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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from _______________ to _____________
Commission file number 1-10677
Integrated Orthopaedics, Inc.
(formerly DRCA Medical Corporation)
(Exact name of small business issuer as specified in its charter)
Texas 76-0203483
(State or other jurisdiction of (IRS Employer
incorporation or orgainzation Identification No.)
3 Riverway, Suite 1430, Houston, Texas 77056
(Address of principal executive offices, including zip code)
(713) 439-7511
(Issuer's telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act:
Name of each exchange
Title of each class on which registered
Common Stock American Stock Exchange
Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer (1) filed all reports required by Section 13 or
15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
Net revenues of the issuer for the fiscal year ended December 31, 1996 were
$14,313,154.
The aggregate market value of Common Stock held by non-affiliates of the
issuer as of March 17, 1997, computed by reference to the closing price at which
the stock was sold, was $13,852,137.
As of March 17, 1997, 5,286,641 shares of Common Stock were outstanding
Transitional Small Business Disclosure Format: Yes [ ] No [X]
Documents Incorporated by Reference
Portions of the Proxy Statement for registrant's 1997 Annual Meeting of
Shareholders are incorporated by reference in Part III.
The Exhibit Index is located on pages 34 - 37.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
DESCRIPTION OF COMPANY
Integrated Orthopaedics, Inc. (formerly DRCA Medical Corporation) was formed on
April 1, 1990 as a successor corporation ("IOI", "DRCA" or the "Company"). The
Company has organized its operations through wholly- and majority-owed
subsidiaries and affiliates controlled through contract and otherwise.
DESCRIPTION OF SERVICES
IOI is a Physician Practice Management ("PPM") company specializing in the
management of orthopaedic medicine practices and other musculoskeletal-related
patient services. In December, 1996, the Company divested substantially all
assets not directly related to the planned expansion of its management of
musculoskeletal-related healthcare delivery systems in selected geographic
markets. IOI's current business strategy is to acquire, develop and manage
orthopaedic and other musculoskeletal-related medical practices and ancillary
services in selected markets so as to provide a cost effective, broad continuum
of health care services required by patients with musculoskeletal injuries and
illnesses. Pursuant to a long term management agreement, the Company currently
manages a musculoskeletal-related healthcare delivery system in Houston, Texas
which consists of orthopaedic and orthopaedics-related medical services,
diagnostic imaging, physical and occupational rehabilitation, pain management
and work hardening. These operations provide a broad range of orthopaedic
medicine and ancillary services to diagnose, treat and rehabilitate patients
with musculoskeletal injuries and illnesses.
The musculoskeletal-related healthcare delivery system currently managed by the
Company includes an orthopaedic medicine practice, three work hardening clinics,
two physical/occupational therapy centers (one of which is operated under a
facility management contract with a major hospital system), and one magnetic
resonance imaging center in Houston, Texas. During 1996, the Company, in a
strategic effort to restructure its operations towards a single focus
musculoskeletal-related physician practice management company, divested its
interests in eight occupational medicine centers, four physical and medical
therapy centers associated with the occupational medicine centers, seven mobile
health testing units operated in conjunction with the occupational medicine
programs in Houston, Texas and Little Rock, Arkansas, and one magnetic resonance
imaging ("MRI") center in Little Rock, Arkansas.
Services provided by medical providers under management by the Company include
diagnostic, treatment and rehabilitation programs for patients experiencing
disabilities due to a variety of physical or orthopaedic problems principally
related to musculoskeletal disorders common to on-the-job injuries, sports
injuries, and age-related musculoskeletal injuries and illnesses. Services are
provided to patients who are members of preferred provider or managed care
organizations, as well as those who are covered by workers' compensation
insurance. Revenues are also derived by the medical group from services to
personal injury patients and, to a small extent, from patients covered under
Medicare.
In March 1995, the Company reorganized its Houston operations whereby
substantially all medical and ancillary services are provided by a medical group
practice affiliated with the Company. In connection with this reorganization,
the Company entered into a long term management services agreement with a newly
formed medical group in Houston, Texas. At its inception, this group included
the Houston-based non-medical, ancillary and rehabilitation services previously
provided directly by DRCA, the occupational
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medicine and mobile health testing components of the managed occupational health
care program previously provided by a professional medical association under
management contract with DRCA, and one orthopaedic medicine practice with two
clinic locations in Houston. In this regard, the Company assisted in the
formation of this professional limited liability partnership ("PLLP") and all
medical and ancillary services in the Houston region have been consolidated
within the PLLP. This structure is designed to streamline the Company's billing
and collection procedures as well as provide a vehicle through which to contract
all services with managed care payors. It is the intention of the Company and
its affiliated medical groups to comply with federal and state laws which
prohibit the corporate practice of medicine, referrals by physicians to certain
ancillary service providers in which the physician has a financial interest, and
kick backs (or payments to physicians for patient referrals). The legal
structure described above was designed to address these prohibitions.
By aggregating these physicians and facilities in one musculoskeletal-related
healthcare delivery system under the Company's management, IOI intends to
position the practice as a comprehensive solution to managed care payors while
also setting the stage to expand its physician practice management business
through the acquisition and consolidation of other orthopaedic and related
medical practices. IOI's near term growth strategy includes continuation of its
vertical integration strategy through physician practice management programs in
orthopaedics and orthopaedics-related medical specialties, expansion of services
at existing and acquired locations, and the continued development in targeted
geographical markets of a broad base of referral sources among physicians,
employers, and payors.
IOI's long term strategic plan is to expand its operations through affiliations
with orthopaedic practices and related medical specialties and ancillary
services in selected geographic markets. Orthopaedic practices are uniquely
positioned as the focal point of a multi-disciplinary, musculoskeletal-related
healthcare delivery system which can include the ancillary services on which
DRCA was founded.
IOI expects to pursue its expansion program by affiliating with orthopaedic
practices in both new and existing geographic markets. Because of its
significant experience in orthopaedics-related medical and ancillary services,
IOI believes it holds a competitive advantage in negotiating for affiliations
with these practices. The Company intends to increase the scope of these
orthopaedic practices by implementing ancillary services such as rehabilitation,
ambulatory surgery, diagnostic imaging, and pain treatment programs based upon
the profile and volume of the group's existing patient base. Targeted
geographic areas for expansion will be those with well established,
reputable orthopaedic or related medical specialty practices with which the
Company could affiliate by acquiring their non-medical assets and entering
into long-term management services agreements with the practices. Targeted areas
would, ideally, also possess a high incidence of workers' compensation claims,
favorable workers' compensation reimbursement rates, available qualified
professionals to staff the facilities and other favorable demographic factors
such as population density and projected growth rate, although expansion through
orthopaedic consolidation is not limited to only such areas.
The Company also intends to selectively expand through other means which might
include the establishment of joint ventures, strategic alliances and management
contracts with major health care service providers, workers' compensation
insurance carriers, and strategically appropriate merger candidates.
PHYSICIAN PRACTICE MANAGEMENT ("PPM") OVERVIEW
IOI has identified the consolidation of orthopaedic and orthopaedic-related
practices as a potentially significant growth opportunity within the PPM
marketplace. Pioneered in the late 1980's, PPM companies offer a mechanism by
which physicians can "partner" with corporate entities. The physician's
practice benefits from the management talent, business skills, operating
structures, business systems, economies of
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scale, and access to capital of its corporate partner. The PPM company benefits
from potentially significant growth through expanding numbers of practice
management contracts and increasing management fees.
The early 1990's saw the emergence of PPM as a significant segment of the health
care industry. Alex. Brown and Sons Incorporated attributes this emerging
industry to four key elements:
(i) The complexity of having numerous managed care contracts with multiple
insurance carriers called for billing and collections systems more
sophisticated than an average physician could afford or manage.
(ii) The increasing cost and sophistication of medical equipment required
greater capital resources and more professional purchasing systems than
that available to the average physician.
(iii) The increasing penetration of managed care payors diminished the
influence of solo practitioners and small, isolated groups.
(iv) The uncertainty of health care reform made group practice a more
attractive alternative.
Physicians provide approximately $200 billion annually in personal services to
patients, and control an estimated $700 - 800 billion in health care
expenditures by deciding what non-physician health care services and products
are required by their patients. Orthopaedic physicians provide approximately
$12 billion or 6% of the $200 billion spent annually on professional medical
services. Along with other physicians, orthopaedic physicians control the
utilization of services in the entire musculoskeletal-related component of the
healthcare market, approximately $120 billion or 16% of total healthcare
expenditures. The PPM industry has tapped this vast pool of dollars by
consolidating both single- and multi-specialty practices for the mutual benefit
of the physicians and the shareholders of their corporate "partners".
Although structures vary, PPM companies generally do not provide medical
services. Instead, the medical services are provided by medical group practices
which contract with the PPM company on a long term basis. The PPM company
generally acquires the hard assets of the medical groups with which it contracts
and structures its provision of those assets and its management services in such
a way as to promote a long term relationship with the medical groups it manages.
OPERATIONS
DIVESTITURE OF CERTAIN OPERATIONS
During 1996, the Company significantly altered the composition of its operations
to restructure itself for expansion as a single focus musculoskeletal-related
PPM company. Toward that goal, the Company sold a wholly-owned subsidiary which
owned the MRI center in Little Rock, Arkansas on March 29, 1996, and the Company
and its affiliated medical groups divested all occupational medicine operations
in Houston, Texas and Little Rock, Arkansas on December 31, 1996 (see Liquidity
and Capital Resources and Notes to the Consolidated Financial Statements).
Following the divestiture of these operations, the Company continues to manage a
musculoskeletal-related healthcare delivery system in Houston, Texas.
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MUSCULOSKELETAL-RELATED HEALTHCARE DELIVERY SYSTEM
In March, 1995, the Company facilitated the creation of a medical group practice
in Houston, Texas which consolidated all medical and ancillary services
previously provided by DRCA and its affiliated medical group with one
orthopaedic medicine practice. Following the divestiture of assets in 1996, the
remaining operations constitute the first musculoskeletal-related healthcare
delivery system with which the Company holds a management contract. Under the
terms of the management agreement, the Company provides all operating assets,
leaseholds, non-clinical personnel, business office functions, and the
management of the non-medical aspects of the system's medical personnel, in
exchange for a management fee and the reimbursement of expenses incurred on
behalf of the group. The composition of this system includes the following:
Orthopaedic Medicine. Patients are seen by the orthopaedic medicine practice for
a variety of musculoskeletal illnesses and injuries. Orthopaedic surgery is the
source of a significant portion of the revenues of this practice. In November,
1995, the medical group first added spinal reconstruction services to this
practice.
Work Hardening. The medical group practice managed by the Company currently
operates work hardening clinics in Houston, Texas under the trade name
"WorkWell." The physical plants of these clinics are the property of the
Company and are provided to the Houston medical group pursuant to a long term
management services contract.
Work hardening is a therapy philosophy based on a comprehensive, multi-
disciplinary approach to industry's need for injury prevention and injury
rehabilitation. Work hardening addresses the physical, psychological, behavioral
and social aspects of an injured worker's ability to work. This program is
carried out in a simulated job environment. A typical program consists of up to
eight weeks, five days per week, eight hours per day. Patients who require
physical conditioning prior to undertaking the work hardening program may
receive "transitional" or "work conditioning" treatment for up to two weeks at a
work hardening clinic prior to entering the work hardening program. The work
hardening program requires the worker to perform the tasks usually performed on
the job and provides cardiovascular, strength and flexibility conditioning. The
program re-educates workers on how to use their tools and perform their tasks in
a safer manner. The goals are to (i) increase physical work tolerance,
endurance, and productivity, (ii) provide an early return to work, and (iii)
improve the injured worker's employability. Accordingly, the patient assumes an
active role in the management of his/her individual case.
