-----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, VAKObhDtfQL9rV51sFXZGC6xbKSMKHUKER+xJgG/pblYcDLiHwEVqo/0B3aSVBbZ rrSCgCxLPQJ8T0vWcx9Naw== 0000927016-99-003079.txt : 19990823 0000927016-99-003079.hdr.sgml : 19990823 ACCESSION NUMBER: 0000927016-99-003079 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990820 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-Q SEC ACT: SEC FILE NUMBER: 333-26137 FILM NUMBER: 99697150 BUSINESS ADDRESS: STREET 1: 950 WINTER STREET CITY: WALTHAM STATE: MA ZIP: 02154 BUSINESS PHONE: 6178905560 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended June 30, 1999 ------------------------------------------ OR X 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 Identification No.) Incorporation or Organization) 700 Technology Park Drive, Billerica, Massachusetts 01821 - -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (978) 439-0323 ----------------------------- Not Applicable - -------------------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check X 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_________ --------- APPLICABLE ONLY TO CORPORATE ISSUERS: Number of shares outstanding of registrant's common stock as of June 30, 1999: 22,258,944 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, 7,692,309 shares of Class C Common Stock, $.01 par value and 2,461,538 shares of Class L Common Stock. PHYSICIANS QUALITY CARE, INC. FORM 10-Q TABLE OF CONTENTS
PAGE ---- PART I FINANCIAL INFORMATION Item 1. Balance Sheets as of June 30, 1999 (Unaudited) and December 31, 1998........................................................... 1 Unaudited Statements of Operations for the three and six months ended June 30, 1999 and 1998......................................... 2 Unaudited Statements of Cash Flows for the six months ended June 30, 1999 and 1998................................................ 3 Notes to unaudited financial statements six months ended June 30, 1999 and 1998...................................................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 5 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K............................................ Signatures................................................................................. 27 Exhibit Index.............................................................................. 27
PART I FINANCIAL INFORMATION Item 1. Financial Statements. Physicians Quality Care, Inc. Balance Sheets
(Unaudited) June 30, 1999 December 31, 1998 ------------- ----------------- ASSETS Current Assets: Cash and Cash Equivalents $ 1,034,613 $ 4,038,802 Restricted cash 1,058,663 1,248,655 Intercompany 5,750,243 6,884,020 Note receivable 3,891,000 - Other current assets............................................ - 121,497 ------------- ----------------- Total current assets 11,734,519 12,292,974 Investment in long term affiliation agreements, net 4,349,015 6,095,253 Property and equipment, net 307,616 395,768 Other assets.................................................... 59,144 407,421 ------------- ----------------- Total assets $ 16,450,294 $ 19,191,416 ============= ================= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 520,167 $ 453,891 Accrued expenses 1,860,709 1,172,834 ------------- ----------------- Total current liabilities............................................. $ 2,380,876 1,626,725 Common Stock, Subject to Put, 13,951,636 and 18,751,636 shares 31,391,182 42,191,181 authorized, issued and outstanding at June 30, 1999 and December 31, 1998, respectively Stockholders' deficiency: Preferred stock $.01 par value, 10,000,000 shares authorized, none issued Class A Common Stock, $.01 par value, 75,000,000 shares authorized 93,198 93,052 9,319,808 and 9,305,208 shares issued at June 30, 1999 and December 31, 1998, respectively Class B-1 Common Stock, $.01 par value, 15,257,915 shares 28,093 28,093 authorized, 2,809,296 shares issues and outstanding Class B-2 Common Stock, $.01 par value, 9,732,085 shares 17,907 17,907 authorized, 1,790,704 shares issued and outstanding Class C Common Stock, $.01 par value, 13,846,155 shares authorized, 76,923 76,923 7,692,309 shares issued and outstanding Class L Common Stock, $.01 par value 2,461,538 shares authorized, 24,615 24,615 issued and outstanding Additional paid-in capital 70,255,720 59,452,218 Accumulated Deficit (87,808,095) (84,309,173) Less cost of 1,012,500 shares of Class A Common Stock held in Treasury (10,125) (10,125) ------------- ----------------- Total stockholders' deficiency........................................ (17,321,764) (24,626,490) ------------- ----------------- Total liabilities and stockholders' deficiency........................ $ 16,450,294 $ 19,191,416 ============= =================
See accompanying notes. 1 Physicians Quality Care, Inc. Statements of Operations (Unaudited)
