PROSPECTUS SUPPLEMENT NO. 14 Filed pursuant to Rule 424(b)(3)
To the Prospectus dated January 24, 1997 Registration No. 333-01926
As supplemented to Date
================================================================================
UNITED STATES
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 March 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 333-1926
DOCTORS HEALTH SYSTEM, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 52-1907421
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10451 MILL RUN CIRCLE
10TH FLOOR
OWINGS MILLS, MARYLAND 21117
(Address of principal executive offices)
(Zip Code)
(410) 654-5800
(Registrant's telephone number, including area code)
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
___ ___
As of May 14, 1997 810,000 shares of the registrant's Class A Common stock
and 2,634,448 shares of the Registrant's Class B Common Stock were outstanding.
================================================================================
The date of this Prospectus Supplement is May 15, 1997.
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DOCTORS HEALTH SYSTEM, INC.
FORM 10-Q
MARCH 31, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
NO.
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PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements
Unaudited Consolidated Balance Sheets.......................................................... 1
Unaudited Consolidated Statements of Operations................................................ 2
Unaudited Consolidated Statements of Cash Flows................................................ 3
Notes to Unaudited Consolidated Financial Statements........................................... 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................................................. 7
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders............................................ 12
Item 6. Exhibits and Reports on Form 8-K............................................................... 12
SIGNATURES
</TABLE>
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
PRO-FORMA
JUNE 30, JUNE 30, MARCH 31,
1996 1996 1997
--------- --------- ----------
<S> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents........................................................... $ 1,419,295 $ 1,419,295 $ 3,309,833
Accounts receivable (net of allowance for doubtful accounts of $324,521 at June 30,
1996, and $334,000 at March 31, 1997, respectively)............................... 1,303,941 1,303,941 2,102,120
Accounts receivable-affiliates...................................................... 1,208,685 1,208,685 1,194,349
Other receivables................................................................... 64,251 64,251 752,410
Prepaid expenses.................................................................... 117,096 117,096 316,493
Due from affiliates................................................................. 891,985 891,985 923,743
TOTAL CURRENT ASSETS.............................................................. 5,005,253 5,005,253 8,598,948
PROPERTY AND EQUIPMENT, NET........................................................... 2,485,547 2,485,547 3,075,071
OTHER ASSETS
Intangibles (net of accumulated amortization of $65,170 at June 30, 1996 and
$257,846 at March 31, 1997, respectively)......................................... 2,448,030 2,448,030 5,902,071
Deferred charges (net of accumulated amortization of $147,475 at June 30, 1996 and
$410,089 at March 31, 1997, respectively)......................................... 636,772 636,772 1,147,864
Note receivable..................................................................... 300,000 300,000 --
Accrued interest receivable......................................................... 253,976 253,976 342,076
Deposits............................................................................ 24,560 24,560 75,756
3,663,338 3,663,338 7,467,767
TOTAL ASSETS...................................................................... $ 11,154,138 $11,154,138 $ 19,141,786
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Notes Payable....................................................................... 303,915 303,915 3,605,689
Current maturities of capital lease obligations..................................... 101,985 101,985 110,493
Accounts payable.................................................................... 330,647 330,647 249,738
Accrued medical claims.............................................................. 550,520 550,520 3,412,554
Other accrued expenses.............................................................. 2,069,579 2,069,579 2,319,543
Due to affiliates................................................................... 766,475 766,475 479,337
TOTAL CURRENT LIABILITIES......................................................... 4,123,121 4,123,121 10,177,354
LONG-TERM OBLIGATIONS
Note payable........................................................................ 3,400,000 3,400,000 2,853,044
Notes payable and purchase obligations-related parties.............................. 2,077,364 2,077,364 2,605,469
Capital lease obligations, less current maturities.................................. 320,673 320,673 236,260
5,798,037 5,798,037 5,694,773
COMMITMENTS AND CONTINGENCIES
REDEEMABLE CONVERTIBLE PREFERRED STOCK
6.5% cumulative, Series A, $5 par value, authorized and issued 1,000,000 shares
(liquidation value $3,500,000).................................................... 5,273,305 5,273,305 5,517,055
Less subscription receivable........................................................ (1,500,000) (1,500,000) (1,500,000)
3,773,305 3,773,305 4,017,055
9.75% cumulative, Series B, $11.25 par value, authorized and issued 355,556 shares
(liquidation
value $4,000,000)................................................................. 4,137,526 4,137,526 4,430,059
8% cumulative, Series C, $17.50 par value, authorized 1,500,000 shares; issued and
outstanding 571,428 shares (liquidation value $10,000,000)........................ -- -- 10,379,656
7,910,831 7,910,831 18,826,770
REDEEMABLE CLASS A COMMON STOCK
$.01 per value, authorized, issued and outstanding 800,000 shares at June 30,
1996.............................................................................. 2,400,000 -- --
STOCKHOLDERS' EQUITY (Deficit)
Preferred Stock, $.01 par value; authorized 1,000,000 shares, no shares issued...... -- -- --
Common Stock
Class A, $01 par value; authorized 20,700,000 shares, issued and outstanding
810,000 shares at March 31, 1997................................................ -- 8,000 8,100
Class B, $.01 par value; authorized 10,000,000; issued and outstanding 2,398,000
shares at June 30, 1996 and 2,623,100 at March 31, 1997.......................... 23,980 23,980 26,231
Class C, $.01 par value; authorized 29,050,000; no shares issued.................. -- -- --
Additional paid in capital.......................................................... 2,323,600 2,323,798 4,684,157
Retained earnings (accumulated deficit)............................................. (11,425,431) (9,033,629) (20,275,599)
TOTAL STOCKHOLDERS' EQUITY (DEFICIT).............................................. (9,077,851) (6,677,851) (15,557,111)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT).............................. $ 11,154,138 $11,154,138 $ 19,141,786
</TABLE>
See accompanying notes to financial statements.