The work hardening clinics conduct an objective and standardized evaluation of
physical function. The evaluation utilizes the ERGOS work simulator, a fully
integrated computerized instrument, to measure physical capabilities as they
relate to work activity. The ERGOS work simulator produces graphic and
narrative reports that compare the injured patient's physical capabilities with
national standards promulgated by the Department of Labor.
The work hardening clinics can also provide pre-employment screening. This
screening can decrease injuries by objectively evaluating an employee's physical
capacity to perform the functions of a specific job description. In addition,
the work hardening clinics provide vocational rehabilitation which addresses the
patients' ability to meet the physical demand of a specific job. The work
hardening clinics' injury prevention and wellness programs help instruct
employees in techniques to prevent injury and maintain health while on the job.
This program also includes classes in back care, stretching, smoking cessation,
and dietary consultation and stress management. Staff personnel also offer
recommendations which can modify or alter the demands on the worker or the
demands of the job which may ultimately prevent on-the-job injury.
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The work hardening program also includes vocational evaluation services. The
comprehensive vocational evaluation program is a 2-6 week program designed to
assess and predict disabled individuals' vocational interests and potential
aptitudes through various techniques to reveal possible employment opportunities
and training programs. WorkWell in Houston, Texas, has been designated by the
Texas Rehabilitation Commission to serve as one of its evaluation sites for the
performance of vocational evaluations.
Presently, the work hardening clinics hold a one-year certification given by the
Commission on Accreditation of Rehabilitation Facilities ("CARF"). The Texas
Workers' Compensation Commission ("TWCC") has recognized the quality of care
inherent in a CARF-certified work hardening program. Effective April 1, 1996,
TWCC almost doubled the reimbursement paid to CARF-certified work hardening
centers. WorkWell staffing includes varying combinations of licensed
occupational therapists, licensed physical therapists, certified occupational
therapy assistants, exercise physiologists, work hardening supervisors,
vocational specialists and licensed social workers. In addition, each WorkWell
Clinic has available a psychologist and a nutritionist.
Physical/Occupational Therapy. The medical group practice managed by the
Company currently operates one free standing physical therapy center and one
hospital-based physical and occupational therapy department which provides
services to four hospital-based programs on three campuses. The hospital-based
physical and occupational therapy programs are operated pursuant to a facility
management agreement with a major hospital system
The physical therapy centers provide a broad view of health care, emphasizing
the preventive, acute/trauma and rehabilitative healthcare needs of the patient.
The services generally include physical and occupational therapy, with primary
emphasis on musculoskeletal disorders. To a lesser extent, the
physical/occupational therapy centers treat and instruct injured patients on how
to use prosthetic and orthotic devices.
Presently, the physical and occupational therapy centers are staffed with
varying combinations of licensed physical and occupational therapists, licensed
physical and occupational therapy assistants and unlicensed physical and
occupational therapy aides.
The Company also has arrangements with independent contractor therapists in
Houston, Texas, to cover temporary absences of center personnel, and assist
during peaks in patient loads. These independent contractor therapists are
utilized by the Company only on an as needed basis.
Magnetic Resonance Imaging ("MRI"). The medical group practice managed by the
Company currently operates one MRI center in Houston under the name of Spectrum
Imaging Centers. This unit operates a Hitachi MRP-20 which performs a full
range of diagnostic studies involving magnetic resonance imaging. Patients are
referred to the MRI center primarily by orthopaedists and neurologists, working
often with personal injury patients who originate from attorney referrals and,
to a lesser extent, preferred provider organizations and health maintenance
organizations. The center is staffed by a licensed radiologic technologist who
has received specialized training in magnetic resonance imaging, and by clerical
personnel. Licensed radiologists are utilized in third-party contractor
arrangements to interpret the studies and prepare reports for the referring
physicians.
Chronic Pain Treatment Program. The Company has operated a chronic pain
treatment program since July 1993. In 1995, this program was consolidated into
the Houston medical group and in 1996 the psychological, cognitive, physical
conditioning and rehabilitation, and vocational services functions of this
program were absorbed by the work hardening program. Invasive pain management
services are also provided by the medical group.
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DIVESTED OPERATIONS
Occupational Medicine. Until their sale in December, 1996, the Company managed
occupational medicine clinics in Houston, Texas and Little Rock, Arkansas
pursuant to management agreements with medical groups in each location.
Operating under the name Medi-Stat Medical Centers, these clinics provided
industrial compliance testing and treatment of on-the-job injuries for both
industrial employers and workers' compensation insurance carriers.
Mobile Health Testing. Until its sale in December, 1996, the Company managed
the operation of a fleet of mobile health testing units designed to meet
industry's demands for on-site compliance with medical surveillance required by
OSHA and other regulatory agencies. Mobile testing services included hearing
testing, heart and lung testing, drug screen specimen collection, X-ray, EKG's
and physical examinations by physicians.
Magnetic Resonance Imaging. Until its sale in March, 1996, the Company owned
and operated a wholly-owned subsidiary in Little Rock, Arkansas which operated
an MRI center under the name Spectrum Little Rock Imaging. This unit operated a
Shimadzu SMT-100X MRI which performed a full range of diagnostic studies
involving magnetic resonance imaging.
MARKETING AND BUSINESS DEVELOPMENT
IOI's marketing and business development functions fulfill two different
missions, both of which are critical elements of the Company's business
strategy. IOI pursues its PPM affiliation strategy through its business
development function. The Company's business development department presently
consists of senior management and director level staff, and is currently
recruiting additional personnel.
Once a practice is under management contract with IOI, the Company intends to
present the practice to the payor and patient referral markets through health
care marketing professionals in each service area. IOI intends to follow the
strategy of marketing a practice's services both on a stand-alone basis and as
part of a vertically integrated musculoskeletal-related healthcare delivery
system. There are presently three full-time marketing professionals calling on
the industrial, insurance, and medical communities for the Houston
musculoskeletal-related healthcare delivery system.
EMPLOYEES
At March 17, 1997, the Company and its affiliated medical groups had
approximately 70 full time employees and approximately 4 part time employees.
None of the Company's employees is covered by collective bargaining agreements.
COMPETITION, MAJOR CUSTOMERS AND REIMBURSEMENT
Competition. The healthcare services market in general, and the PPM business in
particular, is highly competitive. The Company is aware of at least one other
publicly traded company and several private companies which compete or intend to
compete for the right to manage orthopaedic and musculoskeletal-related medical
and ancillary service practices. In addition, several, large multi-specialty
medical management companies also compete with the Company and the Company
believes others in the healthcare industry may employ strategies similar to
those of the Company. Many of these current and potential
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competitors are significantly larger and have substantially greater resources
than the Company. The success of the medical group practice presently managed by
the Company and of those practices with which the Company contracts in the
future will be a determining factor in the Company's success. These medical
groups encounter competition, in various forms, from many sources including
other single- and multi-specialty physician groups, hospitals, managed care
organizations, and sole practitioners.
Major Customers. The services of eight full time and numerous part time
physicians which were under the Company's management throughout 1996 were
included in the divestiture of the occupational medicine business on December
31, 1996. After the divestiture, the Company provides substantially all of its
services to one affiliated musculoskeletal-related healthcare delivery system in
Houston, Texas which has a total of one full-time and three part-time
physicians. The loss of the services of any of the physicians could have a
material adverse effect on the Company's revenues and profits. The professional
medical services provided to the medical groups' patients by William F. Donovan,
M.D., a Company shareholder and director, was 15% of reported revenues in 1996
and 16% in 1995. A majority of the ancillary service revenues provided by the
Houston musculoskeletal-related healthcare delivery system also originated from
patients treated by Dr. Donovan. Personal injury claimants have injuries similar
to those of workers' compensation injury patients and are pursuing settlement or
damage awards through the judicial system. Due to the judicial backlog of such
cases and related factors, revenues related to personal injury claimants may
take more than two years to collect. Revenue derived from services provided to
personal injury claimants, as a percent of revenues, was 12% in 1996, 16% in
1995, and 12% in 1994. The medical group practice managed by the Company also
operates a physical and occupational therapy program under contract with a major
hospital corporation. These programs provided approximately 8%, 7%, and 10% of
the Company's revenues in 1996, 1995, and 1994, respectively.
Reimbursement. The various services rendered by the medical practices under
Company management are generally covered by employers, private insurance,
workers' compensation insurance, settlement or adjudication of personal injury
litigation, and Medicare or Medicaid. The current group practice provides an
insignificant amount of services under Medicare and Medicaid programs, although
it is likely that practices acquired in the future may have a higher incidence
of such patients. To some extent, professional medical services are covered by
all payors of medical care. Certain of the ancillary services are more likely
to be covered by employers and workers' compensation insurance than by other
payors due to the nature of the services rendered. Patients pursuing personal
injury claims may require the services of any or all elements of the
musculoskeletal-related healthcare delivery system.
TRADEMARKS
The Company obtained a certificate of trademark and service mark registration
for the mark "WorkWell" and the WorkWell design from the State of Texas in
January 1990. These marks are registered for a term of ten years, and can be
reserved for an additional ten-year period.
The Company obtained Certificates of Registration on the Principal Register of
the U.S. Patent and Trademark Office on March 17, 1992 for the mark "Work
Hardening Dynamics" and on April 7, 1992 for the "Work Hardening Dynamics"
design logo. These marks are registered for a term of ten years, and can be
reserved for an additional ten-year period.
The Company obtained Certificates of Registration on the Principal Register of
the U.S. Patent and Trademark Office on January 19, 1993, for the mark "Medi-
Stat" and on May 11, 1993 for the "Medi-Stat" design logo. These marks are
registered for a term of ten years, and can be reserved for an additional ten-
year period. These marks were sold in December, 1996 in conjunction with the
divestiture of the
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occupational medicine business.
The Company obtained Certificates of Registration on the Principal Register of
the U.S. Patent and Trademark Office on September 12, 1995, for the mark "DRCA".
This mark is registered for a term of ten years, and can be reserved for an
additional ten-year period.
In late 1996 and early 1997, the Company filed applications for Certificates of
Registration on the Principal Register of the U.S. Patent and Trademark Office
for the marks "Integrated Orthopaedics" and "IOI", and for the "IOI" design
logo. Registration is pending determination by the U.S. Patent and Trademark
Office.
REGULATION
General. The health care industry is highly regulated, and there can be no
assurance that the regulatory environment in which the Company operates will not
change significantly in the future. The Company believes that health care
regulations will continue to change and will monitor these changes. The Company
expects to modify its agreements and operations from time to time as the
business and regulatory environments change. While the Company believes it will
be able to structure all its agreements and operations in accordance with
applicable law, there can be no assurance that it will be able to successfully
address changes in the regulatory environment.
Every state imposes licensing requirements on individual physicians and on
facilities and services operated by physicians. In addition, federal and state
laws regulate HMOs and other managed care organizations with which affiliated
practices or their affiliated physicians may have contracts. Many states
require regulatory approval, including certificates of need, before establishing
or expanding certain types of health care facilities, offering certain services
or making expenditures for health care equipment, facilities or programs in
excess of statutory thresholds. Some states also require licensing of
collection agencies and employee leasing companies. In connection with its
operations and its expansion into new markets, the Company believes it is in
compliance with all such laws and regulations and current interpretations
thereof, but there can be no assurance that such laws, regulations, or
interpretations will not change in the future or that additional laws and
regulations will not be enacted. The ability of the Company to operate
profitably will depend in part upon the Company and its affiliated medical
practices obtaining and maintaining all necessary licenses, certificates of
need, and other approvals and operating in compliance with applicable health
care regulations.
