PROSPECTUS SUPPLEMENT NO. 1 Filed pursuant to Rule 424(b)(3)
To Prospectus Dated January 24, 1997 Registration No. 333-01926
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 DECEMBER 31, 1996
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 incorporation or (I.R.S. Employer
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 March 7, 1997 810,000 shares of the registrant's Class A Common stock
and 2,623,100 shares of the Registrant's Class B Common Stock were outstanding.
The date of this Prospectus Supplement is March 18, 1997.
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
FORM 10-Q
DECEMBER 31, 1996
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
NO.
<S> <C>
PART 1. 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....... 11
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, DECEMBER 31,
1996 1996 1996
------------ ----------- ------------
<S> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents........................................................... $ 1,419,295 $ 1,419,295 $ 2,883,049
Accounts receivable (net of allowance for doubfful accounts of $324,521 at June 30,
1996, and $440,000 at December 31, 1996, respectively)............................ 1,303,941 1,303,941 1,845,079
Accounts receivable-affiliates...................................................... 1,208,685 1,208,685 1,377,102
Other receivables................................................................... 64,251 64,251 456,873
Prepaid expenses.................................................................... 117,096 117,096 447,339
Due from affiliates................................................................. 891,985 891,985 1,103,895
------------ ----------- ------------
TOTAL CURRENT ASSETS.............................................................. 5,005,253 5,005,253 8,113,337
PROPERTY AND EQUIPMENT, NET........................................................... 2,485,547 2,485,547 3,087,829
OTHER ASSETS
Intangibles (net of accumulated amortization of $65,170 at June 30, 1996 and
$162,424 at
December 31, 1996, respectively).................................................. 2,448,030 2,448,030 5,116,572
Deferred charges (net of accumulated amortization of $147,475 at June 30, 1996 and
$306,188 at December 31, 1996, respectively)...................................... 636,772 636,772 1,235,115
Note receivable..................................................................... 300,000 300,000 --
Accrued interest receivable......................................................... 253,976 253,976 308,762
Deposits............................................................................ 24,560 24,560 60,817
------------ ----------- ------------
3,663,338 3,663,338 6,721,266
------------ ----------- ------------
TOTAL ASSETS...................................................................... $ 11,154,138 $11,154,138 $ 17,922,432
============ =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Bridge Loan......................................................................... $ -- $ -- $ 983,017
Notes Payable....................................................................... 303,915 303,915 3,605,689
Current maturities of capital lease obligations..................................... 101,985 101,985 106,360
Accounts payable.................................................................... 330,647 330,647 638,969
Accrued medical claims.............................................................. 550,520 550,520 2,235,613
Other accrued expenses.............................................................. 2,069,579 2,069,579 2,392,781
Due to affiliates................................................................... 766,475 766,475 1,413,884
------------ ----------- ------------
TOTAL CURRENT LIABILITIES......................................................... 4,123,121 4,123,121 11,376,313
LONG-TERM OBLIGATIONS
Note payable........................................................................ 3,400,000 3,400,000 --
Notes payable and purchase obligations-related parties.............................. 2,077,364 2,077,364 2,458,171
Capital lease obligations, less current maturities.................................. 320,673 320,673 265,575
------------ ----------- ------------
5,798,037 5,798,037 2,723,746
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 5,435,805
Less subscription receivable-....................................................... (1,500,000) (1,500,000) (1,500,000)
------------ ----------- ------------
3,773,305 3,773,305 3,935,805
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 4,332,548
8% cumulative, Series C, $17.50 par value, authorized 1,071,428 shares; issued and
outstanding 428,751 shares (liquidation value $7,500,000)......................... -- -- 7,683,463
------------ ----------- ------------
7,910,831 7,910,831 15,951,816
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
800,000 shares at December 31, 1996.............................................. -- 8,000 8,000
Class B, $.01 par value; authorized 10,000,000; issued and outstanding 2,398,000
shares at June 30, 1996 and 2,552,000 at December 31, 1996....................... 23,980 23,980 25,520
Class C, $.01 par value; authorized 29,050,000; no shares issued.................. -- -- --
Additional paid in capital........................................................ 2,323,600 2,323,798 4,117,268
Retained earnings (accumulated deficit)........................................... (11,425,431) (9,033,629) (16,280,231)
------------ ----------- ------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT)............................................ (9,077,851) (6,677,851) (12,129,443)
------------ ----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)............................ $ 11,154,138 $11,154,138 $ 17,922,432
============ =========== ============
</TABLE>
See accompanying notes to financial statements.
