS Advisors Inc. Its General Partner By: /s/ ----------------------------- Title: GOLDMAN, SACHS & CO. VERWALTUNGS GMBH By: /s/ ----------------------------- Managing Director By: /s/ ----------------------------- Managing Director or Registered Agent GS CAPITAL PARTNERS II OFFSHORE, L.P. By: GS Advisors II (Cayman), L.P. Its General Partner By: GS Advisors II, Inc. Its General Partner By: /s/ ----------------------------- Title: -15- THE GOLDMAN SACHS GROUP, L.P. By: The Goldman Sachs Corporation Its General Partner By: /s/ ----------------------------- Title: Executive Vice President -16- _________________________________ Jerilyn P. Asher, individually _________________________________ Arlan Fuller, Jr. M.D., individually _________________________________ Thomas M. Zizic, M.D. individually _________________________________ , individually _________________________________ , individually _________________________________ , individually -17- EX-10.16 4 SERVICES AGREEMENT Exhibit 10.16 ------------- SERVICES AGREEMENT Services Agreement (the "Agreement") dated August 30, 1996, between Physicians Quality Care, Inc., a Delaware corporation ("PQC"), with its principal offices located at 950 Winter Street, Waltham, Massachusetts and Medical Care Partners, P.C., a Massachusetts professional corporation ("MCP"), with its principal offices located at 950 Winter Street, Waltham, Massachusetts. Whereas MCP engages in the provision of medical and surgical services through its physicians and has agreed to provide certain services to such physicians in connection with its employment of physicians pursuant to MCP's General Terms and Conditions of Physician Employment in effect as of the date hereof (the "Terms and Conditions"); and Whereas, MCP wishes to retain PQC to provide certain of such services on MCP's behalf and PQC wishes to provide such services; Now, therefore, MCP and PQC hereby agree as hereinafter provided. 1. Terms defined in the Terms and Conditions and not otherwise defined herein shall be used herein with the meanings so defined. 2. MCP hereby appoints and engages PQC to provide the services contemplated by Article II of the General Terms and Conditions of Member Physician Employment and PQC accepts such appointment and engagement on and subject to the terms and conditions set forth in this Agreement. 3. In consideration for the services to be provided by PQC pursuant to Section 2, MCP hereby assigns to PQC all amounts allocated to MCP, including without limitation Stage One Gross Margins, Stage Two Gross Margins, Stage Three Gross Margins and IHS Profits, pursuant to Article VII of the Terms and Conditions. 4. PQC shall review the payables of MCP and shall cause payment thereof to be made out of the funds of MCP. All Operating Revenues and IHS Revenues shall be deposited in a bank account maintained in the name of and owned by MCP with a banking institution selected by PQC and approved by MCP, (the "Account") but managed solely by PQC in accordance with the terms of this Agreement. A representative of PQC shall be the authorized signatory for the Account. The Shareholder of MCP shall also be, and MCP hereby appoints the Shareholder as, an authorized signatory for the Account. MCP covenants that it will not permit any funds to be withdrawn from the Account except as authorized by PQC. In addition to billing, collecting and payment services, PQC shall manage the cash and cash equivalents of MCP. 5. MCP hereby exclusively authorizes PQC to take the following actions for and on behalf of and in the name of MCP throughout the term of this Agreement and thereafter in accordance with Section 7: (a) bill, in MCP's name, under its provider number when obtained and on its behalf, and until such time as MCP has obtained its provider number, bill, in the Physicians= names under their respective provider numbers and on their behalf, all claims (including co-payments due from patients) for reimbursement or indemnification from all other Managed Care Payors, fiscal intermediaries or patients for all covered items and services provided by MCP or by the Physicians to patients; (b) take possession of and endorse in the name of the Physicians or MCP, all cash, notes, checks, money orders, insurance payments, and any other instruments received as payment of accounts receivable (and MCP will cause an individual Physician who receives any payments for the benefit of MCP directly, to deliver such amounts promptly to PQC for deposit in the Account, and MCP covenants to transfer and deliver promptly to PQC for deposit in the Account, all funds received by MCP from patients or Managed Care Payors for medical services), all such funds to be deposited directly into the Account and to be applied in a manner consistent with this Agreement; (c) deposit all collections directly into the Account and to make withdrawals from the Account for such purposes as are consistent with this Agreement; (d) in MCP's name and on its behalf, and in the Physicians' names and on behalf of each of them, as necessary, collect and receive all accounts receivable generated by such billings and claims for reimbursement, place such accounts for collection, settle and compromise claims and institute legal action for the recovery of accounts; MCP shall cooperate fully with PQC in facilitating such collections and in collecting accounts receivable transferred to PQC for deposit in the Account by MCP, including endorsement of checks and delivery to PQC for deposit in the Account of all revenues in whatever form, received from patients or Managed Care Payors on their behalf, and completion of all forms necessary for the collection of said monies; and (e) sign checks on behalf of MCP and make withdrawals from the Accounts for payments specified in this Agreement and as requested from time to time by MCP for purposes not inconsistent with this Agreement. In addition to the foregoing, MCP, to the extent not prohibited by law, hereby grants to PQC an exclusive power of attorney and appoints PQC its exclusive true and lawful attorney in fact to take each of the actions specified in Sections (a) through (e) above for and on behalf of and in the name of MCP -2- throughout the term of this Agreement and thereafter in accordance with Section 7. Upon request of PQC, MCP shall, and shall cause each of the Physicians to, execute and deliver to PQC and to each financial institution wherein MCP or PQC maintains an account, such additional documents or instruments (including one or more powers of attorney naming PQC as its or their, as the case may be, exclusive true and lawful attorney in fact) as may be necessary or desirable to evidence or effect the authority or the power of attorney or both granted to PQC pursuant to this Section. 6. This Agreement shall continue in effect for forty (40) years commencing with the date of this Agreement as noted above. Unless terminated earlier as provided for in section 7 of this Agreement, the term of this Agreement shall be automatically extended for additional terms of five (5) years each. 7. Termination. (a) Termination on Default. i. Either party shall be entitled to terminate this Agreement if the other party fails to perform in any material respect any material obligation required of it hereunder, and such default continues for sixty (60) days after the giving of written notice by the non-defaulting party, specifying the nature and extent of such default; provided, however, that ----------------- the non-defaulting party shall not be entitled to terminate this Agreement if the defaulting party commences the cure of such default within the first sixty (60) day period and thereafter diligently and in good faith continues to cure such default until completion. ii. Termination at election of PQC. PQC shall be entitled to terminate this Agreement upon written notice to MCP if: (x) a law firm with nationally recognized expertise in healthcare law and acceptable to PQC and the Joint Policy Board renders an opinion to PQC, with a copy provided to the Joint Policy Board stating that a material provision of this Agreement is in violation of applicable law, and the parties do not agree to amend this Agreement pursuant to Section 10 to cure such violation; or -3- (y) any court or regulatory agency enters an order finding a material provision of this Agreement is in violation of applicable laws; or (z) PQC is prevented by MCP or any person under the MCP's direction or control, from entering any of the Physician Responsibility Centers, and such inability to enter such premises continues for more than forty-eight (48) hours after notice thereof to the Joint Policy Board. iii. Termination by MCP. MCP may terminate this Agreement if and only if such termination has been approved by the Joint Policy Board and: (x) upon written notice to PQC of the failure of PQC to make any payments required under this Agreement when due and continued failure to pay such compensation after thirty (30) days notice of such failure to PQC unless the amount of such payment is being contested in good faith; or (y) a law firm with a nationally recognized expertise in health care law and acceptable to PQC and the Joint Policy Board renders an opinion to MCP, with a copy provided to the Joint Policy Board, stating that a material provision of this Agreement is in violation of applicable law, and the parties do not agree to amend this Agreement pursuant to Section 10 hereof to cure such violation; or (z) any court or regulatory agency enters an order finding a material provision of this Agreement is in violation of applicable laws. (b) Effect of Termination. Upon termination of this Agreement --------------------- pursuant to this Section 7: i. PQC and MCP shall cooperate and continue to perform their obligations under this Agreement as may be necessary to ensure the provision of proper care to patients under treatment until appropriate alternative arrangements are made. ii. MCP and PQC shall cooperate to ensure the appropriate billing and collection for all health care items and services provided by MCP prior to the effective date of -4- termination, and any such monies collected shall be retained by MCP and/or paid to PQC in accordance with the terms of this Agreement. iii. Any amounts due and owing to PQC under any loan to MCP shall become immediately due and payable. iv. MCP shall reimburse PQC for all drug and pharmaceutical inventory retained by MCP following termination to the full extent of funds advanced by PQC for the purchase of such inventory. v. Provisions of this Agreement shall survive any termination if so provided herein or if necessary or desirable fully to accomplish the purposes of such provision. 8. All notices required or permitted under this Agreement shall be in writing and shall be deemed effective upon personal delivery or upon deposit in the United States Post Office, by registered or certified mail, postage prepaid, addressed to the other party at the address shown above, or at such other address or addresses as either party shall designate to the other in accordance with this Section 8. 9. This Agreement constitutes the entire agreement between the parties and supersedes all prior agreements and understandings, whether written or oral, relating to the subject matter of this Agreement. 10. This Agreement may be amended or modified only by a written instrument executed by PQC and MCP, provided, however, in the event (a) any state or ----------------- federal laws or regulations, now existing or enacted or promulgated after the Effective Date are interpreted by judicial decision, a regulatory agency, or legal counsel in such a manner as to indicate that this Agreement or any provision hereof may be in violation of such laws or regulations, or (b) the Financial Accounting Standards Board or other applicable accounting standard setting entity promulgates standards that would prevent PQC from consolidating for financial statement presentation purposes all revenues of MCP on PQC's consolidated financial statements, then PQC shall propose to the Joint Policy Board and the MCP Shareholder for their approval such amendments to this Agreement as necessary to preserve the underlying economic and financial arrangements between PQC and MCP and without substantial economic detriment to either PQC or MCP. Any such amendment approved by the Joint Policy Board and MCP Shareholder shall be binding upon MCP, and MCP hereby consents to any such amendment. To the extent any act or service required of PQC should be construed or deemed, by any governmental authority, agency or court, to constitute the practice of medicine by PQC, the performance of said act or service by PQC shall be deemed waived and forever unenforceable and the provisions of this Section 10 shall be applicable. MCP hereby waives and agrees not to assert illegality as a -5- defense to the enforcement of this Agreement or any provision hereof; instead, any such purported illegality shall be resolved pursuant to the terms of this Section 10. 11. This Agreement shall be construed, interpreted and enforced in accordance with the laws of The Commonwealth of Massachusetts. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year set forth above. PHYSICIANS QUALITY CARE, INC. By: /s/ Jerilyn P. Asher ---------------------------------------------- MEDICAL CARE PARTNERS, P.C. By: /s/ Jay Ungar M.D. ---------------------------------------------- -6- EX-10.22 5 AMENDED AND RESTATED SERVICES AGREEMENT Exhibit 10.22 ------------- AMENDED AND RESTATED SERVICES AGREEMENT AMONG FLAGSHIP HEALTH, P.A., FLAGSHIP HEALTH II, P.A. and PHYSICIANS QUALITY CARE, INC. TABLE OF CONTENTS ----------------- Page ---- 1. APPOINTMENT OF PQC; RETENTION OF CLINICAL AUTHORITY..................... 1 1.1 Appointment and Authority.......................................... 1 1.2 Retention of Authority............................................. 2 2. OBLIGATIONS OF MEDICAL GROUP............................................ 2 2.1 Physician Personnel................................................ 2 2.2 Credentialing of Medical Group Physicians.......................... 2 2.3 Employment and Engagement of Medical Group Physicians.............. 2 (a) General........................................................ 2 (b) Pods........................................................... 3 (c) Form of Agreements............................................. 3 (d) Medical Group Physician Qualifications......................... 3 2.4 Licensing and Accreditation........................................ 3 2.5 Supervision and Direction of Clinical Staff........................ 4 2.6 Liability Insurance................................................ 4 2.7 Medical Records.................................................... 4 2.8 Assignment of Intellectual Property................................ 5 3. OBLIGATIONS OF PQC...................................................... 5 3.1 General............................................................ 5 3.2 Facilities......................................................... 5 3.3 Equipment and Office Furnishings................................... 6 3.4 Personnel and Payroll.............................................. 6 3.5 Borrowings......................................................... 6 3.6 Supplies and Inventory............................................. 7 3.7 Contracts.......................................................... 7 3.8 Budgets............................................................ 8 (a) General Preparation Principles................................ 8 (b) Approval of Budgets........................................... 8 (c) Reporting..................................................... 10 3.9 Preparation of Tax Returns......................................... 10 3.10 Charges............................................................ 10 3.11 Billing and Collection............................................. 10 3.12 Payment of Accounts and Indebtedness............................... 10 3.13 Power of Attorney for Billing and Payment of Accounts.............. 11 3.14 Other Billings and Charges......................................... 12 3.15 Insurance.......................................................... 12 3.16 Other Administrative Services...................................... 13 3.17 Development of Integrated Health Services.......................... 13 3.18 Advertising and Public Relations................................... 14 4. MANAGEMENT FEE; FINANCIAL ARRANGEMENTS.................................. 14 -i- 5. TERM AND TERMINATION.................................................... 14 5.1 Term............................................................... 14 5.2 Termination on Default............................................. 14 5.3 Effect of Termination.............................................. 15 6. JOINT POLICY BOARD; CERTAIN PROVISIONS REGARDING GOVERNANCE OF MEDICAL GROUP........................................................... 16 6.1 Joint Policy Board............................ . .................. 16 (a) Representation................................................. 16 (b) Authority and Responsibility................................... 17 (c)................................................................ 18 (d)................................................................ 19 (e)................................................................ 19 (f) Voting; Procedures............................................. 20 6.2 Medical Advisory Board........................ .................... 21 6.3 The President of Medical Group................ .................... 21 6.4 The Medical Director of Medical Group......... ................... 23 6.5 Operating Manager.................................................. 24 7. INTELLECTUAL PROPERTY................................................... 24 8. RESTRICTIVE COVENANTS................................................... 24 8.1 Noncompetition..................................................... 24 8.2 Ancillary Enterprise............................................... 25 8.3 Non-solicitation of Employees and Patients......................... 25 8.4 Enforcement of Medical Group Physician Employment Agreements......................................................... 25 8.5 Remedies........................................................... 25 9. MISCELLANEOUS........................................................... 26 9.1 Exclusivity........................................................ 26 9.2 Names; Trademarks.................................................. 26 9.3 Independent Contractors............................................ 26 9.4 [Reserved]......................................................... 26 9.5 Severability....................................................... 26 9.6 Waiver............................................................. 26 9.7 Notices............................................................ 27 9.8 Entire Agreement................................................... 27 9.9 Amendment.......................................................... 27 9.10 Successors and Assigns............................................. 27 9.11 Governing Law...................................................... 27 9.12 Headings........................................................... 27 9.13 No Obligation to Third Parties..................................... 27 9.14 Contract Modifications for Prospective Legal Events................ 28 9.15 Availability of Certain Documents.................................. 28 9.16 Gender............................................................. 29 -ii- APPENDIX A............................................................... 1 - ---------- APPENDIX B............................................................... 1 - ---------- SCHEDULE B-1............................................................. 8 - ------------ APPENDIX C............................................................... 1 - ---------- APPENDIX D............................................................... 1 - ---------- EXHIBIT A................................................................ 1 - --------- -iii- FLAGSHIP HEALTH, P.A. FLAGSHIP HEALTH II, P.A. SERVICES AGREEMENT This Agreement (this "Agreement") is made as of November 30, 1996, and amended and restated as of July 31, 1997, by and among Physicians Quality Care, Inc., a Delaware corporation ("PQC"), Flagship Health II, P.A., a Maryland Professional corporation ("Flagship II") and Flagship Health, P.A., a Maryland professional association ("Flagship I" and collectively with Flagship II, "Medical Group"). (All capitalized terms not defined below in this Agreement shall have the meanings set forth in Appendix A or B attached hereto.) WHEREAS, Medical Group has entered into a business arrangement with PQC in order to help effectuate the parties' mutual vision of establishing a high quality, competitive, cost-effective health care delivery system, as part of which Medical Group and PQC will work together to enhance the efficiency of the business aspects of Medical Group's practice, to promote the quality of care and patient satisfaction, and to create sufficient economies of scale to permit Medical Group to undertake risk-based managed care obligations; WHEREAS, Medical Group engages in the provision of medical and surgical services through its physicians (each a "Medical Group Physician" and collectively the "Medical Group Physicians"), who currently practice in a number of divisions (each a "Pod"), each of which may have one (1) or more Practice Locations; and WHEREAS, Medical Group wishes to retain PQC to provide or arrange for comprehensive management, administrative and other support services to manage Medical Group and each Pod in order better to serve its patients, enhance efficiency, and improve financial results of operation of the Medical Group's activities. NOW, THEREFORE, in consideration of the mutual covenants and premises herein contained, the parties hereby agree as follows: 1. APPOINTMENT OF PQC; RETENTION OF CLINICAL AUTHORITY 1.1 Appointment and Authority. Medical Group hereby appoints and ------------------------- engages PQC as Medical Group's sole and exclusive business manager and PQC accepts such appointment and engagement on and subject to the terms and conditions set forth in this Agreement. Subject to the terms of this Agreement, including applicable requirements of consultation and prior approval of the Joint Policy Board, PQC shall have the authority and responsibility to: (i) manage all business operations of Medical Group in an efficient and cost- effective manner; (ii) provide or arrange for such services in any manner as PQC, in the exercise of its reasonable business judgment, deems appropriate to meet the day-to-day requirements of the business functions of Medical Group; and (iii) negotiate and execute, on behalf of Medical Group, all contracts that, in the exercise of PQC's reasonable business judgment, are necessary and appropriate for the business and affairs of Medical Group, subject, in the case of Payor Contracts, to the approval of the Joint Policy Board. -1- 1.2 Retention of Authority. Notwithstanding anything to the contrary in ---------------------- this Agreement, Medical Group will have exclusive authority and control over the provision of medical services, including all diagnoses, treatment and ethical determinations with respect to patients. All diagnoses, treatments, procedures and other medical and professional services shall be provided and performed exclusively by or under the supervision of a physician employed or otherwise engaged by Medical Group who meets the qualifications set forth in this Agreement. It is acknowledged that PQC is not authorized nor qualified to engage in any activity that constitutes the practice of medicine. To the extent, if any, that any act or service of PQC under this Agreement is determined to constitute the practice of medicine, the performance of such act or service by PQC shall be deemed waived and excused by Medical Group. 2. OBLIGATIONS OF MEDICAL GROUP 2.1 Physician Personnel. Medical Group, subject to oversight by the ------------------- Medical Advisory Board, shall be solely responsible for all determinations with respect to an individual physician concerning the recruitment, hiring, termination, Credentialing, training and supervision of such physician. PQC shall not exercise any control over nor have any responsibility for Medical Group Physicians or other Clinical Staff (as defined in Section 2.5) with respect to the provision of clinical services. 2.2 Credentialing of Medical Group Physicians. Medical Group, through ----------------------------------------- the Medical Advisory Board, shall credential its physicians in conformity with the requirements imposed under state and federal law and by the terms of any third party payment agreement to which the Medical Group is bound. Medical Group shall assure that each Medical Group Physician at all times is: (i) duly licensed to practice medicine by the applicable state within the Geographic Area (as defined in Section 10.10 of Appendix A); and (ii) a member in good standing of the medical staffs of hospitals designated from time to time by the Joint Policy Board or as may be necessary in connection with the participation in one (1) or more Payor Contracts negotiated on Medical Group's behalf by PQC. No physician other than those Medical Group Physicians who meet the requirements and qualifications of this Agreement, including without limitation Section 2.3, shall be permitted: (a) to use or occupy the Pod Practice Locations, except as approved by the Joint Policy Board; or (b) except as may be required to assure appropriate medical care (e.g., locum tenens coverage), to render services to patients of Medical Group. New physicians may be employed by Medical Group, or physician groups or practices may be acquired by Medical Group, subject to approval of the Joint Policy Board and the Medical Advisory Board. 2.3 Employment and Engagement of Medical Group Physicians. ----------------------------------------------------- (a) General. During the term of this Agreement, Medical Group, ------- through its Pods, shall operate and maintain a full-time practice of medicine providing primary care, medical and surgical specialty services and such other services as are agreed upon by the Joint Policy Board and PQC. Medical Group shall engage a sufficient number of Medical Group Physicians to provide services to patients of Medical Group during the normal office hours of the Practice Locations and to provide after hours coverage for -2- all patients of Medical Group whether on an inpatient or outpatient basis (it being agreed that the practice patterns in effect as of the Effective Date are acceptable to PQC and Medical Group); provided, however, that a Pod may close its practice to new patients for such period as the Joint Policy Board and Medical Advisory Board may determine to be necessary in the event the Pod has reached capacity. (b) Pods. Each Medical Group Physician hired or otherwise engaged ---- by Medical Group shall be a member of a Pod and shall provide services at the Practice Locations associated with that Pod. (c) Form of Agreements. Medical Group shall maintain employment ------------------ agreements with all Medical Group Physicians (individually, an "Employment Agreement"). Such Employment Agreements shall be in substantially the form attached hereto as Annex A-1 with respect to Medical Group Physicians who are assigned to a Pod that was created prior to July 31, 1997 (each a "Founding Pod"), and in substantially the form attached hereto as Annex A-2 with respect to Medical Group Physicians who are assigned to a Pod that is created on or after July 31, 1997 (each an "Additional Pod"), in each case with such changes as may be agreed upon by PQC and Medical Group and approved by the Joint Policy Board. Except as otherwise expressly provided in this Agreement, Medical Group shall not amend any Employment Agreements nor waive any rights thereunder without the prior written approval of PQC. Except as otherwise expressly provided in this Agreement, Medical Group shall not offer, agree to or amend any salary, benefit or other compensation terms with a Medical Group Physician except as expressly approved by PQC in writing. (d) Medical Group Physician Qualifications. Medical Group shall -------------------------------------- assure that each Medical Group Physician meets at all times each of the qualifications set forth in the approved form of Employment Agreement (subject to any exceptions that are approved by PQC and the Joint Policy Board in connection with individual Employment Agreements) and to any other qualifications reasonably established by the Medical Advisory Board and PQC. In the event that any disciplinary, malpractice or other actions are initiated against any Medical Group Physician, the Medical Group, through the Medical Advisory Board, shall immediately inform PQC of such action and shall inform PQC of the underlying facts and circumstances. 2.4 Licensing and Accreditation. Medical Group, through the Medical --------------------------- Advisory Board, shall ensure that all Medical Group Physicians maintain such licenses and certifications as are reasonably necessary for the provision of medical services by Medical Group and all Medical Group Physicians in a manner that complies with all laws and applicable third-party payor requirements. Medical Group shall obtain and maintain such additional licenses and -3- accreditation as the Medical Advisory Board and PQC mutually determine are advisable. Medical Group shall conduct its medical practice in compliance with all applicable laws and all applicable contractual requirements. 2.5 Supervision and Direction of Clinical Staff. (As used in this ------------------------------------------- Agreement, the term "Clinical Staff" shall mean nurses and any other non- physician clinical personnel and shall not include Medical Group Physicians or any other physician.) Medical Group Physicians shall supervise and direct the Clinical Staff. Medical Group shall assure that all Clinical Staff members perform only those duties permitted by applicable law and regulation to be performed by such personnel, and only under such supervision and in such a manner as permitted by applicable law and regulation. 2.6 Liability Insurance. Medical Group shall assure that each Medical ------------------- Group Physician maintains in effect a policy of professional liability insurance in accordance with the Medical Group Physician's employment agreement. Medical Group shall maintain in effect a policy of comprehensive general liability and professional liability insurance in the minimum amount of $1,000,000 per occurrence or claim and $3,000,000 annual aggregate, or such greater amount as is required by the Joint Policy Board or by law, to cover Medical Group, Medical Group Physicians and Clinical Staff. In addition, Medical Group shall maintain in effect (i) comprehensive general liability insurance with limits and a deductible reasonably determined by PQC and the Joint Policy Board and (ii) property damage insurance covering all Practice Locations and equipment with limits and deductibles reasonably determined by PQC and the Joint Policy Board. Each such policy shall name PQC as an additional insured. As set forth in Section 3.15, PQC shall be responsible for administering Medical Group's insurance policies required under this Section 2.6. 2.7 Medical Records. Medical Group, through its Pods, shall maintain --------------- and cause each Medical Group Physician to maintain accurate and complete patient records in accordance with all applicable laws and regulations. Such records shall be maintained by Medical Group in a manner sufficient to enable PQC, on behalf of Medical Group, to bill and collect for the services provided by Medical Group and Medical Group Physicians. Subject to the requirements of applicable law, Medical Group shall permit PQC to access the patient records to perform its duties under this Agreement, including, without limitation, billing and collection services. All patient medical records relating to services rendered by Medical Group and Medical Group Physicians shall be and remain the property of Medical Group. Medical Group hereby grants to PQC the exclusive right to develop and commercialize any statistical data base or other quality assurance, utilization review or medical management data base or software program derived from Medical Group's medical records (collectively, "Medical Data") and agrees to include in all patient consent forms a mutually agreeable provision permitting the commercialization of such Medical Data; provided, however, that PQC shall in all events delete or otherwise disguise any patient identifying information such as the name or street address of a patient and comply with all applicable laws concerning patient confidentiality. If PQC determines to commercialize any Medical Data derived solely from medical records of Medical Group, then PQC shall offer to Medical Group a right of first refusal to participate in the effort to commercialize such Medical Data on terms consistent with those set forth in Section 3.17 with respect to the development of Integrated Health -4- Services. If PQC determines to commercialize any Medical Data derived from both Medical Group and other PQC-managed physician practices, PQC shall offer to Medical Group and the other PQC-managed practices a right of first refusal to participate in the effort to commercialize such Medical Data. The terms of such commercialization between PQC, on one hand, and the Medical Group and the other PQC-managed practices (the "Physicians' Share"), on the other hand, shall be consistent with those set forth in Section 3.17 with respect to the development of Integrated Health Services. Prior to entering into any arrangement to commercialize such Medical Data with the Medical Group and other PQC-managed practices acting jointly, PQC shall solicit the advice of the Medical Advisory Board, which may make a recommendation to PQC's National Medical Advisory Board, concerning an allocation of Physicians' Share of revenue, expenses, profits and losses from such commercialization between Medical Group and any other medical group or entity also contributing data, software or other resources to the commercialization effort. Such allocation shall be made in a manner that is fair and not inconsistent with PQC's legitimate business objectives and its obligations to its shareholders. The recommendation, if any, of the National Medical Advisory Board shall be considered by PQC in reaching its determination concerning any commercialization of Medical Data and the allocation of proceeds thereof, but ultimate decision-making authority with respect to such commercialization and any recommended allocation of proceeds thereof shall remain exclusively within the discretion of the Board of Directors of PQC and Medical Group shall have no right to any allocation of proceeds except and to the extent, if any, authorized by the Board of Directors of PQC after consultation as set forth in this Section 2.7. 2.8 Assignment of Intellectual Property. Medical Group hereby assigns ----------------------------------- to PQC (i) any Intellectual Property rights that Medical Group acquires or develops during the term of this Agreement and (ii) agrees to cause each Medical Group Physician to assign to PQC such Intellectual Property rights as may be specified in, and subject to the terms of, the applicable employment agreement, as the case may be. 3. OBLIGATIONS OF PQC 3.1 General. Subject to Medical Group's control of the practice of ------- medicine, PQC shall have authority and responsibility to conduct, supervise and manage the day-to-day business operation of Medical Group and shall be responsible for providing the services set forth in this Section 3 to Medical Group. All services, facilities, furniture, fixtures and equipment provided by PQC under this Agreement shall be in a manner consistent with community standards for a medical practice of similar size. Notwithstanding anything in this Agreement to the contrary, the parties realize that development of appropriate reporting systems for financial and utilization information and similar tools designed to support the efficient management and development of Medical Group should be a collaborative process between the parties, and accordingly the parties agree to work together to develop such tools, particularly during the initial months following the Effective Date. 3.2 Facilities. PQC shall arrange for Medical Group to use the premises ---------- at the locations listed on Schedule 3.2 which may be amended by PQC from time to ------------ time (collectively, the "Practice Locations"), subject to the terms of any leases for the premises entered into from time to time by Medical Group or PQC, as the case may be, and subject to approval of the Joint Policy Board. PQC -5- shall provide or arrange for routine maintenance and cleaning services for the Practice Locations required to cause the Practice Locations to satisfy the standard set forth in Section 3.1. 