Three Months Six Months Ended June 30 Ended June 30 1999 1998 1999 1998 ----------------------------------------------------- Management fee $ 572,971 570,364 $ 933,565 $ 1,419,998 Operating expenses: Salaries and benefits 587,619 691,494 1,010,032 1,341,234 General and administrative expenses 486,779 856,252 949,503 1,767,894 Depreciation and amortization 85,465 608,800 175,830 1,046,221 ------ ------- ------- --------- Total expenses 1,159,863 2,156,546 2,135,365 4,155,349 Operating loss (586,892) (1,586,182) (1,201,800) (2,735,351) Other income (expense): Interest income 11,730 33,950 55,875 126,404 Loss of investment in subsidiary and affiliates (1,781,356) (1,130,488) (2,319,627) (2,018,829) Interest expense - - (3,661) (4,818) ----------------------------------------------------- (1,769,626) (1,096,538) (2,267,413) (1,897,243) Loss before income taxes (2,356,518) (2,682,720) (3,469,213) (4,632,594) Income tax (benefit) provision (44,541) - 29,709 - ----------------------------------------------------- Net loss $(2,311,977) $(2,682,720) $(3,498,922) $(4,632,594) =========== =========== =========== =========== Net loss available to common stock $(2,311,977) $(7,222,214) $(3,498,922) $(9,172,090) =========== =========== =========== =========== Net loss per common share-basic $ (0.06) $ (0.18) $ (0.09) $ (0.23) =========== =========== =========== =========== Weighted average common shares outstanding 38,595,209 39,461,589 40,192,611 39,352,829 =========== =========== =========== ===========
See accompanying notes. 2 Physicians Quality Care, Inc. Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 1999 1998 ---- ---- Operating Activities Net loss $(3,498,922) $(4,632,594) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 175,830 1,046,221 Changes in operating assets and liabilities, net of effects of business acquisitions: Due from affiliated physician practices (523,293) (3,710,752) Prepaid expenses and other assets 55,196 (159,543) Accounts payable and accrued expenses 754,151 (519,916) ----------- ----------- Net cash used in operating activities............................ (3,037,038) (7,976,584) Investing Activities Purchase of property and equipment (2,537) (93,402) Decrease/(increase) in restricted cash 189,992 (1,106,290) Cash paid for affiliations....................................... (158,255) (50,000) ----------- ----------- Net cash provided by (used in) investing activities 29,200 (1,249,692) Financing Activities Proceeds from issuance of common stock, net of issuance costs.... 3,649 186,440 ----------- ----------- Net cash provided by financing activities........................ 3,649 186,440 ----------- ----------- Net decrease in cash and cash equivalents (3,004,189) (9,039,835) Cash and cash equivalents at beginning of period................. 4,038,802 8,782,019 ----------- ----------- Cash and cash equivalents at end of period....................... $ 1,034,613 $ (257,817) =========== ===========
See accompanying notes. 3 Physicians Quality Care, Inc. Notes to Unaudited Financial Statements Six Months Ended June 30, 1999 and 1998 (1) Basis of Presentation --------------------- The accompanying unaudited financial statements of Physicians Quality Care, Inc., a Delaware corporation (the "Company"), have been prepared in accordance with generally accepted accounting principles and in accordance with Rule 10-01 of Regulation S-X. In the opinion of management, the unaudited interim financial statements contained in this report reflect all adjustments, consisting of only normal recurring accruals which are necessary for a fair presentation of the financial position as of June 30, 1999 and the results of operations for the six months ended June 30, 1999. The results of operations for the six month periods ended June 30, 1999 are not necessarily indicative of results for the full year. These unaudited financial statements, footnote disclosures and other information should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the amounts reported in the accompanying financial statements and notes. Actual results could differ from those estimates. (2) New Accounting Standards ------------------------ In the fourth quarter of 1998, the Company adopted Emerging Issues Task Force Issue 97-2, Consolidation of Physician Practice Entities ("EITF-97- 2"). Due to the existence of a Joint Policy board at each affiliated physician practices, the Company cannot demonstrate a controlling financial interest in its affiliated physician practices, as defined by EITF 97-2, and therefore, does not consolidate the operating results and accounts of the affiliated physician practices. The adoption of EITF 97-2 resulted in reclassifications in certain amounts presented in the accompanying statements of operations and cash flows for the periods presented but did not impact the current or any previously reported net loss or net loss per common share. (3) Sales of Business and Restructuring ----------------------------------- In 1999, the Company determined that it would not be able to achieve positive cash flows under its current service agreements with the affiliated medical practices. The Company also concluded that it did not have sufficient financial resources to expand its operations or to continue to incur financial losses at historical rates, including the rate incurred during the first six months 4 of 1999. To address this situation, the Company sold in May 1999 its interest in Clinical Associates, P.A. (Flagship II) to the physicians affiliated with Clinical Associates. The total proceeds to the Company from said sale were $3,527,000, with the final installment of such payment being due in August 1999. On July 1, 1999, $2,000,000 of the total proceeds was paid. A closing service fee of $500,000 will also be paid. The Company is also currently negotiating the potential sale of its interest in physician practices of Flagship Health, PA. If such transactions are completed, the Company will have discontinued, substantially all of its operation in the Baltimore, Maryland