1
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ -------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1996 1997 1996 1997
--------- --------- --------- ---------
<S> <C>
REVENUES
Net revenue.................................................... $ 1,813,021 $ 3,599,391 $ 3,285,990 $ 8,499,743
Capitation revenue............................................. 246,349 3,163,080 246,349 6,650,255
Total Revenue............................................... 2,059,370 6,762,471 3,532,339 15,149,998
EXPENSES
Medical services expense....................................... 372,889 3,096,363 372,889 6,842,259
Care center costs.............................................. 1,709,371 3,463,540 3,033,074 8,263,302
General and administrative..................................... 2,303,626 3,184,840 3,690,376 9,039,310
Depreciation and amortization.................................. 128,414 480,473 273,269 993,550
Total Expenses.............................................. 4,514,300 10,225,216 7,369,608 25,138,421
Loss from operations........................................... (2,454,930) (3,462,745) (3,837,269) (9,988,423)
OTHER INCOME (EXPENSE)
Interest and other income...................................... 51,735 65,084 163,490 202,889
Interest expense............................................... (80,310) (222,752) (174,777) (529,696)
Total Other Income (Expense)................................ (28,575) (157,668) (11,287) (326,807)
Loss before income taxes....................................... (2,483,505) (3,620,413) (3,848,556) (10,315,230)
Income taxes................................................... -- -- -- --
NET LOSS......................................................... $(2,483,505) $(3,620,413) $(3,848,556) $(10,315,230)
Loss applicable to common stock
Net loss....................................................... $(2,483,505) $(3,620,413) $(3,848,556) $(10,315,230)
Preferred stock dividends accreted............................. 178,770 374,955 373,770 926,740
Loss applicable to common stock................................ (2,662,275) (3,995,368) (4,222,326) (11,241,970)
Net loss per share............................................... $ (.87) $ (1.17) $ (1.39) $ (3.39)
Weighted average number of shares outstanding.................... 3,068,538 3,411,801 3,022,680 3,313,169
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- ------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1996 1997 1996 1997
--------- ---------- --------- ---------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITY
Net loss....................................................... $(2,483,505) $(3,620,413) $(3,848,556) $(10,315,230)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities
Depreciation and amortization............................... 128,414 480,473 273,269 993,550
Provision for uncollectible accounts receivables............ 97,915 (16,960) 152,375 98,519
Changes in assets and liabilities, net of effects of medical
practice receivables acquired
Accounts receivable....................................... (1,090,744) (142,941) (828,838) (57,391)
Accounts receivable -- affiliates......................... 314,374 182,753 282,354 59,998
Prepaid expenses and other receivables.................... (226,864) (198,005) (215,985) (975,656)
Due from/to affiliates.................................... (872,328) (754,395) (1,521,089) (318,896)
Accounts payable.......................................... 586,310 (389,231) 720,830 (80,909)
Accrued and other liabilities............................. 843,601 1,206,905 1,225,497 2,818,904
Organizational costs and deferred charges................. (99,324) (16,650) (107,709) (783,573)
Net cash used in operating activities.................. (2,802,151) (3,268,464) (3,867,852) (8,560,684)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment............................. (392,524) (271,972) (1,086,164) (979,895)
Payments for acquisition costs................................. (173,085) (309,642) (182,439) (1,132,756)
Deposits....................................................... (3,046) (14,939) 127,017 (51,196)
Net cash used in investing activities.................. (568,655) (596,553) (1,141,586) (2,163,847)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of redeemable convertible preferred
stock....................................................... -- 2,500,000 4,410,000 9,989,200
Borrowings under notes payable................................. 1,012,578 2,800,000 1,012,578 3,983,017
Principal payments on capital lease obligations................ (20,096) (25,182) (57,743) (75,905)
Issuance of Note Receivable.................................... (300,000) -- (300,000) --
Payments on notes payable...................................... (8,278) (983,017) (26,986) (1,281,243)
Net cash provided by financing activities.............. 684,204 4,291,801 5,037,849 12,615,069
Net increase (decrease) in cash and
cash equivalents..................................... (2,686,602) 426,784 28,411 1,890,538
Cash and cash equivalents at beginning of period................. 2,846,898 2,883,049 131,885 1,419,295
Cash and cash equivalents at end of period....................... $ 160,296 $ 3,309,833 $ 160,296 $ 3,309,833
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest......................................... $ 35,425 $ 93,453 $ 79,150 $ 281,905
Cash paid for income taxes..................................... $ -- $ -- $ -- $ --
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS AND NINE MONTHS ENDED MARCH 31, 1997 AND 1996
NOTE 1 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles of interim
financial reporting and in accordance with Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements.
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 and the results of operations for the interim periods presented. The
results of operations for any interim period are not necessarily indicative of
results for the full year.
The consolidated financial statements for the three months and nine months
ended March 31, 1996 and 1997 are unaudited and should be read in conjunction
with the financial statements and the notes thereto included in the Company's
Amendment No. 7 to its S-1 Registration Statement for the year ended June 30,
1996.