3.3 Equipment and Office Furnishings. PQC shall arrange for Medical -------------------------------- Group to have use of such equipment and office furnishings reasonably deemed necessary by PQC, in consultation with the Joint Policy Board, for the operation of Medical Group at each Practice Location (the "Equipment") in a manner consistent with community standards for a medical practice of similar characteristics. PQC shall arrange for reasonable and necessary repair and maintenance of the Equipment. In connection with PQC's obligation hereunder, Medical Group shall notify PQC immediately upon becoming aware of any Equipment in need of repair. 3.4 Personnel and Payroll. PQC shall arrange for the provision to --------------------- Medical Group of all administrative personnel deemed necessary by PQC, in consultation with the Joint Policy Board, for the operation of Medical Group (the "Administrative Staff"). PQC shall also arrange for the provision to Medical Group of all Clinical Staff reasonably deemed necessary by PQC, in consultation with Medical Group and the Joint Policy Board, for the efficient, professional operation of Medical Group. All members of the Clinical Staff shall be employees of Medical Group. All members of the Administrative Staff on the Effective Date shall be employees of Medical Group. Subject to the provisions of Section 2.5 and this Section and in consultation with Medical Group and the Joint Policy Board, PQC shall be responsible for recruiting, hiring, discharging and determining the compensation, benefits and conditions of employment of the Administrative Staff and Clinical Staff. PQC shall perform all payroll and payroll accounting transactions for the Administrative Staff, the Clinical Staff and the Medical Group Physicians. Any member of the Administrative Staff and Clinical Staff may, upon assignment by PQC following consultation with the affected Pods, provide services to more than one (1) Pod. If any Medical Group Physician is dissatisfied with the services of any employee who provides services for such Medical Group Physician at a Practice Location, PQC, after consultation with the Joint Policy Board, shall in good faith determine whether the performance of that employee could be brought to acceptable levels through counsel and assistance, or whether the employment of such employee should be terminated. If PQC determines to retain such employee and the Medical Group Physician is still dissatisfied with such employee's services after a two (2) month period, PQC shall either relocate such employee or otherwise cease to use such employee unless PQC reasonably determines that such termination may expose Medical Group to liability. 3.5 Borrowings. ---------- (a) All borrowings of Medical Group shall be subject to prior approval by the Joint Policy Board. Upon receipt of such approval to borrow funds on behalf of Medical Group, PQC shall arrange for such borrowing on behalf of Medical Group on terms approved by the Joint Policy Board pursuant to Section 6. 1(b)(i) and in accordance with the Practice Expense definition set forth provisions in Section 10.27 of Appendix A. In addition to or in -6- lieu of the foregoing, and subject always to prior approval by the Joint Policy Board, PQC may make loans to Medical Group from time to time to fund capital expenditures or working capital of the Medical Group, in each case on such terms and conditions as are agreed upon by the parties and the Joint Policy Board. The making of any such loan shall be at the sole discretion of PQC provided that PQC shall commit to fund loans for working capital purposes of the Medical Group in an amount determined from time to time by the Joint Policy Board which amount shall not exceed $1,000,000. (b) In the event that during the Fiscal Periods ended December 31, 1997 and December 31, 1998, Medical Group does not receive distributions with respect to a Founding Pod under Appendix B hereto equal to the full Baseline Amount (as defined in Section 10.2 of Appendix A) (minus the amount necessary to pay all Deductible Expenses) due to (a) a failure by PQC to assist Medical Group in establishing additional revenue sources from services other than professional services so as to increase Practice Revenues, or (b) such other cause as may be approved by the Joint Policy Board, PQC shall loan to Medical Group with respect to the Founding Pods an amount not to exceed an aggregate of $1,000,000 at any one time outstanding on a non-interest bearing basis to cover such shortfalls in Baseline Amount, and in no event shall PQC Direct Expenses be included in determining whether a shortfall in Baseline Amount exists (the "Loan"). The Loan shall be carried on the balance sheet of Medical Group and shall be repaid in successive Fiscal Periods from the first available dollars of Net Margin allocable to Medical Group with respect to the Founding Pods. In the event PQC undertakes a public offering of securities at any time prior to which the Loan has been repaid in full, the parties agree to consider in good faith whether interest on the Loan should be assessed at a fair market interest rate in order to comply with then applicable health care laws. 3.6 Supplies and Inventory. PQC shall be responsible for all inventory ---------------------- systems of Medical Group at each Practice Location and for the ordering, purchasing and maintenance of all supplies and inventory necessary for the operation of Medical Group. All drugs shall be purchased and maintained by Medical Group or, at PQC's discretion and to the extent consistent with applicable law, on behalf of Medical Group by PQC. 3.7 Contracts. PQC shall negotiate and administer contracts for --------- equipment, materials, supplies and data processing services for the Medical Group and for each Pod. PQC shall seek, review, evaluate and negotiate Payor Contracts on behalf of Medical Group. Medical Group agrees to enter into and be bound by all such Payor Contracts negotiated on its behalf by PQC; provided, however, that any such Payor Contract must be approved in advance by the Joint Policy Board in the manner contemplated by Section 6.1. The Payor Contracts listed on Schedule 3.7 shall be deemed to be approved by the Joint Policy Board. -------- --- If required by applicable law, such contracts will be entered into in the name of Medical Group. PQC shall arrange for administrative support appropriate to fulfill reporting requirements under Payor Contracts, such as eligibility verification and financial and utilization reporting. -7- 3.8 Budgets. ------- (a) General Preparation Principles. ------------------------------ (i) PQC, acting through the Operating Manager in cooperation with a Physician representative (the "Representative") of the Pod, shall have responsibility for the preparation of budgets for each Pod (a "Pod Budget"). (ii) Each Pod Budget shall consist of an operating budget (revenues and expenses) and an annual capital expenditures budget, prepared on an accrual basis of accounting and in conformity with generally accepted accounting principles. (iii) PQC shall prepare, with input from the Joint Policy Board, budget guidelines ("Budget Guidelines") that PQC shall then follow in the preparation of each Pod Budget. Examples of possible Budget Guidelines include but are not limited to the following: (A) each Pod Budget shall be constructed on management policies that enable the Pod to achieve its financial goals (profit from operations); (B) each Pod Budget shall provide specific detail sufficient for the Pod Physicians and PQC to evaluate and prioritize changes in programs and capital expenditures; (C) each Pod Budget period shall be for a twelve (12) month period ending December 31 or, for the initial Pod Budget for each newly formed Pod, such shorter period ending December 31 as is appropriate; and (D) each Pod Budget shall be prepared on a pre-physician compensation, pre-management fee and pre-tax basis. (iv) PQC shall prepare the initial Pod Budgets for each Pod using available historical financial information. PQC shall follow the Budget Guidelines and identify budget preparation assumptions that deviate from the acquired medical group's historical financial information. Subsequent Pod Budgets shall be prepared in a similar manner by PQC (on the basis of the prior year's results) and take into account deviations from the Pod Budget that occurred in the prior year. (b) Approval of Budgets. The Joint Policy Board shall have the ------------------- responsibility for and authority to approve each Pod Budget. PQC shall submit each Pod Budget to the Joint Policy Board for approval on a timely basis. Once approved in accordance with this Section 3.8(b), all of PQC, Pod and Pod Physicians shall be -8- bound by the terms of the approved Pod Budget for the following twelve (12) month period or such lesser period as may be provided for in the Budget Guidelines, subject only to any modifications suggested by PQC and/or Pod Physicians and approved by the Joint Policy Board. At any point during a Fiscal Period, including for example if the actual Physician Pod Practice Revenues less actual Physician Pod Practice Expenses is below budgeted levels for such Physician Pod or if there is an actual or projected negative Net Margin the Joint Policy Board may review the budgets for such Physician Pod and make such changes to such budgets, including the aggregate Pod Distributions (as defined in Section 3 of Appendix A to the Employment Agreements), as the Joint Policy Board deems to be appropriate. All capital and operating budgets, and changes thereto, also shall be subject to the approval of PQC. The Joint Policy Board shall not unreasonably withhold its approval of a Pod Budget but if such approval is not forthcoming, the following process shall prevail so that the Pod may remain open to treat patients: (i) If, prior to the commencement of any budget period, the Joint Policy Board has not yet approved the Pod Budget, then PQC and Medical Group will work diligently in good faith to obtain such approval. Until such approval is obtained, the following procedures shall apply: (A) as to any disputed line items, the immediately preceding budget period's Pod Budget shall be controlling until such time, if any, as agreement is reached on the amounts to be allocated to such disputed line items, except that: (1) non-recurring extraordinary items shall not be continued from the Pod Budget for the immediately preceding budget period; (2) if items such as lease payments or payroll taxes are subject to an automatic increase, such increases shall be effective at the increased rate; and (3) for items such as personnel salaries, the total salary number shall be adjusted to take into account changes in the number and classifications of personnel members employed or contracted; and (B) as to any line items which are not in dispute, the new Pod Budget submitted by PQC shall be effective for the new budget period. -9- (c) Reporting. PQC shall establish and administer the accounting --------- procedures and control for Medical Group and the Pods in accordance with generally accepted accounting principles. PQC shall have the responsibility to prepare and submit to each Pod and to the Joint Policy Board as soon as practicable after the end of each month, but in any event within forty-five (45) days of the end of each month, management reports designed to convey Pod and Medical Group financial performance for the month and on a year-to-year basis. PQC shall design the management reports to highlight actual financial performance and actual to budget variances in the Pod's financial performance. Additionally, PQC shall from time to time attempt to identify, discuss with the Joint Policy Board and implement appropriate management intervention to counter adverse financial trends. 3.9 Preparation of Tax Returns. PQC shall prepare any and all required -------------------------- tax returns of Medical Group but shall not have responsibility for preparation of individual tax returns or other tax returns (e.g., IRS forms W-2s, 5500s, etc.) for any Medical Group Physician or for any entity of which such Medical Group Physician was a shareholder, partner, member, or employee prior to the date of execution of this Agreement. 3.10 Charges. PQC shall advise Medical Group on the establishment, ------- maintenance and revision of a schedule of charges for physician services, ancillary services, supplies, medication and all other services rendered by Medical Group through each Pod. Revisions to the fee schedule of a Pod must be approved by the Joint Policy Board. 3.11 Billing and Collection. PQC shall provide or arrange for such ---------------------- billing and collection services as are reasonably necessary to attempt to collect in a timely manner all Practice Revenues, including without limitation all allowable charges resulting from Medical Group's provision of all billable items and services. 3.12 Payment of Accounts and Indebtedness. ------------------------------------ (a) PQC shall review the payables of Medical Group and shall cause payment of any undisputed amounts thereof to be made out of the funds of Medical Group. In addition to billing, collecting and payment services, PQC shall manage the cash and cash equivalents of Medical Group. (b) All Practice Revenues shall be deposited in one or more bank accounts maintained in the name of and owned by Medical Group (collectively, the "Medical Group Account") but managed solely by PQC in accordance with the terms of this Agreement and the applicable Pod's budgets. A separate Medical Group Account shall -10- be established for the Founding Pods (the "Founding Pod Medical Group Account") and the Additional Pods (the "Additional Pod Medical Group Account"). The bank in which the Medical Group Account is maintained shall be federally insured and shall be selected by PQC subject to approval by the Joint Policy Board. A representative of PQC shall be the authorized signatory for the Medical Group Account. Medical Group hereby appoints the Medical Group Shareholder as an additional authorized signatory for the Medical Group Account. Medical Group covenants that it will not permit any funds to be withdrawn from the Medical Group Account except as authorized by PQC in accordance with the terms of this Agreement. 3.13 Power of Attorney for Billing and Payment of Accounts. Medical ----------------------------------------------------- Group hereby exclusively authorizes PQC to take the following actions for and on behalf of and in the name of Medical Group throughout the term of this Agreement and thereafter in accordance with Section 5: (a) bill, in Medical Group's name, under its provider number when obtained and on its behalf, and until such time as Medical Group has obtained its provider number, bill, in the Medical Group Physicians, names under their respective provider numbers and on their behalf, all claims (including co-payments due from patients) for reimbursement or indemnification from all other Payors, fiscal intermediaries or patients for all covered items and services provided by Medical Group or by the Medical Group Physicians to patients; (b) take possession of and endorse in the name of the Medical Group Physicians or Medical Group, all cash, notes, checks, money orders, insurance payments, and any other instruments received as payment of accounts receivable (and Medical Group will cause an individual Medical Group Physician who receives any payments for the benefit of Medical Group directly, to deliver such amounts promptly to PQC for deposit in the Founding Pod Medical Group Account or the Additional PQC Medical Group Account, as the case may be, and Medical Group covenants to transfer and deliver promptly to PQC for deposit in the applicable Medical Group Account, all funds received by Medical Group from patients or Payors for medical services), all such funds to be deposited directly into a Medical Group Account and to be applied in a manner consistent with this Agreement; (c) deposit all collections directly into the applicable Medical Group Account and to make withdrawals from such Medical Group Account for such purposes as are permitted by this Agreement; (d) in Medical Group's name and on its behalf, and in the Medical Group Physicians' names and on behalf of each of them, as necessary, collect and receive all accounts receivable generated -11- by such billings and claims for reimbursement, place such accounts for collection, settle and compromise claims and institute legal action for the recovery of accounts (it being agreed that Medical Group shall write-off amounts of uncollected billings at the request of a Medical Group Physician to the extent contemplated in the Employment Agreement); Medical Group shall cooperate fully with PQC in facilitating such collections and in collecting accounts receivable transferred to PQC for deposit in the Medical Group Account by Medical Group, including endorsement of checks and delivery to PQC of all revenues in whatever form, received from patients or Payors on their behalf, and completion of all forms necessary for the collection of said monies; and (e) sign checks on behalf of Medical Group and make withdrawals from the Medical Group Accounts for payments specified in this Agreement and as requested from time to time by Medical Group. In addition to the foregoing, Medical Group, to the extent not prohibited by law, hereby grants to PQC an exclusive power of attorney and appoints PQC its exclusive true and lawful attorney in fact to take each of the actions specified in Sections (a) through (e) above for and on behalf of and in the name of Medical Group throughout the term of this Agreement and thereafter in accordance with Section 5. Upon request of PQC, Medical Group shall, and shall cause each of the Medical Group Physicians to, execute and deliver to PQC and to each financial institution wherein Medical Group or PQC maintains an account, such additional documents or instruments (including one (1) or more powers of attorney naming PQC as its or their, as the case may be, exclusive true and lawful attorney in fact) as may be necessary or desirable to evidence or effect the authority or the power of attorney or both granted to PQC pursuant to this Section. 3.14 Other Billings and Charges. PQC shall serve as Medical Group's -------------------------- exclusive billing agent. Medical Group covenants that neither it nor any Medical Group Physician shall bill or submit a statement of charges to, or enter into any agreement or, except in the event of an emergency, any undertaking with, any patient, third person or entity for the provision of items and services (with or without consideration), nor shall it make any surcharge for care without the prior written authorization and approval of PQC. 3.15 Insurance. PQC, on behalf of Medical Group, shall negotiate, --------- obtain, and maintain with such licensed insurance companies as are reasonably acceptable to the Joint Policy Board the policies of general liability, fire and property insurance that satisfy the requirements of Section 2.6. PQC shall furnish certificates of insurance to Medical Group evidencing the coverage set forth in this section upon request by Medical Group. Subject to approval by the Joint Policy Board, PQC may arrange for a group professional liability insurance policy covering Medical Group Physicians that would satisfy Medical Group's obligations under 2.6. The liability insurance coverage maintained as of the date of this Agreement by PQC with respect to its own operations is set forth on Schedule 3.15. PQC shall advise the Joint Policy Board of any material decrease - -------- ---- in the amount or scope of such insurance coverage. -12- 3.16 Other Administrative Services. In addition to the business and ----------------------------- administrative services specifically described above in this Section 3, PQC shall be responsible for providing all other administrative services necessary to the business operations of Medical Group, including without limitation human resource services, administrative support for Medical Group's recruitment efforts, management information systems (including development on a uniform data base across all Pods), accounting services and systems, and advertising, sales and marketing services. 3.17 Development of Integrated Health Services. Neither PQC nor any ----------------------------------------- Affiliate shall provide Integrated Health Services in the Geographic Area unless PQC gives Medical Group the option to be the exclusive provider of these services, as provided in this Section. To that end, if PQC or one (1) of its Affiliates proposes to provide any Integrated Health Service in the Geographic Area, PQC shall notify Medical Group and the Joint Policy Board of the nature of the service and the terms upon which PQC or its Affiliate proposes to provide the service, and the Joint Policy Board, on behalf of Medical Group, shall have forty-five (45) days during which to elect to participate in the provision of such Integrated Health Service in the Geographic Area on such terms as are mutually acceptable to the Joint Policy Board and PQC. Any such proposal shall specify the proposed manner in which the net revenues (meaning all receipts from such Integrated Health Services less all expenses attributable to such Integrated Health Services, determined in accordance with generally accepted accounting principles) shall be allocated between Medical Group and PQC, but to the extent permitted by law in any event such proposal shall offer to Medical Group the right to receive an allocation to the Variable Distribution Pool (as defined in the Employment Agreements) of at least fifty percent (50%) of the net revenues attributable to such Integrated Health Service provided that as a condition thereof Medical Group shall agree that a percentage of any net loss attributable to such Integrated Health Service equal to the percentage of net revenues attributable to such Integrated Health Service shall be offset against amounts otherwise allocable to Medical Group under Appendix B in any one (1) or more Fiscal Periods thereafter occurring. PQC agrees to use its reasonable efforts to structure any proposal for the provision of Integrated Health Services in the Geographic Region in a manner so that the allocation to Medical Group contemplated by the forgoing sentence is in accordance with applicable law. Medical Group shall not agree to participate in any Integrated Health Service or fail to elect to participate in such Integrated Health Service except as approved by and on such terms as have been approved by the Joint Policy Board. If Medical Group does not elect to participate in such Integrated Health Service in the Geographic Area within such forty-five (45) day period, PQC may, but shall not be obligated to, provide such Integrated Health Service directly or through another Affiliate or subsidiary (but in no event through or with any outside third party without the prior consent of the Joint Policy Board) and Medical Group shall have no right to participate in the revenues or income from such Integrated Health Service; provided, however, that PQC shall not directly -------- ------- or indirectly provide such Integrated Health Service if within such forty-five (45) day period the Medical Advisory Board reasonably determines and notifies PQC that the provision of such services have not been determined to be clinically efficacious, are clinically dangerous, or would otherwise adversely affect the reputation of PQC and/or Medical Group as to quality of care and; provided, further, that PQC shall not directly or indirectly provide any - -------- ------- Integrated Health Services in the Geographic Area if all of the PQC Representatives on the Joint Policy Board voted against Medical Group participating in such Integrated Health Service. -13- 3.18 Advertising and Public Relations. PQC shall design and implement -------------------------------- local public relations and advertising programs, subject to approval by the Joint Policy Board. In the event that there is any adverse incident involving Medical Group or any Medical Group Physician or patient, any public statement and announcement by or on behalf of Medical Group or any Medical Group Physician shall be approved in advance by PQC. 4. MANAGEMENT FEE; FINANCIAL ARRANGEMENTS In consideration for the services furnished by PQC to Medical Group under this Agreement and in order to encourage the cost-effective management of the Medical Group, PQC shall be entitled to receive, and Medical Group hereby agrees to pay PQC, an aggregate management fee calculated under the formulas set forth in Appendix B -1 with respect to the Founding Pods and B-2 with respect to the Additional Pods hereto. 5. TERM AND TERMINATION 5.1 Term. The term of this Agreement shall commence on the date first ---- written above and shall continue until the date forty (40) years thereafter, unless terminated earlier in accordance with this Agreement. After the expiration of the initial forty (40) year term, this Agreement shall automatically renew for successive forty (40) year terms unless sooner terminated in accordance with the provisions hereof. 5.2 Termination on Default. ---------------------- (a) Either party shall be entitled to terminate this Agreement if the other party fails to perform in any material respect any material obligation required of it hereunder, and such default continues for sixty (60) days after the giving of written notice by the nondefaulting party, specifying the nature and extent of such default; provided, however, that the non- defaulting party shall -------- ------- not be entitled to terminate this Agreement if the defaulting party commences the cure of such default within the first sixty (60) day period and thereafter diligently and in good faith continues to cure such default until completion. (b) Termination at election of PQC. PQC shall be entitled to terminate this Agreement upon written notice to Medical Group if: (i) a law firm with a nationally recognized expertise in health care law and acceptable to PQC and the Joint Policy Board renders an opinion to PQC, with a copy provided to the Joint Policy Board, stating that a material provision of this Agreement is in violation of applicable law, and the parties do not agree to amend this Agreement pursuant to Section 9.14 hereof to cure such violation; or -14- (ii) any court or regulatory agency enters an order finding a material provision of this Agreement is in violation of applicable laws and the parties do not agree to amend this Agreement pursuant to Section 9.14 hereof to cure such violation; or (iii) PQC is prevented by Medical Group or any person under the Medical Group's direction or control, from entering any material portion of the Pod Practice Locations considered on any aggregate basis, and such inability to enter such premises continues for more than forty-eight (48) hours after notice thereof to the Joint Policy Board. (c) Termination by Medical Group. Notwithstanding Section 5.2(a), Medical Group may terminate this Agreement (if and only if such termination has been approved by the Joint Policy Board) for the reasons set forth below: (i) upon written notice to PQC of the failure of PQC to remit any funds or make any payments required under this Agreement when due and continued failure to remit those funds or make the payment after thirty (30) days notice of such failure to PQC unless the amount of such payment is being contested in good faith; or (ii) a law firm with a nationally recognized expertise in health care law and acceptable to PQC and the Joint Policy Board renders an opinion to the Medical Group, with a copy provided to the Joint Policy Board, stating that a material provision of this Agreement is in violation of applicable law, and the parties do not agree to amend this Agreement pursuant to Section 9.14 hereof to cure such violation; or (iii) any court or regulatory agency enters an order finding a material provision of this Agreement is in violation of applicable laws, and the parties do not agree to amend this Agreement pursuant to Section 9.14 hereof to cure such violation. Medical Group shall take appropriate action to terminate this Agreement pursuant to this Section (c) if recommended by the Joint Policy Board. 5.3 Effect of Termination. Upon termination of this Agreement pursuant --------------------- to this Section 5: (a) PQC and Medical Group shall cooperate and continue to perform their obligations under this Agreement as may be necessary to ensure the provision of proper care to patients under treatment, consistent with applicable law concerning continuation of benefits under Payor Contracts, until appropriate alternative arrangements are made. -15- (b) Medical Group and PQC shall cooperate to ensure the appropriate billing and collection for all health care items and services provided by Medical Group prior to the effective date of termination, and any proceeds of such billings or collections shall be retained by Medical Group and/or paid to PQC in accordance with the terms of this Agreement. (c) Any amounts due and owing to PQC under any loan to Medical Group shall become immediately due and payable, subject to offset for amounts owed hereunder by PQC to Medical Group. (d) Medical Group shall reimburse PQC for all drug and pharmaceutical inventory retained by Medical Group following termination to the full extent of funds advanced by PQC for the purchase of such inventory pursuant to Section 3.6. (e) Provisions of this Agreement shall survive any termination if so provided herein or if necessary or desirable fully to accomplish the purposes of such provision. (f) PQC shall use its reasonable efforts to have Medical Group continue to participate in any Payor Contracts with respect to which PQC and not Medical Group is the contracting party. 6. JOINT POLICY BOARD; CERTAIN PROVISIONS REGARDING GOVERNANCE OF MEDICAL GROUP 6.1 Joint Policy Board. Medical Group and PQC shall establish and ------------------ maintain the Joint Policy Board, which shall have the representation, responsibility and authority described below. (a) Representation. For purposes of this Agreement, "Physician -------------- Members" means only those Medical Group Physicians whose Employment Agreement permits them to share in Net Revenues as provided in Appendix B-1 or B-2 and, for purposes of this Section 6.1, such other non-physician healthcare providers that are employees of Medical Group as the Joint Policy Board shall designate from time to time including the persons listed on Schedule 6.1(a). The Joint Policy Board shall consist of nine (9) individuals: four (4) elected by plurality vote of the Physician Members (the "Medical Group Representatives"), at least one of whom must be a primary care physician and at least one of whom shall be a specialist; four (4) appointed by PQC (the "PQC Representatives"), and the President of Medical Group (who shall serve ex-officio with vote). Each Medical Group Representative shall be a physician selected until June 30, 2000 for a one year term and thereafter for a three (3) year term by Physician Members; provided, however, that new members of the Joint Policy -16- Board shall be selected as of July 31, 1997 (the "Effective Date"); that with respect to the 12 month period ending on the first anniversary of the Effective Date two (2) of the Medical Group Representatives shall be selected by the Founding Pods and two (2) of the Medical Group Representatives shall be selected by Pod R; that with respect to the next succeeding twelve month period, the Medical Group Representatives shall include at least two (2) Physician Member assigned to a Founding Pod and at least two (2) Physician Member assigned to Pod R and, in each case, selected by the Physician Members of the Founding and Additional Pods voting as a single group; and that with respect to any period beginning on or after the second anniversary of the Effective Date, the Medical Group Representatives shall be any Physician Member meeting the above criteria selected by the Founding and Additional Pods voting as a single group. Each Medical Group Representative may serve an unlimited number of terms and shall serve until a successor is selected. The PQC Representatives shall be appointed from time to time by PQC and shall include the chief operating officer of Medical Group. The Medical Group Representatives shall select, from among the physicians who are members of the Joint Policy Board, the Chair of the Joint Policy Board. The Medical Director shall be provided with notice of and shall be entitled to attend meetings of the Joint Policy Board but shall not be entitled, unless the Medical Director is also a Medical Group Representative or a PQC Representative, to vote on any matter before the Joint Policy Board. (b) Authority and Responsibility. The Joint Policy Board shall be ---------------------------- responsible for periodically reviewing and making any appropriate recommendations to PQC and the Board of Directors of Medical Group regarding the operations of Medical Group, and, to the extent expressly provided in this Agreement, shall have the right to approve certain decisions by Medical Group and PQC. Any amendment of this Agreement that would limit or otherwise materially diminish the authority or responsibility of the Joint Policy Board, including without limitation any changes to this Section 6 or Appendices B-1 or B-2, shall require the prior approval of the Joint Policy Board. In addition, the following actions shall require the affirmative vote of a majority of the members of the Joint Policy Board: (i) approval of all budgets and borrowings pursuant to Section 6.1; (ii) approval of the number and type of physicians required for the efficient operation of Medical Group; (iii) review and approval of all advertising and other marketing of the services performed by Medical Group; -17- (iv) approval of Integrated Health Services and the scope of those services to be provided by Medical Group as contemplated by Section 3.17; (v) approval of the formation, maintenance and/or termination of relationships with institutional health care providers and payors, including Payor Contracts in accordance with Section 3.7; (vi) approval of all contracts material to Medical Group, including all amendments to real property leases in effect as of the date of this Agreement, and all the terms of and amendments to real property leases entered into after such date governing the space utilized by any Medical Group Physician; (vii) consideration and determination of non-clinical matters raised by Medical Group Physicians; (viii) approval of fee schedules and charges; (ix) approval of business and strategic plans; (x) approval of the Operating Manager; (xi) approval of Medical Group's termination of a Medical Group Physician on the basis of disability; (xii) approval of any change in the Baseline Amount (as defined in Section 10.2) to reflect the addition or termination of Medical Group Physicians; and (xiii) approval of the modification or waiver of the restrictive covenants applicable to any Medical Group Physician. The Joint Policy Board may consult with Medical Group, PQC and any Medical Group Physician before taking any action specified in this Section 6.1(b), but, except as otherwise provided in this Agreement, neither the recommendations of Medical Group, PQC nor any Medical Group Physician shall be binding on the Joint Policy Board. Any determination of the Joint Policy Board pursuant to (i), (ii), (iii), (iv), (v), (vi), (xii) and (xiii) shall not be effective unless approved by the Medical Group Shareholder. (c) Certain Matters Requiring Supermajority Approval. ------------------------------------------------- Notwithstanding anything in Section 6.1(b) to the contrary, approval of any action with respect to the following matters shall require the approval of two thirds of the members of the Joint Policy Board (including during the first two years after the Effective Date at least one (1) Medical Group Representative from a Founding Pod and at least (1) Medical Group Representative from an Additional Pod and thereafter, at least one Physician Representative): -18- (i) changes in existing physician practice patterns; (ii) any reimbursement contract providing for compensation to Medical Group at below market rates; (iii) the addition of new physicians; and (iv) any significant budgetary changes or any material changes in the governance or financial provisions of this Agreement following a Change in Control Transaction. (d) Certain Matters Regarding Medical Advisory