<PAGE>
As filed with the Securities and Exchange Commission on August 11, 1997
Registration No. 333-26137
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
Amendment No. 2 to
------------------
FORM S-1
REGISTRATION STATEMENT
under
THE SECURITIES ACT OF 1933
-----------------------------
PHYSICIANS QUALITY CARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 8011 04-3267297
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or Classification Code Number) Identification No.)
organization)
950 Winter Street, Suite 2410
Waltham, Massachusetts 02154
(617) 890-5560
(Address, including zip code, and telephone number,
including area code of registrant's principal executive offices)
--------------------------------------
Jerilyn P. Asher
Chief Executive Officer and Chairman of the Board
PHYSICIANS QUALITY CARE, INC.
950 Winter Street, Suite 2410
Waltham, Massachusetts 02154
(617) 890-5560
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------------
Copies to:
Thomas E. Neely, Esq.
Hale and Dorr LLP
60 State Street
Boston, Massachusetts 02109
(617) 526-6000
Approximate date of commencement of proposed
sale to the public: As promptly as practicable after
this Registration Statement becomes effective.
---------------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box: [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [_]
--------------
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [_]
--------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [_]
---------------------------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such state.
SUBJECT TO COMPLETION DATED AUGUST 11, 1997
PROSPECTUS
8,000,000 Shares
PHYSICIANS QUALITY CARE, INC.
Class A Common Stock
---------------------------------
This Prospectus relates to a total of 8,000,000 shares of Class A
Common Stock, $.01 par value per share (the "Common Stock"), of Physicians
Quality Care, Inc. ("PQC" or the "Company"). Of these shares, 4,800,000 are
being issued in connection with the merger of Clinical Associates, a Maryland
professional corporation ("Clinical Associates"), into Flagship Health P.A.
("Flagship"). For additional information regarding Clinical Associates and its
Affiliation transaction, see "Business - Clinical Associates Transaction."
3,200,000 shares of Common Stock may be offered and issued from time to time by
the Company in connection with future affiliation transactions with physician
practices (the "Affiliations") in accordance with Rule 415(a)(1)(viii) of
Regulation C under the Securities Act of 1933, as amended (the "Securities
Act"). These shares will ordinarily represent consideration paid upon the
affiliation of a physician practice with the Company. The Affiliations generally
involve the merger of a physician group into, or the sale of a physician group's
assets to, Flagship, Medical Care Partners, P.C., a Massachusetts professional
corporation ("MCP"), or another professional corporation with which PQC may
enter into a long-term management agreement, pursuant to which the physicians
receive cash and/or Class A Common Stock, $.01 par value per share (the "Class A
Common Stock"). In most instances, the physicians also enter into long-term
employment agreements with Flagship or MCP. The compensation to be received by
the physician group, and the valuation of the Common Stock, are determined based
upon arms-length negotiations between PQC and the physician group. See "Business
Affiliation Structure." The Common Stock may also include shares to be delivered
upon the exercise or satisfaction of conversion or purchase rights which were
previously created or assumed by the medical practices whose businesses or
properties become affiliated with PQC.
---------------------------------
See "Risk Factors" beginning on page 10 for a
discussion of certain factors which should be considered
by prospective investors.
---------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
August __,1997
<PAGE>
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK. NO ONE SHOULD INVEST WHO IS NOT
PREPARED TO LOSE HIS OR HER ENTIRE INVESTMENT. THERE IS NO PUBLIC MARKET FOR
THESE SECURITIES, THE SHARES WILL BE SUBJECT TO CONTRACTUAL RESTRICTIONS ON
RESALE, AND IT IS NOT EXPECTED THAT THERE WILL BE A MARKET FOR THE RESALE OF
THESE SECURITIES IN THE FORESEEABLE FUTURE.
IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF
THE COMPANY AND THE TERMS OF THE TRANSACTION DESCRIBED HEREIN, INCLUDING THE
MERITS AND RISKS INVOLVED. PROSPECTIVE INVESTORS SHOULD NOT CONSTRUE THE
CONTENTS OF THIS PROSPECTUS AS LEGAL OR INVESTMENT ADVICE. INVESTORS SHOULD
CONSULT THEIR OWN COUNSEL, ACCOUNTANTS OR BUSINESS ADVISORS AS TO LEGAL AND
RELATED MATTERS CONCERNING AN INVESTMENT IN THE SECURITIES OFFERED HEREBY.
THE COMPANY WILL MAKE AVAILABLE TO ANY PROSPECTIVE INVESTOR, PRIOR TO THE
CLOSING, THE OPPORTUNITY TO ASK QUESTIONS OF AND TO RECEIVE ANSWERS FROM THE
COMPANY CONCERNING THE TERMS AND CONDITIONS OF THE OFFERING, THE COMPANY OR ANY
OTHER RELEVANT MATTERS, AND TO OBTAIN ANY ADDITIONAL INFORMATION TO THE EXTENT
THE COMPANY POSSESSES SUCH INFORMATION OR CAN OBTAIN IT WITHOUT UNREASONABLE
EXPENSE.
BY ACCEPTING DELIVERY OF THIS PROSPECTUS, PROSPECTIVE INVESTORS RECOGNIZE AND
ACCEPT THE NEED TO CONDUCT THEIR OWN THOROUGH INVESTIGATION AND TO EXERCISE
THEIR OWN DUE DILIGENCE BEFORE CONSIDERING AN INVESTMENT IN THE COMPANY.
----------------------------------------------
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (the "Registration
Statement") under the Securities Act with respect to the shares of Common Stock
offered hereby. This Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits and schedules thereto, as
permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the shares of Common Stock offered
hereby, reference is hereby made to such Registration Statement, exhibits and
schedules. Statements contained in this Prospectus as to the contents of any
contract or other document referred to are not necessarily complete, and in each
instance reference is made to the copy of such contract or other document filed
as an exhibit to the Registration Statement, each such statement being qualified
in all respects by such reference. A copy of the Registration Statement may be
examined without charge at the offices of the Commission at 450 Fifth Street,
N.W., Washington, D.C. 20549 and at regional offices of the Commission located
at 7 World Trade Center, 13th Floor, New York, New York 10048 and Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of all or any part thereof may be obtained from the Public Reference
Section of the Commission, Washington, D.C. 20549 upon payment of the fees
prescribed by the Commission. The Commission maintains a website
(http://www.sec.gov) that contains the Registration Statement and exhibits.
----------------------------------------------
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 4
Risk Factors.............................................................. 11
Use of Proceeds........................................................... 21
Dilution.................................................................. 21
Dividend Policy........................................................... 22
Selected Financial Data................................................... 23
Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................ 26
Business.................................................................. 32
Management................................................................ 48
Certain Transactions...................................................... 53
Plan of Distribution...................................................... 54
Principal Stockholders.................................................... 55
Description of Capital Stock.............................................. 57
Shares Eligible for Future Sale........................................... 62
Legal Matters............................................................. 63
Index to Financial Statements.............................................F-1
</TABLE>
No person has been authorized in connection with the offering made
hereby to give any information or to make any representation not contained in
this Prospectus and, if given or made, such information or representation must
not be relied upon as having been authorized by the Company. This Prospectus
does not constitute an offer to sell or a solicitation of an offer to buy any of
the securities offered hereby to any person or by anyone in any jurisdiction in
which it is unlawful to make such offer or solicitation. Neither the delivery of
this Prospectus nor any sale made hereunder shall, under any circumstances,
create any implication that the information contained herein is correct as of
any date subsequent to the date hereof.
4
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Financial Statements and notes thereto appearing elsewhere
in this Prospectus, including the information under "Risk Factors."
The Company
Physicians Quality Care, Inc. ("PQC" or the "Company") provides
practice management services for multi-specialty medical practice groups. The
Company's objective is to establish networks of primary and specialty care
physicians and related diagnostic and therapeutic support services which can
provide comprehensive healthcare services in targeted geographic areas. PQC is a
development stage company that has actively managed physician practices since
August 1996. As a result of the costs associated with developing its network of
affiliated physicians, during most of which period PQC was not receiving any
revenue, PQC realized losses of approximately $2.1 million and $5 million for
the periods ending December 31, 1995 and 1996, respectively, and a loss of
approximately $1.1 million for the three month period ended March 31, 1997.
PQC was incorporated in March 1995 as a Delaware corporation. The
Company's executive offices are located at 950 Winter Street, Suite 2410,
Waltham, Massachusetts 02154 and its telephone number is (617) 890-5560.
PQC's strategy has four central elements:
. developing economies of scale in support services for physician
practices (i.e., administrative, billing and clerical staff), managed
care contracting and geographic penetration by affiliating with large
numbers of qualified physicians;
. assisting the affiliated practices in providing cost-effective
healthcare to special populations;
. building comprehensive local healthcare networks by developing
contractual or strategic relationships with providers of a full
continuum of health care services in the community; and
. improving the financial performance of affiliated physicians' practices
by seeking to maximize the value of each physician encounter.
The Company believes that this strategy will enable it to generate
increased demand for the services and capabilities of its affiliated physicians,
treat patients in lower cost settings and negotiate favorable managed care
contracts. The Company intends to achieve growth through the recruitment of
additional physicians, the expansion of managed care relationships and the
development of contractual or strategic relationships with providers of
ancillary services.
The core of PQC's proposed integrated healthcare delivery system is its
affiliation with groups of physicians who enter into long-term management
agreements with the Company. The Company assumes responsibility for non-medical
aspects of an affiliated physician's practice and focuses its efforts on
increasing revenues and improving operating margins, implementing management
information systems and negotiating managed care contracts. The physicians
remain responsible for, among other things, the medical, professional and
ethical aspects of their practices. By affiliating with the Company, physicians
have increased opportunity to access capital, continue to participate in the
profitability of their individual practices and, through stock ownership, share
a financial interest in the overall performance of the Company.
5
<PAGE>
General Affiliation Model. Although the details of each affiliation
transaction may differ, the Company has developed a general affiliation model
designed to capture the benefits of integration while preserving significant
physician autonomy (the "General Affiliation Model"). In the General Affiliation
Model, physicians initially affiliating with the Company in each geographic area
become stockholders of the Company and transfer their practices by merger or
asset sale to a newly-formed professional corporation or professional
association permitted to practice medicine under applicable law (each, an
"Affiliated Group"). These physicians, along with other physicians in that
geographic area who subsequently become part of an Affiliated Group and become
stockholders of the Company (collectively, the "Stockholder Physicians"),
execute multi-year employment agreements (each, an "Employment Agreement") with
the Affiliated Group at the time that they transfer their practice assets. The
Affiliated Group, in turn, enters into a 40-year agreement (a "Services
Agreement") with the Company pursuant to which the Company agrees to provide the
physicians in the Affiliated Group with comprehensive management services in
exchange for a fee. As consideration for transferring their practices to and
becoming employed by the Affiliated Group, Stockholder Physicians receive shares
of the Class A Common Stock and in some cases cash. The relative proportion of
the consideration to be paid in cash and Class A Common Stock is determined on
the basis of arms-length negotiations between PQC and the affiliating
physicians. In the case of affiliation transactions structured as tax-free
reorganizations, more than 50% (and in certain types of reorganizations 80%) of
the consideration must be received in Class A Common Stock. In the case of
physicians who have combined their practices into MCP, approximately $7.9
million (based upon a valuation of $2.50 per share) of the consideration has
been paid in the form of Common Stock and approximately $4.1 million in cash. In
the case of physicians who have combined their practices into Flagship,
approximately $17.1 million (based upon a valuation of $2.50 per share) of the
consideration to physicians has been paid in the form of Class A Common Stock
and approximately $2.3 million in the form of cash. Physicians who are not
stockholders of the Company may also be employed by the Affiliated Group.
The Employment Agreements with the Stockholder Physicians contain
certain restrictive covenants, including covenants relating to noncompetition,
confidentiality and nonsolicitation of employees. Each Employment Agreement
generally is terminable by the Affiliated Group with respect to any individual
Stockholder Physician upon the death or disability of such Stockholder Physician
or upon the occurrence of certain events that either interfere with the ability
of such Stockholder Physician to practice medicine or significantly diminish the
value of such Stockholder Physician's affiliation to the Affiliated Group. Each
Stockholder Physician may terminate his or her Employment Agreement under
certain circumstances, including without cause upon six months notice to the
Affiliated Group.
The two existing Affiliated Groups, Flagship and MCP, include both
primary care physicians and physicians with specialist practices and are
intended to be the only Affiliated Groups in their respective regions. At March
31, 1997, of the 98 physicians affiliated with the Company, 65 physicians have
primary care (including pediatric) practices and 33 physicians have specialist
practices. See " - Established Affiliations." PQC anticipates that future
Affiliated Groups similarly will be composed of both primary care physicians and
specialists in exclusive regions; however, the Company may pursue alternative
strategies in specific geographic regions.
Established Affiliations. The Company is in the early stages of its
development. The Company has completed affiliation transactions with (i)
thirty-nine (39) physicians in the Springfield, Massachusetts area who
transferred their practices to, and became employees of, a newly formed
Massachusetts professional corporation, MCP (the "Springfield Affiliated
Group"), which has a long-term Services Agreement with PQC and (ii) fifty-nine
(59) physicians in the greater Baltimore-Annapolis, Maryland area who
transferred their practices to, and became employees of, a newly formed Maryland
professional association, Flagship (the "Flagship Affiliated Group"), that also
has a long-term Services
6
<PAGE>
Agreement with PQC. The physicians in the Springfield Affiliated Group and
Flagship Affiliated Group remain in their pre-affiliation locations offering
their patients the continuity and convenience of decentralized offices.
Laboratory and administrative services are provided on a centralized basis,
however, thereby providing the Company with the potential for economies of scale
in purchasing and other administrative efficiencies.
The physicians in the Springfield Affiliated Group serve patients in
western Massachusetts and northern Connecticut. Twenty-four of the physicians
are engaged in primary care practices and 15 are engaged in specialist practices
including pulmonology, cardiology, oncology, infectious diseases, rheumatology
and gastroenterology. During 1996, the practices combined into the Springfield
Affiliated Group generated approximately $16.5 million in patient revenue. The
physicians in the Flagship Affiliated Group serve patients in the Baltimore-
Annapolis, Maryland area. Forty-one of the Flagship physicians are engaged in
primary care practices, including 20 physicians with pediatric practices.
Eighteen of the Flagship physicians are engaged in specialist practices,
including hematology, cardiology, oncology, infectious diseases, rheumatology,
gastroenterology and neurology. The practices combined into the Flagship
Affiliated Group generated approximately $25 million in patient revenue in 1996.
The Flagship Affiliated Group and the Springfield Affiliated Group are
structured in accordance with the General Affiliation Model, although there are
differences in the manner in which the fee earned by PQC is calculated. See
"Business -Affiliation Structure."
Clinical Associates. The Company has entered into an agreement with
Flagship, Clinical Associates and the stockholders and optionholders of Clinical
Associates pursuant to which Clinical Associates will become an affiliate of the
Company and subject to the Services Agreement between PQC and Flagship. The
Clinical Associates transaction is expected to close on June 30, 1997 or as soon
thereafter as practicable. The fifty-five stockholder and sixteen employee
physicians of Clinical Associates will become employees of the Flagship
Affiliated Group and will receive an aggregate of $3.0 million and 4,800,000
shares of the Common Stock.
The Clinical Associates transaction will add 71 physicians in the
Baltimore, Maryland area to the Flagship Affiliated Group, increasing the
Flagship Affiliated Group to 130 physicians and the total number of PQC
affiliated physicians to 169. Clinical Associates includes 29 primary care
physicians, including physicians with pediatric practices, and 42 physicians
engaged in specialist practices. Clinical Associates had patient service revenue
of approximately $36.8 million for the fiscal year ended July 31, 1996 and $26.9
million for the 9 months ended March 31, 1997. Approximately 60% of such revenue
was received under capitated contracts. The method of determining the fees of
PQC and the compensation of the Clinical Associates physicians differs from the
arrangements with respect to the current Springfield and Flagship physicians.
The Clinical Associates physicians have the right to sell back the Common Stock
to PQC at $3.00 per share if PQC has not completed a public offering within four
years of the closing of such transaction. See "Business - Clinical Associates
Transaction".
7
<PAGE>
The Offering
<TABLE>
<S> <C>
Common Stock offered by the Company............................................. 8,000,000 shares
Company Common Stock to be outstanding after this offering...................... 41,111,974 shares(1)
Use of Common Stock being offered............................................... To constitute all or a
portion of the purchase
price of the Affiliation with
Clinical Associates, and
future Affiliations. See "Use
of Proceeds."
</TABLE>
- ---------------
(1) Based upon shares outstanding on June 30, 1997, including outstanding shares
of Class A Common Stock, Class B-1 Common Stock, $.01 par value per share (the
"Class B-1 Common Stock"), Class B-2 Common Stock, $.01 par value per share (the
"Class B-2 Common Stock," and together with the Class B-1 Common Stock, the
"Class B Common Stock"), and Class C Common Stock, $.01 par value per share (the
"Class C Common Stock", and together with the Class A Common Stock and the Class
B Common Stock, the "Company Common Stock"). The number of shares to be
outstanding after the offering does not include any shares of Common Stock that
may be issued by the Company to finance its operations or cash payments in
Affiliations or shares issuable pursuant to outstanding options or warrants.
Such sources of equity financing may include certain institutional funds
affiliated with Bain Capital, Inc., ABS Capital Partners II, L.P., and Goldman,
Sachs & Co. (the "Institutional Investors") that have entered into an Amended
and Restated Class B and Class C Stock Purchase Agreement with the Company,
pursuant to which the Company sold 7,692,309 shares of Class C Common Stock to
the Institutional Investors on June 23, 1997 and the Institutional Investors
have the right to purchase up to an additional 6,153,846 shares of Class C
Common Stock at $3.25 per share. The Institutional Investors also received
warrants to purchase additional shares of Class C Common Stock. See "Business --
Equity Financing." On a fully diluted basis, assuming exercise of all
outstanding warrants and options, and the issuance of shares under certain earn-
out agreements, 61,478,167 shares of Class A, Class B and Class C Common Stock
were outstanding on June 23, 1997.
8
<PAGE>
Summary Financial Data
(in thousands, except per share data)
The following summary financial data for the Company should be read in
conjunction with the financial statements and notes thereto, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the pro forma financial statements of the Company and notes thereto, included
elsewhere in this Prospectus. The summary financial data of the Company for the
period from March 20, 1995 (inception) through December 31, 1995 and for the
year ended December 31, 1996 have been derived from financial statements of the
Company which have been audited by Ernst & Young LLP, independent auditors.
Ernst & Young LLP's report on the financial statements of the Company for the
year ended December 31, 1996 and Note 2 to such financial statements which are
included in this Prospectus describe an uncertainty about the Company's ability
to continue as a going concern. The financial data as of March 31, 1997, and for
the three months ended March 31, 1996 and 1997 are derived from unaudited
financial statements of the Company. The unaudited financial statements include
all adjustments, consisting of normal recurring accruals, which management
considers necessary for a fair presentation of the financial position and the
results of operations for these periods. Operating results for the three months
ending March 31, 1997 are not necessarily indicative of the results that may be
expected for the entire year ended December 31, 1997.
9
<PAGE>
<TABLE>
<CAPTION>
PQC
--------------------------------------------------------------------
Period from
March 20, 1995 Three months Three months
(inception) to Year Ended ended ended
December 31, December 31, March 31, March 31,
1995 1996 1996 1997
------ --------- ------ ------
<S> <C> <C> <C> <C>
Statement of Operations Data:
Net patient service revenue $ - $ 6,027 $ - $10,553
Retained by physicians - 2,195 - 3,731
Management fee revenue - 3,832 - 6,821
Nonphysician salaries and benefits - 1,816 - 3,141
Other practice expenses - 535 - 688
General corporate expenses 2,062 5,953 1,397 3,438
Depreciation and amortization 6 194 - 342
Provision for bad debts - 214 - 273
Operating income (loss) (2,068) (4,882) (1,397) (1,060)
Other, net 18 (13) (13) (27)
Income (loss) before taxes (2,050) (4,895) (1,410) (1,087)
Income taxes (benefit) 32 78 9 -
Net income (loss) $(2,082) $(4,973) $(1,419) $(1,087)
Net income (loss) per common share $ (0.27) $ (1.80) $ (0.18) $ (0.04)
Weighted average common shares and
common share equivalents outstanding 7,706 10,786 7,706 24,757
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
PQC
------------------------------------------------------
Actual Pro Forma
---------------------------- ---------------------
December 31, March 31, March 31,
1995 1996 1997 1997
------ ------ --------- ---------------------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............... $3,480 $136 $66 $25,065
Net current assets ..................... 2,651 860 (1,698) 23,302
Total assets............................ 4,363 35,484 39,360 64,360
Total current liabilities............... 850 2,776 4,964 4,964
Long-term obligations................... 1,410 1,129 1,135 1,135
Class A Common Stock, subject to put.... - 31,851 33,283 33,283
Total stockholders' equity (deficiency). $2,104 $(272) $(22) $24,978
</TABLE>
(1) The proforma balance sheet as of March 31, 1997 reflect the issuance of
7,692,309 shares of PQC Class C Common Stock for total consideration of
$25,000,000 in connection with the Equity Financing.
12
<PAGE>
RISK FACTORS
In evaluating the Company and its business, prospective investors
should carefully consider the following risk factors, in addition to the other
information contained elsewhere in this Prospectus.
Lack of Operating History; History of Operating Losses; Going Concern
Qualification in Financial Statements
The Company was formed in March 1995, the first group of physicians
affiliated with the Company in August 1996 and a majority of the current
physicians affiliated with the Company in December 1996. Accordingly, the
Company's historical financial condition and results of operations may not be
indicative of the Company's results of operations and financial condition for
future periods. For the period from March 20, 1995 (inception) to December 31,
1995, the Company recorded a net loss of $2,082,264, for the year ended December
31, 1996, the Company recorded a net loss of $4,973,188 and for the three-month
period ended March 31, 1997, the Company recorded a net loss of $1,086,817. The
Company expects to incur operating losses for at least the immediate future and
to fund such operating losses through the issuance of additional equity and debt
securities. See "-- Need for Substantial Additional Capital." There can be no
assurance that the Company will achieve or maintain profitability. The report of
Ernst & Young LLP, PQC's independent public accountants, on the Company's
financial statements for the year ended December 31, 1996, and Note 2 to such
financial statements which are included in this Prospectus, describe an
uncertainty about the Company's ability to continue as a going concern. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business."
Need for Substantial Additional Capital
The Company will require substantial capital resources to obtain the
necessary scale to become profitable and to fulfill its business plan.
Additional funds will be required to fund the acquisition, integration,
operation and expansion of affiliated practices, capital expenditures including
the development of the information systems to manage such practices, operating
losses and general corporate purposes. Through June 20, 1997, the Company has
satisfied its capital requirements through the issuance of $11.5 million of
Class B Common Stock to affiliates of Bain Capital, Inc. ("Bain Capital"),
private offerings of Class A Common Stock and a $3.5 million line of credit with
Banker's Trust Company ("Banker's Trust") as Agent, and the lenders from time to
time a party thereto (the "Credit Agreement"). On June 23, 1997, the Company
issued 7,692,309 shares of Class C Common Stock to the Institutional Investors
for an aggregate consideration of $25 million. Under the agreement with the
Institutional Investors (the "Equity Facility"), the Institutional Investors, at
their option, may purchase up to $20 million of Class C Common Stock in
addition to their rights under outstanding warrants. See "Business - Equity
Financing." The Company expects that this additional capital will be sufficient,
depending upon the Company's operating results and the consideration paid in
connection with the Affiliations, to satisfy the Company's projected capital
requirements for the next year. For the year ended December 31, 1996 and the
three-months ended March 31, 1997, net cash used by the Company in operating
activities were $5.7 million and $2.4 million respectively. If PQC continues to
incur operating losses, the Company would not be able to continue as a going
concern without access to additional sources of capital.
To date, a significant portion of the consideration paid in affiliation
transactions has been in the form of Class A Common Stock. If the percentage of
cash required to finance future affiliation transactions increases
significantly, the Company's capital requirement will also significantly
increase.
The Credit Agreement has significant financial and other conditions to
its continued availability and to avoid a default and there can be no assurance
that such conditions will be satisfied when capital is sought. The remaining
amount under the Equity Facility is only available with the consent of the
Institutional Investors. The Company's ability to meet the financial conditions
is dependent upon a significant increase in revenues and income from future
affiliation transactions and improved productivity of the Springfield and
Flagship Affiliated Groups. The Equity Facility also restricts the sources of
capital available to the Company without the consent of the Institutional
Investors. There can also be no assurance that the Company will be able to
refinance the Credit Agreement when the outstanding balance becomes due in
13
<PAGE>
January 1998. See "Business -- The Equity Financing" and "Business -- The Credit
Agreement." Except for the Credit Agreement, the Company has no committed
external sources of capital. Without the consent of the director elected by the
stockholders of the Class B-1 Common Stock (the "Class B-1 Director"), the
director elected by the stockholders of the Class B-2 Common Stock (the "Class
B-2 Director," and together with the Class B-1 Director the "Class B Directors")
and the directors elected by the holders of Class C Common Stock (the "Class C
Directors"), the Company may not obtain additional financing through external
borrowings or the issuance of additional securities. The issuance of additional
Capital Stock could have an adverse effect on the value of the shares of Common
Stock held by the then existing stockholders. There can be no assurance that the
Class B Directors and Class C Directors will approve such capital raising
activities or that the Company will be able to raise additional capital when
needed on satisfactory terms or at all. The failure to obtain additional
financing when needed and on appropriate terms could have a material adverse
effect on the Company.
Absence of Trading Market for Common Stock
No trading market for the Common Stock of the Company currently exists.
The Common Stock is not listed on a stock exchange or traded through the
National Association of Securities Dealers, Inc. There can be no assurance that
a public market in the Common Stock will develop in the future and the Company
does not expect such a market to develop until such time, if any, that the
Company completes a public offering of its securities other than to Stockholder
Physicians.
Contractual Restriction on Resale of Common Stock
The Equity Facility requires that most current and all future
stockholders of the Company become parties to a Stockholders Agreement dated as
of August 30, 1996 (the "Stockholders Agreement"), which agreement, among other
things, contains provisions which significantly limit the transferability of the
Class A Common Stock and provide the Company with a right to purchase Class A
Common Stock from Stockholder Physicians who are parties to such Stockholders
Agreement upon their termination of employment. Consequently, an investment in
the Common Stock should only be considered as a long-term investment and is
extremely illiquid. Stockholders will be required to make their own judgment as
to the value of their shares without the benefit of an independent market price.
In circumstances where the Company is entitled to repurchase the Common Stock of
a Physician Stockholder upon death or termination of the Physician Stockholder's
employment by an Affiliated Group or the right of the Physician Stockholders to
sell the Common Stock to the Company upon a Physician Stockholder's death, the
fair market value of the Common Stock, if a public market has not yet developed,
will be determined by the Board of Directors of the Company. See "Description of
Capital Stock -- Stockholders Agreement."
Risk that Future Affiliation Transactions Will Not Be Consummated; Costs of
Affiliation Transactions
There can be no assurance that the Clinical Associates transaction or
any future affiliation transactions will be consummated. There is no assurance
that the Company would be able to use the shares registered in this offering to
affiliate with additional medical practices on acceptable terms. In consummating
these future affiliation transactions, the Company will rely upon certain
representations, warranties and indemnities made by sellers with respect to the
affiliation transaction, as well as its own due diligence investigation. There
can be no assurance that such representations and warranties will be true and
correct, that the Company's due diligence will uncover all material adverse
facts relating to the operations and financial condition of the affiliated
medical practices or that all of the conditions to the Company's obligations to
consummate these future affiliations will be satisfied. Any material
misrepresentations could have a material adverse effect on the Company's
financial condition and results of operations. See "Business - Company
Strategy."
The Company has incurred significant (approximately $4.3 million during
1996) accounting, legal and other costs in developing its affiliation structure
and completing its initial affiliation transactions. The Company's ability to
enter into affiliation transactions with a significant number of physicians and
to achieve positive cash flow will be adversely affected unless it is able to
reduce the expenses associated with future
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transactions. There can be no assurance that the Company will be able to reduce
transaction costs on a per affiliated physician basis in the future.
Dependence upon Affiliated Medical Practices
Although the Company does not and will not employ physicians or control
the medical aspects of the practices of the physicians employed by the
Springfield Affiliated Group, the Flagship Affiliated Group or similar
Affiliated Groups, the Company's revenue and profitability are directly
dependent on the revenue generated by the operation and performance of and
referrals among the affiliated medical practices. The compensation to the
Company under its Services Agreements with the Affiliated Groups is based upon a
percentage of the profits or revenues generated by the Affiliated Groups'
practices with a substantial portion of the profits or revenues being allocated
to the physicians until threshold levels of income or revenues, based upon the
physicians' historical compensation or billings, are achieved. Accordingly, the
performance of affiliated physicians affects the Company's profitability and the
success of the Company depends, in part, upon an increase in net revenues from
the practice of affiliated physicians compared to historical levels. The
inability of the Company's Affiliated Groups to attract and retain patients, to
manage patient care effectively and to generate sufficient revenue or a material
decrease in the revenues of the Affiliated Groups would have a material adverse
effect on the financial performance of the Company. To the extent that the
physicians affiliated with the Company are concentrated in a limited number of
target markets, as is currently the case in western Massachusetts and Maryland,
deterioration in the economies of such markets could have a material adverse
effect upon the Company. See "Business - Company Strategy" and " - Affiliation
Structure".
Risks Related to Expansion of Operations
Integration Risks. The Company has completed in the past nine months
the initial transactions with the Springfield Affiliated Group and the Flagship
Affiliated Group, is in the process of closing the Clinical Associates
transaction, and is seeking to enter into Affiliations with additional
physicians. In the Springfield and Greater Baltimore-Annapolis areas and in
other potential affiliation markets, the Company is integrating physician
practice groups that have previously operated independently. The Company is
still in the process of integrating its affiliated practices. The Company may
encounter difficulties in integrating the operations of such physician practice
groups and the benefits expected from such affiliations may not be realized. Any
delays or unexpected costs incurred in connection with integrating such
operations could have an adverse effect on the Company's business, operating
results or financial condition.
While each Affiliation conforms to PQC's overall business plan, the
profitability, location and culture of the physician practices that have been
combined into Affiliated Groups are different in some respects. PQC's management
faces a significant challenge in its efforts to integrate and expand the
business of the Affiliated Groups. The need for management to focus upon such
integration and future Affiliations may limit resources available for the
day-to-day management of the Company's business. While management of the Company
believes that the combination of these practices will serve to strengthen the
Company, there can be no assurance that management's efforts to integrate the
operations of the Company will be successful. The profitability of the Company
is largely dependent on its ability to develop and integrate networks of
physicians from the affiliated practices, to manage and control costs and to
realize economies of scale. There can be no assurances that there will not be
substantial costs associated with such activities or that there will not be
other material adverse effects on the financial results of the Company as a
result of these integration and affiliation activities.
The Company intends to continue to pursue an aggressive growth strategy
through affiliations and internal development for the foreseeable future. The
Company's ability to pursue new growth opportunities successfully will depend on
many factors, including, among others, the Company's ability to identify
suitable growth opportunities and successfully integrate affiliated or acquired
businesses and practices. There can be no assurance that the Company will
anticipate all of the changing demands that expanding operations will impose on
its management, management information systems and physician network. Any
failure by the Company to adapt its systems and procedures to those changing
demands could have a material adverse effect on the operating results and
financial condition of the Company.
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Need to Hire and Retain Additional Physicians. The success of the
Company is dependent upon its ability to affiliate with a significant number of
qualified physicians and the willingness of such affiliated physicians to
maintain and enhance the productivity of their practices following affiliation
with PQC. The market for affiliation with physicians is highly competitive, and
the Company expects this competition to increase. The Company competes for
physician affiliations with many other entities, some of which have
substantially greater resources, greater name recognition and a longer operating
history than the Company and some of which offer alternative affiliation
strategies which the Company may not be able to offer. In addition, under
current law the Company has no or only limited ability to enforce restrictive
covenants in the employment agreements with the physicians with whom the Company
affiliates. The Company is subject to the risk that physicians who receive
affiliation payments may discontinue such affiliation with the Company,
resulting in a significant loss to the Company and a decrease in the patient
base associated with such affiliated physicians. There can be no assurance that
PQC will be able to attract and retain a sufficient number of qualified
physicians. If the Company were unable to affiliate with and retain a sufficient
number of physicians, the Company's operating results and financial condition
would be materially adversely affected. A material increase in costs of
affiliations could also adversely affect PQC and its stockholders.