NOTE 2 -- ACQUISITIONS
The Company acquires certain assets of medical practices from Equity
Physicians and enters into long-term contracts with Core Medical Groups (CMG)
who employ the physicians. The Company currently derives a significant portion
of its total revenues pursuant to the Physician Services Organization Agreements
(PSO Agreement), which are long-term contracts between CMGs and the Company. The
Company's PSO Agreements have a 30-year term with an unlimited number of 10-year
renewals. Under the PSO Agreements, the Company provides a number of services
including general management, billing and collection, office personnel, managed
care contracting and care management services. Under the PSO Agreements, the
Core Medical Groups agree to comply with the terms of managed care contracts,
including the delivery of health care services, 24-hour coverage, cooperation
with utilization review, quality assurance and peer review programs. The PSO
Agreements do not convey any equity interest in the CMGs, which retain autonomy
and independence over clinical matters.
On March 4, 1997, the Company completed the merger of Medtrust Medical
Group, Inc. into Doctors Health of Virginia, Inc. ("DHVA"), a wholly-owned
subsidiary of the Company. In connection with the Merger, DHVA became the
successor to Medtrust's non-exclusive independent practice association and
certain Medtrust members entered into exclusive participation agreements with a
Company-owned independent practice association. Pursuant to the merger, members
of Medtrust and certain directors and officers of Medtrust received
approximately $140,000 in cash and 30,100 shares of the Company's Class B Common
Stock.
NOTE 3 -- NET REVENUE
The Company's net revenues represent the contractual management and similar
fees earned under its long-term PSO Agreements with CMGs. Under the PSO
Agreements, the Company is contractually responsible and at risk for the
operating costs of the CMGs with the exception of amounts retained by
physicians. The Company's net revenues include the reimbursement of all medical
practice operating costs and the contractual management fees as defined in the
PSO Agreements. Contractual fees are accrued when collection is probable.
Revenue from all CMGs is recorded at established rates reduced by allowances for
doubtful accounts and contractual adjustments and amounts retained by physician
groups.
The following represents amounts included in the determination of net
revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------ ------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1996 1997 1996 1997
--------- --------- --------- ---------
<S> <C>
Gross physician revenue........................................... $ 3,850,238 $ 8,656,935 $ 8,139,288 $22,361,570
Less: Provision for contractual and other adjustments........... (1,144,893) (3,479,763) (2,799,980) (9,136,134)
Gatekeeper capitated income....................................... 304,886 829,381 758,663 2,221,885
Net physician revenue............................................. 3,010,231 6,006,553 6,097,971 15,447,321
Amount retained by affiliated core medical groups:
Physicians...................................................... 787,444 2,106,193 2,162,008 6,431,159
Ancillary employees and expenses................................ 409,766 300,969 649,973 516,419
Net revenue....................................................... $ 1,813,021 $ 3,599,391 $ 3,285,990 $ 8,499,743
</TABLE>
4
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 3 -- NET REVENUE -- Continued
During the three months ended March 31, 1996 and 1997, the Company derived
substantially all of its net revenue from two and five, respectively, affiliated
CMGs with which it has PSO agreements. For the three months ended March 31, 1996
and 1997, one of these CMGs comprised approximately 97% and 40%, respectively,
of the Company's net revenue.
NOTE 4 -- CAPITATION REVENUE AND MEDICAL SERVICES EXPENSE RECOGNITION
As of March 31, 1997, the Company has three global capitation contracts and
five gatekeeper capitation contracts with seven separate Health Maintenance
Organizations (HMOs). Under the contracts, the Company receives monthly
capitation fees based on the number of enrollees selecting any one of the
Company's affiliated primary care physicians. The capitation revenue under these
contracts is prepaid monthly based on the number of enrollees and is recognized
as capitation revenue during the month services are provided to the enrollees.
During the three months ended March 31, 1997, $2,796,098 and $366,982, were
recorded as global capitation and gatekeeper capitation revenue, respectively,
in the Company's financial statements. During the nine months ended March 31,
1997, $5,294,940 and $1,355,315 were recorded as global capitation and
gatekeeper capitation revenue, respectively, in the Company's financial
statements. During the three months ended March 31, 1996, $106,349 and $140,000
were recorded as global capitation and gatekeeper capitation revenue,
respectively, in the Company's financial statements. The Company had no
capitation contracts prior to January 1, 1996.
The Company's commercial capitation contract also includes a provision
whereby the Company can earn incentive revenue or incur medical services
expenses based upon the enrollees' utilization of hospital services. Estimated
amounts receivable or payable from the HMO are recorded based upon actual
hospital utilization and associated costs incurred by assigned HMO enrollees,
compared to the portion of the commercial capitation fees allocated for
hospitalization. Differences between actual contract settlements and estimated
receivables or payables relating to the arrangement are recorded in the year of
settlement. Included in accrued medical services as of March 31, 1997 is
approximately $85,000 and $50,000 of estimated amounts due to the HMO under this
arrangement for the 1996 and 1997 contract years respectively.
Under the Company's two Medicare global capitation contracts, the Company
has assumed responsibility for managing and paying for substantially all of the
medical care for the respective payor's enrollees. Consequently, the Company
does not perform a settlement with the HMOs under the two Medicare contracts.
The Company is responsible for the cost of the medical services provided by
its affiliated physicians and other providers who are covered under global
capitation contracts. The cost of medical services is recognized in the period
in which it is provided and includes an estimate of the cost of services which
have been incurred but not yet reported. The estimate for accrued medical
services is based on several methods of projecting costs including historical
studies of claims paid. Estimates are continually monitored and reviewed and, as
settlements are made or estimates are adjusted, differences are reflected in
current operations. As of March 31, 1997, approximately $3,277,000 was recorded
as accrued medical services for incurred but not reported services.