Board Recommendation. --------------------------------------------------------------- Notwithstanding anything in this Section 6.1 to the contrary, the Joint Policy Board shall not be authorized to take any action with respect to the following matters unless requested by the Medical Advisory Board: (i) referrals of patients' accounts to collection agencies and development and execution of courtesy and write-off policies; (ii) technical procedures pursued by a Medical Group Physician (as long as appropriate credential requirements are satisfied); (iii) non-monetary aspects of quality assurances and credentialing decisions, including dismissal for quality assurance reasons of any healthcare professional; and (iv) the determination for quality assurance or credentialing reasons to terminate any Employment Agreement in the form attached hereto as Annex A-2 pursuant to Sections 8(c)(i), (B), (C), (D), (E), (F), (G), (K) or (L) of such Employment Agreement; provided, however, that a determination that termination of an Employment Agreement pursuant to Sections 8(c)(i)(C), (F), (G), (K) or (L) of such Employment Agreement is in the best interests of Medical Group for any other reason, including the reputation, financial results or financial condition of Medical Group, may be made by the Joint Policy Board without recommendation by the Medical Advisory Board. (e) Medical Advisory Board Recommendations Regarding New Physicians. --------------------------------------------------------------- (i) Notwithstanding anything in this Section 6.1 to the contrary, the Joint Policy Board shall not authorize the employment of any additional physicians (other than in connection with the merger of a physician group into Medical Group) unless the Joint Policy Board shall have sought the recommendation of the Medical Advisory Board whether the addition of such physicians is advisable on the basis of the reputation and ability of the proposed physician and the compatibility of such physician with the existing Medical Group Physicians with the same area of -19- practice. In making its recommendation to the Joint Policy Board, the Medical Advisory Board shall consult with Medical Group Physicians in similar practice areas as the proposed additional physician. If the Medical Advisory Board recommends the physician, the Joint Policy Board shall be free to approve an Employment Agreement with such physician. If the Medical Advisory Board recommends that a physician not be approved by the Joint Policy Board, the Medical Advisory Board must recommend to the Joint Policy Board, within six months of the initial request by the Joint Policy Board, another physician with the same speciality or practice area and whose Baseline Net Adjusted Billings would be comparable to the physician proposed by the Joint Policy Board who is prepared to become a Medical Group Physician. The Medical Advisory Board shall act expeditiously in considering whether to recommend any physician to the Joint Policy Board. If the Medical Advisory Board fails to make such a recommendation within the six month period, the Joint Policy Board shall be free to offer employment to the physician originally proposed to the Medical Advisory Board if Medical Advisory Board recommended against such physician on the basis of lack of compatibility with existing Medical Group Physicians or the Medical Advisory Board made no determination. (ii) Notwithstanding anything in this Section 6.1 to the contrary, the Joint Policy Board shall not authorize the employment of any additional physicians in connection with the merger of a physician group into Medical Group unless the Joint Policy Board shall have sought the recommendation of the Medical Advisory Board whether the addition of such physicians is advisable on the basis of the reputation and ability of the proposed physician(s) and the compatibility of such physician(s) with the existing Medical Group Physicians with the same area of practice. The Medical Advisory Board must make a recommendation to approve or reject the employment of such physician(s) within 30 days of being advised of the proposed transaction. In reaching its recommendation, the Medical Advisory Board shall only consider the reputation and ability of the proposed physicians and the compatibility of such physicians with the existing Medical Group Physicians with the same area of practice. The Medical Advisory Board may consult with Medical Group Physicians in similar practice areas as the proposed additional physician. If the Medical Advisory Board recommends the physician(s) or fails to make a recommendation with the thirty-day period, the Joint Policy Board shall be free to approve Employment Agreement(s) with such physician(s). (f) Voting; Procedures. ------------------ (i) Each Medical Group Representative shall have one (1) vote and shall have the right to grant his proxy to another Medical Group Representative. Each of the PQC Representatives and the President of Medical Group shall have one (1) vote and shall have the right to grant his -20- proxy to another member of the Joint Policy Board. Except as provided in clause (c)(ii) below, no action of the Joint Policy Board shall be effective unless authorized by a majority (or, in the case of matters set forth in Sections 6.1(c), by two-thirds) of the members of the Joint Policy Board. A quorum of the Joint Policy Board shall consist of at least three (3) Medical Group Representatives and three (3) PQC Representatives, present in person or by proxy; provided, however, that if a meeting is called and a quorum cannot be obtained within thirty (30) days of notice of such meeting, then the quorum requirement shall be automatically reduced for the first meeting thereafter to a majority of the members of the Joint Policy Board, present in person or by proxy. (ii) The Joint Policy Board shall meet from time to time when a meeting is called by the chair or by three (3) or more members of the Joint Policy Board upon at least five (5) days' written notice to the other members of the Joint Policy Board, which notice requirement may be waived with respect to any member of the Joint Policy Board by the attendance at such meeting. The Joint Policy Board may also hold meetings by telephone or act by written consent according to procedures established by the Joint Policy Board. Minutes shall be kept of all formal actions taken by the Joint Policy Board. The Joint Policy Board may appoint a secretary who is not a member of the Joint Policy Board. 6.2 Medical Advisory Board. A Medical Advisory Board shall be ---------------------- established, which shall be responsible for: (i) providing medical advice to Medical Group on managed care contracting, including oversight of all utilization review, risk management, and peer review functions required by any Payor Contract; (ii) developing and disseminating, subject to Medical Group's approval, medical protocols and quality and outcome measures for Medical Group and the Physicians; (iii) advising Medical Group with respect to the number and qualifications of physicians required for the efficient operation of Medical Group's practice; (iv) overseeing the recruitment by Medical Group and credentialing of new physicians; and (v) whether to recommend that the Joint Policy Board consider the matters set forth in Section 6.1(d). The Medical Advisory Board shall consist of seven (7) members. The members of the Medical Advisory Board shall be the Medical Director of Medical Group and six (6) other licensed physicians elected by a plurality vote of the Physician Members, of whom three (3) shall be primary care physicians and three (3) shall be engaged in a specialist practice. The Medical Director of Medical Group shall act as chair of the Medical Advisory Board. 6.3 The President of Medical Group. ------------------------------ (a) Medical Group shall appoint, in the manner set forth in (b) below, a physician to act as President of Medical Group who shall -21- work in conjunction with PQC in order to implement the policies established by the Joint Policy Board. Such individual shall also be an employee of PQC. Subject to the direction and supervision of the Medical Group Shareholder, the duties of the President shall include, without limitation: (i) interfacing with representatives from the national corporate offices of PQC; (ii) implementing the business and strategic plans of Medical Group and overseeing the business operation of Medical Group; and (iii) working with PQC representatives in negotiating and interfacing with Payors and other regulatory agencies. The Medical Group Shareholder shall determine the salary and fringe benefits of the President. (b) Subject to the By-Laws of Medical Group (which shall not be amended to reduce the rights of the Medical Group Physicians under this section without the prior consent of a majority of the Physician Members), the Physician Members shall nominate by plurality vote three (3) candidates, who shall be Physician Members, for the position of President, and the Medical Group Shareholder shall select one (1) candidate from among such nominees to be President. In the event that there is a vacancy in the position of President at any time for any reason, the Medical Group Shareholder shall have the authority to appoint a person to serve as interim President until another person is duly appointed in accordance with the above specified procedures. The President shall serve part-time in this capacity until such time as his responsibilities warrant full-time employment status. Notwithstanding the foregoing, the President shall be a Medical Group Physician active in the practice of medicine, until such time as the President's responsibilities warrant full-time employment status with the Medical Group. Medical Group may remove the President at any time in the event that the employment agreement between the President and PQC is terminated, but in such event the position of President may be filled by Medical Group Shareholder for an interim period only until a successor to the position of President has been appointed in accordance with the provisions of this Section 6.3(b). Medical Group shall assist in the development of procedures for the nomination, appointment and replacement of the President in such a manner as to ensure a smooth transition period in the medical practice of any individual who assumes the position of the President. -22- 6.4 The Medical Director of Medical Group. ------------------------------------- (a) Medical Group shall hire and appoint a physician to act as Medical Director to provide guidance and advice to Medical Group on clinical issues. The duties of the Medical Director shall include, without limitation: (i) interfacing with the National Medical Advisory Board of PQC and representing Medical Group on the PQC National Medical Advisory Board; (ii) chairing the Medical Advisory Board; (iii) providing medical advice on managed care contracting by Medical Group; (iv) leading the development and dissemination of medical protocols, quality and outcome measures; and (v) overseeing the recruitment and credentialing of new physicians. The Medical Group Shareholder shall determine the salary and fringe benefits of the Medical Director. (b) Subject to the By-Laws of Medical Group (which shall not be amended to reduce the rights of the Medical Group under this Section without the prior consent of a majority of Physician Members), the Physician Members shall nominate by plurality vote three (3) candidates who shall be Physician Members for the position of Medical Director, and the Medical Group Shareholder shall select one (1) candidate from among such nominees to be Medical Director. In the event that there is a vacancy in the position of Medical Director at any time for any reason, the Medical Group Shareholder shall have the authority to appoint a person to serve as interim Medical Director until another person is duly appointed in accordance with the above specified procedures. The Medical Director shall serve part-time in this capacity until such time as his responsibilities warrant full- time employment status. Notwithstanding the foregoing, the Medical Director shall be a Medical Group Physician active in the practice of medicine, until such time as the Medical Director's responsibilities warrant full-time employment status with the Medical Group. Medical Group shall assist in the development of procedures for the nomination, appointment and replacement for the Medical Director in such a manner as to ensure a smooth transition period in the medical practice of any individual who assumes the position of the Medical Director. The Physician Members shall have the right to remove the Medical Director upon a two-thirds (2/3) vote of all Physician Members, but in such -23- event the position of Medical Director may be filled only in accordance with the provisions of this Section 6.4(b). 6.5 Operating Manager. Subject to the reasonable approval of the Joint ----------------- Policy Board, PQC shall retain a full-time non-physician employee to serve as an operating manager (the "Operating Manager"). The Operating Manager shall manage and administer all of the day-to~day business transactions necessary for the operation of Medical Group. PQC shall determine the salary and fringe benefits of the Operating Manager, who shall be an employee of PQC. At the direction, supervision and control of PQC, the Operating Manager shall implement the policies established by Medical Group and the Joint Policy Board and shall generally perform the duties and have the responsibilities of an administrator. 7. INTELLECTUAL PROPERTY Medical Group acknowledges that PQC will continually develop Intellectual Property and that Medical Group may have access to and use Intellectual Property during the term of this Agreement. Medical Group agrees that, except as required for the proper operation of the medical practice in accordance with applicable law and the terms of this Agreement, it will not, directly or indirectly, use or disclose any Intellectual Property. Medical Group understands and agrees that this restriction will continue to apply after the termination of this Agreement for any reason. Medical Group agrees that all Intellectual Property to which it has access as a result of its relationship with PQC under this Agreement is and shall remain the sole and exclusive property of PQC. Except as required for the proper operation of the medical practice in accordance with applicable law and the terms of this Agreement, Medical Group will not copy any documents, tapes or other media containing Intellectual Property ("Documents"). Medical Group will return to PQC immediately after this Agreement terminates, and at such other times as may be specified by PQC, all Documents and copies of Documents. Medical Group shall use its best efforts to assure that all Medical Group Physicians and other employees and agents of Medical Group are aware of and comply with the restrictions on disclosure and use of Intellectual Property set forth in this Section. (For purposes of this Section, references to PQC shall be deemed to refer to PQC and any Affiliates.) 8. RESTRICTIVE COVENANTS The parties recognize that the services to be provided by PQC hereunder shall be feasible only if Medical Group operates an active medical practice to which the physicians associated with Medical Group devote their full time and attention. Accordingly, the parties hereto agree as follows: 8.1 Noncompetition. During the term of this Agreement, Medical Group -------------- shall not, without the prior written consent of PQC, establish, operate or provide physician or other medical services at any medical office, clinic or other health care facility providing services similar to those provided by Medical Group, PQC or any Affiliate of PQC, within the Geographic Area. -24- 8.2 Ancillary Enterprise. During the term of this Agreement, except as -------------------- permitted by this Agreement, Medical Group shall not provide any of the additional services that have been approved by the Joint Policy Board and PQC as "Integrated Health Services" or any other services provided by PQC. For two (2) years after termination of this Agreement, except as permitted by this Agreement, Medical Group shall not provide any of the additional services that have been approved by the Joint Policy Board and PQC as "Integrated Health Services" or any other services provided by PQC, within fifteen (15) miles of any Pod Practice Location. 8.3 Non-solicitation of Employees and Patients. During the term of this ------------------------------------------ Agreement and for a two (2) year period thereafter, Medical Group shall not recruit, solicit or induce or attempt to induce, any employee or employees of PQC to terminate their employment with, or otherwise cease their relationship with, PQC. During the term of this Agreement and for a one (1) year period thereafter, Medical Group shall not solicit, attempt to divert or to take away, the business or patronage of any of the patients, clients, customers or accounts, or prospective patients, clients, customers or accounts of PQC or any of its Affiliates. 8.4 Enforcement of Medical Group Physician Employment Agreements. ------------------------------------------------------------ Medical Group shall enforce the Employment Agreements of Medical Group Physicians, including, without limitation, restrictive covenants and liquidated damages provisions contained in such agreements. In the event that, after a request by PQC, Medical Group does not pursue any remedy that may be available to it by reason of a breach or default of the restrictive covenants and liquidated damages provisions or any other provision of any Employment Agreement, upon the request of PQC, and Medical Group shall assign to PQC such causes of action and any other rights it has related to such breach or default and shall cooperate with and provide reasonable assistance to PQC with respect thereto. 8.5 Remedies. PQC and Medical Group acknowledge and agree that a remedy -------- at law for any breach or attempted breach of the provisions of this Section 8 shall be inadequate, and, therefore, either party shall be entitled to specific performance and injunctive or other equitable relief in the event of any such breach or attempted breach, in addition to any other rights or remedies available to either party at law or in equity or under the Employment Agreements, including without limitation provisions thereunder relating to the repurchase by the Medical Group and/or the Medical Group Physicians of certain assets. Each party hereto waives any requirement for the securing or posting of any bond in connection with the obtaining of any such injunctive or other equitable relief. If any provision of this Section 8 relating to the restrictive period, scope of activity and the territory described therein shall be declared by a court of competent jurisdiction to exceed the maximum time period, scope of activity restricted or geographical area such court deems reasonable and enforceable under applicable law, the time period, scope of activity restricted and area of restriction held reasonable and enforceable by the court shall thereafter be the restrictive period, scope of activity restricted and the territory applicable to such provision of this Section 8. The invalidity or non-enforceability of any provision of this Section 8 in any respect shall not affect the validity or enforceability of the remainder of this Section 8 or of any other provisions of this Agreement. -25- 9. MISCELLANEOUS 9.1 Exclusivity. During the term of this Agreement, PQC shall be the ----------- exclusive provider to Medical Group of the types of services to be provided under this Agreement by PQC (the "Management Services"). During the Term, Medical Group shall not establish, operate, or provide medical services or practice medicine at a medical office, clinic or other health care facility anywhere except at offices, clinics and facilities at which PQC is the exclusive provider of Management Services; provided, however, that the Medical Group may provide (i) services at hospital and other facilities unaffiliated with PQC so long as PQC retains the sole right to provide Management Services in connection with all activities conducted by Medical Group at such hospitals and other facilities and (ii) the services set forth on Schedule 9.1. Except in connection with any Integrated Health Services which PQC is permitted to provide itself or through an Affiliate pursuant to Section 3.8 or except as two-thirds of the members of the Joint Policy Board shall otherwise approve, neither PQC nor any Affiliate may, during the term of this Agreement, provide to any other person or entity which is located or doing business in the Maryland Area, the management or other services to be provided by PQC pursuant to this Agreement or any medical or other medical related services of the type provided by Medical Group or Clinical Associates on the Effective Date, including the management of capitated contracts. If during the term of this Agreement, either PQC or any Affiliate proposes to establish an IPA in the Maryland Area, the terms set forth in Appendix E shall apply to such IPA unless another arrangement is approved by two- thirds of the members of the Joint Policy Board. For purposes of this Section 9.1, "Maryland Area" means the state of Maryland and the following counties in the Commonwealth of Pennsylvania: 9.2 Names; Trademarks. Medical Group and the Pods shall conduct their ----------------- professional practice under the name or names mutually agreed upon by PQC and Medical Group and subject to the terms of applicable trademark licenses between PQC and Medical Group. 9.3 Independent Contractors. For the purpose of this Agreement and for ----------------------- all services to be provided hereunder, each party will be, and will be deemed to be, independent contractors and not (except to the limited extent provided in Sections 3.7, 3.13 and 3.14) employees or agents of the other party. 9.4 [Reserved] -------- 9.5 Severability. If any provision of this Agreement is found by a ------------ court of competent jurisdiction to be void, invalid or unenforceable, the same will either be reformed to comply with applicable law or stricken if not so conformable, so as not to affect the validity or enforceability of the remainder of this Agreement. 9.6 Waiver. Failure of either party to enforce a right under this ------ Agreement will not act as a waiver of that right or the ability to later assert that right relative to the particular situation involved. -26- 9.7 Notices. Any notice required to be given pursuant to the terms and ------- provisions of this Agreement shall be in writing and shall be sent by certified mail, return receipt requested, postage prepaid or by reputable overnight delivery service, to PQC and Medical Group at their respective places of business as designated from time to time by the parties and to the Joint Policy Board at the address of its Chair. Notices shall be effective the second day after mailing (in the case of certified mail) or the first day after mailing (in the case of overnight delivery). A copy of any notice given to Medical Group shall be addressed to the President of Medical Group with a copy to PQC. 9.8 Entire Agreement. This Agreement, together with all appendices, ---------------- schedules and exhibits attached hereto, constitutes the entire agreement among the parties pertaining to the subject matter hereof and supersedes all prior and contemporary agreements, understandings, negotiations, and discussion, whether oral or written, of the parties respecting the subject matter hereof. All appendices, schedules and exhibits attached hereto are hereby made a part of this Agreement. 9.9 Amendment. Except as specifically provided elsewhere in this --------- Agreement, no change or modification of this Agreement shall be valid unless the same shall be in writing and signed by an authorized officer of Medical Group and PQC and shall have been approved by the Joint Policy Board. Except as specifically provided elsewhere in this Agreement, no waiver of any material provision of this Agreement shall be valid unless the same shall be in writing and signed by an authorized officer of Medical Group and PQC and shall have been approved by the Joint Policy Board. 9.10 Successors and Assigns. PQC shall have the right to assign its ---------------------- rights and obligations under this Agreement to any entity controlled by, controlling or under common control with PQC. Except as set forth in the prior sentence, neither PQC nor Medical Group may assign its rights or delegate its obligations under this Agreement without the prior written consent of the other party. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective transferees, successors and assigns. 9.11 Governing Law. This Agreement will be construed and enforced in ------------- accordance with the laws of the State of Maryland. Each of the parties hereto submits to the exclusive jurisdiction of the United States federal district courts seated in that state and agrees that process may be served upon it if it cannot otherwise be served in such state by registered or certified mail addressed as provided for notices under this Agreement. 9.12 Headings. Headings in this Agreement are inserted for convenience -------- only and are not to be considered in construing the provisions hereof. 9.13 No Obligation to Third Parties. Except as expressly set forth in ------------------------------ this Section 9.13, none of the obligations and duties of PQC or Medical Group under this Agreement shall in any way or in any manner be deemed to create any obligation of PQC or of the Medical Group to, or any rights in, any person or entity not a party to this Agreement. Notwithstanding the foregoing, in accordance with and subject to the terms of the provisions of the Employment Agreements between the Medical Group Physicians and Medical Group, the Medical -27- Group Physicians are hereby made third party beneficiaries of and may enforce the obligations of PQC hereunder (as the same may be amended from time to time in accordance with the provisions of Section 9.9 hereof) by any means, at law or in equity, all in accordance with any procedural requirements set forth in the said Employment Agreements; it being expressly agreed that this Agreement may be amended by the parties in accordance with Section 9.9 without the consent of the Medical Group Physicians. In the event that a dispute arises between PQC and Medical Group, or between PQC, Medical Group and a Medical Group Physician, that is not to be resolved by the Joint Policy Board under this Agreement or the Employment Agreements, the parties to the dispute shall submit the dispute to binding arbitration in Baltimore, Maryland. Each of PQC and Medical Group (in the case of a dispute between PQC and Medical Group) or PQC and the Medical Group Physician (in the case of a dispute between PQC or Medical Group and a Medical Group Physician) shall select, within 30 days of the notice of the other party's's election to arbitrate, one arbitrator, who shall not be affiliated with PQC, Medical Group or any Medical Group Physician. Each of the arbitrators so selected shall select, within 10 days of their selection, select a third arbitrator. Each of the parties to the arbitration shall present their case to the arbitrators within 30 says of the selection of the final arbitrator. All disputes shall be settled by the vote of a majority of the arbitrators. The arbitration shall be conducted in accordance with the rules of the American Arbitration Association. 9.14 Contract Modifications for Prospective Legal Events. In the event --------------------------------------------------- (a) any state or federal laws or regulations, now existing or enacted or promulgated after the Effective Date are interpreted by judicial decision, a regulatory agency, or legal counsel with a nationally recognized expertise in the field of law in question in such a manner as to indicate that this Agreement or any provision hereof may be in violation of such laws or regulations, or (b) the Financial Accounting Standards Board, Emerging Issues Task Force or other applicable accounting standard setting entity promulgates standards or issues a consensus that would prevent PQC from consolidating for financial statement presentation purposes all Practice Revenues of Medical Group on PQC's consolidated financial statements, then PQC shall propose to the Joint Policy Board and Medical Group for their approval such amendments to this Agreement as necessary to conform the Agreement to all applicable law and preserve the underlying economic and financial arrangements between PQC and Medical Group without substantial economic detriment to either PQC or Medical Group. Any such amendment approved by the Joint Policy Board and Medical Group shall be binding upon Medical Group, and Medical Group hereby consents to any such amendment. To the extent any act or service required of PQC should be construed or deemed, by any governmental authority, agency or court, to constitute the practice of medicine by PQC, the performance of said act or service by PQC shall be deemed waived and forever unenforceable and the provisions of this Section 9.14 shall be applicable. To the fullest extent permitted by law, Medical Group hereby waives and agrees not to assert illegality as a defense to the enforcement of this Agreement or any provision hereof, instead, any such purported illegality shall be resolved pursuant to the terms of this Section 9.14. 9.15 Availability of Certain Documents. The parties agree, to the --------------------------------- extent required by law necessary to permit receipt of reimbursement for services by Medical Group, to make available to the Secretary of Health and Human Services, the Comptroller General of the General Accounting Office, or their -28- authorized representatives, any books, documents and records in their possession relating to the nature and extent of the costs of services hereunder for a period of four (4) years after the provision of such services. 9.16 Gender. References herein to the masculine shall be deemed to ------ refer to the feminine or neuter gender as the context may require. -29- IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the date first written above. FLAGSHIP HEALTH, P.A. PHYSICIANS QUALITY CARE, INC. ("PQC") By: /s/ Dana Frank, M.D. By: /s/ Samantha J. Trotman ---------------------------------- ----------------------------- Dana Frank, M.D. Samantha J. Trotman President Chief Financial Officer and Vice President FLAGSHIP HEALTH II, P.A. By: /s/ Dana Frank, M.D. ---------------------------------- Dana Frank, M.D. President -30- APPENDIX A ---------- DEFINITIONS 10.1. As used in this Agreement, the following terms shall have the meanings set forth below: 10.2. "Affiliate" or "Affiliates" means with respect to any person, a --------- ---------- person that directly or indirectly through one (1) or more intermediaries controls, or is controlled by or is under common control with, such person. 10.3. "Baseline Amount" means with respect to the Founding Pods the sum of --------------- Eight Million, Four Thousand, Six Hundred Fifty Six Dollars ($8,004,656). The Baseline Amount shall be adjusted from time to time as determined by the Joint Policy Board and Medical Group (i) to reflect the addition of new Physicians to the Founding Pods or the termination or resignation of any Medical Group Physician included in a Founding Pod or (ii) to reflect such other factors as PQC and the Joint Policy Board shall mutually agree to be appropriate, in consultation with the Medical Group Compensation Committee, as appropriate. 10.4. "Baseline Net Adjusted Billings" with respect to each Medical Group ------------------------------ Physician in an Additional Pod shall mean initially the amount set forth as the Baseline Net Adjusted Billings in an appendix to the Medical Group Physician's employment agreement with Medical Group, which amount is based upon such physician's estimated Net Adjusted Billings as an employee of Clinical Associates for the fiscal year ended June 30, 1997. PQC shall have the right to adjust such initial Baseline Net Adjusted Billings amount to reflect such physician's actual Net Adjusted Billings as an employee of Clinical Associates for the fiscal year ended June 30, 1997 as soon as such information is available. Baseline Net Adjusted Billings for a Medical Group Physician shall also be adjusted by PQC for changes in practice patterns (i.e., weekly hours worked, part time status), which changes shall be notified by Medical Group and the Medical Group Physician to PQC immediately; provided that Baseline Net Adjusted Billings shall be adjusted back in the event that the practice patterns of the physicians return to their original status. PQC shall be entitled to review each Medical Group Physician's Baseline Net Adjusted Billings at the end of each Fiscal Year. PQC shall be entitled, without the approval of the Joint Policy Board, to reduce the Baseline Net Adjusted Billings of Medical Group Physicians engaged in a primary care practice (including OB/GYN) to reflect the Net Adjusted Billings of such Medical Group Physicians in the event that average fee for service collections for such primary care Medical Group Physicians as a percentage of fee for service billings declines by more than 5% compared to the percentage realized by such primary care Medical Group Physicians for the year ended June 30, 1997; provided, however, that the amount of such reduction shall only be equal to the excess of the actual percentage decline over 5%. PQC shall also be entitled, without the approval of the Joint Policy Board, to reduce the Baseline Net Adjusted Billings of Medical Group Physicians engaged in a specialist practice to reflect then current Net Adjusted Billings for such Medical Group Physicians in the event that average fee for service collections for such specialist Medical Group Physicians as a percentage of fee for service billings declines by more than 5% compared to the percentage realized by such A-1 specialist Medical Group Physicians for the year ended June 30, 1997; provided, however, that the amount of such reduction shall only be equal to the excess of the actual percentage decline over 5%. 10.5. "Book Value" means the value of an asset, after deduction for any ---------- depreciation or amortization, reflected on a balance sheet prepared in accordance with generally accepted accounting principles. 10.6. "Change in Control Transaction" means any transaction or series of ----------------------------- related transactions pursuant to which a single person or entity or a group of entities under common control acquire more than 50% of the capital stock of PQC; provided, however, that a Change in Control Transaction shall not be deemed to have occurred if Bain Capital, Inc or its affiliates acquires 50% or more of the outstanding capital stock of PQC or becomes entitled to exercise or exercises management control of PQC pursuant to the terms of PQC's Articles of Incorporation. 10.7. "Deductible Expenses" with respect to any Fiscal Period shall mean, ------------------- when used with respect to any Pod, an amount equal to (i) any income tax Medical Group is required to pay or withhold with respect to Medical Group Physicians assigned to such Pod, (ii) the cost of any pension and any other benefits not included in Practice Expenses, in each case that are provided to such Medical Group Physicians and (iii) any Discretionary Expenses; provided, however, that the parties agree and understand that Deductible Expenses may include items that are not deductible for income tax purposes, and PQC makes no representation as to the deductibility of such items for purposes of income tax liabilities of any Medical Group Physician or Medical Group. 