area. At this time, the Company has not entered into definitive agreements for the sale of such businesses and there can be no assurance that any such agreements will be reached. The Company is also conducting negotiations with the physicians affiliated with Medical Care Partners, PC (Springfield) with the objective of either entering into a new Services Agreement with such physicians or selling the Company's interest in Medical Care Partners to such physicians. At this time, the Company has not entered into a definitive agreement with respect to either Flagship Health or Medical Care Partners and there can be no assurance that any such agreement will be reached. There can be no assurance if a sale of Flagship Health and a restructuring of the arrangements with Medical Care Partners are completed that the Company's remaining operations will constitute a viable business. The Company is also considering the sale of its interest in the Atlanta IPA businesses (TLC Management Company and Total Quality Practice Management, Inc.). If the Company sells all of the practices, it anticipates that such proceeds will be substantially less than the liquidation preference on the Class B, C and L Common Stock. In light of its financial condition, the Company has taken significant steps to reduce its operating expenses. Such actions, including staff reductions and termination arrangements, have resulted in certain contractual obligations that will be payable in future periods. These related actions were recorded as part of a restructuring charge taken by the Company at December 31, 1998. The Company believes the restructuring charge will be sufficient to cover these obligations. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. There are a number of important factors that could cause the Company's actual results to differ materially from those indicated by such forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed under Factors Affecting Future Operating Results. The following discussion should be read in conjunction with the Company's Unaudited Financial Statements and Notes thereto included elsewhere in this documents. OVERVIEW The Company was established to affiliate with and operate 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 5 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. On October 24, 1997, the Company also acquired a 50% interest in Total Life Care and a 50% interest in Total Quality Practice Management, Inc. Both companies are developing IPA business located in Atlanta, Georgia. In 1999, the Company determined that it would not be able to achieve positive cash flows under its current service agreements with the affiliated medical practices. The Company also concluded that it did not have sufficient financial resources to expand its operations or to continue to incur financial losses at historical rates, including the rate incurred during the first six months of 1999. To address this situation, the Company sold in May 1999 its interest in Clinical Associates, P.A. (Flagship II) to the physicians affiliated with Clinical Associates. The total proceeds to the Company from said sale were $3,527,000, with the final installment of such payment being due in August 1999. On July 1, 1999, $2,000,000 of the total proceed was paid. A closing service fee of $500,000 will also be paid. The Company is also currently negotiating the potential sale of its interest in the physician practices of Flagship Health, PA. If such transactions are completed, the Company will have discontinued, substantially all of its operation in the Baltimore, Maryland area. At this time, the Company has not entered into definitive agreements for the sale of such businesses and there can be no assurance that any such agreements will be reached. The Company is also conducting negotiations with the physicians affiliated with Medical Care Partners, PC (Springfield) with the objective of either entering into a new Services Agreement with such physicians or selling the Company's interest in Medical Care Partners to such physicians. At this time, the Company has not entered into a definitive agreement with respect to either Flagship Health or Medical Care Partners and there can be no assurance that any such agreement will be reached. There can be no assurance if a sale of Flagship Health and a restructuring of the arrangements with Medical Care Partners are completed that the Company's maintaining operations will constitute a viable business. The Company is also considering the sale of its interest in the Atlanta IPA businesses (TLC Management Company and Total Practice Management, Inc.). If the Company sells all of the practices, it anticipates that such proceeds will be substantially less than the liquidation preference on the Class B, C and L Common Stock. In light of its financial condition, the Company has taken significant steps to reduce its operating expenses. Such actions, including staff reductions and termination arrangements, have resulted in certain contractual obligations that will be payable in future periods. These related actions were recorded as part of a restructuring charge taken by the Company at December 31, 1998. The Company believes the restructuring charge will be sufficient to cover these obligations. 