Risk of Inability to Manage Expanding Operations. The Company is
seeking to expand its operations rapidly, which, if successful, will create
significant demands on the Company's administrative, operational and financial
personnel and systems. There can be no assurance that the Company's systems,
procedures, controls and staffing will be adequate to support the proposed
expansion of the Company's operations. The Company's future operating results
will substantially depend on the ability of its officers and key employees to
integrate the management of the Affiliated Groups, to implement and improve
operational, financial control and reporting systems and to manage changing
business conditions.
Dependence Upon the Growth of Numbers of Covered Lives. The Company is
also largely dependent on the continued increase in the number of covered lives
under managed care and capitated contracts. This growth may come from
affiliation with additional physicians, increased enrollment with managed care
payors currently contracting with the Affiliated Groups and additional
agreements with managed care payors. A decline in covered lives or an inability
to increase the number of covered lives under contractual arrangement with
managed care or capitated payors could have a material adverse effect on the
operating results and financial condition of the Company.
Risks of Industry Integration and Consolidation
The healthcare industry is in the process of rapid and fundamental
change, triggered by the deregulation of the acute care hospital reimbursement
system in many states and the growing strength of managed care plans. The growth
of the managed care industry is being driven, in part, by increasing pressure
from employers and other purchasers who are seeking to reduce their healthcare
premium costs. As the healthcare market in many states shifts from a heavily
regulated, largely fee-for-service payment system towards a deregulated,
capitated payment system, large integrated delivery systems are developing.
These systems are intended to provide adequate geographical coverage for major
purchasers of healthcare and to provide a system in which significant cost
savings can be realized from efficiencies resulting from the alignment of the
financial interests of physicians and other providers. Many of these integrated
systems may be substantially larger and better capitalized than the Company. In
addition, the rapidly changing alignment of numerous market participants creates
an uncertain environment in which it may be difficult for smaller market
participants, such as the Company, to implement an effective strategic plan. The
Company's inability to implement its business strategy could have a material
adverse effect on the Company. See "Business-Industry Overview" "- Competition."
Potential Regulatory Restraints Upon the Company's Operations
The healthcare industry is subject to extensive federal and state
regulation. Changes in the regulations or interpretations of existing
regulations could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Governmental
Regulations."
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Prohibition on Corporate Practice of Medicine. The laws of most states,
including Massachusetts and Maryland, prohibit business corporations such as the
Company from practicing medicine or employing physicians to do so. The
contractual relationships with the Affiliated Groups are designed to comply with
these laws. Because there is very limited judicial or regulatory interpretation
of the scope of these laws in most states, however, there can be no assurance
that the Company's contractual arrangements will be found to comply with such
laws. Any determination that such contractual relationships violate such laws
could have a material adverse effect on the Company, and there can be no
assurance that the Company would be able to restructure its arrangements on
favorable terms or at all.
The Massachusetts Board of Registration in Medicine (the "BRM") has
proposed regulations that, if promulgated as proposed, might limit physicians
licensed within the Commonwealth of Massachusetts in entering into management
contracts with proprietary business entities unless a majority of the governing
board of those business entities are licensed physicians and certain other
conditions are met. The BRM also indicated that it may seek to limit
significantly the extent to which proprietary business entities may have control
or consultation rights with respect to medical decisions or business decisions
that may affect patient care, such as the amount of time each physician spends
with a patient. Extensive commentary has been filed in opposition to the
proposed regulations, and it is not known whether, when or in what form final
regulations will be promulgated. The final regulations may have a material
adverse effect on the Company's relationship with the Springfield Affiliated
Group and its ability to operate in Massachusetts as currently contemplated.
Comparable regulations have not been proposed in Maryland, but there can be no
assurance that such regulations will not be proposed or adopted.
Stark Law. The federal law commonly known as the "Stark law"
significantly limits the ability of physicians to maintain any ownership or
other financial relationship with an entity (including their own group practice)
to which they refer patients for a broad class of "designated health services",
including ancillary services such as laboratory and radiology services. The
Stark law is extremely broad and complex, and extensive regulations have been
promulgated governing the application of the Stark law to physician
relationships with clinical laboratories. These clinical laboratory regulations
are difficult to apply to many common situations, and regulations have not yet
been issued applying the law to other designated health services. However, the
government has indicated that it will look to the regulations applicable to
clinical laboratories for guidance with respect to the law's application to
other designated health services. Significant monetary penalties and denial of
reimbursement may be assessed for violation of the Stark law, and a provider may
be excluded from the Medicare and state health programs in certain instances. In
addition, violation of the Stark law may result in assertion of a federal false
claim, which could result in civil and criminal penalties. The assertion or
determination that the Company's contractual relationship with the physicians
employed by the Affiliated Groups or the relationship of the physicians within
one or more Affiliated Groups was in violation of the Stark law could have a
material adverse effect on the Company. In addition, there can be no assurance
that, in the event of such assertion, the Company would be able to restructure
its relationships with the Affiliated Groups upon favorable terms or at all.
Fraud and Abuse Laws. Federal law and the laws of many states prohibit
the offer, payment, solicitation or receipt of any form of remuneration in
return for the referral of Medicare or state health program (such as Medicaid)
patients or in return for the purchase or order of items or services that are
covered by Medicare or state health programs. These laws are commonly referred
to as the "fraud and abuse" laws. Violations of the fraud and abuse laws may
result in substantial civil or criminal penalties for individuals or entities,
including large monetary penalties and exclusion from participation in the
Medicare and state health programs. The Company has attempted to structure its
contractual relationships with the Affiliated Groups so as to avoid violating
the fraud and abuse laws, but in view of the broad and ambiguous nature of such
laws and the lack of applicable safe harbor exceptions, there can be no
assurance that the Company's contractual relationships with the Affiliated
Groups comply with such laws. Any allegation or determination that the Company
or the Affiliated Groups have violated the fraud and abuse laws could have a
material adverse effect on the Company.
Healthcare Reform. The United States Congress has considered various
types of healthcare reform, including comprehensive revisions to the current
healthcare system. It is uncertain what legislative proposals
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will be adopted in the future, if any, or what actions federal or state
legislatures or third party payors may take in anticipation of or in response to
any healthcare reform proposals or legislation. Healthcare reform legislation
adopted by Congress could, among other things, result in lower payment levels
for the services of physicians managed by the Company and lower profitability
for the Affiliated Groups, which could have a material adverse effect on the
operations of the Company.
Insurance Laws. Laws in all states regulate the business of insurance
and the operation of health maintenance organizations ("HMOs"). Many states also
regulated the establishment and operation of networks of healthcare providers.
While these laws do not generally apply to the hiring and contracting of
physicians by other healthcare providers, there can be no assurance that
regulatory authorities of the states in which the Company operates would not
apply these laws to require licensure of the Company's operations as an insurer,
as an HMO or as a provider network.
Risks of Capitated Contracts
The physician groups with which the Company is affiliated and proposes
to affiliate are parties to certain capitated contracts with third party payors,
such as insurance companies. The Company intends to seek to expand the capitated
patient base of its Affiliated Groups, particularly for Medicare enrollees. In
general, risk contracts pay a flat dollar amount per enrollee in exchange for
the physician's obligation to provide or arrange for the provision of a broad
range of healthcare services (including in-patient care) to the enrollee. A
significant difference between a full risk capitated contract and traditional
managed care contracts is that the physician is sometimes responsible for both
professional physician services and many other healthcare services, e.g.,
hospital, laboratory, nursing home and home health. The physician is not only
the "gatekeeper" for enrollees, but is also financially at risk for
over-utilization and for the actuarial risk that certain patients may consume
significantly more healthcare resources than average for patients of similar age
and sex (such patients are referred to herein as "high risk patients").
While physicians often purchase reinsurance to cover some of the
actuarial risk associated with high risk patients, such insurance typically does
not apply with respect to the risk of over-utilization until a relatively high
level of aggregate claims has been experienced and therefore does not completely
protect against any capitation risk assumed. If over-utilization occurs with
respect to a given physician's enrollees (or the physician's panel of enrollees
includes a disproportionate share of high risk patients not covered by
reinsurance), the physician is typically penalized by failing to receive some or
all of the physician's compensation under the contract that is contingent upon
the attainment of negotiated financial targets, or the physician may be required
to reimburse the payor for excess costs. In addition, a physician may be liable
for over-utilization by other physicians in the same "risk pool" and for
utilization of ancillary, in-patient hospital and other services when the
physician has agreed contractually to manage the use of those services. Neither
the Company nor the Affiliated Groups currently maintain any reinsurance
arrangement and, to date, the Affiliated Groups have not experienced losses from
participation in risk pools or incurred any material penalties or obligations
with respect to excess costs under capitated contracts. The participation of the
Flagship Affiliated Group under capitated contracts will significantly increase
after the Clinical Associates transaction. Also, the Company is pursuing a
strategy of seeking increased participation in capitated contracts for all of
its affiliated physicians. As the percentage of the Company's revenues derived
from capitated contracts increases, the risk of the Company experiencing losses
under capitated contracts increases. As the revenues from capitated contracts
became of increasing importance to PQC and its Affiliated Groups, the Company
will review the financial attractiveness of reinsurance arrangements.
Medical providers, such as the Affiliated Groups, are experiencing
increasing pricing pressure in negotiating capitated contracts while facing
increased demands on the quality of their services. If these trends continue,
the costs of providing physician services could increase while the level of
reimbursement could grow at a lower rate or decrease. Because the Company's
financial results are dependent upon the profitability of such capitated
contracts, the Company's results will reflect the financial risk associated with
such capitated contracts. See "Business -- Industry Overview." Liabilities or
insufficient revenues under capitated and other risk-sharing arrangements could
have a material adverse effect on the Company.
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Risks of Changes in Payment for Medical Services.
The profitability of the Company may be adversely affected by Medicare
and Medicaid regulations, cost containment decisions of third party payors and
other payment factors over which PQC and its Affiliated Groups have no control.
The federal Medicare program has undergone significant legislative and
regulatory changes in the reimbursement and fraud and abuse areas, including the
adoption of the resource-based relative value scale ("RBRVS") schedule for
physician compensation under Medicare, which may have a negative impact on PQC's
revenue. Efforts to control the cost of healthcare services are increasing.
PQC's Affiliated Groups contract with provider networks, managed care
organization and other organized healthcare systems, which often provided fixed
fee schedules or capitation payment arrangements which are lower than standard
charges. Future profitability in the changing healthcare environment, with
differing methods of payment for medical services, is likely to be affected
significantly by management of healthcare costs, pricing of services and
agreements with payors. Because PQC derives its revenues from the revenues
generated by its affiliated physician groups, further reductions in payment to
physicians generally or other changes in payment for healthcare services could
have an adverse effect on the Company.
Exposure to Professional Liability; Liability Insurance
In recent years, physicians, hospitals and other participants in the
healthcare industry have become subject to an increasing number of lawsuits
alleging medical malpractice, negligent credentialing of physicians, and related
legal theories. Many of these lawsuits involve large claims and substantial
defense costs. There can be no assurance that the Company will not become
involved in such litigation in the future. Through its management of practice
locations and provision of non-physician healthcare personnel, the Company could
be named in actions involving care rendered to patients by physicians or other
practitioners employed by Affiliated Groups. In addition, to the extent that
affiliated physicians are subject to such claims, the physicians may need to
devote time to defending such claims, adversely affecting their financial
performance for the Company, and potentially having an adverse effect upon their
reputations and client base. The Company and the Affiliated Groups maintain
professional and general liability insurance, which is currently maintained at
$1 million per occurrence and $3 million annually for each affiliated physician.
Nevertheless, certain types of risks and liabilities are not covered by
insurance, and there can be no assurance that the limits of coverage will be
adequate to cover losses in all instances.
Certain Federal Income Tax Considerations
Physician groups which operated as professional corporations ("PCs") in
Springfield prior to affiliating with the Company were merged into the
Springfield Affiliated Group, with stockholders of each PC receiving shares of
Class A Common Stock of the Company and cash in exchange for their capital stock
in the PC. Physician groups which operated as professional associations ("PAs")
in the greater Baltimore-Annapolis area prior to affiliating with the Company
were similarly merged into the Flagship Affiliated Group, with stockholders of
each PA receiving shares of Class A Common Stock of the Company and cash in
exchange for their capital stock in the PA. Each such merger is intended to
qualify as a "reorganization" under Section 368(a) of the Internal Revenue Code
of 1986, as amended (the "Code"), in which case no gain or loss would generally
be recognized by the PC or PA or the stockholders (other than as cash received)
of the PC or PA. The Company has not sought or obtained a ruling from the
Internal Revenue Service or an opinion of counsel with respect to the tax
treatment of the mergers of PCs or PAs into the Springfield or Flagship
Affiliated Groups. The Company does not believe that the Internal Revenue
Service is issuing rulings at this time on transactions using the Company's
affiliation structure. If a merger were not to so qualify, the exchange of
shares would be taxable to the stockholders of the PC or PA, and the
consideration (net of asset basis) issued in connection with the merger would be
taxable to the Affiliated Group into which such PC or PA was merged. Because of
such tax liability, failure of a merger or mergers to qualify as tax-free
reorganizations could have a material adverse effect on the applicable
Affiliated Group and the Company. Also, the inability to structure future
Affiliations on a tax deferred basis may adversely affect the Company's ability
to attract additional physicians.
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New Management; Dependence on Key Personnel
The current management structure and the senior management team of the
Company have been in place for a relatively short time. The Company's future
success depends, in large part, on the continued service of Jerilyn P. Asher,
the Chief Executive Officer, and on PQC's ability to continue to attract,
motivate and retain highly qualified senior management and employees. The
Company has an employment agreement with Ms. Asher. See "Management." The
Company does not maintain key person life insurance with respect to Ms. Asher.
As a development stage company, PQC has experienced some turnover in staff,
including two of the founding officers. The Company and one of the departed
founders are currently in a dispute concerning the vesting of approximately
400,000 shares of Class A Common Stock granted to the founder and the founder's
right to severance payments of approximately $440,000. See "Business - Legal
Proceedings." Although the Company has entered into employment agreements with
certain of its other executives that contain covenants not to compete with the
Company, there can be no assurance that the Company will be able to retain such
key executives or its senior managers and employees. The inability to hire and
retain qualified personnel or the loss of the services of personnel could have a
material adverse effect upon the Company's business and future business
prospects. The Company's Compensation Committee currently only has one member.
See "Management."
Risks Related to the Equity Financing
Risk of the unavailability of the Equity Facility. The $20 million
remaining under the Equity Facility is only available with the consent of the
Institutional Investors and there can be no assurance that the Institutional
Investors will be willing to provide additional capital when needed by the
Company. The Equity Facility also restricts the sources of capital available to
the Company without the consent of the Institutional Investors. Except for the
Equity Facility, the Company has no committed external sources of capital.
Except with the consent of the director elected by the Institutional Investors,
the Company may not obtain additional financing through external borrowings or
the issuance of additional securities. The Institutional Investors also have
received warrants to purchase a substantial number of shares of Class A Common
Stock. These warrants are exercisable at $2.50 or $3.25 per share, which
exercise price may be substantially below the fair market value of the Class A
Common Stock at the time of exercise. Any additional equity issuance could have
an adverse effect on the value of the shares of Class A Common Stock held by the
then existing stockholders. See "Business - Equity Financing."
Voting Control by Institutional Investors. Pursuant to the Company's
Restated Certificate of Incorporation (the "Restated Certificate") and the
Stockholders Agreement, the Institutional Investors have the right to appoint
the Class B and C Directors, four of the thirteen members (with one position to
remain vacant until such time as the remaining amount to be purchased by
affiliates of Goldman, Sachs & Co. under the Equity Facility is drawn down) of
the Board of Directors of the Company and the Institutional Investors have the
right to approve seven of the other directors. The Class B and C Directors are
entitled to five votes each, giving them a majority of the voting power of the
Board of Directors, (i) with respect to certain actions of the Company,
including public offerings, issuances and redemptions of equity securities,
declarations of dividends, incurrences of debt, mergers, assets sales and
liquidation of the Company and its affiliates, material amendments to the
management agreements between the Company and its affiliates and employment of
the Chief Executive Officer, and (ii) with respect to any matter before the
Board of Directors upon the occurrence of certain events, including the failure
of the Company to meet certain financial objectives. In addition to being
approved by the Board of Directors, certain actions of the Company, including
mergers, material asset sales, liquidation, certain medical practice affiliation
transactions, dividends, material changes in the business of the Company or its
affiliates, retention and dismissal of the Chief Operating and Financial
Officers, transactions with affiliates and commencement and management of
material litigation, must be approved by the Institutional Investors. See
"Business--Equity Financing" and "Description of Capital Stock." As a result of
those provisions of the Restated Certificate and "drag-along" rights in the
Stockholders Agreement, the Institutional Investors have significant control
over the actions of the Company including if and when the Company is sold to a
third party or a public market for the Company Common Stock is established.
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Risks from Put and Other Rights Held by Certain Stockholders.
Each physician and management stockholder who is a party to the
Stockholders Agreement, dated as of August 30, 1996, has the right to require
PQC to purchase the Common Stock owned by such stockholder at fair market value
upon their death or disability. Pursuant to the Stockholders Agreement, fair
market value, as determined by the Board of Directors, reflects an arms-length
private sale. In determining the fair market value, the Board is to consider
recent arms-length sales by the Company and the stockholders, as well as other
factors considered relevant. The put option is only triggered by death or
disability (and in a few instances retirement) and will terminate upon the
completion of a public offering which results in at least $50.0 million in gross
revenues to the Company and which meets certain other criteria. To the extent
that the "put options" are likely to be exercised, the Company expects to fund
such repurchases from working capital, the Equity Facility or other sources. If
the Clinical Associates transaction is completed, the physician affiliated with
Clinical Associates will have the right to require the Company to repurchase
their Common Stock at $3.00 per share (in the form of a five year, non-interest
bearing note) in the event that the Company has not completed an initial public
offering with four years. The exercise of such right could have a material
adverse effect upon the Company.
Immediate and Substantial Dilution
Persons receiving shares of Class A Common Stock of the Company in the
expected transaction with Clinical Associates will incur an immediate and
substantial dilution of approximately 97.7% of their investment in such shares
because the net tangible book value of the Company Common Stock after such
transaction would be approximately $.07 per share as compared with the
anticipated $3.00 per share valuation of the Class A Common Stock in such
transactions. In addition, assuming the exercise of the repurchase rights
described above in determining such per-share dilution, recipients of such
shares, would incur immediate and substantial dilution of approximately 331% of
their investments in such shares because the net tangible book value of the
Company Common Stock after such transaction would be approximately $(6.94) per
share as compared with the anticipated $3.00 per share valuation of the Class A
Common Stock in such transaction. See "Dilution".
The Company expects to continue to issue Class A Common Stock as a
principal component of the consideration for future affiliation transactions. To
the extent that all or a portion of future affiliation transactions are paid in
cash, the Company may need to issue additional equity securities to fund such
payment or to fund anticipated operating losses. If the Company achieves its
goal of affiliating with a significant number of physicians, the number of
shares issued may be substantial, resulting in further dilution to the
stockholders of the Company at that time of any such affiliation.
Conflicts of Interest
Certain conflicts of interest are inherent in the structure of the
Company and its contractual and organizational relationships. The President of
the Springfield Affiliated Group (who is also a director of the Company) is a
practicing physician in the Springfield Affiliated Group, the president of the
Flagship Affiliated Group is a practicing physician in the Flagship Affiliated
Group and two directors of the Company, one of whom is also President of the
Company, are practicing physicians in the Flagship Affiliated Group. Four
directors of the Company are appointed by the Institutional Investors which are
the primary financing source for the Company. From time to time, the interests
of such persons, and persons serving in multiple roles in existing and future
affiliation transactions, may conflict with those of the Company due to such
relationships. The Company seeks to minimize or avoid such conflicts of interest
through contractual arrangements with the Affiliated Group that clearly specify
the responsibilities of PQC and the physicians in the Affiliated Groups, dispute
resolution structures, such as the Joint Policy Boards established with respect
to each Affiliated Group, at which certain issues are required to be addressed,
contractual arrangements with the Institutional Investors and the careful
selection of the individuals who occupy such multiple roles. See also "-- Voting
Control" and "Certain Transactions."
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Antitrust Considerations
The Company, its affiliated physicians and other entities with which it
contracts are subject to the United States and state antitrust statutes. Because
the Company will be contracting with third party payors and other entities who
could be deemed to compete with the Company or its Affiliated Groups, and for
other reasons, the Company, its affiliated physicians and other entities with
which it contracts could be subject to public and private investigations and
enforcement actions under such statutes. The Company believes that, given its
small size relative to its competitors and the overall market for physician
services, it is currently in compliance with applicable federal and state
anti-trust laws. However, as the Company and its Affiliated Groups increase in
size, particularly within specific markets, federal and state anti-trust laws
may act as a practical constraint upon the Company's expansion and operations.
Amortization of Intangible Assets
In connection with its Affiliations, the Company has recorded, and is
expected to continue to record, a significant amount of intangible assets as the
consideration paid to physicians exceeds the value of the practice assets. At
March 31, 1997, the Company had intangible assets of approximately $30.4 million
reflected on its balance sheet as long-term affiliation agreements. The Company
amortizes such intangible assets over a 30 year period. See the Notes to the
Company's Financial Statements. The amortization of these intangible assets,
while not affecting the Company's cash flow, has an ongoing negative impact upon
the Company's earnings. During the three month period ended March 31, 1997,
amortization of intangible assets contributed $169,835 to the Company's net loss
of $1,086,817. See "Managements' Discussion and Analysis of Financial Condition
and Results of Operations."
Competition
The business of providing healthcare related services is highly
competitive. Many companies, including professionally managed physician practice
management companies like the Company, have been organized to pursue the
acquisition of medical clinics, manage such clinics, employ clinic physicians or
provide services to IPAs. Large hospitals, other multi-speciality clinics and
other healthcare companies, HMOs and insurance companies are also involved in
activities similar to those of PQC. Some of these competitors have longer
operating histories and significantly greater resources than PQC. There can be
no assurance that PQC will be able to compete effectively, that additional
competitors will not enter the market, or that such competition will not make it
more difficult to acquire the assets of multi-speciality clinics on terms
beneficial to PQC. See "Business - Competition."
Risks Related to Penny Stock
Since the value of the Common Stock is $3.00 per share it may be
considered "penny stock." Penny stocks are low-priced shares of companies not
traded on an exchange or quoted on Nasdaq. Prices are often not available and
investors in penny stock are often unable to sell the Company's stock once they
purchase it.
Forward-Looking Statements
Certain statements made in this Prospectus are forward-looking,
including without limitation statements with respect to the future affiliations,
capital requirements, future plans for expansion and future success of the
Company, and future development of the healthcare industry. Forward-looking
statements made herein are not guarantees of future performance and are subject
to risks and uncertainties, including without limitation the factors discussed
in this "Risk Factors" section, that could cause actual results to differ
materially from those described in the forward-looking statements.
22
<PAGE>
USE OF PROCEEDS
In exchange for the Common Stock (and other consideration in certain
cases), PQC expects that its Affiliated Groups will receive certain assets of or
ownership interests in physician practices, as well as certain contractual
rights.
Of the 8,000,000 shares of Common Stock covered by this Prospectus,
4,800,000 are being issued as partial consideration for the Clinical Associates
transaction. See "Business - Clinical Associates Transaction". The remaining
3,200,000 shares of Common Stock covered by the Prospectus may be issued in
future Affiliations.
<TABLE>
<CAPTION>
Shares Value* %
<S> <C> <C> <C>
Clinical Associates 4,800,000 $14,400,000 60%
Future Affiliations 3,200,000 $ 9,600,000 40%
--------- ----------- ----
Total 8,000,000 $24,000,000 100%
*Assumes a value of $3.00 per share.
</TABLE>
For a discussion of the factors that the Company considers in selecting
medical groups with which to affiliate, see "Business - Company Strategy" and
"Business - Affiliation Structures."
DILUTION
The difference between the $3.00 per share valuation of the Company's
Class A Common Stock in the Clinical Associates transaction (the "Clinical
Transaction") and the pro forma net tangible book value per share of the Company
Common Stock after such transaction constitutes the dilution per share to
recipients of the Company's Class A Common Stock in the Clinical Transaction.
Net tangible book value per share is determined by dividing the net tangible
book value (total tangible assets less total liabilities) by the number of
outstanding shares of Company Common Stock. Because the number of shares
outstanding, the total liabilities of the Company and the net tangible book
value, and resulting dilution, per share of Company Common Stock all vary
significantly depending on whether certain repurchase rights discussed in
"Description of Capital Stock" are exercised by the Company's existing
stockholders, the following discussions of dilution assume, in turn, the
exercise and lack of exercise of such repurchase rights.
Dilution Assuming the Exercise of Repurchase Rights. Assuming the
exercise by stockholders of the Company of the repurchase rights described above
and based on the resulting 11,358,615 shares of Company Common Stock
outstanding, as of March 31, 1997, the Company had a pro forma net tangible book
value of $(34,478,244), or $(3.04) per share of Company Common Stock. After
giving effect to the issuance of 4,800,000 shares of Class A Common Stock in the
Clinical Transaction at a valuation of $3.00 per share and the issuance of
600,000 shares of Class B Common Stock on April 18, 1997, the pro forma book
value of the Company at March 31, 1997 would have been $(49,563,695), or
approximately $(7.56) per share of Company Common Stock. This represents an
immediate decrease in net tangible book value of approximately $4.52 per share
to existing shareholders and an immediate dilution of approximately $10.56 per
share or approximately 352% to recipients of Class A Common Stock in the
Clinical Transaction.
The following table illustrates the dilution per share of Company
Common Stock resulting from the Clinical Transaction, assuming the exercise of
the repurchase rights and without giving effect to the operating results of the
Company subsequent to March 31, 1997.
<TABLE>
<S> <C> <C>
Valuation of Class A Common Stock in Clinical Transaction............... $ 3.00
------
Pro forma net tangible book value before Clinical Transaction.........$(3.04)
-------
Decrease attributable to Clinical Transaction......................... (4.52)
-------
Pro forma net tangible book value after Clinical Transaction............ (7.56)
------
Dilution to recipients of Class A Common Stock in Clinical Transaction.. $10.56
------
</TABLE>
Dilution Assuming No Exercise of Repurchase Rights. Assuming no
exercise of the repurchase rights and based on the resulting 24,671,615 shares
of Company Common Stock outstanding, as of March 31, 1997, the Company had a pro
forma net tangible book value of $(1,195,538), or $(.05) per share of Company
common Stock. After giving effect to the issuance of 4,800,000 shares of Class A
Common Stock in the Clinical Transaction at a valuation of $3.00 per share and
the issuance of 600,000 shares of Class B Common Stock on April 18, 1997, the
pro forma book value of the Company at March 31, 1997 would have been
$(1,880,989), or approximately $(.06) per share of Company Common Stock. This
represents an immediate decrease in net tangible book value of $.01 per share to
existing shareholders and an immediate dilution of approximately $2.99 per share
or approximately 99.7% to recipients of Class A Common Stock in the Clinical
Transaction.
The following table illustrates the dilution per share of Company
Common Stock resulting from the Clinical Transaction, assuming no exercise of
the repurchase rights and without giving effect to the operating results of the
Company subsequent to March 31, 1997.
<TABLE>
<S> <C> <C>
Valuation of Class A Common Stock in Clinical Transaction............... $3.00
------
Pro forma net tangible book value before Clinical Transaction.........$ (.05)
-------
Decrease attributable to Clinical Transaction......................... (.06)
-------
Pro forma net tangible book value after Clinical Transaction............ (.01)
------
Dilution to recipients of Class A Common Stock in Clinical Transaction.. $2.99
------
</TABLE>
The following table summarizes the number of shares of Class A Common
Stock issued by the Company in the Clinical Transaction, such shares as a
percentage of outstanding Company Common Stock, the aggregate valuation of such
shares, such valuation as a percentage of consideration received by the Company
for shares of Company Common Stock, the average price per share paid by the
Company's existing shareholders and the per-share valuation of Class A Common
Stock in the Clinical Transaction. This table assumes no exercise of the
repurchase rights described above.
<TABLE>
<CAPTION>
Shares Issued Total Consideration Price/
--------------------- -------------------------- Valuation
Number Percent Amount Percent Per Share
---------- --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C>
Existing Stockholders(1).. 24,671,615 83.7% $44,782,485 75.7% $1.82
New Investors............. 4,800,000 16.3% $14,400,000 24.3% $3.00
Total................... 29,471,615 100% $59,182,485 100.0%
(1) Includes the 600,000 shares of Class B Common Stock issued on April 18,
1997.
</TABLE>
Jerilyn Asher, the Chief Executive Officer, Arlan Fuller, M.D., a
director, and Jay Greenberg, a former Executive Vice President of the Company,
received restricted stock grants of 4,162,500, 618,750 and 1,012,500 shares,
of Class A Common Stock respectively, in connection with the formation of the
Company and their employment agreements. Such stock is subject to vesting and
partial forfeiture in certain circumstances, including termination of employment
with the Company. The purchase price of the restricted stock was $0.01 per
share. Officers and employees of the Company have also received, as of March 31,
1997, options to purchase an aggregate of 574,836 shares of Class A Common Stock
at a weighted average exercise price of $0.49 per share. Other non-employees
hold additional options to purchase 17,500 shares of Class A Common Stock with
an exercise price of $0.85 per share. All other options or shares of the
Company's outstanding Class A and Class B Common Stock were issued at prices
between $2.40 and $2.50 per share. In addition, the Institutional Investors have
the right to purchase an additional 6,153,876 shares of Class C Common Stock
(and in connection with such purchase to receive warrants to purchase an
additional 6,153,846 shares of Class C Common Stock) at a purchase price of
$3.25 per share and there are warrants to purchase 6,415,000 shares of Class B
Common Stock at $2.50 per share and 7,692,309 shares of Class C Common Stock at
$3.25 per share outstanding. Since there is no public market for the Class A
Common Stock, future issuance of the Company Common Stock (except for shares
issued pursuant to the Equity Facility and related warrants which provided for
the purchase of shares, subject to adjustment to prevent dilution, of $3.25 per
share) will be issued at prices negotiated with physicians affiliating with the
Company and determined to reflect fair value at the time of issuance by the
Board of Directors. Any such future issuances or exercises of the rights
described above would result in further dilution to recipients of Class A Common
Stock of the Company in the Clinical Transaction.
23
<PAGE>
DIVIDEND POLICY
PQC has not declared or paid any dividends on the Company Common Stock
and does not anticipate paying cash dividends in the foreseeable future. The
terms of the Equity Facility restrict the payment of dividends. It is the
present intention of the Board of Directors to reinvest any earnings in the
business of the Company to support growth of its operations.
24
<PAGE>
Selected Financial Data
(in thousands, except per share data)
The following selected financial data for the Company should be read in
conjunction with the financial statements and notes thereto, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the pro forma financial statements of the Company and the notes thereto,
included elsewhere in this Prospectus. The selected financial data of the
Company for the period from March 20, 1995 (inception) through December 31, 1995
and for the year ended December 31, 1996, have been derived from financial
statements of the Company which have been audited by Ernst & Young LLP,
independent auditors. Ernst & Young LLP's report on the financial statements of
the Company for the year ended December 31, 1996 and Note 2 to such financial
statements which are included in this Prospectus describe an uncertainty about
the Company's ability to continue as a going concern. The financial data as of
March 31, 1997, and for the three months ended March 31, 1996 and 1997 are
derived from unaudited financial statements of the Company. The unaudited
financial statements include all adjustments, consisting of normal recurring
accruals, which management considers necessary for a fair presentation of the
financial position and the results of operations for these periods. Operating
results for the three months ending March 31, 1997 are not necessarily
indicative of the results that may be expected for the entire year ended
December 31, 1997.