In addition to extensive, existing health care regulation, there have been
numerous federal and state initiatives for comprehensive reforms affecting the
payment for and availability of health care services. The Company believes that
such initiatives will continue. Aspects of certain of these reforms as
previously proposed, such as further reductions in insurance payments and
additional restrictions on direct or indirect physician ownership of facilities
to which they refer patients, if adopted, could adversely affect the Company.
Other aspects of such initiatives, such as universal health insurance coverage
and coverage of certain previously uncovered services, could have a positive
impact on the Company's business.
The ability of the Company to operate profitably will depend, in part, upon the
Company and its affiliated medical practices obtaining and maintaining all
necessary licenses, certificates of need and other approvals, and operating in
compliance with applicable health care regulations.
Fee Splitting; Corporate Practice of Medicine. The laws of many states prohibit
physicians from splitting fees with non-physicians and prohibit non-physician
entities, such as the Company, from practicing medicine. Under such laws, the
Company is prohibited from exercising control over the provision of
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medical services. These laws vary from state to state and are enforced by
regulatory authorities with broad discretion. The Company believes its
operations will be in compliance with existing applicable laws. There can be no
assurance that review of the Company's business by courts or regulatory
authorities will not result in determinations that could adversely affect the
operations of the Company, or that changes in health care regulations will not
restrict the Company's existing or expanding operations. In addition, the
regulatory framework of certain jurisdictions may limit the Company's ability to
expand into such jurisdictions.
Fraud and Abuse. Federal law prohibits the offer, payment, solicitation or
receipt of any form of remuneration in return for, or in order to induce, (i)
the referral of a person for services, (ii) the furnishing or arranging for the
furnishing of items or services, or (iii) the purchase, lease or order or
arranging or recommending purchasing, leasing or ordering of any item or
service, in each case, reimbursable under Medicare or Medicaid. Pursuant to
this anti-kickback law, the federal government recently announced a policy of
increased scrutiny of joint ventures and other transactions among health care
providers in an effort to reduce potential fraud and abuse related to Medicare
and Medicaid costs. Many states, including Texas, have similar anti-kickback
laws and in the case of Texas these laws apply to all types of patients, not
just Medicare and Medicaid beneficiaries. The applicability of these federal
and state laws to many business transactions in the health care industry,
including those intended by the Company, has not yet been subject to significant
judicial interpretation.
Noncompliance with, or violation of, the federal anti-kickback legislation can
result in exclusion for Medicare and Medicaid programs and civil and criminal
penalties. Similar penalties are provided for violation of state and anti-
kickback laws. The federal government has promulgated "safe harbor" regulations
that identify certain business and payment practices which are deemed not to
violate the federal anti-kickback statute. Although the Company' business does
not fall within certain of the current or proposed safe harbors, the Company
believes that its intended operations materially comply with the anti-kickback
statutes and regulations.
Prohibitions on Referrals to Certain Entities. The so-called "Stark Law" (named
after its chief sponsor, Congressman Fortney "Pete" Stark) originally prohibited
a physician from referring a Medicare patient to an entity for the provision of
clinical laboratory services if the physician or an immediate family member of
the physician had a financial relationship, which includes an ownership or
investment interest or compensation arrangement, with the entity. The revised
Stark Law, known as "Stark II," dramatically enlarged the field of physician-
owned or physician-interested entities to which the referral prohibitions apply.
Effective January 31, 1995, Stark II prohibits a physician from referring
Medicare or Medicaid patients to an entity providing "designated health
services" in which the physician has an ownership or investment interest, or
with which the physician has entered into a compensation agreement. The
penalties for violating Stark II include a prohibition on payment by these
government programs and civil penalties. Many states have similar restrictions
on referrals by physicians. The applicability of these federal and state laws
to many business transactions in the health care industry, including those
intended by the Company, has not yet been subject to significant judicial
interpretation. To the extent that the Company or any affiliated medical
practice is deemed to be subject to Stark I or II or similar state laws, the
Company believes its intended activities will materially comply with such
statutes and regulations.
In addition, the Company also believes that the methods used to acquire the
assets of existing practices do not violate anti-kickback or anti-referral laws
and regulations. Specifically, the Company believes the consideration paid to
physicians to acquire the tangible and intangible assets associated with their
practices is consistent with fair market value in arm's-length transactions and
not intended to induce the referral of patients. Should this practice be deemed
to constitute an arrangement designed to induce the referral of
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patients, then such could be viewed as possibly violating anti-kickback and
anti-referral laws and regulations. A determination of liability under any such
laws could have a material adverse effect on the Company's revenue.
HMO and Insurance Laws. Federal and state laws regulate insurance companies,
HMOs and other managed care organizations. Generally, these laws apply to
entities that accept financial risk. There is a potential that certain risk
arrangements that may be entered into by the Company could be characterized by
some states as the business of insurance or an HMO. The Company, however,
believes that the acceptance of capitation payments by a health care provider
does not constitute the conduct of the business of insurance or of an HMO. Many
states also regulate the establishment and operation of networks of health care
providers. Generally, these laws do not apply to the hiring and contracting of
physicians by other health care providers. There can be no assurance that
regulators of the states in which the Company operates would not apply these
laws to require licensure of the Company's operations as an insurer or provider
network. The Company believes that its intended activities are and will be in
compliance with these laws in the states in which it does or intends to do
business, but there can be no assurance that interpretations of these laws by
the regulatory authorities in these states or the states in which the Company
may expand will not require licensure or a restructuring of some or all of the
Company's operations. In the event that the Company is required to become
licensed under these laws, the licensure process can be lengthy and time
consuming and, unless the regulatory authority permits the Company to continue
to operate while the licensure process is progressing, the Company could
experience a material adverse change in its business while the licensure process
is pending. In addition, many of the licensing requirements mandate strict
financial and other requirements which the Company may not immediately be able
to meet. Further, once licensed, the Company would be subject to continuing
oversight by and reporting to the respective regulatory agency.
Antitrust. As the Company expands, the Company and its affiliated medical
groups will be subject to various antitrust laws which prohibit anti-competitive
conduct, including such issues as price fixing, concerted refusal to deal and
division of markets. The company believes it is presently in compliance with
applicable law, but there can be no assurance that a regulatory review would not
result in an adverse determination or that the regulatory environment might not
change in a manner which could have a material adverse effect on the Company's
operations and its expansion strategy.
Certificate of Need. A majority of states require that providers of certain
health care services and facilities obtain a Certificate of Need ("CON") prior
to commencement of construction and/or operation. The types of facilities and
services covered by CON requirements as well as the spending threshold below
which CON statutes do not apply varies on a state-by-state basis. While the
Company's development plans presently emphasize operations in non-CON states and
several states in recent years have discontinued their CON programs altogether,
there is no assurance that some or all of these states may not at some future
time institute such programs. In addition, the Company may elect in the future
to operate in CON states. As a result, CON regulations may have an adverse
affect on the Company's expansion policy.
Accreditation. The Commission on Accreditation of Rehabilitation Facilities
("CARF") is an independent organization that reviews rehabilitation facilities
and accredits those facilities that meet its guidelines. While participation in
the CARF accreditation is currently voluntary, some states have passed
legislation requiring that certain workers' compensation treatment be provided
by CARF-accredited facilities. Currently, all of the Company's work hardening
clinics are accredited by CARF. (See Work Hardening under Item 1).
10
<PAGE>
Sales Tax. The Company does not charge or collect sales tax relating to the
services provided by the Company to the medical group it manages pursuant to a
management services agreement. The Company believes the provision of services,
as set forth in the management services agreement, does not constitute a taxable
event for sales tax purposes in any state in which the Company has operated. The
Company has not sought any judicial or administrative ruling on this issue.
Should a review of the Company's operations occur and result in a determination
contrary to the Company's position, such a determination could have a material
adverse effect on the Company's earnings and could adversely impact the
Company's expansion strategy. Sales tax statutes vary from state to state and
the Company's ability to successfully contract with medical groups in certain
states may be adversely impacted by the state sales tax environment.
Regulatory Compliance. The Company believes that regulations and statutes will
continue to change and, as a result, it regularly monitors developments in
related law. The Company expects to modify its agreements and operations from
time to time as the business, statutory and regulatory environment changes.
While the Company believes it will be able to structure all its agreements and
operations in accordance with applicable laws, there can be no assurance that
its arrangements will not be successfully challenged in the future.
ITEM 2. DESCRIPTION OF PROPERTY
The Company does not own any real property. All clinic facilities are leased at
commercial property rates for the size, location, and tenant finish included in
the lease. Clinic facilities range in size from 1,500 square feet to 11,500
square feet and all facilities are of a size and configuration and house various
types of equipment appropriate to the services rendered within the facility.
All facilities are on or near major thoroughfares serviced by public
transportation, are insured and are maintained in good operating condition.
(See Note 11, Related Party Transactions)
The Company leases approximately 8,700 square feet in Houston, Texas which
houses the Company's Houston regional office and executive offices. Prior to
the sale of the occupational medicine program in Little Rock, Arkansas, the
Company's regional office was located in approximately 1,150 square feet of
leased space adjacent to one of the Little Rock Medi-Stat clinics.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company may be subject, from time to
time, to claims and legal actions. While the Company cannot predict the outcome
of litigation actions, it is management's opinion that these matters will not
have a material impact on the Company's financial position or results of
operations. As of March 17, 1997, no actual or unasserted material claims or
actions are pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1996.
11
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
During 1996, the Company's Common Stock was principally traded on the American
Stock Exchange under the symbol "DRC". On March 12, 1997 the shareholders of
the Company voted to change the name of the Company to Integrated Orthopaedics,
Inc. Immediately following that vote the Board of Directors of the Company
voted to change the trading symbol of the Company to "IOI".
Closing Sales Price
(American Stock Exchange)
-------------------------
Low High
------- --------
1995
- ----
1st Quarter 2 1/4 3 7/8
2nd Quarter 3 1/8 4
3rd Quarter 3 1/16 6 1/8
4th Quarter 2 3/4 4 1/2
1996
- ----
1st Quarter 3 3/8 5 5/8
2nd Quarter 3 5/8 5 7/16
3rd Quarter 2 9/16 4
4th Quarter 2 15/16 5
1997
- ----
1st Quarter (through March 17, 1997) 4 5 1/8
On March 17, 1997, the Company had 129 shareholders of record. A significant
portion of the Company's common stock not held by affiliates of the Company is
held through securities depositories.
The Company has not declared or paid any dividend since it was formed. It is
the present policy of the Company not to pay cash dividends and to retain future
earnings to support the Company's growth. Any payment of cash dividends in the
future will be dependent upon the amount of funds legally available, the
Company's earnings, financial condition, capital requirements and other factors
that the Board of Directors may deem relevant. Pursuant to the terms of the
Company's Series A Cumulative Convertible Preferred Stock (the "Preferred
Stock"), no dividends can be paid on the common stock until all dividends
accrued on the Preferred Stock have been paid. Dividends on the Preferred Stock
are cumulative from the date of issuance and are payable quarterly after June
30, 1999. At December 31, 1996, the Company has accrued unpaid dividends of
$127,167 on the Preferred Stock.