10.8. "Discretionary Expenses" means, during the Fiscal Period ended ---------------------- December 31, 1996, any increase in actual staffing or other expenses, including Physician Pod Practice Expenses, above the levels set forth in Appendix D to this Agreement, subject to adjustment in successive Fiscal Periods pursuant to approval by the Joint Policy Board as part of the budgetary process contemplated in Appendix A to the form of Employment Agreement attached hereto. With respect to any Fiscal Period commencing after December 31, 1996, Discretionary Expenses means any personnel, operating and other expenses, including Physician Pod Practice Expenses, over and above the standard levels developed by the Joint Policy Board and approved by PQC and included in a Pod's annual operating budget, as adjusted from time to time in accordance with Appendix B attached hereto or the terms of any Employment Agreement. In addition, "Discretionary Expenses" shall include for a given Pod any liability (in the case of Flagship II, in excess of the amount accrued therefor on Flagship II financial statements as of the Effective Date) for federal, state, local or other taxes attributable to the merger into Medical Group (or attributable to taxable periods preceding the merger) of any entity owned by one or more Medical Group Physicians practicing in such Pod; provided, however that there shall be excluded any such tax liability if and to the extent that Medical Group or PQC has received payment from the Physician Members of the applicable Pod pursuant to the indemnification provisions of any agreement of merger pursuant to which the said merger has occurred; and provided, further that if any such Discretionary Expense arises prior to an initial public offering of PQC stock, the Joint Policy Board may recommend to PQC that it consider taking steps to finance such A-2 taxes or otherwise stage the imposition of such Discretionary Expenses over a period of three years, which recommendation shall be subject to the Board of Directors of PQC. 10.9. "Effective Date" means July 31, 1997. -------------- 10.10. "Fiscal Period" means the twelve (12) month or shorter period ------------- ending on December 31 of each year. 10.11. "Geographic Area" means the states of Maryland, Delaware, --------------- Pennsylvania (including all areas within a 15 mile radius of Philadelphia), Virginia, West Virginia, and the District of Columbia 10.12. "Gross Margin" means, for any Fiscal Period, the excess (or ------------ deficit) of Practice Revenues over Practice Expenses. 10.13. "Including" or "to include" any item shall mean containing or to --------- ---------- contain such item as part of a whole, without any implied exclusion of other items. 10.14. "Incremental Amount" means the excess, if any, of Net Adjusted ------------------ Billings attributable to a Medical Group Physician over the Market Compensation for such physicians. "Market Compensation" means an amount equal to twice the average compensation of physicians with a similar practice in the Baltimore metropolitan area as reported by a standardized reporting source selected by the Joint Policy Board. 10.15. "Integrated Health Services" means any business that Medical Group -------------------------- or PQC establishes in the Geographic Area, whether directly or through a subsidiary, that (i) provides medical or medical related services that are not traditionally performed by physicians or physician practices at medical offices (it being agreed that in-office laboratory and other ancillary services performed by the Medical Group Physicians on the Effective Date of this Agreement shall be deemed to be medical services and are not Integrated Health Services) and (ii) are determined to be Integrated Health Services by PQC, Medical Group, and the Joint Policy Board. 10.16. "Intellectual Property" means all (i) patents, patent applications, --------------------- patent disclosures and all related continuation, continuation-in-part, divisional, reissue, re-examination, utility model, certificate of invention and design patents, registrations and applications for registrations, (ii) trademarks, services marks, trade dress, logos, trade names and corporate names and registration and applications for registration thereof, (iii) copyrights and registrations and applications for registration thereof, (iv) mask works and registrations and applications for registration thereof, (v) computer software, data and documentation, (vi) trade secrets and confidential business information, whether patentable or non-patentable and whether or not reduced to practice, know-how, clinical product and service processes and techniques, research and development information, medical protocols, copyrightable works, financial, marketing and business data, pricing and cost information, business and marketing plans and customer and supplier lists and information, (vii) other proprietary rights relating to the foregoing (including, without limitations, remedies against infringement thereof and rights of protection of interest therein under the laws of all jurisdictions) and (viii) copies and tangible embodiments thereof; provided, however, that there is excluded from the A-3 definition of "Intellectual Property" any information (a) previously known to or under development by a Medical Group Physician and listed on an Appendix to his Employment Agreement, (b) generally known in the health care industry, or (c) obtained by a Medical Group Physician from a third party lawfully possessing such Intellectual Property 10.17. "Medical Group Shareholder" means the individual or individuals in ------------------------- whose name the shares of Medical Group have been issued. 10.18. "Net Adjusted Billings" shall have the meaning set forth in --------------------- Schedule 10.18 attached hereto, as such schedule shall be amended from time to - -------------- time by the Joint Policy Board. 10.19. "Net Margin" means, for any Fiscal Period, the excess (or deficit) ---------- of Gross Margin less the sum of (i) the Baseline Amount, and (ii) PQC Direct Expenses. 10.20. "Non-Established Physician" shall mean any Medical Group Physician ------------------------- assigned to an Additional Pod (i) who did not have an established practice that is merged into the Medical Group, (ii) listed in Schedule B-2, or (iii) whose ------------ Baseline Net Adjusted Billings would be less than the Market Compensation (as defined in 10.13) for such physician; provided, however, that a Medical Group Physician shall cease to be a Non-Established Physician on the basis of clauses (i) or (ii) above at such time as the Joint Policy Board determines to be appropriate. 10.21. "Payor" shall mean any insurer, health maintenance organization, ----- preferred provider organization, self-insured employer, labor union or other organization or entity that arranges for the delivery of health care services to enrollees or patients, including the Medicare and Medicaid programs and including independent practice associations, physician-hospital organizations, medical groups and other licensed providers. 10.22 "Payor Contracts" shall mean the contracts, agreements and --------------- arrangements between Medical Group and Payors for the provision of health care items and services. 10.23. "Physician Draw" shall mean, with respect to each Physician, for -------------- each Fiscal Period (prorated for any partial Fiscal Periods) the amount of cash to be advanced to Physician on a bi-weekly or monthly basis as an interim payment of, in the case of the Founding Pods, the portion of Gross Margin and Net Margin due to Physician hereunder, and in the case of the Additional Pods, the Available Amount. Physician Draw shall be subject to change from time to time in accordance with the provisions of Appendix B hereof. For purposes of the Fiscal Period commencing January 1, 1996, the Physician Draw shall be, for each Physician, the amount set forth on Schedule B-1 attached to this Agreement. 10.24. "Pod Physician" shall mean, with respect to a Pod, all Medical ------------- Group Physicians who are assigned to the Pod. 10.25. "Pod Practice" or "Pod" shall mean, with respect to a Pod, the ------------ --- medical practice of Medical Group as conducted through the Pod: (i) a Pod A-4 Practice Location, or (ii) a group of Pod Practice Locations, or (iii) a functional line of business such as a laboratory, and in the case of clause (ii) or (iii), as approved by the Joint Policy Board to function as a distinct reporting unit within Medical Group. 10.26. "Pod Practice Locations" shall mean, with respect to a Pod, all ---------------------- Practice Locations assigned to the Pod. 10.27. "PQC Direct Expenses" or "Direct Expenses" shall mean all actual ------------------- --------------- direct expenses of PQC incurred in connection with providing management services to Medical Group under this Agreement calculated in accordance with generally accepted accounting principles, including rent, utilities, cleaning, and other occupancy costs attributable to PQC's Baltimore office or any other office in the Geographic Area maintained for the purpose of supporting one (1) or more Pod Practice Locations (together with PQC's Baltimore office, the "Area Offices"); salary and benefit expense for PQC's employees providing services to benefit any one (1) or more of the Pod Practice Locations; depreciation and amortization of equipment located at the Area Offices except depreciation and amortization with respect to the assets initially acquired by PQC or Medical Group from Medical Group Physicians on their practices; telephone, facsimile, and similar communication charges (including the cost of any so-called tie-line from the Area Offices to the office housing the principal central computer system for physician practice sites managed by PQC or any of its affiliates); maintenance and repair costs for the Area Offices and equipment located therein; insurance related to the Area Offices and PQC's employees based in any such office or any one (1) or more of the Pod Practice Locations; professional services (including legal and accounting) related directly to the Area Offices or any of the Pod Practice Locations; office supplies used by PQC's Area Offices or any of PQC's employees located at any of the Pod Practice Locations; and other expenses incurred by PQC with the consent of the Joint Policy Board. 10.28. "Practice Expenses" shall mean, with respect to a Pod, the ----------------- following expenses: (a) Salaries, fringe benefits, and employment taxes and insurance (or self insured losses) of all Administrative Staff and Clinical Staff (as defined in Sections 3.4 and 2.5 of this Agreement) and physicians who are not Medical Group Physicians, whether employees or independent contractors, working at or for the direct benefit of the Pod Practice Locations; and employment taxes and expenses for a standard package of health and disability insurance approved by the parties prior to the Effective Date and for up to $50,000 of term life insurance coverage for Pod Physicians; (b) The direct cost (excluding any general and administrative overhead of PQC) of any other management, administrative or professional services provided at or in connection with the Pod Practice that are incurred by PQC or Medical Group, including management, billing and collections, business office consultation, accounting and legal services for the Pod Practice; (c) (i) The cost of capital (including actual interest on indebtedness incurred by or on behalf of Medical Group but only to the extent actual interest A-5 is incurred from a third party other than Bain Capital), to finance or refinance obligations of Medical Group related to the Pod Practice, to purchase medical or nonmedical equipment for the Pod Practice (other than those assets, if any, purchased by PQC as part of the initial acquisition of the medical practice that served as the basis of the Pod) or to provide working capital or finance new ventures of Medical Group related to the Pod Practice; (ii) depreciation and amortization charges to be paid to PQC, the amounts of which shall be set forth in the Pod Budget or for costs of capital described in Section 10.27(e)(i) of this Appendix A, or, if in excess of the budgeted amount, is agreed upon by PQC and the Joint Policy Board (expressly excluding any depreciation and amortization charges relating to assets, if any, purchased by PQC as part of the initial acquisition of the medical practice that served as the basis of the Pod; (d) Occupancy costs attributed be the Pod Practice (whether principal, interest, depreciation, taxes or rent) incurred in obtaining, improving, developing, leasing, operating, maintaining; replacing and preserving office space and equipment for the Pod Practice, including janitorial services, refuse disposal and medical waste disposal; (e) Direct costs incurred in obtaining, leasing, operating, maintaining and replacing computer systems and software located at the Pod Practice Locations, including billing systems, outcomes reporting systems and financial reporting systems and the cost of so-called tielines; (f) All utilities, including but not limited to telephone service (including business calls on cellular telephones), answering services, electricity, heat, water, and sewer that are used at the Pod Practice Locations; (g) Postage, facsimile, collection and credit verification costs incurred for the Pod Practice; (h) Pharmaceuticals, x-ray and laboratory expenses (both in-house and other) for the Pod Practice; (i) Medical supplies for the Pod Practice; (j) All office supplies for the Pod Practice; (k) Copying charges for the Pod Practice; (l) Professional journals and books, professional dues and memberships, and magazine and newspaper subscriptions for the Pod Practice; (m) Continuing Medical Education expenses for the Pod Physicians, within guidelines approved by the Joint Policy Board; (n) Direct advertising, accounting and legal expenses incurred in connection with the Pod Practice; A-6 (o) Insurance expenses, including but not limited to (1) general liability, fire, and property for each Pod Practice Location and (2) professional liability insurance for Pod Physicians and for Clinical Staff while providing services in connection with the Pod Practice; provided, that, in the event that PQC causes Pod R to change professional liability insurance carriers, Practice Expenses shall not include the cost of coverage to the extent, but only to the extent, that the aggregate cost of the new professional liability policy and the nose and/or tail coverage exceeds the cost of the professional liability coverage maintained by the physicians in Rod R on the Effective Date; (p) Any casualty losses suffered by Medical Group that are related to the Pod Practice to the extent that such losses are not reimbursed by any third party responsible therefor or through insurance; (q) A pro rata share calculated on the basis of the ratio of the number of Pod Physicians to the number of Medical Group Physicians or such other reasonable allocation methodology as PQC may develop from time to time and as may be approved by the Joint Policy Board, of expenses incurred by PQC and included within a budget approved by the Joint Policy Board for Medical Group as a whole (excluding any corporate-related general and administrative overhead of PQC), for example, Medical Group-wide management information system expenses, malpractice costs for Medical Group as a whole (as opposed to individual physicians), accounting and pension plan services, Medical Group tax return preparation, and providing or arranging for other necessary administrative, accounting and legal services. Overhead of Medical Group and PQC included in Practice Expenses shall be allocated by PQC and the Joint Policy Board among the Additional and Founding Pods in an equitable manner that (i) does not penalize the Additional Pods for (a) the higher historical overhead expenses of the Founding Pods compared to Pod R and (b) increased overhead expense incurred by Medical Group to improve the profitability of the Founding Pods and (ii) does not penalize the Founding Pods for increased overhead expense due to the Additional Pods. (r) With respect to Pod R, 100% (subject to the limitations set forth in Section 7.5(a) of the Merger Agreement between Flagship II, Clinical Associates and PQC) of any Damages (as defined in the Merger Agreement ) arising out of, or relating to, the conduct of the business of Clinical Associates prior to August 1, 1997, except to the extent that PQC recovers such Damages pursuant to Article VII of the Merger Agreement. 29. "Practice Revenues" with respect to a Pod, the amount equal to all ----------------- revenues of Medical Group attributable to the Pod Practice or assigned by the Pod Physicians pursuant to their Employment Agreements with the Medical Group, net of federal, state and local income taxes of Medical Group, adjustments for uncollectible accounts, Medicare, Medicaid and other contractual allowances, discounts, workers' compensation adjustments, professional courtesies and other reductions in collections, including: (a) all professional fees and other charges actually recorded each month on an accrual basis of accounting under generally accepted accounting principles as a result of medical services rendered by Medical Group through the Pod and the Pod Physicians, whether rendered in an outpatient or inpatient setting; (b) the technical component of fees earned with respect to services rendered by Medical Group through the Medical Group Pod (including all fees for technical and ancillary services and A-7 all facility fees and similar charges); (c) all collections from managed care organizations and Payors, or payments made in respect of enrollees of such managed care organizations or Payors, including payments made periodically on a per member basis for the partial or total medical needs of a subscribing member, and any co-payments and incentive bonuses, management fees and other amounts received and fees paid in respect of services provided by or through the Pod as a result of a capitation plan or risk-sharing arrangement; (d) grants, fees and other payments in connection with basic or clinical research conducted by Pod Physicians or under grant programs, whether publicly or privately funded, including grants or programs for the care of special patient populations; (e) consulting fees of Pod Physicians, including without limitation honoraria, witness fees and like amounts; (f) fees and payments for workers compensation evaluations or independent medical examinations; (g) all coordination of benefits, patient co-payments or deductibles and third-party liability recoveries; and (h) any other revenues from the practice of medicine or provision of health care items and services of any kind, except to the extent that the parties may otherwise agree in writing). With respect to Pod R, Practice Revenues shall also include, without duplication of the foregoing, all revenues earned with respect to Pod R from sources of revenue that were included in the revenues of Clinical Associates prior to the Closing Date. Notwithstanding the foregoing, Practice Revenues shall not include any income unrelated to any of the foregoing items that is personal to a Pod Physician and unrelated to the provision of health care or ancillary services (e.g., personal dividend or trust income), and provided further that the Joint Policy Board may approve in writing the retention by a Pod Physician of limited honoraria and similar amounts. A-8 APPENDIX B-1 ------------ FINANCIAL ARRANGEMENTS FOUNDING PODS ------------- 1. General. As set forth in greater detail below and subject to all of ------- the conditions and provisions hereof, the parties agree that the aggregate compensation to be paid to PQC for services rendered under this Agreement with respect to the Founding Pods shall equal the sum of (1) all PQC Direct Expenses which are incurred in connection with the provision of services to Medical Group and (2) additional compensation equal to fifty percent (50%) of Net Margin of the Founding Pods. This Appendix B-1 also provides for the priority of application of Practice Revenues of the Founding Pods to various categories of expenditures. 2. Application of Practice Revenues of the Founding Pods. ----------------------------------------------------- Practice Revenues of the Founding Pods shall be applied to expenses and other required distributions under this Agreement in the following order of priority: (a) Step 1 - Practice Revenues of the Founding Pods shall be applied to pay --- ------ Practice Expenses of the Founding Pods. (b) Step 2 - Any Gross Margin attributable to the Founding Pods remaining --- ------ after Step 1 above shall next be applied to payment of (i) the Baseline Amount (minus the amount necessary to pay all Deductible Expenses of the Founding Pods) and (b) PQC Direct Expenses on a proportional basis equal to the ratio of (i) the Baseline Amount to (ii) PQC Direct Expenses as approved by the Joint Policy Board for the then current Fiscal Period or in the absence of approval of a budget for the then current Fiscal Period, in the ratio set forth on Schedule B- 1 attached to this Agreement. By way of example only and not as a limitation, if the Baseline Amount is $12 million and budgeted PQC Direct Expenses allocated to the Founding Pods are $1 million, then under this Step 2 12/13ths or 92.31% of each dollar of Gross Margin shall be allocated to Medical Group for payment of the Baseline Amount and the remaining 1/13th or 7.69% of each dollar of Gross Margin shall be allocated to PQC. (c) Step 3 - After completion of Step 2, any remaining Net Margin --- ------ attributed to the Founding Pods shall be allocated fifty percent (50%) to Medical Group for distribution to the Medical Group Physicians in the Founding Pods and fifty percent (50%) to PQC as additional compensation hereunder. Subject to review by the Joint Policy Board, PQC shall calculate the amounts of Gross Margin and Net Margin to be allocated to each of Medical Group and PQC under this Section 2. If the Gross Margin is negative in any Fiscal Period, such negative amount shall constitute Practice Expenses of the Founding Pods for the next following Fiscal Period. In the event Net Margin is negative in the Fiscal Periods ending December 31, 1997 or December 31, 1998, PQC may be obligated to make a loan to Medical Group in accordance with the provisions of Section 3.5 of the Agreement. B-1 3. Payment of Physician Draw. On a bi-weekly basis, PQC shall distribute ------------------------- to Medical Group from the Founding Pod Medical Group Account referred to in Section 3.12 of this Agreement an amount equal to one twenty-sixth of the budgeted aggregate Physician Draw (minus the amount necessary to pay all Deductible Expenses) for distribution by Medical Group; provided, however, if (a) at any time during a Fiscal Period, PQC determines that the amount of Practice Revenues allocated to the payment of aggregate Physician Draw under this Appendix B-1 for any Fiscal Period may be less than ninety-five percent (95%) of the budgeted aggregate Physician Draw of Medical Group Physicians in the Founding Pods for such Fiscal Period, or (b) if PQC or the Joint Policy Board determines (1) the aggregate Practice Expenses of a Founding Pod for such Fiscal Period will exceed the aggregate budgeted Practice Expenses of such Founding Pod for such Fiscal Period, or (2) the aggregate Practice Revenues of a Founding Pod will be less than the aggregate budgeted Practice Revenues of such Founding Pod, PQC may, and upon direction from the Joint Policy Board, shall, reduce the aggregate Physician Draw in such manner as PQC determines to be appropriate. Subject to the provisions of Section 3.5 of this Agreement, the aggregate Physician Draw of Medical Group Physicians in the Founding Pods shall be adjusted to reflect the addition of new Medical Group Physicians to a Founding Pod or the termination or resignation of any Medical Group Physician assigned to a Founding Pod or to reflect such other factors as PQC and the Joint Policy board shall mutually agree to be appropriate. PQC may, but shall not be required to, advance money to the Compensation Pool as defined in Appendix A to the Employment Agreement to fund such Physician Draw. 4. Payment of Variable Distribution Pool. Within forty-five (45) days of ------------------------------------- the end of each of the first three (3) calendar quarters in each Fiscal Period, PQC shall advise Medical Group's Compensation Committee (as defined in Employment Agreements) of the amount (the "Variable Distribution"), if any, of Net Margin allocable to Medical Group under Section 2 of this Appendix B-1 that has not been used, or is not reasonably anticipated by PQC to be needed for Medical Group to fund, all amounts required to be funded by Section 3. PQC shall disburse to Medical Group from the Founding Pod Medical Group Account referred to in Section 3.12 of this Agreement the amount of the Variable Distribution, which shall be distributed to the Medical Group Physicians in the Founding Pods in such manner consistent with law as is described in Section 4 of Appendix A to the Employment Agreements. 5. Annual Reconciliation of Distributions. Within sixty (60) days after -------------------------------------- the end of each year, PQC shall (i) total and report Practice Revenues and Practice Expenses for each of the Founding Pods, (ii) total and report aggregate Practice Revenues for all Founding Pods and aggregate Practice Expenses for all Founding Pods, (iii) total and report PQC Direct Expenses, (iv) total and report all amounts advanced as Physician Draws and Variable Distributions with respect to the Founding Pods, (v) total and report the level of Gross Margin, whether positive or negative, and (vi) total and report the level of Net Margin, whether positive or negative (taking into account any adjustments necessary in the event that distributions during the said Fiscal Period or any prior Fiscal Periods have resulted in an over-advancement or under-advancement of funds). Each Founding Pod, as a Discretionary Expense of its Medical Group Physicians, may inspect Medical Group's books and records and PQC's books and records in order to verify the amount and proper calculation of the sums to be determined hereunder. PQC may not charge any Pod or Physician Member any access or similar fee in connection with any request to review books and records. If such B-2 independent accounting presents a report identifying a departure in such financial reports from generally accepted accounting principles, which departure has had a material adverse effect on the revenues allocated to Physician Group, PQC shall reimburse the Physician Members for the cost of such report. 6. Distribution in Event of Actual or Anticipated Negative Gross Margin. -------------------------------------------------------------------- In the event that for any calendar quarter, Gross Margin is a negative number or in the event either party gives notice to the other that there is reason to believe Gross Margin may be a negative number, PQC shall promptly propose a remedial plan of action to the Joint Policy Board and the parties agree to cooperate in good faith in order to implement such remedial plan or such other corrective action as shall be approved by the Joint Policy Board. At PQC's sole discretion, PQC may elect to advance working capital funds to Medical Group in such amounts and at such times, and from time to time, as PQC shall determine necessary to satisfy aggregate Practice Expenses for all Founding Pods, such advances to be treated as loans, the repayment of which shall be required in accordance with the definition of "Practice Expenses" in Section 10.27 of Appendix A hereto. In the event PQC shall elect not to make advances sufficient to satisfy aggregate Practice Expenses for all Founding Pods and Medical Group has not otherwise satisfied Practice Expenses from its own resources, either party shall have the right to terminate this Agreement upon thirty (30) days' written notice. 7. Manner of Payment of Final Reconciliation. Within seventy (70) days ----------------------------------------- after the end of the Fiscal Period, Medical Group and PQC shall make such payments, if any, to each other as may be required under the provisions of this Appendix B-1. Medical Group covenants to distribute any amounts to the Medical Group Physicians in a manner that complies with all applicable law. 8. Manner of Payment of PQC Direct Expenses and Compensation to PQC. PQC ---------------------------------------------------------------- shall arrange for the payment of PQC Direct Expenses and the compensation to PQC itself in accordance with the terms of this Appendix and is hereby authorized to make withdrawals from the Founding Pod Medical Group Account for such amounts at the time or times that the amounts become due. Medical Group hereby authorizes PQC to make such withdrawals from the Founding Pod Medical Group Account for accrued but unpaid PQC Direct Expenses and compensation owed to PQC under the provisions of this Appendix B-1 after termination of this Agreement. B-3 APPENDIX B-2 ------------ FINANCIAL ARRANGEMENTS ADDITIONAL PODS --------------- 1. General. As set forth in greater detail below and subject to all of ------- the conditions and provisions hereof, the parties agree that the aggregate compensation to be paid to PQC for services rendered under the Agreement with respect to the Additional Pods shall be the aggregate of the amounts determined in paragraphs 2, 3, 4, 5, 6 and 7 below. A Revenue Flow table is attached as Schedule B-2. Practice Revenue Attributable to Net Adjusted Billings. 2. Pod R Specialists. Net Adjusted Billings with respect to Physicians ----------------- with specialists practice (a specialist being a physician at least 80% of whose billings are derived from a specialist practice, excluding OB/GYN and mental health) in Pod R on the Effective Date ("Net Adjusted Specialists Billings") for any Fiscal Year shall, except as provided in Section 4 of this Appendix B-2, be allocated between PQC and Medical Group in the following order of priority: (a) Step 1 - Net Adjusted Specialist Billings shall be allocated to the ------ Additional Pod Medical Group Account until an amount equal to the Baseline Net Adjusted Billings for Medical Group Physicians with specialist practices in Pod R on the Effective Date has been allocated to the Additional Pod Medical Group Account. (b) Step 2 - The next $3 million (or any lesser amount, if there shall not ------ be $3 million of additional Net Adjusted Specialist Billings) of Net Adjusted Specialist Billings shall be allocated 35% to PQC as compensation for its services and 65% to the Additional Pod Medical Group Account. (c) Step 3 - Any Net Adjusted Specialist Billings that remains unallocated ------ after Steps 1 and 2, shall be allocated 20% to PQC as compensation for its services and 80% to the Additional Pod Medical Group Account. 3. Other Physicians. Net Adjusted Billings with respect to primary care ---------------- physicians and any physicians with specialist practices who are not subject to paragraph 2 or 4 ("Net Adjusted Physician Billings") for any Fiscal Year shall, except as provided in Section 4 of this Appendix B-2, shall be allocated between PQC and Medical Group in the following order of priority: (a) Step 1 - Net Adjusted Physician Billing shall be allocated to ------ Additional Pod Medical Account until an amount equal to the Baseline Adjusted Net Billings for primary care Group Medical Physicians and Group Medical Physicians with specialist practices who are not subject to paragraphs 2 or 4 has been allocated to the Additional Pod Medical Group Account. B-4 (b) Step 2 - Any Net Adjusted Physician Billing not allocated in Step 1 ------ shall be allocated 20% to PQC as compensation for its services under this Agreement and 80% to the Additional Pod Medical Group Account. 4. Non-Established Physicians. With respect to any Non-Established -------------------------- Physician, 20% (unless a different percentage is approved by the Joint Policy Board) of the Incremental Amount with respect to such physician shall be allocated to PQC as compensation for its services under this Agreement and the remaining Net Adjusted Billings with respect to such Medical Group Physician (less the compensation payable to the Non-Established Physician under the Non- Established Physician's employment agreement with Medical Group) shall be allocated to the Additional Pod Medical Group Account. Practice Revenue Not Attributable to Net Adjusted Billings. 5. Revenue not included in Net Adjusted Billings. Any Practice Revenues ---------------------------------------------- of the Additional Pods for any fiscal year that are not included in Net Adjusted Billings ("Other Revenues") shall be allocated to Additional Pod Medical Group Account, provided, however, if Practice Expenses are less than [__% to be included based upon historical Net Adjusted Billings] ("Historical Overhead") of Practice Revenue, PQC shall be allocated an amount equal to 50% of (x) Practice Revenue multiplied by (y) the difference between Historical Overhead and Overhead for such fiscal year. Overhead shall be calculated in the manner set forth on Schedule B-2(b). Ancillary Revenue 6. Laboratory Services. Net Margin from centralized laboratory services -------------------- (which for purposes of this paragraph 6 shall mean revenue from laboratory ancillary services less (i) direct expenses of such laboratory ancillary services and (ii) an allocation of overhead of the Medical Group, which allocation, or the methodology used to make such allocation, shall be approved by the Joint Policy Board) attributable to Additional Pods will be allocated 80% to PQC and 20% to the Additional Pods Medical Group Account. 7. Non- Laboratory Ancillary Services. Net Margin from incremental non- ----------------------------------- laboratory ancillary services other than the non-laboratory ancillary services listed in Schedule 10.17 (which for purposes of this paragraph 7 shall mean -------------- revenue of non-laboratory ancillary services less (i) direct expenses from such non-laboratory ancillary services and (ii) an allocation of Medical Group overhead, which allocation, or the methodology used to make such allocation, shall be approved by the Joint Policy Board) will be allocated 50% to PQC and 50% in the aggregate to the Found Pod Medical Group Account and the Additional Pod Medical Group Account. B-5 Certain Practice Expenses 8. Certain Expense Not Practice Expenses. Expenses of administrative -------------------------------------- staff and support services (including all PQC or Flagship support services) included within Clauses (a) and (b) of the definition of Practice Expenses shall not be deemed to be Practice Expense of Pod R to the extent, but only to the extent, that the costs of such administrative staff and support services are in excess of historical levels for Clinical Associates and such increase in costs is specifically attributable to (x) services performed by such administrative staff for Pods other than Pod R and not to the addition of physicians to Pod R or change in the market costs for such services or labor rates or (y) additional support services to which Pod R, acting reasonably, shall have objected at the time their implementation was proposed by PQC. Medical Group Account 9. Allocation of Net Adjusted Billings to Medical Group Account. Amounts ------------------------------------------------------------- allocable to the Additional Pod Medical Group Account pursuant to paragraphs 2, 3, 4, 5, 6 and 7 (to the extent the allocation in made to the Additional Pods) shall first be used to pay all Practice Expenses of the Additional Pods. Any amount remaining after the payment of Practice Expenses shall be available for distribution to Medical Group Physicians in the Additional Pods. 10. Payment of Physician Draw. On a monthly basis, PQC shall distribute ------------------------- to Medical Group from the Additional Pod Medical Group Account referred to in Section 3.12 of this Agreement an amount equal to one twelfth of the budgeted aggregate Physician Draw of Medical Group Physicians in the Additional Pods (minus the amount necessary to pay all Deductible Expenses) for distribution by Medical Group; provided, however, if (a) at any time during a Fiscal Period, PQC determines that the amount of Net Adjusted Billings allocated to the Additional Pod Medical Group Account pursuant to this Appendix B-2 net of Practices Expenses (the "Available Amount") for any Fiscal Period may be less than ninety- five percent (95%) of the budgeted aggregate Physician Draw for such Fiscal Period with respect to the Medical Group Physicians in the Additional Pods, or (b) if PQC or the Joint Policy Board determines (1) the aggregate Practice Expenses of an Additional Pod for such Fiscal Period will exceed the aggregate budgeted Practice Expenses for such Additional Pod for such Fiscal Period, or (2) the aggregate Net Adjusted Billings allocable to the Additional Pod Medical Group Account with respect to an Additional Pod will be less than the aggregate budgeted Net Adjusted Billings allocable to the Medical Group with respect to such Additional Pod, PQC may, and upon direction from the Joint Policy Board, shall, reduce the aggregate Physician Draw with respect to the Additional Pods in such manner as PQC determines to be appropriate. Subject to the provisions of Section 3.5 of this Agreement, the aggregate Physician Draw with respect to the Additional Pods shall be adjusted to reflect the addition of new Medical Group Physicians to an Additional Pod or the termination or resignation of any Medical Group Physician from an Additional Pod or to reflect such other factors as PQC and the Joint Policy board shall mutually agree to be appropriate. PQC may, but shall not be required to, advance money to the Compensation Pool as defined in Appendix A to the Employment Agreement to fund such Physician Draw. B-6 11. Payment of Variable Distribution Pool. Within forty-five (45) days of ------------------------------------- the end of each of the first three (3) calendar quarters in each Fiscal Period, PQC shall advise Medical Group's Compensation Committee (as defined in Employment Agreements) of the amount (the "Variable Distribution"), if any, of the Available Amount that has not been used, or is not reasonably anticipated by PQC to be needed for Medical Group to fund, all amounts required to be funded by paragraph 10. PQC shall disburse to Medical Group from the Additional Pod Medical Group Account referred to in Section 3.12 of this Agreement the amount of the Variable Distribution, which shall be distributed to the Medical Group Physicians in the Additional Pod in such manner consistent with law as is described in Section 4 of Appendix A to the Employment Agreements. 