NOTE 5 -- CAPITALIZATION
On January 2, 1997, the Company issued 142,857 shares of Series C
Redeemable Convertible Preferred Stock to the Series C Preferred Stockholder for
$2,500,000. Subsequent to that issuance, the Series C Preferred Stockholder held
571,428 shares of Series C Redeemable Convertible Preferred Stock. In addition,
on January 31, 1997, the Company and the Series C Preferred Stockholder entered
into a Note Purchase Agreement pursuant to which the Series C Preferred
Stockholder established a $5,000,000 credit facility for the Company. The
Company issued its Convertible Subordinated 11% Promissory Note ("Subordinated
Debt Facility") to the Series C Preferred Stockholder. On January 31, 1997, and
the Series C Preferred Stockholder advanced the sum of $2,800,000 pursuant to
the Subordinated Debt Facility. Interest shall be payable at maturity in shares
of Series C Preferred Stock at the rate of $14 per share. The Subordinated Debt
Facility matures on January 31, 1999 or upon the earlier consummation of a
$30,000,000 debt and/or equity financing ("the Permanent Financing"). The
Company contemplates that the Permanent Financing will be completed on or before
July 31, 1997. The Series C Preferred
5
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 5 -- CAPITALIZATION -- Continued
Stockholder and the Company have agreed to amend certain terms of the
Subordinated Debt Facility as part of the "Permanent Financing" (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources"). The Subordinated Debt Facility
is now convertible into shares of Convertible Series C Preferred Stock. The
Company may request additional advances under the Subordinated Debt Facility,
from time to time (See Note 8).
On January 31, 1997, the Company issued to the Series C Preferred
Stockholder a Warrant to purchase 250,000 shares of Class A Common stock at
$14.00 per share in consideration of the Series C Preferred Stockholder's
efforts to assist the Company in securing additional financing for the Company.
On January 13, 1997, the Company repaid to First National Bank of Maryland
$983,017 which represents the retirement of the bridge loan facility.
NOTE 6 -- COMMON STOCK REPURCHASE AGREEMENT
Under the terms of the stockholders' agreement with three founding
shareholders (who are also officers and directors of the Company), the Company
may be required to purchase shares of the Company's Class A Common Stock in
certain circumstances including death or disability. As of June 30, 1996, the
Company had obtained insurance to cover the purchase of the capital stock in the
event of death. On December 20, 1996, the Company obtained insurance to cover
the purchase of the capital stock in the event of a disability. By agreement
dated February 1, 1997, one of the founding shareholders agreed to waive the
repurchase requirement with respect to any disability not covered by insurance.
As of February 17, 1997, the insurance lapsed with respect to the founding
shareholder who had waived the repurchase requirement. Under each of the above
policies, the Company has obtained insurance that is in excess of the estimated
fair value of its Class A Common Stock. In order to comply with Article 5 of
Regulation S-X, the Company has presented the common stock that is redeemable
based on events outside the Company's control (i.e. a disability) as Redeemable
Class A Common Stock in the accompanying Balance Sheet as of June 30, 1996. As a
result of the coverage provided by the life and disability policies described
above and the waiver of certain stock repurchase rights described above, there
are no circumstances in which a redemption event would result in a decrease in
the Company's stockholders' equity. Accordingly, the Company will present the
Class A Common Stock as stockholders' equity in all balance sheets subsequent to
December 20, 1996. The Company has presented an unaudited Pro Forma Balance
Sheet as of June 30, 1996 assuming the Class A Common Stock is covered by
insurance for any event of redemption and consequently presented all the Class A
Common Stock as Stockholders' equity. The Company intends to maintain insurance
at levels sufficient to finance its redemption obligations. The terms of the
stock purchase agreement terminate in the event of an initial public offering or
a change in control of the Company as defined in the stockholders' agreement.
NOTE 7 -- NOTES PAYABLE
The Company has presented the $3,600,000 note payable due on December 31,
1997 as a current liability in the accompanying March 31, 1997 balance sheet.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" for discussion regarding the
Company's intent to refinance or retire this amount as part of the Permanent
Financing.
NOTE 8 -- SUBSEQUENT EVENTS
On March 31, 1997, the Company entered into a System Implementation
Agreement with IDX Corporation, pursuant to which it has licensed certain
billing and accounts receivable and managed care software and purchased computer
hardware. The System Implementation Agreement and related agreements provide
that the Company will spend approximately $1,500,000 to purchase such software
and hardware.
On April 23, 1997 the Series C Preferred Stockholder advanced an additional
$525,000 pursuant to the Subordinated Debt Facility.
6
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
NOTE 8 -- SUBSEQUENT EVENTS -- Continued
On May 2, 1997, the Company and an institutional investor ("Investor")
entered into a Letter of Understanding, pursuant to which the Company intends to
issue to the Investor 3,000,000 shares of Series D Preferred Stock for an
aggregate purchase price of $30,000,000 (the "Permanent Financing"). The
transaction is subject to various conditions, including satisfactory completion
of customary business and legal due diligence and the execution of definitive
stock purchase and other agreements. The Company and the Investor anticipate
that the transaction will be completed on or before July 31, 1997. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources.")
On May 14, 1997, the Company borrowed $2,000,000 from HBO & Company
("HBOC"), the Company's current information system vendor, and issued its
subordinated promissory note to HBOC in the principal amount of $2,000,000 (the
"Note"). The Note is payable in full on May 14, 1998.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Doctors Health System is a managed care and medical management company
which develops and consolidates individual and groups of internists,
pediatricians and family practitioners ("primary care physicians" -- PCPs),
specialist physicians, hospitals and other health care providers into primary
care-driven, comprehensive managed care health delivery networks. PCPs and
specialist physicians are referred to herein as the "Network Physicians." The
Company is focusing on the development of its networks in the Baltimore and
Washington metropolitan area and surrounding regions. As of March 31, 1997, the
Company had PCPs in six regional networks throughout the state of Maryland and
one regional network in Northern Virginia.