1
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
------------- ------------- ------------- -------------
<S> <C>
REVENUES
Net revenue..................................................... $ 915,902 $ 2,705,841 $ 1,472,969 $ 4,900,352
Capitation revenue.............................................. -- 2,219,562 -- 3,487,175
----------- ----------- ----------- -----------
915,902 4,925,403 1,472,969 8,387,527
EXPENSES
Medical services expense........................................ -- 2,550,395 -- 3,745,896
Care center costs............................................... 837,452 2,696,243 1,323,703 4,799,762
General and administrative...................................... 850,635 3,184,390 1,386,750 5,854,470
Depreciation and amortization................................... 94,310 288,693 144,855 513,077
----------- ----------- ----------- -----------
1,782,397 8,719,721 2,855,308 14,913,205
----------- ----------- ----------- -----------
Loss from operations......................................... (866,495) (3,794,318) (1,382,339) (6,525,678)
OTHER INCOME (EXPENSE)
Interest and other income....................................... 39,950 68,767 111,755 137,805
Interest expense................................................ (59,356) (158,729) (94,467) (306,944)
----------- ----------- ----------- -----------
(19,406) (89,962) 17,288 (169,139)
----------- ----------- ----------- -----------
Loss before income taxes..................................... (885,901) (3,884,280) (1,365,051) (6,694,817)
Income taxes.................................................... -- -- -- --
----------- ----------- ----------- -----------
NET LOSS..................................................... $ (885,901) $(3,884,280) $(1,365,051) $(6,694,817)
=========== =========== =========== ===========
Loss applicable to common stock
Net loss..................................................... $ (885,901) $(3,884,280) $(1,365,051) $(6,694,817)
Preferred stock dividends accreted........................... 113,750 328,761 195,000 551,785
=========== =========== =========== ===========
Loss applicable to common stock.............................. $ (999,651) $(4,213,041) $(1,560,051) $(7,246,602)
=========== =========== =========== ===========
Net loss per share................................................ ($0.33) ($1.27) ($0.52) ($2.22)
=========== =========== =========== ===========
Weighted average number of shares outstanding..................... 3,000,000 3,323,304 3,000,000 3,264,761
=========== =========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
------------- ------------- ------------- -------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITY
Net loss........................................................ $ (885,901) $(3,884,280) $(1,365,051) $(6,694,817)
Adjustments to reconcile net loss to net cash (used in) provided
by operating activities
Depreciation and amortization................................ 94,310 288,693 144,855 513,077
Provision for uncollectible accounts receivables............. 37,145 55,268 54,460 115,479
Changes in assets and liabilities, net of effects of medical
practice receivables acquired
Accounts receivable........................................ 202,197 476,997 261,906 85,550
Accounts receivable -- affiliates.......................... (70,374) (222,362) (32,020) (122,755)
Prepaid expenses and other receivables..................... (4,967) (646,138) 10,879 (777,651)
Due from/to affiliates..................................... (71,013) 296,156 (648,761) 435,499
Accounts payable........................................... (360,448) 244,606 134,520 308,322
Accrued and other liabilities.............................. (502,534) 1,426,787 381,896 1,611,999
Organizational costs and deferred charges.................. (8,385) (540,801) (8,385) (766,923)
----------- ----------- ----------- -----------
Net cash (used in) provided by operating activities..... (1,569,970) (2,505,074) (1,065,701) (5,292,220)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment.............................. (352,976) (474,306) (693,640) (707,923)
Payments for acquisition costs.................................. (6,514) (592,373) (9,354) (823,114)
Deposits........................................................ 111,678 (9,589) 130,063 (36,257)
----------- ----------- ----------- -----------