12
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
RESULTS OF OPERATIONS
The following table presents revenues by category and the statement of
operations items as percentages of total revenues:
1996 1995 1994
---- ---- ----
Houston musculoskeletal-related delivery system
Medical services 22.0% 16.8% 1.5%
Ancillary services 34.2 35.9 43.2
Operations divested in 1996 43.8 45.7 55.3
Other revenue 0.0 1.6 0.0
----- ----- -----
Revenues 100.0% 100.0% 100.0%
===== ==== =====
Direct operating costs
Compensation costs and medical services 52.2% 41.8% 38.9%
Other direct costs 26.6 23.9 25.0
Selling, general and administrative 18.6 14.0 18.2
Depreciation and amortization 5.5 7.0 8.7
Provision for doubtful accounts 9.9 5.7 2.2
Net gain from restructuring (22.1) 0.0 0.0
----- ----- -----
Income from operations 9.3% 7.6% 7.0%
Interest expense (0.8) (2.0) (2.3)
Minority interest and other 0.0 .2 .3
(Provision for) income taxes (3.0) (2.4) (1.8)
----- ----- -----
Net income 5.5% 3.4% 3.2%
===== ==== =====
Year ended December 31, 1996, compared with the year ended December 31, 1995.
Revenues
Revenues declined from 1995 to 1996 by $1,226,000 (8%). Approximately $836,000
or 68% of this decrease is attributable to declining revenues in the
occupational medicine and diagnostic imaging businesses which were divested in
1996 at a reported gain of $3,272,000. Another $235,000 of this reduction is
due to the one-time inclusion in 1995 of collection fee revenue arising from an
accounts receivable collection agreement entered into in March, 1995 as one
component of the creation of the Houston medical group limited liability
partnership. The remaining decline of $155,000 relates to the medical and
ancillary services which now remain as part of the Houston musculoskeletal-
related healthcare delivery system. This decline represents less than a 2%
variance from prior year revenues.
Compensation Costs and Medical Services
Overall compensation costs and medical services increased approximately $977,000
(15%) from 42% of revenues in 1995 to 52% of revenues in 1996. Compensation
costs and medical services at the occupational medicine and diagnostic imaging
businesses which were divested in 1996 showed an immaterial change from year to
year. The remaining increase is primarily related to the physician
13
<PAGE>
compensation component of the medical and ancillary services which now remain as
part of the Houston musculoskeletal-related healthcare delivery system.
Other Direct Costs
Other direct costs increased from 1995 to 1996 by approximately $88,000 (2%)
from 24% of revenues in 1995 to 26% of revenues in 1996. Other direct costs at
the occupational medicine and diagnostic imaging businesses which were divested
in 1996 rose $15,000 (less than 1%). The other direct costs of the medical and
ancillary services which now remain as part of the Houston musculoskeletal-
related healthcare delivery system increased by $73,000 (2%).
Selling, General and Administrative
Selling, general and administrative costs rose approximately $437,000 from 14%
in revenues in 1995 to 18% of revenues in 1996. This increase is attributable
to increased salary, compensation and recruiting costs related to additional
senior management staff to support the Company's PPM strategy, to legal and
accounting costs related to the development of transaction documents for
practice affiliations, and to normal operating variances. During 1996 the
Company incurred approximately $482,000 in selling, general and administrative
expenses which were directly related to the occupational medicine business
divested in December, 1996.
Depreciation and Amortization
Depreciation and amortization expense declined approximately $304,000 in 1996.
This decline is due primarily to (i) reduced expenses arising from the sale of a
wholly-owned subsidiary which owned a magnetic resonance imaging center in
March, 1996, (ii) cost savings arising from the full amortization in 1995 of a
non-competition covenant relating to the acquisition of the occupational
medicine clinics in Little Rock, Arkansas, and (iii) the full depreciation of
certain fixed assets in 1995.
Provision for Doubtful Accounts
The Company increased its provision for doubtful accounts by approximately
$524,000 from 1995 to 1996, or about $82,000 less than the $606,000 increase
incurred in 1995. Overall, the provision for doubtful accounts rose by 4% of
revenue from 6% in 1995 to 10% in 1996. The provision for doubtful accounts
requires the Company to make an accounting estimate of amounts which may be
uncollectable in the future. The Company reviews these estimates on a regular
basis and adjusts its estimate of the provision for doubtful accounts as
indicated by that review. The increase in the provision for doubtful accounts
in 1996 is primarily attributable to increased write-offs realized in 1996
related to all medical and ancillary service components of the Houston
musculoskeletal-related healthcare delivery system plus the resultant increase
in the estimate of future write-offs which may be realized on accounts
receivable.
Minority Interest and Other
The Company reported no minority interest or other expense in 1996.
14
<PAGE>
Interest Expense
Interest expense decreased by approximately $131,000 from 1995 to 1996. This
savings is due to the reduction and retirement of notes payable and is
significantly reduced usage of the company's line of credit during 1996.
Net Gain from Restructuring
During 1996, the Company, in a strategic effort to restructure its operations
towards a single focus musculoskeletal-related physician practice management
company, divested its interests in eight occupational medicine centers , four
physical and medical therapy centers associated with the occupational medicine
centers, seven mobile health testing units operated in conjunction with the
occupational medicine programs in Houston, Texas and Little Rock, Arkansas, and
one magnetic resonance imaging ("MRI") center in Little Rock, Arkansas. The
consideration and net gain from restructuring is as follows:
Occupational Little Rock Net
Medicine MRI Gain
------------ ----------- ----------
Cash proceeds $7,773,234 $ 700,000 $8,473,234
Note receivable 156,859 156,859
Assumption of capital
leases, net 166,945 166,945
---------- ---------- ----------
Total consideration 8,097,038 700,000 8,797,038
---------- ---------- ----------
Accounts receivable, net sold 1,165,951 1,165,951
Property and equipment sold 1,195,571 804,154 1,999,725
Intangible assets, net sold 782,565 782,565
Other assets sold 16,407 16,407
Divestiture costs 1,664,689 1,664,689
---------- ---------- ----------
Net gain from restructuring $3,271,855 $ (104,154) $3,167,701
========== ========== ==========
Year ended December 31, 1995, compared with the year ended December 31, 1994
Revenues
Revenues in 1995 increased by $2,650,531 or 20.6% over 1994. The increase in
revenues was mainly due to the orthopaedic and spinal reconstruction practice.
Revenues were also higher at the other Houston medical clinics, mobile testing
service and MRI facility, and at the Little Rock occupational medicine clinics.
Revenues from other business units were flat or lower. Changes in those
revenues are generally attributable to changes in the number of patient visits.
Compensation Costs and Medical Services
Compensation costs and medical services in 1995 increased $1,484,490 or 29.6%
over 1994. This increase is due mainly to the addition of two orthopaedic
clinics to the medical group in March, 1995. The increase as a percentage of
revenues was also due principally to higher compensation costs in the
orthopaedic clinics compared to other operations.
15
<PAGE>
Other Direct Costs
Other direct costs in 1995 increased $503,545 or 15.7% over 1994, due primarily
to the addition of two orthopaedic clinics to the affiliated medical group in
March, 1995. The slight decline in these costs as a percentage of revenues is
primarily a result of the increase in orthopaedic services which generally have
less direct costs as a percentage of revenues.
Selling, General and Administrative
Selling, general and administrative expenses in 1995 decreased by $170,285, or
7.3%, from 1994 principally because expenses incurred in 1994 included $259,000
associated with the settlement of two legal proceedings. Other selling, general
and administrative expenses increased by about $88,715. As a percentage of
revenues, selling, general and administrative expenses declined to 14% from
18.2% as a result of the absolute reductions described above as well as
economies of scale.
Depreciation and Amortization
The decrease in 1995 of $26,906 is due to the full depreciation of certain older
assets in 1994.
Provision for Doubtful Accounts
In absolute amounts and as a percentage of revenue, the provision for doubtful
accounts increased in 1995 over 1994 because the allowance percentage for
orthopaedic surgery cases billed to third-party payors was higher than the
Company had experienced in the past for third-party claims. Generally, mandated
orthopaedic reimbursement rates decline per individual patient as more
procedures are performed.
Minority Interest and Other
Minority interest and other decreased by $7,584, reflecting the minority
partners' interest in the final expenses of the partnerships which were higher
in 1995 by $29,050, and a 1994 gain on the sale of an asset held for sale of
$36,634.
Interest Expense
Interest expense increased by $1,858, or less than 1%. This was due mainly to
slight increases in the prime interest rate which affects the Company's interest
on the term notes and the revolving line of credit with its major lending bank.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital at December 31, 1996 was $7,697,663 as compared to
$2,654,842 at December 31, 1995, an improvement of $5,042,821. This is due
mainly to (i) the retention of $2,347,430 in net cash proceeds from the
Company's issuance of a subordinated, convertible note on April 12, 1996 and its
subsequent conversion into 25,226 shares of cumulative, convertible preferred
stock in May, 1996, (ii) net cash proceeds of $7,773,234 from the sale of the
Company's occupational medicine and mobile health testing operations on December
31, 1996, (iii) a $1,755,443 reduction in net accounts receivable resulting from
(a) the sale of the net accounts receivable of the occupational medicine and
mobile health testing businesses and (b) the reduction of net accounts
receivable arising from the Company's increased allowance for doubtful accounts
in 1996, and (iv) a $2,926,825 increase in accounts payable, accrued
16
<PAGE>
expenses and current and deferred income taxes payable arising primarily from
the sale of the occupational medicine and mobile health testing businesses.
Personal injury accounts receivable relating to the Houston musculoskeletal-
related healthcare delivery system remaining after the sale of the occupational
medicine and mobile health testing businesses declined approximately $173,000
during 1996 due primarily to the increased reserves and allowances provided by
the Company on those accounts, resulting in a reduction in personal injury
accounts receivable as a percentage of total related net accounts receivable
from 45% at December 31, 1995 to 43% at December 31, 1996. Although currently
due, personal injury claims usually take significantly longer to collect than
claims billed to insurance carriers and employers.
On January 30, 1996, the Company amended the loan agreement with its primary
commercial bank to increase its revolving line of credit from $1,000,000 to
$2,000,000. The line of credit is secured by substantially all the assets of
the Company and its affiliated medical groups. The revolving line of credit
requires the payment of a 1% annual fee. Borrowings under the line bear
interest at prime + 1.25% and the line expires April 15, 1997. Advances under
the line of credit are subject to a borrowing base formula under which the
Company presently has sufficient collateral to support over 80% of the line
availability. The Company also received a commitment to fund up to $500,000 in
equipment purchases through April 15, 1997, at which time all amounts
outstanding under the commitment will convert to either 3- or 4- year term
notes. The line of credit, as well as other borrowings from the Company's major
lender, are subject to the terms of a loan agreement which include typical
financial ratio covenants and various other provisions. The Company believes
these credit facilities, its cash on hand and cash provided by operations will
be sufficient to provide its working capital requirements for at least the next
twelve months for its existing operations. However, to pursue its PPM growth
strategy of acquiring and developing orthopaedic practices and musculoskeletal-
related ancillary services, additional capital is required. The Company is
currently exploring a number of alternatives for additional financing, including
equity investment, additional indebtedness and strategic partnering.
During 1996, the Company significantly altered the composition of its operations
to restructure itself for expansion as a single focus musculoskeletal-related
PPM company. Toward that goal, the Company sold a wholly-owned subsidiary which
owned the MRI center in Little Rock, Arkansas on March 29, 1996, and the Company
and its affiliated medical groups divested all occupational medicine and mobile
health testing operations in Houston, Texas and Little Rock, Arkansas on
December 31, 1996.
To implement this musculoskeletal-related PPM expansion strategy, the Company
began building its corporate infrastructure during the fourth quarter of 1996.
This building process included the hiring of certain senior management and other
key management positions. The Company is presently expanding its management and
operations staff and is planning for a corporate office relocation to
accommodate this expansion. The execution and success of the Company's PPM
strategy will be dependent, in part, on its ability to attract and retain
qualified executive and management personnel in the various disciplines required
to affiliate with and to operate and develop affiliated practices into multi-
disciplinary musculoskeletal-related healthcare delivery systems.