12. Annual Reconciliation of Distributions. Within sixty (60) days after -------------------------------------- the end of each year, PQC shall (i) total and report Net Adjusted Billings and Practice Expenses for each Additional Pod, (ii) total and report aggregate Net Adjusted Billings and Practice Expenses for all Additional Pods, (iii) total and report all amounts advanced as Physician Draws and Variable Distributions with respect to the Additional Pods. Each Additional Pod, as a Discretionary Expense of its Medical Group Physicians, may inspect Medical Group's books and records and PQC's books and records in order to verify the amount and proper calculation of the sums to be determined hereunder. PQC may not charge any Pod or Physician Member any access or similar fee in connection with any request to review books and records. If such independent accounting presents a report identifying a departure in such financial reports from generally accepted accounting principles, which departure has had a material adverse effect on the revenues allocated to Physician Group, PQC shall reimburse the Physician Members for the cost of such report and appropriate adjustments to the Additional Pod Medical Group Account. 13. Manner of Payment of Final Reconciliation. Within seventy (70) days ----------------------------------------- after the end of the Fiscal Period, Medical Group and PQC shall make such payments, if any, to each other as may be required under the provisions of this Appendix B-2. Medical Group covenants to distribute any amounts to the Physicians in a manner that complies with all applicable law. 14. Manner of Payment of Compensation to PQC. PQC shall arrange for the ---------------------------------------- payment of the compensation to PQC itself in accordance with the terms of this Appendix B-2 and is hereby authorized to make withdrawals from the Medical Group Account for such amounts at the time or times that the amounts become due. Medical Group hereby authorizes PQC to make such withdrawals from the Additional Pod Medical Group Account for compensation owed to PQC under the provisions of this Appendix B-2 after termination of this Agreement. B-7 SCHEDULE B-1 ------------ I. Name of Physician Physician Draw for Fiscal Period Ending December 31, 1996 --------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- [See Section 6 of Appendix A to the Employment Agreements with the Physician Members.] - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- II. Ratio of Baseline Amount to budgeted PQC Direct Expenses - ------------------------------------------------------------------------------- B-8 APPENDIX C ---------- LIST OF PHYSICIANS ------------------ Name of Pod Partner Physicians Employed Physicians - ----------- ------------------ ------------------- Pod A Pod B Pod C Pod D Pod E Pod F Pod G Pod H Pod I Pod J Pod K Pod L Pod M Pod N Pod O Pod P Pod Q Pod R C-1 Services Agreement Schedules Schedule 2 - Facilities Flagship leases offices at the following addresses: Lease Agreement by and between Park Medical Associates, P.A. and Johns Hopkins Suburban Health Center Limited Partnership for Green Spring Station, dated January 28, 1994. Sublease by and between Broadway Medical Management Corp. and Marshall S. Bedine, M.D., P.A., dated December 11, 1995, for lease of office space at 10751 Falls Road, Lutherville, Maryland 21093. Lease Agreement by and between Johns Hopkins Suburban Health Limited Partnership and Drs. Berg & Wen, P.A. dated April 5, 1996. Standard Full Service Office Building Lease Agreement by and between Joppa Green II Limited Partnership and Ira T. Fine, M.D. and Joyce K. Burd, M.D., dated August 25, 1989, as amended by an amendment by and between Joppa Green II Limited Partnership and Ira T. Fine, M.D., dated August 8, 1994, for lease of office space at 2328 W. Joppa Road, Lutherville, MD. Lease Agreement by and between Johns Hopkins Suburban Health Center Limited Partnership and Ira T. Fine, M.D., and Joyce K. Burd, M.D., dated April 7, 1994, for lease of office space located at 10755 Falls Road, Lutherville, MD 21093. Sublease Agreement between Ira T. Fine, M.D. & Joyce K. Burd, M.D., P.A. (Sublandlord) and Johns Hopkins Health System Corporation (Subtenant), dated April 1, 1996, for sublease of office space located at 10755 Falls Road, Lutherville, MD 21093. Agreement of Lease by and between Suite B, 222 West Cold Spring Lane, a Maryland general partnership, and Koeppel, Rosen, Rudikoff, M.D., P.C., dated December 31, 1994, for lease of office space at 222 West Cold Spring Lane, Baltimore, Maryland 21210. Sublease by and between Steinbach & Benesh, P.A. (Landlord) and Koeppel, Rosen, Rudikoff, M.D., P.C. (Tenant), dated April 4, 1994, for sublease of office space at 21 Crossroads Drive, Suite 400, Owings Mill, Maryland 21117. Agreement of Lease by and between Naylors Lane Limited Partnership and Drs. Goldgeier, Levine, Friedman and Halle, dated November 28, 1994, for use of office space at 4000 Old Court Road, Suite 306, Pikesville, Maryland 21208. The Rotunda Office Lease by and between Rotunda Associates and Drs. Goldgeier, Levine, Friedman, Zygler, Bardin, P.A., dated July 14, 1993, as amended by First -1- Amendment of Lease by and between Rotunda Associates and Drs. Goldgeier, Levine and Friedman, P.A., undated, and as amended by Second Amendment of Lease by and between Rotunda Associates and Drs. Goldgeier, Levine and Friedman, P.A., dated July 11, 1996, for use of premises at 711-733 West 40th St., Baltimore, Maryland 21211. Sublease Agreement by and between Sinai Hospital of Baltimore, Inc. (Sublandlord) and Drs. Goldgeier, Levine and Friedman, P.A. (Subtenant) dated August 1, 1996. Sublease Agreement by and between Drs. Goldgeier, Levine and Friedman, P.A. (Sublandlord) and Barry D. Stein (Subtenant), dated July 1, 1996, for use of 533 square feet of space at 4000 Old Court Road, Pikesville, Maryland 21208. Lease for office space at 19 Walker Ave. Suite 203 by and between Milan Wister, M.D. and Stanley Friedler, M.D. (Walker Center), effective July 1, 1992. Lease for 10807 Falls Road, Lutherville, MD by and between Green Spring Professional Associates Limited Partnership (was Falls-Valley Limited Partnership and currently is Maryland Prime Investors, Inc.) and Sigler, Roskes, Holden & Schuberth, P.A. (was Sigler, Rosenstein, Roskes & Holden, P.A.), dated November 9, 1976, amended August 31, 1987, September 5, 1991, and September 16, 1991. Sublease by and between Sigler, Roskes, Holden and Schuberth, P.A. (Landlord) and Sinai Hospital of Baltimore, Inc. (Tenant), dated July 1, 1994 (no signed by Sinai). Rent: $25,200/year (approximately 1,200 square feet) (rent includes all - ---- utilities (heat, air conditioning, electricity, water, and local telephone); plus up to $2,400 to cover additional costs for insurance, cleaning services, office supplies, utilities, etc., if costs of the foregoing are greater than the monthly rent; plus an additional amount for expenditures exceeding the $2,400, provided that the tenant must give prior consent to such expenditures. Agreement of Lease by and between Johns Hopkins Suburban Health Center Limited Partnership and Drs. Pakula and Davick, P.A. [now known as Drs. Pakula, Davick & Bogue, P.A.], dated February 28, 1995, for lease of office space at 10755 Falls Road, Suite 260, Lutherville, Maryland 21093. License Agreement by and between Drs. Pakula and Davick, P.A. [now known as Drs. Pakula, Davick & Bogue, P.A.], and Sandra S. Rosenblatt, Ph.D., undated, for lease of office space at 10755 Falls Road, Lutherville, Maryland 21093. Oral lease by and between Neuro-Realty Partners (Landlord) and Peter Schilder, M.D., and Nicholas Capozzoli, M.D., P.A. (Tenant) for the lease of Unit 230, Weems Creek Medical Center, Annapolis, Maryland. -2- Lease Agreement by and between Drs. Sutton, Fortier, Gordon and Libber, P.A., and YWCA of Annapolis and Anne Arundel County, Maryland, dated January 1, 1994, for use of office space at 1517 Governor Ritchie Highway, Arnold, Maryland 21012. Lease assigned to Drs. Sutton, Fortier, Gordon and Libber, P.A., pursuant to Assignment and Assumption of Lease by and between Stanley R. Weimer, M.D., and Drs. Sutton, Fortier, Gordon, Libber, P.A., dated February 1, 1996, and Consent of Landlord, dated February 1, 1996. Lease Agreement by and between Annapolis Pediatrics and Piera Family Limited Partnership, dated September 22, 1993, as amended by Amendment to Lease Agreement, dated October 28, 1996, for use of office space at 1202-B Annapolis Road, Odenton, Maryland. Lease Agreement by and between Monterey Medical Associates and Drs. Sutton, Fortier, Gordon and Libber, P.A., dated July 1, 1992, for use of office space at 200 Forbes Street, Annapolis, Maryland 21401. Lease for 900 Bestgate Road dated May 2, 1991 by and between Bestgate "900" Limited Partnership and Richard Peeler, Robert Biern, Stanley Watkins, Enser Cole, Barry Nathanson, Stuart Selonick, Mary Michels [sic] and David Barnes (Lease not executed), with: (1) Memorandum of Amendment dated December 13, 1991 (copy not available, although terms of this amendment have been superseded), (2) Memorandum of Lease Modification dated December 1, 1991 (not executed), and (3) First Addendum to Lease dated December 14, 1995, by and between Bestgate "900" Limited Partnership and Annapolis Medical Specialists. Memorandum of Lease Modification dated December 1, 1991, by and between Bestgate "900" Limited Partnership and Richard Peeler, Robert Biern, Stanley Watkins, Enser Cole, Barry Nathanson, Stuart Selonick, Mary Michels and David Barnes. [Not executed.] Rent: Rent Schedule for the period December 1, 1991 to November 1992 is - ---- attached to the Memorandum. Lease Agreement by and between Johns Hopkins Suburban Health Center Limited Partnership (Landlord) and Laura M. Mumford, M.D. (Tenant), dated February 16, 1996. Sublease Letter Agreement by and between Laura Mumford, M.D. (Landlord) and Johns Hopkins Suburban Health Center Limited Partnership (Tenant), dated July 15, 1996 (signed only by Dr. Mumford) (letter is addressed to Gil Wylie, BMMC). Net Lease by and between Stone/Snyder General Partnership and Faith Hackett, M.D. and Jeffrey C. Schmidlein, M.D., dated October 18, 1991 and amended September 17, 1996. Net Lease by and between Stone/Snyder General Partnership and Faith Hackett, M.D. and Jeffrey C. Schmidlein, M.D., dated October 18, 1991 and amended September 17, 1996. -3- Office Lease by and between Severn Professional Center and Andre B. Gvozden, M.D., dated September 24, 1996, for 605 Baltimore-Annapolis Boulevard, Suite B. Agreement of Lease by and between University of Maryland Medical System Corporation (Landlord) and Andre Gvozden, [M.D.]
RENTAL PROPERTY - -------------------------------------------------------------------------------------------------- Lessor Monthly Payment Lessor Monthly Payment - -------------------------------------------------------------------------------------------------- G.S. Properties $ 5,590.59 Mark Kaplan $ 225.00 - -------------------------------------------------------------------------------------------------- 600.00 G.S. Properties 4,928.83 Noel McCall (some months) 750.00 - -------------------------------------------------------------------------------------------------- Sea 25,745.60 Landmark 750.00 - -------------------------------------------------------------------------------------------------- Wabash 410.00 Tower Management 2,463.79 - -------------------------------------------------------------------------------------------------- Security MDC 13,500.00 Helen McGill 2,400.00 - -------------------------------------------------------------------------------------------------- Lawrence Boas 1,800.00 Nissim, Schonfeld 2,500.00 - -------------------------------------------------------------------------------------------------- keiffer Mitchell 500.00 Woodholme Medical 10,354.04 - -------------------------------------------------------------------------------------------------- York Road Association 3,103.33 O'Dea Medical Arts 3,258.78 Building - -------------------------------------------------------------------------------------------------- Herbert Yousim 1,741.16 Towson Building 75,000.00/year Associates - -------------------------------------------------------------------------------------------------- Hill Management 6,704.53 William Tucker 500.00 - --------------------------------------------------------------------------------------------------
-4- Schedule 3.07 - Payor Contracts ELP U.S. Healthcare PHYCP (Prudential) -5- Schedule 3.15 - Insurance Separately provided. -6- Schedule 6.1 - Acceptable Non-Physicians William Bartholomay Sarah Bodnar Marla Caplan -7- Schedule 9.1 none -8- Additional schedules available upon written request to the Company. -9- EX-10.23 6 AGREEMENT Exhibit 10.23 ------------- AGREEMENT Agreement entered into as of November 30, 1997 by and among Physicians Quality Care, Inc., a Delaware corporation ("PQC"), Flagship Health, P.A., a Maryland professional association ("Flagship I"), Flagship Health II, P.A. ("Flagship II" and collectively with Flagship I, "Flagship"), and the physicians listed on the signature page of this Agreement who are former stockholders and optionholders (the "Stockholders") of Clinical Associates, a Maryland professional association. This Agreement provides for certain understandings between the Stockholders, PQC and Flagship in connection with the Amended and Restated Services Agreement between PQC and Flagship and the Employment Agreements between each Stockholder and Flagship. Now, therefore, in consideration of the representations, warranties and covenants herein contained, the parties agree as follows. Capitalized terms used in this Agreement and not defined in this Agreement shall have the meaning assigned to them in the Services Agreement. 1. Addition of Founding Medical Group Physicians to Additional Pod --------------------------------------------------------------- Compensation Model. The Services Agreement provides for a different - ------------------ compensation methodology for the Founding Pods and the Additional Pods. As a part of their long-term business goals, PQC and Flagship may determine that it is in their best interest to merge the compensation arrangements of the Founding Pods into the compensation arrangements for the Additional Pods. While PQC and Flagship shall have no obligation to do so, PQC and Flagship shall have the right to amend the Services Agreement, including Appendices B-1 and B-2 thereto, to merge the compensation arrangements of the Founding Pods into the compensation arrangements for the Additional Pods; provided that such merger and its material terms are approved by PQC and two-thirds of the Stockholders who continue to be Medical Group Physicians at such time. In the event that the compensation arrangements for the Founding Pods and the Additional Pods are merged, PQC shall provide a guarantee (which shall be in a form acceptable to two-thirds of the Stockholders, acting reasonably) to the Stockholders that for a two year period (commencing on the date of the merger of the compensation arrangements for at least ten physicians in one or more Founding Pods into the compensation arrangements for the Additional Pods) that the compensation of each Stockholders who continues to be a Medical Group Physician will not be less than the Physician Draw for such Stockholders as in effect at the time of such merger; provided that the guarantee shall provide for reduction of the guaranteed Physician Draw for the Stockholders to reflect declines, if any, in productivity and billing. At the end of the two-year period covered by the guarantee, the Services Agreement shall be amended, if requested by two-thirds of the members of the Management Committee, to establish a separate Medical Group Account and Compensation Pool with respect to Pod R. 2. Option to Amend Purchase Price. Within six months after the Effective ------------------------------ Date, the Stockholders, by the approval of two-thirds of the Stockholders, shall have the right to elect to receive up to an additional 2,000,000 shares of Class A Common Stock of PQC (the "Common Stock") as additional consideration for the merger of Clinical Associates into Flagship. As a condition to receipt of such additional shares, the Stockholders must agree to amend, effective upon delivery of such Common Stock, the Services Agreement and their Employment Agreements so that an additional $760,000 (or such proportionately reduced amount if less than 2,000,000 shares of Common Stock are elected) with respect to each fiscal year is payable to PQC from the amount that would otherwise be allocated pursuant to Appendix B-2 of the Services Agreement to the Additional Pod Medical Group Account. 3. Right to Additional Compensation in the Event of a Shortfall. With -------------------------------------------------------------- respect to each fiscal year during the Shortfall Period (as defined below), the amount that would have been allocated to PQC pursuant to Appendix B-2 of the Services Agreement shall be reduced by the Adjustment Amount and the amount that is allocated to the Additional Pod Medical Group Account shall be increased by the Adjustment Amount; provided, however, that if with respect to any fiscal year there is no Shortfall (as defined below) or PQC completes a public offering of its Common Stock at a price to the public of $9.00 or more per share, this Section 3 shall be of no further effect and no further adjustment shall be made pursuant to this Section 3 during any subsequent fiscal year. "Shortfall Period" shall mean every fiscal year commencing after December 31, 1997 to and including the earlier of (i) the first fiscal year in which there is no Shortfall or (ii) the fiscal year immediately preceding the date of the closing of a public offering of Common Stock with a price to the public of $9.00 or more. "Shortfall" shall mean the difference, if a positive amount, between $3 million and the aggregate increase in Net Adjusted Billings over Baseline Net Adjusted Billings by the specialist physicians in any Additional Pod; provided, however, that there shall not be deemed to be a Shortfall in the event that there is less than $3 million increase in Net Adjusted Billings because the specialist physicians in the Additional Pods do not have the capacity to accept (unless the Additional Pods are attempting in good faith to add physicians with the applicable speciality and do add such additional capacity within six months of notification from PQC), or were otherwise unwilling to accept (provided that PQC shall give the Management Committee one month to cure any such unwillingness to accept new patients if such refusals to accept new patients are isolated occurrences and are not recurring), such referrals. "Adjustment Amount" with respect to any fiscal year shall be equal to (i) 45% of the Shortfall for such fiscal year less the Laboratory Allocation. The Laboratory Allocation with respect to each fiscal year shall be equal to the Net Margin from Laboratory Services allocated to Pod R under the Services Agreement. The amount of any Shortfall, Laboratory Allocation and Adjustment Amount shall be calculated as soon as practicable after the end of each fiscal year. Any reallocation on the basis of an Adjustment Amount shall be made on or prior to the date that the Additional Pod Medical Group Account is to be distributed to the physicians in the Additional Pods under the Services Agreement. 4. Option to Sell Shares to PQC. In the event that on the fourth ---------------------------- anniversary of the Effective Date PQC has not completed an underwritten initial public offering, each Stockholder shall have the right to require PQC to repurchase the Common Stock issued to such Stockholder pursuant to the Merger Agreement at a purchase price of $3.00 per share (subject to adjustment for -2- stock splits and combination). PQC shall have the right to pay the purchase price in the form of a five (5) year non-interest bearing note. The principal payable with respect to each such note issued to a Stockholder shall be reduced each year that the note is outstanding by the amount, if any, that such Stockholder=s compensation from Flagship during such year exceeds the Stockholders' Physician Draw for such year. The election to have PQC repurchase the Common Stock must be made within 45 days of the fourth anniversary of the Effective Date. 5. Board Representation. PQC agrees that it will use its best efforts to -------------------- cause two physicians nominated by the Stockholders to be elected to PQC's Board of Directors. In addition, the Stockholders shall be entitled until such time as PQC completes an initial public offering to appoint a representative who will have the right to notice of and to be present at regularly scheduled meetings of the PQC Board. 6. Management Services for Pod R. PQC and Flagship agree that neither PQC ----------------------------- nor Flagship shall materially change the billing methodology used on the Effective Date with respect to Pod R or replace any senior level supervisory personnel used on the Effective Date by Pod R in billing and collections without the approval of a majority of the Members of the Management Committee. PQC and Flagship also agree not to replace the Flagship Chief Operating Officer or the Medical Director without the approval of a majority of the members of the Pod R Management Committee. 7. Operating Policies. PQC and Flagship intend that the operating policies ------------------- set forth on Annex A to this Agreement will be adopted by the Joint Policy Board as soon as practicable after the Effective Date. PQC agrees that the PQC Representatives to the Joint Policy Board will vote in favor of the adoption of such policies. 8. Publicity Budget. PQC and Flagship agree that the Flagship publicity -------------- budget for the first twelve months after the Effective Date shall be at least $1,000,000, $250,000 of which shall be a Practice Expense of Pod R. 9. Pod R Management Committee. The Stockholders agree that Pod R shall -------------------------- establish a Management Committee that shall primarily be responsible for overseeing the relationship between PQC, Flagship and the Medical Group Physicians assigned to Pod R and for taking the actions expressly contemplated by this Agreement. The membership and rules governing the Management Committee will be determined from time to time by the Medical Group Physicians assigned to Pod R. PQC and Flagship agree to work with Pod R in establishing the Management Committee. 10. Certain Changes in Control. PQC agrees that neither PQC nor Flagship ------------------------- will (i) merge or consolidate with or into, (ii) joint venture with, (iii) sell or lease all or substantially all of their assets to, (iv) grant governance participation to, (v) become managed by, or (vi) sell a controlling interest in the stock of Flagship or PQC to, a Baltimore Health Care Entity without the approval of a majority of the members of the Management Committee. A Baltimore -3- Health Care Entity means any hospital, medical group or other organization that principally conducts its business in and derives its revenues from the delivery of healthcare services in Maryland, but shall not include any physician group that enters into an affiliation transaction with PQC. 11. No Third Party Beneficiaries. This Agreement shall not confer any ---------------------------- rights or remedies upon any person other than PQC, Flagship and the Stockholders and their respective successors and permitted assigns. 12. Entire Agreement. This Agreement (including the documents referred to ---------------- herein) constitutes the entire agreement among the parties and supersedes any prior understandings, agreements, or representations by or among the parties, written or oral, with respect to the subject matter hereof. 13. Counterparts. This Agreement may be executed in two (2) or more ------------ counterparts, each of which shall be deemed an original but all of which together shall constitute one (1) and the same instrument. 14. Headings. The section headings contained in this Agreement are -------- inserted for convenience only and shall not affect in any way the meaning or interpretation of this Agreement. 15. Notices. All notices, requests, demands, claims, and other ------- communications hereunder shall be in writing. Any notice, request, demand, claim, or other communication hereunder shall be deemed duly delivered two (2) business days after it is sent by registered or certified mail, return receipt requested, postage prepaid, or one (1) business day after it is sent via a reputable nationwide overnight courier service, in each case to the intended recipient as set forth below: If to the Stockholders: - ----------------------- To the last known home address of each Stockholder as maintained in the records of Flagship with a copy to: Epstein, Becker & Green, P.C. 1227 25th Street, N.W. Washington, DC 20037-1156 Attention: Mark Lutes, Esq. -4- If to PQC or Flagship: - ---------------------- Physicians Quality Care, Inc. 950 Winter Street Suite 2410 Waltham, MA 02154 Attention: Jerilyn Asher With a copy to: David C. Phelan, Esq. Hale and Dorr 60 State Street Boston, MA 02109 Any party may give any notice, request, demand, claim, or other communication hereunder using any other means (including personal delivery, expedited courier, messenger service, telecopy, telex, ordinary mail, or electronic mail), but no such notice, request, demand, claim, or other communication shall be deemed to have been duly given unless and until it actually is received by the party for whom it is intended. Any party may change the address to which notices, requests, demands, claims, and other communications hereunder are to be delivered by giving the other Parties notice in the manner herein set forth. 16. Governing Law. This Agreement shall be governed by and construed in ------------- accordance with the internal laws (and not the law of conflicts) of the State of Maryland. 17. Amendments and Waivers. No amendment of any provision of this ---------------------- Agreement shall be valid unless the same shall be in writing and signed by PQC, Flagship and two-thirds of the Stockholders. No waiver by any party of any default, misrepresentation, or breach of warranty or covenant hereunder, whether intentional or not, shall be deemed to extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant hereunder or affect in any way any rights arising by virtue of any prior or subsequent such occurrence. 18. Severability. If any term, provision, covenant or restriction of this ------------ Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 19. Expenses. Except as otherwise expressly provided herein, each party to -------- this Agreement shall pay its own costs and expenses in connection with the transactions contemplated hereby. -5- IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. PHYSICIANS QUALITY CARE, INC. /s/ Samantha J. Trotman ------------------------------------------ By: Samantha J. Trotman Title: Chief Financial Officer and Vice President FLAGSHIP HEALTH, P.A. /s/ Dana Frank, M.D. ----------------------------------------- By: Dana Frank, M.D. Title: President FLAGSHIP HEALTH II, P.A. /s/ Dana Frank, M.D. ----------------------------------------- By: Dana Frank, M.D. Title: President -6- CLINICAL ASSOCIATES STOCKHOLDERS: /s/ Mohammed Ahmed ----------------------------------- /s/ Samuel Akman -------------------------------------- /s/ Mahmood Alikhan ------------------- /s/ Robert S. Baxt ------------------ /s/ George Bedon ---------------- /s/ Paul Z. Bodnar ------------------ /s/ William Bouchelle --------------------- /s/ James M. Corkum ------------------- /s/ Albert F. DeLoskey ---------------------- /s/ James F. Dunlay ------------------- /s/ Paul J. Edgar ----------------- /s/ Clara E. Escuder -------------------- /s/ Carl S. Friedman -------------------- -7- /s/ Miquel A. Frontera ---------------------- /s/ John Gambrill ----------------- /s/ Carlton Greene ------------------ /s/ Gregory Hall ---------------- /s/ Michael Jacobs ------------------ /s/ Kenneth P. Judd ------------------- /s/ Virginia Kranz ------------------ /s/ Michael Lifson ------------------ /s/ Richard H. Mack ------------------- /s/ Richard Maffezzoli ---------------------- /s/ Gary A. Manko ----------------- /s/ Steven Miller ----------------- /s/ Judah A. Minkove -------------------- /s/ Keiffer J. Mitchell ----------------------- -8- /s/ Charlotte E. Modly ---------------------- /s/ Rose Mary Mulaikal ---------------------- /s/ Bindu Noor -------------- /s/ Bonnie Orzech-Nixon ----------------------- /s/ James Paskert ----------------- /s/ Radha Pathak ---------------- /s/ Robert Peques ----------------- /s/ Toby Ritterhoff ------------------- /s/ Bruce Rosenberg ------------------- /s/ Duncan Salmon ----------------- /s/ David Saltzberg ------------------- /s/ Lise K. Satterfield ----------------------- /s/ Richard T. Scholz --------------------- /s/ Sidney Seidman ------------------ -9- /s/ Linda Sevier ---------------- /s/ David S. Shear ------------------ /s/ Ronald Sher --------------- /s/ Alan M. Shorofsky --------------------- /s/ Stephen M. Siegel --------------------- /s/ Stuart B. Silver -------------------- /s/ Edward Souweine ------------------- /s/ Jonathan E. Surell ---------------------- /s/ Anthony Vazzano ------------------- /s/ Barry Vogelstein -------------------- /s/ Richard Weisman ------------------- /s/ Julie Winston ----------------- /s/ Wayland Wong ---------------- /s/ Robert E. Zadek ------------------- -10- CLINICAL ASSOCIATES OPTIONHOLDERS: /s/ William Bartholomay ----------------------- /s/ Sarah Bodnar ---------------- /s/ Marla Caplan ---------------- -11- ANNEX A ------- Operational Policies. The approval of the Joint Policy Board or the Management Committee of Pod R will be required prior to PQC authorizing expenditures in excess of budgeted amounts. -12- EX-10.24 7 MERGER AGREEMENT Exhibit 10.24 ------------- MERGER AGREEMENT Agreement entered into as of July 31, 1997 by and among Physicians Quality Care, Inc., a Delaware corporation ("PQC"), Flagship Health II, P.A., a Maryland professional association ("Flagship"), Clinical Associates, P.A., a Maryland professional association (the "Company"), and the Stockholders ("the Stockholders") and Optionholders (the "Optionholders") of the Company listed on Schedule I hereto. Flagship, PQC, the Company, the Stockholders and the Optionholders are referred to collectively herein as the "Parties." This Agreement contemplates a merger of Flagship into the Company. In such merger, the Stockholders will receive cash and/or shares of PQC Class A Common Stock, par value $0.01 per share (the "Common Stock"), in exchange for their capital stock of the Company. Now, therefore, in consideration of the representations, warranties and covenants herein contained, the Parties agree as follows. ARTICLE I THE MERGER 1.1 The Merger. Upon and subject to the terms and conditions of this ---------- Agreement, Flagship shall merge with and into the Company (with such merger referred to herein as the "Merger") at the Effective Time (as defined below). From and after the Effective Time, the separate corporate existence of Flagship shall cease, and the Company shall continue as the surviving corporation in the Merger (the "Surviving Corporation"). The "Effective Time" shall be the time at which the Company and Flagship file the Articles of Merger or other appropriate documents prepared and executed in accordance with the relevant provisions of the Maryland General Corporation Law (the "Articles of Merger") with the Department of Assessments of Taxation of the State of Maryland. The Merger shall have the effects set forth in '3-114 of the Maryland General Corporation Law. The Articles of Merger shall be filed promptly following the Closing. 1.2 The Closing. The closing of the transactions contemplated by this ----------- Agreement (the "Closing") shall take place at the offices of PQC in Baltimore, Maryland, commencing at 9:00 a.m. local time on July 31, 1997 or on such mutually agreeable date as soon as practicable after the satisfaction or waiver of all conditions to the obligations of the Parties to consummate the transactions contemplated hereby (the "Closing Date"). 1.3 Actions at the Closing. At the Closing: (a) the Company, the ---------------------- Stockholders and the Optionholders shall deliver to Flagship and PQC the various certificates, instruments and documents referred to in Article V; (b) Flagship and PQC shall deliver to the Company, the Stockholders and the Optionholders the various certificates, instruments and documents referred to in Article VI; (c) the Company and Flagship shall file with the Department of Assessments of Taxation of the State of Maryland the Articles of Merger; (d) each Stockholder shall deliver to Flagship for cancellation the certificates representing his Shares (as defined in Section 1.5(a) below); (e) each Optionholder shall deliver to Flagship for cancellation the Options (as defined in Section 1.5(a) below); and (f) each Stockholder and Optionholder shall receive the amount of cash (by check) and/or the number of shares of Common Stock with an assumed value, as determined and provided in Section 1.12, as set forth opposite such Stockholder's or Optionholder's name on Schedule 1.3 attached hereto (the ------------ "Merger Consideration"). PQC shall not be required to deliver the Merger Consideration to a Stockholder or Optionholder until such Stockholder or Optionholder has executed and delivered: (i) an instrument of joinder the Stockholder Agreement attached as Exhibit A hereto, (ii) the Letter Agreement attached as Exhibit D hereto, (iii) a cross indemnity and release agreement previously delivered by the Company to the Stockholder and Optionholder and (iv) the stock certificates of the Company or options held by such Stockholder or Optionholder endorsed in favor of Flagship II. 1.4 Additional Action. The Surviving Corporation may, at any time after ----------------- the Effective Time, take any action, including executing and delivering any document, in the name and on behalf of either the Company or Flagship, in order to consummate the transactions contemplated by this Agreement. 