Net cash used in investing activities................... (247,812) (1,076,268) (572,931) (1,567,294)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of redeemable convertible preferred
stock........................................................ 3,910,000 -- 4,410,000 7,489,200
Borrowings under notes payable.................................. -- -- -- 1,183,017
Principal payments on capital lease obligations................. (33,800) (26,014) (37,647) (50,723)
Payments on notes payable....................................... (10,915) (130,111) (18,708) (298,226)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities..... 3,865,285 (156,125) 4,353,645 8,323,268
Net increase (decrease) in cash and cash equivalents.... 2,047,503 (3,737,467) 2,715,013 1,463,754
Cash and cash equivalents at beginning of period.................. 799,395 6,620,516 131,885 1,419,295
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period........................ $ 2,846,898 $ 2,883,049 $ 2,846,898 $ 2,883,049
=========== =========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest.......................................... $ 36,451 $ 90,860 $ 43,725 $ 188,452
=========== =========== =========== ===========
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 SIX MONTHS ENDED DECEMBER 31, 1996 AND 1995
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 six months
ended December 31, 1995 and 1996 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 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 Agreement does not convey
any equity interest in the CMGs, which retain autonomy and independence over
clinical matters.
During the three months ended December 31, 1996, the Company acquired
certain assets of the medical practices of 16 physicians. In connection with the
transactions, the Company added 10 of the physicians to an existing CMG (Doctors
Health Montgomery, LLC) and 6 to a new CMG (Anne Arundel Medical Group, LLC).
During the three months ended December 31, 1995, the Company added 8 physicians
and expanded its Core Medical Groups from one to two. During the three months
ended December 31, 1996, the consideration paid for the acquisition of medical
practice assets totaled approximately $2,921,000 and consisted of 26% cash, 51%
stock and 23% notes payable and liabilities assumed. During the three months
ended December 31, 1995, the consideration paid for the acquisition of medical
practice assets totaled approximately $771,000 and consisted of 1% cash, 64%
stock and 35% notes payable and liabilities assumed.
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 and
stipulated in the PSO Agreements. Contractual fees are accrued when collection
is probable. Revenue for all CMGs is recorded at established rates reduced by
allowances for doubtful accounts and contractual adjustments and amounts
retained by physician groups.
4
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
NOTE 3 -- NET REVENUE -- Continued
The following represents amounts included in the determination of net
revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
------------ ------------ ------------ ------------
<S> <C>
Gross physician revenue........................................... 2,557,561 7,820,725 4,289,050 13,704,635
Less: Provision for contractual and other adjustments........... (1,008,295) (3,348,485) (1,655,087) (5,656,371)
Gatekeeper capitated income....................................... 295,299 775,063 453,777 1,392,504
---------- ---------- ---------- ----------
Net physician revenue............................................. 1,844,565 5,247,303 3,087,740 9,440,768
Amount retained by affiliated core medical groups:
Physicians...................................................... 775,724 2,490,249 1,374,564 4,324,966
Ancillary employees and expenses................................ 152,939 51,213 240,207 215,450
---------- ---------- ---------- ----------
Net revenue....................................................... 915,902 2,705,841 1,472,969 4,900,352
========== ========== ========== ==========
</TABLE>
During the three months ended December 31, 1995 and 1996, 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
December 31, 1995 and 1996, one of these CMGs comprised approximately 99% and
69%, respectively, of the Company's net revenue respectively.