The Company provides services to its Network Physicians, who deliver health
care services to patients under various reimbursement arrangements. The
Company's level of profitability depends on (i) increasing the number of Network
Physicians; (ii) attracting patients that seek medical services in benefit plans
that enter into Global Capitated Contracts with the Company; (iii) securing
additional and maintaining Global Capitated Contracts, with adequate
reimbursement rates; and (iv) generating earnings through assisting Network
Physicians in managing the delivery of high quality care at a cost less than the
reimbursement received under Global Capitated Contracts. As of March 31, 1997,
the Company has two Global Capitated Medicare Contracts and one Global Capitated
Commercial Contract.
The Company intends to continue acquiring certain assets of medical
practices and obtaining managed care contracting rights and is currently in
active discussions with a number of primary and specialty care physicians. The
Company also expects to derive revenues and earnings from the participation of
physicians in its Independent Practice Association (IPAs).
RESULTS OF OPERATIONS
The Company's operating results are affected by the number of PCPs
participating in Global Capitated Contracts, the number of executed Global
Capitated Contracts, and the number of patients enrolled in benefit plans under
Global Capitated Contracts with the Company. The following table summarizes the
Company's history with respect to PCPs participating in Global Capitated
Contracts, executed Global Capitated Contracts and patients enrolled in benefit
plans under Global Capitated Contracts with the Company:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1995 1996 1996 1996 1997
-------- -------- ------------- ------------ ----------
<S> <C>
Number of PCPs participating in Global Capitated Contracts as
of............................................................ -- 45* 45 62 78
Number of regional networks as of............................... 1 5 6 7 7
Number of Global Capitated Contracts as of...................... -- 3 3 3 3
Number of Global Capitated Patients:
Commercial.................................................... -- 2,039 2,174 2,272 4,195
Medicare...................................................... -- 491 965 1,283 2,351
</TABLE>
* There is a lag between when physicians join networks and when they become
eligible to participate in Global Capitated Contracts as a result of the
credentialing and enpaneling processes and other internal Company procedures.
7
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DOCTORS HEALTH SYSTEM, INC.
The following table shows the percentage of total revenues represented by
various expense and other income items reflected in the Company's unaudited
consolidated statements of operations. The information that follows should be
read in conjunction with the Company's unaudited consolidated financial
statements and notes thereto included elsewhere herein. As a result of the
Company's rapid growth and the limited period of affiliation with the physician
practices, the Company does not believe that the period-to-period comparisons
and percentage relationships within periods are meaningful at this time.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1996 1997 1996 1997
--------- --------- --------- ---------
<S> <C>
Net revenue...................................................... 88.0% 53.2% 93.0% 56.1%
Capitation revenue............................................... 12.0% 46.8% 7.0% 43.9%
Total revenues................................................... 100.0% 100.0% 100.0% 100.0%
Medical services expense......................................... 18.1% 45.8% 10.6% 45.1%
Care center costs................................................ 83.0% 51.2% 85.9% 54.5%
General and administrative....................................... 111.9% 47.1% 104.5% 59.7%
Depreciation and amortization.................................... 6.2% 7.1% 7.7% 6.6%
Interest and other income........................................ (2.5)% (1.0)% (4.6)% (1.3)%
Interest expense................................................. 3.9% 3.3% 4.9% 3.5%
Income tax expense............................................... -- -- -- --
Net loss......................................................... (120.6)% (53.5)% (109.0)% (68.1)%
</TABLE>
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
1996.
TOTAL REVENUES. The Company's total revenues increased to $6,762,471 for
the three months ended March 31, 1997 from $2,059,370 for the three months ended
March 31, 1996. This increase was attributable to the growth in net revenue to
$3,599,391 or 53.2% of total revenue from $1,813,021 or 88.0% of total revenue
and the increase in capitation revenue to $3,163,080 ($2,796,098 for Global
Capitated Contracts and $366,982 for Gatekeeper Capitation Contracts) or 46.8%
of total revenue from $246,349 or 12.0% of total revenue. These increases
resulted primarily from the increase in the number of physicians included in
Core Medical Groups from 54 to 88, the increase in the number of PCP's
participating in Global Capitated Contracts from 36 to 78, the increase in the
number of Global Capitated Contracts from 1 to 3, the increase in the number of
Global Capitated patients from 1,777 to 4,195 (Commercial) and 0 to 2,351
(Medicare), and the increase in the number of Gatekeeper Capitation Contracts
from 4 to 5.
MEDICAL SERVICES EXPENSE. Medical services expense was $3,096,363 or 45.8%
of total revenue for the three months ended March 31, 1997 compared to $372,889
or 18.1% of total revenue for the three months ended March 31, 1996. This
increase resulted from the increase in the number of PCP's participating in
Global Capitated Contracts from 36 to 78, the increase in the number of Global
Capitated Contracts from 1 to 3, the increase in the number of Global Capitated
patients from 1,777 to 4,195 (Commercial) and 0 to 2,351 (Medicare), and the
increase in the number of Gatekeeper Capitated Contracts from 4 to 5. The
Company expects these expenses to increase as the number of PCP's participating
in and the number of patients enrolled in benefit plans under Global Capitated
Contracts with the Company grows.