1.5 Conversion of Securities. At the Effective Time, by virtue of the ------------------------ Merger and without any action on the part of any Party or the holder of any of the following securities: (a) Each share of common stock of the Company (collectively, the "Shares") held by the Stockholders or held in the Company's treasury immediately prior to the Effective Time and each outstanding option to acquire common stock of the Company (the "Options") held by the Optionholder shall be canceled and retired without payment of any consideration therefor, other than the payment of the Merger Consideration to the Stockholders as set forth in Section 1.3; (b) Each share of common stock, $5.00 par value per share, of Flagship issued and outstanding immediately prior to the Effective Time shall be cancelled and retired without payment of consideration therefor; and (c) The Stockholder of Flagship shall receive 1,000 shares of the Common Stock, par value $1.00 per share of the Company, which shall constitute all of the issued and outstanding capital stock of the Surviving Corporation as of and after the Effective Time. -2- 1.6 Dissenting Stockholder. Each Stockholder represents that such ---------------------- Stockholder has voted the Shares owned beneficially or of record by such Stockholder in favor of the adoption of this Agreement and the Merger and, consequently, shall not be entitled to, and shall not, demand and perfect appraisal rights in accordance with '3-201, et. seq. of the Maryland General Corporation Law. 1.7 Articles of Incorporation. The Articles of Incorporation of the ------------------------- Surviving Corporation shall be the same as the Articles of Incorporation of Flagship immediately prior to the Effective Time. 1.8 Bylaws. The bylaws of the Surviving Corporation shall be the same as ------ the bylaws of Flagship immediately prior to the Effective Time. 1.9 Directors and Officers. The directors and officers of the Surviving ---------------------- Corporation as of the Effective Time shall be those officers and directors specified on Schedule 1.9. ------------ 1.10 No Further Rights. From and after the Effective Time, except as ----------------- provided in Section 1.5(c), no Shares of the Company or Flagship shall be deemed to be outstanding, and holders of certificates formerly representing Shares shall cease to have any rights with respect thereto except as provided herein or by law. 1.11 Closing of Transfer Books. At the Effective Time, the stock transfer ------------------------- books of the Company and Flagship shall be closed and no transfer of Shares shall thereafter be made. If, after the Effective Time, certificates formerly representing Shares are presented to the Surviving Corporation, they shall be canceled and exchanged for the Merger Consideration as set forth in Section 1.3. 1.12 PQC Common Stock. ---------------- (a) The parties agree that the per share fair market value of the Common Stock to be included in the Merger Consideration shall be Three Dollars ($3.00). (b) The Stockholders agree to enter into, and the shares of Common Stock shall be subject to, the Stockholders Agreement dated as of August 30, 1996, by and among PQC and certain of its Stockholders, as amended and in effect from time to time (the "Stockholders Agreement") attached hereto as Exhibit A. --------- (c) Each Stockholder represents, warrants and covenants to PQC as follows: (i) The Stockholder has received a copy of the Preliminary Prospectus, dated as of July 7, 1997, with respect to PQC and the Common Stock and -3- has had such opportunity as the Stockholder has deemed adequate to obtain from representatives of PQC such information as is necessary to permit the Stockholder to evaluate the merits and risks of the Stockholder's investment in PQC. (ii) The Stockholder has sufficient experience in business, financial and investment matters to be able to evaluate the risks involved in the acquisition of the shares of Common Stock and to make an informed investment decision with respect to such acquisition or has relied upon professional business, legal and investment advisers and consultants that the Stockholder reasonably believes have the necessary skills and experience to evaluate the investment on behalf of the Stockholder. (iii) The Stockholder can afford a complete loss of the value of the shares of Common Stock and is able to bear the economic risk of holding such Common Stock for an indefinite period. (iv) The Stockholder understands that: (A) the Common Stock have not been registered under the Securities Exchange Act of 1934 and is not listed on any national securities exchange, (B) no public trading market in the Common Stock currently exists or is expected to develop, (C) the Common Stock is subject to restrictions upon transfer under the Stockholders Agreement and (D) PQC shall not be subject to the information reporting requirements of the Securities Exchange Act of 1934 and, consequently, financial and other information regarding PQC may not be available. (v) A legend substantially in the following form will be placed on the certificate representing the Common Stock: "The shares of stock represented by this certificate are subject to restrictions on transfer and requirements of sale set forth in the Stockholders Agreement dated as of August 30, 1996, as amended and in effect from time to time. The Company will furnish a copy of such agreement to the holder of this certificate without charge upon written request. The shares of stock represented by this certificate were originally issued to, or issued with respect to shares originally issued to the following Physician Stockholder: _________" (d) PQC's Registration Statement on Form S-1 with respect to the Common Stock filed with the Securities and Exchange Commission has been declared -4- effective under the Securities Act of 1933. PQC has made all necessary filings with the Securities Division of the State of Maryland with respect to the Common Stock. 1.13 Certain Tax Agreements. The Parties intend to adopt this Agreement ---------------------- and Merger as a tax-free reorganization under Section 368(a) of the Internal Revenue Code of 1986, as amended, (the "Code"). The Parties shall not take a position on any tax return or engage in any activities inconsistent with this Section 1.13. Without limiting the foregoing each Stockholder agrees that: (a) Such Stockholder has not sold, exchanged, transferred or disposed of or received any shares of the Company's capital stock in contemplation of the Merger except as disclosed on Schedule 1.13 attached hereto, and such -------- ---- Stockholder has no present intent to sell, exchange, transfer, dispose of or receive the Company's capital stock in contemplation of the Merger, nor has such Stockholder entered into any discussions or negotiations with regard to the possible sale, exchange, transfer or other disposition of such capital stock. (b) Such Stockholder is not subject to any obligation to sell, exchange, transfer or otherwise dispose of all or any of the Common Stock of PQC to be received by such Stockholder in the Merger. Such Stockholder has not entered into any discussions or negotiations with regard to the possible sale, exchange, transfer or other disposition of all or any of the Common Stock. Such Stockholder has no plan or intent to engage in any transaction or arrangement that would reduce such Stockholder's risk of ownership in any way, including without limitation a short sale, hedging transaction or otherwise, with respect to all or any of such Common Stock. 1.14 Adjustments to Merger Consideration. ------------------------------------ (a) The Merger Consideration shall be reduced on a dollar for dollar basis to the extent that the Net Assets (as defined in Section 5.15) of the Company as of the Closing Date is less than $2,314,519. (b) The Merger Consideration shall be reduced in the event that less than all of the Stockholders enter into Employment Agreements with Flagship on the Closing Date in the form attached hereto as Exhibit B. The amount of such reduction with respect to each physician who does not enter into such Employment Agreement shall equal 50% of the Merger Consideration set forth on Schedule 1.3 -5- ARTICLE II REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company, the Stockholders and the Optionholders, who join herein individually (not jointly) and subject to the limitations contained in Section 7.5, represent and warrant to Flagship and PQC that the statements contained in this Article II are true and correct, except as set forth in the disclosure schedule attached hereto (the "Disclosure Schedule"), as of the date hereof and as of the Effective Time. Each representation or warranty made by a Stockholder or Optionholder herein regarding the Stockholders or Optionholder of the Company shall be deemed to have been made only with respect to the Stockholder or Optionholder making the representation or warranty and not with respect to any other Stockholder or Optionholder. The Disclosure Schedule shall be arranged in paragraphs corresponding to the numbered and lettered paragraphs contained in this Article II, and the disclosures in any paragraph of the Disclosure Schedule shall qualify only the corresponding paragraph in this Article II. 2.1 Organization, Qualification and Corporate Power. The Company is a ----------------------------------------------- professional association duly organized, validly existing and in corporate and tax good standing under the laws of the State of Maryland and has all power and authority to carry on the businesses in which it is engaged and to own and use the properties owned and used by it. The Company has furnished to PQC true and complete copies of its Articles of Incorporation and Bylaws, each as amended and as in effect on the date hereof. The Company is not in default under or in violation of any provision of its Articles of Incorporation or Bylaws. Except as set forth in Schedule 2.1 hereto, the Company has no subsidiaries or any ------------ equity interest in any corporation, partnership, joint venture or other entity. 2.2 Capitalization. Schedule 2.2 accurately sets forth (i) the authorized -------------- ------------ and outstanding capital stock of the Company and (ii) all outstanding Options. Schedule 2.2 sets forth a complete and accurate list of all Stockholders and - ------------ Optionholders of the Company, indicating the numbers of Shares and Options held by each Stockholder and Optionholder. Other than the Stockholders and the Optionholders, no person or entity owns or has the right to acquire any capital stock, options, or other securities of the Company. The Shares are all of the issued and outstanding shares of capital stock of the Company and each Share is duly authorized, validly issued, fully paid, nonassessable and free of all preemptive rights. Other than the Options, there are no outstanding or authorized options, warrants, rights, agreements or commitments to which the Company is a party or which are binding upon the Company providing for the issuance, disposition or acquisition of any of its capital stock. There are no outstanding or authorized stock appreciation, phantom stock or similar rights with respect to the Company. There are no agreements, voting trusts, proxies or understandings with respect to the voting, or registration under the -6- Securities Act of 1933, of any Shares. All of the issued and outstanding Shares and Options were issued in compliance with applicable federal and state securities laws. 2.3 Authorization. This Agreement and the other agreements, documents and ------------- instruments to be executed and delivered by the Company pursuant hereto and the consummation by the Company of the transactions contemplated hereby and thereby have been approved by all required corporate action, including approval by the Board of Directors of the Company and all of the Stockholders. No further corporate or other proceedings on the part of Company are necessary to authorize this Agreement or the other agreements, documents and instruments to be executed and delivered by the Company pursuant hereto or the transactions contemplated hereby or thereby. 2.4 Valid and Binding Agreement. The Company and each Stockholder and --------------------------- Optionholders have the necessary power and authority to enter into this Agreement and the other agreements, documents and instruments to be executed and delivered by the Company or any Stockholder and Optionholder pursuant hereto, and to carry out the transactions contemplated hereby and thereby. Assuming due authorization, execution and delivery thereof by Flagship and PQC, this Agreement and each of the other agreements, documents and instruments to be executed and delivered by the Company, the Stockholders or Optionholders pursuant hereto will constitute valid and binding agreements of the Company, the Stockholders and/or Optionholders enforceable against the Company and/or the Stockholders and/or Optionholders as the case may be, in accordance with their terms, except to the extent that enforceablitity is limited by bankruptcy or similar laws or by general principles of equity. 2.5 No Violation. Except as set forth in Schedule 2.5 hereto, neither the ------------ ------------ execution and delivery of this Agreement or the other agreements, documents and instruments to be executed and delivered by the Company , the Stockholders or the Optionholders pursuant hereto nor the consummation by the Company or the Stockholders of the transactions contemplated hereby or thereby: (a) will violate any provision of the charter documents or Bylaws of the Company, each as currently in effect; (b) subject to obtaining the required consents and approvals described in Schedule 2.6, will violate or conflict with any ------------ applicable statute, law, ordinance, rule, regulation, order, judgment or decree except that no representation or warranty is made under this section with regard to laws referred to in Section 2.22; or (c) subject to obtaining the required consents and approvals described in Schedule 2.6, will violate or conflict with ------------ or constitute a default (or an event which, with notice or lapse of time, or both, would constitute a default) under, or will result in the termination of, or accelerate the performance required by, or result in the creation of any Security Interest (as defined in Section 2.12) upon any of the properties of the Company under, any contract, commitment, understanding, arrangement, agreement or restriction of any kind by which the properties of the Company are bound or -7- affected, or to which the Company or any Stockholder is a party except for any such violation, conflict or default that would not have a Material Adverse Effect. The term "Material Adverse Effect" as used in this Agreement shall mean any change or effect or any prospective change or effect that, individually or when taken together with other changes or effects, is or is reasonably likely (whether now or after the Effective Time) to be materially adverse to the medical practice conducted by the Stockholders (the "Practice"), the financial condition or results of operation of the Company, Flagship or PQC, the financial arrangements contemplated by the Employment Agreements (as defined in Section 5.16(a)), the value to Flagship or PQC of their affiliation with the Company and the Stockholders or any Party's ability to consummate the transactions contemplated herein. 2.6 Consents; Filings. Except as set forth in Schedule 2.6 hereto, no ----------------- ------------ registration or filing with, or consent, approval, permit, authorization or action by, any third-party (including, without limitation, any federal, state, local, foreign or other governmental agency, instrumentality, commission, authority, board or body or other person or entity (a "Governmental Entity") is required in connection with the execution and delivery by the Company, any Stockholder or any Optionholder of this Agreement or the other agreements, documents and instruments to be executed and delivered by Company, any Stockholder or Optionholder pursuant hereto or the consummation by the Company, the Stockholders or the Optionholders of the transactions contemplated hereby or thereby. 2.7 Financial Statements. The Company has delivered to Flagship and PQC -------------------- the balance sheets and statements of income of the Company for and as at the fiscal years ended June 30, 1994, 1995 and 1996 (the "Financial Statements") and the fiscal period ended March 31, 1997 (the "Interim Financial Statements"), and such balance sheets and statements of income have been prepared in accordance with generally accepted accounting principles consistently applied, are true, complete and accurate and fairly present the financial condition and results of operations for and as at the end of the periods therein referred to on a stand- alone basis. 2.8 Undisclosed Liabilities. To the best knowledge of the Company, the ----------------------- Stockholders and the Optionholders, the Company has no liabilities or obligations (whether known or unknown, whether absolute or contingent, whether liquidated or unliquidated and whether due or to become due), except for (a) liabilities shown on the balance sheet referred to in Section 2.7 for the period ended March 31, 1997, (the "Most Recent Balance Sheet") or otherwise listed on Schedule 2.8(a) as being assumed by Flagship as part of the Merger, or (b) - --------------- liabilities which have arisen since the most recent Financial Statements in the Ordinary Course of Business (as defined in Section 2.12). 2.9 No Material Adverse Change. Except as set forth in Schedule 2.9 -------------------------- ------------ hereto, to the best knowledge of the Company, no event with respect to the Company -8- or the Practice involving a Material Adverse Effect has occurred since the date of the Financial Statements. 2.10 Compliance with Law. To the best knowledge of the Company, the ------------------- Stockholders and the Optionholders, the Company has complied with, and the Practice has been conducted in compliance with, all applicable laws, regulations and other requirements of all national governmental authorities, of all states, municipalities and other political subdivisions and agencies thereof, having jurisdiction over the Company, the Stockholders or the Optionholders, including without limitation, all such laws, regulations and requirements relating to antitrust, consumer protection, employee benefit, equal opportunity, health, occupational safety, pension, pollution or environmental protection matters, except for such noncompliance as would not have a Material Adverse Effect. Neither the Company, any Stockholder nor any Optionholder has received any notification of any asserted present or past failure to comply with such laws, rules or regulations. 2.11 Tax Matters. ----------- (a) The Company has filed in a timely manner all Tax Returns (as defined below) that it was required to file and all such Tax Returns were correct and complete in all material respects. The Company has timely paid all Taxes (as defined below) that are shown to be due on any such Tax Returns. The unpaid Taxes of the Company for tax periods through the date of the Most Recent Balance Sheet do not exceed the accruals and reserves for Taxes set forth on the Most Recent Balance Sheet (excluding any accruals and reserves for deferred Taxes established to reflect timing difference between book and Tax income). The Company does not have any actual or potential liability for any Tax obligation of any taxpayer (including without limitation any affiliated group of corporations or other entities that included the Company during a prior period) other than the Company. All Taxes that the Company is or was required by law to withhold or collect have been duly withheld or collected and, to the extent required, have been paid to the proper Governmental Entity. For purposes of this Agreement, "Taxes" means all taxes, charges, fees, levies or other similar assessments or liabilities, including without limitation income, gross receipts, ad valorem, premium, value-added, excise, real property, personal property, sales, use, transfer, withholding, employment, payroll and franchise taxes imposed by the United States of America or any state, local or foreign government, or any agency thereof, or other political subdivision of the United States or any such government, and any interest, fines, penalties, assessments or additions to tax resulting from, attributable to or incurred in connection with any tax or any contest or dispute thereof. For purposes of this Agreement, "Tax Returns" means all reports, returns, declarations, statements or other information required to be supplied to a taxing authority in connection with Taxes. -9- (b) The Company has delivered to PQC correct and complete copies of all federal income Tax Returns, examination reports and statements of deficiencies assessed against or agreed to by the Company during the past five years. Except as disclosed on Schedule 2.11, no examination or audit of any Tax -------- ---- Returns of the Company by any Governmental Entity is currently in progress or, to the knowledge of the Company, threatened or contemplated. The Company has not waived any statute of limitations with respect to Taxes or agreed to an extension of time with respect to a Tax assessment or deficiency. (c) The Company is not a "consenting corporation" within the meaning of Section 341(f) of the Code, and none of the assets of the Company are subject to an election under Section 341(f) of the Code. The Company has not been a United States real property holding corporation within the meaning of Section 897(c)(2) of the Code during the applicable period specified in Section 897(c)(1)(A)(ii) of the Code. The Company is not a party to any Tax allocation or sharing agreement. (d) The Company is not nor has ever been a member of an "affiliated group" of corporations (within the meaning of Section 1504 of the Code). (e) The Company is not a party to any agreement, contract, arrangement or plan that has resulted or would result, separately or in the aggregate, in the payment of any "parachute payments" within the meaning of Section 280G of the Code. 2.12 Assets. The Company owns or leases all tangible assets necessary for ------ the conduct of the Practice. Each such tangible asset is free from material defects, has been maintained in accordance with normal industry practice, is in good operating condition and repair (subject to normal wear and tear) and is suitable for the purposes for which it presently is used. Except as disclosed on Schedule 2.12, no asset of the Company (tangible or intangible) is subject to ------------- any Security Interest. The term "Security Interest" means any mortgage, pledge, security interest, encumbrance, charge or other lien (whether arising by contract or by operation of law), other than (i) mechanics', materialmen's and similar liens, (ii) liens arising under worker's compensation, unemployment insurance, social security, retirement and similar legislation and (iii) liens on goods in transit incurred pursuant to documentary letters of credit, in each case arising in the ordinary course of business consistent with past practice (including with respect to frequency and amount) (the "Ordinary Course of Business"). 2.13 Leases. ------ (a) Schedule 2.13 contains a complete and accurate listing of all ------------- leases (the "Leases") pursuant to which the Company leases real or personal property, which listing sets forth a general description of the leased property or items, the -10- term, the annual rent, any and all renewal options, and any requirements for the consent of third parties to assignments thereof. To the knowledge of the Company, all such Leases are valid, binding and enforceable in accordance with their terms and are in full force and effect; no event of default has occurred which (whether with or without notice, lapse of time or both or the happening or occurrence of any other event) would constitute a default thereunder on the part of the Company; and the Company has no knowledge of the occurrence of any event of default which (whether with or without notice, lapse of time or both or the happening or occurrence of any other event) would constitute a default thereunder by any other party. (b) Except for Leases listed on Schedule 2.13, there are no leases, ------------- subleases, licenses, occupancy agreements, options, rights, concessions or other agreements or arrangements, written or oral, granting to any person the right to purchase, use or occupy any facility occupied by the Company. (c) With respect to each Lease, the Company has and will transfer to Flagship at the Closing an unencumbered interest in the leasehold interest covered thereby. The Company enjoys peaceful and undisturbed possession of all the leased real property, and the Company has in all material respects performed all the obligations required to be performed by it through the date hereof. 2.14 Contracts and Commitments. ------------------------- (a) Schedule 2.14 sets forth a complete and accurate list of all ------------- contracts known to the Company, the Stockholders or the Optionholders after reasonable investigation which have been entered into by the Company or any Stockholder relating to the Practice and still in effect as of the date hereof (the "Contracts"), of the following categories: (i) Managed care contracts and other contracts with third-party payors; (ii) Employment or similar contracts and severance agreements; (iii) Contracts (other than Leases set forth on Schedule 2.13) ------------- relating to the Company or the Practice which are not cancelable without liability on thirty (30) calendar days (or less) notice; (iv) Options with respect to any property, real or personal, whether the Company is the grantor or grantee thereunder; -11- (v) Contracts involving expenditures or liabilities, actual or potential, in excess of one thousand dollars ($1,000) or otherwise material to the Practice or the Company; (vi) Promissory notes, loans, agreements, indentures, evidences of indebtedness, letters of credit, guarantees, or other instruments relating to an obligation to pay money, individually in excess of or in the aggregate in excess of one thousand dollars ($1,000), whether the Company shall be the borrower, lender or guarantor thereunder or whereby any properties of the Company are pledged; (vii) Contracts containing covenants limiting the freedom of the Company or any officer, director, employee, or Stockholder of the Company, to engage in any line of business or compete with any person; and (viii) Any Contract with the United States, state or local government or any agency or department thereof. The Company has made available to PQC true, correct and complete copies within the Company's, a Stockholder's or an Optionholder's possession of, and all records relating to, all of the Contracts listed on Schedule 2.14, including all ------------- amendments and supplements thereto. (b) Absence of Breaches or Defaults. To the knowledge of the Company ------------------------------- or any Stockholder or Optionholder, all of the Contracts are valid and in full force and effect. To the knowledge of the Company, or any Stockholder or Optionholder, the Company and the Stockholders have duly performed all of its or their obligations under the Contracts, and no violation of, or default or breach, under any Contracts by the Company or any other party has occurred except for any violations, defaults, or breaches that would not have a Material Adverse Effect and neither Company nor any other party, to the best of Company's or any Stockholder's knowledge after due inquiry, has repudiated any provisions thereof. 2.15 Permits. The Company, the Stockholders and any other physicians ------- employed by the Company have all licenses, permits, franchises, approvals, authorizations, consents or orders of, or filings with ("Permits") any Governmental Entity or any other person, necessary or desirable to conduct the Practice as now being conducted, except where the failure to obtain such Permits would not have a Material Adverse Effect. All Permits of the Company, each Stockholder and any other physicians employed by the Company are valid and in full force and effect and are listed on Schedule 2.15. Except as disclosed on ------------- Schedule 2.15, no notice to, declaration, filing or registration with, or Permit - ------------- or consent from, any governmental or regulatory body or authority, or any other person or entity, is required to be made or obtained by the Company or any Stockholder in connection with the execution, delivery or performance of this Agreement and the consummation of the transactions -12- contemplated hereby, except as set forth on Schedule 2.15. No Stockholder has ------------- suffered any loss, revocation, suspension, expiration without renewal or other failure to keep in full force and effect and good standing the Stockholder's membership on the medical staff of the hospitals listed for such Stockholder on Schedule 2.23, or any material license, certification, accreditation, clinical - ------------- privilege or other right or authorization necessary for the unrestricted practice of medicine by the Stockholder or for the conduct of the Practice as previously conducted. 2.16 Books and Records. The Company has made and kept (and given Flagship ----------------- and PQC access to) books and records (including patient lists) and accounts, which, in reasonable detail, accurately and fairly reflect the activities of the Company. 2.17 Litigation. Except as set forth on Schedule 2.17, there is not, and ---------- ------------- during the past three (3) years there has not been any, action, order, writ, injunction, judgment or decree outstanding or any claim, suit, litigation, proceeding, labor dispute, arbitral action, governmental audit or investigation (collectively, "Actions") pending or, to the best of the Company's, any Stockholder's or any Optionholder's knowledge threatened (a) against, related to or affecting (i) the Company, any of the Stockholders, any of the Optionholders, the Practice or the assets of the Company, (ii) any officers, directors or employees of the Company as such, or (iii) any Stockholder of the Company in such Stockholder's capacity as a Stockholder of the Company; (b) seeking to delay, limit or enjoin the transactions contemplated by this Agreement; (c) that involves the risk of criminal liability (other than minor traffic violations); or (d) in which the Company is a plaintiff. Neither the Company, any Stockholder or any Optionholder is in default with respect to or subject to any judgment, order, writ, injunction or decree of any court or governmental agency, and there are no unsatisfied judgments against the Company, any of the Stockholders, any of the Optionholders, the Practice or the Company's assets. 2.18 Transactions with Certain Persons. Except as set forth on Schedule --------------------------------- -------- 2.18, no officer, director or employee of the Company nor any member of any such - ---- person's immediate family is presently, or within the past two (2) years has been a party to any transaction with the Company relating to the Practice with an aggregate annual value of more than twenty thousand dollars ($20,000) (provide that all transactions in an amount less than $20,000 that are not set forth on Schedule 2.18 were at fair market value) to the Company or the other ------------- parties thereto, including, without limitation, any contract, agreement or other arrangement (a) providing for the furnishing of services by, (b) providing for the rental of real or personal property from, or (c) otherwise requiring payments to (other than for services as officers, directors or employees of the Company) any such person or corporation, partnership, trust or other entity in which any such person has an interest as a Stockholder, officer, director, trustee or partner, except that the Company provides certain medical services to employees and family members as set forth on Schedule 2.18. ------------- -13- 2.19 Insurance. Schedule 2.19 contains a complete and accurate list of --------- ------------- all policies or binders of fire, liability, title, worker's compensation, malpractice and other forms of insurance (showing as to each policy or binder the carrier, policy number, coverage limits, expiration dates, annual premiums and a general description of the type of coverage provided) maintained by the Company on any of its assets, the Stockholders, the Practice or the Company's employees. Such insurance provides, and during such period provided, coverage to the extent and in the manner as may be required by applicable law and by any and all Contracts known to the Company or any Stockholder to which the Company, or any of its physicians or other employees is a party. The Company is not in default under any of such policies or binders, and the Company has not failed to give any notice or to present any claim under any such policy or binder in a due and timely fashion. No insurer has advised the Company that it intends to reduce coverage, increase premiums or fail to renew an existing policy or binder. Except as disclosed in Schedule 2.19, there are no outstanding unpaid -------- ---- claims under any such policies or binders. All policies and binders are in full force and effect on the date hereof and shall be kept in full force and effect through the Closing Date. 2.20 Brokers. The Company is not obligated to pay, nor has the Company ------- retained any broker or finder or other person who is entitled to, any broker's or finder's fee or any other commission or financial advisory fee based on any agreement or understanding made by the Company in connection with the transactions contemplated hereby. 2.21 Benefit Plans. ------------- (a) Except as set forth in Schedule 2.21, the Company is not a party ------------- to any pension, retirement, profit sharing, savings, bonus, incentive, deferred compensation, group health insurance or group life insurance plan or any similar obligation (an "Employee Benefit Plan"), or to any collective bargaining agreement or other contract, written or oral, with any trade or labor union, employees; association or similar organization. Except as set forth in Schedule -------- 2.21, the Company does not have any obligations to provide to its active - ----- employees or current retirees any post-retirement non-pension benefits. No Stockholder has any present intention of discontinuing the Stockholder's medical practice with the Company except to become an employee of Flagship. (b) To the knowledge of the Company or any Stockholder or Optionholder, the Company (i) is and has been in compliance in all material respects with all applicable laws respecting employment and employment practices, terms and conditions of employment, and wages and hours, (ii) has made all contributions required to be made under any state unemployment or disability laws or regulations and has accrued the amount of any such contribution required for any period prior to the Closing Date which is not yet due and payable and (iii) is not engaged in any -14- unfair labor practice, and there are no arrears in the payment of wages or taxes with respect to employees. (c) Except as set forth in Schedule 2.21, no employee has any claims ------------- pending against Company (whether under any law, any employment agreement or otherwise) on account of or for: (i) overtime pay, other than overtime pay for the current payroll period, (ii) wages or salary (excluding bonuses and amounts accruing under pension and profit sharing plans) for any period other than the current payroll period, (iii) vacation, time off or pay in lieu of vacation or time off, other than that earned in respect of the current fiscal year, (iv) any violation of any statute, ordinance or regulation relating to minimum wages or maximum hours of work or (v) the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). (d) Except as set forth on Schedule 2.21 (which liabilities will be ------------- discharged on or prior to the Closing Date) the Company is not, and neither PQC nor Flagship shall be, pursuant to any employment agreement, employee benefit plan or other law, arrangement or understanding, obligated to pay or be liable for the payment of any compensation (including accrued vacation), severance pay or other benefit (including any disability benefit or payment or any unfunded liabilities relating to pension benefits) by reason of the voluntary or involuntary termination at or prior to the Effective Time of employment of any employee, or the consummation of the transactions contemplated by this Agreement. (e) To the knowledge of the Company and any Stockholder or Optionholder, each employee benefit plan of the Company intended to be qualified under Section 401(a) of the Code has received a favorable determination letter and the Company or any entity which, within the last five (5) years, has been under common control or affiliated with Company (an "ERISA Affiliate") within the meaning of Section 414(b), (c) or (m) of the Code, and each employee benefit plan of the Company is in compliance in all material respects with the requirements prescribed by any and all statutes, orders or governmental rules or regulations currently in effect, including, but not limited to, ERISA and the Code, applicable to such employee benefit plans and the Company is in compliance in all material respects with its obligations under the terms of such plans. None of the employee benefit plans are subject to Title IV of ERISA. Neither the Company nor any ERISA Affiliate has ever been obligated to contribute to any "multi-employer plan" as such term is defined in Section III(37) of ERISA. No employee benefit plan of the Company or any ERISA Affiliate has engaged in any prohibited transaction as such term is defined in Section 4975 of the Code or Section 406 of ERISA. 