NOTE 4 -- CAPITATION REVENUE AND MEDICAL SERVICES EXPENSE RECOGNITION
As of December 31, 1996, the Company has three global capitation contracts
and twelve gatekeeper capitation contracts with thirteen 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 December 31, 1996, $1,572,229 and
$647,333, were recorded as global capitation and gatekeeper capitation revenue,
respectively, in the Company's financial statements. During the six months ended
December 31, 1996, $2,498,842 and $988,333, were recorded as global capitation
and gatekeeper capitation revenue, respectively, in the Company's financial
statements. During the three months and six months ended December 31, 1995, the
Company had no global or gatekeeper capitation contracts.
The Company's commercial capitation contract also includes a provision
whereby the Company can earn additional 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 December 31,
1996 is approximately $95,000 of estimated amounts due to the HMO under this
arrangement.
Under the Company's two Medicare full risk 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 projections of costs using 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 December 31, 1996, approximately $2,140,000 was recorded as accrued
medical services for incurred but not reported services.
5
<PAGE>
DOCTORS HEALTH SYSTEM, INC.
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
NOTE 5 -- CAPITALIZATION
On September 4, 1996, the Company issued 428,571 shares of Series C
Preferred Stock to Genesis Health Ventures, Inc. (Genesis), in exchange for
$7,500,000 in cash. See Subsequent Events below for a summary of the additional
investment by Genesis on January 2, 1997 and January 31, 1997.
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 agreement with respect to any disability not covered by insurance. As
of February 17, 1997, the insurance lapsed with respect to the founding
shareholder who waived the Company's obligation to purchase such founding
shareholder's capital stock in the event of a disability. 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. 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. 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 with three founding shareholders.
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 December 31, 1996 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 this amount as part of the Permanent Financing.
NOTE 8 -- SUBSEQUENT EVENTS
On January 2, 1997, the Company issued 142,857 shares of Series C
Redeemable Convertible Preferred Stock to Genesis for $2,500,000. As of that
issuance, Genesis held 571,428 shares of Series C Redeemable Convertible
Preferred Stock. In addition, on January 31, 1997, the Company and Genesis
entered into a Note Purchase Agreement pursuant to which Genesis agreed to
provide the Company a $5,000,000 credit facility. The Company issued its
Convertible Subordinated 11% Promissory Note to Genesis and on January 31, 1997,
Genesis advanced the sum of $2,800,000 pursuant to the credit facility. The
credit facility matures on January 31, 1999 or the consummation of a $30,000,000
debt and/or equity Permanent Financing (See Management Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources). The $5,000,000 note is convertible at the option of Genesis into a
minimum of 500,000 shares of Convertible Series C Preferred stock. Beginning on
March 31, 1997, the Company may request additional advances under the Note.
Also, on January 31, 1997, the Company issued to Genesis a Warrant to purchase
250,000 shares of Class A Common stock at $14.00 per share.
On January 13, 1997, the Company repaid to First National Bank of Maryland
$983,017 which represents the retirement of the bridge loan facility.
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 cash and
shares of the Company's Class B Common Stock.
6
<PAGE>
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 December 31, 1996,
the Company had approximately 310 Network 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 mechanisms. The Company's
level of profitability depends on (i) increasing the number of Network
Physicians, (ii) attracting patients to enroll in benefit plans that enter into
Global Capitated Contracts with the Company (principally Medicare
beneficiaries), (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 December 31, 1996, the Company has two Global Capitated
Medicare Contracts and one 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 intends to begin management of multi-speciality CMGs pursuant to a
medical practice asset acquisition of and merger with a cardiology practice. The
Company also expects to derive revenues and earnings from the participation of
physicians in its Independent Practice Association (IPAs). As of September 30,
1996, 50 Network PCPs were participants in the Company's IPAs. As of December
31, 1996, the Network PCPs participating in the Company's IPAs increased to 186.