CARE CENTER COSTS. Care center costs were $3,463,540 or 51.2% of total
revenue for the three months ended March 31, 1997 compared to $1,709,371 or
83.0% of total revenue for the three months ended March 31, 1996. This increase
in dollar amount resulted from the increase in the number of physicians included
in Core Medical Groups from 54 to 88. While these expenses are expected to
increase as the Company continues adding Network Physicians, the Company expects
that these expenses will continue to decline as a percentage of total revenue
assuming continued growth in capitation revenue.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $3,184,840 or 47.1% of total revenue for the three months ended March 31,
1997 compared to $2,303,626 or 111.9% of total revenue for the three months
ended March 31, 1996. This increase in dollar amount resulted primarily from
increased compensation expenses from expansion of the Company's corporate
management team, as well as its marketing, acquisitions, network development and
care management departments and additional operating costs incurred in adding
physicians to the Company's networks and attracting patients who enroll in
benefit plans under Global Capitated Contracts. While these expenses are
expected to increase as the
8
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
Company adds Network Physicians, the Company expects that these expenses will
continue to decline as a percentage of total revenues assuming continued growth
in revenue.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses were $480,473 or 7.1% of total revenue for the three months ended March
31, 1997 compared to $128,414 or 6.2% of total revenue for the three months
ended March 31, 1996. The increase in dollar amount resulted primarily from
intangibles acquired in connection with the purchase of certain medical practice
assets from Equity Physicians, accelerated depreciation of the Company's billing
system in preparation for the transition to a new information system, as well as
fixed asset additions. While these expenses are expected to increase as the
Company continues adding Network Physicians, the Company expects that these
expenses will decline as a percentage of total revenue assuming continued growth
in revenue.
INTEREST AND OTHER INCOME. Interest and other income was $65,084 or 1.0% of
total revenue for the three months ended March 31, 1997 compared to $51,735 or
2.5% of total revenue for the three months ended March 31, 1996.
INTEREST EXPENSE. Interest expense was $222,752 or 3.3% of total revenue
for the three months ended March 31, 1997 compared to $80,310 or 3.9% of total
revenue for the three months ended March 31, 1996. The increase in dollar amount
resulted primarily from the increase in the level of borrowings.
INCOME TAX EXPENSE. In light of the Company's losses and its allowance for
deferred tax assets, for the three months ended March 31, 1997 and 1996, the
Company did not require a provision for income taxes.
NET LOSS. The Company had a net loss of $3,620,413 for the three months
ended March 31, 1997 compared to $2,483,505 for the three months ended March 31,
1996.
LOSS APPLICABLE TO COMMON STOCK. The Company's net loss is increased by
dividends payable to the Redeemable Convertible Preferred Stockholders. The net
loss applicable to common stock was $3,995,368 for the three months ended March
31, 1997 compared to $2,662,275 for the three months ended March 31, 1996.
NINE MONTHS ENDED MARCH 31, 1997 COMPARED TO NINE MONTHS ENDED MARCH 31, 1996.
TOTAL REVENUES. The Company's total revenues increased to $15,149,998 for
the nine months ended March 31, 1997 from $3,532,339 for the nine months ended
March 31, 1996. This increase was attributable to the growth in net revenue to
$8,499,743 or 56.1% of total revenue from $3,285,990 or 93.0% of total revenue
and the increase in capitation revenue to $6,650,255 ($5,294,940 Global
Capitation and $1,355,315 from Gatekeeper Capitation Contracts) or 43.9% of
total revenue from $246,344 or 7.0% of total revenue. These increases resulted
primarily from the increase in the number of physicians included in Core Medical
Groups from 54 to 88, the increase in the number of PCP's participating in
Global Capitated Contracts from 36 to 78, the increase in the number of Global
Capitated Contracts from 1 to 3, the increase in the number of Global Capitated
patients from 1,777 to 4,195 (Commercial) and 0 to 2,351 (Medicare), and the
increase in the number of Gatekeeper Capitation Contracts from 4 to 5.
MEDICAL SERVICES EXPENSE. Medical services expense was $6,842,259 or 45.1%
of net revenue for the nine months ended March 31, 1997 compared to $372,889 or
10.6% of net revenue for the nine months ended March 31, 1996. These increases
resulted form the increase in the number of PCP's participating in Global
Capitation Contracts from 36 to 78, the increase in the number of Global
Capitated Contracts from 1 to 3, the increase in the number of Global Capitated
patients from 1,777 to 4,195 (Commercial) and 0 to 2,351 (Medicare), and the
increase in the number of Gatekeeper Capitation Contracts from 4 to 5. The
Company expects these expenses to increase as the number of PCPs participating
in and the number of patients enrolled in benefit plans under Global Capitation
Contracts with the Company grows.
CARE CENTER COSTS. Care center costs were $8,263,302 or 54.5% of total
revenue for the nine months ended March 31, 1997 compared to $3,033,074 or 85.9%
of total revenue for the nine months ended March 31, 1996. The increase in
dollars resulted from the increase in the number of physicians included in Core
Medical Groups from 54 to 88.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $9,039,310 or 59.7% of total revenue for the nine months ended March 31,
1997 compared to $3,690,376 or 104.5% of net revenue for the nine months ended
March 31, 1996. The increase in dollars resulted primarily from increased
compensation expenses from development of the Company's corporate management
team, as well as the formation of its marketing, acquisitions, network
development and care management functions and additional organizational costs
from developing physician networks.
9
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses were $993,550 or 6.6% of total revenue for the nine months ended March
31, 1997 compared to $273,269 or 7.7% of total revenue for the nine months ended
March 31, 1996. The increase in dollars resulted primarily from intangibles
acquired in connection with the purchase of certain medical practice assets from
Equity Physicians, accelerated depreciation on the company's billing system in
preparation for the transition to a new information system, as well as fixed
asset additions.