As of December 31, 1996, the Company reported a working capital position of
$7,697,663, and held over $10,000,000 cash. It is the Company's plan to utilize
its earnings and working capital to build the management and operations
infrastructure as required to support the level of affiliation and practice
implementation projects resulting from the Company's business development
activities. The Company anticipates that the cost of building the management
and operational infrastructure necessary to implement this strategy may exceed
the Company's earnings for at least a portion of 1997.
17
<PAGE>
Item 7. Financial Statements
Index to Financial Statements - Consolidated Financial Statements of DRCA
Medical Corporation as of December 31, 1996 and 1995 and for the three years
ended December 31, 1996:
Page
Report of Independent Accountants 19
Consolidated Balance Sheet 20
Consolidated Statement of Operations 21
Consolidated Statement of Stockholders' Equity 22
Consolidated Statement of Cash Flows 23
Notes to Consolidated Financial Statements 24-33
18
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
DRCA Medical Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of DRCA Medical
Corporation and its subsidiaries at December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Houston, Texas
March 26, 1997
19
<PAGE>
DRCA MEDICAL CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS December 31,
------------------------
1996 1995
----------- ----------
CURRENT ASSETS
Cash and equivalents $10,176,947 $ 109,231
Accounts receivable, net 3,796,715 5,552,158
Income taxes receivable 82,495 404,717
Notes receivable, net 88,811 235,801
Other current assets 252,893 147,855
----------- -----------
TOTAL CURRENT ASSETS 14,397,861 6,449,762
----------- -----------
PROPERTY AND EQUIPMENT
Equipment (including equipment
under capital leases) 3,171,495 5,531,709
Leasehold improvements 316,999 437,676
Furniture and fixtures 386,979 368,962
Vehicles 108,301
----------- -----------
3,875,473 6,446,648
Less - accumulated depreciation
and amortization (3,210,788) (3,999,252)
----------- -----------
664,685 2,447,396
----------- -----------
INTANGIBLES ASSETS, NET 904,161
OTHER ASSETS 106,165 49,620
----------- -----------
TOTAL ASSETS $15,168,711 $ 9,850,939
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,271,842 $1,166,557
Accrued expenses 3,129,216 683,868
Income taxes payable 584,360
Deferred income taxes 208,168
Current obligations under capital leases 14,081 139,103
Current portion of notes payable 1,700,699 1,597,224
----------- -----------
TOTAL CURRENT LIABILITIES 6,700,198 3,794,920
----------- -----------
NOTES PAYABLE 386,231 905,890
OBLIGATIONS UNDER CAPITAL LEASES 14,426 117,504
DEFERRED INCOME TAXES 160,174 156,586
----------- -----------
TOTAL LIABILITIES 7,261,029 4,974,900
----------- -----------
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value,
10,000,000 shares authorized,
Series A, cumulative convertible,
25,226 shares issued and outstanding 252
(liquidating preference $100 per share,
aggregating $2,522,600)
Common stock, $.001 par value,
50,000,000 shares authorized,
5,302,474 and 5,301,808 issued 5,303 5,302
Additional paid-in capital 4,842,015 2,470,570
Retained earnings 3,060,128 2,400,183
Treasury shares, 15,833 shares (16) (16)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 7,907,682 4,876,039
----------- -----------
COMMITMENTS AND CONTINGENCIES
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $15,168,711 $ 9,850,939
=========== ===========
The accompanying notes are an integral part of this statement.
20
<PAGE>
DRCA MEDICAL CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
Years Ended December 31,
-----------------------------------------
1996 1995 1994
----------- ----------- -----------
REVENUES $14,313,154 $15,539,355 $12,888,824
----------- ----------- -----------
Costs and expenses:
Compensation costs and
medical services 7,471,423 6,494,792 5,010,302
Other direct costs 3,807,499 3,720,318 3,216,773
Selling, general and
administrative 2,612,645 2,175,528 2,345,813
Depreciation and amortization 790,523 1,094,386 1,121,292
Provision for doubtful accounts 1,417,485 893,316 287,270
Net gain from restructuring (3,167,701)
----------- ----------- -----------
12,931,874 14,378,340 11,981,450
----------- ----------- -----------
INCOME FROM OPERATIONS 1,381,280 1,161,015 907,374
Minority interest and other 33,654 41,238
Interest expense (170,577) (301,532) (299,674
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,210,703 893,137 648,938
Provision for income taxes (423,591) (375,423) (235,201)
----------- ----------- -----------
NET INCOME $ 787,112 $ 517,714 $ 413,737
=========== =========== ===========
Earnings per common and
equivalent share $ .12 $ .10 $ .08
=========== =========== ===========
Shares used in per
share calculations 5,456,080 5,436,558 5,278,690
=========== =========== ===========
The accompanying notes are an nintegral part of this statement.
21
<PAGE>
DRCA MEDICAL CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Amount Additional
Shares -------------------- Paid-In Retained Treasury
Common Preferred Common Preferred Capital Earnings Stock Total
---------- --------- ------ --------- ----------- -------- ------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1993 5,301,808 $ 5,302 $ $ 2,470,570 $1,468,732 $ (16) $ 3,944,588
Net Income 413,737 413,737
---------- --------- --------- --------- ----------- ---------- -------- ------------
Balance at
December 31, 1994 5,301,808 5,302 2,470,570 1,882,469 (16) 4,358,325
Net Income 517,714 517,714
---------- --------- --------- --------- ----------- ---------- -------- ------------
Balance at
December 31, 1995 5,301,808 5,302 2,470,570 2,400,183 (16) 4,876,039
Issuance cost of
Preferred Stock--
Series A (152,570) (152,570)
Issuance of Preferred
Stock--Series A 25,226 252 2,522,351 2,522,603
Dividends Preferred
Stock--Series A (127,167) (127,167)
Exercise of stock options 666 1 1,664 1,665
Net Income 787,112 787,112
---------- --------- --------- --------- ----------- ---------- -------- ------------
Balance at
December 31, 1996 5,302,474 25,226 $ 5,303 $ 252 $ 4,842,015 $3,060,128 $ (16) $ 7,907,682
========== ========= ========= ========= =========== ========== ======== ============
</TABLE>
The accompanying notes are an integral part of this statement.
22
<PAGE>
s
DRCA MEDICAL CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 787,112 $ 517,714 $ 413,737
Noncash adjustments:
Net gain from restructuring (3,167,701)
Depreciation and amortization 790,523 1,094,386 1,121,292
Minority interest (33,654) (4,604)
Deferred income taxes (283,202) 347,754 33,000
Other (36,634)
Change in assets and liabilities, excluding
acquisitions and dispositions:
Accounts receivable, net 589,492 (1,751,830) (1,470,694)
Other current assets 35,412 (27,696) (40,447)
Other assets 22,077 (3,018) 9,836
Accounts payable 105,285 97,618 134,109
Accrued expenses 653,493 339,588 108,152
Income taxes receivable/payable 906,583 (393,443) 326,202
----------- ----------- -----------
Net cash provided by operating activities 439,074 187,419 593,949
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (778,546) (132,643) (50,682)
Proceeds from restructuring 8,473,234
Net proceeds from assets held for sale 237,388
Issuance of notes receivable (58,089) (600,000)
Collections on notes receivable 205,079 403,031 8,240
----------- ----------- -----------
Net cash provided (used) by
investing activities 7,841,678 (329,612) 194,946
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Bank borrowings 3,175,000 2,066,033
Payments on bank borrowings (2,691,290) (1,780,461)
Payments on other notes, net (899,894) (408,337) (458,177)
Payments on capital lease obligations (168,550) (422,041) (384,584)
Minority interest distributions (17,712) (36,500)
Proceeds from issuance of convertible note 2,522,603
Direct costs of preferred stock issuance (152,570)
Proceeds from stock option exercises 1,665
----------- ----------- -----------
Net cash provided (used) by financing
activities 1,786,964 ( 562,518) (879,261)
----------- ----------- -----------
NET CHANGE IN CASH AND EQUIVALENTS 10,067,716 (704,711) (90,366)
CASH AND EQUIVALENTS:
BEGINNING OF YEAR 109,231 813,942 904,308
----------- ----------- -----------
END OF YEAR $10,176,947 $ 109,231 $ 813,942
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 147,973 $ 330,749 $ 306,311
Income taxes paid (recovered) (416,653) 405,000 (204,058)
Dividends accrued on preferred stock 127,167
Note payable converted to preferred stock 2,522,603
Equipment acquired under capital leases 107,396 24,065 180,415
</TABLE>
The accompanying notes are an integral part of this statement.
23
<PAGE>
DRCA MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
DRCA Medical Corporation ("DRCA" or the "Company") is a physician practice
management company specializing in the management of orthopaedic medicine
practices and other musculoskeletal-related patient services. In 1996, the
Company divested all assets not directly related to the planned expansion of its
management of musculoskeletal-related healthcare delivery systems in selected
geographic markets. The divested assets included the managed occupational
health care program previously developed by DRCA. Prior to this divestiture,
the Company operated principally in the Houston, Texas and Little Rock and North
Little Rock, Arkansas areas. After the divestiture, the Company manages a
musculoskeletal-related healthcare delivery system in Houston, Texas which
consists of orthopaedic and orthopaedics-related medical services, diagnostic
imaging, physical and occupational rehabilitation, pain management, and work
hardening. These operations provide a broad range of orthopaedic medicine and
ancillary services to diagnose, treat and rehabilitate patients with
musculoskeletal injuries and illnesses.
Effective March 12, 1997, the Company changed its legal name from DRCA Medical
Corporation to Integrated Orthopaedics, Inc.
The following is a summary of the Company's significant accounting policies:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, its
wholly-owned subsidiaries and limited partnerships in which the Company holds
majority control through its general and limited partner interests. The equity
of limited partner investors in consolidated partnerships is reported as
minority interest. The consolidated financial statements also include the
results of operations of the affiliated medical groups which the Company
effectively controls through contractual relationships. The Company believes
that it exercises perpetual and unilateral control over such entities as a
result of (i) the long term, noncancellable nature of the related management
services agreements, (ii) the nominal capital of the affiliated medical groups,
(iii) economic interdependency of operations and (iv) the Company's right to
designate the physician owners, and successors thereto, of the affiliated
medical groups. All significant intercompany transactions and balances have
been eliminated in consolidation.
Use of Estimates in the Consolidated Financial Statements
The preparation of consolidated financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, as well as the disclosures of contingent assets and
liabilities. Because of the inherent uncertainties in this process, actual
future results could differ from those expected at the reporting date.
Revenue Recognition
Revenue is recognized at the net amounts expected to be received as the related
patient care, management or related services are rendered. A substantial
portion of the Company's revenues are billed to insurance companies and other
third-party payors, and as such are subject to retrospective review and possible
reduction. Such adjustments, if any, are charged or credited to income when
they become known. Revenues related to
24
<PAGE>
DRCA MEDICAL CORPORATION
NOTES TO CONSOLIDTED FINANCIAL STAEMENTS
services provided to personal injury claimants is subject to reduction based on
the outcome of the related legal actions. A provision is made for revenues
estimated to be uncollectible.
Cash and Equivalents
For purposes of the Consolidated Statement of Cash Flows, the Company considers
all highly liquid investments purchased with original maturities of three months
or less to be cash equivalents.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization of
property and equipment, including assets under capital leases, is provided over
estimated useful lives ranging from 5 to 7 years using the straight-line method.
Expenditures for additions, renewals, and betterments are capitalized and
expenditures for repairs and maintenance are charged to expense as incurred.