RESULTS OF OPERATIONS
The Company's operating results are significantly affected by the number of
Network PCPs, the number of Network 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
Network PCPs, 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,
1995 1996 1996 1996
-------- -------- ------------- ------------
<S> <C>
Number of Network PCPs as of............................................... 24 155 176 310
Number of Network PCPs participating in Global Capitated Contracts as of... -- 45* 45 62
Number of regional networks as of.......................................... 1 5 6 7
Number of Global Capitated Contracts as of................................. -- 3 3 3
Number of Global Capitated Patients:
Commercial............................................................... -- 2,039 2,174 2,272
Medicare................................................................. -- 491 965 1,283
</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 process and other internal Company controls.
The increase in the number of Network Physicians has contributed to the
increase in net revenue growth as well as the increase in operating costs to
support physician growth. In preparation for the acquisition of medical
practices and other physician transactions, the Company had invested in the
personnel and infrastructure necessary to accommodate its anticipated growth,
which resulted in substantial increases in corporate expenses throughout 1996
and 1995.
7
<PAGE>
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 fully meaningful at this time.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1995 1996 1995 1996
------------ ------------ ------------ ------------
<S> <C>
Net revenue....................................................... 100.0% 54.9% 100.0% 58.4%
Capitation revenue................................................ -- 45.1% -- 41.6%
----- ----- ----- -----
Total revenues.................................................... 100.0% 100.0% 100.0% 100.0%
Medical services expense.......................................... -- 51.8% -- 44.7%
Care center costs................................................. 91.4% 54.8% 89.9% 57.2%
General and administrative........................................ 92.9% 64.7% 94.1% 69.7%
Depreciation and amortization..................................... 10.3% 5.9% 9.8% 6.1%
Interest and other income......................................... (4.4)% (1.4)% (7.6)% (1.6)%
Interest expense.................................................. 6.5% 3.2% 6.4% 3.7%
Income tax expense................................................ -- -- -- --
----- ----- ----- -----
Net loss.......................................................... (96.7)% (79.0)% (92.6)% (79.8)%
===== ===== ===== =====
</TABLE>
THREE MONTHS ENDED DECEMBER 31, 1996 COMPARED TO THE THREE MONTHS ENDED
DECEMBER 31, 1995.
TOTAL REVENUES. The Company's total revenues increased to $4,925,403 for
the three months ended December 31, 1996 from $915,902 for the three months
ended December 31, 1995. This increase was attributable to the growth in net
revenue to $2,705,841 or 54.9% of total revenue from $915,902 or 100% of total
revenue and the increase in capitation revenue to $2,219,562 ($1,572,229 for
Global Capitated Contracts and $647,333 for Gatekeeper Capitation Contracts) or
45.1% of total revenue from $0 over the prior period. These increases resulted
primarily from the increase in the number of Network Physicians from 36 to 310,
the increase in the number of Network Physicians participating in Global
Capitated Contracts from 0 to 62, the increase in the number of Global Capitated
Contracts from 0 to 3 and the increase in the number of Gatekeeper Capitation
Contracts from 0 to 12.
MEDICAL SERVICES EXPENSE. Medical services expense was $2,550,395 or 51.8%
of total revenue for the three months ended December 31, 1996 compared to $0 of
total revenue for the three months ended December 31, 1995. This increase
resulted from the increase in the number of Network Physicians participating in
Global Capitated Contracts from 0 to 62, the increase in the number of Global
Capitated Contracts from 0 to 3 and the increase in the number of Gatekeeper
Capitated Contracts from 0 to 12. The Company expects these expenses to increase
as the number of Network Physicians 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 $2,696,243 or 54.8% of total
revenue for the three months ended December 31, 1996 compared to $837,452 or
91.4% of total revenue for the three months ended December 31, 1995. This
increase in dollar amount resulted from the increase in the number of Network
Physicians from 36 to 310. 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 revenue.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $3,184,390 or 64.7% of total revenue for the three months ended December
31, 1996 compared to $850,635 or 92.9% of total revenue for the three months
ended December 31, 1995. 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 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 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 $288,693 or 5.9% of total revenue for the three months ended
December 31, 1996 compared to $94,310 or 10.3% of total revenue for the three
months
8
<PAGE>
ended December 31, 1995. The increase in dollar amount resulted primarily from
intangibles acquired in connection with the purchase of certain medical practice
assets from Equity Physicians, as well as fixed asset additions. While these
expenses are expected to increase as the Company continues adding Equity
Physicians to the affiliated CMGs, the Company expects that these expenses will
continue to decline as a percentage of total revenue assuming continued growth
in revenue.