INTEREST AND OTHER INCOME. Interest and other income was $202,889 or 1.3%
of total revenue for the nine months ended March 31, 1997 compared to $163,490
or 4.6% of total revenue for the nine months ended March 31, 1996.
INTEREST EXPENSE. Interest expense was $529,696 or 3.5% of total revenue
for the nine months ended March 31, 1997 compared to $174,777 or 4.9% of total
revenue for the nine months ended March 31, 1996. The increase in dollars
resulted primarily from the increase in the level of borrowings.
INCOME TAX EXPENSE. In light of the Company's losses and its allowance for
deferred tax assets, for the nine months ended March 31, 1997 and 1996, the
Company did not require a provision for income taxes.
NET LOSS. The Company had a net loss of $10,315,230 for the nine months
ended March 31, 1997 compared to $3,848,556 for the nine months ended March 31,
1996.
LOSS APPLICABLE TO COMMON STOCK. The Company's net loss is increased by
dividends payable to the Redeemable Convertible Preferred Stockholders. The net
loss applicable to common stock was $11,241,970 for the nine months ended March
31, 1997 compared to $4,222,326 for the nine months ended March 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1997, the Company had approximately $2,680,000 in available
cash and negative working capital of $1,578,406. The negative working capital is
a result of the presentation of the $3,600,000 note payable due on December 31,
1997, as a current liability. See the discussion below regarding the Company's
intent to refinance or retire this amount as part of the Permanent Financing.
On January 31, 1997, the Company established a $5,000,000 credit facility
(the "Subordinated Debt Facility") with an affiliate of the Series C Preferred
Stockholder, which was guaranteed by the Series C Preferred Stockholder. The
Subordinated Debt Facility will mature on January 31, 1999, unless made part of
the Permanent Financing (as described below). Advances under the Subordinated
Debt Facility bear interest at a rate of 11% per annum. Such interest shall be
payable at maturity in shares of Series C Preferred Stock at the rate of $14.00
per share. The Subordinated Debt Facility is subordinated to the Company's bank
line-of-credit and is secured by a second lien on all accounts receivable and
assets of the Company. Advances under the Subordinated Debt Facility are
convertible into shares of Series C Preferred Stock at maturity or in
conjunction with the Permanent Financing at a price per share equal to the
lesser of (i) the price which would result in a weighted average price of $14.00
per share for all shares of Series C Preferred stock issued by the Company or
(ii) the price assigned to shares of the Company's securities issued in the
Permanent Financing. These terms are anticipated to change as part of the
Permanent Financing described below.
In connection with the execution of the Subordinated Debt Facility, the
Company and the Series C Preferred Stockholder amended the Option Agreement
dated September 4, 1996 to reduce the shares issuable pursuant to the Option
from 500,000 shares of Series C Preferred Stock to 250,000 shares of Series C
Preferred Stock, and a reduction in the cash available to the Company under the
Option from $10,000,000 to $5,000,000. The amended Option Agreement dated
January 31, 1997, provides that the Company may require the Series C Preferred
Stockholder to purchase 250,000 shares of Series C Preferred Stock at a price of
$20.00 per share when the Company's Global Capitation Contracts include at least
20,000 Medicare lives. The Series C Preferred Stockholder may exercise the
option at any time prior to the occurrence of certain events, including
completion of a public offering or Permanent Financing transaction.
The Company has established a Certificate of Deposit in the amount of
$630,000 in accordance with a Medicare Capitated Contract which requires the
Company to provide a letter of credit or other similar security, for a portion
of the capitation revenue received by the Company. The certificate of deposit
was funded with the Company's working capital and excluded from the $3,587,000
of available cash.
Until the Company and its Payors attract an adequate number of Capitation
Lives in Global Capitated Contracts, the Company anticipates that it will incur
operating losses and experience negative operating cash flows. The Company
believes
10
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
that its available cash at May 14, 1997, of approximately $3,587,000, amounts
remaining under a bank line of credit and the amounts remaining available under
the Subordinated Debt Facility or other resources will be sufficient to fund the
Company's operations through July 31, 1997. However, in the event that the
Company either has not attracted an adequate number of Capitated Lives in Global
Capitated Contracts in order to offset operating expenses, or has not secured
the Permanent Financing described below, the Company will not be able to execute
its business strategy and the Company's operating results and financial
condition would be materially and adversely affected.
On May 2, 1997, the Company entered into a Letter of Understanding with the
Investor pursuant to which the Company intends to issue to the Investor
3,000,000 shares of Series D Preferred Stock for an aggregate purchase price of
$30,000,000. (the "Permanent Financing"). The Series D Preferred Stock will be
convertible into Class C Common Stock on a one for one basis. The conversion
ratio of Series D Preferred Stock is subject to adjustment, up or down, based on
whether the Company achieves certain Medicare medical loss ratio and physician
recruitment targets in Fiscal Year 1998. Consummation of the Permanent Financing
is subject to various conditions, including customary due diligence and the
preparation of a definitive purchase agreement and other agreements. The Company
and the Investor anticipate that the transaction will be completed on or before
July 31, 1997. Pursuant to the Letter of Understanding, the Company has agreed
not to pursue alternative financing until August 2, 1997, and to pay to the
Investor a $1,000,000 "break-up fee" in the event there is a failure to close
the Permanant Financing that is followed (within 6 months) by an investment in
the Company by a person unaffiliated with the Investor. Under the terms of the
Letter of Understanding, Series D Preferred Stock will be senior to the existing
holders of Series A, Series B, and Series C Preferred Stock. The holders of the
Series A, Series B and Series C Preferred Stock have either consented to such
seniority and to the other terms of the Permanent Financing, or have made
arrangements to transfer their shares at the time of the Permanent Financing to
existing preferred stockholders who have consented to such seniority and such
other terms. At the option of the holder of Series B Preferred Stock, the
Investor has under certain circumstances agreed to permit the conversion of
Series B Preferred Stock to debt senior to Series D Preferred Stock at the
closing of the Permanent Financing.