25
<PAGE>
<TABLE>
<CAPTION>
PQC
---------------------------------------------------------------
Period from
March 20, 1995 Three months Three months
(inception) to Year ended ended ended
December 31, December 31, March 31, March 31,
1995 1996 1996 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
Statement of Operating Data:
Net patient service revenue........ $ - $ 6,027 $ - $10,553
Retained by physicians............. - 2,195 - 3,731
Management fee revenue............. - 3,832 - 6,821
Nonphysician salaries and benefits. - 1,816 - 3,141
Other practice expenses............ - 535 - 688
General corporate expenses......... 2,062 5,953 1,397 3,438
Depreciation and amortization...... 6 194 - 342
Provision for bad debts............ - 214 - 273
Operating income (loss)............ (2,068) (4,882) (1,397) (1,060)
Other, net......................... 18 (13) (13) (27)
Income (loss) before taxes......... (2,050) (4,895) (1,410) (1,087)
Income taxes (benefit)............. 32 78 9 -
Net income (loss).................. $(2,082) $(4,973) (1,419) (1,087)
Net income (loss) per common share. $ (0.27) $ (1.80) $(0.18) $(0.04)
Weighted average common shares and
common share equivalents
outstanding....................... 7,706 10,786 7,706 24,757
</TABLE>
<PAGE>
<TABLE>
<CAPTION> PQC
------------------------------------------------------
Actual Pro Forma
---------------------------- ---------------------
December 31, March 31, March 31,
1995 1996 1997 1997
------ ------ --------- ---------------------
<S> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents............... $3,480 $136 $66 $25,065
Net current assets ..................... 2,651 860 (1,698) 23,302
Total assets............................ 4,363 35,484 39,360 64,360
Total current liabilities............... 850 2,776 4,964 4,964
Long-term obligations................... 1,410 1,129 1,135 1,135
Class A Common Stock, subject to put.... - 31,851 33,283 33,283
Total stockholders' equity (deficiency). $2,104 $(272) $(22) $24,978
</TABLE>
(1) The proforma balance sheet as of March 31, 1997 reflect the issuance of
7,692,309 shares of PQC Class C Common Stock for total consideration of
$25,000,000 in connection with the Equity Financing.
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Financial Data" and the Company's Financial Statements and Notes thereto
included elsewhere in this Prospectus.
Overview
The Company affiliates with and operates multi-specialty medical
practice groups. The first physician affiliation took place on August 30, 1996,
with 32 physicians in the Springfield, Massachusetts and Enfield, Connecticut
area. On December 11, 1996, PQC consummated the affiliation with the Flagship
Affiliated Group, which consisted of 59 physicians in Baltimore and Annapolis,
Maryland. PQC is working with these groups of physicians to improve operating
practices and to obtain managed care contracts.
On June 23, 1997, the Company issued 7,692,309 share of Class C Common
Stock for an aggregate consideration of $25 million. See "Business - Equity
Financing."
Results of Operations
The Company's Fee under Service Agreements. Pursuant to the Services
Agreement between PQC and the Springfield Affiliated Group, all amounts
allocated to the Springfield Affiliated Group under the employment agreements
with those physicians in any fiscal year are remitted to the Company. Under the
employment agreements with the twenty-nine Springfield Stockholder Physicians,
revenues from patient care remaining after payment of operating expenses,
including expenses of the Springfield Affiliated Group, ("Gross Margin") are
allocated first between the Springfield Affiliated Group's Compensation Pool
(the "Springfield Compensation Pool") and the Springfield Affiliated Group in a
95%/5% proportion until 95% of the base compensation of the Springfield
Stockholder Physicians is achieved, then to payment of certain other expenses
incurred with respect to the Springfield practices, and then 80% to the
Springfield Affiliated Group and 20% to the Springfield Compensation Pool until
the Springfield Affiliated Group has been allocated $1.5 million, with any
remaining Gross Margin being divided evenly between the Springfield Affiliated
Group and the Springfield Compensation Pool. Under the employment agreements
with the Springfield Stockholder Physicians who subsequently affiliated with the
Springfield Affiliate Group any Gross Margin attributable to these physicians
are allocated between the Springfield Compensation Pool and the Springfield
Affiliated Group in a 80%/20% proportion until the physicians receive 80% of
their base compensation, and then to payment of certain other expenses incurred
with respect to the Springfield practices, with any remaining Gross Margin being
divided evenly between the Springfield Compensation Pool and the Springfield
Affiliated Group. The base compensation of the Springfield Stockholder
Physicians is $6.7 million.
Pursuant to the Services Agreement between PQC and the Flagship
Affiliated Group and the employment agreements with the Flagship Stockholder
Physicians, revenues from patient services remaining after payment of
third-party operating expenses ("Net Margin") is allocated between the Flagship
Stockholder Physicians' Compensation Pool (the "Flagship Compensation Pool") and
reimbursement of the Company's direct expenses relating to the Flagship
Affiliated Group, based on a ratio of such budgeted compensation to such
budgeted expenses. Once both the Company's direct expenses and the aggregate
base physician compensation have been fully satisfied, any remaining Net Margin
will be divided evenly between the Company and the Flagship Compensation Pool.
The base compensation of the Flagship physicians is $8.15 million.
29
<PAGE>
For further information regarding the contractual arrangements between
PQC and its Affiliated Groups, see "Business - Affiliation Structure."
Under the foregoing contractual arrangements, the Company can improve
its management fee revenues by increasing the patient care revenue of its
Affiliated Groups, whether through improved billing and operating efficiency,
additional patient encounters or increased capitated revenues, and controlling
the expenses of Affiliated Groups. To the extent that patient revenue increases
at a greater rate than practice expenses, PQC's management fee will increase.
Conversely, if PQC is not able to control practice expenses or assist the
Affiliated Groups in increasing patient care revenue, PQC will earn no or only a
limited management fee. Under the proposed arrangements with Clinical
Associates, PQC will earn a fee based, in part, upon increases in billings, net
of bad debts and discounts, above historical levels, and a reduction in the
percentage of revenue needed to pay practice expenses. While this structure
causes PQC's management fee not to be as dependent upon controlling practice
expenses, PQC believes that both increased revenues and controlling costs will
continue to be important factors to its management fee growth as increased
billings depend upon affiliated physicians being motivated by competitive levels
of compensation.
The Company's and its Affiliated Groups' revenues are derived from
governmental programs, managed care payors and traditional fee-for-service
arrangements. The following table sets forth the approximate percentage of the
revenues received by the practices that were affiliated with the Company at
December 31, 1996 during the twelve-month period December 31, 1996:
<TABLE>
---------------------------------------------------------------
<S> <C>
Medicare 31.4%
---------------------------------------------------------------
Medicaid 4.2%
---------------------------------------------------------------
Capitated Managed Care Contracts 5.5%
---------------------------------------------------------------
Fee for Service Contracts 54.4%
---------------------------------------------------------------
Other 4.5%
---------------------------------------------------------------
</TABLE>
The Company
First Quarter Ended March 31, 1997 and First Quarter Ended March 31, 1996.
The completion of the Springfield and Baltimore affiliation
transactions resulted in the Company having net revenues of $10.6 million for
the first quarter ended March 31, 1997 compared to no revenues in the first
quarter fiscal of 1996. The increases in revenues were more than offset by
increases in expenses. The affiliation transactions resulted in the addition of
physicians compensation, non-physician salaries and benefits, other practice
expenses, provision for bad debt, and depreciation and amortization. In
addition, the $2.04 million increase in general corporate expenses reflects the
inclusion of non-salary clinic expenses. Amortization of intangibles acquired in
the transactions will increase in future periods as future transactions are
completed. The profitability of the Company in future periods will be dependent
upon increases in the revenues of the affiliation physicians and the Company's
ability to manage general corporate and other expenses.
Pro Forma Results of Operations for Year Ended December 31, 1996
PQC on a pro forma basis, as if the Springfield and Baltimore
transactions had been completed on January 1, 1996, had management fee revenue
of approximately $22.8 million. Operating expenses were $27.4 million, the most
significant of which included $18.1 million of non-physician practice expenses
and $6.3 million of general corporate expense. The net loss for the period was
$4.3 million.
30
<PAGE>
Although the completion of the Springfield and Baltimore affiliation
transactions resulted in the Company having management fee revenue of $3.8
million for the year ended December 31, 1996 as compared to no revenue in the
period from March 20, 1995 to December 31, 1995, increases in expense,
particularly corporate expense, exceeded the growth of revenues. The $3.9
million increase in general corporate expense in fiscal 1996 as compared to the
period from inception to December 31, 1995 reflects the increase in corporate
and regional office level personnel necessary to support operations, finance and
affiliations. Due to the completion of the affiliation transactions,
depreciation, amortization and the provision for bad debts are significantly
higher. Amortization of goodwill acquired in the transactions will increase in
future periods as it is reflected for a full year and as future transactions are
completed. The profitability of the Company in future periods will be dependent
upon an increase in the revenues of the affiliated physicians and the Company's
ability to control general corporate and other expenses.
31
<PAGE>
Liquidity and Capital Resources
The Company's principal requirements for capital are payments to
physicians in connection with affiliation transactions with the Company and its
Affiliated Groups, transaction costs associated with such affiliation
transactions, working capital requirements for its Affiliated Groups and the
funding of operating losses. The Company anticipates that its liquidity and
capital resource requirements will be similar on a long-term and short-term
basis. Due to its start-up status, the Company has incurred significant
operating losses to date and does not have operating cash flow to fund growth or
further losses. The Company cannot continue as a going concern without external
capital sources. The Company's principal sources of capital to date have been
the issuance of Class B and Class C Common Stock under the Equity Facility,
issuances of Class A Common Stock to Physician Stockholders, other issuances of
Class A Common Stock to private investors and borrowing under a Credit Agreement
with Bankers Trust Company.
During 1996, the Company paid aggregate consideration of approximately
$29.5 million in connection with affiliation transactions. Of such amount,
approximately $5.9 million was paid in cash and approximately $23.6 million was
paid in Class A Common Stock. Of these amounts, $3.2 million in cash and $6.5
million in Class A Common Stock was paid to physicians in the Springfield
Affiliated Group and $2.7 million in cash and $17.1 million in Class A Common
Stock was paid to the physicians in the Flagship Affiliated Group. The majority
of such payments were accounted for as an addition to intangible assets, which
represented $28 million of the Company's total assets of $39 million at December
31, 1996. The Company is amortizing the intangible assets over 40 years. The
Company has entered into or completed during 1997 Affiliation transactions with
a value of $19.7 million, $3.8 of which was or will be paid in cash.
Of the Company Common Stock outstanding 13,313,082 shares of Class A
Common Stock are subject to a put option which provides for the put of the
shares back to the Company at fair value upon the death or disability of the
holder. In addition, 1,072,285 of such shares are also subject to a fair value
put option back to the Company at the later of the shareholder's retirement from
the Company or 18 months after the date (December 11, 1996) of the shareholders'
agreement. Consequently, these 13,331,082 shares of Class A Common Stock have
been recorded at fair value outside of permanent equity in the accompanying
balance sheet. Under the Company's stockholder agreements, the holders of an
aggregate of 10,626,163 shares of Class A Common Stock, the Company may
repurchase such shares for fair value if the shareholder's termination of
employment with the Company is without cause or is by resignation, and for the
lower of cost or fair value if termination is with cause. The terms of such
repurchase provision may not permit the Company to fully recover its affiliation
payments to the physician or reflect the cost of affiliation transactions at the
time of termination. To date, no Stockholder Physician has terminated an
employment agreement or repurchased any practice assets. All of the above put
and call provisions expire on the closing of a public offering of the Company's
common stock which results in net proceeds to the Company of at least $50.0
million and which meets certain other criteria. Because the Company's shares are
subject to a number of restrictions in the stockholders' agreements and will not
trade until the occurrence of such an offering, the Company believes it is a
nonpublic entity for compensation accounting purposes and, accordingly, has not
recorded any compensation expense for
32
<PAGE>
these puts and calls. On December 31, 1996 and February 12, 1997, the Company
issued an aggregate of 614,000 additional shares of Class A Common Stock at
$2.50 per share for a total consideration of $1.535 million.
Working capital existing at the date of affiliation has generally been
retained in the practices. Therefore, additional working capital investment is
generally only required to the extent billing processing is slowed during payor
administrative changes after an affiliation and also to fund growth of revenues.
At December 31, 1996, the Company and its affiliated entities had total net
accounts receivable of $5.4 million. At March 31, 1997, the Company and its
affiliated entities had total net accounts receivable of $7,163,000.
The Company currently anticipates that its and the Affiliated Group's
capital expenditures during 1997 will be approximately $1,500,000.
The Company has executed a contract with HBO and Company that obligates
the Company to purchase $1.1 million worth of equipment and licenses pertaining
to practice management systems. The term of the contract is five years.
At March 31, 1997, Bain Capital had $20 million of unused commitment to
purchase the Company's Class B Common Stock. Such commitment was terminated on
June 20, 1997 in connection with the amendment of the Equity Facility at which
time $25 million was issued in consideration for the issuance of 7,682,309
shares of Class C Common Stock. An additional $20 million in shares of Class C
Common Stock may be issued in the future. The purchase of such additional shares
of Class C Common Stock is at the option of the Institutional Investors and
there can be no assurance that such equity capital will be available when
needed. Pursuant to the Equity Facility, the Company has also agreed that it
will not use other sources of equity or debt financing, other than bank
financing, without the consent of the Institutional Investors. See "Business --
The Equity Financing."
On January 16, 1997, the Company entered into the Credit Agreement with
Bankers Trust, as Agent, and the lenders from time to time a party thereto,
pursuant to which the lenders have agreed, subject to the terms and conditions
set forth in the Credit Agreement, to provide a revolving credit facility (the
"Facility") to the Company in an aggregate amount of up to $3.5 million (subject
to downward adjustment in the event that the Company and the Affiliated Groups
do not maintain an adequate amount of accounts receivable). On March 31, 1997,
the Company's outstanding borrowings under the Facility were $3.0 million and
the remaining available commitment on such date was $500,000. The Company will
need to repay or refinance the outstanding balance under the Credit Agreement
when the facility terminates in January 1998. While the Company currently
expects to enter into a replacement credit facility there can be no assurance
that the Company will be able to do so or to do so on terms favorable to the
Company. See "Business -- The Credit Agreement."
In addition to the Equity Facility, borrowing under the Credit
Agreement and cash generated by the operations of the Affiliated Groups, the
Company has also obtained capital to fund operating losses and affiliation
payments through the private placement of Class A Common Stock. In August 1996,
the Company issued $1.0 million of convertible notes, all of which were
converted into Class A Common Stock at a conversion price of $2.50 per share on
August 30, 1996. The proceeds from the convertible notes were used to fund the
Company's operations prior to the initial closing of the Equity Facility. On
December 31, 1996 and February 12, 1997, the Company issued an aggregate of
614,000 additional shares of Class A Common Stock at $2.50 per share for a total
consideration of $1.535 million.
33
<PAGE>
BUSINESS
The Company
Physicians Quality Care, Inc., which was incorporated in March 1995,
provides practice management services for multi-specialty medical practice
groups. The Company's objective is to establish networks of primary and
specialty care physicians and related diagnostic and therapeutic support
services which can provide comprehensive healthcare services in targeted
geographic areas.
PQC's strategy has four central elements: developing economies of scale
in support services for physician practices (i.e., administrative, billing and
clerical staff) and managed care contracts and geographic penetration by
affiliating with large numbers of qualified physicians in targeted geographic
areas, assisting the affiliated practices in providing cost-effective healthcare
to special populations, building comprehensive local healthcare networks by
developing contractual or strategic relationships with providers of, ancillary
services such as home healthcare and weight and health management and improving
the financial performance of affiliated physician's practices by seeking to
maximize the value of each physician encounter. To date, the Company has focused
upon developing its presence in western Massachusetts, northern Connecticut and
Maryland. The Company believes that once the Company has developed a large base
of affiliated physicians its strategy will enable the Company to generate
increased demand for the services and capabilities of its affiliated physicians,
treat patients in lower cost settings and negotiate favorable managed care
contracts. The Company intends to achieve growth through the recruitment of
additional physicians, the expansion of managed care relationships and the
development of contractual or strategic relationships with providers of
ancillary services.
The core of PQC's proposed integrated healthcare delivery system is its
affiliation with groups of physicians who enter into long-term management
agreements with the Company. The Company assumes responsibility for non-medical
aspects of an affiliated physician's practice and focuses its efforts on seeking
to increase revenues and improve operating margins, implementing management
information systems and negotiating managed care contracts. The physicians
remain responsible for, among other things, the medical, professional and
ethical aspects of their practices. By affiliating with the Company, physicians
have increased opportunity to access capital, continue to participate in the
profitability of their individual practices and, through stock ownership, share
a financial interest in the overall performance of the Company.
Industry Overview
Traditionally, health insurance plans reimbursed providers on a
fee-for-service basis, a system that offered very little incentive for
efficiency. In recent years, the healthcare industry has undergone significant
changes as both the private and public sectors seek to slow spending growth.
Since the early 1980s, much of the healthcare coverage in the U.S. has shifted
to managed care systems which offer cost savings in exchange for limiting the
utilization of services. Moreover, there has been a shift to prepaid insurance
plans that offer comprehensive healthcare services to enrollees and pay
providers a fixed, prepaid monthly premium. The most prevalent of these prepaid
health insurance alternatives is the health maintenance organization ("HMO"). To
remain competitive, HMOs and other similar payors seek to align themselves with
the most cost- and service-effective providers, generally channeling patient
volume to such providers.
In the managed care environment, doctors must contract or affiliate
with leading insurers or healthcare networks in their practice area. The
third-party payors rely on primary care physicians to play a "gatekeeping" role
and to make important medical decisions for the patient. Many payors look to
share the risk of providing services through capitation arrangements which
provide for fixed payments for patient care over a specified period of time. In
general, capitated contracts pay a flat dollar amount per enrollee in exchange
for the physician's obligation to provide or arrange for the provision of a
broad range of healthcare services (including inpatient care) to the enrollee. A
significant difference between a capitated contract and traditional managed care
contracts is that the physician is sometimes responsible for both professional
physician services and many other healthcare services, e.g., hospital,
laboratory, nursing home and home health. The physician is not only the
"gatekeeper" for enrollees, but is also financially at risk for over-utilization
and for the actuarial risk that certain patients may consume significantly more
healthcare resources than average for patients of similar age and sex (such
patients being referred to as "high risk patients"). Although physicians often
purchase reinsurance to cover some of the actuarial risk associated with
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high risk patients, such insurance typically does not apply with respect to the
risk of over-utilization until a relatively high level of aggregate claims has
been experienced. If over-utilization occurs with respect to a given physician's
enrollees (or if the physician's panel of enrollees includes a disproportionate
share of high risk patients not covered by reinsurance), the physician typically
is penalized by failing to receive some or all of the physician's compensation
under the contract that is contingent upon the attainment of negotiated
financial targets, or the physician may be required to reimburse the payor for
excess costs. In addition, a physician may be liable for over-utilization by
other physicians in the same "risk pool" and for utilization of ancillary,
inpatient hospital and other services when the physician has agreed
contractually to manage the use of those services. Under this payment system,
primary care physicians have important economic incentives to reduce costs by
ensuring the efficient utilization of other providers of care, shifting care to
outpatient settings where feasible, monitoring the progress of patients
throughout the course of treatment and encouraging preventive healthcare.
In this environment, physicians are facing reimbursement pressures,
greater administrative burdens, increasing financial responsibility for the risk
of patient care, and a shift in demand from specialty to primary care. In
addition, legislative changes have substantially limited a physician's ability
to maintain an ownership interest in entities that provide ancillary services
such as outpatient laboratories, infusion centers and diagnostic and
rehabilitation facilities. These factors have all contributed to a moderation,
if not reduction, in the growth of many physicians' incomes. With greater
oversight by third-party payors, physicians are also facing a decrease in
control over medical decisions and the administration of their practices.
In response to these changes in the marketplace, many physicians are
joining together to maintain clinical autonomy, create greater negotiating
leverage vis-a-vis HMOs and other third party payors and reduce escalating
administrative costs. Physicians also are increasingly abandoning traditional
private practice which typically has higher operating costs and little
purchasing power with suppliers and must spread overhead over a relatively small
revenue base in favor of affiliations with larger organizations. Three basic
groups have emerged as managers of physician practices each of which encompasses
several variations in format: hospitals, which may employ physicians directly or
provide support through a management services organization ("MSO"); insurance
companies, which may employ physicians directly through HMOs or may provide
management services through an affiliated MSO; and independent, investor-owned
physician practice management companies.
Company Strategy
The Company believes that physician practice management companies
("PPMs"), such as PQC, offer physicians significant advantages over other
alternatives in the industry consolidation. PPMs provide physicians with
improved practice management and an opportunity to participate in the growth of
the PPM through stock ownership while maintaining control over medical
decisions. The physician market is currently highly fragmented, and PPMs and
other organizations providing physicians with management alternatives have thus
far captured only a small portion of this potential market. Thus, the Company
believes there is a significant opportunity to expand the number of its
affiliated physicians.
In addition, the Company believes that because physicians can serve as
gatekeepers for patient care, they can exercise direct control over healthcare
spending and should be in a position to share in the savings generated by the
cost containment practices they adopt. For a fee or a percentage of the group's
earnings, a PPM provides physician groups with administrative and practice
management services that are needed for a physician group to realize these cost
savings and to seek to optimize contractual relationships with managed care
organizations, thus retaining some or most of the cost savings so generated.
The central elements of the Company's strategy are to develop long-term
affiliations with physicians, focus on cost effective healthcare delivery to
special populations, and build comprehensive local healthcare networks. To date,
the Company has focused upon developing a network of affiliated physicians. The
Company believes that its strategy will enable the Company to generate increased
demand for the services and capabilities of its affiliated physicians, treat
patients in lower cost settings and negotiate favorable managed care contracts.
Develop long-term affiliations with physicians. PQC seeks to affiliate
with physicians in solo or group practices by entering into contractual
arrangements pursuant to which PQC, or a professional corporation or
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professional association affiliated with PQC, assumes management of non-medical
aspects of the practices. Upon affiliation, PQC seeks to provide the physicians
with, among other things, increased opportunity to access capital, management
experience, improved information systems and increased opportunity to
participate in favorable managed care contracts. The Company intends to assist
affiliated physicians in improving clinical outcomes and seeks to keep medical
costs down by merging physicians into Affiliated Groups. The Company's structure
allows physicians to continue to practice in their existing locations with no
disruption to patient flow patterns while providing access to coordinated
ancillary services. By affiliating with PQC, physicians, through the revenue
sharing provisions of their employment agreements and the Services Agreements
between the Affiliated Group and PQC, continue to participate in the
profitability of their individual practices and, through stock ownership, share
a financial interest in the overall performance of the Company. Physicians
constitute a majority of the Board of the Directors of PQC and all local
advisory boards, which control such decisions as clinical protocols and
utilization review, payor relations and the addition of ancillary services.
Balance of Primary Care Physicians and Specialists. PQC believes that a
successful system should be balanced between primary care physicians and
specialists to provide efficient coordination and utilization of the appropriate
levels of care, and PQC intends to seek to develop this balance in the physician
groups with which it affiliates. Of the 98 physicians affiliated with the
Company at March 31, 1997, 65 are engaged in primary care practices and 33 are
engaged in specialist practices. The Company believes the industry trend toward
integrated delivery systems will result in an increasing demand for primary care
physicians because a higher degree of coordination of care and risk-sharing will
be required than that which can be achieved in a system controlled by
specialists. The Company's strategy is to have the primary care physician serve
as the central manager in the patient system and to develop effective
coordination between specialists and the primary care physicians within its
network.
Focus on special populations. PQC believes that the management of
healthcare costs for certain populations provides significant opportunities that
are not being addressed in the marketplace. The Company believes that special
populations, including the elderly, the disabled and those with debilitating
chronic or high-cost, complex diseases represent a minority of the population
but account for a disproportionately high percentage of the healthcare costs in
the United States due to the significantly greater need of such patients for
medical care compared to the population as a whole. The Company believes that a
significant portion of these costs can be avoided with effective case
management, use of information systems, and coordinated use of the full
continuum of healthcare. At present, a relatively small percentage of these
patients are enrolled under capitated contracts. However, the Company believes
that the cost pressures that fostered the development of managed care for other
segments of the population should have an even more significant impact on the
rapid development of managed care for such patients. Through affiliation with
physicians and academic experts who specialize in geriatrics and medical
conditions that disproportionately affect these population segments, effective
use of case management techniques designed specifically for such populations,
and management information systems, the Company believes that its affiliated
physicians should be able to manage cost effectively the risks of providing care
to these populations on a capitated basis.
Improved Medical Quality and Performance. Over time, the Company
intends that its affiliated physicians will devise medical protocols and the
Company will perform outcome analyses, such that the most effective medical
practices in each network can be shared across physician groups. The Company is
in the process of establishing a quality assurance program that will incorporate
peer review, self-critiquing mechanisms, patient satisfaction surveys,
continuing medical staff development and regular continuing medical education
seminars. Once a large base of affiliated physicians at Affiliated Groups is
established, medical directors of each local care network will participate in
the Company's National Medical Advisory Board that will meet regularly to
establish and review medical standards, policies and procedures for all
physicians affiliated with the Company.
Affiliation Structure
General Affiliation Model. Although the details of each affiliation
transaction may differ, the Company has developed the General Affiliation Model,
designed to capture the benefits of integration while preserving significant
physician autonomy. In the General Affiliation Model, physicians initially
affiliating with the Company in each geographic area who will become
stockholders of the Company transfer their practices by mergers or asset sales
to an Affiliated Group, a newly-formed professional corporation or professional
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association permitted to practice medicine under applicable law. These
physicians, along with other physicians in that geographic area who subsequently
become part of an Affiliated Group and become stockholders of the Company (the
"Stockholder Physicians"), execute an Employment Agreement with the Affiliated
Group at the time that they transfer their practice assets. The Affiliated
Group, in turn, enters into a 40-year Services Agreement with the Company
pursuant to which the Company agrees to provide the physicians in the Affiliated
Group with comprehensive management services in exchange for a fee. As
consideration for transferring their practices to and becoming employed by the
Affiliated Group, Stockholder Physicians receive shares of the Company's Common
Stock and in some cases cash, the amount of which is negotiated on an individual
basis between each Stockholder Physician and the Company. Physicians who are not
stockholders of the Company may also be employed by the Affiliated Group.
The factors that the Company considers in selecting physician or
physician groups for Affiliation include the location of the practice, whether
the practice can be successfully integrated into an Affiliated Group, the
ability of the Company to assist the physician to increase billings and control
costs, the size of the practices, the compensation sought by the physician or
physician group, the nature of the physician's practice and the reputation of
the physician in the medical community.
All of the outstanding capital stock of each Affiliated Group is held
by a Stockholder Physician designated by the Company (the "Affiliated Group
Stockholder"). At the time of the affiliation, the Affiliated Group Stockholder
enters into an agreement (the "Designation Agreement") with the Company and the
Affiliated Group pursuant to which he or she agrees to consult with the Company
in voting the stock of the Affiliated Group, agrees to transfer the stock of the
Affiliated Group without consideration to another licensed physician at the
direction of the Company and agrees to pay over to the Company any dividend or
distribution on the stock received from the Affiliated Group. The Designation
Agreement also provides that the stock of the Affiliated Group is automatically
transferred at the direction of the Company in the event that the Affiliated
Group Stockholder attempts to transfer it to a third party. The Designation
Agreement provides, however, that the Affiliated Group Stockholder is not
required to consult with the Company as to matters requiring the exercise of
professional medical judgment.
The Employment Agreements contain certain restrictive covenants,
including covenants relating to noncompetition, confidentiality and
nonsolicitation of employees. Pursuant to these restrictive covenants, the
Stockholder Physicians agree, during the term of the employment agreement and
for a one year period thereafter, not to establish, operate or provide medical
services in a specified geographic region (generally 15 miles within the
physician's practice site), subject to certain limited exceptions. In addition,
the Stockholder Physicians agree during the employment agreement and for a two
year period thereafter not to provide certain other services related to the
practice of medicine in the geographic region and not to solicit any employee or
patients of the Affiliated Group. Under current state laws and judicial
decisions that restrict the enforcement of non-competition agreements against
physicians on public policy grounds, the Company has no or limited ability to
enforce the covenants not to compete. Each Employment Agreement generally is
terminable by the Affiliated Group with respect to any individual Stockholder
Physician upon the death or disability of such Stockholder Physician or upon the
occurrence of certain events that either interfere with the ability of such
Stockholder Physician to practice medicine or significantly diminish the value
of such Stockholder Physician's affiliation to the Affiliated Group. Each
Stockholder Physician may terminate his or her Employment Agreement under
certain circumstances, including without cause upon six months notice to the
Affiliated Group. With respect to the Flagship Stockholder Physicians (as
defined below), such notice may only be given after the first anniversary of the
Employment Agreement. The Employment Agreements also contain terms permitting or
requiring a Stockholder Physician upon termination after certain material
breaches of the Affiliated Group's or the Company's obligations under the
employment agreement or the Services Agreement between PQC and the Affiliated
Group, to repurchase from the Affiliated Group the restrictive covenants and his
or her practice assets (i.e., office and examination equipment, in certain cases
the lease for premises at which the physician practices, patient lists and
records, and third party payor contracts) upon termination of employment. The
terms of such repurchase provision may not permit the Company to fully recover
its affiliation payments to the physician or reflect the cost of affiliation
transactions at the time of termination. To date, no Stockholder Physician has
terminated an employment agreement or repurchased any practice assets.
Pursuant to the Services Agreement, the Company provides (or arranges
for the provision of) a comprehensive package of services to the Affiliated
Group and its physicians, including offices and facilities,
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equipment, nursing and other non-physician professional support, administrative
personnel, information systems, comprehensive professional liability insurance
and general management and financial advisory services. The Company, on behalf
of the physicians in the Affiliated Group, supervises the billing of all
patients, insurance companies and third-party payors and negotiates all
contracts and relationships with payors. The physicians remain responsible for,
among other things, the medical, professional and ethical aspects of their
practices.
Generally, under a Services Agreement, net revenues from patient care
are first applied to the payment of the operating expenses of the practices. Any
remaining net revenues are allocated between a pool from which physician
compensation is paid ("Compensation Pool") and the Company. The majority of the
net revenues are initially allocated to the Compensation Pool until the
physicians receive as compensation a minimum level of income based upon a
significant percentage of their historical compensation. The Company receives a
portion of the net revenues as the net revenues exceed such base levels. For
additional information regarding the terms of the revenue sharing arrangements
see "The Springfield Affiliated Group", - "The Flagship Affiliated Group" and
"The Clinical Associates Transaction." Unlike the current arrangements, the
revenue sharing arrangements with respect to the physician in Clinical
Associates provide in part for PQC to receive a percentage of billings, net of
bad debts and discounts, above certain threshold levels with practice expenses
and physician compensation being paid from the billings after PQC's management
fee. The Company may use either a compensation formula based upon a sharing of
profits or billings in the future. Profits from integrated health services that
may be established by the Company or an Affiliated Group are allocated
separately and will be determined based upon the nature of the integrated health
service, or in the absence of such an agreement, 50% of the profit from such
services will be allocated to the Company. Because compensation of Stockholder
Physicians is a function of many factors including the financial performance of
such physicians, neither the Company nor an Affiliated Group can guarantee that
a Stockholder Physician will receive any minimum level of compensation, and the
Stockholder Physicians are not entitled to any compensation other than their
allocated share of the Compensation Pool. The Compensation Pool is initially
allocated to the Stockholder Physicians until each physician has received a pre-
agreed draw. Any amount remaining in the Compensation Pool is allocated among
the Stockholder Physicians as determined by a Compensation Committee appointed
by the Physicians.
The Company believes that its General Affiliation Model offers a number
of advantages. For example, physicians remain in their pre-affiliation
locations, offering their patients the continuity and convenience of
decentralized offices. At the same time, laboratory and administrative services
generally are provided on a centralized basis, allowing the Affiliated Groups to
achieve economies of scale in purchasing and other administrative efficiencies.
Moreover, the Company believes that as it completes its initial affiliation
transactions in particular geographic markets, Affiliated Groups will provide it
with both a visible business presence and a corporate framework for securing
additional affiliations with physicians in those markets.