2.22 Fraud and Abuse; Stark Law. Except as set forth in Schedule 2.22 -------------------------- ------------- hereto, to the knowledge of the Company or any Stockholder or Optionholder, neither the Company, any of the Stockholders, any of the Optionholders, nor any other persons or entities providing professional services for the Practice, have -15- engaged in any activities which are prohibited under 42 U.S.C. (S)1320a-7b or 42 U.S.C. (S)1395nn et seq., or the regulations promulgated thereunder pursuant to -- --- such statutes, or related state or local statutes or regulations, or which are prohibited by rules of professional conduct, including but not limited to the following: (i) knowingly and willfully making or causing to be made a false statement or representation of a material fact in any application for any benefit or payment; (ii) knowingly and willfully making or causing to be made any false statement or representation of a material fact for use in determining rights to any benefit or payment; (iii) failure to disclose knowledge by a claimant of the occurrence of any event affecting the initial or continued right to any benefit or payment on its own behalf or on behalf of another, with intent to fraudulently secure such benefit of payment; (iv) knowingly and willfully soliciting or receiving any remuneration (including any kickback, bribe or rebate), directly or indirectly, overtly or covertly, in cash or in kind or offering to pay or receive such remuneration (a) in return for referring an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part by Medicare or Medicaid, or (b) in return for purchasing, leasing, or ordering or arranging for or recommending purchasing, leasing, or ordering any good, facility, service, or item for which payment may be made in whole or in part by Medicare or Medicaid; and (v) referring a patient for Designated Health Services (within the meaning of 42 U.S.C. (S)1395nn) when the referring physician has a financial relationship with the entity to which the referral is made in the absence of an applicable exception under 42 U.S.C. (S)1395nn. 2.23 Hospital Privileges. Schedule 2.23 hereto lists all of the hospitals ------------------- ------------- at which each Stockholder is a member of the medical staff. 2.24 Employment Agreements. No event permitting termination under the --------------------- Employment Agreements, if they were in effect at such time of such event, shall have occurred at any time prior to the Closing Date. Except as set forth on Schedule 2.24, no Stockholder has any current intention of terminating an - ------------- Employment Agreement with Flagship prior to the termination of its initial five (5) year term (provided, that, the foregoing shall in no way limit any Stockholder's rights pursuant to Section 3 of the letter agreement among PQC, Flagship and the Stockholder dated as of the Closing Date). 2.25 Powers of Attorney. Except as set forth in Schedule 2.25, there are ------------------ no outstanding powers of attorney executed on behalf of the Company. 2.26 Employees. Schedule 2.26 contains a list of all employees of the --------- ------------- Company, other than the Stockholders, along with the position and the rate of compensation of each such person. To the knowledge of the Company, any of the Stockholders, or any of the Optionholders, no employee or group of employees has any plans to terminate employment with the Company or not to continue as an employee of the Surviving Corporation after the Effective Time. The Company is not -16- a party to or bound by any collective bargaining agreement, nor has it experienced any strikes, grievances, claims of unfair labor practices or other collective bargaining disputes. 2.27 Environmental Matters. --------------------- (a) To the knowledge of the Company, or any Stockholder or Optionholder, the Company has complied with all applicable Environmental Laws (as defined below). There is no pending or, to the knowledge of the Company or any Stockholder, threatened civil or criminal litigation, written notice of violation, formal administrative proceeding, or investigation, inquiry or information request by any Governmental Entity, relating to any Environmental Law involving the Company. For purposes of this Agreement, "Environmental Law" means any federal, state or local law, statute, rule or regulation or the common law relating to the environment or occupational health and safety, including without limitation any statute, regulation or order pertaining to (i) treatment, storage, disposal, generation and transportation of industrial, toxic or hazardous substances or solid or hazardous waste; (ii) air, water and noise pollution; (iii) groundwater and soil contamination; (iv) the release or threatened release into the environment of industrial, toxic or hazardous substances, or solid or hazardous waste, including without limitation emissions, discharges, injections, spills, escapes or dumping of pollutants, contaminants or chemicals; (v) underground and other storage tanks or vessels, abandoned, disposed or discarded barrels, containers and other closed receptacles; (vi) health and safety of employees and other persons; and (vii) manufacture, processing, use, distribution, treatment, storage, disposal, transportation or handling of pollutants, contaminants, chemicals or industrial, toxic or hazardous substances or oil or petroleum products or solid or hazardous waste. As used above, the terms "release", and "environment" shall have the meaning set forth in the federal Comprehensive Environmental Compensation, Liability and Response Act of 1980 ("CERCLA"). (b) To the knowledge of the Company, or any Stockholder or Optionholder, there have been no releases of any Materials of Environmental Concern (as defined below) into the environment at any parcel of real property or any facility formerly or currently owned, operated or controlled by the Company. With respect to any such releases of Materials of Environmental Concern, the Company has given all required notices to Governmental Entities (copies of which have been provided to PQC in its due diligence process). The Company is not aware of any releases of Materials of Environmental Concern at parcels of real property or facilities other than those owned, operated or controlled by the Company that could reasonably be expected to have an impact on the real property or facilities owned, operated or controlled by the Company. For purposes of this Agreement, "Materials of Environmental Concern" means any chemicals, pollutants or contaminants, hazardous substances (as such term is defined under CERCLA), solid wastes and hazardous -17- wastes (as such terms are defined under the federal Resources Conservation and Recovery Act), toxic materials, oil or petroleum and petroleum products. (c) Set forth in Schedule 2.27 is a list of all environmental reports, ------------- investigations and audits relating to premises currently or previously owned or operated by the Company (whether conducted by or on behalf of the Company or a third party, and whether done at the initiative of the Company or directed by a Governmental Entity or other third party) which the Company has possession of or access to. 2.28 Disclosure. No representation or warranty by the Company, the ---------- Stockholders or the Optionholders contained in this Agreement or in any other document delivered to Flagship or PQC in connection with their due diligence investigation of the Company, taken as a whole, contains or will contain any untrue statement of a material fact or omits or will omit to state any material fact necessary, in light of the circumstances under which it was or will be made, in order to make the statements herein or therein not misleading. The Company, the Stockholders and the Optionholders have disclosed to PQC all material information relating to the Practice, the Company, the Stockholders and the Optionholders and the transactions contemplated by this Agreement. ARTICLE III REPRESENTATIONS AND WARRANTIES OF PQC AND FLAGSHIP Each of Flagship and PQC jointly and severally represents and warrants to the Company, the Stockholders and the Optionholders as of the date hereof and as of the Effective Time as follows: 3.1 Organization. Each of Flagship and PQC is a corporation duly ------------ organized, validly existing and in good standing under the laws of the jurisdictions of their incorporation, and each of Flagship and PQC has the power and authority to carry on its business as presently being conducted. PQC has provided the Company with complete and accurate copies of the Certificate of Incorporation and bylaws of PQC and the Articles of Incorporation and bylaws of Flagship. Flagship and PQC each is duly qualified and is in good standing as a foreign corporation in each jurisdiction where the nature of its business, properties or other activities requires it to be qualified. 3.2 Capitalization of Flagship and PQC. The authorized capital stock of ---------------------------------- PQC consists of 140,000,000 shares of Class A Common Stock, par value $0.01 per share, of which 20,151,864 Class A shares are outstanding, 6,727,043 shares of Class B-1 Common Stock, par value $0.01 per share of which 2,809,296 shares are -18- outstanding, 4,287,957 shares of Class B-2 Common Stock, par value $0.01 per share, of which 1,790,704 shares are outstanding, 27,692,309 shares of Class C Common Stock of which 7,692,309 are outstanding and 10,000,000 shares of Preferred Stock, par value $0.01 per share, of which no shares are outstanding. Except for Physicians Quality Care of Massachusetts, Inc. and Physician Quality Care of Maryland, Inc., PQC is not the owner of record of the equity securities of any issuer. On the Closing Date, Flagship's authorized capital stock will consist of 1,000 shares of common stock, $5.00 par value per share, of which 1,000 shares will be outstanding. Except as set forth in Schedule 3.2, there ------------ are not, and on the Closing Date there will not be, outstanding (i) any options, warrants or other rights to purchase any capital stock of PQC or Flagship; (ii) any securities convertible into or exchangeable for shares of such stock; or (iii) any other commitments of any kind for the issuance of additional shares of capital stock or options, warrants or other securities of PQC or Flagship. Except as disclosed on Schedule 3.2, there are no agreements, voting trusts, ------------ proxies or understandings with respect to the voting, or registration under the Securities Act of 1933 of any shares of PQC or Flagship except for the Stockholders Agreement and the Shareholder Designation and Stock Transfer Agreement by and among PQC, Flagship and the sole shareholder of Flagship dated as of the date hereof (the "Designation Agreement"). 3.3 Authorization. The execution and delivery of this Agreement and the ------------- other agreements, documents and instruments to be executed and delivered by Flagship and PQC pursuant hereto and the consummation by Flagship and PQC of the transactions contemplated hereby and thereby will, on the Closing Date, have been authorized by all necessary corporate action on the part of PQC and Flagship. 3.4 Valid and Binding Agreement. Each of Flagship and PQC has the --------------------------- necessary power and authority to enter into this Agreement and the other agreements, documents and instruments to be executed and delivered by Flagship and PQC pursuant hereto, and to carry out the transactions contemplated hereby and thereby. When fully executed and delivered, this Agreement and each of the other agreements, documents and instruments to be executed and delivered by Flagship and PQC pursuant hereto will constitute valid and binding agreements of Flagship and PQC, enforceable against them in accordance with their terms, except to the extent that enforceability is limited pursuant to bankruptcy or similar laws or by general principles of equity. 3.5 No Violation. Neither the execution and delivery of this Agreement or ------------ the other agreements, documents and instruments to be executed and delivered by Flagship and PQC pursuant hereto nor the consummation by Flagship and PQC of the transactions contemplated hereby or thereby (a) will violate any provision of the Certificate of Incorporation or bylaws of PQC or the Articles of Incorporation or bylaws of Flagship, each as currently in effect, (b) will violate or conflict with any applicable statute, law, ordinance, rule, regulation, order, judgment or decree, except -19- that no representation or warranty is made under this Section with regard to the laws referred to in Section 3.9, or (c) will violate any contract or commitment which violation would have the effect of preventing PQC or Flagship from performing its obligations hereunder or preventing PQC or Flagship or any of their respective affiliates from consummating the transactions contemplated herein and in the agreements and instruments to be executed and delivered by Flagship and PQC and their respective affiliates in connection therewith. 3.6 Consents; Filings. Except as set forth in Schedule 3.6, no ----------------- registration or filing with, or consent, approval, permit, authorization or action by, any third party (including, without limitation, any federal, state, local, foreign or other governmental agency, instrumentality, commission, authority, board or body or other person or entity) is required to be made by Flagship or PQC in connection with the execution and delivery by Flagship and PQC of this Agreement or the other agreements, documents and instruments to be executed and delivered by Flagship and PQC pursuant hereto or the consummation by Flagship and PQC of the transactions contemplated hereby or thereby. 3.7 Capital Stock. All shares of Common Stock issued to any Stockholder ------------- in connection with the transactions contemplated by this Agreement shall be duly authorized, validly issued, fully paid and nonassessable and not subject to any pre-emptive rights created by statute, PQC's Certificate of Incorporation or bylaws, or any agreement (other than the Stockholders Agreement) to which PQC is a party or by which PQC is bound. The shares of Common Stock included in the Merger Consideration are being issued pursuant to PQC's Registration Statement on Form S-1, which has been declared effective by the Securities and Exchange Commission and the Securities Division of the State of Maryland. 3.8 Brokers. Neither PQC nor Flagship is obligated to pay, nor has PQC or ------- Flagship retained any broker or finder or other person who is entitled to, any broker's or finder's fee or any other commission or financial advisory fee based on any agreement or understanding made by PQC or Flagship in connection with the transactions contemplated hereby. 3.9 Fraud and Abuse; Stark Law. Neither Flagship nor PQC has engaged in -------------------------- any activities which are prohibited under 42 U.S.C. (S)1320a-7b or 42 U.S.C. (S)1395nn et seq., or the regulations promulgated thereunder pursuant to such -- --- statutes, or related state or local statutes or regulations, or which are prohibited by rules of professional conduct, including but not limited to the following: (i) knowingly and willfully making or causing to be made a false statement or representation of a material fact in any application for any benefit or payment; (ii) knowingly and willfully making or causing to be made any false statement or representation of a material fact for use in determining rights to any benefit or payment; (iii) failure to disclose knowledge by a claimant of the occurrence of any event affecting the initial or continued right to any -20- benefit or payment on its own behalf or on behalf of another, with intent to fraudulently secure such benefit of payment; (iv) knowingly and willfully soliciting or receiving any remuneration (including any kickback, bribe or rebate), directly or indirectly, overtly or covertly, in cash or in kind or offering to pay or receive such remuneration (a) in return for referring an individual to a person for the furnishing or arranging for the furnishing of any item or service for which payment may be made in whole or in part by Medicare or Medicaid, or (b) in return for purchasing, leasing, or ordering or arranging for or recommending purchasing, leasing, or ordering any good, facility or item for which payment may be made in whole or in part by Medicare or Medicaid; and (v) referring a patient for Designated Health Services (within the meaning of 42 U.S.C. (S)1395nn) when the referring physician has a financial relationship with the entity to which the referral is made in the absence of an applicable exception under 42 U.S.C. (S)1395nn. 3.10 Litigation. Except as set forth on Schedule 3.10, there is not, and ---------- ------------- during the past five (5) years there have not been any Actions pending or, to the best of Flagship and PQC's knowledge: (a) threatened against, related to or affecting (i) PQC or Flagship, (ii) any officers, directors or employees of Flagship or PQC as such, or (iii) any shareholder of Flagship or PQC in such shareholder's capacity as a shareholder of Flagship or PQC; (b) seeking to delay, limit or enjoin the transactions contemplated by this Agreement; (c) that involves the risk of criminal liability; or (d) in which Flagship or PQC is a plaintiff. Neither Flagship nor PQC is in default with respect to or subject to any judgment, order, writ, injunction or decree of any court or governmental agency, and there are no unsatisfied judgments against Flagship or PQC. 3.11 Disclosure. No representation or warranty by Flagship or PQC ---------- contained in this Agreement or in any other document delivered to the Company in connection with its due diligence investigation of Flagship or PQC, including the Preliminary Prospectus dated June 7, 1997, together with any amendment or supplement thereto provided to the Company prior to the Class Date, taken as a whole, contains or will contain any untrue statement of a material fact or omits or will omit to state any material fact necessary, in light of the circumstances under which it was or will be made, in order to make the statements herein or therein not misleading. ARTICLE IV COVENANTS 4.1 Reasonable Efforts to Close. Each of Company, the Stockholders, the --------------------------- Optionholders, Flagship and PQC shall use its or their respective reasonable efforts to proceed to the closing of the transactions contemplated hereby and to satisfy any of -21- the conditions precedent to the other Parties' obligations set forth in Articles V and VI to the extent such conditions are within such Party's control. 4.2 Notices and Consents. The Company and each Stockholder shall use its -------------------- best efforts to obtain, at its expense, all such waivers, permits, consents, approvals or other authorizations from third parties and Governmental Entities, and to effect all such registrations, filings and notices with or to third parties and Governmental Entities, as may be required by or with respect to the Company or any Stockholder in connection with the transactions contemplated by this Agreement, including without limitation those listed in Schedule 2.6. ------------ 4.3 Conduct of Business. Without the prior written consent of PQC (which ------------------- consent shall not be unreasonably withheld), the Company shall not and the Stockholders shall not permit the Company to: (a) take any action to amend the Company's Articles of Incorporation or bylaws or other organizational documents; (b) issue any stock, bonds or other corporate securities or grant any option or issue any warrant to purchase or subscribe to any of such securities or issue any securities convertible into such securities or authorize the transfer of any of its outstanding capital stock; (c) split, combine or reclassify any shares of its capital stock; declare, set aside or pay any dividend or other distribution (whether in cash, stock or property or any combination thereof) in respect of its capital stock; or make any payment under the Company's Stockholder Benefits Plan or similar Plan if such payment would cause, or is reasonably expected to cause, the Company to fail to satisfy any of the conditions to Closing in Article V of this Agreement. (d) incur any obligations or liabilities (absolute or contingent) greater than one thousand dollars ($1,000) in the aggregate, except current liabilities incurred and obligations under contracts entered into in the Ordinary Course of Business; (e) acquire, sell, lease, encumber or dispose of any assets or property, corporation, partnership, association or other business, other than purchases and sales of assets in the Ordinary Course of Business; (f) discharge or satisfy any Security Interest or pay any obligation or liability other than in the Ordinary Course of Business; (g) mortgage or pledge any of its property or assets or subject any such assets to any Security Interest; -22- (h) take any action or fail to take any action within their respective control and permitted by this Agreement with the knowledge that such action or failure to take action would result in (i) any of the representations and warranties of the Company and the Stockholders set forth in this Agreement becoming untrue or (ii) any of the conditions to the Merger set forth in Article V not being satisfied; (i) merge or consolidate with or into any corporation or other entity; (j) make, accrue or become liable for any bonus, profit sharing or incentive payment, except for accruals under existing plans, if any, or increase the rate of compensation payable or to become payable by it to any of its officers, directors or employees, other than increases in the Ordinary Course of Business consistent with past practice; (k) make any election or give any consent under the Code or the tax statutes of any state or other jurisdiction or make any termination, revocation or cancellation of any such election or any consent or compromise or settle any claim for past or present tax due; (1) waive any rights of material value; (m) modify, amend, alter or terminate any of its executory contracts of a material value or which are material in amount; (n) take any act or permit to occur any omission constituting a breach or default under any contract, indenture or agreement by which it or its properties are bound; (o) fail to use its reasonable efforts to: (i) preserve the possession and control of its assets and the Practice; (ii) keep in faithful service its present officers and employees; (iii) preserve the goodwill of its patients, suppliers, agents, brokers and others having business relations with it; and (iv) keep and preserve its business existing on the date hereof until after the Closing Date; (p) fail to operate its business and maintain its books, accounts and records in the customary manner and in the Ordinary Course of Business and maintain in good repair its business premises, fixtures, machinery, furniture and equipment; (q) enter into any leases, contracts, agreements or understandings which are required to be performed in whole or in material part after the Closing Date; -23- (r) engage any new employee except in the Ordinary Course of Business; (s) materially alter the terms, status or funding condition of any Employee Benefit Plan; or (t) commit or agree to do any of the foregoing in the future. 4.4 Access to Management, Properties and Records. From the date of this -------------------------------------------- Agreement until the Closing Date, the Company shall afford the officers, attorneys, accountants and other authorized representatives of PQC and Flagship free and full access upon reasonable notice and during normal business hours to all management personnel, offices, properties, books and records of the Company, and all properties under the management of the Company and all records relating thereto, so that PQC and Flagship may have full opportunity to make such investigation as they shall desire to make of the management, business, properties and affairs of the Company and the properties under the management of the Company, and PQC shall be permitted to make abstracts from, or copies of, all such books and records. The Company shall furnish to PQC such financial and operating data and other information as to the business of the Company as PQC shall reasonably request. 4.5 Taxes. The Company will, on a timely basis, file all Tax Returns for ----- and pay any and all taxes which shall become due on or prior to the Closing Date. 4.6 Compliance with Laws. The Company, the Stockholders and the -------------------- Optionholders will comply in all material respects with all laws and regulations which are applicable to it or each of them and the Practice or to the conduct of its Practice and will perform and comply in all material respects with all contracts, commitments and obligations by which it or each of them is bound. 4.7 Exclusive Dealing. None of the Company, the Stockholders or the ----------------- Optionholders will not, directly or indirectly, through any officer, director, agent or otherwise, (a) solicit, initiate or encourage submission of proposals or offers from any person relating to any affiliation transaction between the Company, the Stockholders or the Optionholders and any health care company or practice management company or any acquisition or purchase of all or a material portion of the assets of the Company, or any equity interest in the Company or any equity investment, merger, consolidation or business combination with the Company, or (b) participate in any discussions or negotiations regarding, or furnish to any other person, any non-public information with respect to, or otherwise cooperate in any way with, or assist or participate in, facilitate or encourage, any effort or attempt by any other person to do or seek any of the foregoing except to inform such person of the Company's obligations hereunder. -24- 4.8 Notice of Breaches. The Company, Stockholders and Optionholders shall ------------------ promptly deliver to PQC written notice of any event or development that would (a) render any statement, representation or warranty of the Company in this Agreement (including the Disclosure Schedule) inaccurate or incomplete in any material respect, or (b) constitute or result in a breach by the Company, Stockholders or Optionholders of, or a failure by the Company, Stockholders or Optionholders to comply with, any agreement or covenant in this Agreement applicable to such Party. PQC or Flagship shall promptly deliver to the Company written notice of any event or development that would (i) render any statement, representation or warranty of PQC or Flagship in this Agreement inaccurate or incomplete in any material respect, or (ii) constitute or result in a breach by PQC or Flagship of, or a failure by PQC or Flagship to comply with, any agreement or covenant in this Agreement applicable to such Party. No such disclosure shall be deemed to avoid or cure any such misrepresentation or breach. 4.9 Severance Obligations. The Company shall satisfy all severance --------------------- obligations related to each person employed by the Company prior to or at the Closing Date who is, or as a consequence of the transactions contemplated by this Agreement will be, entitled to any severance or compensation from the Company, any Stockholder or any Optionholder. 4.10 Confidentiality. All information not previously disclosed to the --------------- public or generally known to persons engaged in the respective businesses of the Company, the Practice, Flagship or PQC which shall have been furnished by PQC or the Company to the other Party in connection with the transactions contemplated hereby or as provided pursuant to this Agreement shall not be disclosed to any person other than their respective employees, directors, attorneys, accountants or financial advisors or other than as expressly contemplated herein or as required by law or legal process. In the event that the transactions contemplated by this Agreement shall not be consummated, all such information which shall be in writing shall upon request be returned to the Party furnishing the same, including, to the extent reasonably practicable, all copies or reproductions thereof which may have been prepared, and none of the Parties, without the consent of PQC and the Company, shall at any time thereafter disclose to third parties, or use, directly or indirectly, for its or their own benefit, any such information, written or oral, about the business of the other Party hereto. 4.11 Provision of Certain Closing Date Financial Information. Two (2) ------------------------------------------------------- days prior to the Closing Date, the Company shall deliver to Flagship and PQC a certificate setting forth in detail to the best of the Company's knowledge; (i) all liabilities of the Company, including liabilities for accrued vacation and any Employee Benefit Plan (as defined in Section 2.21) that shall accrue on or before the Closing Date but shall remain unpaid on the Closing Date; (ii) all prepaid expenses of the Company that relate to a period subsequent to the Closing Date; (iii) all cash, -25- cash equivalents and accounts receivables expected to be reflected in accordance with generally accepted accounting principals on the Company's records on the Closing Date; and (iv) the Net Worth (as defined in Section 5.15) of the Company as of the Closing Date. 4.12 Continuing Obligation to Inform. From time to time prior to the ------------------------------- Closing, the Parties shall deliver or cause to be delivered to the other Parties supplemental information concerning events subsequent to the date hereof which would render any statement, representation or warranty in this Agreement or any information contained in any Schedule inaccurate or incomplete in any material respect at any time after the date hereof until the Closing Date. ARTICLE V CONDITIONS TO FLAGSHIP'S AND PQC'S OBLIGATIONS The obligation of each of Flagship and PQC to consummate the Merger is subject to the satisfaction on the Closing Date of the following conditions precedent, each of which may be waived in writing by Flagship and PQC: 5.1 Approval of Merger. This Agreement and the Merger shall have been ------------------ unanimously approved by the Board of Directors of the Company and the Stockholders and no Stockholder shall be entitled to exercise appraisal rights. 5.2 Continued Truth of Representations and Warranties of The Company; ----------------------------------------------------------------- Compliance with Covenants and Obligations. The representations and warranties - ----------------------------------------- of the Company, the Stockholders and Optionholders shall be true on and as of the Closing Date as though such representations and warranties were made on and as of such date, except for any changes permitted by the terms hereof or consented to in writing by Flagship and PQC. The Company and the Stockholders shall have performed and complied with all terms, conditions, covenants, obligations, agreements and restrictions required by this Agreement to be performed or complied with by it prior to or at the Closing Date. 5.3 No Proceedings or Litigation. No action by any Governmental Entity or ---------------------------- other person shall have been instituted or threatened which questions the validity or legality of the transactions contemplated hereby and which could reasonably be expected to result in a Material Adverse Effect. There shall not be any statute, rule or regulation that makes the Merger or the other transactions contemplated hereby illegal or otherwise prohibited. 5.4 Material Changes. Between June 30, 1996 and the Closing, there shall ---------------- not have been any material adverse change in the business, prospects, operations or conditions of the Company or the Practice. -26- 5.5 Stockholders Agreement. The Stockholders and Optionholders shall have ---------------------- become parties to and be in compliance with the Stockholders Agreement. 5.6 Due Diligence. The Company, the Stockholders and the Optionholders ------------- shall have provided to PQC and Flagship access to all material and information requested by PQC and Flagship to conduct a thorough due diligence review of all aspects of the Company and the Practice. PQC and Flagship shall be satisfied with such review, both in scope and substance. 5.7 Real Estate Arrangements. PQC shall have entered into leases, ------------------------ subleases or assignments of leases for each of the existing premises of the Company, which leases shall be in form and on terms satisfactory to PQC. 5.8 Government and Third Party Approvals. The transactions contemplated ------------------------------------ by this Agreement shall have been approved by all government agencies and third parties from whom such approval is required, including, but not limited to, Bain Capital, Inc. and Bankers Trust Company. 5.9 Corporate Approvals. This Agreement and the transaction contemplated ------------------- hereby shall have been approved by the Boards of Directors of PQC and Flagship, the Joint Policy Board of Flagship, the Class B shareholders of PQC and, to the extent required, by the physicians affiliated with Flagship. 5.10 Financing. PQC shall have obtained the financing equal to the cash --------- included in the Merger Consideration from affiliates of Bain Capital, Inc. or other sources acceptable to PQC. 5.11 S-1 Registration Statement. The Securities and Exchange Commission -------------------------- and the Securities Division of the State of Maryland shall have declared effective PQC's Registration Statement on Form S-1. 5.12 Employment Agreements. At least 80% of the Stockholders (and all of --------------------- the Stockholders listed on a Schedule 5.12) shall have entered into Employment ------------- Agreements with Flagship in the form attached hereto as Exhibit B. 5.13 Amendment to Services Agreement. Flagship and PQC shall have entered ------------------------------- into an Amended and Restated Services Agreement in substantially the form attached hereto as Exhibit C. --------- 5.14 Net Asset Test. On the Closing Date, the Company shall have cash, --------------- cash equivalents and accounts receivable of at least $ and a Net Assets (being total assets less total liabilities, in each case determined in accordance with generally accepted accounting principals) equal to at least $2,314,519. Since the date of the -27- Interim Financial Statements, the Company shall not have incurred any liabilities other than in the Ordinary Course of Business. 5.15 Closing Deliveries. Simultaneously with the Closing, the Company, ------------------ the Stockholders and the Optionholders shall deliver or cause to be delivered to PQC the following: (a) an Instrument of Joinder to Stockholders Agreement executed by each of the Stockholders in a form reasonably acceptable to PQC; (b) certificates of duly authorized officers of the Company, dated the Closing Date, setting forth the resolutions of the Board of Directors and Stockholders of the Company authorizing the execution and delivery by the Company of this Agreement and the consummation of the transactions contemplated hereby, and certifying that such resolutions were duly adopted and have not been rescinded or amended; (c) a report of a reputable lien search firm indicating that there are no liens of record against any of the Company's assets (except for liens which are (i) acceptable to Flagship and PQC in their sole discretion or (ii) arising under equipment leases listed on Schedule 5.15); --------------- (d) a release from any party with a mortgage or lien on any of the assets of the Company, except for liens which, pursuant to subsection (c) of this Section 5.16, are acceptable to Flagship and PQC; (e) the consents of all parties necessary for the consummation of the Merger and to consummate the other transactions contemplated by this Agreement; (f) a tax lien waiver, if required, from the Comptroller of the Treasury of the State of Maryland; and (g) such other agreements, consents and documents as PQC and Flagship shall reasonably request in connection with (i) their due diligence investigation of the Company, (ii) the affiliation of the Stockholders with Flagship and PQC, (iii) the transactions contemplated by this Agreement and the Employment Agreements. -28- ARTICLE VI CONDITIONS TO OBLIGATIONS OF THE COMPANY, THE STOCKHOLDERS AND THE OPTIONHOLDERS The obligations of Company, the Stockholders and the Optionholders under this Agreement are subject to the fulfillment, at the Closing Date, of the following conditions precedent, each of which may be waived in writing in the sole discretion of Company: 6.1 Continued Truth of Representations and Warranties of PQC and Flagship; ---------------------------------------------------------------------- Compliance with Covenants and Obligations. The representations and warranties - ----------------------------------------- of Flagship and PQC shall be true on and as of the Closing Date as though such representations and warranties were made on and as of such date, except for any changes permitted by the terms hereof or consented to in writing by the Company. Flagship and PQC shall have performed and complied with all terms, conditions, covenants, obligations, agreements and restrictions required by this Agreement to be performed or complied with by it prior to or at the Closing Date. 6.2 No Proceedings or Litigation. No action by any Governmental Entity or ---------------------------- other person shall have occurred or shall have been instituted or threatened which questions the validity or legality of the transactions contemplated hereby and which could reasonably be expected to result in a Material Adverse Effect. There shall not be any statute, rule or regulation that makes the Merger or the other transactions contemplated hereby illegal or otherwise prohibited. 