6 As of June 30, 1999, the Company had affiliations or IPA arrangements with the following physicians: Affiliated Physicians Maryland Massachusetts Georgia -------------- -------------------- ------------- Total: 56 42 0 IPA Physicians Maryland Massachusetts Georgia(*) -------------- -------------------- ------------- Total: 0 0 350 (*) Reflects number of physicians in IPA network in which the Company has a 50% interest. 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, 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 and terminated as of May 1999) PQC earned 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. 7 Write-down of Intangible Assets In connection with its Affiliations, the Company has recorded 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 $61.2 million reflected on its balance sheet as long-term affiliation agreements. The Company has written the value of such intangibles down to $6.1 million at December 31, 1998. During the six months ended June 30, 1999, additional adjustments and reclassifications reduced the carrying value to $4.3 million. Depending upon the outcome of negotiations with affiliated physicians, additional write-downs are possible. Results of Operations Six Months ended June 30, 1999 Management fee income was approximately $934,000 for the first six months of 1999 compared to approximately $1,420,000 during the first six months of 1998. Each of the 8 three affiliated groups were parties to their respective Services Agreement during the entire period of both years, except that the Services Agreement with Flagship Health II, PA ("Flagship II") terminated in May 1999. The decline in 1999 is principally attributable to the reduction in the fee payable by Flagship II due to a shortfall in incremental income, as well as declines in gross margins at the other affiliated physician practices. Management fee income is expected to continue to decrease in future periods resulting from the termination in May 1999 of affiliate arrangements with Flagship II and the other anticipated termination of affiliate arrangements with the majority of physicians affiliated with Flagship Health, PA. The Company's operating expenses also declined significantly during the period, with salaries and benefits declining from approximately $1,341,000 in the 1998 period to approximately $1,010,000 for the first six months of 1999. This decline principally reflects the reduction in staffing levels as the Company has reduced the size of its corporate staff. General and administrative expenses declined from approximately $1,768,000 during the first six months of 1998 to approximately $950,000 during the corresponding period in 1999. The decline in general and administrative expenses reflects cost saving measures undertaken by the Company, the smaller scope of the Company's corporate activities, reduced office rent as the Company moved to a smaller and less expensive facility and reduced business development activities. Depreciation and amortization declined by approximately $870,000 for the first six months of 1999 compared to 1998. This reduction is attributable to the $54.0 million write down of goodwill at the end of 1998. Since the reduction in expenses outpaced the reduction in management fees, the Company narrowed the operating loss in the first six months from approximately $2,735,000 in 1998 to a loss of approximately $1,202,000 in 1999. After giving effect to non-operating losses (principally loss of investment in subsidiaries and affiliates), the Company had a net loss of approximately $3,499,000 for the first six months of 1999, compared to a loss of approximately $4,633,000 for the first six months of 1998. Liquidity and Capital Resources The Company's principal requirements for capital have been working capital requirements for its Affiliated Groups and the funding of operating losses. 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 principal sources of capital to date have been the issuance of Class B, Class C Common Stock and Class L Common Stock to certain institutional investors, issuances of Class A Common Stock to Physician Stockholders, other issuances of Class A Common Stock to private investors and cash generated by the operations of the Affiliated Groups. 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 extent billing processing is slowed during payor administrative changes after an affiliation and also to fund growth of revenues. The Company has a total of $5.8 million due from the Affiliated Groups at June 30, 1999 compared to approximately $6.9 million at December 31, 1998. The decrease reflects a decrease in the number of days that collections of the affiliated groups remain outstanding, and the sale of Flagship II. 9 The Company's liquidity position continued to decline during the first six months of 1999. The Company's only source of capital during the period was its operations. The Company used net cash of approximately $3.0 million in its operations. Cash and cash equivalents declined from approximately $4.0 million at December 31, 1998 to approximately $1.0 million at June 30, 1999. In light of its financial condition, the Company has taken significant steps to reduce its operating expenses. Such actions, including staff reductions and termination arrangements, have resulted in contractual obligations that will be payable in future periods. These related actions were recorded as part of a restructuring charge taken by the Company at December 31, 1998. The Company believes the restructuring charge will be sufficient to cover these obligations. The Company anticipates that its future uses of cash will