Currently, most of the contractual arrangements with managed care
payors and other third party payors involve contracts between the Stockholder
Physicians and the payors. Such contracting structure does not decrease the
Company's revenues since the physicians are contractually obligated to pay over
any amounts received to the Affiliated Group. However, PQC expects that it will
in the future negotiate payor contracts directly between payors and Affiliated
Groups or payors and PQC in order to take full advantage of the economies of
scale resulting form a having a large number of affiliated physicians.
The Company also believes that the decision making structure that it
establishes in connection with each Affiliated Group facilitates information
sharing and cooperation between the affiliated physicians and the Company. Each
Affiliated Group maintains its own policy making structure, including a Joint
Policy Board and a Medical Advisory Board. The Joint Policy Board is charged
with, among other things, developing certain management and administrative
policies for the Affiliated Group, approving operating and capital expenditure
budgets, establishing fee schedules for services provided by the Affiliated
Group, approving the establishment of managed care contracts and determining of
the number and type of physicians required for the operation of the Affiliated
Group. Certain decisions that may have a material impact upon the business,
results of operation or financial condition of the Affiliated Group must also be
approved by the Affiliated Group Stockholder. The current Joint Policy Boards
have nine members: the President of the Affiliated Group (selected by the
Affiliated Group Stockholder from physicians nominated by the Stockholder
Physicians), four persons designated by the Company and four persons designated
by the Stockholder Physicians. The Medical Advisory Board, which is responsible
for providing medical input on managed care contracting by the
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Affiliated Group and leading the development and dissemination of medical
protocols among the physicians, is chaired by the Medical Director of the
Affiliated Group (selected by the Affiliated Group Stockholder from physicians
nominated by the Stockholder Physicians) and consists of six other physicians
elected by the Stockholder Physicians.
Physicians who affiliated with the Company after August 30, 1996, are
required to become parties to a Stockholders Agreement that grants certain
rights to the Company, the Institutional Investors and the Stockholders,
including certain put and call rights on the Common Stock and "drag-along" and
"tag-along" rights. For further information regarding these provisions. See
"Description of Capital Stock - Stockholders Agreement" and the Notes to the
Financial Statements.
Although the Springfield and Flagship Affiliations generally track the
General Affiliation Model, the Company may depart to some extent or
significantly from it or pursue an altogether different approach in completing
future physician affiliations.
The Springfield Affiliated Group
The Company has entered into affiliation transactions with nine medical
practices located in western Massachusetts, consisting of a total of 39
physicians, 34 of whom are stockholders in the Company (the "Springfield
Stockholder Physicians") and 5 of whom are employed by the Springfield
Affiliated Group as employees (the "Springfield Affiliation"). These physicians
treat patients from 28 towns in western Massachusetts and northern Connecticut,
which area had a total population in 1990 of approximately 650,000. Twenty-four
of the physicians are engaged in primary care practices, including two
physicians with pediatric practices. Fifteen of the physicians are engaged in
specialist practices, including pulmonology, cardiology, oncology/hematology,
infectious disease, rheumatology and gastroenterology. The Springfield
Affiliated Group leases offices in 11 locations, of which 9 are located in
Springfield, Massachusetts. Certain of the offices are leased from Springfield
Stockholder Physicians. The Springfield Affiliated Group had total patient
revenue of approximately $16.5 million for the year ended December 31, 1996. At
December 31, 1996, the Springfield Affiliates Group had a patient base of
approximately 50,000.
The Springfield Affiliated Group has a capitated Medicare Risk contract
with Tufts Health Plan's Secure Horizons product. As of March 31, 1997, there
were 1,975 covered lives. Profitability of the Secure Horizons contract is
dependent upon many factors including regular utilization review of inpatient,
skilled nursing facility, home care and outpatient services, subcapitations,
close collaboration with the partner hospital, primary care and specialist
physician communication, data analysis and review and physician leadership.
The Springfield Affiliated Group also participates in managed care
plans of Aetna, Blue Cross and Blue Shield of Massachusetts, Cigna, Fallon
Health Plan, Health New England, Pioneer (PPO), and Tufts Health Plan.
Consistent with the General Affiliation Model, the Springfield
Stockholder Physicians, or the professional corporations and other entities with
whom they were affiliated, merged or sold their practice assets to the
Springfield Affiliated Group in exchange for an aggregate of approximately
3,164,738 shares of Common Stock of the Company and approximately $4.1 million
in cash. The 29 initial Stockholder Physicians entered into a three-year
employment agreement with the Springfield Affiliated Group, pursuant to which
each physician received options to purchase 2,500 shares of Common Stock of PQC
at an exercise price of $2.50 per share. The options expire on the earlier of
termination of employment or three years from commencement of employment. The
Physicians who subsequently affiliated with the Springfield Affiliated Group
entered into ten-year employment agreements with the Springfield Affiliated
Group. Four of these Springfield Physician Stockholders each received options to
purchase 37,500 shares of Class A Common Stock at an exercise price of $1.00 per
share which options are subject to certain vesting conditions. In addition, up
to $2.15 million, payable in Class A Common Stock at $2.50 per share, may be
paid in the future to certain Springfield Stockholder Physicians provided that
certain revenue goals are met. The Springfield Affiliated Group in turn entered
into a 40-year services agreement with the Company pursuant to which the Company
(on behalf of the Springfield Affiliated Group) agreed to provide management
services to the Springfield Affiliated Group physicians.
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Under the Employment Agreements with the twenty-nine initial
Springfield Stockholder Physicians, revenues from patient care remaining after
payment of operating expenses, including expenses of the Springfield Affiliated
Group ("Gross Margin") are allocated first between the Springfield Affiliated
Group's Compensation Pool (the "Springfield Compensation Pool") and the
Springfield Affiliated Group in a 95%/5% proportion until 95% of the base
compensation of the Springfield Stockholder Physicians is achieved, then to
payment of certain non-operating expenses, and then 80% to the Springfield
Affiliated Group and 20% to the Springfield Compensation Pool until the
Springfield Affiliated Group has been allocated $1.5 million, with any remaining
Gross Margin being divided evenly between the Springfield Affiliated Group and
the Springfield Compensation Pool. Under the Employment Agreements with the
Springfield Stockholder Physicians who subsequently affiliated with the
Springfield Affiliate Group any Gross Margin attributable to these physicians
are allocated between the Springfield Compensation Pool and the Springfield
Affiliated Group in a 80%/20% proportion until the physicians receive 80% of
their base compensation, and then to payment of certain non-operating expenses
attributable to the Springfield Affiliated Group, with any remaining Gross
Margin being divided evenly between the Springfield Compensation Pool and the
Springfield Affiliated Group. The base compensation of the Springfield
Stockholder Physicians is $6.7 million. The allocation of Gross Margin to the
Springfield Compensation Pool is calculated separately for each fiscal period.
If the Gross Margin for any such period is negative, such negative amount
constitutes an operating expense in the next fiscal period. Pursuant to the
Springfield Services Agreement, all amounts allocated to the Springfield
Affiliated Group in any fiscal period are remitted to the Company.
Six months prior to the third anniversary of the closing of the initial
Springfield Affiliation, the Springfield Affiliated Group (on behalf of the
Company) or a majority of the Springfield Shareholder Physicians may amend the
financial arrangements, effective as of the third anniversary of such closing,
such that the economic terms of the Springfield Stockholder Physicians'
employment agreements, taken as a whole (and giving effect to any payments or
other compensation received by the Springfield Stockholder Physicians in
connection with their affiliation), are adjusted to reflect the terms being
entered into by independent third parties for similar affiliation and employment
relationships at that time.
The Flagship Affiliation. On December 11, 1996, pursuant to affiliation
transactions with the Company, 15 existing professional practices located in the
greater Baltimore-Annapolis, Maryland area, consisting of a total of 59
physicians, transferred their practice assets to and became employed by the
Flagship Affiliated Group. In exchange for such affiliation, the physicians
received a combination of approximately $2.3 million in cash and 6,842,675
shares of Class A Common Stock (the "Flagship Affiliation"). Forty-one of the
physicians are engaged in primary care practices, including 20 physicians with
pediatric practices. Eighteen of the physicians are engaged in specialist
practices, including pulmonology, cardiology, oncology/hematology, infectious
disease, rheumatology, gastroenterology and neurology. Fifty-five physicians are
stockholders in the Company (the "Flagship Stockholder Physicians") and 4
physicians are employed by the Flagship Affiliated Group as employees. The
Flagship Affiliated Group leases 15 practice locations in Maryland, some of
which are leased from the Flagship Stockholder Physicians. The practices
included in the Flagship Affiliated Group had total patient revenue of
approximately $25 million for the year ended December 31, 1996. During the year
ended December 31, 1996, the Flagship Affiliated Group had a patient base of
approximately 100,000. The majority of patient revenues are fee-for-service
rather than capitated.
In order to effectuate the Flagship Affiliation, the Flagship
Stockholder Physicians, or the professional associations, business corporations
and limited liability partnerships with whom they were affiliated, transferred
their practice assets to the Flagship Affiliated Group by merger or by sale of
assets. The Company entered into a 40-year management services agreement with
the Flagship Affiliated Group (the "Flagship Services Agreement"), which entered
into a five-year Employment Agreement with each Flagship Stockholder Physician.
In addition, the Company entered into an agreement with the Flagship Affiliated
Group pursuant to which the Company agreed to grant options to purchase, subject
to certain conditions, up to 400,000 shares of Class A Common Stock to the
Flagship Stockholder Physicians.
Pursuant to the Flagship Services Agreement and the Employment
Agreements with the Flagship Stockholder Physicians, revenues from patient
services remaining after payment of third-party operating expenses ("Net
Margin") will be allocated between the Flagship Stockholder Physicians'
Compensation Pool (the "Flagship Compensation Pool") and reimbursement of the
Company's direct expenses relating to the Flagship Affiliated Group, based on a
ratio of such budgeted compensation to such budgeted expenses. Once both the
Company's direct expenses and the aggregate base physician compensation have
been fully satisfied,
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any remaining Net Margin will be divided evenly between the Company and the
Flagship Compensation Pool. The base compensation of the Flagship physicians is
$8.15 million.
Future Affiliation Transactions. The Company's current primary focus is
on expanding the Springfield Affiliated Group and the Flagship Affiliated Group,
and developing additional Affiliated Groups in the eastern United States. The
Company expects to close its Affiliation transaction with Clinical Associates,
which will add 71 physicians to the Flagship Affiliated Group on JulY 31, 1997
or as soon thereafter as practicable.
The Company is currently discussing a transaction with Blue Cross/Blue
Shield of Massachusetts, Inc. ("BCBS"). No definitive agreement regarding this
transaction has been reached. The Company is currently negotiating to purchase
the assets of BCBS's Health Centers Division, which operates medical clinics
serving BCBS enrollees at nine locations in western Massachusetts and suburban
Boston (the "Health Centers"). If the transaction is eventually consummated as
it is presently being discussed, MCP would offer to enter into employment
agreements with the approximately 115 physicians who currently practice at the
Health Centers as well as the support personnel. MCP would also enter into a
multi-year agreement with BCBS to participate in BCBS's managed care products.
With respect to certain products, MCP may accept, in exchange for a portion of
BCBS's premium, full capitation risk for BCBS enrollees who designate a Health
Center physician as their primary care physician. Material terms of the proposed
acquisition are still subject to negotiation and there can be no assurance that
BCBS and the Company will enter into an agreement. The Company further has the
right not to go forward with the transaction if, in its sole discretion, it is
not satisfied with the scope, substance and findings of its review of all
material and information relating to the Health Centers Division. Any agreement
would require POC to obtain a significant amount of additional capital from the
Institutional Investors to fund the purchase price and anticipated initial
operating losses. The transaction being discussed would greatly increase the
Company's participation in capitation arrangements, which involve certain risks
(see "Risk Factors"). The Company anticipates that it may initially incur a
significant loss in operating the Health Centers and the long-term profitability
of the business would depend in part upon the Company's ability to attract
additional patients to the Health Centers, including patients who are not BCBS
enrollees. If the Company and BCBS consummate the transaction, there can be no
assurance that the Company could succeed in placing the Health Centers on a
sound operating basis and may incur losses indefinitely.
The Company will determine which geographic markets to enter in the
future based upon consideration of the following factors (among others): (i)
population and economic profile, (ii) level of managed care penetration and
effectiveness of providers in coping with the managed care environment, (iii)
physician practice density, specialty composition, and average group size, (iv)
receptivity of the medical community to the Company's management philosophy, (v)
local competition in the physician practice management business and (vi)
commercial and Medicare reimbursement rates. The Company also regularly
considers the addition of physicians on an employee, rather than a Stockholder
Physician, basis.
The Clinical Associates Transaction
The Company and the Flagship Affiliated Group have entered into an
agreement with Clinical Associates, a Maryland professional association,
pursuant to which Clinical Associates will become affiliated with the Company
and subject to an amended and restated Services Agreement between PQC and the
Flagship Affiliated Group. Although the closing of the transaction with Clinical
Associates is subject to certain conditions in favor of the Company and Clinical
Associates, the Company expects the Clinical Associates transaction to close
during July 1997 or as soon thereafter as practicable. Pursuant to the
agreements with Clinical Associates, the stockholders and optionholders of
Clinical Associates will receive in the aggregate 4,800,000 shares of Common
Stock and $3 million. The Clinical Associates physicians will also enter into
five year employment agreements with the Flagship Affiliated Group or another
Maryland professional association under common control with the Flagship
Affiliated Group and a party to the Services Agreement.
Clinical Associates is located in the Baltimore, Maryland metropolitan
area, and includes 71 physicians, 55 of whom will become stockholders in the
Company and 16 of whom are employed by the medical practice. The physicians
treat patients from the metropolitan Baltimore area. Twenty-nine of the
physicians are engaged in primary care practices, including 12 physicians with
pediatric practices. Forty-two of the physicians are engaged in speciality
practices, including cardiology, dermatology, endocrinology, gastroenterology,
immunology, neurology, psychiatry, pulmonology, obstetrics/gynecology,
ophthalmology, orthopedics, otolaryngology, plastic surgery, urology, general
surgery, and vascular surgery. The group leases offices in 13 locations, all of
which are in Baltimore county. The group had total patient revenue of
approximately $36.8 million for the year ended June 30, 1996 and $26.9 million
for the nine months ended March 31, 1997. Clinical Associates has a patient base
of approximately 150,000 lives. Approximately 50 percent of Clinical Associates'
patient revenues from the most recently completed fiscal year are from capitated
contracts and 50 percent are from fee-for-service arrangements. The physicians
in Clinical Associates participate in full professional capitation contracts
with CareFirst, Freestate (Maryland Blue Cross/Blue Shield) and Prudential.
The method for determining PQC's management fee and the compensation of
the Clinical Associates physicians differs from the model used in the
Springfield Affiliated Group and with the original Flagship physicians. Instead
of a sharing of gross margin after practice expenses, PQC is entitled to a
percentage of billings, net of uncollectible amounts and discounts ("Net
Adjusted Billings"). The revenue splitting arrangements for the Clinical
Associates physicians differ based upon whether the revenue is derived from an
existing specialist practice, a primary care practice, future specialist
practices and the practices of physicians without established practices. Except
as provided below, Net Adjusted Billings in excess of baseline Net Adjusted
Billings reflecting the historical level billings for such physician subject to
reductions for changes in practice patterns ("Specialist Net Adjusted Billings")
from specialist (a specialist being a physician at least 80% of whose billings
are derived from a specialist practice) practices with respect to any fiscal
year will be allocated 35% to PQC and 65% to an account established with respect
to the Clinical Associates physicians and any future physicians included in the
same compensation arrangements (the "Account") until $3 million has been
allocated between the Account and PQC; and any remaining Specialist Billings
will be allocated 20% to PQC and 80% to the Account.
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Net Adjusted Billings by primary care, OB/GYN physicians and physicians (whether
primary care or specialist) added to the compensation arrangements in the future
in excess of the agreed upon baseline Net Adjusted Billings will be allocated
20% to PQC and 80% to the Account. With respect to any physician recruited to
join Flagship after the closing who does not have a practice that is merged into
Flagship (and to certain physicians currently affiliated with Clinical
Associates ), 20% of the Incremented Amount shall be allocated to PQC.
"Incremented Amount" means the excess, if any, of Net Adjusted Billings
attributable to such physician over an amount equal to twice the average
compensation of physicians with a similar practice in the Baltimore metropolitan
area as reported by a standardized reporting source. Any Net Adjusted Billings
attributable to such physician less (A) the amounts allocated to PQC and (B) the
compensation payable to the physician under the physician's employment agreement
shall be allocated to the Account. Any revenue not included in Net Adjusted
Billings will be allocated to the Compensation Pool to offset practice expenses,
provided that if the ratio of practice expenses to practice revenue declines
below historical levels, revenues not included in Net Adjusted Billings will be
allocated equally to PQC and the Account. Net Margin from centralized laboratory
services (which for this purpose shall mean revenue from laboratory ancillary
services less (i) direct expenses of such laboratory ancillary services and (ii)
an allocation of Flagship overhead) attributable to the Clinical Associate
physicians will be allocated 80% to PQC and 20% to the Account. Net Margin from
incremental non-laboratory ancillary services will be allocated 50% to PQC and
50% to the Account together with the current Flagship Compensation Pool.
The amount allocated to the Account is first used to pay the practice
expenses of the physicians whose compensation is paid through the Account. Any
remaining amount in the Account with respect to any fiscal year will be
distributed to the Clinical Associates physicians as their sole source of
compensation. The allocation of such compensation among the physicians will be
determined by a committee elected by, or pursuant to a formula approved by, the
Clinical Associates physicians.
PQC expects to consider restructuring the compensation arrangements
with respect to the current Flagship Affiliated Group to determine whether to
merge the two compensation arrangements. In the event that PQC elects to modify
the compensation arrangements of the Flagship physicians in this manner, PQC
will guarantee for a two year period (commencing on the date of such merger)
that the compensation of the Clinical Associates physicians under the combined
compensation distribution system is not less than the baseline compensation that
such physicians would have received if the compensation distribution systems are
not merged.
Within six months after the closing of the affiliation transaction, the
Clinical Associate physicians have the right to elect to receive up to an
additional 2,000,000 shares of Common Stock as consideration for the
Affiliation. If the Clinical Associate physicians elect in their sole discretion
to receive such additional Common Stock, the compensation arrangements set forth
above will be amended, as an effective adjustment to the merger consideration,
so that an aggregate of $760,000 of Net Adjusted Billings (or such
proportionately reduced amount if less than 2,000,000 shares of Common Stock
shares are elected) that would otherwise be allocated to the Account with
respect to each fiscal year shall instead be allocated to PQC.
The Services Agreement would include a provision that penalizes PQC if
certain revenue targets described below are not met. Until there is no Shortfall
(as defined below) or PQC completes a public offering of the Company Common
Stock at a price to the public of $9.00 or more per share, the amount that would
have been allocated to PQC pursuant to the Services Agreement will be reduced by
the Adjustment Amount and the amount that is allocated to the Account will be
increased by the Adjustment Amount. "Shortfall" means the difference between
$3.0 million and the aggregate increase in Net Adjusted Billings over baseline
Net Adjusted Billing by the specialist physicians in Clinical Associates or who
are subsequently added to the practice. The "Adjustment Amount" is 45% of any
Shortfall. Consequently, unless Net Adjusted Billing increases by $3.0 million
over historical levels, and Adjustment Amount will be due.
PQC has agreed with the stockholders of Clinical Associates that
neither PQC nor Flagship will merge with or into, become a subsidiary of, or
sell Flagship or all or substantially all of PQC's assets to, or grants
governance participation to, a Baltimore Health Care Entity without the approval
of a majority of the members of the Management Committee. A Baltimore Health
Care Entity means any hospital, medical group or other organization that
principally conducts its business in and derives its revenues from the delivery
of healthcare services in Maryland.
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In the event that PQC or any of its affiliates propose the
establishment of an independent provider association ("IPA") network in the
Maryland Area, PQC is required to obtain the approval of the Joint Policy Board
with respect to the structure, governance and financial arrangements of the IPA
network, including whether the Physicians in the Flagship Affiliated Group will
participate in such IPA network. PQC will be entitled to a fee of up to 10% of
the aggregate revenue of the IPA network, which fee PQC shall not be required to
share with the physicians employed by the Flagship Affiliated Group. Any
residual profits of the IPA network (in excess of the 10% fee) that are retained
by PQC shall be allocated 50% to PQC and 50% to the physicians in the Flagship
Affiliated Group.
In the event that on the fourth anniversary of the closing of the
affiliation transaction, PQC has not completed an underwritten initial public
offering, the Clinical Associates physicians shall have the right, within 45
days thereafter, to require PQC to repurchase the Common Stock issued in the
Affiliation at a purchase price of $3.00 per share. PQC shall have the right to
pay the purchase price by a five (5) year non-interest bearing note. The
principal payable with respect to such note shall be reduced by the amount, if
any, that the Clinical Associates physicians' compensation between the issue
date of the note and its maturity exceeds the base compensation with respect to
the Clinical Associates physicians during that period.
Ancillary Services
In general, the Company anticipates that it will obtain access to
ancillary services, such as laboratories, skilled nursing facility services, and
home healthcare, for its Affiliated Groups through contractual relationships or
strategic alliances with other healthcare providers. The Company anticipates
that these services will be closely coordinated with services provided by its
physicians. Over time, the Company, to the extent permitted by federal and state
regulations, may seek to own some of these ancillary services, if cost and
effectiveness considerations indicate that it would be beneficial to do so and
if favorable strategic alliances cannot be entered into. As of the date of this
prospectus, the Company and its affiliated entities do not own any ancillary
services other than the Springfield and Flagship laboratories and do not have
any contractual relationships with respect to any other ancillary services. See
"-- Company Strategy."
Relationship With Other Provider Organizations
The Company may, in the future, contract with other provider
organizations such as IPAs and physician hospital organizations ("PHOs") on a
selective basis. Such contracts may provide management services, including
claims processing, member services and administrative support, for a management
fee. In other areas, PQC's role may include providing policy guidelines, medical
management, credentialing and provider contracting.
The Equity Financing
In order to finance the cash payments made to the Springfield and
Flagship Stockholder Physicians, to fund the Company's operating expenses and to
finance subsequent affiliation and working capital requirements, PQC entered
into a financing transaction with Bain Capital Fund V, L.P., Bain Capital Fund
V-B, L.P., BCIP Associates and BCIP Trust Associates, L.P., on August 30, 1996.
Pursuant to the Class B Stock and Warrant Purchase Agreement entered into as of
that date (the "Bain Purchase Agreement"), the Institutional Investors
affiliated with Bain Capital agreed to purchase and the Company agreed to sell,
in each case subject to certain conditions, up to 12,000,000 shares of the
Company's Class B Common Stock at a price of $2.50 per share, together with
warrants to purchase 13,000,000 shares of Class B Common Stock (the "Class B
Warrants"), of which 4,600,000 shares of Class B Common Stock and Class B
Warrants to purchase 6,415,000 shares of Class B Common Stock have been
purchased as of June 20, 1997. The Class B Warrants entitle the holder to
purchase shares of Class B Common Stock at $2.50 per share (the "Class B
Exercise Price"). The Class B Exercise Price is subject to adjustment (i) to
reflect any stock dividends, stock splits, reverse stock splits, reorganizations
and recapitalizations of the Company's capital stock and (ii) to prevent
dilution, on a weighted-average basis, in the event that the Company issues
additional securities at a purchase price less than the applicable Exercise
Price (with the exception of securities issued or reserved for issuance to
employees pursuant to stock option plans approved by the Company's Board of
Directors).
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On June 20, 1997, the Company entered into an Amended and Restated
Class B and Class C Common Stock Purchase Agreement with the Institutional
Investors. On June 23, 1997, the Company issued 7,692,309 shares of Class C
Common Stock pursuant to the Equity Facility for an aggregate consideration of
$25 million and warrants to purchase 7,692,309 shares of Class C Common Stock.
The Class C Warrants entitle the holder to purchase the shares of Class C Common
Stock at $3.25 per share (the "Class C Exercise Price"). The Class C Exercise
Price is subject to adjustment (i) to reflect any stock dividends, stock splits,
reverse stock splits, reorganization and recapitalization of the Company's
Common Stock and (ii) to prevent dilution, on a weighted-average basis, in the
event that the Company issues additional securities at a purchase price less
than the applicable Class C Exercise Price (with certain exceptions).
Pursuant to the Equity Facility, the Institutional Investors are
entitled at any time prior to an underwritten public offering of the Company's
Common Stock to purchase up to an additional 6,153,846 shares of Class C Common
Stock at a purchase price of $3.25 per share and in connection with that
purchase, to receive warrants to purchase up to 6,153,846 shares of Class C
Common Stock.
The Company has agreed that it will not take certain actions unless the
Company receives the prior approval of the Institutional Investors. Such actions
involving the Company, its subsidiaries or any Affiliated Groups include
mergers, sales of assets, affiliation transactions, declarations of dividends or
other distributions, material changes in business, amendments to the Restated
Certificate or By-laws, the hiring, firing and compensation of the Company's
chief executive and chief financial officers, adoption of annual operating
budget, transactions with affiliates and the commencement or settlement of any
litigation.
The Company's Class A Common Stock, Class B Common Stock and Class C
Common Stock are identical except for certain special voting rights of the
directors appointed by the holders of each class and the Class C Common Stock
being entitled to certain antidilution protection and to a liquidation
preference of $3.25 per share. See "Description of Capital Stock."
In connection with the Equity Facility, the Company entered into a
Management Agreement dated as of August 30, 1996 with Bain Capital Partners, V,
L.P. ("BCP V"). See "Certain Transactions."
The Credit Agreement
On January 16, 1997, the Company entered into the Credit Agreement with
Bankers Trust, as Agent, and the lenders from time to time a party thereto,
pursuant to which the lenders agreed, subject to the terms and conditions set
forth in the Credit Agreement, to provide an aggregate amount of up to $3.5
million to the Company under the Facility. On March 31, 1997, the Company's
outstanding borrowings under the Facility were $3.0 million and the remaining
available commitment at such date was $500,000. On June 25, 1997, the Company
repaid the outstanding principal and interest on the loan and the entire
commitment remains available.
Loans under the Facility (the "Loans") bear interest at (i) the higher
of (A) 0.5% over the "Adjusted Certificate of Deposit Rate" or (B) the prime
rate announced by Bankers Trust Company from time to time, plus 1.5% or (ii) the
"Eurodollar Rate," plus 2.5%, and are payable upon the earlier of a "Change of
Control Event" or January 16, 1998. The Company may use the Facility to provide
financing for general corporate and working capital purposes including, subject
to the terms and conditions set forth in the Credit Agreement, establishment by
the Company of Affiliated Groups and acquisitions by the Affiliated Groups of
physician practice groups.
The Loans are secured by all of the assets of the Company and its
subsidiaries, including subsequently created subsidiaries, and the receivables
of the Affiliated Groups, including the Flagship Affiliated Group and
subsequently created Affiliated Groups. The Loans are guaranteed by the Flagship
Affiliated Group and the Springfield Affiliated Group and must be guaranteed by
any subsequently created Affiliated Group.
The Credit Agreement contains various representations and covenants of
the Company, including a covenant to maintain a minimum amount of accounts
receivable of the Affiliated Groups. Certain other covenants, among other
things, limit the ability of the Company or the Affiliated Groups to (i) amend
or terminate the Stockholders Agreement, the Services Agreements and certain
other agreements set forth in the Credit Agreement, (ii) make capital
expenditures, (iii) sell assets, (iv) incur additional debt, (v) make
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investments or loans, (vi) pay dividends or distributions and (vii) issue
capital stock. In addition, the Company is required to maintain a minimum
earning before interest, taxes, depreciation and amortization ("EBITDA") equal
or exceeding a loss of $830,000 for the fiscal quarter ended March 31, 1997, a
loss of $1.4 million for the six months ended June 30, 1997, a loss of $1.5
million for the nine-months ended September 30, 1997 and a loss of $1.1 million
for the year ended December 31, 1997. The Company had a EBITDA of a loss of
$718,514 for the fiscal quarter ended March 31, 1997. Failure to comply with
such covenants, as well as other events, including a payment default, a default
under certain agreements, a change in control, adverse judgments in excess of
$25,000 and a default under any security documents constitute events of default
under the loans. The Company has not fully complied with certain reporting
obligations under the Credit Agreement; however, the bank has not advised the
Company that a default exists.
In connection with the Credit Agreement, Bankers Trust received a
commitment fee of $157,500, which fee was converted into 63,000 shares of Class
A Common Stock on February 15, 1997.
Governmental Regulation
As a participant in the healthcare industry, the Company's operations
and relationships, and the business and activities of its affiliated physicians,
will be subject to extensive and increasing regulation by a number of
governmental entities at the federal, state and local levels and by fiscal
intermediates appointed by various payors and other private brokers. The Company
will also be subject to laws and regulations relating to business corporations
in general. Because of the uniqueness of the structure of the relationship
with the physician groups, many aspects of the Company's business operations
have not been the subject of state or federal regulatory interpretation, and
there can be no assurance that a review of the business of the Company or its
affiliated physicians by courts or regulatory authorities will not result in a
determination that could adversely affect the operations of the Company or the
affiliated physicians. In addition, there can be no assurance that the
healthcare regulatory environment will not change so as to restrict the
Company's or the affiliated physicians' existing operations or their expansion.
Prohibition on Corporate Practice of Medicine. The laws of most states,
including Massachusetts and Maryland, prohibit business corporations such as the
Company from practicing medicine or employing physicians to do so. The
contractual relationships the Company has entered into with the Affiliated
Groups attempt to comply with these laws. Because there is very limited judicial
or regulatory interpretation of the scope of the corporate practice of medicine
prohibition in most states, however, there can be no assurance that the
Company's contractual arrangements will be found to comply with such laws. Any
determination that the contractual relationships violate such laws could have a
material adverse effect on the Company, and there can be no assurance that the
Company would be able to restructure its arrangements on favorable terms or at
all.
The BRM has proposed regulations that, if promulgated as proposed,
might prohibit physicians licensed within the Commonwealth of Massachusetts from
entering into management contracts with proprietary business entities unless a
majority of the governing board of those business entities are licensed
physicians and certain other conditions are met. The BRM also indicated that it
may seek to limit significantly the extent to which proprietary business
entities may have control or consultation rights with respect to medical
decisions or business decisions that may affect patient care, such as the amount
of time each physician spends with a patient. Extensive commentary has been
filed in opposition to the proposed regulations, and it is not known when or in
what form final regulations will be promulgated. The final regulations may have
a material adverse effect on the Company's relationship with the Springfield
Affiliated Group and its ability to operate in Massachusetts as currently
contemplated. Comparable regulations have not been proposed in Maryland, but
there can be no assurance that such regulations will not be proposed or adopted.
Restrictions on Referrals and Fee-Splitting. In addition to prohibiting
the practice of medicine, numerous states prohibit entities such as the Company
from engaging in certain healthcare-related activities such as fee-splitting
with physicians or from making referrals to entities in which the referring
physician has an ownership interest. For example, Maryland has enacted
legislation that significantly restricts patient referrals for certain services,
and requires disclosure of ownership in businesses to which patients are
referred and places other regulations on healthcare providers. The Company has
structured its arrangements with the practices in the Flagship Affiliation to
fit within the group practice exemption contained in the Maryland act; however,
investments or contractual relationships with businesses not specifically
operated by the Flagship
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Affiliated Group would, in some cases, be prohibited. The Company believes it is
likely that other states will adopt similar legislation. Accordingly, expansion
of the operations of the Company to certain jurisdictions may require it to
comply with such jurisdictions' regulations which could lead to structural and
organizational modifications of the Company's anticipated form of relationships
with physician groups. Such changes, if any, could have an adverse effect on the
Company.
Certain provisions of the Social Security Act, commonly referred to as
the "Anti-kickback Statute," prohibit the offer or receipt of any form of
remuneration in return for the referral of Medicare or state health program
(such as Medicaid) patients, or in return for the recommendation, arrangement,
purchase, lease, or order of items or services that are covered by Medicare or
state health programs. The Anti-kickback Statute is broad in scope and has been
broadly interpreted by courts in many jurisdictions. Read literally, the statute
places at risk many customary business arrangements, potentially subjecting such
arrangements to lengthy, expensive investigations and prosecutions initiated by
federal and state governmental officials. Many states have adopted similar
prohibitions against payments intended to induce referrals of state health
program and other third-party payor patients. While the Company has attempted to
structure its contractual relationships so as to comply with the Anti-kickback
Statute, there can be no assurance that such relationships do in fact comply
with the Anti-kickback Statute given the broad wording of the statute. While the
federal government has promulgated or proposed various "safe harbor" exceptions
to the Anti-kickback Statute, the Company does not expect its operations to fit
within any of the safe harbors. Violation of the Anti-kickback Statute is a
felony, punishable by fines up to $25,000 per violation and imprisonment for up
to five years. In addition, the Department of Health and Human Services may
impose civil penalties excluding violators from participation in Medicare or
state health programs.