Intangible Assets
Intangible assets arising from historical acquisitions, consisting principally
of noncompete agreements, patient medical records and goodwill, are amortized on
a straight-line basis over their estimated useful lives of 4 to 20 years. The
Company periodically assesses the recoverability of long-lived assets based on
their related future cash flows and provides for impairment, if any, at that
time.
Income Taxes
Deferred income taxes are provided using the liability method for the temporary
differences between the financial reporting basis and income tax basis of the
Company's assets and liabilities. Deferred income taxes are measured using the
rates expected to be in effect when the temporary differences are expected to be
included in the Company's consolidated tax return. In estimating future tax
consequences, all expected future events are considered other than enactments of
changes in the tax laws or rates.
Earnings Per Share
Computations of earnings or loss per common share are based upon the weighted-
average number of shares of common stock outstanding during the periods and the
dilutive effect of common stock equivalents of outstanding options and warrants
to purchase common stock. Fully diluted per share amounts have not been
presented since they do not differ significantly from the primary presentation.
Fair Values of Financial Instruments
Due, generally, to their short term nature and current interest rates and terms,
where applicable, the carrying value of the Company's assets and liabilities is
believed to approximate their fair values unless otherwise indicated.
NOTE 2 - REVENUE AND ACCOUNTS RECEIVABLE CONCENTRATIONS:
During 1996, the Company provided substantially all of its services through
affiliated medical groups in Texas and Arkansas which had a total of ten full-
time and numerous part-time physicians. As a result of the
25
<PAGE>
December 31, 1996 divestiture of the Company's occupational medicine business
(See Note 9), services are provided primarily in the state of Texas through one
full-time and three part-time physicians. The loss of the services of any of the
remaining physicians could have a material effect on the Company's revenues. In
1996 and 1995, the medical services provided to the medical group's patients by
William F. Donovan, M.D., a Company shareholder and director, was 15% and 16%,
respectively, of the Company's revenues. A majority of the ancillary service
revenues relating to non-divested operations also originated from patients
treated by Dr. Donovan.
In the years ended December 31, 1996, 1995 and 1994, the Company's payor mix as
a percentage of net revenues was follows: state workers' compensation
programs - 41%, 47% and 49%; direct billings to industrial clients - 20%, 22%
and 23%; personal injury claims subject to legal action -12%, 16% and 12%;
indemnity insurance; and other - 27%, 15% and 16%.
Included in net accounts receivable at December 31, 1996 and 1995 are amounts
due from patients pursuing personal injury cases of approximately $1,633,000 and
$2,396,000, respectively. Due to the nature of the judicial process, these
receivables frequently have a collection cycle which could approach two or more
years. The Company provides contractual allowances on personal injury claimant
revenues based on historical collection experience and related factors. While
the Company believes that the allowances provided are adequate, changes in the
court and public attitudes toward such claims, levels of judicial backlogs of
such claims, the quality and validity of related legal actions and other factors
can affect the ultimate amounts which will be collected. Texas continues to
experience claims backlogs in the courts; however, payment experience currently
indicates that recoverability rates do not vary significantly based on the age
of the claim. Changes in factors affecting collectibility are reflected as
revenue adjustments in the period they become known.
Accounts receivable are net of an allowance for doubtful accounts of $711,214
and $180,070 at December 31, 1996 and 1995, respectively. Substantially all the
Company's revenues are billed to third-party payors, principally insurance
companies, self-insured employers and industry insurers, and the related
receivables are generally not collateralized. Due to the numerous payors with
which the Company operates, the more significant of which are large established
entities, as well as the ongoing review conducted by the Company of the adequacy
of its allowances for doubtful accounts and contractual adjustments, additional
credit risk in accounts receivable is not believed to be significant.
NOTE 3 - INTANGIBLE ASSETS:
The intangible assets reported in 1995 related to the occupational medicine
business and were divested in conjunction with the Company's restructuring (See
Note 9). Intangible assets consist of the following at December 31, 1995:
Useful Lives
Noncompete agreements 4 - 5 $ 625,000
Patient medical records 8 - 15 774,661
Goodwill 20 372,368
----------
1,772,029
Accumulated amortization (867,868)
----------
$ 904,161
==========
Amortization expense amounted to $121,596 in 1996 and $234,096 in 1995.
26
<PAGE>
NOTE 4 - NOTES PAYABLE:
On June 5, 1996, the Company obtained a $275,000 fixed rate term loan which
bears interest at 9/15% and is payable in 36 monthly installments of $8,781.
The term loan is secured by MRI equipment.
On April 12, 1996, the Company issued a $2,500,000 subordinated note payable to
Chartwell Capital Investors, LP. The note bears interest at 10% and is
convertible into preferred stock at a conversion price of $100 per share. The
note and accumulated interest of $2,522,603 was converted into 25,226 shares of
cumulative, convertible preferred stock on May 15, 1996.
The Company's bank credit facilities are secured by substantially all assets of
the Company, its subsidiaries and affiliated medical groups. The revolving line
of credit requires the payment of a 1% annual fee. Borrowings under the line
bear interest at prime + 1.25% and the line expires April 15, 1997. Advances
under the line of credit are subject to a borrowing base formula under which the
Company presently has sufficient collateral to support approximately 80% of the
line availability. The line of credit as well as other borrowings from the
lender are subject to the terms of a loan agreement which includes financial
ratio covenants and various other provisions. The term loan is payable monthly
at $19,061 with interest at prime +1.5% and it matures in January, 1999. The
Company also received a commitment to fund up to $500,000 in equipment
purchases. Amounts advanced against this commitment will convert to term notes
with 3- and 4- year maturities as of April 15, 1997.
Notes payable consisted of the following at December 31:
1996 1995
----- -----
Bank credit facilities:
Revolving line of credit, 9.75% in 1996,
expires April 1997 $ 1,400,000 $ 858,953
Term note, 10% in 1996, payable monthly,
due January 1999 427,870 604,248
9.15% note, secured by MRI equipment,
monthly payment of $8,781, principal
and interest, due June 1999 233,498
7.75% note, secured by MRI equipment,
paid in March, 1996 727,544
10% acquisition notes, monthly payments
of $8,000 principal and interest,
remaining paid in January 1996 127,354
8.5% acquisition note, $5,221
payable monthly through January 3, 1997 25,562 64,629
Equipment notes at various rates,
paid in 1996 120,386
----------- -----------
2,086,930 2,503,114
Less current portion (1,700,699) (1,597,224)
----------- -----------
$ 386,231 $ 905,890
=========== ===========
Maturities of indebtedness are $1,700,699 in 1997, $283,509 in 1998
and $102,722 in 1999.
27
<PAGE>
NOTE 5 - INCOME TAXES:
The provisions (benefit) for income taxes for the years ended December 31 are
comprised of:
1996 1995 1994
---------- --------- ---------
Federal:
Current $ 584,360 $ 2,862 $ 151,075
Deferred (251,256) 337,138 33,000
State 90,487 35,423 51,126
---------- --------- ---------
$ 423,591 $ 375,423 $ 235,201
========== ========= =========
The difference between the effective income tax rate and the amount which would
be determined by applying the statutory U.S. income tax rate to income before
income taxes for the years ended December 31 is as follows:
1996 1995 1994
---------- --------- ---------
Provision (benefit) for income
taxes at U.S. statutory rates $ 411,639 $ 303,667 $ 220,639
State income taxes 90,487 35,423 51,126
Refund on amended returns (42,277)
Nondeductible expenses and other (78,535) 36,333 5,713
---------- --------- ---------
$ 423,591 $ 375,423 $ 235,201
========== ========= =========
Deferred income taxes at December 31
are comprised of:
1996 1995
---------- ---------
Deferred tax assets:
Accrued expenses $ 107,769 $ 21,179
Allowance for doubtful accounts 44,878 30,676
Operating loss carryforward 93,295
Depreciation 78,622
Other 6,741 6,335
---------- ---------
238,010 151,485
---------- ---------
Deferred tax liabilities:
Accrued expenses (32,602)
Amortization of intangible assets (83,869)
Depreciation (72,718)
Cash basis for certain revenues
for tax reporting (319,562) (327.050)
---------- ---------
(319,562) (516,239)
---------- ---------
Net deferred liability $ (81,552) $(364,754)
========== =========
NOTE 6 - LEASES:
The Company leases office space, clinic facilities and certain equipment under
noncancelable operating and capital leases expiring through the year 1999. Rent
expense for all noncancellable operating leases amounted to $1,060,934 in 1996,
$1,128,783 in 1995 and $1,081,542 in 1994.
28
<PAGE>
Future minimum payments by year and in the aggregate related to capital and
noncancelable operating leases at December 31, 1996 are:
Capital Operating
Leases Leases
---------- ----------
1997 $ 16,091 $ 937,774
1998 12,271 145,081
1999 4,039 86,002
---------- ----------
Total minimum lease payments 32,401 $1,168,857
==========
Amounts representing interest (3,894)
Present value of net minimum
lease payments 28,507
----------
Less current portion (14,081)
Long-term obligation $ 14,426
==========
Included in equipment are assets acquired under capital leases of $60,215 at
December 31, 1996 and $1,850,867 at December 31, 1995. Accumulated amortization
of assets under capital leases amounted to $14,498 at December 31, 1996 and
$1,349,349 at December 31, 1995. Contingent rentals based on utilization of
certain MRI equipment amounted to $1,198 in 1996, $42,201 in 1995 and $55,456 in
1994. The contingent rental obligation expired in March, 1996.
NOTE 7 - STOCK OPTIONS AND WARRANTS:
The Company has a Stock Option Plan which provides for the granting of options
at not less than market value to purchase up to 1,000,000 shares of common stock
by eligible employees of the Company. Option prices and other terms are
determined by the Board of Directors. Transactions for the years ended December
31, 1996, 1995 and 1994 for employee stock options granted under the plan are as
follows:
Weighted Average
Shares Exercise Price
--------- ----------------
Balance, December 31, 1993 319,000 $3.91
Granted 24,500 $3.13
Forfeited (103,500) $4.14
---------
Balance, December 31, 1994 240,000 $3.73
Granted 141,750 $2.56
Forfeited (40,000) $3.96
---------
Balance, December 31, 1995 341,750 $3.22
Granted 265,000 $3.49
Exercised (666) $2.50
Forfeited (10,500) $4.36
Expired (9,002) $2.94
---------
Balance, December 31, 1996 586,582 $3.33
=========
29
<PAGE>
Weighted Average
Shares Exercise Price
--------- ----------------
Exercisable at December 31, 1994 170,667 $3.88
Exercisable at December 31, 1995 321,582 $3.23
Exercisable at December 31, 1996 316,582 $3.19
The following table summarizes information about the Company's stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------- -------------------------------------
Range of Number Weighted-Average Weighted-Average Number Weighted-Average
Exercise Outstanding Remaining Exercise Exercisable Exercise
Prices at 12/31/96 Contractual Life Price at 12/31/96 Price
---------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$2.50 - 3.75 551,082 7.32 years $ 3.24 291,082 $ 3.03
$3.76 - 5.13 35,500 5.75 years $ 4.73 25,500 $ 5.02
------- -------
Total 586,582 7.23 years $ 3.33 316,582 $ 3.19
======= =======
</TABLE>
During 1995, the exercise price for a total of 142,500 options to purchase
common stock granted under the plan was reduced from $4.525 to $3.50 per share,
the market price at the repricing date. No compensation expense was recognized
with this repricing.