primarily be such expenses and the funding of operating losses. In addition to cash available at June 30, 1999, the Company will receive the remaining payments due from Flagship II during the third fiscal quarter of 1999 and may receive payments in connection with the sale of its interest in Flagship Health and Medical Care Partners (Springfield). If both Medical Care Partners and Flagship Health are sold, such proceeds, after payment of the Company's obligations, are expected to be less than the liquidation preference on the Class B, C and L Common Stock. Consequently, if the Company were to be dissolved, the holders of Class A Common Stock are unlikely to be entitled to participate in the proceeds of the disposition of the Company's businesses. In light of its financial condition, the Company does not have any material capital expenditures budgeted for 1999. Factors Affecting Future Operating Results History of Operating Losses The Company has incurred losses in each of its fiscal years and through the second quarter of 1999. The Company expects to incur operating losses for at least the immediate future. The Company currently does not have significant resources to fund future operating losses. See "-- Need for Substantial Additional Capital." There can be no assurance that the Company will achieve or maintain profitability. Restructuring The Company has sold the operations of Flagship II and is in the process of negotiating transactions to sell the assets of Flagship Health and either to restructure the terms of the Company's fee under the Services Agreements with Medical Care Partners (Springfield) or to sell Medical Care Partner's practices back to the affiliated physicians. Even if the Company succeeds in such efforts, the Company will not have significant capital resources and anticipates that it would receive proceeds from the sale of the practices and the Atlanta IPA businesses (TLC Management Company and Total Quality Practice Management, Inc.) that are substantially less than the liquidation preferences on the Class B, C and L common stock. Consequently, if the Company were to liquidate its assets and dissolve the Company, it is likely that the holders of Class A Common Stock would not receive any proceeds in such dissolution. If the Company were to negotiate revised Service Agreements 10 with one or more groups of affiliated physicians, there can be no assurance that the Company will not continue to incur losses or that it will continue to be a viable, long-term business. Need for Substantial Additional Capital The Company required substantial capital resources to obtain the necessary scale to become profitable and to fulfill its original business plan. If the Company continues to restructure its operations, additional funds would 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 and does not anticipate that it will obtain additional financing from the institutional investors which have previously invested in the Company. 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. 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 or the Flagship Affiliated Group, the Company's revenue and profitability are directly dependent on the revenue generated by the operation and performance of 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 11 Company. Risk of Inability to Manage Expanding Operations The Company has sought to expand its operations rapidly, which has created significant demands on the Company's administrative, operational and financial personnel and systems. During the past six months, the Company has sought to reduce its staff and overhead. There can be no assurance that the Company's systems, procedures, controls and staffing are adequate to support the Company's operations. If the Company continues its affiliate relationships, 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 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 12 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 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 13 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 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 14 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. 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. To the extent that the "put options" are likely to be exercised, the Company expects to fund such repurchases from working capital, or other sources. 15 PART II OTHER INFORMATION ITEM 6. Exhibits and Reports on Form 8-k. (A) Exhibits Exhibit Index 27 Financial Data Schedule (b) Reports on Form 8-K: None 16 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Date: August 20, 1999 PHYSICIANS QUALITY CARE, INC. By: /s/ Eugene M. Bullis ------------------------------ Eugene M. Bullis Chief Financial Officer and Senior Vice President EXHIBIT INDEX Exhibits - -------- 27 Financial Data Schedule EX-27 2 FINANCIAL DATA SCHEDULE
5 6-MOS YEAR DEC-31-1999 DEC-31-1998 JAN-01-1999 JAN-01-1999 JUN-30-1999 DEC-31-1998 1,034,613 4,038,802 0 0 0 0 0 0 0 0 11,734,519 12,292,974 307,616 395,768 40,576 163,022 16,450,294 19,191,416 2,380,876 1,626,725 0 0 31,391,182 42,191,181 0 0 240,736 240,590 17,562,500 24,867,080 16,450,294 19,191,416 933,565 1,053,620 933,565 1,053,620 0 0 2,135,365 61,640,612 2,319,627 4,775,826 0 0 3,661 4,818 (3,469,213) (65,073,998) 29,709 (802,211) (3,498,922) (64,271,787) 0 0 0 0 0 0 (3,498,922) (64,271,787) (0.09) (1.26) 0 0
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