Significant prohibitions against physician referrals were enacted by
Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions,
commonly known as "Stark II," amended prior physician self-referral legislation
known as "Stark I" by dramatically enlarging the field of physician-owned or
physician-interested entities to which the referral prohibitions apply. Stark II
prohibits, subject to certain exemptions, a physician or a member of his or her
immediate family from referring Medicare or state health program patients for
"designated health services" to an entity in which the physician has an
ownership or investment interest or with which the physician has entered into a
compensation arrangement including the physician's own group practice. The
designated health services include radiology and other diagnostic services,
radiation therapy services, physical and occupational therapy services, durable
medical equipment, parenteral and enteral nutrients, equipment, and supplies,
prosthetics, orthotics, outpatient prescription drugs, home health services, and
inpatient and outpatient hospital services. The penalties for violating Stark II
include a prohibition on payment by these government programs for services
rendered pursuant to such references and civil penalties of as much as $15,000
for each violative referral and $100,000 for participation in a "circumvention
scheme." In addition, the provider may be disqualified from participating in the
Medicare and state health care programs based on the submission of a false claim
or participation in a circumventive scheme. The Company has attempted to
structure its activities in compliance with Stark I and Stark II. However, the
Stark legislation is broad and the Stark I regulations are complex and do not
provide clear guidance on how Stark II will be interpreted. A finding that the
Company or its Affiliated Groups has violated Stark could have a material
adverse effect on the Company. In addition, future regulations or clarification
of the existing regulations could require the Company to modify the form of its
relationships with physician groups and may limit the Company's ability to
implement fully its plan for integrated care.
Prohibition on False Claims. There are also state and federal civil and
criminal statutes imposing substantial penalties, including civil and criminal
fines and imprisonment, on healthcare providers who fraudulently or wrongfully
bill governmental or other third-party payors for healthcare services. The
federal law prohibiting false billings allows a private person to bring a civil
action in the name of the United States government for violations of its
provisions. There can be no assurance that the Company's activities will not be
challenged or scrutinized by governmental authorities. Moreover, technical
Medicare and other reimbursement rules affect the structure of physician billing
arrangements. Regulatory authorities might challenge the billing arrangements
with the Affiliated Groups and, in such event, the Company may have to modify
its relationship with physician groups. Noncompliance with such regulations may
adversely affect the operation of the Company and subject the Company and
Affiliated Groups to lost reimbursement, penalties and additional costs.
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Direct Provision of Healthcare Services. The Company plans to develop a
network of integrated healthcare services (other than acute care) in the future,
depending on market conditions. If the Company determines that it is
advantageous to provide such services through a wholly-owned subsidiary or other
controlled relationship, it is possible that one or more subsidiaries or
affiliates of the Company could become licensed providers of healthcare
services. Any such provider would have to comply with applicable regulatory
requirements. In addition, the direct provision of healthcare services by a
subsidiary or affiliate might increase the risk to the Company of regulatory or
other investigation or litigation.
Healthcare Reform. A portion of the revenues of the Company's
Affiliated Groups is derived from payments made by governmental sponsored
healthcare programs (principally, Medicare and Medicaid). Government revenue
sources are subject to statutory and regulatory changes, administrative rulings,
interpretations of policy, determinations by fiscal intermediaries, and
government funding restrictions, all of which may materially decrease the rates
of payment and cash flow to physicians and other healthcare providers. The
federal Medicare program adopted a system of reimbursement of physician
services, known as the resource based relative value scale schedule ("RBRVS"),
which took effect in 1992 and is expected to be fully implemented by December
31, 1996. The Company expects that the RBRVS fee schedule and other future
changes in Medicare reimbursement will, in some cases, result in a reduction
from historical levels in the per patient Medicare revenue received by certain
of the Affiliated Groups with which the Company may contract, which in turn may
result in a decrease in revenues to the Company.
In addition to current regulation, the United States Congress has
considered various types of healthcare reform, including comprehensive revisions
to the current healthcare system. It is uncertain what legislative proposals
will be adopted in the future, if any, or what actions federal or state
legislatures or third party payors may take in anticipation of or in response to
any healthcare reform proposals or legislation. Healthcare reform legislation
adopted by Congress could result in lower payment levels for the services of
physicians managed by the Company and lower profitability of the Affiliated
Groups, which could have a material adverse effect on the operations of the
Company.
Insurance Laws. Laws in all states regulate the business of insurance
and the operation of HMOs. Many states also regulate the establishment and
operation of networks of healthcare providers. While these laws do not generally
apply to the hiring and contracting of physicians by other healthcare providers,
there can be no assurance that regulatory authorities of the states in which the
Company operates would not apply these laws to require licensure of the
Company's operations as an insurer, as an HMO or as a provider network.
Antitrust Laws. Because the affiliated practice groups are not
subsidiaries of the Company and thus remain separate legal entities for
antitrust purposes, they may be deemed competitors subject to a range of
antitrust laws which prohibit anti-competitive conduct, including price fixing,
concerted refusals to deal and division of market. The Company intends to comply
with such state and federal laws as they may affect its development of
integrated healthcare delivery networks, but there is no assurance that the
review of the Company's business by courts or regulatory authorities will not
result in a determination that could adversely affect the operation of the
Company and its affiliated physician groups.
Competition
The Company faces competition for both the recruitment and retention of
affiliated physicians. The market for affiliation with physicians is highly
competitive, and the Company expects this competition to increase. The Company
competes for physician affiliations with many other entities, some of whom have
substantially greater resources, greater name recognition and a longer operating
history than the Company and some of whom offer alternative affiliation
strategies which the Company may not be able to offer.
The provision of physician practice management services is a highly
competitive business in which the Company will compete for contracts with
several national and many regional and local providers of such services. Certain
of the Company's competitors will have access to substantially greater resources
than the Company. Although the nature of the competition may vary, competition
is generally based on cost and quality of care.
Legal Proceedings
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On June 12, 1997, Jay N. Greenberg, a founder and former executive vice
president of the Company, filed a complaint against the Company in Massachusetts
state court seeking damages of $1.4 million and a declaratory judgment that
843,750 of the shares registered in Mr. Greenberg's name (out of 1,012,500
shares of Class A Common Stock originally granted to Mr. Greenburg) have
"vested" under this Employment Agreement. The complaint involves a dispute over
whether an amendment in December 1996 to Mr. Greenberg's Employment Agreement is
valid and whether Mr. Greenberg resigned or was terminated in January 1997. The
Company maintains that the amendment was fraudulently induced based upon a
commitment by Mr. Greenberg for long-term employment with the Company and that
Mr. Greenberg resigned in January 1997. Under such facts Mr. Greenberg is
entitled to have no more than 450,000 shares of Class A Common Stock vest (and,
depending upon counterclaims that may be brought by the Company, possible fewer)
and is entitled to no severance payment. Mr. Greenberg claims that 843,750
shares of Class A Common Stock have vested and that his employment was
terminated in January 1997 by the Company entitling him to severance payments of
$440,000. The Company is not able to predict the outcome of this litigation. No
other claims are pending against the Company.
Facilities
The Company leases a 6,358 square foot facility in Waltham,
Massachusetts for its headquarters and also leases office space in Springfield,
Massachusetts and Baltimore, Maryland. The Springfield Affiliated Group also
leases a total of 45,910 square feet at 13 practice locations and the Flagship
Affiliated Group leases a total of 78,191 square feet at 21 practice locations.
The facilities leased by the Company and its Affiliated Groups are sufficient
for its current operations.
Employees
As of March 31, 1997, the Company had 34 employees and the Affiliated
Groups had 553 employees, including 98 physicians.
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MANAGEMENT
Executive Officers and Directors
The executive officers and directors of the Company and their ages as
of June 23, 1997 are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Jerilyn P. Asher.......................54 Chief Executive Officer and Chairman of the Board
Alphonse Calvanese, M.D................45 Director
Leslie Fang, M.D.(1)...................52 Director
Ira Fine, M.D. .....................48 Director
Dana Frank, M.D........................46 President and Director
Arlan F. Fuller, Jr., M.D..............51 Executive Vice President, Medical Affairs and Director
Stephen G. Pagliuca....................42 Director
Marc Wolpow .....................38 Director
Timothy T. Weglicki....................45 Director
Samantha J. Trotman ...................29 Chief Financial Officer
</TABLE>
- -------------------
(1) Member of the Compensation Committee.
There are currently three vacancies on the Board.
Directors, Executive Officers and Other Key Employees
Jerilyn P. Asher is a founder of the Company and has served as Chief
Executive Officer and as Chairman of the Board since its inception. She has over
eighteen years of experience as a healthcare executive in both the public and
private sectors, with broad-based responsibilities for all aspects of
constituency building with physicians and payors, business development, finance,
operations, sales, marketing and federal and state healthcare regulation. From
1994 to 1995, Ms. Asher served as President and a member of the Board of
Directors of Abbey Healthcare Group Incorporated ("Abbey"), a home healthcare
provider. Ms. Asher was a founder and served as President, Chief Executive
Officer and Chairman of the Board of Directors from 1988 to 1995 and Executive
Vice President from 1985 to 1988 of Protocare, Inc., a leading regional provider
of home healthcare products and services. From 1978 to 1984, Ms. Asher served as
Executive Director of United Cerebral Palsy of Western Massachusetts, Inc., a
multi-service agency providing direct care services to persons of all ages with
multiple disabilities.
Alphonse Calvanese, M.D. has been a member of the Board of Directors of
the Company since November 1996 and President of the Springfield Affiliated
Group since August 1996. He has been in the private practice of medicine since
1981. He received his B.S. from the University of Massachusetts and his M.D.
from Tufts Medical School. He completed his internship and residency at Baystate
Medical Center.
Leslie Fang, M.D. has served as a member of the Board of Directors of
the Company and a member of the Board's compensation committee since its
inception. Dr. Fang has been Associate Director of the Hemodialysis Unit,
Massachusetts General Hospital since 1980 and an Assistant Professor of Medicine
at Harvard University Medical School since 1983. He is also Director of the
Charles River Plaza Dialysis Unit and a nationally recognized expert in the
field of nephrology. Dr. Fang received his B.S., M.S. and Ph.D. in physiology
and biophysics from the University of Illinois and his M.D. from Harvard
University Medical School. He completed his internship and residency at
Massachusetts General Hospital.
Ira Fine, M.D. has been a member of the Board of Directors of the
Company since November 1996. He has been in the private practice of medicine for
16 years and has been the Chief, Division of Rheumatology at Sinai Hospital
since 1988 and St. Joseph Medical Center in Baltimore since 1992. He is the
Chairman of the Board of The Physician Group. He is also an Assistant Professor
of Medicine at the University of Maryland School of Medicine and an Assistant
Professor of Medicine at the Johns Hopkins University School of Medicine. He
received his B.S. from the Virginia Polytechnic Institute and his M.D. from
University of Maryland School of Medicine. He completed his internship at
University of Maryland Hospital/Baltimore
49
<PAGE>
Veterans Administration Hospital, his residency at University of Maryland
Hospital and a fellowship in rheumatology at the Johns Hopkins University School
of Medicine.
Dana Frank, M.D. has been President of the Company since March 1997 and
the Flagship Affiliated Group since December 1996 and has served as a member of
the Board of Directors of the Company since November 1996. He has been in the
private practice of medicine since 1981 and is President of Park Medical
Associates, P.A. He is an Assistant Professor at the Johns Hopkins University
School of Medicine and has been a Consulting Internist and Headache Specialist
at the Johns Hopkins University School of Medicine since 1981. He has also
served on the Johns Hopkins Hospital Medical Board. He received his A.B. from
Brown University and his M.D. from George Washington University. He completed
his internship and residency at Johns Hopkins Hospital.
Arlan F. Fuller, Jr., M.D. has served as Executive Vice President of
Medical Affairs and a member of the Board of Directors of the Company since its
inception. He also co-chairs the Company's National Medical Advisory Board, and
is responsible for organizing and directing the company's clinical systems. Dr.
Fuller has been an Associate Professor of Obstetrics and Gynecology at Harvard
University Medical School since 1987 and has been the Director of the
Gynecologic Oncology Service of Massachusetts General Hospital since 1985. Dr.
Fuller maintains a practice in gynecologic surgery and gynecologic oncology at
the Massachusetts General Hospital and is affiliated with the North Shore Cancer
and Medical Centers in Peabody and Salem, Massachusetts. In 1988, Dr. Fuller was
a founder and served as President of Massachusetts General Physicians
Corporation, the first organized physician group at the Massachusetts General
Hospital and a forerunner to the Massachusetts General Physicians Organization,
which manages group practices at the Massachusetts General Hospital. Previously,
Dr. Fuller was a member of the Board of Trustees of Partners Community
Healthcare, Inc., the primary care network and integrated health system which
includes the Massachusetts General Hospital and Brigham and Women's Hospital.
Dr. Fuller received his undergraduate degree from Bowdoin College and his M.D.
from Harvard University Medical School. He completed his internship at
Massachusetts General Hospital, his residencies at the former Boston Hospital
for Women (now the Brigham and Women's Hospital) and a fellowship in
gynecological oncology at Sloan-Kettering Memorial Cancer Center.
Stephen G. Pagliuca has been a member of the Board of Directors of the
Company since August 1996. He has been with Bain Capital, Inc., where he is a
Managing Director, since 1989, and has actively invested in the medical and
information industries. Prior to joining Bain Capital, Inc., he was a partner at
Bain & Company, where he managed client relationships in the healthcare and
information services industries, including assisting clients in developing
acquisition strategies. He is chairman of the board of PhysioControl Corporation
and Dade International, Inc. and a director of Vivra, Inc., Coram Healthcare,
Gartner Group, Executone, Medical Specialities Group and Wesley-Jessen.
Marc Wolpow has been a member of the Board of Directors of the Company
since August 1996. He joined Bain Capital, Inc. in 1990 and has been a Managing
Director since 1993. Previously he was a member of the corporate finance
department of Drexel Burnham Lampert, Inc. He is a director of American Pad &
Paper Corp., Miltex Instruments, Inc., Professional Services Industries, Inc.,
Paper Acquisition Corp. and Waters Corp.
Timothy T. Weglicki has been a member of the Board of Directors of the
Company since June 1997. Mr. Weglicki has been a principal with ABS Partners II,
L.L.C., the general partner of ABS Capital Partners II, L.P., a private equity
fund, and related entities since December 1993. Prior to joining ABS Partners,
he was a Managing Director of Alex Brown & Sons, Inc., where he established and
headed its Capital Markets Group and prior thereto headed the Firm's Equity
Division, Corporate Finance Department, and Health Care Investment Banking
Group. Mr. Weglicki holds an M.B.A. from the Wharton Graduate School of Business
and a B.A. from the John Hopkins University. He is a director of VitalCom, Inc.
and several privately held companies.
Samantha J. Trotman has served as Chief Financial Officer since
December 1996. She is responsible for all financial functions and physician
affiliation activities. She is also a member of the senior management team. Ms.
Trotman joined PQC from Bain Capital, where she was a senior associate. While at
Bain Capital, she managed and completed over a dozen transactions with combined
value of approximately $500 million, including the $30 million capital
commitment to the company. Prior to joining Bain Capital, Ms. Trotman was an
analyst with Wasserstein Perella, a leading mergers and
50
<PAGE>
acquisitions advisory firm. Ms. Trotman holds a BA in Engineering from Cambridge
University, England, an MA and MEng also from Cambridge and an MBA from Harvard
Business School.
Ann M. Keehn has served as Vice President of Finance since February
1997. Prior to joining PQC, Ms. Keehn was Director, Health Services Management
Consulting for John Snow, Inc. ("JSI"), an international health care consulting
firm. During her eight years with JSI, Ms. Keehn provided management consulting
services to a wide array of health care provider organizations including
integrated delivery systems, physician practices, community health centers, and
hospitals. Consulting engagement areas included strategic planning, affiliation
strategies, financial management under capitation arrangements, and operational
effectiveness. From 1988 to 1995, Ms. Keehn served as the chief financial
officer and interim chief executive officer for Acton Medical Associates, a
primary group practice affiliated with Harvard Pilgrim (formerly Harvard
Community Health Plan). Ms. Keehn has also held financial positions with
Children's Hospital and Brigham and Women's Hospital in Boston. Ms. Keehn worked
for Price Waterhouse from 1978 to 1981. She is a certified public accountant and
a member of the Massachusetts Society of CPAs. Ms. Keehn received her BA in
Accounting from Kansas State University and her Masters in Business
Administration from the University of Texas.
Director Compensation
Historically, members of the Board of Directors of the Company have not
received any cash compensation for their services as members of the Board,
although they are reimbursed for reasonable travel expenses while attending
Board and Committee meetings.
Executive Compensation
The following table sets forth compensation earned by (i) the Company's
Chief Executive Officer and (ii) the other executive officer of the Company
whose compensation during 1996 was greater than $100,000 (collectively, the
"Named Executive Officers"):
<TABLE>
<CAPTION>
Long-Term
1996 Annual Compensation Compensation All Other
Name and Principal Position Salary($) Bonus ($) Awards (1) Compensation($)
- --------------------------- --------------- ------------- ---------- ---------------
<S> <C> <C> <C> <C>
Jerilyn P. Asher........................... 250,000 --- --- 9,647(2)
Chief Executive Officer
Arlan F. Fuller, Jr., M.D.(3).............. 170,192 --- --- ---
Executive Vice President, Medical
Affairs
Jay Greenberg (5).......................... 220,000 --- --- 6,935(2)
Former Executive Vice President
Samantha J. Trotman........................ 4,808(4) --- --- ---
Chief Financial Officer
Nancy J. Kelley (6)........................ 18,333 55,000 --- 216,907(7)
Former Executive Vice President
</TABLE>
- --------------------
<TABLE>
<S> <C>
(1) The Company granted Jerilyn P. Asher, Arlan F. Fuller and Jay Greenberg
shares of restricted stock as described below in "--Employment
Agreements." The Company did not grant any stock appreciation rights
during the year ended December 31, 1996. The Company did not grant any
stock options to the Named Executive Officers nor did they exercise any
options during the year ended December 31, 1996. The Company does not
have any long-term incentive plans.
(2) Represents amounts paid in connection with an automobile allowance and
compensatory group life insurance premiums.
</TABLE>
51
<PAGE>
(3) Dr. Fuller has advised the Company that he will reduce his base annual
salary to $50,000 beginning in December 1996 reflecting a reduction on
the amount of time he anticipates attending to Company matters compared
to his other professional obligations.
(4) Amount based on annual salary of $125,000 from December 16, 1996.
(5) Mr. Greenberg resigned as an officer and director of the Company in
January 1997.
(6) Ms. Kelley ceased to be an officer of the Company in January 1996. The
bonus was paid in 1996 but is based upon services to the Company during
1995.
(7) Represents severance compensation due to Ms. Kelly in connection with
the termination of her employment agreement.
Employment Agreements
The Company has entered into the following employment agreements with
Jerilyn P. Asher and Arlan F. Fuller.
The Company is a party to an employment agreement with Ms. Asher
pursuant to which Ms. Asher serves as Chief Executive Officer of the Company for
the three-year period ending June 21, 1998. The term of the agreement will be
automatically extended for successive one-year terms, unless the Company
notifies Ms. Asher to the contrary at least 90 days prior to the expiration of
the then current term. For her services, Ms. Asher is entitled to an initial
base salary of $250,000 per year (subject to periodic increases as determined by
the Board) and is eligible to receive bonuses under the Company's management
incentive program, if such a program is adopted, in an amount up to 100% of her
base pay based upon individual and Company performance. Pursuant to an amendment
to the employment agreement dated August 30, 1996, Ms. Asher waived the right to
receive any unpaid amounts of base salary and bonus to which she was entitled
and had not received as of August 1, 1996. Ms. Asher is also entitled to receive
other benefits available to the Company's senior management generally. Pursuant
to a stock restriction agreement executed as of the date of the employment
agreement, the Company issued 4,162,500 shares of Series A Common Stock to Ms.
Asher at a purchase price of $.01 per share, 346,875 of which remain subject to
vesting if Ms. Asher maintains her employment with the Company until June 1998,
which vesting will be accelerated in the event of a Change in Control. A Change
in Control is defined to include a person or group becoming the beneficial owner
of 50% or more of the outstanding voting securities of the Company, certain
changes to the composition of the Board of Directors, certain mergers and a
liquidation of the Company. A percentage of the vested shares (50% in the case
of termination for cause and 35% in the case of voluntary termination) are
subject to the Company's repurchase rights in certain circumstances, including
termination of Ms. Asher for "cause" or Ms. Asher's voluntary resignation, at
the fair market value at the time of repurchase.
The Company may terminate Ms. Asher's employment at any time without
cause and upon 10 days' written notice with cause. Ms. Asher may terminate her
employment for any reason upon 90 days' written notice. If Ms. Asher's
employment is terminated by the Company without cause, or if Ms. Asher
terminates her employment for good reason, the Company must pay Ms. Asher an
amount equal to two times her annual salary. Cause, for purposes of the
termination provisions, means willful and continued failure to perform her
duties, willful engagement in misconduct materially injurious to the Company or
her conviction for a felony, fraud or embezzlement of the Company's property. In
addition, the Company must also make such payment if Ms. Asher's employment is
terminated at any time within 24 months after a "Change in Control" for any
reason other than (i) death or disability, (ii) by the Company for Cause or
(iii) by Ms. Asher other than for Good Reason.
During the term of the agreement, the Company must nominate Ms. Asher
to and Ms. Asher will be eligible to serve on the Board of Directors. Ms. Asher
also agreed to standard non-competition and non-disclosure terms with the
Company.
The Company is also party to an employment agreement with Dr. Fuller,
pursuant to which Dr. Fuller serves as Executive Vice President, Medical
Information Systems and Academic Development of the
52
<PAGE>
Company for the three-year period ending June 20, 1998. The term of the
agreement will be automatically extended for successive one-year terms, unless
the Company notifies Dr. Fuller to the contrary at least 90 days prior to the
expiration of the then current term. Dr. Fuller was required to devote 40% of
his time to the Company and, for such services, was entitled to an initial base
salary of $175,000 per year (subject to periodic increases as determined by the
Board). Dr. Fuller reduced his base annual salary to $50,000 beginning in
December 1996. Pursuant to a stock restriction agreement executed as of the date
of the employment agreement, the Company issued 618,750 shares of Common Stock
to Dr. Fuller at a purchase price of $.01 per share. These shares are subject to
vesting based on individual performance and duration of employment, which
vesting will be accelerated in the event of a "Change in Control." The Company
may terminate Dr. Fuller's employment at any time with cause and upon 60 days'
notice without cause. Dr. Fuller may terminate his employment for any reason
upon 60 days' written notice.
During the term of the agreement, the Company must nominate Dr. Fuller
to and Dr. Fuller will be eligible to serve on the Board of Directors. Dr.
Fuller also agreed to standard non-competition and non-disclosure terms with the
Company.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Directors generally consists
of two non-employee directors. Dr. Fang is currently the only member. The
Compensation Committee makes recommendations to the Board of Directors
concerning salaries and incentive compensation for employees of and consultants
to the Company. No interlocking relationships exists between any member of the
Compensation Committee and any member of any other company's board of directors
or compensation committee.
1995 Equity Incentive Plan
The Company's 1995 Equity Incentive Plan (the "1995 Plan") was adopted
by the Board of Directors and approved by the stockholders of the Company in
June 1995. The 1995 Plan provides for the grant of stock options and the
issuance of shares of restricted stock to employees, officers and directors of,
and consultants or advisers to, the Company and its subsidiaries. Under the 1995
Plan, the Company may grant options that are intended to qualify as incentive
stock options within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended (the "Code") ("incentive stock options"), or options not
intended to qualify as incentive stock options ("non-statutory options").
Incentive stock options may only be granted to employees of the Company.
A total of 1,875,000 shares of Class A Common Stock (adjustable up or
down in response to a change in the number of outstanding shares of Class A
Common Stock due to any merger, consolidation, reorganization, recapitalization,
reclassification, stock dividend, stock split or other similar transaction) may
be issued under the 1995 Plan. In the event that additional securities of the
Company are to be issued in connection with future affiliation transactions, the
Company may initially use such authorized but unissued shares. The maximum
number of shares with respect to which options or awards may be granted to any
employee under the 1995 Plan in any calendar year shall not exceed 500,000
shares of Class A Common Stock. Additionally, for so long as the Code shall so
provide, incentive stock options granted to an employee under the 1995 Plan will
not, in any calendar year, have an aggregate fair market value of more than
$100,000. If not previously terminated, the 1995 Plan will terminate on June 20,
2005 and options still outstanding at that time will continue to have force and
effect in accordance with the provisions of the instruments evidencing such
options.
The 1995 Plan is administered by the Board of Directors whose duties
are delegable to a committee. Subject to the provisions of the 1995 Plan, the
Board of Directors has the authority to select the employees to whom options are
granted and awards of restricted stock are made and determine the terms of each
option or award, including (i) the number of shares subject to the option or
award, (ii) the vesting schedule of the option or award, (iii) the option
exercise price, which, in the case of incentive stock options, must be at least
100% (110% in the case of incentive stock options granted to a shareholder
owning in excess of 10% of the Company's Class A Common Stock) of the fair
market value of the Class A Common Stock as of the date of grant, and (iv) the
duration of the option (which, in the case of incentive stock options, may not
exceed five years if granted to a shareholder owning in excess of 10% of the
Company's Class A Common Stock or ten years for all other recipients). As a
condition to the grant of an option under the 1995 Plan, each recipient of an
option must
53
<PAGE>
execute an option agreement, which may differ among recipients. The 1995 Plan
may be modified, amended or terminated at any time by the Board of Directors but
such a modification, amendment or termination will not, without the consent of
the optionee or recipient affect his or her rights under any option or award
previously granted to him or her. In addition, the Board of Directors may, in
its sole discretion (i) include additional provisions in any option or award
granted or made under the 1995 Plan (including restrictions on transfer,
repurchase rights, commitments to pay cash bonuses, to make or guarantee loans
or to transfer other property to optionees upon exercise of options, or such
other provisions as may be determined by the Board of Directors) so long as such
provisions are not inconsistent with the 1995 Plan or applicable law and (ii)
accelerate or extend dates on which options granted under the 1995 Plan may be
exercised.
Payment of the option exercise price may be made in cash and/or Common
Stock or by any other method (including delivery of a promissory note payable on
terms approved by the Board of Directors and consistent with Section 422 of the
Code, Rule 16b-3 under the Securities Exchange Act of 1934, as amended, and
Regulation T promulgated by the Federal Reserve Board). Options are not
assignable or transferable except by will or the laws of descent and
distribution and, in the case of non-statutory options, pursuant to a qualified
domestic relations order (as defined in the Code).
As of March 31, 1997, the Company had 34 employees, all of whom were
eligible to participate in the 1995 Plan. As of March 31, 1997, options to
purchase an aggregate of 574,836 shares of Class A Common Stock were outstanding
pursuant to the 1995 Plan.
CERTAIN TRANSACTIONS
Through June 20, 1997, pursuant to the Equity Facility, the
institutional investors affiliated with Bain Capital purchased an aggregate of
4,600,000 shares of Class B Common Stock and warrants exercisable for 6,415,000
shares of Class B Common Stock for an aggregate purchase price of $11,500,000.
On June 23, 1997, the Company issued 7,692,309 shares of Class C Common Stock
and Warrants to purchase 7,692,309 shares of Class C Common Stock to the
Institutional Investors for an aggregate consideration of $25 million. See
"Business -- The Equity Financing." In connection with the Bain Financing, the
Company entered into a Management Agreement dated as of August 30, 1996 with BCP
V, pursuant to which the Company will pay BCP V (or an affiliate designated by
BCP V) a management fee of $750,000 per year, plus 1% of any financings from
parties other than affiliates of Bain Capital, for services including advice in
connection with financings and financial, managerial and operational advice in
connection with day-to-day operations (the "Management Agreement"). The Company
is also obligated to pay certain expenses, not to exceed $250,000 per year
without the Company's consent, of BCP V, Bain Capital and the Institutional
Investors in connection with the Management Agreement. Each of Stephen G.
Pagliuca and Marc Wolpow is a Director of the Company, a limited partner of BCP
V, which is the general partner of Bain Capital Fund V, L.P. and Bain Capital
Fund V-B, L.P., and a general partner of BCIP Associates, L.P. and BCIP Trust
Associates, L.P., and a Managing Director of Bain Capital, which manages each of
the Institutional Investors.
Alphonse Calvanese, M.D., is a director of the Company and transferred
his practice to the Springfield Affiliated Group for which he received his
allocable portion of the $11.8 million total consideration paid to the
physicians who transferred their practices to the Springfield Affiliated Group.
Ira Fine, M.D. and Dana Frank, M.D., each a Director of the Company,
are members of medical practice groups which transferred their practice assets
to the Flagship Affiliated Group in the Flagship Affiliation. Upon consummation
of the Flagship Affiliation, Dr. Fine received his allocable share of the total
consideration of $566,580 payable to his existing practice group, and Dr. Frank
received his allocable share of the total consideration of $3,647,064 payable to
his existing practice group.
PLAN OF DISTRIBUTION
Shares of Common Stock will be offered in connection with PQC's (or an
Affiliated Group's) acquisition of businesses, properties or equity and/or debt
securities in business combination transactions from
54
<PAGE>
time to time. A maximum of 8,000,000 shares of Common Stock may be issued and
sold pursuant to this Prospectus of this amount, 4,800,000 are being issued in
connection with the Clinical Associates transaction and 3,200,000 may be issued
in connection with future Affiliations. These shares will ordinarily represent
all or part of the consideration paid upon affiliation of a physician practice
with the Company or its Affiliated Groups through business combination
transactions. The shares may also include shares to be delivered upon the
exercise or satisfaction of conversion or purchase rights which are created in
connection with acquisitions or which were previously created or assumed by the
companies whose businesses or properties are acquired by PQC (or its Affiliated
Group). The number of shares of Common Stock to be issued in any Affiliation, as
well as the valuation of such shares, are determined on a case by case basis as
a result of arms-length negotiation between PQC and the physicians in the
practice group affiliating with the Company. In determining the value of a
practice to the Company, PQC considers factors such as the historical revenues
of the practice, underutilization of patient care capacity, location, patient
base, participation in managed care contracts, the mix between primary care and
physicians with a specialist practice and the potential for successful
integration into the Affiliated Group.
55
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth the number of shares of capital stock of
the Company beneficially owned as of June 30, 1997 by (i) each owner who is
known by the Company to beneficially own 5% or more of any class of voting
stock, (ii) each of the Company's directors, (iii) each of the Company's Named
Executive Officers and (iv) all directors and executive officers as a group.
Except as otherwise indicated, the named owner has sole voting and investment
power with respect to all shares beneficially owned.
<TABLE>
<CAPTION>
Class A Common Stock (2) Class B Common Stock(2) Class C Common Common Stock(1)(2)
------------------------ ---------------------- Stock(2) -----------------
---------------
Number
------
Number Percent of Number Percent of Number Percentage of
Name and Address of Class of Class of of Common
of Beneficial Owner Shares Outstanding Shares Outstanding Shares Class Stock
------------------- ------ ----------- ------ ----------- ------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Bain Funds(3)(4)................... --- --- 11,015,000 100.0% 3,076,924 33.3% 14,091,924
c/o Bain Capital, Inc.
Two Copley Place
Boston, Massachusetts 02116
Goldman Sachs Funds(3)(4).......... --- --- --- --- 3,076,924 33.3% 3,076,924
c/o Goldman Sachs & Co.