The anticipated proceeds from the Permanent Financing will be used to fund
working capital needs, including operating losses, to acquire certain assets of
physician practices, and the payment of signing bonuses to IPA Equity
Physicians, and, subject to certain conditions, to repay a bank line of credit
guaranteed by the Series B Preferred Stockholder. The Investor will be granted a
variety of investor protections and negative covenants, as well as Board and
Executive Committee representation. In certain defined material financial
default scenarios involving Medicare medical loss ratios, the Investor will also
have the right to control of the Company's Board and Executive Committee.
The Series C Preferred Stockholder and the Company have agreed to change
the terms of the Subordinated Debt Facility as part of the Permanent Financing.
The Company believes the Subordinated Debt Facility will be convertible into up
to 285,714 shares of Convertible Series C Preferred Stock. As part of the
Permanent Financing, the Series C Preferred Stock will convert into Class C
Common Stock at a ratio of 1.25 shares of Common Stock for every share of Series
C Preferred Stock at the time of a Qualifying Initial Public Offering or change
of control. Also, in connection with the Permanent Financing, the Company has
agreed to adjust the exercise price of the warrants issued to the Series C
Preferred Stockholder on January 31, 1997 to purchase 250,000 shares of the
Company's Class A Common Stock from $14.00 per share to $10.00 per share.
Furthermore, as part of the Permanent Financing, the Series C Preferred
Stockholder has entered into a binding contractual commitment to purchase
approximately 408,000 shares of DHS Series B Preferred Stock from Medical Mutual
Insurance Company ("Medical Mutual") for $4,590,000. Such shares represent
Medical Mutual's original investment and all accrued dividends and interest paid
in shares. This commitment is expressly conditioned on the closing of a
$30,000,000 transaction with the Investor. The Company anticipates that pursuant
to the Permanent Financing, the Note issued to the Series C Preferred
Stockholder pursuant to the Subordinated Debt Facility will remain outstanding.
The inability of the Company to complete the Permanent Financing or obtain
alternative financing in a timely manner would adversely impact the Company's
ability to execute its planned strategy, impair the Company's ability to make
intended capital expenditures and would have a material adverse effect on the
Company's results of operations and financial condition.
11
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
FORWARD-LOOKING STATEMENT REGARDING
FUTURE OPERATING RESULTS
This Quarterly Report on Form 10-Q contains statements which, to the extent
they are not recitations of historical fact, may constitute forward-looking
statements regarding future operating results and financial condition. All
forward-looking statements involve risks and uncertainties. Although the Company
believes that its expectations are based upon reasonable assumptions within the
bounds of its knowledge of its business and operations, there can be no
assurance that actual results will not materially differ from its expectations.
The future operating results and financial condition of the Company are
dependent upon the Company's ability to market its services profitably,
successfully increase market share and manage expense growth relative to revenue
growth. In addition, the future operating results and financial condition of the
Company may also be affected by several factors, including (i) the Company's
growth strategy and its ability to raise sufficient capital to support growth,
(ii) government regulation of the health care industry; (iii) integration risks,
(iv) dependence on managed care contracts and dependence on enrollment patients
in managed care contracts with HMOs, (v) health care cost-containment decisions
of Payors; (vi) controlling and estimating health care costs; and (vii)
competition for opportunities to expand the Company's network of physicians and
health care providers. Changes in one or more of these factors could have a
material adverse effect on the future operating results and financial condition
of the Company.
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
By unanimous consent in lieu of meeting dated January 29, 1997, the
following matters were submitted to a vote of the Registrant's stockholders:
1. Adoption of Articles of Amendment and Restatement and Bylaws of the
Registrant to (i) increase the size of the Board of Directors from 18 to 19
members to provide the Series C Preferred Stockholders an additional seat on the
Board; (ii) increase the size of the Executive Committee of the Board from seven
to eight members to provide the Series C Preferred Stockholder an additional
seat on the Executive Committee; (iii) to provide that a majority of the
Executive Committee members constitutes a quorum; and (iv) to increase the
number of authorized shares of Series C Preferred Stock from 1,071,428 shares to
1,500,000 shares.
VOTES FOR VOTES AGAINST ABSTENTIONS
--------- ------------- -----------
Class A and Class B Common Stock...... 4,403,000 0 0
Series B Preferred Stock.............. 355,556 0 0
Series C Preferred Stock.............. 571,428 0 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.6) Amended and Restated Employment Agreement dated April 21, 1997 by
and between Doctors Health System, Inc. and Scott Rifkin M.D.
(10.7) Letter Agreement dated February 1, 1997 between Scott Rifkin, M.D.
and Doctors Health System, Inc.
(10.8) Promissory Note dated May 14, 1997 (payable to HBO & Company of
Georgia)
(27) Financial Data Schedule
(b) Reports on Form 8K
None
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
DOCTORS HEALTH SYSTEM, INC.
By: /s/ John R. Dwyer, Jr.
__________________________
John R. Dwyer, Jr.
Chief Financial Officer