In February 1989, the Company issued warrants to purchase 100,000 shares of
common stock each to Jose E. Kauachi, the Company's Chairman of the Board of
Directors, President and CEO (Mr. Kauachi) and Mr. William F. Donovan, M. D.,
Director of the Company and Medical Director of the Company's affiliated medical
groups (Dr. Donovan). These warrants were issued as compensation for services
rendered and for the officers' personal guarantee of corporate debt and other
obligations. The warrant exercise price was $1.75 per share and were originally
exercisable through February 22, 1994. By amendments effective in February 1994
and 1995, the expiration dates of the warrants have been extended to February
22, 1999 and the exercise price has been adjusted to the then market value of
$2.125 per share.
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No.123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for fixed
options granted to Company employees. Had compensation cost for the Company's
stock option plan been determined based on the fair market value at grant for
awards in 1996 and 1995 consistent with the provisions of SFAS No. 123, the
Company's net income and net income per share would have been reduced to the pro
forma amounts indicated below:
1996 1995
--------- ---------
Net income - as reported $ 787,112 $ 517,714
Net income - pro forma $ 783,100 $ 405,829
Earnings per share - as reported $ .12 $ .10
Earnings per share - pro forma $ .12 $ .07
30
<PAGE>
Options granted in 1996 and 1995 had weighted average fair values of $1.95 and
$1.34, respectively. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
1996 1995
------- -------
Expected dividend yield 0% 0%
Expected stock price votability 44% 35%
Expected life 7 years 7 years
Expected risk-free interest rate 6.3% 7.5%
NOTE 8 - PREFERRED STOCK:
In May 1996, the Company's shareholders approved the amendment of its Articles
of Incorporation to authorize 10,000,000 shares of preferred stock at a par
value of $.01 per share. Pursuant thereto, the Company established 26,000
shares of cumulative convertible preferred stock ("Series A Preferred Stock").
The Series A Preferred Stock has a liquidation value of $100 per share plus
unpaid dividends and is convertible at the option of the holder into common
stock of the Company at a conversion price calculated as the liquidation value
divided by $3.50, subject to adjustment in certain events. The Company, at its
option, may require conversion of the preferred stock into common stock at any
time, provided that certain trading and pricing levels are met.
The holders of Series A Preferred Stock are entitled to receive cumulative
dividends at the rate of (i) $8.00 per share from the date of issuance to June
30, 2001, (ii) $10.00 per share for the period beginning July 1, 2001 and ending
June 30, 2002, (iii) $12.00 per share for the period beginning July 1, 2002 and
ending June 30, 2003, and (iv) $16.00 per share after July 1, 2003. Such
dividends shall be payable in preference and priority to any payment of any cash
dividend on common stock. Dividends are cumulative from the date of issuance
and are payable quarterly after June 30, 1999. At December 31, 1996 the Company
has accrued unpaid dividends on the Series A Preferred Stock of $127,167.
The Series A Preferred Stock is redeemable at the option of the Company after
June 30, 2001 at a redemption price of $100 per share plus unpaid dividends.
31
<PAGE>
NOTE 9 NET GAIN FROM RESTRUCTURING:
During 1996, the Company, in a strategic effort to restructure its operations
towards a single focus musculoskeletal-related physician practice management
company, divested its interests in eight occupational medicine centers, four
physical and medical therapy centers associated with the occupational medicine
centers, seven mobile health testing units operated in conjunction with the
occupational medicine programs in Houston, Texas and Little Rock, Arkansas, and
one magnetic resonance imaging ("MRI") center in Little Rock, Arkansas. The
consideration and net gain from restructuring is as follows:
Occupational Little Rock Net
Medicine MRI Gain
------------ ----------- -----------
Cash proceeds $ 7,773,234 $ 700,000 $ 8,473,234
Note receivable 156,859 156,859
Assumption of capital leases, net 166,945 166,945
------------ ----------- -----------
Total consideration 8,097,038 700,000 8,797,038
------------ ----------- -----------
Accounts receivable, net sold 1,165,951 1,165,951
Property and equipment sold 1,195,571 804,154 1,999,725
Intangible assets, net sold 782,565 782,565
Other assets sold 16,407 16,407
Divestiture Costs 1,664,689 1,664,689
------------ ----------- -----------
Net gain from restructuring $ 3,271,855 $ (104,154) $ 3,167,701
============ =========== ===========
The following unaudited pro forma information assumes that the sale of the
occupational medicine business occurred on January 1, 1996 and 1995,
respectively. The pro forma information does not purport to be indicative of
the results of operations that actually would have been attained if the sale had
occurred at these earlier dates or results which may occur in the future.
Year ended December 31,
-----------------------
1996 1995
--------- ---------
Revenues (in thousands) $ 8,100 $ 8,877
Net Income (in thousands) $ 1,238 $ 804
Earnings per common share:
Primary $ .20 $ .15
Assuming full dilution $ .20 $ .15
NOTE 10 - CONTINGENCIES:
The Company maintains professional liability insurance in levels it believes to
be adequate in the circumstances. In the ordinary course of its business, the
Company is subject, from time to time, to claims and legal actions, including as
a named party to professional liability claims involving medical groups and
physicians affiliated with the Company. As of March 21, 1997, management is not
aware of any material actual or unasserted claims or actions pending against the
Company.
32
<PAGE>
NOTE 11 - RELATED PARTY TRANSACTIONS:
The Company, either directly or through an affiliated medical group, paid
William F. Donovan, M.D., a Company director, and Northshore Orthopedics Assoc.
("NSO"), a professional corporation owned by Dr. Donovan, $728,731 in 1996 and
$504,878 in 1995 for Dr. Donovan's professional medical services to patients of
an affiliated medical group, medical director's fees, equipment and leasehold
rentals, and contracted services. Dr. Donovan began practicing medicine full
time with the Company's Houston affiliated medical group during 1995 and,
pursuant to such affiliation, the Company loaned NSO $500,000 for operating
expenses. The loan was collateralized by NSO's accounts receivable and was
payable as receivables were collected. Interest at 9.5% was earned by the
Company in the amount of $7,481 in 1996 and $13,792 in 1995. The balance of the
note at December 31, 1995 of $135,802 was paid off during 1996. In 1995, the
Company retained a fee for collecting NSO's receivables totaling $242,480.
There were no such fees collected from NSO during 1996.
The Company leased several office suites used for clinic and administrative
functions at prevailing market rates from Pacati, Inc., a company which is
jointly owned by Jose E. Kauachi, Chairman and Chief Executive Officer of the
Company, and Dr. Donovan. The leases were canceled in October, 1996, as a
result of Pacati, Inc.'s sale of the property to an unrelated party. The
Company paid Pacati, Inc. $160,623 in 1996, $210,099 in 1995 and $174,763 in
1994 under the rental arrangements.
Dr. Donovan purchased a medical clinic from the Company in March 1994 for
$240,000. The original cost to the Company was $190,000 and the gain on the
transaction was $36,634.
In 1996, the Company converted a $2,522,603 loan with Chartwell Capital
Investors (Chartwell) into 25,226 shares of cumulative, convertible preferred
stock. In addition, Chartwell received $30,215 in management fees relating to
investment consultations.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
This information is incorporated by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A not later than 120 days after
the end of the Company's fiscal year.
ITEM 10. EXECUTIVE COMPENSATION
This information is incorporated by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A not later than 120 days after
the end of the Company's fiscal year.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A not later than 120 days after
the end of the Company's fiscal year.
33
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated by reference to the Company's definitive proxy
statement to be filed pursuant to Regulation 14A not later than 120 days after
the end of the Company's fiscal year.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits and Index to Exhibits
Exhibit No. Exhibit Title Filed As
- ----------- -------------------------------------- --------
2.1 Stock and Asset Purchase Agreement dated
December 31, 1996 among OccuCenters, Inc.,
Occupational Health Centers of the
Southwest, P.A. and DRCA Medical Corporation,
William F. Donovan, M.D., PhysiCare, L.L.P.,
and DRCA Houston Clinics, Inc. /16/Same
3.1 Articles of Incorporation of the Company,
as amended to date. /15/Exhibit 3.1
3.2 Bylaws of the Company, as amended to date. /12/Exhibit 3.2
3.3 Articles of Merger of DRCA and Doctors
Rehabilitation Corporation of America filed
June 29, 1990. /2/Exhibit 3.3
3.4 Articles of Merger of DRCA and Doctors
Rehabilitation Corporation of America filed
July 16, 1990. /1/Exhibit 3.2
3.5 Plan and Agreement of Merger between DRCA and
Doctors Rehabilitation Corporation
of America dated May 10, 1990. /1/Exhibit 3.3
4.1 Specimen of Common Stock Certificate, $.001
par value, of the Company. /1/Exhibit 4.1
4.2 Warrant Agreement between the Company and
Jose E. Kauachi dated February 23, 1989. /3/Exhibit 4.3*
4.3 Warrant Agreement extension between the
Company and Jose E. Kauachi dated
February 22, 1994. /11/Exhibit 4.3*
4.4 Warrant Agreement Amendment between the
Company and Jose E. Kauachi dated
November 21, 1994 and effective
February 22, 1994 /12/Exhibit 4.4*
34
<PAGE>
Exhibit No. Exhibit Title Filed As
- ----------- -------------------------------------- --------
4.5 Warrant Agreement between the Company and
William F. Donovan, M.D. dated
February 23, 1989. /3/Exhibit 4.5*
4.6 Warrant Agreement extension between the Company
and William F. Donovan, M.D.
dated February 22, 1994. /11/Exhibit 4.5*
4.7 Warrant Agreement Amendment between the
Company and William F. Donovan, M.D.
dated November 21, 1994 and effective
February 22, 1994. /12/Exhibit 4.7*
4.10 Warrant Agreement between the Company and
Victor M. Rivera, M.D. dated April 26, 1992. /9/Exhibit 4.8
4.11 Second Warrant Agreement Amendment dated
February 2, 1995 between the Company and
Jose E. Kauachi /12/Exhibit 4.11*
4.12 Second Warrant Agreement Amendment dated
February 2, 1995 between the Company and
William F. Donovan, M.D. /12/Exhibit 4.12*
10.1 Guaranty Agreement dated effective
January 3, 1992 by the Company for the
benefit of Medi-Stat, Inc. /2/Exhibit 10.39
10.2 1988 Stock Option Plan of Doctors
Rehabilitation Corporation of America. /4/Exhibit 10.1*
10.3 Amendment of 1988 Stock Option Plan /10/Exhibit 10.2*
10.4 Stock Option Agreement dated
September 1, 1992 between Ray Bishop
and the Company /9/Exhibit 10.35
10.5 Management Agreement between DRCA Houston
Clinics, Inc. and Occupational Medicine
Associates of Houston, P.A. Dated effective
August 1, 1993 /11/Exhibit 10.53*
10.6 Administrative Services Agreement between
DRCA Houston Clinics, Inc. and the Company
dated effective August 1, 1993. /11/Exhibit 10.57
10.7 Option Agreement among Occupational Medicine
Associates of Houston, P.A.,
William F. Donovan, M.D., and DRCA Houston
Clinics, Inc. dated effective August 1, 1993. /11/Exhibit 10.58*
10.8 Loan Agreement dated January 30, 1995
between the Company, its subsidiaries,
affiliates and guarantors and First
Interstate Bank of Texas, N.A. /12/Exhibit 10.78
10.9 Promissory Note for $750,000 dated
January 30, 1995 between the Company
and First Interstate Bank of Texas, N.A. /12/Exhibit 10.79
35
<PAGE>
Exhibit No. Exhibit Title Filed As
- ----------- -------------------------------------- --------
10.10 Promissory Note for $1,000,000 dated
January 30, 1995 between the Company
and First Interstate Bank of Texas, N.A. /12/Exhibit 10.80
10.11 Commercial Guaranty dated January 30, 1995
between Jose E. Kauachi and First
Interstate Bank of Texas, N.A. /12/Exhibit 10.81
10.12 Commercial Guaranty dated January 30, 1995
between William F. Donovan, M.D. and
First Interstate Bank of Texas, N.A. /12/Exhibit 10.82
10.13 Commercial Guaranty dated January 30, 1995
between Sharon A. Donovan and
First Interstate Bank of Texas, N.A. /12/Exhibit 10.83
10.14 Incentive Stock Option Agreement between
the Company and William F. Donovan, M.D.