85 Broad Street
New York, NY 10004
ABS Capital Partners II, L.P.(3)(5) --- --- --- --- 9,160,004 74.6% 9,160,004
One South Street
Baltimore, MD 21201
Offshore Health Industries, Inc.(6) 1,582,500 7.5% --- --- --- --- 1,582,500
Two Park Plaza
Boston, MA 02116
Jerilyn P. Asher (7)............... 4,318,748 20.7% --- --- --- --- 4,318,748
Arlan F. Fuller, Jr., M.D.......... 618,750 3.0% --- --- --- --- 618,750
Samantha J. Trotman (8)............ --- --- 1,729,016 15.6% --- --- 1,729,016
Alphonse Calvanese, M.D (11)....... 512,382 2.4% --- --- --- --- 512,382
Leslie Fang, M.D................... --- --- --- --- --- --- ---
Ira Fine, M.D...................... 113,316 * --- --- --- --- 113,316
Dana Frank, M.D (11)............... 472,904 2.2% --- --- --- --- 472,904
Stephen G. Pagliuca(3)(9).......... --- --- 11,015,000 100.0% 3,074,924 33.3% 14,091,924
Marc Wolpow(3)(9).................. --- --- 11,015,000 100.0% 3,074,924 33.3% 14,091,924
Timothy T. Weglicki(10)............ --- --- --- --- 9,160,004 74.6% 9,160,004
All directors and executive officers
as a group (9 persons)(5) (14,985,600
(1)(3)(6) shares or 54.8% assuming
conversion of Class B Common Stock
into Class A Common Stock)......... 6,036,100 28.1% --- ---
<CAPTION>
Percentage
----------
of
--
Common
Name and Address ------
of Beneficial Owner Stock
------------------- -----
<S> <C>
Bain Funds(3)(4)................... 40.6%
c/o Bain Capital, Inc.
Two Copley Place
Boston, Massachusetts 02116
Goldman Sachs Funds(3)(4).......... 8.8%
c/o Goldman Sachs & Co.
85 Broad Street
New York, NY 10004
ABS Capital Partners II, L.P.(3)(5) 24.3%
One South Street
Baltimore, MD 21201
Offshore Health Industries, Inc.(6) 4.7%
Two Park Plaza
Boston, MA 02116
Jerilyn P. Asher (7)............... 13.0%
Arlan F. Fuller, Jr., M.D.......... 1.9%
Samantha J. Trotman (8)............ 5.1%
Alphonse Calvanese, M.D (11)....... 1.5%
Leslie Fang, M.D................... *
Ira Fine, M.D...................... *
Dana Frank, M.D (11)............... 1.4%
Stephen G. Pagliuca(3)(9).......... 40.7%
Marc Wolpow(3)(9).................. 40.7%
Timothy T. Weglicki(10)............ 24.3%
All directors and executive officers
group (9 persons)(5) (14,985,600
(1)(3)(6) shares or 54.8% assuming
conversion of Class B Common Stock
into Class A Common Stock)...........
</TABLE>
- --------------------------------
*Less than 1%.
(1) Reflects the percentage of shares of Class A, Class B and Class C
Common Stock. The Class B and Class C Common Stock of the Company are
convertible at the option of the holder into Class A Common Stock.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that
person,
56
<PAGE>
shares of the Company's capital stock subject to options or warrants held by
that person that are exercisable on or before August 30, 1997 are deemed
outstanding. Such shares, however, are not deemed outstanding for purposes of
computing the ownership of each other person.
(3) Does not include 6,153,846 shares of Class C Common Stock or warrants to
purchase 6,153,846 shares of Class C Common Stock which the Institutional
Investors are entitled to purchase pursuant to the Equity Facility.
(4) Includes warrants to purchase 1,538,462 shares of Class C Common Stock.
(5) Includes warrants to purchase 4,580,002 shares of Class C Common Stock.
(6) Includes warrants to purchase 332,500 shares of Class A Common Stock.
(7) Includes warrants to purchase 52,082 shares of Class A Common Stock.
(8) Includes an aggregate of 722,059 shares of Class B Common Stock and
1,006,957 shares of Class B Common Stock issuable upon outstanding
warrants held by BCIP Associates and BCIP Trust Associates. Ms. Trotman
is a general partner of BCIP Associates and BCIP Trust Associates. As
such, Ms. Trotman may be deemed to own beneficially shares owned by BCIP
Associates and BCIP Trust Associates, although Ms. Trotman disclaims
beneficial ownership of any such shares.
(9) Includes an aggregate of 4,600,000 shares of Class B Common Stock
beneficially owned by the institutional investors affiliated with Bain
Capital (11,015,000 shares on a fully diluted basis) and 1,538,426 shares
of Class C Common Stock (3,076,924 on a fully diluted basis). Each of Mr.
Pagliuca and Mr. Wolpow is a Managing Director of Bain Capital, which
manages each of the institutional investors. Bain Capital is a limited
partner in the partnership which is the general partner of Bain Capital
Fund V, L.P. and Bain Capital Fund V-B, L.P., and a general partner of
BCIP Associates and BCIP Trust Associates. As such, Messrs. Pagliuca and
Wolpow may be deemed to own beneficially shares owned by such
institutional investors, although each of Mr. Pagliuca and Mr. Wolpow
disclaims beneficial ownership of any such shares.
(10) Includes 4,615,385 shares of Class C Common Stock (9,230,770 shares of
Class C Common Stock on a fully diluted basis) beneficially owned by ABS
Capital Partners II, L.P. Mr. Weglicki is a managing member of ABS
Partners II, L.L.C., which manages ABS Capital Partners II, L.P. As such
Mr. Weglicki may be deemed to own beneficially shares owned by ABS
Capital Partners II, L.P., although Mr. Weglicki disclaims beneficial
ownership of such shares.
(11) Includes options to purchase 300,000 shares of Class A Common Stock.
57
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 10,000,000 shares
of Preferred Stock, $.01 par value per share, and 140,000,000 shares of common
stock, $.01 par value per share, of which (i) 101,292,691 shares are designated
as Class A Common Stock, (ii) 6,727,043 shares are designated as Class B-1
Common Stock, and (iii) 4,287,957 shares are designated as Class B-2 Common
Stock and 27,692,309 are designated as Class C Common Stock. As of June 30,
1997, there were issued and outstanding (i) 20,819,665 shares of Class A Common
Stock held by approximately 166 stockholders, (ii) 2,809,296 shares of Class B-1
Common Stock and 1,790,704 shares of Class B-2 Common Stock held by 4
stockholders and (iii) 7,692,309 shares of Class C Common Stock held by 21
stockholders. There were no outstanding Shares of Preferred Stock.
Class A Common Stock, Class B Common Stock and Class C Common Stock
Except as otherwise provided below, all shares of Class A Common Stock,
Class B Common Stock and Class C Common Stock are identical in all respects and
entitle the holders thereof to the same rights, privileges and preferences and
are subject to the same qualifications, limitations and restrictions. Holders of
the Class A Common Stock, the Class B Common Stock or Class C Common Stock are
entitled to one vote per share with respect to all matters to be voted on by the
stockholders of the Company and do not have cumulative voting rights. There are
no sinking fund provisions with respect to any of the Company's Class A Common
Stock, Class B Common Stock or Class C Common Stock. No distribution (whether in
cash, securities or otherwise) may be made in respect of any class of Common
Stock or the Class B Common Stock unless an equivalent distribution is made with
respect to each outstanding share of the other classes.
Subject to the special voting rights of the Class B and Class C Directors
and the approval rights of the Institutional Investors described below, the
Board of Directors of the Company may, at any time, without any vote of the
holders of the Company's capital stock, issue all or any part of the unissued
capital stock of the Company from time to time authorized under the Restated
Certificate and may determine, subject to any requirements of law, the
consideration for which such stock is to be issued and the manner of allocating
such consideration between capital and surplus.
Class B Common Stock. Shares of Class B Common Stock are convertible into
shares of Class A Common Stock at the option of the holder, and automatically
convert into shares of Class A Common Stock upon the earlier of a "Qualified
Public Offering" or a reduction in the number of shares of Class B Common Stock
below certain thresholds. A "Qualified Public Offering" is a public offering (i)
in which the net proceeds of the sale of such shares by the Company and any
stockholder of the Company equal or exceed $50.0 million, provided that the net
proceeds of the sale thereof to the Institutional Investors equal or exceed the
greater of (x) fifty percent of the purchase price paid by the Institutional
Investors in any closing under the Equity Facility or (y) $45.0 million; and
(ii) involving a firm commitment underwriting by a nationally recognized
underwriter acceptable to the Class B and Class C Directors (as defined below).
In any such conversion, each outstanding share of Class B Common Stock converts
into the number of shares of Class A Common Stock determined by application of
the conversion ratio in effect, which was one as of June 23, 1997, subject to
adjustment in order to reflect any stock dividends, stock splits, reverse stock
splits, reorganizations or recapitalizations of the Company's capital stock.
Class C Common Stock. Shares of Class C Common Stock are convertible into
Class A Common Stock at the option of the holder and automatically convert into
Class A Common Stock upon the earlier of a Qualified Public Offering or a
reduction in the number of shares of Class C Common Stock below certain
thresholds. In any such conversion, each outstanding share of Class C Common
Stock converts into the number of shares of Class A Common Stock determined by
application of the conversion ratio in effect, which was one as of June 23,
1997, subject to adjustments (i) in order to reflect any stock dividends, stock
splits, reverse stock splits, reorganization or recapitalization of the
Company's Capital Stock, (ii) to prevent dilution for the issuance or sale of
rights or options below the then applicable conversion price or (iii) upon the
sale of any class of Common Stock at a price less than the then applicable
conversion price. The Class
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C Common Stock is entitled to a distribution upon liquidation (including a
deemed liquidation upon certain mergers) in preference to any other class of
Company Common Stock equal to the greater of $3.25 per share or the amount to be
distributed with respect to each share of Class A or Class B Common Stock.
Election of Directors. The holders of the Class A Common Stock, voting
separately as a single class, are entitled to elect two of the thirteen
directors of the Company (each, a "Class A Director"), there currently being
three vacancies. Any vacancy in the seats held by the Class A Directors shall be
filled only by vote of a majority of the outstanding shares of Class A Common
Stock, and no Class A Director may be removed without the consent of a majority
of the holders of the Class A Common Stock. The Company may not in any manner
subdivide or increase (by stock split, stock dividend or other similar manner)
reclassify or combine in any manner the outstanding shares of Class A Common
Stock unless a proportional adjustment is made to the Class B Conversion Factor.
The holders of the Class B-1 Common Stock, voting separately as a single
class, are entitled to elect one of the eleven directors of the Company, the
Class B-1 Director and the holders of the Class B-2 Common Stock, voting
separately as a single class, are entitled to elect one director of the Company,
the Class B-2 Director. Any vacancy in the seats held by the Class B Directors
shall be filled only by vote of a majority of the outstanding shares of Class
B-1 Common Stock or Class B-2 Common Stock, as applicable, and no Class B
Director may be removed without the consent of a majority of the holders of the
Class B-1 Common Stock or Class B-2 Common Stock, as applicable. The Company may
not in any manner subdivide or increase (whether by stock split, stock dividend
or other similar manner), reclassify or combine in any manner the outstanding
shares of the Class B Common Stock unless a proportional adjustment is made to
the Common Stock.
The holders of Class C Common Stock are entitled to elect two directors
(with one position to remain vacant until the remaining amount to be purchased
by affiliates of Goldman, Sachs & Co. under the Equity Facility is drawn down).
Any vacancy in the seats held by the Class C Directors shall only be filled by
holders of a majority of the shares of Class C Common Stock. The Company may not
in any manner subdivide or increase (whether by stock split, stock dividend or
other similar manner), reclassify or combine in any manner the outstanding
shares of the Class C Common Stock unless a proportional adjustment is made to
the Common Stock.
The holders of the Class A Common Stock, the Class B Common Stock and
Class C Common Stock, voting together as a single class, are entitled to elect
seven of the thirteen directors of the Company (each, a "Common Stock
Director"). Any vacancy in the seats held by the Common Stock Directors shall be
filled only by vote of a majority of the outstanding shares of Company Common
Stock, and no Common Stock Director may be removed without the consent
of a majority of the holders of Company Common Stock. Except as provided below,
each director of the Company is entitled to one vote on all matters to be voted
on by the directors, and the directors vote together as a single class on all
matters.
Pursuant to the Stockholders Agreement, the Institutional Investors and
the Class A Common Stockholders who are parties to such agreement are required
to elect as Class A Directors two individuals who are employees of the Company
and are selected by the Chief Executive Officer and seven other Directors who
are physicians and are selected by the Chief Executive Officer and approved by
the Institutional Investors. See " -- Stockholders' Agreement."
Special Rights of Class B and Class C Directors. The Class B Directors
are entitled to one vote on any matter before the Board of Directors, except
that each Class B and Class C Director is entitled to five votes (providing the
Class B and Class C Directors with a majority of the voting power of the Board)
(i) with respect to any Class B and Class C Director Action and (ii) with
respect to all matters in the event that any Class B and Class C Director
Control Event remains uncured.
"Class B and Class C Director Actions" include (i) the issuance,
redemption or similar disposition of capital stock or securities convertible
into capital stock of the Company or any of its subsidiaries or affiliates
(including its Affiliated Groups), (ii) the declaration of dividends or other
distributions in respect of the capital stock of the Company or any of its
subsidiaries or affiliates (including its Affiliated Groups), (iii) the
incurrence of indebtedness by the Company or any of its subsidiaries or the
incurrence of material indebtedness by any
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of its affiliates (including its Affiliated Groups), (iv) a merger, sale,
liquidation or similar transfers involving the Company or any of its
subsidiaries or affiliates (including its Affiliated Groups), (v) public
offerings, (vi) material amendments to any management or similar agreement by
the Company or any of its subsidiaries with its affiliates (including its
Affiliated Groups) or with the shareholder of any of its Affiliated Groups and
(vii) the employment, termination and compensation of the Chief Executive
Officer.
"Class B and Class C Director Control Event" means any of the following:
(i) the Company fails to achieve 75% of a financial plan, if any, provided by
the Board (including the Class B and Class C Directors) for two consecutive
fiscal quarters or 50% of such a plan for one fiscal quarter; (ii) Jerilyn Asher
is no longer employed on a full time basis as Chief Executive Officer for any
reason other than her employment having been terminated without Cause (as
defined in the Restated Certificate) or (iii) the Company shall have taken a
"Restricted Action" (as described below) without the prior approval of the
Institutional Investors. No financial plan has been currently approved by the
Board.
Certain "Restricted Actions," in addition to being approved by the Board
of Directors, must be approved by the Institutional Investors. Restricted
Actions include (without limitation) (i) a merger, sale, liquidation or similar
transaction involving disposition of all, substantially all, or a material part
of, the property, business or assets of the Company or any of its subsidiaries
or affiliates (including its Affiliated Groups), (ii) any agreement by the
Company or any of its subsidiaries or affiliates (including its Affiliated
Groups) for an acquisition or affiliation transaction (other than acquisitions
or affiliations not in excess of $1 million in any 12-month period), (iii)
dividends and other distributions by the Company or any of its subsidiaries,
(iv) any material change in the business of the Company or any of its
subsidiaries or affiliates (including its Affiliated Groups), (v) any amendment
to the charter or by-laws of the Company or its subsidiaries, (vi) retention or
dismissal of the Chief Operating Officer or Chief Financial Officer of the
Company, (vii) transactions by the Company or any of its subsidiaries with
affiliates (including its Affiliated Groups) and (viii) commencement and
management of any material litigation.
The Restated Certificate provides that upon conversion of all outstanding
shares of Class B Common Stock and Class C Common Stock into Class A Common
Stock, the holders of the Class A Common Stock will be entitled to elect all the
directors, each director will have one vote on all matters to be voted on by the
directors, and the provisions therein granting the Class B and Class C Directors
special voting rights will be eliminated.
Other Obligations. Under the Equity Facility, the Company has certain
other obligations relating to its capital stock that are not reflected in the
Restated Certificate. Subject to certain conditions, the Equity Facility
requires that the Company provide the Institutional Investors with an
opportunity to participate in future financings by the Company involving debt or
equity securities in lieu of and on the same conditions as other potential
investors. The Equity Facility, independently from the Restated Certificate,
also requires that the Company not engage in any Restricted Action without the
prior approval of the Institutional Investors. Both of these obligations
terminate only upon a Qualified Public Offering.
Certain Corporate Provisions. The Restated Certificate authorizes
10,000,000 shares of Preferred Stock and grants the Board of Directors the
authority to issue series of Preferred Stock with such voting rights and other
powers as the Board of Directors may determine (subject to the special voting
rights of the Class B and Class C Directors and the approval rights of the
Institutional Investors). Those provisions, as well as the voting rights of the
Class B and Class C Directors and the approval rights of the Institutional
Investors, may be deemed to have an "anti-takeover" effect in that they may
delay, defer or prevent a change of control of the Company.
Preferred Stock
The Board of Directors is authorized, subject to any limitations
prescribed by law, without further stockholder approval, to issue from time to
time up to an aggregate of 10,000,000 shares of preferred stock, in one or more
series. Each such series of preferred stock shall have such number of shares,
designations, preferences, voting powers, qualifications and special relative
rights or privileges as shall be determined by
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<PAGE>
the Board of Directors, which may include among others, dividend rights, voting
rights, redemption and sinking fund provisions, liquidation preferences,
conversion rights and preemptive rights.
The stockholders of the Company have granted the Board of Directors
authority to issue the preferred stock and to determine its rights and
preferences in order to eliminate delays associated with a stockholder vote on
specific issuances. The rights of the holders of Common Stock will be subject to
the rights of holders of any preferred Stock issued in the future. The issuance
of preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, a majority of the outstanding voting
stock of the Company. The Company has no present plans to issue any shares of
preferred stock.
Warrants
At June 23, 1997, the Company had issued Class B Warrants to acquire up
to 6,415,000 shares of Class B Common Stock to the Institutional Investors
affiliated with Bain Capital at an exercise price of $2.50 per share of Class B
Common Stock and Class C Warrants to purchase up to 7,692,309 shares of Class C
Common Stock at $3.25 per share of Class C Common Stock. Pursuant to the Equity
Facility, the Company may be obligated to issue Class C Warrants to purchase an
additional 6,153,846 shares of Class C Common Stock. The Warrants expire on the
seventh anniversary of their issuance. The number of shares of Class B Common
Stock and Class C Common Stock issuable upon exercise and the exercise price are
subject to adjustment to prevent dilution, including adjustment in the event
that any Class A Common Stock is issued at a price less than Exercise Price. The
Warrants become warrants to purchase Class A Common Stock at such time as the
Class B Common Stock or Class C Common Stock is converted to Class A Common
Stock. The Company has also issued warrants to purchase 853,076 shares of Class
A Common Stock at $2.40 per share, of which 436,538 expire in 2000 and 416,538
expire in 2001, warrants to purchase 50,000 shares of Class A Common Stock at
$3.00 per share, all of which expire in 2003, and 201,150 warrants to purchase
Class A Common Stock at $5.00 per share which expire in 2003.
Stockholders Agreement
The Company, the Institutional Investors, management holders of the
Company's equity securities, the Flagship Stockholder Physicians, certain
Springfield physicians and all other holders of the Company's equity securities
(other than the Springfield Stockholder Physicians) are parties to the
Stockholders Agreement dated as of August 30, 1996, as amended. The 28
Springfield Stockholder Physicians are parties to a separate stockholders
agreement and registration rights agreement described below. In addition,
approximately 7 Flagship Shareholder Physicians nearing retirement age entered
into an additional agreement containing provisions with respect to the treatment
of Securities (as defined below) held by them at retirement.
The Stockholders Agreement requires each Stockholder (as defined in the
Agreement) to vote his or her shares of the Company to elect as directors of the
Company: (i) two employees designated by the Chief Executive Officer, and (ii)
seven physicians designated by the Chief Executive Officer and approved by the
Institutional Investors. Pursuant to the Company's Restated Certificate, the
Institutional Investors have the right to designate the two other directors of
the Company. See "Description of Capital Stock."
The Stockholders Agreement prohibits the transfer of shares of the
Company held by officers and employees (except shares issuable pursuant to
certain incentive stock options granted to employees) ("Management Shares") and
options, warrants and shares issued in affiliation transactions ("Physician
Shares") (collectively, "Restricted Shares") except under certain limited
circumstances, such as transfer of such Restricted Shares to members of the
holder's immediate family or to the holder's estate and heirs provided that they
agree to become bound by the Stockholders Agreement.
Except with respect to Management Shares held by Ms. Asher, upon
termination of a holder's employment with the Company or an Affiliated Group,
the Company has the right to acquire Restricted Shares held by such holder,
together with any exercisable warrants or options held by such holder (such
warrants,
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options and Restricted Shares, collectively, "Securities") at fair market value
(or, in the event of termination for cause, at the lower of cost or fair market
value). Upon the death of any officer, employee or affiliated physician, the
estate of such holder has the right, subject to certain limitations, to sell all
or any part of the holder's Securities to the Company at fair market value.
Because the obligation to purchase Common Stock under the Stockholders Agreement
is limited to circumstances in which a physician stockholder dies or is
disabled, the Company does not anticipate this put right to cause significant
liquidity issues for the Company. To the extent that the Company needs to
repurchase common stock pursuant to this provision, the Company anticipates
using its working capital, the Equity Facility or other available sources of
capital. The Stockholders Agreement also provides for certain take along
obligations pursuant to which, at the request of the Institutional Investors,
holders are required to sell a proportionate amount of their shares to persons
who are acquiring shares from the Institutional Investors on the same terms and
conditions. In addition, subject to certain conditions, all holders have the
right to join pro rata in any sale of shares by another holder.
All holders have so-called "piggyback registration rights" which permit
them to cause the Company to use its best efforts to add their shares (subject
to certain limitations) to registration statements filed by the Company under
the Securities Act for any public offering, other than registration statements
pertaining to employee benefit plans or acquisitions. The Institutional
Investors have so-called "demand registration rights" which permit them, subject
to certain conditions, to cause the Company to use its best efforts to effect a
registration under the Securities Act of all or a part of their shares. These
demand registration rights may only be exercised with respect to three such
registrations. Each holder agrees that upon the request of the underwriters
managing any underwritten public offering of the Company's securities, it will
not transfer any shares for a period beginning not more than seven days
immediately preceding and ending not more than 180 days following the public
offering without the prior written consent of the underwriters.
The Stockholders Agreement further provides that the Company shall not,
without the prior written consent of the Institutional Investors, enter into any
agreement with any holder or prospective holder of any securities of the Company
relating to registration rights unless such agreement (to the extent the
agreement would allow such holder or prospective holder to include such
securities in any registration filed under the provisions of the Stockholders
Agreement) includes a provision that such holder or prospective holder may
include such securities in any such registration only to the extent that the
inclusion of its securities will not (i) reduce the amount of the securities
held by the Institutional Investors which would otherwise be included in such
registration and (ii) otherwise diminish the rights provided in the Stockholders
Agreement.
Subject to certain limited exceptions, each holder agrees that it will
not transfer any shares to any person unless such person has delivered to the
Company a written acknowledgment and agreement that the shares to be received
are subject to all of the provisions of the Stockholders Agreement and that such
person agrees to be bound by and party to the Agreement to the same extent as if
it were the original holder and an original signatory thereto.
The Springfield Stockholder Physicians who entered into affiliation
transaction on August 30, 1996, are subject to a separate stockholders agreement
with the Company dated as of August 9, 1996 (the "Springfield Stockholders
Agreement"). The Springfield Stockholders Agreement provides that no Springfield
Stockholder Physician may transfer, assign or pledge his or her rights in shares
of the Company until August 9, 1998, unless the Company concludes that such
transfer will not prevent the merger pursuant to which such physician became
affiliated with the Company from qualifying as a tax free transaction. In
addition to that limitation, the Company has a right of first refusal for 60
days upon a Springfield Stockholder Physician's decision to transfer his or her
shares pursuant to which the Company must purchase all or none of such shares.
The Company's right of first refusal does not extend to transfers (i) pursuant
to a registration statement, (ii) as part of a sale of substantially all shares
of the Company, and (iii) to a family member, heir or entity controlled by the
physician. As a condition to each such exempt transfer, the transferee must
agree to be bound by the terms of the Springfield Stockholders Agreement. The
Company's right of first refusal terminates upon an initial public offering or
merger, sale of the Company, or similar transaction. The Company also has the
right to redeem the shares held by a physician at fair market value upon
termination of his or her employment for any reason prior to August 9, 1999. The
shares subject to the Springfield Stockholders Agreement are held in an escrow
account controlled jointly by the Company and each physician.
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The Springfield Stockholder Physicians who entered into affiliation
transactions on August 30, 1996, are also subject to a separate registration
rights agreement with the Company dated as of August 9, 1996 (the "Springfield
Registration Rights Agreement"). The Springfield Registration Rights Agreement
grants the Springfield Stockholder Physicians unlimited piggy-back registration
rights with respect to any registration statement (other than a registration
statement on Form S-8 or Form S-4) filed by the Company for a public offering,
except the registration statement relating to the initial public offering of the
Company's stock. The shares to be registered may be limited by the underwriters,
provided that the physicians who have elected to participate in the offering
will participate pro rata with all other holders registering shares. The
Springfield Registration Rights Agreement terminates on August 9, 1998.
Pursuant to the Stockholders Agreement and the Springfield Registration
Rights Agreement, at March 31, 1997, 4,600,000 shares of Class B Common Stock
and 7,692,309 shares of Class C Common Stock are entitled to demand registration
rights and all outstanding shares of Company Common Stock are entitled to piggy-
back registration rights.
SHARES ELIGIBLE FOR FUTURE SALE
Shares offered hereby may generally be resold by the persons acquiring
them without further registration under the Securities Act, unless such persons
are "affiliates" or "underwriters" within the meaning of the Securities Act.
However, it is expected that each future stockholder, including physicians
entering into affiliation transactions with the Company, will enter into a
Stockholders Agreement which impose certain restrictions upon the resale of
shares of the Company's Class A Common Stock.
At March 31, 1997, the Company had outstanding 24,071,614 shares of Class
A Common Stock and Class B Common Stock (before giving effect to any future
exercise of outstanding warrants and options). 1,666,151 shares of Class A
Common Stock are freely tradeable without restriction under Rule 144(k) of the
Securities Act. None of the outstanding shares of Class A Common Stock and Class
B Common Stock (collectively, the "Restricted Shares"), including Restricted
Shares to be issued in connection with the exercise of outstanding warrants and
options, have been registered under the Securities Act, and they may be resold
publicly only upon registration under the Securities Act or in compliance with
an exemption from the registration requirements of the Securities Act.
At present, Rule 144 provides generally that if one year has elapsed
since the later of the date of the acquisition of Restricted Shares from the
Company or any affiliate of the Company, the acquiror or subsequent holder
thereof may sell, within any three-month period, a number of shares that does
not exceed the greater of 1% of the then outstanding shares of Common Stock or
the average weekly trading volume of the Common Stock during the four calendar
weeks preceding the date on which notice of the sale if filed with the
Commission. Sales under Rule 144 are also subject to certain manner of sale
provisions, notice requirements and the availability of current public
information about the Company. If two years have elapsed since the later
of the date of acquisition of Restricted Shares from the Company or from any
affiliate of the Company, and the acquiror or subsequent holder thereof is
deemed not to have been an affiliate of the Company at any time during the 90
days preceding a sale, such person would be entitled to sell such shares without
regard to the limitations described above. As of March 31, 1997, holders of
14,313,295, 6,984,676, 440,000 and 667,493 Restricted Shares will be eligible to
sell such shares pursuant to Rule 144 under the Securities Act, subject to the
manner of sale, volume, notice and information requirements of Rule 144,
beginning in September 1997, December 1997, January 1998 and February 1998,
respectively.
LEGAL MATTERS
The validity of the Common Stock offered hereby has been passed upon for
the Company by Hale and Dorr LLP, Boston, Massachusetts. As of the date of this
Prospectus, H&D Investments II, a general partnership in which certain members
of Hale and Dorr LLP are partners, beneficially owns 20,833 shares of the
Company's Class A Common Stock.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
PHYSICIANS QUALITY CARE, INC.
Report of Independent Auditors ..........................................
*Balance Sheets as of December 31, 1995 and 1996
and March 31, 1997 (unaudited).........................................
Statements of Operations for the period from March 20, 1995
(inception) to December 31, 1995 and the year ended December 31, 1996
and the three months ended March 31, 1996 (Unaudited) and March 31,
1997 (Unaudited).......................................................
*Statements of Changes in Stockholders' Equity (Deficit) and Common Stock
Subject to Put for the period from March 20, 1995 (inception) to
December 31, 1995 and the year ended December 31, 1996 and the three
months ended March 31, 1996 (Unaudited) and March 31, 1997 (Unaudited).
*Statements of Cash Flows for the period from March 20, 1995
(inception) to December 31, 1995 and the year ended December 31, 1996
and the three months ended March 31, 1996 (Unaudited) and March 31,
1997 (Unaudited).......................................................
Notes to Financial Statements ...........................................
SPRINGFIELD MEDICAL ASSOCIATES, INC.
Report of Independent Auditors ..........................................
Consolidated Balance Sheets as of December 31, 1994 and 1995 and
August 31, 1996 .......................................................
*Consolidated Statements of Operations for the year ended December 31,
1993, 1994 and 1995, the period January 1, 1996 through August 30,
1996 and three months ended March 31, 1996 (unaudited) ................
Consolidated Statements of Stockholders' Equity for the year ended
December 31, 1993, 1994 and 1995, the period January 1, 1996 through
August 30, 1996 and nine months ended September 30, 1995 (unaudited)...
Consolidated Statements of Cash Flows for the year ended December 31,
1993, 1994 and 1995, the period January 1, 1996 through August 30,
1996 and nine months ended September 30, 1995 (unaudited) .............
Notes to Consolidated Financial Statements ..............................
ALPHONSE F. CALVANESE, M.D., P.C.
Report of Independent Auditors ..........................................
Balance Sheets as of September 30, 1995 and August 30, 1996 (unaudited)..
Statements of Operations for the year ended September 30, 1995 and the
period October 1, 1995 through August 30, 1996 (unaudited) ............
Statements of Stockholder's Equity for the year ended September 30, 1995
and the period October 1, 1995 through August 30, 1996 (unaudited) ....
Statements of Cash Flows for the year ended September 30, 1995 and the
period October 1, 1995 through August 30, 1996 (unaudited) ............
Notes to Financial Statements ...........................................
CARDIOLOGY AND INTERNAL MEDICINE ASSOCIATES, INC.
Report of Independent Auditors ..........................................
Balance Sheets as of December 31, 1995 and August 30, 1996 (unaudited)...
Statements of Operations for the years ended December 31, 1994 and 1995
and period January 1, 1996 through August 30, 1996 (unaudited) and
nine months ended September 30, 1995 (unaudited) ......................
Statements of Stockholder's Equity for the years ended December 31,
1994 and 1995 and period January 1, 1996 through August 30, 1996
(unaudited) and nine months ended September 30, 1995 (unaudited) ......
Statements of Cash Flows for the years ended December 31, 1994 and 1995
and period January 1, 1996 through August 30, 1996 (unaudited) and
nine months ended September 30, 1995 (unaudited) ......................
Notes to Financial Statements ...........................................
</TABLE>
<PAGE>
<TABLE>
<S> <C>
JAMES F. HAINES AND WILLIAM J. BELCASTRO, PARTNERSHIP
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and August 31, 1996 (unaudited)..
Statements of Operations for the year ended December 31, 1995 and
period January 1, 1996 through August 30, 1996 (unaudited) and nine
months ended September 30, 1995 (unaudited) ..........................
Statements of Partners' Capital for the year ended December 31, 1995
and period January 1, 1996 through August 30, 1996 (unaudited) and
nine months ended September 30, 1995 (unaudited) .....................
Statements of Cash Flows for the year ended December 31, 1995 and
period January 1, 1996 through August 30, 1996 (unaudited) and nine
months ended September 30, 1995 (unaudited) ..........................
Notes to Financial Statements ..........................................
JAY M. UNGAR, M.D.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and August 30, 1996 (unaudited)..
Statements of Operations for the year ended December 31, 1995 and
period January 1 through August 30, 1996 (unaudited) and nine months
ended September 30, 1995 (unaudited) .................................
Statements of Cash Flows for the year ended December 31, 1995 and
period January 1 through August 30, 1996 (unaudited) and nine months
ended September 30, 1995 (unaudited) .................................
Notes to Financial Statements ..........................................