INTEREST AND OTHER INCOME. Interest and other income was $68,767 or 1.4% of
total revenue for the three months ended December 31, 1996 compared to $39,950
or 4.4% of total revenue for the three months ended December 31, 1995.
INTEREST EXPENSE. Interest expense was $158,729 or 3.2% of total revenue
for the three months ended December 31, 1996 compared to $59,356 or 6.5% of
total revenue for the three months ended December 31, 1995. 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 December 31, 1996 and 1995, the
Company did not require a provision for income taxes.
NET LOSS. The Company had a net loss of $3,884,280 for the three months
ended December 31, 1996 compared to $885,901 for the three months ended December
31, 1995.
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 $4,213,041 for the three months ended
December 31, 1996 compared to $999,651 for the three months ended December 31,
1995.
SIX MONTHS ENDED DECEMBER 31, 1996 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
1995.
TOTAL REVENUES. The Company's total revenues increased to $8,387,527 for
the six months ended December 31, 1996 from $1,472,969 for the six months ended
December 31, 1995. This increase was attributable to the growth in net revenue
to $4,900,352 or 58.4% of total revenue from $1,472,969 or 100% of total revenue
and the increase in capitation revenue to $3,487,175 ($2,498,842 Global
Capitation and $988,333 from Gatekeeper Capitation Contracts) or 41.6% of total
revenue from $0 over the prior year. These increases resulted primarily from the
increase in the number of Network Physicians from 36 to 310, the increase in the
number of Network Physicians participating in Global Capitated Contracts from 0
to 62, the increase in the number of Global Capitated Contracts from 0 to 3 and
the increase in the number of Gatekeeper Capitation Contracts from 0 to 12.
MEDICAL SERVICES EXPENSE. Medical services expense was $3,745,896 or 44.7%
of net revenue for the six months ended December 31, 1996 compared to $0 or 0%
of net revenue for the six months ended December 31, 1995. These increases
resulted form the increase in the number of Network Physicians participating in
Global Capitation Contracts from 0 to 62, the increase in the number of Global
Capitated Contracts from 0 to 3 and the increase in the number of Gatekeeper
Capitation Contracts from 0 to 12. The Company expects these expenses to
increase as the number of Network 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 $4,799,762 or 57.2% of total
revenue for the six months ended December 31, 1996 compared to $1,323,703 or
89.9% of total revenue for the six months ended December 31, 1995. The increase
in dollars resulted from the increase in the number of Network Physicians from
36 to 310.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $5,854,470 or 69.7% of total revenue for the six months ended December 31,
1996 compared to $1,386,750 or 94.1% of net revenue for the six months ended
December 31, 1995. 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.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization
expenses were $513,077 or 6.1% of total revenue for the six months ended
December 31, 1996 compared to $144,855 or 9.8% of total revenue for the six
months ended December 31, 1995. The increase in dollars resulted primarily from
intangibles acquired in connection with the purchase of certain medical practice
assets from Equity Physicians, as well as fixed asset additions.
INTEREST AND OTHER INCOME. Interest and other income was $137,805 or 1.6%
of total revenue for the six months ended December 31, 1996 compared to $111,755
or 7.6% of total revenue for the six months ended December 31, 1995.
INTEREST EXPENSE. Interest expense was $306,944 or 3.7% of total revenue
for the six months ended December 31, 1996 compared to $94,467 or 6.4% of total
revenue for the six months ended December 31, 1995. The increase in dollars
resulted primarily from the increase in the level of borrowings.