6.3 Offers of Employment. Flagship shall have extended offers of -------------------- employment upon the same financial terms as the employee received from the Company on the date of execution hereof, subject to any subsequent changes acceptable to the Company and PQC, to the persons listed on Schedule 6.3. ------------ 6.4 Real Estate Arrangements. PQC shall have entered into leases, ------------------------ subleases or assignments of leases for each of the existing premises of the Company, which leases shall be in form and on terms satisfactory to PQC. 6.5 Government and Third Party Approvals. The transactions contemplated ------------------------------------ by this Agreement shall have been approved by all government agencies and third parties from whom such approval is required, including, but not limited to, the Class B shareholders of PQC and Bankers Trust Company. 6.6 Corporate Approvals. This Agreement and the transaction contemplated ------------------- hereby shall have been approved by the Boards of Directors of PQC and Flagship, the Joint Policy Board of Flagship, the Class B shareholders of PQC and, to the extent required, by the physicians affiliated with Flagship. -29- 6.7 Financing. PQC shall have obtained the financing equal to the cash --------- included in the Merger Consideration. 6.8 S-1 Registration Statement. The Securities and Exchange Commission -------------------------- shall have declared effective PQC's Registration Statement on Form S-1. 6.9 Letter Agreement. PQC, Flagship and the Stockholders shall have ---------------- entered into the Letter Agreement ("Letter Agreement") attached hereto as Exhibit D. 6.10 Amendment to Services Agreement. Flagship and PQC shall have entered ------------------------------- into an Amended and Restated Services Agreement in substantially the form attached hereto as Exhibit C. ---------- 6.11 Material Changes. Between March 31, 1997, and the Closing, there ---------------- shall not have been any Material Adverse Change in the business, prospects, operations or conditions of Flagship or PQC. 6.12 Due Diligence. PQC shall have provided to the Company access to all ------------- material and information requested by the Company to conduct a thorough due diligence review of all aspects of PQC. The Company shall be satisfied with such review, both in scope and substance. 6.13 Physicians. Flagship shall have offered to enter into Employment ----------- Agreements with each of the Stockholders in the form attached hereto as Exhibit B. 6.14 Deliveries by PQC. Simultaneously with the Closing, PQC shall ----------------- deliver or cause to be delivered to the Stockholders and Optionholders the following: (a) the Merger Consideration. (b) certificates of duly authorized officers of Flagship and PQC, dated the Closing Date, setting forth the resolutions of the Board of Directors of Flagship and PQC authorizing the execution and delivery by Flagship and PQC of this Agreement and the consummation of the transactions contemplated hereby, and certifying that such resolutions were duly adopted and have not been rescinded or amended; (c) such other instruments, consents and documents as the Company shall reasonably request in connection with (i) its due diligence investigation of PQC and (ii) the transactions contemplated by this Agreement. -30- ARTICLE VII INDEMNIFICATION 7.1 Indemnification. --------------- (a) The Stockholders and Optionholders, severally and not jointly, shall indemnify, defend, and hold harmless PQC, Flagship and their respective subsidiaries and affiliates and their directors, officers, employees and agents or the successor of any of the foregoing (collectively, the "PQC Indemnified Parties"), and reimburse the PQC Indemnified Parties for, from and against all payments, demands, claims, suits, judgments, liabilities, losses, costs, damages and expenses, including, without limitation, interest, penalties and reasonable attorneys' fees, disbursements and expenses (collectively, "Damages"), imposed on or incurred by any PQC Indemnified Party which relate to or arise out of: (i) breach of any representation and warranty of, or covenant or agreement to be performed by, the Company, any Stockholder or any Optionholder, in each case contained in this Agreement or the Stockholders Agreement; (ii) failure of any Stockholder to have good, valid and marketable title to the issued and outstanding Shares held by such Stockholder, free and clear of all liens, claims, pledges, options, adverse claims or charges of any nature whatsoever; (iii) any claim by a Stockholder, an Optionholder or former Stockholder or Optionholder of the Company, or any other person, firm, corporation or entity, seeking to assert, or based upon: (A) ownership or rights to ownership of any shares of stock of the Company; (B) any rights of a Stockholder, including any options, preemptive rights or rights to notice or to vote; (C) any rights under the Articles of Incorporation or bylaws of the Company; or (D) any claim that such Stockholder's shares were wrongfully repurchased by the Company; (iv) any Tax liabilities arising out of the operation of the Company prior to the Closing Date provided however, that with respect to any Stockholder, there is excluded from Section 7.1 (a)(iv) any amounts actually deducted as a Deductible Expense of such Stockholder under Section 10.4 of Appendix A of the Services Agreement; (v) the conduct of the Practice prior to the Closing Date, except for liabilities described in Section 2.8(a); -31- (vi) any liability of the Company incurred prior to the Closing Date that is not described in Schedule 2.8(a); and ---------------- (vii) any liability incurred by PQC or Flagship relating to agreements or obligations of the Company or any Stockholder, whether written or oral, that are not specifically identified on the Disclosure Schedule. (b) PQC and Flagship shall indemnify and hold harmless the Company and the Stockholders and their respective agents or the successors of any of the foregoing (collectively, the "Company Indemnified Parties") and together with the PQC Indemnified Parties (the "Indemnified Parties"), and reimburse such Company Indemnified Parties for, from, and against all Damages imposed on or incurred by such Company Indemnified Parties which relate to or arise out of any breach of any representation or warranty of, or covenant or agreement to be performed by, PQC or Flagship, in each case contained in this Agreement. 7.2 Method of Asserting Claims. -------------------------- (a) An Indemnified Party shall give prompt written notice to an indemnifying party (the "Indemnifying Party") of any payments, demands, claims, suits, judgments, liabilities, losses, costs, damages or expenses (a "Claim") in respect of which such Indemnifying Party has a duty to provide indemnity to such Indemnified Party under this Article VII, except that any delay or failure so to notify the Indemnifying Party only shall relieve the Indemnifying Party of its obligations hereunder to the extent, if at all, that it is prejudiced by reason of such delay or failure. (b) If a Claim is brought or asserted by a third party (a "Third-Party Claim"), the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified Party and the payment of all expenses. The Indemnified Party shall have the right to employ separate counsel in such Third-Party Claim and participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of the Indemnified Party. In the event that the Indemnifying Party, within twenty (20) days after written notice of any Third-Party Claim, fails to assume the defense thereof, or in the event the Indemnifying Party fails to demonstrate, to the reasonable satisfaction of the Indemnified Party, that it has sufficient assets to meet its indemnification obligations hereunder, the Indemnified Party shall have the right to undertake the defense, compromise or settlement of such Third-Party Claim for the account of the Indemnifying Party. Anything in this Section 7.2(b) to the contrary notwithstanding, the Indemnifying Party shall not, without the Indemnified Party's prior written consent, settle or compromise any Third-Party Claim or consent to the entry of any judgment with respect to any Third-Party Claim which would have any adverse effect on the Indemnified Party, except as provided immediately below. The -32- Indemnifying Party may, without the Indemnified Party's prior written consent, settle or compromise any such Third-Party Claim or consent to entry of any judgment with respect to any Third-Party Claim which requires solely money damages paid by the Indemnifying Party and which includes as an unconditional term thereof the release by the claimant or the plaintiff of the Indemnified Party from all liability in respect of such Third-Party Claim. (c) With respect to any Claim other than a Third Party Claim, the Indemnifying Party shall have thirty (30) days from receipt of written notice from the Indemnified Party of such Claim within which to respond thereto. If the Indemnifying Party does not respond within such thirty (30) day period, the Indemnifying Party shall be deemed to have accepted responsibility to make payment and shall have no further right to contest the validity of such Claim. If the Indemnifying Party notifies the Indemnified Party within such thirty (30) day period that it rejects such Claim in whole or in part, the Indemnified Party shall be free to pursue such remedies as may be available to the Indemnified Party under applicable law. 7.3 Survival. All representations, warranties, covenants and agreements -------- made by the Parties herein or in any instrument or document furnished in connection herewith shall survive the Closing and any investigation at any time made by or on behalf of the Parties hereto. All such representations and warranties and the Stockholders' obligations pursuant to Section 7.1(a)(i) and the obligations of PQC and Flagship pursuant to Section 7.1(b) shall expire on the third anniversary of the Closing Date, except for Claims, if any, asserted in writing prior to such second anniversary, which shall survive until satisfied in full or otherwise finally resolved. The obligation of the Stockholders pursuant to Section 7-1(a)(ii), (iii), (iv), (v), (vi) and (vii) shall survive until six (6) months after the expiration of the applicable statute of limitations with respect thereto. All Claims and actions for indemnity pursuant to this Article VII shall be asserted or maintained in writing by a Party hereto on or prior to the expiration of such periods. 7.4 Set-off and Recoupment. Any amount or amounts due from any ---------------------- Indemnifying Party to PQC under this Article VII may be paid to PQC, at PQC's option, by set-off or recoupment against any amounts due to the Indemnifying Party pursuant to this Agreement or pursuant to any agreement between the Indemnifying Party and PQC, Flagship or any of their respective affiliates. Any such set-off will be without prejudice to PQC's right to pursue any other remedies at law or in equity available to it. 7.5 Limitation on Indemnification. ----------------------------- (a) Notwithstanding any other term or condition contained herein or in any other agreement or instrument referred to herein, the indemnification obligations -33- of each Stockholder under Section 7.1(a)(i) - (vii) shall be limited, in the aggregate, to the dollar value on the Closing Date of the Merger Consideration paid to such Stockholder reduced by any amount deducted as a Deductible Expense of such Stockholder under Section 10.4 of Appendix A of the Services Agreement resulting from any Tax Liabilities of the Company, if, but only if, the Company has filed all tax returns based on the good faith determination of its accountants and paid all taxes shown to be due thereon through the taxable year ending on the date of the Merger. (b) Notwithstanding any other term or condition contained herein, PQC shall not be entitled to any indemnification pursuant to Section 7.1(a)(v), (vi) or (vii) with respect to any Damages where the indenmitor (or in the case of the Company, a member of the management committee) did not have knowledge of the liability giving raise to such Damages prior to the Closing Date, if, and only if, an amount equal to 100% of such Damages (subject to the limitation in Section 7.5(a)) is included as a Practice Expense of Pod R pursuant to the Services Agreement and PQC or Flagship, as in the case may be, is actually reimbursed for 100% of such Damages (subject to the limitation in Section 7.5(a)) in accordance with terms of the Services Agreement. Notwithstanding any other term or condition contained herein, PQC shall not be entitled to any indemnification pursuant to Section 7.1(a) with respect to the tax liability set forth on Schedule 7.5(b) provided that PQC is reimbursed for such tax liability -------- ------ over a period of three years (or such longer period as the Internal Revenue Service may agree) out of the Pod R Account as such term is defined in the Services Agreement. (c) No Indemnified Party shall be indemnified and held harmless under this Article VII from and against any Damages unless the Damages exceed on a cumulative basis an amount equal to $250,000, in which case an Indemnitor shall be liable only for Damages in excess of $250,000. The foregoing limitation shall apply to the Company, Stockholders, and Optionholders in the aggregate and not individually. ARTICLE VIII TERMINATION 8.1 Optional Termination. This Agreement may be terminated and the -------------------- transaction contemplated herein abandoned at any time prior to the Closing as follows: (a) by the mutual consent of the Company, PQC and Flagship; (b) by the Company, upon a material breach of any representation, warranty, covenant or agreement on the part of PQC or Flagship set forth in this Agreement, or if any representation or warranty of PQC or Flagship has become materially untrue, in either case such that any of the conditions set forth in Article VI -34- would be incapable of being satisfied by July 31, 1997; provided, that in any case, a willful breach will be deemed to cause such conditions to be incapable of being satisfied for purposes of this paragraph (b). Any breach on the part of PQC or Flagship of the representations and warranties contained in Article III or the covenants contained in Article IV, which permits termination of this Agreement shall permit the Company, the Stockholders and the Optionholders to immediately terminate any other agreement between PQC or Flagship and the Company, any of the Stockholders. (c) by PQC and Flagship upon a material breach of any representation, warranty, covenant or agreement on the part of the Company, the Stockholders or the Optionholders set forth in this Agreement, or if any representation or warranty of the Company has become materially untrue, in either case such that any of the conditions set forth in Article V would be incapable of being satisfied by July 31, 1997; provided, that in any case, a willful breach will be deemed to cause such conditions to be incapable of being satisfied for purposes of this paragraph (c). Any breach on the part of the Company, the Stockholders or the Optionholders of the representations and warranties contained in Article II or the covenants contained in Article IV, which permits termination of this Agreement shall permit PQC and Flagship to immediately terminate any other agreement between the Company, the Stockholder or the Optionholder and PQC or Flagship; or (d) by either Party if the Closing shall not have occurred by July 31, 1997, or such other date agreed to by the Parties. 8.2 Effect of Termination. In the event this Agreement is terminated as --------------------- provided above, (a) each of PQC, Flagship, the Stockholders, the Optionholders and the Company shall, upon another Party's request, deliver to such other Party all documents previously delivered (and copies thereof in its possession) concerning one another and the transactions contemplated hereby as required by Section 4.10 above, and (b) none of the Parties nor any of their respective Stockholders, directors, officers or agents shall have any liability to the other Parties, except for any deliberate breach or deliberate omission resulting in a material breach of any of the provisions of this Agreement. In such case, the breaching Party shall be liable only for the expenses and costs of the non- breaching Party, and in no event shall either Party be liable for anticipated profits or consequential damages. After termination each Party shall keep confidential all information provided by the others pursuant to this Agreement which is not in the public domain, shall exercise the same degree of care in handling such information as it would exercise with similar information of its own, and shall return any such information upon another Party's request. -35- ARTICLE IX MISCELLANEOUS 9.1 Press Releases and Announcements. No Party shall issue any press -------------------------------- release or public disclosure relating to the subject matter of this Agreement without the prior written approval of the other Parties; provided, however, that -------- ------- any Party may make any public disclosure it believes in good faith is required by law or regulation (in which case the disclosing Party shall advise the other Parties and provide them with a copy of the proposed disclosure prior to making the disclosure). 9.2 No Third Party Beneficiaries. This Agreement shall not confer any ---------------------------- rights or remedies upon any person other than the Parties and their respective successors and permitted assigns; provided, however, that the provisions in -------- Article I concerning payment of the Merger Consideration are intended for the benefit of the Stockholders and Optionholder. 9.3 Entire Agreement. This Agreement (including the documents referred to ---------------- herein) constitutes the entire agreement among the Parties and supersedes any prior understandings, agreements, or representations by or among the Parties, written or oral, with respect to the subject matter hereof. 9.4 Succession and Assignment. This Agreement shall be binding upon and ------------------------- inure to the benefit of the Parties named herein and their respective successors and permitted assigns. No Party may assign either this Agreement or any of its rights, interests, or obligations hereunder without the prior written approval of each of the other Parties. 9.5 Counterparts. This Agreement may be executed in two (2) or more ------------ counterparts, each of which shall be deemed an original but all of which together shall constitute one (1) and the same instrument. 9.6 Headings. The section headings contained in this Agreement are -------- inserted for convenience only and shall not affect in any way the meaning or interpretation of this Agreement. 9.7 Notices. All notices, requests, demands, claims, and other ------- communications hereunder shall be in writing. Any notice, request, demand, claim, or other communication hereunder shall be deemed duly delivered two (2) business days after it is sent by registered or certified mail, return receipt requested, postage prepaid, or one (1) business day after it is sent via a reputable nationwide overnight courier service, in each case to the intended recipient as set forth below: -36- If to the Company or the Stockholders: - -------------------------------------- To the last known home address of each Stockholder as maintained in the records of Flagship with a copy to: Epstein, Becker & Green, P.C. 1227 25th Street, N.W. Washington, DC 20037-1156 Attention: Mark Lutes, Esq. If to PQC or Flagship: - ---------------------- Physicians Quality Care, Inc. 950 Winter Street Suite 2410 Waltham, MA 02154 Attention: Jerilyn Asher With a copy to: David C. Phelan, Esq. Hale and Dorr 60 State Street Boston, MA 02109 Any Party may give any notice, request, demand, claim, or other communication hereunder using any other means (including personal delivery, expedited courier, messenger service, telecopy, telex, ordinary mail, or electronic mail), but no such notice, request, demand, claim, or other communication shall be deemed to have been duly given unless and until it actually is received by the Party for whom it is intended. Any Party may change the address to which notices, requests, demands, claims, and other communications hereunder are to be delivered by giving the other Parties notice in the manner herein set forth. 9.8 Governing Law. This Agreement shall be governed by and construed in ------------- accordance with the internal laws (and not the law of conflicts) of the State of Maryland. 9.9 Amendments and Waivers. The Parties may mutually amend any provision ---------------------- of this Agreement at any time prior to the Effective Time. No amendment of any provision of this Agreement shall be valid unless the same shall be in writing and signed by all of the Parties. No waiver by any Party of any default, misrepresentation, or breach of warranty or covenant hereunder, whether intentional or not, shall be deemed to extend to any prior or subsequent default, misrepresentation, or breach of warranty or covenant hereunder or affect in any way any rights arising by virtue of any prior or subsequent such occurrence. -37- 9.10 Severability. If any term, provision, covenant or restriction of this ------------ Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 9.11 Expenses. Except as otherwise expressly provided herein, each Party -------- to this Agreement shall pay its own costs and expenses in connection with the trans actions contemplated hereby. 9.12 Further Assurances. From time to time, at the request of any Party ------------------ hereto and without further consideration, the other Parties will execute and deliver to such requesting Party such documents and take such other action (but without incurring any material financial obligation) as such requesting Party may reasonably request in order to consummate more effectively the transactions contemplated hereby. 9.13 Specific Performance. Each of the Parties acknowledges and agrees -------------------- that one (1) or more of the other Parties would be damaged irreparably in the event any of the provisions of this Agreement are not performed in accordance with their specific terms or otherwise are breached. Accordingly, each of the Parties agrees that the other Parties shall be entitled to an injunction or injunctions to prevent breaches of the provisions of this Agreement and to enforce specifically this Agreement and the terms and provisions hereof in any action instituted in any court of the United States or any state thereof having jurisdiction over the Parties and the matter, in addition to any other remedy to which it may be entitled, at law or in equity. 9.14 Construction. The language used in this Agreement shall be deemed to ------------ be the language chosen by the Parties hereto to express their mutual intent, and no rule of strict construction shall be applied against any Party. Any reference to any federal, state, local, or foreign statute or law shall be deemed also to refer to all rules and regulations promulgated thereunder, unless the context requires otherwise. 9.15 Incorporation of Exhibits and Schedules. The Exhibits and Schedules --------------------------------------- identified in this Agreement are incorporated herein by reference and made a part hereof. 9.16 Gender. All references herein to the masculine gender shall be deemed ------ to include the feminine or neuter gender as appropriate. 9.17 Table of Cross-References. The following defined terms have the ------------------------- meaning set forth in the respective locations within this Agreement set forth below: -38- "Actions" Section 2.17 "Affiliated Group" Section 2.11(d) "Articles of Merger" Section 1.1 "CERCLA" Section 2.27(a) "Claim" Section 7.2(a) "Code" Section 1.13 "Closing" Section 1.2 "Closing Date" Section 1.2 "Common Stock" Preamble "Company" Preamble "Company Indemnified Parties" Section 7.1(b) "Consenting Corporation" Section 2.11(c) "Contracts" Section 2.14(a) "Damages" Section 7.1(a) "Disclosure Schedule" Article II "ERISA" Section 2.21(c) "ERISA Affiliate" Section 2.21(e) "Effective Time" Section 1.1 "Employee Benefit Plan" Section 2.21(a) "Employment Agreements" Section 5.12(a) "Environment" Section 2.27(a) "Environmental Law" Section 2.27(a) "Financial Statements" Section 2.7 "Flagship" Preamble "Governmental Entity" Section 2.6 "Indemnified Parties" Section 7.1(b) "Indemnifying Party" Section 7.2(a) "Interim Financial Statements" Section 2.7 "Leases" Section 2.13(a) "Material Adverse Effect" Section 2.5 "Material of Environmental Concern" Section 2.27(b) "Merger" Section 1.1 "Merger Consideration" Section 1.3 "Multi-Employer Plan" Section 2.21(e) "Ordinary Course of Business" Section 2.12 Optionholders Preamble "PQC" Preamble "PQC Indemnified Parties" Section 7.1(a) "Parachute Payments" Section 2.11(e) "Parties" Preamble "Permits" Section 2.15 "Practice" Section 2.5 "Release" Section 2.27(a) "Security Interest" Section 2.12 -39- "Shares" Section 1.5(a) "Stockholders" Preamble "Surviving Corporation" Section 1.1 "Tax Returns" Section 2.11(a) "Taxes" Section 2.11(a) "Third Party Claim" Section 7.2(b) [BALANCE OF THIS PAGE LEFT BLANK INTENTIONALLY] -40- IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as of the date first above written. PHYSICIANS QUALITY CARE, INC. /s/ Samantha J. Trotman ------------------------------------ By: Samantha J. Trotman Title: Chief Financial Officer and Vice President FLAGSHIP HEALTH, P.A. /s/ Dana Frank, M.D. ------------------------------------ By: Dana Frank, M.D. Title: President CLINICAL ASSOCIATES, P.A. By: ------------------------------------ By: Richard Maffezzoli Its: President CLINICAL ASSOCIATES STOCKHOLDERS: /s/ Mohammed Ahmed ------------------------------------ /s/ Samuel Akman ------------------------------------ -41- /s/ Mahmood Alikhan ------------------------------------ /s/ Robert S. Baxt ------------------------------------ /s/ George Bedon ------------------------------------ /s/ Paul Z. Bodnar ------------------------------------ /s/ William Bouchelle ------------------------------------ /s/ James M. Corkum ------------------------------------ /s/ Albert F. DeLoskey ------------------------------------ /s/ James F. Dunlay ------------------------------------ /s/ Paul J. Edgar ------------------------------------ /s/ Clara E. Escuder ------------------------------------ /s/ Carl S. Friedman ------------------------------------ /s/ Miquel A. Frontera ------------------------------------ /s/ John Gambrill ------------------------------------ /s/ Carlton Greene ------------------------------------ -42- /s/ Gregory Hall ------------------------------------ /s/ Michael Jacobs ------------------------------------ /s/ Kenneth P. Judd ------------------------------------ /s/ Virginia Kranz ------------------------------------ /s/ Michael Lifson ------------------------------------ /s/ Richard H. Mack ------------------------------------ /s/ Richard Maffezzoli ------------------------------------ /s/ Gary A. Manko ------------------------------------ /s/ Steven Miller ------------------------------------ /s/ Judah A. Minkove ------------------------------------ /s/ Keiffer J. Mitchell ------------------------------------ /s/ Charlotte E. Modly ------------------------------------ /s/ Rose Mary Mulaikal ------------------------------------ /s/ Bindu Noor ------------------------------------ /s/ Bonnie Orzech-Nixon ------------------------------------ /s/ James Paskert ------------------------------------ -43- /s/ Radha Pathak ------------------------------------ /s/ Robert Peques ------------------------------------ /s/ Toby Ritterhoff ------------------------------------ /s/ Bruce Rosenberg ------------------------------------ /s/ Duncan Salmon ------------------------------------ /s/ David Saltzberg ------------------------------------ /s/ Lise K. Satterfield ------------------------------------ /s/ Richard T. Scholz ------------------------------------ /s/ Sidney Seidman ------------------------------------ /s/ Linda Sevier ------------------------------------ /s/ David S. Shear ------------------------------------ /s/ Ronald Sher ------------------------------------ /s/ Alan M. Shorofsky ------------------------------------ /s/ Stephen M. Siegel ------------------------------------ /s/ Stuart B. Silver ------------------------------------ -44- /s/ Edward Souweine ------------------------------------ /s/ Jonathan E. Surell ------------------------------------ /s/ Anthony Vazzano ------------------------------------ /s/ Barry Vogelstein ------------------------------------ /s/ Richard Weisman ------------------------------------ /s/ Julie Winston ------------------------------------ /s/ Wayland Wong ------------------------------------ /s/ Robert E. Zadek ------------------------------------ CLINICAL ASSOCIATES OPTIONHOLDERS: /s/ William Bartholomay ------------------------------------ /s/ Sarah Bodnar ------------------------------------ /s/ Marla Caplan ------------------------------------ -45- SCHEDULE 1.9 ------------ Director Laura Mumford, M.D. President Dana Frank, M.D. Treasurer Warren Kosterman Secretary Katherine Kaminski -46- SCHEDULE 3.2 ------------- Options to purchase 2,450,766 shares of Class A Common Stock are outstanding under the 1995 Equity Incentive Plan. Options to purchase 72,500 shares of Class A Common Stock issued to Springfield Physicians. Options to purchase 10,000 shares of Class A Common Stock issued to Faust Management Company. Options to purchase 7,500 shares of Class A Common Stock issued to Zurich Davis. Warrants to purchase 1,054,207 shares of Class A Common Stock are outstanding Warrants to purchase 6,415,000 shares of Class B Common Stock are outstanding Warrants to purchase 7,629,309 shares of Class C Common Stock are outstanding. The Class C shareholders also have the right to purchase an additional 6,153,846 Class C shares and 6,153,846 Class C Warrants under the Class B and Class C Common Stock Purchase Agreement. The Merger Agreements among the Company, Medical Care Partners, PC and Chestnut Medical Associates, Inc and the Company, Medical Care Partners, PC and Springfield Medical Associates and the Affiliation Agreement among the Company, Medical Care Partners, PC and Jay Ungar, MD provide for contingent payments if certain performance criteria are met; however, such contingent obligations are payable up to an additional 800,000 shares of Class A Common Stock. There are transfer restrictions in the Stockholders Agreement attached as Exhibit A. There are transfer restrictions in the Stockholders Agreement, dated August 30, 1996, between the Company and the initial group of physicians affiliated with Medical Care Partners, PC (MCP). The Company and the initial group of physicians affiliated with Medical Care Partners, PC are a parties to a registration rights agreement. -47- SCHEDULE 3.6 ------------ PQC is required to obtain the consent of the institutional investors under the Class B and Class C Common Stock Purhase Agreement for the completion of the transactions contemplated by the Merger Agreement. PQC is required to obtain the approval of Bankers Trust Company to any amendment to the Services Agreement before any borrowings are outstanding under the Credit Agreement. No amount is currently outstanding under the Credit Agreement. -48- SCHEDULE 3.10 ------------- Jay Greenberg, a former Executive Vice President of the Company, has commenced a civil action in Middlesex County, Massachusetts. Mr. Greenberg seeks certain injunctive and equitable relief, $1.4 million in damages and a declaratory judgement that he owns 843,750 shares of Class A Common Stock -49- Schedule 1.13, 2.1-2.26, 5.12, 5.15 and 7.5(b) are available upon written request to the Company. -50- EX-10.25 8 AMENDMENT NO. 1 TO THE MANAGEMENT AGREEMENT Exhibit 10.25 ------------- BAIN CAPITAL PARTNERS V, L.P. TWO COPLEY PLACE, 7TH FLOOR BOSTON, MASSACHUSETTS 02116 April 18, 1997 Physicians Quality Care, Inc. 950 Winter Street, Suite 2410 Waltham, Massachusetts 02154 Re: Amendment No. 1 to Management Agreement (the "Amendment") --------------------------------------------------------- Ladies and Gentlemen: Bain Capital Partners V, L.P. ("Bain") and Physicians Quality Care, Inc. (the "Company") hereby agree as follows: 1. REFERENCE TO MANAGEMENT AGREEMENT. Reference is made to the Management --------------------------------- Agreement (the "Agreement") dated August 30, 1996 between Bain and the Company. Terms defined in the Agreement and not otherwise defined herein are used herein with the meanings so defined. 2. AMENDMENTS TO AGREEMENT. The Company and Bain agree that, effective as ----------------------- of the date hereof, Section 2(a) of the Agreement is amended and restated in its entirety as follows: "a. during the Term, pay to Bain (or an affiliate of Bain designated by it) a management fee of $750,000 per annum in exchange for the services provided to the Company by Bain, as more fully described in Section 1 of this Agreement, such fee being payable by the Company quarterly in advance, the first such payment to be made at the closing of the first Equity Investment; provided, however, that with the consent of Bain, the Company may accrue $250,000 of such management fee per annum until the earlier of (i) five business days following notification by Bain to the Company to make such payment, or (ii) 30 days prior to an initial public offering of the Company's capital stock; and" 3. MISCELLANEOUS. Except to the extent specifically amended hereby, the ------------- provisions of the Agreement shall remain unmodified and the Agreement as amended hereby is hereby confirmed as being in full force and effect. This Amendment may be executed in counterparts which together shall constitute one instrument and shall be deemed by a contract made under and laws of The Commonwealth of Massachusetts and shall be construed under and governed by the laws of such Commonwealth and shall bind and inure to the benefit of the parties hereto and their respective successors and assigns. IN WITNESS WHEREOF, each of the parties has caused this Agreement to be executed on its behalf as an instrument under seal as of the date first above written by its officer or representative thereunto duly authorized. THE COMPANY: PHYSICIANS QUALITY CARE, INC. By: s/s Jerilyn P. Asher ------------------------------------- Title: BAIN: BAIN CAPITAL PARTNERS V, L.P. By: Bain Capital Investors V, Inc., Its general partner By: /s/ Stephen G. Pagliuca ----------------------------------- Title: -2- EX-21.1 9 LIST OF SUBSIDIARIES EXHIBIT 21.1 List of Subsidiaries -------------------- Name Jurisdiction of Incorporation - ---- ----------------------------- Physicians Quality Care of Massachusetts, Inc. Massachusetts Physicians Quality Care of Maryland, Inc. Maryland 1 EX-27 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED FINANCIAL STATEMENTS OF THE COMPANY FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1997, RESPECTIVELY, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. AS MORE FULLY DESCRIBED IN NOTE 2 TO THE AUDITED FINANCIAL STATEMENTS, THE COMPANY ADOPTED SFAS 128 "EARNINGS PER SHARE" IN 1997. THE ADOPTION OF SFAS 128 DID NOT IMPACT THE EARNINGS PER SHARE CALCULATIONS FOR 1996 AND 1995. YEAR YEAR DEC-31-1996 DEC-31-1997 JAN-01-1996 JAN-01-1997 DEC-31-1996 DEC-31-1997 136,926 8,782,019 0 0 0 0 0 0 0 0 1,915,769 14,606,483 271,782 1,548,068 57,774 220,208 34,789,573 73,410,583 2,775,808 2,113,337 271,552 0 31,851,473 54,473,947 0 0 112,360 207,975 (470,812) 15,869,262 34,789,573 73,410,583 6,026,452 46,037,234 6,117,556 46,535,329 0 0 10,779,966 51,675,017 0 98,269 214,404 1,105,616 104,255 161,938 (4,981,069) (6,505,511) 78,128 (795,281) (5,059,197) (5,710,230) 0 0 0 0 0 0 (5,059,197) (5,710,230) (1.81) (0.41) 0 0
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