WESTERN MASSACHUSETTS MEDICAL GROUP, INC.
Report of Independent Auditors .........................................
Balance Sheets as of November 30, 1995 and August 30, 1996 (unaudited)..
Statements of Operations for the year ended November 30, 1995 and the
period December 1, 1995 through August 30, 1996 (unaudited) and nine
months ended August 31, 1995 (unaudited) .............................
Statements of Stockholder's Equity for the year ended November 30, 1995
and the period December 1, 1995 through August 30, 1996 (unaudited)
and nine months ended August 31, 1995 (unaudited) ....................
Statements of Cash Flows for the year ended November 30, 1995 and the
period December 1, 1995 through August 30, 1996 (unaudited) and nine
months ended August 31, 1995 (unaudited) .............................
Notes to Financial Statements ..........................................
ANNAPOLIS MEDICAL SPECIALISTS, LLP
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1994 and 1995 and September 30, 1996
(unaudited) ..........................................................
Statements of Operations for the years ended December 31, 1993, 1994
and 1995, and nine months ended September 30, 1995 (unaudited) and
nine months ended September 30, 1996 (unaudited) .....................
Statements of Stockholder's Equity for the years ended December 31,
1993, 1994 and 1995, and nine months ended September 30, 1995
(unaudited) and nine months ended September 30, 1996 (unaudited) .....
Statements of Cash Flows for the years ended December 31, 1993, 1994
and 1995, and nine months ended September 30, 1995 (unaudited) and
nine months ended September 30, 1996 (unaudited) .....................
Notes to Financial Statements ..........................................
</TABLE>
<PAGE>
<TABLE>
<S> <C>
DRS. FORTIER, LIBBER, CLEMMENS & WEIMER, P.A.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and September 30, 1996
(unaudited) ..........................................................
Statements of Operations for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Statements of Shareholders' Equity for the year ended December 31, 1995
and nine months ended September 30, 1995 (unaudited) and
September 30, 1996 (unaudited) .......................................
Statements of Cash Flows for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Notes to Financial Statements ..........................................
DRS. GOLDGEIER, LEVINE & FRIEDMAN, P.A.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and September 30, 1996
(unaudited) ..........................................................
Statements of Operations for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Statements of Shareholders' Equity (Deficit) for the year ended
December 31, 1995 and nine months ended September 30, 1995 (unaudited)
and September 30, 1996 (unaudited) ...................................
Statements of Cash Flows for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Notes to Financial Statements ..........................................
KOEPPEL, ROSEN, RUDIKOFF, M.D., P.C.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and September 30, 1996
(unaudited) ..........................................................
Statements of Operations for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Statements of Stockholders' Equity for the year ended December 31,
1995 and nine months ended September 30, 1995 (unaudited) and
September 30, 1996 (unaudited) .......................................
Statements of Cash Flows for the year ended December 31, 1995 and nine
months ended September 30, 1995 (unaudited) and September 30, 1996
(unaudited) ..........................................................
Notes to Financial Statements ..........................................
DRS. PAKULA, DAVICK & BOGUE, P.A.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and September 30, 1996
(Unaudited) ..........................................................
Statements of Operations for the year ended December 31, 1995 and nine
months ended September 30, 1996 (unaudited) and September 30, 1995
(unaudited) ..........................................................
Statements of Stockholders' Equity for the year ended December 31,
1995 and nine months ended September 30, 1996 (unaudited) and
September 30, 1995 (unaudited) .......................................
Statements of Cash Flows for the year ended December 31, 1995 and nine
months ended September 30, 1996 (unaudited) and September 30, 1995
(unaudited) ..........................................................
Notes to Financial Statements ..........................................
</TABLE>
<PAGE>
<TABLE>
<S> <C>
PARK MEDICAL ASSOCIATES, P.A. AND PARK MEDICAL LABS, INC.
Report of Independent Auditors .........................................
Consolidated Balance Sheets as of December 31, 1994 and 1995 and
September 30, 1996 (unaudited) .......................................
Consolidated Statements of Operations for the years ended December 31,
1993, 1994 and 1995 and nine months ended September 30, 1995
(unaudited) and nine months ended September 30, 1996 (unaudited) .....
Consolidated Statements of Owners' Equity for the years ended
December 31, 1993, 1994 and 1995 and nine months ended
September 30, 1995 (unaudited) and nine months ended
September 30, 1996 (unaudited) .......................................
Consolidated Statements of Cash Flows for the years ended December 31,
1993, 1994 and 1995 and nine months ended September 30, 1995
(unaudited) and nine months ended September 30, 1996 (unaudited) .....
Notes to Consolidated Financial Statements .............................
DRS. SIGLER, ROSKES, HOLDEN & SCHUBERTH, P.A.
Report of Independent Auditors .........................................
Balance Sheets as of December 31, 1995 and September 30, 1996
(unaudited) ..........................................................
Statements of Operations for the years ended December 31, 1994 and
1995, and nine months ended September 30, 1995 (unaudited) and
September 30, 1996 (unaudited) .......................................
Statements of Shareholders' Equity for the years ended December 31,
1994 and 1995, and nine months ended September 30, 1995 (unaudited)
and September 30, 1996 (unaudited) ...................................
Statements of Cash Flows for the years ended December 31, 1994 and
1995, and nine months ended September 30, 1995 (unaudited) and
September 30, 1996 (unaudited) .......................................
Notes to Financial Statements ..........................................
CLINICAL ASSOCIATES, P.A.
Report of Independent Auditors .........................................
Balance Sheet as of June 30, 1994 ......................................
Statement of Income for the year ended June 30, 1994 ...................
Statement of Changes in Stockholder's Equity for the year ended June 30,
1994 .................................................................
Statement of Cash Flows for the year ended June 30, 1994 ...............
Notes to Financial Statements ..........................................
CLINICAL ASSOCIATES, P.A.
Report of Independent Auditors .........................................
Balance Sheet as of June 30, 1995 ......................................
Statement of Income for the year ended June 30, 1995 ...................
Statement of Changes in Stockholder's Equity for the year ended June 30,
1995 .................................................................
Statement of Cash Flows for the year ended June 30, 1995 ...............
Notes to Financial Statements ..........................................
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
CLINICAL ASSOCIATES, P.A.
Report of Independent Auditors .........................................
Balance Sheet as of June 30, 1996 ......................................
Statement of Income for the year ended June 30, 1996 ...................
Statement of Changes in Stockholder's Equity for the year ended June 30,
1996 .................................................................
Statement of Cash Flows for the year ended June 30, 1996 ...............
Notes to Financial Statements ..........................................
UNAUDITED FINANCIAL STATEMENTS OF CLINICAL ASSOCIATES, P.A.
Unaudited Balance Sheet as of March 31, 1997............................
Unaudited Statements of Income (loss) for the nine months ended
March 31, 1996 and March 31, 1997.....................................
Unaudited Statements of Cash Flows for the nine months ended
March 31, 1996 and March 31, 1997.....................................
UNAUDITED PRO FORMA BALANCE SHEET OF PHYSICIANS QUALITY CARE, INC.
Unaudited Pro Forma Balance Sheet as of March 31, 1997 .................
Notes to Unaudited Proforma Balance Sheet...............................
</TABLE>
<PAGE>
Physicians Quality Care, Inc.
Audited Financial Statements
The period from March 20, 1995 (inception) to
December 31, 1995 and the year ended December
31, 1996 and three months ended March 31, 1996
(Unaudited) and three months ended March 31, 1997
(Unaudited)
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors......................................... 1
Audited Financial Statements
Balance Sheets......................................................... 2
Statements of Operations............................................... 3
Statements of Changes in Stockholders' Equity (Deficit) and Common
Stock Subject to Put................................................... 4
Statements of Cash Flows............................................... 5
Notes to Financial Statements.......................................... 6
</TABLE>
<PAGE>
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheets of Physicians Quality Care, Inc.
(the Company) as of December 31, 1995 and 1996, and the related statements of
operations, changes in stockholders' equity (deficit) and common stock subject
to put, and cash flows for the period from March 20, 1995 (inception) to
December 31, 1995 and the year ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physicians Quality Care, Inc.
as of December 31, 1995 and 1996 and the results of its operations and its cash
flows for the period from March 20, 1995 (inception) to December 31, 1995 and
the year ended December 31, 1996, in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company's ability to continue as a going concern will
be dependent upon obtaining adequate financing and consummating future
affiliations with physician practices. In addition, the recoverability of
assets and payment of liabilities will be dependent upon the Company's ability
to continue as a going concern. These uncertainties raise substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Ernst & Young LLP
March 28, 1997
Boston, Massachusetts
1
<PAGE>
Physicians Quality Care, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31, March 31,
1995 1996 1997
--------------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 3,479,781 $ 136,926 $ 65,544
Prepaid expenses 12,644 58,776 32,745
Due from related parties 1,694,687 3,153,488
Other current assets 8,138 25,380 14,354
---------------------------------------
Total current assets 3,500,563 1,915,769 3,266,131
Long-term affiliation agreements, less accumulated
amortization of $112,625 and $174,287 in 1996 and
1997 (unaudited), respectively 32,487,314 34,435,087
Deferred affiliation and equity offering costs 772,209 137,831 21,397
Property and equipment, net 90,646 214,008 661,018
Other assets 120,660 368,324
Deferred tax asset 608,171 608,171
---------------------------------------
---------------------------------------
Total assets $ 4,363,418 $35,483,753 $ 39,360,128
=======================================
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
(Unaudited)
December 31 March 31,
1995 1996 1997
-----------------------------------------------
<S> <C> <C> <C>
Liabilities and stockholders' equity (deficit)
Current liabilities:
Accounts payable $ 604,765 $ 1,217,630 $ 1,641,167
Accrued compensation 109,664 218,893 221,707
Accrued expenses 103,456 1,053,892 95,818
Income taxes payable 32,000 69,708 (10,292)
Current portion of note payable - 200,000 3,000,000
Current portion of capital lease obligations - 15,685 15,962
--------------------------------------------
Total current liabilities 849,885 2,775,808 4,964,362
Convertible promissory note 1,410,000 -
Capital lease obligations, less current maturities 55,867 51,772
Deferred taxes 1,073,048 1,083,048
Commitments and contingencies
Common stock, subject to put, 12,740,589 and 13,313,082
shares authorized, issued and outstanding at December 31, 1996
and March 31, 1997, (unaudited), respectively 31,851,473 33,282,706
Stockholders' equity (deficit):
Common stock, $.01 par value, 15,308,333 shares
authorized, 7,706,250 shares issued and outstanding
at December 31, 1995 77,063
Class A common stock, $.01 par value, 75,000,000 shares
authorized, 7,236,033 and 7,771,033 shares issued and
6,223,533 and 6,758,533 outstanding at December 31, 1996
and March 31, 1997, (unaudited), respectively 72,359 77,709
Class B-1 common stock, $.01 par value, 15,267,915
shares authorized, 2,442,866 shares issued and
outstanding at December 31, 1996 24,429 24,429
Class B-2 common stock, $.01 par value, 9,732,085 shares
authorized, 1,557,134 shares issued and outstanding
at December 31, 1996 15,571 15,571
Series A Convertible Preferred Stock, $.01 par value,
$3,998,762 liquidation value, 1,666,667 shares
authorized 1,666,151 shares issued and outstanding
at December 31, 1995 3,750,609
Preferred stock, $.01 par value, 10,000,000 shares authorized
Additional paid-in capital 420,000 21,117,623 22,449,773
Accumulated deficit (2,082,264) (21,492,300) (22,579,117)
Due from stockholders (61,875)
Less treasury stock, at cost, 1,012,500 shares at
December 31, 1996 (10,125) (10,125)
--------------------------------------------
Total stockholders' equity (deficit) 2,103,533 (272,443) (21,760)
--------------------------------------------
Total liabilities and stockholders' equity $ 4,363,418 $ 35,483,753 $39,360,128
============================================
</TABLE>
See accompanying notes.
<PAGE>
Physicians Quality Care, Inc.
Statements of Operations
<TABLE>
<CAPTION>
Period from (Unaudited)
March 20, 1995 Year ended March 31,
(inception) to December 31, -------------------------------
December 31, 1995 1996 1996 1997
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net patient service revenue - $ 6,026,452 - $10,552,532
Less: amounts retained by physician groups - 2,194,571 - 3,730,910
----------------------------------------------------------------------------------
Management fee revenue - 3,831,881 - 6,821,622
Operating expenses:
Nonphysician salaries and benefits - 1,816,309 - 3,141,146
Other practice expenses - 535,479 - 687,579
General corporate expenses $ 2,061,737 5,953,117 $ 1,396,789 3,438,148
Depreciation and amortization 6,704 194,481 - 341,534
Provision for bad debts - 214,404 - 273,263
----------------------------------------------------------------------------------
Total expenses 2,068,441 8,713,790 1,396,789 7,881,670
----------------------------------------------------------------------------------
Operating loss (2,068,441) (4,881,909) (1,396,789) (1,060,048)
Other income (expense):
Interest income 108,177 91,104 31,794 3,955
Interest expense (90,000) (104,255) (45,000) (30,724)
----------------------------------------------------------------------------------
18,177 (13,151) (13,206) (26,769)
----------------------------------------------------------------------------------
Loss before income taxes (2,050,264) (4,895,060) (1,409,995) (1,086,817)
Income tax provision 32,000 78,128 9,400 -
----------------------------------------------------------------------------------
Net loss $ (2,082,264) $ (4,973,188) (1,419,395) (1,086,817)
==================================================================================
Net loss available to common stock $ (2,082,264) $ (19,410,036) $(1,419,395) $(1,086,817)
==================================================================================
Net loss per common share $ (0.27) $ (1.80) $ (0.18) $ (0.04)
==================================================================================
Weighted average common shares
outstanding 7,706,250 10,785,605 7,706,250 24,756,907
==================================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Physicians Quality Care, Inc.
Statements of Changes in Stockholders' Equity (Deficit)
and Common Stock Subject to Put
Period from March 20, 1995 (inception) to December 31, 1995
and Year ended December 31, 1996 and March 31, 1997 (unaudited)
<TABLE>
<CAPTION>
Common Stock Class A Common Stock Class B-1 Common Stock
----------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock 7,706,250 $ 77,063
Issuance of convertible preferred stock,
net of issuance costs of $98,153
Issuance of warrant
Issuance of warrants in lieu of interest on
convertible promissory note
Issuance of warrants in connection with
convertible preferred stock
Loan to stockholders
Net loss
----------------------------------------------------------------------------
Balance at December 31, 1995 7,706,250 77,063
Purchase of treasury shares
Recapitalization in connection with
restatement of Charter (7,706,250) (77,063) 7,706,250 $ 77,063
Reclassification of common stock in
connection with recapitalization (5,897,914) (58,980)
Accretion of common stock subject to
put to fair value
Issuance of Class A common stock upon
upon conversion of bridge loan 402,301 4,023
Issuance of Class A common stock upon
conversion of Series A convertible
preferred stock 1,666,151 16,662
Issuance of Class A common stock upon
conversion of subordinated note 625,000 6,250
Issuance of Class A common stock in
connection with the Springfield affiliation 2,592,245 25,921
Issuance of Class A common stock in
connection with the Baltimore affiliation 6,842,675 68,426
Reclassification of common stock
subject to put (6,842,675) (68,426)
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $1,410,881 1,587,863 $15,879
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $640,214 855,003 8,550
Payment received from Stockholder
Issuance of Class A common stock to
Shareholders for cash 142,000 1,420
Net loss
----------------------------------------------------------------------------
Balance at December 31, 1996 - $ - 7,236,033 $ 72,359 2,442,866 $24,429
Issuance of Class A Common Stock In
acquistion of business (Chestnut) (unaudited) 440,000 4,400
Reclassification of common stock
subject to put to fair value (unaudited) (440,000) (4,400)
Issuance of Class A Common Stock
for Cash (Shareholders), (unaudited) 130,000 1,300
Issuance of Class A Common Stock
for Cash (Shareholders), (unaudited) 342,000 3,420
Issuance of Class A Common Stock
to Banker's Trust (unaudited) 63,000 630
Issuance of Class A Common Stock in
acquisition of business (Izenstein) (unaudited) 132,493 1,325
Reclassification of common stock
subject to put to fair value (unaudited) (132,493) (1,325)
Net Loss (unaudited)
----------------------------------------------------------------------------
Balance at 3-31-97 (unaudited) - $ - 7,771,033 $77,709 2,442,866 $24,429
============================================================================
<CAPTION>
Series A Convertible Additional
Class B-2 Common Stock Preferred Stock Treasury Stock Paid-in
----------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount Capital
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock
Issuance of convertible preferred stock,
net of issuance costs of $98,153 1,666,151 $ 3,750,609
Issuance of warrant $ 90,000
Issuance of warrants in lieu of interest on
convertible promissory note 180,000
Issuance of warrants in connection with
convertible preferred stock 150,000
Loan to stockholders
Net loss
-------------------------------------------------------------------------------------
Balance at December 31, 1995 1,666,151 3,750,609 420,000
Purchase of treasury shares 1,012,500 $(10,125)
Recapitalization in connection with
restatement of Charter
Reclassification of common stock in
connection with recapitalization (248,958)
Accretion of common stock subject to
put to fair value
Issuance of Class A common stock upon
upon conversion of bridge loan 1,001,727
Issuance of Class A common stock upon
conversion of Series A convertible
preferred stock (1,666,151) (3,750,609) 3,733,947
Issuance of Class A common stock upon
conversion of subordinated note 1,493,750
Issuance of Class A common stock in
connection with the Springfield affiliation 6,454,672
Issuance of Class A common stock in
connection with the Baltimore affiliation 17,038,261
Reclassification of common stock
subject to put (17,038,261)
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $1,410,881 1,012,137 $10,121 5,063,119
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $640,214 544,997 5,450 2,845,786
Payment received from Stockholder
Issuance of Class A common stock to
Shareholders for cash 353,580
Net loss
-------------------------------------------------------------------------------------
Balance at December 31, 1996 1,557,134 $15,571 - $ - (1,012,500) $(10,125) $ 21,117,623
Issuance of Class A Common Stock In
acquistion of business (Chestnut) 1,095,600
Reclassification of common stock
subject to put to fair value (1,095,600)
Issuance of Class A Common Stock
for Cash (Shareholders), 323,700
Issuance of Class A Common Stock
for Cash (Shareholders), 851,580
Issuance of Class A Common Stock
to Banker's Trust 156,870
Issuance of Class A Common Stock in
acquisition of business (Izenstein) 329,908
Reclassification of common stock
subject to put to fair value (329,908)
Net Loss
-------------------------------------------------------------------------------------
Balance at March 31, 1997 1,557,134 $15,571 - $ - (1,012,500) $(10,125) $ 22,449,773
=====================================================================================
<CAPTION>
Common
Total Stock
Accumulated Due from Stockholders' Subject
Deficit Stockholders Equity to Put
------------------------------------------------------------
<S> <C> <C> <C> <C>
Issuance of common stock $ 77,063
Issuance of convertible preferred stock,
net of issuance costs of $98,153 3,750,609
Issuance of warrant 90,000
Issuance of warrants in lieu of interest on
convertible promissory note 180,000
Issuance of warrants in connection with
convertible preferred stock 150,000
Loan to stockholders $(61,875) (61,875)
Net loss $ (2,082,264) (2,082,264)
-------------------------------------------------------------
Balance at December 31, 1995 (2,082,264) (61,875) 2,103,533
Purchase of treasury shares 10,125
Recapitalization in connection with
restatement of Charter
Reclassification of common stock in
connection with recapitalization (307,938) $ 307,938
Accretion of common stock subject to
put to fair value (14,436,848) (14,436,848) 14,436,848
Issuance of Class A common stock upon
upon conversion of bridge loan 1,005,750
Issuance of Class A common stock upon
conversion of Series A convertible
preferred stock
Issuance of Class A common stock upon
conversion of subordinated note 1,500,000
Issuance of Class A common stock in
connection with the Springfield affiliation 6,480,593
Issuance of Class A common stock in
connection with the Baltimore affiliation 17,106,687
Reclassification of common stock
subject to put (17,106,687) 17,106,687
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $1,410,881 5,089,119
Issuance of Class B-1 and B-2 common
stock for cash, net of issuance costs
of $640,214 2,859,786
Payment received from Stockholder 51,750 51,750
Issuance of Class A common stock to
Shareholders for cash 355,000
Net loss (4,973,188) (4,973,188)
-------------------------------------------------------------
Balance at December 31, 1996 $(21,492,300) $ - $ (272,443) 31,851,473
Issuance of Class A Common Stock In
acquistion of business (Chestnut) 1,100,000
Reclassification of common stock
subject to put to fair value (1,100,000) 1,100,000
Issuance of Class A Common Stock
for Cash (Shareholders), 325,000
Issuance of Class A Common Stock
for Cash (Shareholders), 855,000
Issuance of Class A Common Stock
to Banker's Trust 157,500
Issuance of Class A Common Stock in
acquisition of business (Izenstein) 331,233
Reclassification of common stock
subject to put to fair value (331,233) 331,233
Net Loss (1,086,817) (1,086,817)
--------------------------------------------------------------
Balance at March 31, 1997 $(22,579,117) $ - $ (21,760) $ 33,282,706
==============================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Physicians Quality Care, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Three
Period from Months Ended
March 20, 1995 Year ended March 31,
(inception) to December 31 ---------------------------------
December 31, 1995 1996 1996 1997
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating activities
Net loss $(2,082,264) $(4,973,188) $(1,419,395) $(1,086,817)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 6,704 194,481 10,891 341,534
Interest accretion on convertible promissory note 90,000 90,000 45,000 -
Changes in operating assets and liabilities, net of
effects of business acquisitions:
Increase in due from related parties - (2,522,221) - (1,095,756)
Increase/Decrease in prepaid expenses and other assets (20,782) (184,034) (32,708) 37,753
Increase/Decrease in accounts payable, accrued 817,885 1,672,530 188,339 (531,723)
compensation and accrued expenses
Increase in income taxes payable 32,000 37,708 9,400 (80,000)
------------------------------------------------------------------------
Net cash used in operating activities (1,156,457) (5,684,724) (1,198,473) (2,415,009)
Investing activities
Purchase of property and equipment (97,350) (120,218) (57,660) (535,922)
(Increase) decrease in deferred acquisition costs (315,071) 195,436 (266,653) 98,238
Cash paid for affiliation costs - (1,839,274) - (208,188)
Cash paid for affiliation - (5,880,974) - (831,231)
------------------------------------------------------------------------
Net cash used in investing activities (412,421) (7,645,030) (324,313) (1,477,103)
Financing activities
Proceeds from issuance of common stock, net of
issuance costs 15,188 8,309,655 - 1,337,500
Net proceeds from issuance of convertible preferred stock 3,750,609 - - -
Proceeds from issuance of warrants 420,000 - - -
Proceeds from bridge financing - 1,000,000 - -
Proceeds from note payable - 200,000 - 3,000,000
Proceeds from convertible promissory note 1,320,000 - - -
Proceeds from repayment of shareholder loan - 51,750 - -
(Increase) decrease in deferred financing costs (457,138) 438,942 (29,617) 18,196
Payments on capital lease obligations - (13,448) (2,381) (203,818)
Cash Paid for Debt issuance cost (331,146)
------------------------------------------------------------------------
Net cash provided by financing activities 5,048,659 9,986,899 (31,998) 3,820,730
------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 3,479,781 (3,342,855) (1,554,784) (71,382)
Cash and cash equivalents at beginning of period - 3,479,781 3,479,781 136,926
------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 3,479,781 $ 136,926 $ 1,924,997 $ 65,544
------------------------------------------------------------------------
</TABLE>
Supplemental disclosure of cash flow information:
During the year ended December 31, 1996, the Company entered into capital lease
obligations aggregating $85,000.
On August 30, 1996, the Company converted a bridge loan in the principal amount
of $1,000,000 to 402,301 shares of common stock (see Note 10).
Cash paid for interest was $0 and $14,225 for the year ended December 31, 1995
and 1996, respectively.
Cash paid for income taxes was $0 and $31,800 for the year ended December 31,
1995 and 1996, respectively.
See accompanying notes.
5
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements
December 31, 1996
1. Business and Organization
Formed in March 1995, Physicians Quality Care, Inc. (PQC or the Company)
provides complete practice management for multi-specialty medical practice
groups. The Company's objective is to establish and manage networks of
specialty and primary care physicians and related diagnostic and therapeutic
support services which can provide comprehensive health care services in
targeted geographic areas.
On August 30, 1996, the Company consummated affiliations with seven physician
practices (32 physicians and a physician-owned laboratory) in Springfield,
Massachusetts, and on December 11, 1996, the Company consummated affiliations
with fifteen physician practices (59 physicians and a physician-owned
laboratory) in the Baltimore/Annapolis, Maryland area. As of the date of the
affiliations the Company began providing management services to the physicians
under long-term management agreements and recognizing revenues from these
physician practices (the Physician Practices). Prior to August 30, 1996, the
Company's operations consisted primarily of seeking affiliations with physician
practices and negotiating the terms of the affiliations and management
agreements with such physician practices.
2. Operations and Basis of Presentation
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. Since its inception, the activities of the
Company have been primarily devoted to seeking affiliations with physician
practices, negotiating the terms of the affiliations with and management
agreements with, physician practices. The Company consummated affiliations with
91 physicians during 1996, the terms of which are more fully disclosed in Note
4. Due to the absence of significant revenues prior to the affiliations, the
Company has predictably incurred significant operating losses and currently does
not have working capital available to fund its growth strategy or operating
losses expected during the next year. These conditions raise substantial doubt
about the Company's ability to continue as a going concern.
Management expects to finance its future affiliations with sales of equity
pursuant to existing financing agreements with its Institutional Investors (see
Note 10). In addition, management expects to fund operations in the short term
with proceeds of an equity offering to private investors and a working capital
line of credit (see Note 13) and with management fee income and positive cash
flow from existing physician practices. However, no assurances can be provided
that the Company will successfully complete these financings. Should any of the
planned financing not be completed, management
6
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
2. Operations and Basis of Presentation (continued)
will seek financing through other sources; however, there can be no assurance
that other sources of capital will be available on terms and conditions
acceptable to the Company or at all. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
3. Summary of Significant Accounting Policies
Basis of Presentation
The financial statements have been prepared on the accrual basis of accounting.
The Company enters into long-term affiliation arrangements with physician
practices, and through mergers and asset purchases, the assets and liabilities
of the physician practices are transferred to a professional corporation
affiliated with the Company. The Company does not consolidate the operating
results and accounts of the physician practices. For display purposes, the
Company has presented the physician practice revenues and amounts retained by
the physician practices in the accompanying statements of operations to arrive
at the Company's gross management fee revenue. See further discussion below.
Net Patient Service Revenue
Net patient service revenue represents the revenue of the physician practices
reported at the estimated realizable amounts from patients, third-party payors
and others for services rendered, net of contractual and other adjustments.
During 1996, the Company estimates that approximately 40% of net patient service
revenue was received under government-sponsored healthcare programs
(principally, the Medicare and Medicaid programs).
The Company has agreements with various Health Maintenance Organizations (HMOs)
to provide medical services to subscribing participants. Under these agreements,
the Company receives monthly capitation payments based on the number of each
HMO's participants.
7
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
Management Fee Revenue
Management fee revenue represents net patient service revenue less amounts
retained by physician practices and consists of the following for the year ended
December 31, 1996:
<TABLE>
<S> <C>
Net patient service revenue $ 6,026,452
Less: Physician baseline compensation (2,090,385)
Allocation of physician practice net profits to the physicians (104,186)
---------------
$ 3,831,881
===============
</TABLE>
The amounts retained by physician practices represents amounts paid to the
physicians pursuant to the service agreements between the Company and the
physician practices. Physician baseline compensation is determined based on an
agreed-upon percentage (80% to 95%) of the physicians' historic compensation
levels but is subject to reduction if physician practice net revenues are
insufficient to cover baseline compensation. The amounts allocated to the
Company and to the physician groups are determined based on a percentage of
physician group revenue in excess of physician baseline compensation and
reimbursement of practice expenses (hereafter referred to as net profits). The
net profits for one of the Company's Affiliated Groups are first allocated to
the Company up to 5% of the net profits. Net profits remaining after the first
allocation are then allocated 80% to the Company and 20% to the physician groups
up to 15% of the net profits. Net profits remaining after the second allocation
are then allocated equally between the Company and the physician groups. The net
profits for the other Affiliated Group are allocated equally between the Company
and the physician groups. The following is the methodology by which the amounts
retained by physician groups and the management fee revenue is determined for
the year ended December 31, 1996.
<TABLE>
<CAPTION>
Amounts Retained by Physician Groups:
<S> <C>
Excess net profits subject to allocation $ 241,143
Amounts allocated to the Company 136,957
----------
Amounts allocated to physician groups 104,186
Physician baseline compensation 2,090,385
----------
Amounts retained by physician groups $2,194,571
==========
Management Fee Revenue:
Amounts allocated to the Company 136,957
Reimbursement of practice expenses 3,694,924
----------
Management Fee Revenue $3,831,881
==========
</TABLE>
Under the service agreements, the Company provides each physician practice with
a comprehensive package of services, including office and facilities, equipment,
nursing and other non-physician professional support, administrative support,
information systems, comprehensive professional liability insurance, and general
management and financial advisory services. The Company also bills all patients,
insurance companies and third-party payors and negotiates all contracts and
relationships with payors.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at the time of purchase to be cash equivalents. The carrying
amount reported in the balance sheet for cash and cash equivalents approximates
its fair value.
Property and Equipment
Property and equipment is carried at cost. Depreciation is calculated using the
straight-line method over the useful lives of the assets.
Professional Liability Insurance
The Company has obtained professional liability coverage for the Physician
Practices through commercial insurance carriers on either a claims-made or
occurrence basis. The Company has purchased additional insurance to cover the
tail portion of the claims made policies. Management believes that there are no
claims that may result in a loss in excess of amounts covered by its existing
insurance.
8
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
Long-term Affiliation Agreements
The cost of the long-term affiliation agreements over the fair value of
identifiable assets of the affiliate has been reflected as "Intangibles" and is
being amortized over 30 years.
Impairment of Long-Lived Assets
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of." Under SFAS 121, the carrying
value of long-lived assets are reviewed if the facts and circumstances suggest
they may be impaired. If this review indicates that the affected assets may not
be recoverable, as determined based upon a projection of undiscounted operating
cash flows, the carrying value of the affected assets would be reduced to fair
value.
Capital Leases
Assets and liabilities relating to capital leases are recorded at the present
value of the future minimum rental payments using interest rates appropriate at
the inception of the lease. Capital lease amortization is provided on a
straight-line basis over the initial term of the lease and is included with
depreciation expense.
Deferred Affiliation and Equity Offering Costs
Deferred affiliation costs consist of amounts paid in connection with proposed
affiliations with physician practices and related negotiations to provide
management services to such practices. Costs are capitalized in connection with
affiliations that are considered probable and included in the consideration for
the practices upon consummation of affiliation and management agreements.
Affiliation costs deferred at December 31, 1995 and 1996 amounted to
approximately $315,000 and $113,000, respectively. If a proposed affiliation is
no longer considered to be probable, the related deferred affiliation costs are
written off.
Costs incurred in connection with the Company's equity offerings are deferred
until the offering is consummated, at which time they are netted against the
proceeds of the equity
9
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
3. Summary of Significant Accounting Policies (continued)
offering to which they pertain. Equity offering costs deferred at December 31,
1995 and December 31, 1996 amounted to approximately $457,000 and $25,000,
respectively.
Stock Compensation Arrangements
The Company accounts for its stock compensation arrangements under the
provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees",
and intends to continue to do so.
The Company has adopted disclosure-only provisions of Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation".
These provisions require the Company to disclose pro forma net income and
earnings per share amounts as if compensation expense related to grants of stock
options were recognized based on new fair value accounting rules.
Fair Value of Financial Instruments
The Company's financial instruments consist of accounts receivable, accounts
payable, accrued expenses and other liabilities. The Company believes that the
carrying value of its financial instruments approximate fair value.
Net Loss Per Common Share
Net loss per share of common stock is computed by dividing the net loss
available to common stock by the weighted-average number of shares of common and
common equivalent shares outstanding during each period presented. The net loss
available to common stock reflects the accretion of common stock subject to put
to fair value at December 31, 1996 (see Note 10). The effect of options and
warrants is not considered as it would be antidilutive. Fully diluted loss per
share is not presented because the effect would be antidilutive.