dated February 2, 1995 /12/Exhibit 10.85*
10.15 Executive Employment Agreement between
the Company and Jose E. Kauachi dated
November 15, 1994 /12/Exhibit 10.90*
10.16 Executive Employment Agreement between
the Company and Jefferson R. Casey dated
January 22, 1995 /12/Exhibit 10.91*
10.17 Management Services Agreement by and between
DRCA Houston Clinics, Inc. and PhysiCare,
L.L.P. dated effective March 1, 1995 /13/Exhibit 10.99
10.18 Equipment Lease Agreement by and between
Northshore Orthopaedics Assoc. and
DRCA Houston Clinics, Inc. dated
effective March 1, 1995 /13/Exhibit 10.100
10.19 Lease Agreement by and between
William F. Donovan, M.D. and
DRCA Houston Clinics, Inc. dated
effective March 1, 1995 /13/Exhibit 10.101
10.20 Collection Services Agreement by and
between DRCA Houston Clinics, Inc.
and Northshore Orthopaedics Assoc.
dated effective March 1, 1995 /13/Exhibit 10.102
10.21 Promissory Note for $1,000,000 by
PhysiCare, 2 L.L.P. and DRCA Houston
Clinics, Inc. dated effective March 1, 1995 /13/Exhibit 10.105
10.22 Security Agreement between PhysiCare,
L.L.P. and DRCA Houston Clinics, Inc.
dated effective March 1, 1995 /13/Exhibit 10.106
36
<PAGE>
Exhibit No. Exhibit Title Filed As
- ----------- -------------------------------------- --------
10.23 Master Transaction Agreement by and
among the Company, DRCA Houston Clinics,
Inc., Occupational Medicine Associates of
Houston, P.A., Northshore Orthopaedics
Assoc., PhysiCare, L.L.P. and
William F. Donovan, M.D. dated
effective March 1, 1995 /13/Exhibit 10.107
10.24 Professional Services Agreement Medical
Director between William F. Donovan, M.D.
and the Company dated effective
March 1, 1995 /1/3Exhibit 10.108
10.25 Amendment to Loan Agreement dated
January 30, 1995 by and among the Company,
Northshore Orthopaedics Assoc., PhysiCare,
L.L.P., and First Interstate Bank of Texas,
N.A. dated effective May 15, 1995 /13/Exhibit 10.110
10.26 Commercial Guarantee by PhysiCare, L.L.P.
to First Interstate Bank of Texas, N.A.
dated May 15, 1995 /13/Exhibit 10.111
10.27 Amendment to the Loan Agreement dated
January 30,1995 between the Company,
its Subsidiaries, affiliates and
First Interstate Bank of Texas, N.A.
effective January 30, 1996 /14/Exhibit 10.47
10.28 Promissory Note for $2,000,000 dated
January 30,1996 between the Company and
First Interstate Bank of Texas, N.A. /16/Exhibit 10.48
10.29 Promissory Note for $500,000 dated
January 30,1996 between the Company
and First Interstate Bank of Texas, N.A. /16/Exhibit 10.49
10.30 Investment Agreement by and between the
Company and Chartwell Capital Investors,
L.P. dated April 12, 1996 /16/Exhibit 10.50
10.31 Option Agreement between the Company
and Thomas M. Conner dated April 11, 1996 /16/Exhibit 10.51
10.32 Option Agreement between the Company and
Victor M. Rivera, M.D. dated April 11, 1996 /16/Exhibit 10.52
11 Calculations for Primary and Fully Diluted
earnings per share /1/7Same
21 Subsidiaries of the Company. /17/Same
23 Consent of Independent Accountant to
incorporation by reference of 1996
financial statements contained
in this Report on Form 10-KSB into
the Company's Registration Statement on
Form S-8, Registration No. 33-42624,
filed with the Securities and Exchange
Commission on September 6, 1991 /17/Same
37
<PAGE>
/1/ Incorporated by reference to the Company's Annual Report on 10-K dated
March 28, 1991 (under the exhibit number indicated in the column
titled "Filed As").
/2/ Incorporated by reference to the Company's Annual Report on 10-K dated
March 26, 1992, (under the exhibit number indicated in the column
titled "Filed As").
/3/ Incorporated by reference to Post-Effective Amendment No. 1 to the Doctors
Rehabilitation Corporation of America Registration Statement on Form S-1,
Registration No. 33-31691 (under the exhibit number indicated in the column
titled "Filed As").
/4/ Incorporated by reference to the Doctors Rehabilitation Corporation of
America Registration Statement on Form 10, Registration No. 0-17006 (under
the exhibit number indicated in the column titled "Filed As").
/5/ Incorporated by reference to the Company's Current Report on Form 8-K dated
November 1, 1990 (under the exhibit number indicated in the column titled
"Filed As").
/6/ Incorporated by reference to the Company's Form 8 dated December 31, 1990,
amending the Company's Current Report on Form 8-K dated November 1, 1990
(under the exhibit number indicated in the column titled "Filed As").
/7/ Incorporated by reference to the Company's Current Report on Form 8-K dated
January 17, 1992 (under the exhibit number indicated in the column titled
"Filed As").
/8/ Incorporated by reference to the Company's Current Report on Form 8-K dated
February 4, 1993 (under the exhibit number indicated in the column titled
"Filed As").
/9/ Incorporated by reference to the Company's Annual Report on Form 10-KSB
dated March 30, 1993, (under the exhibit number indicated in the column
titled "Filed As").
/10/Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the quarter ended 9/30/93 dated November 12, 1993 (under the exhibit
number indicated in the column titled "Filed As").
/11/Incorporated by reference to the Company's Annual Report on Form 10-KSB
dated March 30, 1994 (under the exhibit number indicated in the column
titled "Filed As").
/12/Incorporated by reference to the Company's Annual Report on Form 10-KSB
dated March 30, 1995 (under the exhibit number indicated in the column
titled "Filed As".
/13/Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the quarter ended 6/30/95 dated August 11, 1995 (under the exhibit
number indicated in the column titled "Filed As".
/14/Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the quarter ended 3/31/96 dated May 14, 1996 (under the exhibit number
indicated in the Column titled "Filed As".
/15/Incorporated by reference to the Company's Quarterly Report on Form 10-QSB
for the quarter ended 6/30/96 date August 11, 1996 (under the exhibit number
indicated in the Column titled "Filed As".
/16/Incorporated by reference to the Company's Current Report on Form 8-K dated
January 14, 1997 (under the exhibit number indicated in the column titled
"Filed As".
38
<PAGE>
/17/Filed herewith
*Management contract or compensatory plan or arrangement
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K with the Securities and Exchange
Commission during the last quarter of the fiscal year ended December 31, 1996.
39
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTEGRATED ORTHOPAEDICS, INC.
/s/ JOSE E. KAUACHI
By: ______________________________
JOSE E. KAUACHI
Chairman of the Board and
Chief Executive Officer
Dated: March 27, 1997
In Accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated:
Signature Title Date
- --------- ----- ----
/s/ JOSE E. KAUACHI Chairman of the Board March 27, 1996
By:_____________________________ and Chief Executive
JOSE E. KAUACHI Officer
/s/ RONALD R. PIERCE President and Chief March 27, 1996
By:_____________________________ Operating Officer
RONALD R. PIERCE
/s/ JEFFERSON R. CASEY Senior Vice President, March 27, 1996
By:_____________________________ (Principal Financial &
JEFFERSON R. CASEY Accounting Officer), and
Secretary
/s/ VICTOR M. RIVERA, M.D. Director March 27, 1996
By:_____________________________
VICTOR M. RIVERA, M.D.
/s/ CLIFFORD R. HINKLE Director March 27, 1996
By:_____________________________
CLIFFORD R. HINKLE
/s/ WILLIAM F. DONOVAN, M.D. Director March 27, 1996
By:_____________________________
WILLIAM F. DONOVAN, M.D.
40
<PAGE>
EXHIBIT 11
DRCA MEDICAL CORPORATION
SCHEDULE RE: EARNINGS (LOSS) PER SHARE
For the three years ended December 31, 1996
1996 1995 1994
---------- ---------- ----------
Primary
Average shares outstanding 5,286,032 5,285,975 5,269,975
Net effect of dilutive stock
options and warrants,
based on the treasury
stock method using average
market price 170,048 150,583 8,715
---------- ---------- ----------
5,456,080 5,436,558 5,278,690
========== ========== ==========
Net income (loss) $ 787,112 $ 517,714 $ 413,737
Dividends on preferred stock 127,167
----------
Income after dividends on preferred stock $ 659,945 $ 517,714 $ 413,737
---------- ---------- ----------
Earnings (loss) per share $ .12 $ .10 $ .08
========== ========== ==========
Fully diluted
Average shares outstanding 5,286,032 5,285,975 5,269,975
Net effect of dilutive stock
options and warrants, based
on the treasury stock
method using the year-end
market price, if higher
than average market price 241,865 150,583 8,715
---------- ---------- ----------
5,527,897 5,436,558 5,278,690
========== ========== ==========
Net income (loss) $ 787,112 $ 517,714 $ 413,737
Dividends on preferred stock 127,167
---------- ---------- ----------
Income after dividends on preferred stock $ 659,945 $ 517,714 $ 413,737
---------- ---------- ----------
Earnings (loss) per share $ .12 $ .10 $ .08
========== ========== ==========
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
TEXAS LIMITED PARTNERSHIPS:
Doctors' Medical Therapy Centers - Orange, Ltd.
Doctors' Medical Therapy Centers - Hemet, Ltd.
Doctors' Medical Therapy Centers - Houston II, Ltd.
Atlanta Work Hardening Dynamics - I, Ltd.
Trade Names: Work Hardening Dynamics
Work Dynamics
Spectrum Imaging Centers - Houston I, Ltd.
Trade Names: Spectrum Imaging
TEXAS CORPORATIONS:
DRCA Houston Clinics, Inc.
CALIFORNIA CORPORATIONS:
Rehabilitation Corporation of America
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-42624) of DRCA Medical Corporation of our report
dated March 26, 1997 appearing on page 19 of this Form 10-KSB.
PRICE WATERHOUSE LLP
Houston, Texas
March 26, 1997
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<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 10,176,947
<SECURITIES> 0
<RECEIVABLES> 4,507,929
<ALLOWANCES> 711,214
<INVENTORY> 0
<CURRENT-ASSETS> 14,397,861
<PP&E> 3,875,473
<DEPRECIATION> 3,210,788
<TOTAL-ASSETS> 15,168,711
<CURRENT-LIABILITIES> 6,700,198
<BONDS> 2,086,930
<COMMON> 5,303
252
0
<OTHER-SE> 7,902,127
<TOTAL-LIABILITY-AND-EQUITY> 15,168,711
<SALES> 14,313,154
<TOTAL-REVENUES> 14,313,154
<CGS> 16,099,575
<TOTAL-COSTS> 16,099,575
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,417,485
<INTEREST-EXPENSE> 170,577
<INCOME-PRETAX> 1,210,703
<INCOME-TAX> 423,591
<INCOME-CONTINUING> 787,112
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<EXTRAORDINARY> 0
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<NET-INCOME> 787,112
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