9
<PAGE>
INCOME TAX EXPENSE. In light of the Company's losses and its allowance for
deferred tax assets, for the six months ended December 31, 1996 and 1995, the
Company did not require a provision for income taxes.
NET LOSS. The Company had a net loss of $6,694,817 for the six months ended
December 31, 1996 compared to $1,365,051 for the six months ended December 31,
1995.
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 $7,246,602 for the six months ended December
31, 1996 compared to $1,560,051 for the six months ended December 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, the Company had approximately $2,800,000 in
available cash and negative working capital of $2,870,000 (excluding the
remaining amount available under the Bridge Loan Facility which was repaid on
January 13, 1997). On January 2, 1997, the Company received $2,500,000 in
exchange for 142,857 shares of Redeemable Convertible Series C Preferred Stock.
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 this amount as part
of the Permanent Financing. On January 13, 1997, the Company repaid the Bridge
Loan Facility of $983,017.
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 will 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. 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. In connection with the execution of the Subordinated Debt
Facility, the Company and the Series C Preferred Stockholder amended their
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 is seeking a $630,000 letter of credit (LOC) from First
National Bank of Maryland which the Company believes will be issued in March
1997. The LOC is a requirement under one of the Company's Medicare Capitated
Contracts with a health maintenance organization. The Medicare Capitated
Contract requires the Company to provide an LOC, or other similar security, for
a portion of the capitation received by the Company during the previous 60 days.
The LOC will be secured by a $630,000 certificate of deposit funded by the
Company's working capital.
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 that its cash on hand at March 6, 1997, of $3,062,000 and the amounts
remaining available under the Subordinated Debt Facility will be sufficient to
fund the Company's operations through June 30, 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, the Company will not be able to
execute its business strategy and the Company's operating results and financial
condition could be materially and adversely affected.
Genesis Health Ventures, Inc. ("Genesis"), the Company's Series C Preferred
Stockholder, has agreed to use its best efforts to assist the Company in raising
$30,000,000 in financing (the "Permanent Financing") until April 30, 1997. The
Company and Genesis are evaluating several initiatives for obtaining the
Permanent Financing. The Permanent Financing may be in the form of issuance of
another class of preferred stock, a debt facility or a combination of both. One
such initiative would be to secure a $20,000,000 senior subordinated debt
facility and $10,000,000 in redeemable convertible preferred stock of the
Company. Genesis has indicated to the Company that it desires to participate in
any debt financing
10
<PAGE>
portion of a Permanent Financing. In connection with the $20,000,000 senior
subordinated debt facility, the Company anticipates that it will issue
detachable warrants with a nominal exercise price. The anticipated proceeds from
the Permanent Financing will be used to repay the Subordinated Debt Facility,
repay a bank line of credit, fund working capital needs, acquire certain assets
of physician practices and, subject to approval of the Series A Stockholder and
certain other conditions, redeem the Series B Preferred Stock at par plus
accrued dividends. All equity components must be junior with respect to
dividends, liquidation and redemption to all existing Preferred Stockholders.
The financing sources will be granted Board representation and Genesis will
have the option of designating an additional Board and Executive Committee
member. In exchange for such assistance, the Company (i) agreed until April 30,
1997, to work exclusively with and through Genesis in seeking additional
financing sources and (ii) granted the Series C Preferred Stockholder a
warrant to purchase 250,000 shares of Class A common stock at an exercise
price of $14.00 per share. Upon consummation of the Permanent Financing, the
remaining right and/or commitment of the Series C Preferred Stockholder's
existing options to purchase 250,000 shares of Series C Preferred Stock at a
price of $20.00 per share when the Company's Global Capitated Contracts include
at least 20,000 Medicare lives shall terminate.
The inability of the Company to obtain such funding, either in whole or in
part, would impair the Company's ability to make intended capital expenditures
and to execute its planned strategy and therefore could have a material adverse
effect on the Company's results of operations and financial condition.
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.
11