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
10
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
4. Affiliations
Springfield
Effective August 30, 1996, the Company entered into affiliation arrangements
with 7 physician practices (32 physicians) located in Western Massachusetts (the
Springfield Affiliation). In connection with this transaction, through mergers
and asset purchases, the assets and liabilities of the physician practices were
transferred to a newly formed professional corporation affiliated with the
Company, Medical Care Partners, P.C. (MCP) and the physicians became employees
of MCP. The aggregate total consideration paid to the physicians for the
mergers and asset purchases was approximately $9.7 million, of which $3.2
million was paid in cash and $6.5 million was paid by the issuance of 2,592,245
shares of common stock. Up to an additional $2.15 million, payable in common
stock, may be paid in the future to certain of the physicians if revenue goals
are met. Such consideration, if and when paid, would be reflected as an expense
in the statement of operations. In addition, 29 physicians received 2,500
options to purchase common stock at an exercise price of $2.50 per share.
Baltimore
Effective December 11, 1996, the Company entered into affiliation arrangements
with 15 physician practices (59 physicians) located in the Baltimore/Annapolis,
Maryland area (the Flagship Affiliation). In connection with this transaction,
through mergers and sales, the assets and liabilities of the physician practices
were transferred to a newly formed professional corporation affiliated with the
Company, Flagship Health, P.A. (Flagship) and the physicians became employees of
Flagship. The aggregate consideration paid to the physicians at the
consummation of the mergers and asset purchases was approximately $19.8 million,
of which $2.7 million was paid in cash and $17.1 million was paid by the
issuance of 6,842,675 shares of common stock. Final total consideration is
subject to working capital adjustments within 120 days after closing.
11
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
4. Affiliations (continued)
The following table depicts the calculation of the Company's affiliation cost,
excess of affiliation cost over the fair value of the affiliates' assets and the
preliminary allocation to the acquired assets of the affiliates. The
determination of the fair market value of the acquired assets and the allocation
of the affiliation cost to both tangible and intangible assets are currently
being performed and may vary from values presented below.
<TABLE>
<CAPTION>
Allocation of affiliation cost:
Springfield Flagship
------------------------------
<S> <C> <C>
Cash $ 336,000 $ 443,000
Fixed assets 317,000 955,000
Other current assets 1,346,000 4,260,000
Intangibles 9,037,000 16,371,000
Accounts payable (190,000) (677,000)
Other liabilities (1,138,000) (1,592,000)
------------------------------
9,708,000 19,760,000
Other affiliation costs 1,238,000 1,711,000
------------------------------
$10,946,000 $21,471,000
==============================
</TABLE>
12
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
5. Property and Equipment
Property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31
1995 1996
-------------------------
<S> <C> <C>
Equipment $74,230 $132,163
Furniture and fixtures 7,755 34,110
Office equipment 15,365 20,509
Leasehold improvements 85,000
-------------------------
97,350 271,782
Less accumulated depreciation 6,704 57,774
-------------------------
$90,646 $214,008
=========================
</TABLE>
Depreciation expense was $6,704 and $81,853 for the period from March 20, 1995
(inception) to December 31, 1995 and for the year ended December 31, 1996,
respectively.
6. Convertible Promissory Note and Warrant
In June 1995, the Company issued a $1,500,000 convertible promissory note to an
investor. In lieu of interest, the Company issued a warrant to purchase 20,000
shares of the Company's common stock at $2.40 per share. The warrant's value of
$180,000 has been reflected in the statements of operations as interest expense.
Effective August 1996, the note was converted into 625,000 shares of the
Company's Class A Common Stock.
7. Leases
The Company maintains operating leases for property and certain office equipment
at its corporate headquarters and a subsidiary site. The property leases
contain renewal options and escalation clauses and require the Company to pay
certain utilities and taxes over established base amounts.
Operating lease expense amounted to $14,679 and $277,046 for the period from
inception to December 31, 1995 and for the year ended December 31, 1996,
respectively.
13
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
7. Leases (continued)
At December 31, 1996, property, plant and equipment amounts included capitalized
lease assets totaling $85,000, net of accumulated depreciation of $15,583.
Future minimum lease payments under noncancelable capital and operating leases
are as follows:
<TABLE>
<CAPTION>
Capital Leases Operating Leases
-------------------------------------
<S> <C> <C>
1997 $ 21,979 $ 216,144
1998 20,845 201,838
1999 19,629 35,537
2000 18,331 33,750
-------------------------------------
82,477 487,269
-------------------------------------
Amounts representing interest (10,920)
-------------------------------------
$ 71,552 $ 487,269
=====================================
</TABLE>
8. Letter of Credit
At December 31, 1996, the Company had a letter of credit outstanding in the
amount of $85,000 securing the Company's payment for office improvements at a
subsidiary site.
9. Transactions with Related Parties
The amounts due from related parties at December 31, 1996 represent working
capital and other adjustments in connection with the affiliations (see Note 4).
Because of the nature of the Company's arrangements with the affiliated
physician groups, substantially all transactions included in net patient service
revenues and amounts retained by physician groups in the accompanying financial
statements are viewed as related-party transactions.
14
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
9. Transactions with Related Parties (continued)
During the year ended December 31, 1996, the Company entered into affiliation
transactions with three of its directors who are physicians. The physicians
received 498,602 shares of Class A common stock, 2,500 options to acquire Class
A common stock, with an exercise price of $2.50 per share and cash in the amount
of $315,000 as consideration for the affiliations. These transactions were
entered into on commercially reasonable terms, substantially similar to the
terms of its affiliation transactions with other affiliated physicians (see Note
4), and the consideration paid in connection with such affiliations was based on
the fair market value of the medical practice assets or services acquired.
At December 31, 1996, the Company had a promissory note with a face value of
$200,000 with a director of the Company. The note bears interest at prime plus
2%. This note, along with accrued interest, was paid by the Company on
February 4, 1997.
On August 30, 1996, the Company entered into a Management Agreement with Bain
Capital Partners V, L.P. (Bain), an affiliate of the Company's Institutional
Investors (see Note 10). Pursuant to the Management Agreement, the Company will
pay Bain a management fee of $500,000, plus 1% of any financings from parties
other than affiliates of Bain, for services including advice in connection with
financings and financial, managerial and operational advice in connection with
day-to-day operations. The Company is also obligated to pay certain expenses,
not to exceed $100,000 per year without the Company's consent, of Bain and its
affiliates in connection with the Management Agreement.
10. Stockholders' Equity
Common Stock
- ------------
During the period from March 20, 1995 (inception) to December 31, 1995, the
Company issued 7,706,250 shares of $.01 par value common stock to its founders
in exchange for cash of $15,188 and notes of $61,875. During the year ended
December 31, 1996, 1,012,500 shares of common stock were reacquired by the
Company at a cost of $10,125 in the form of cancellation of a like amount of a
note due from the shareholder. These shares are subject to certain restrictions
which lapse in August 1998.
Effective August 30, 1996, the Company recapitalized. All shares of then-
existing common stock were canceled (Old Common Stock) and three new classes of
common stock (Class A, Class B-1 and Class B-2) were authorized. Holders of
Class A, Class B-1 and Class B-2 common shares are entitled to elect two, one
and one members of the Company's Board of Directors, respectively. The
remaining seven directors are elected collectively by the holders of Class A,
Class B-1 and Class B-2 common shares, with each share having a single vote.
15
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
10. Stockholders' Equity (continued)
Class A common shares were distributed to holders of Old Common Stock on a one-
for-one basis.
On August 30, 1996, 402,301 of Class A common shares were issued in connection
with the conversion of a bridge loan. The bridge loan, in the amount of $1.0
million, (1) was outstanding during July and August 1996; (2) bore interest at
10.25% and (3) was convertible into Class A common shares at a conversion rate
of $2.50 per share. Warrants to purchase 201,150 shares of common stock at
$5.00 per share were issued in connection with the bridge loan.
During June 1995, the Company issued 1,666,151 shares of Series A Convertible
Preferred Stock (Preferred Stock), par value $.01, which effective August 30,
1996, was converted to Class A common stock on a one-for-one basis. Warrants to
purchase 416,538 shares of Common Stock at $2.40 per share were issued upon the
closing of the sale of the Preferred Stock. Warrants to purchase an additional
416,538 shares of common stock were required to be issued to the holders of the
Preferred Stock in the event that the Company did not complete an initial public
offering on or before June 30, 1996. Accordingly, on August 30, 1996, the
Company issued an additional 416,538 warrants at $2.40 per share. A total value
of $300,000 was assigned to these warrants using the minimum value method.
As discussed in Note 6, 625,000 shares of Class A common stock were issued in
connection with the conversion of a promissory note.
As discussed in Note 4, 2,592,245 Class A common shares were issued in
connection with the Springfield Affiliation, and 6,842,675 Class A common shares
were issued in connection with the Baltimore Affiliation.
In connection with the Springfield Affiliation described in Note 4, on
August 30, 1996, the Company issued 1,587,863 Class B-1 common shares, 1,012,137
Class B-2 common shares and warrants to purchase 3,750,500 shares of Class B
common stock at $2.50 per share to the Institutional Investors in exchange for
cash proceeds of $6.5 million, which after issuance costs of approximately $1.4
million, netted to approximately $5.1 million. In connection with the Baltimore
Affiliation described in Note 4, on December 11, 1996, the Company issued
855,003 Class B-1 common shares, 544,997 Class B-2 common shares and warrants to
purchase 1,799,000 shares of Class B common stock at $2.50 per share to the
Institutional Investors in exchange for cash proceeds of $3.5 million, which
after issuance costs of approximately $640,000, netted to approximately $2.9
million. A total value of $270,000 was assigned to these warrants using the
minimum value method.
16
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
10. Stockholders' Equity (continued)
Subject to certain conditions, the Institutional Investors are required to
purchase up to 8,000,000 additional shares of Class B common stock, together
with warrants to purchase up to 7,450,500 shares of Class B common stock, for
aggregate consideration of $20,000,000. These shares may be sold no later than
December 31, 1999. The number of shares of common stock issuable upon exercise
of the warrants is subject to adjustment based on the Company's future financial
performance.
During December 1996, the Company issued 142,000 shares of Class A common stock
at $2.50 per share to shareholders for cash.
Puts and Calls
- --------------
Of the Company's outstanding common stock, 12,740,589 shares are subject to a
put option which provides for the put of the shares back to the Company at fair
value upon the death of the holder. In addition, 1,072,285 of such shares are
also subject to a fair value put option back to the Company at the later of the
shareholder's retirement from the Company or 18 months after the date
(December 11, 1996) of the shareholders' agreement. Consequently, these
12,740,589 shares have been recorded at fair value outside of permanent equity
in the accompanying balance sheet.
The Company's shareholder agreements also provide that in connection with
10,053,670 shares of common stock, the Company has the right to purchase such
shares for fair value if the shareholder's termination from the Company is
without cause or is by resignation, and for the lower of cost or fair value if
termination is with cause.
All of the above put and call provisions expire on the date of a Qualified
Public Offering (QPO), defined as a public offering of the Company's common
stock with proceeds to the Company of at least $50 million.
Because the Company's shares are subject to a number of restrictions in the
shareholders' agreements and will not trade until the occurrence of a QPO, the
Company believes it is a nonpublic entity for compensation accounting purposes
and, accordingly, has not recorded any compensation expense for these puts and
calls. As noted above, at the date of the QPO, the put and call provisions of
the shareholder agreements will expire.
Warrants
- --------
In May 1995, the Company issued a stock purchase warrant for consideration of
$90,000, which provided the holder the right to purchase 100,000 shares of
common stock at $20.00 per share. The warrant expired unexercised on
December 31, 1995.
In September 1996, the Company issued a stock purchase warrant for consideration
of $115,000, which provided the holder the right to purchase 50,000 shares of
Class A common stock at $3.00 per share.
At December 31, 1996, warrants to purchase 6,653,726 shares of Class A and Class
B common stock were outstanding as follows:
<TABLE>
<CAPTION>
Number Price Expiration Date
----------------------------------------------------
<S> <C> <C>
20,000 $2.40 2000
201,150 5.00 2003
416,538 2.40 2000
416,538 2.40 2001
3,750,500 2.50 2003
1,799,000 2.50 2003
50,000 3.00 2003
</TABLE>
17
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
10. Stockholders' Equity (continued)
Shares Reserved for Future Issuance
- -----------------------------------
At December 31, 1996, the Company has reserved 8,528,726 shares of Common Stock
for future issuance for the following purposes:
<TABLE>
<S> <C>
Equity incentive plan 1,875,000
Warrants 6,653,726
-----------
8,528,726
===========
</TABLE>
Net Loss per Common Share
- -------------------------
Net loss per common share disclosed in the statement of operations is calculated
using the methodology discussed in Note 3. In February 1997, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 128 "Earnings Per Share," which is required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. The impact of SFAS 128
on the calculation of net loss per common share for the first quarter ended
March 31, 1997 and March 31, 1996 is not expected to be material.
Supplemental net loss per common share is presented to reflect the effects of
various conversions that occurred during 1996 as though they occurred on January
1, 1996. These conversions included, 1,666,151 shares of the convertible
preferred stock to common stock on a one for one basis, the conversion of the
convertible promissory note payable (see Note 6) into 625,000 shares of common
stock and the conversion of the convertible bridge loan into 402,301 shares of
common stock. None of the convertible securities are reflected in the historical
earnings per share calculations as their effects were anti-dilutive.The
supplemental net loss per common share for the year ended December 31, 1996 is
as follows:
<TABLE>
<CAPTION>
Year ended
December 31,
1996
---------------
<S> <C>
Supplemental net loss per common share $(1.54)
===============
Weighted average common shares
outstanding 12,581,239
===============
</TABLE>
11. Employee Compensation Plans
Equity Incentive Plan
- ---------------------
The Company's 1995 Equity Incentive Plan provides the opportunity for employees,
consultants, officers and directors to be granted options to purchase, receive
awards or make direct purchases of up to 1,875,000 shares of the Company's
common stock. Options granted under the Plan may be "Incentive Stock Options"
or "Nonqualified Options" under the applicable provisions of the Internal
Revenue Code.
18
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
11. Employee Compensation Plans (continued)
Incentive Stock Options are granted at the fair market value of the Company's
common stock at the date of the grant as determined by the Board of Directors.
Incentive Stock Options granted to employees who own more than 10% of the voting
power of all classes of stock will be granted at 110% of the fair market value
of the Company's common stock at the date of the grant. Nonqualified options
may be granted at amounts up to the fair market value of the Company's common
stock on the date of the grant, as determined by the Board of Directors.
Although FAS 123 requires the presentation of pro forma information to reflect
the fair value method of accounting for employee stock option grants, such
information has not been presented because the pro forma effects are not
material. The fair value for these options was estimated at the date of grant
using the "minimum value method" prescribed by FAS 123. The following weighted-
average assumptions were used to determine the fair value for 1995 and 1996,
respectively: a risk-free interest rate of 6.0% and 6.2%, an expected dividend
yield of 0% each year, and a weighted-average expected life of the options of
six years.
A summary of the Company's stock option activity and related information is as
follows:
<TABLE>
<CAPTION>
Period from March 20
1995 (inception) to Year ended
December 31, 1995 December 31, 1996
------------------------------------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of 476,086 $0.10
period
Granted 476,086 $0.10 340,500 2.12
Exercised
Forfeited (11,750) (0.08)
------------------------------------------------------
Outstanding at end of period 476,086 $0.10 804,836 $0.95
============ ===========
Exercisable at period end 0 140,487
Weighted-average fair value
of options granted during
period $0.02 $0.69
</TABLE>
19
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
11. Employee Compensation Plans (continued)
The following table summarizes information about stock options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
Weighted-Average
Options Remaining Life
Exercise Price Options Outstanding Exercisable (Years)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
$0.01 360,586 111,862 8.48
0.25 102,250 25,750 8.70
0.85 94,000 2,875 9.07
2.50 248,000 0 9.83
</TABLE>
No options were exercised during the period from March 20, 1995 (inception) to
December 31, 1996. All options granted vest equally over a range of three to
four years.
Profit Sharing Plan
- -------------------
The Board of Directors of the Company approved the adoption of a qualified
401(k) profit sharing plan (the Plan) for all employees meeting certain
eligibility requirements. Under the Plan, the participants may make
contributions to the Plan of up to 15% of their compensation, up to the Internal
Revenue Service limitation. Effective December 1, 1996, the Company may make
discretionary contributions to the Plan as determined by the Board of
Directors. Contributions for the year ended December 31, 1996 were
approximately $86,000.
Money Purchase Pension Plan
- ---------------------------
The Board of Directors of the Company approved the adoption of a qualified money
purchase pension plan for the employees of MCP. Effective on August 30, 1996
the Company may provide a contribution on wages up to the Social Security
limitation and up to 9.27% on wages in excess of the Social Security limitation.
The Company contributed approximately $187,000 to the money purchase pension
plan in 1996.
12. Income Taxes
The Company files consolidated tax returns with its affiliated physician
practices. The Company provides for income taxes under the liability method.
Deferred income taxes arise principally from temporary differences related to
capitalized start-up costs, depreciation, net operating losses, certain
accruals, and a change from the cash to accrual method of accounting for tax
purposes. The components of the Company's deferred income taxes are as follows:
20
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
12. Income Taxes (continued)
<TABLE>
<CAPTION>
December 31
1995 1996
---------------------------
<S> <C> <C>
Deferred Tax Liabilities:
Adjustment of cash Basis Practices to Accrual Basis $ 0 $(1,073,048)
Prepaid expenses, other 0 0
--------------------------
Total deferred tax liabilities 0 (1,073,048)
--------------------------
Deferred Tax Assets:
Other Accrued Liabilities 98,529
Fixed Asset Basis Differences 0 85,360
Capitalized Startup Costs 707,000 664,547
Net operating loss carryover 0 1,783,956
Other 0 85,763
--------------------------
707,000 2,718,155
Less valuation allowance (707,000) (2,109,984)
--------------------------
Net deferred tax assets 0 608,171
--------------------------
Net deferred tax assets (liabilities) $ 0 $ (464,877)
==========================
</TABLE>
For financial reporting purposes, a valuation allowance of $707,000 and
$2,109,984 at December 31, 1995 and 1996, respectively, has been recognized to
offset deferred tax assets since uncertainty exists with respect to future
realization of deferred tax assets.
Significant components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
Period from
inception to Year ended
December 31 December 31
1995 1996
----------------------------------
<S> <C> <C>
Current:
Federal $25,500 $22,057
State 6,500 56,071
----------------------------------
$32,000 $78,128
==================================
</TABLE>
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate is as follows:
<TABLE>
<CAPTION>
Period from
inception to Year ended
December 31 December 31
1995 1996
-------------------------------------------------
<S> <C> <C> <C> <C>
Federal taxes at statutory rates $(717,592) 35% $(1,721,439) 35%
Add (deduct):
State income taxes, net of federal benefit 6,500 (0.3%) (209,474) 4.3%
Change in valuation allowance
attributable to operations 707,000 (34.5%) 1,999,182 (40.6%)
Other 36,092 (1.8%) 9,859 (0.2%)
-------------------------------------------------
$ 32,000 (1.6%) $ 78,128 (1.5%)
=================================================
</TABLE>
21
<PAGE>
Physicians Quality Care, Inc.
Notes to Financial Statements (continued)
12. Income Taxes (continued)
At December 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $4,460,000 which expire through the
year 2011. The utilization of net operating losses may be subject to limitation
under the change in stock ownership rules of the Internal Revenue Code. For
financial reporting purposes, a valuation allowance of approximately $2,109,984
has been recognized to offset the deferred tax assets, including these
carryforwards, since uncertainty exist with respect to future realization of
such carryforwards.
13. Commitments
In September, 1996, the Company executed a contract with HBO and Company that
obligates the Company to purchase $1.1 million of equipment and licenses
pertaining to practice management systems. The term of the contract is five
years.
14. Subsequent Events
In January and February 1997, the Company entered into affiliation arrangements
with 6 physicians located in the Springfield, Massachusetts area (the
Springfield II Affiliation). Through mergers and asset purchases, the
Springfield II practices were transferred to MCP and the physicians became
employees of MCP. The aggregate total consideration paid to the physicians or
their practices in connection with the Springfield II Affiliation was
approximately $2.3 million, payable in a combination of cash and common stock.
In January 1997, the Company entered into a $3.5 million line of credit
agreement with a bank. The line carries an interest rate of prime plus 1.5%.
In February 1997, the Company issued 472,000 shares of Class A common stock for
$1,180,000 to shareholders and friends of the Company.
In April the Company issued 600,000 shares of Class B common stock to its
institutional investors for total consideration of $1,500,000.
On June 20, 1997 the Company issued 7,692,309 shares and warrants to purchase
7,692,309 shares of Class C common stock for total consideration of $25,000,000
to its institutional and other investors.
The Company is currently negotiating a long-term affiliation agreement with
Clinical Associates, P.A. (Clinical) Under this agreement, Clinical would
transfer its physician practices and its employees would become employees of
Flagship. The aggregate consideration to the Company for this affiliation is
expected to be in a combination of cash and the Company's common stock.
22
<PAGE>
Springfield Medical Associates, Inc.
Audited Consolidated Financial Statements
Years ended December 31, 1993, 1994 and 1995,
the period January 1, 1996 through August 30, 1996
and three months ended March 31, 1996 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors............................................ 1
Audited Consolidated Financial Statements
Consolidated Balance Sheets............................................... 2
Consolidated Statements of Operations..................................... 3
Consolidated Statements of Stockholders' Equity........................... 4
Consolidated Statements of Cash Flows..................................... 5
Notes to Consolidated Financial Statements................................ 6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying consolidated balance sheets of Springfield
Medical Associates, Inc. (the Company) as of December 31, 1994 and 1995, and
August 30, 1996 and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years ended December
31, 1995 and the period January 1, 1996 through August 30, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Springfield Medical Associates, Inc. at December 31, 1994, 1995, and August 30,
1996 and the consolidated results of its operations and its cash flows for each
of the three years ended December 31, 1995 and the period January 1, 1996
through August 30, 1996, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts 1
<PAGE>
Springfield Medical Associates, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31 August 30
1994 1995 1996
------------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash $ 40,888 $ 178,604 $ 112,116
Accounts receivable, less allowance
for doubtful accounts of $754,767 in
1994, $885,013 in 1995 and $1,202,653
in 1996, respectively 920,971 931,212 1,305,046
Prepaid expenses 73,859 74,067 93,195
Deferred income taxes 126,329 294,124 134,902
Income tax receivable 11,127 - -
Other current assets 27,202 24,154 44,164
------------------------------------
Total current assets 1,200,376 1,502,161 1,689,423
Deferred income tax 43,346 48,877 70,746
Property and equipment, net 300,947 340,636 358,856
------------------------------------
Total assets $1,544,669 $1,891,674 $2,119,025
====================================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 185,337 $ 40,599 $ 267,340
Accrued physician bonuses 231,475
Accrued employee benefits 95,254 331,560 340
Accrued expenses, other 35,231 131,676 101,530
Deferred income taxes 397,932 375,458 559,297
Income tax payable 57,991 51,174
Current portion of notes payable 227,840 88,370 78,759
------------------------------------
Total current liabilities 941,594 1,257,129 1,058,440
Notes payable 252,922 198,232 186,451
Stockholders' equity:
Common stock, no par value, 15,000
shares authorized, 1,600 shares issued
and outstanding
Additional paid-in capital 136,030 136,030 136,030
Retained earnings 214,123 300,283 738,104
------------------------------------
Total stockholders' equity 350,153 436,313 874,134
------------------------------------
Total liabilities and stockholders'
equity $1,544,669 $1,891,674 $2,119,025
====================================
</TABLE>
See accompanying notes.
2
<PAGE>
Springfield Medical Associates, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Three months January 1,
ended 1996 through
Year ended December 31, March 31, August 30,
1993 1994 1995 1996 1996
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue:
Net patient service revenue $6,187,800 $6,663,990 $7,021,521 $1,854,704 $5,986,482
Other income 2,573 149,969 37,673 94,940
Interest income 4,036 3,381 892 220 422
-------------------------------------------------------------------------------------
6,191,836 6,669,944 7,172,382 1,892,597 6,081,844
Operating expenses:
Salaries and wages--physicians 1,975,119 2,017,823 1,951,363 521,381 995,680
Salaries and wages--staff 1,376,401 1,512,357 1,673,917 401,585 1,023,991
Employee benefits--physicians 407,403 452,581 363,598 89,707 84,554
Employee benefits--staff 239,268 301,720 256,425 56,696 190,659
Supplies and other 1,281,638 1,510,779 1,781,480 485,684 1,671,820
Insurance 92,730 102,009 139,870 37,310 61,325
Interest 19,490 20,475 36,406 7,813 17,795
Depreciation 97,601 96,691 127,824 30,000 97,378
Provision for bad debts 668,754 754,767 885,013 287,764 1,202,653
-------------------------------------------------------------------------------------
Net operating expenses 6,158,404 6,769,202 7,215,896 1,917,940 5,345,855
-------------------------------------------------------------------------------------
Net income (loss) before income taxes 33,432 (99,258) (43,514) (25,343) 735,989
Income tax benefit (expense) 1,689 37,709 129,674 96,658 (298,168)
-------------------------------------------------------------------------------------
Net income (loss) $ 35,121 $ (61,549) $ 86,160 $ 71,315 $ 437,821
=====================================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Springfield Medical Associates, Inc.
Consolidated Statements of Stockholders' Equity
<TABLE>
<S> <C>
Balance at December 31, 1992 $356,581
Capital contributions by owners 10,000
Net income 35,121
----------
Balance at December 31, 1993 401,702
Capital contributions by owners 10,000
Net loss (61,549)
----------
Balance at December 31, 1994 350,153
Net loss 86,160
----------
Balance at December 31, 1995 436,313
Net income 437,821
----------
Balance at August 30, 1996 $874,134
==========
</TABLE>
See accompanying notes.
4
<PAGE>
Springfield Medical Associates, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
three months January 1
ended 1996 through
Year ended December 31, March 31, August 30,
1993 1994 1995 1996 1996
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating activities
Net income (loss) $ 35,121 $ (61,549) $ 86,160 $ 71,315 $ 437,821
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation 97,601 96,691 127,824 30,000 97,378
Deferred income taxes (2,145) (26,126) (195,800) (120,994) 843,210
Gain on sale of fixed
assets (400) (2,573) (5,439) (30,600)
Changes in operating assets
and liabilities:
Accounts receivable, net (42,715) (68,802) (10,241) (50,654) (373,834)
Prepaid expenses and
other current assets 37,048 (22,247) (208) 10,734 (39,138)
Accounts payable, accrued
expenses and other current
liabilities 19,880 89,722 491,654 291,154 (894,936)
----------------------------------------------------------------------------------------------------
Net cash provided by
operating activities 144,390 5,116 493,950 231,555 39,901
Investing activities
Proceeds from sale of
property and equipment 2,017 9,436 16,000 30,600
Purchase of property and
equipment (105,163) (149,827) (178,074) (35,191) (115,597)
----------------------------------------------------------------------------------------------------
Net cash used in investing
activities (103,146) (140,391) (162,074) (35,191) (84,997)
Financing activities
Contribution of capital 10,000 10,000
Proceeds from notes payable 36,241 187,575 37,520
Payments on notes payable (104,483) (45,090) (194,160) (23,722) (58,912)
----------------------------------------------------------------------------------------------------
Net cash provided (used) by
financing activities (58,242) 152,485 (194,160) (23,722) (21,392)
----------------------------------------------------------------------------------------------------
Increase (decrease) in cash (16,998) 17,210 137,716 172,642 (66,488)
Cash at beginning of period 40,676 23,678 40,888 156,006 178,604
----------------------------------------------------------------------------------------------------
Cash at end of period $ 23,678 $ 40,888 $ 178,604 $ 328,648 $ 112,116
====================================================================================================
Supplemental disclosure of
cash flow information:
Cash paid during the period
for interest $ 19,490 $ 20,475 $ 36,406 $ 8,079 $ 17,795
====================================================================================================
Cash paid during the
period for income taxes $ 476 $ 456 $ 912 $ 470 $ 470
====================================================================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Springfield Medical Associates, Inc. (the Company) is a taxable entity organized
under the laws of Massachusetts. The Company offers a variety of medical
services including cardiology, cancer treatment and primary care in Western
Massachusetts.
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of
Springfield Medical Associates and its wholly-owned subsidiaries. All
intercompany transactions have been eliminated in consolidation.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Income Taxes
Deferred income taxes are provided for temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
Professional Liability Insurance
The Company has obtained professional liability coverage through commercial
insurance carriers on the occurrence basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
6
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Company has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Company.
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Consolidated Financial Statements
The unaudited consolidated financial statements have been prepared by management
in accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
7
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
2. Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31 August 30
1994 1995 1996
------------------------------------
<S> <C> <C> <C>
Furniture, fixtures and equipment $ 817,499 $ 876,375 $ 934,476
Leasehold improvements 228,028 308,437 293,758
------------------------------------
1,045,527 1,184,812 1,228,234
Less accumulated depreciation 744,580 844,176 869,378
------------------------------------
$ 300,947 $ 340,636 $ 358,856
====================================
</TABLE>
3. Notes Payable
The Company has various notes payable with a combined original principal amount
of $575,675, payable in monthly installments of principal and interest at
interest rates ranging from 7.65% to 10.5% and secured by all of the Company's
assets. The principal balance outstanding under these note agreements
aggregated $480,762 and $286,602 at December 31, 1994 and 1995, respectively,
and $265,210 at August 30, 1996.
The following is a schedule of principal maturities on the notes as of
December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $ 88,370
1997 89,834
1998 71,263
1999 36,293
2000 842
----------
$286,602
==========
</TABLE>
In April 1996, the Company entered into loan agreements for two vehicles for
$37,520. In September 1996, the vehicles were sold to two of the Company's
physicians.
8
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
4. Operating Leases
The Company leases office space and certain equipment from related parties under
operating leases. Total rental expense was $244,095, $280,479 and $295,975 in
1993, 1994 and 1995, respectively, and $196,358, during the period January 1,
1996 through August 30, 1996, and is included in supplies and other in the
accompanying consolidated statements of operations. The following is a schedule
by year of future minimum lease payments under operating leases as of December
31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $228,565
1997 275,122
1998 162,524
1999 41,590
2000 1,558
----------
$709,359
==========
</TABLE>
5. Employee Benefit Plans
The Company has a qualified profit sharing plan covering substantially all
employees. Contributions were determined based upon a percentage of each
eligible employee's compensation, as defined and/or at the discretion of
management. Total contributions were $362,994, $422,293 and $302,174 for the
years ended December 31, 1993, 1994 and 1995, respectively, and $160,000 during
the period January 1, 1996 through August 30, 1996, and are included in employee
benefits in the accompanying consolidated statements of operations.
9
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
6. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The Company is a cash basis tax
payer. Significant components of the Company's deferred tax liabilities and
assets were as follows:
<TABLE>
<CAPTION>
December 31 August 30
1994 1995 1996
-----------------------------------
<S> <C> <C> <C>
Deferred tax liabilities:
Accounts receivable, net $(368,388) $(345,831) $(522,019)
Prepaid expenses, other (29,544) (29,627) (37,278)
-----------------------------------
Total deferred tax liabilities (397,932) (375,458) (559,297)
Deferred tax assets:
Accrued expenses, other 169,675 343,001 205,648
Net operating loss carryover 114,237 548,997
-----------------------------------
283,912 343,001 754,645
Less: valuation allowance 114,237 548,997
-----------------------------------
Net deferred tax assets 169,675 343,001 205,648
-----------------------------------
Net deferred tax liabilities $(228,257) $ (32,457) $(353,649)
===================================
</TABLE>
For financial reporting purposes a valuation allowance of $114,237, $0 and
$548,997 has been recognized at December 31, 1994 and 1995 and August 30, 1996,
respectively, to offset certain deferred tax assets since uncertainty exists
with respect to future realization of these tax assets.
10
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
6. Income Taxes (continued)
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
The period
January 1
1996
through
Year ended December 31 August 30
----------------------------------- -----------
1993 1994 1995 1996
----------------------------------- -----------
<S> <C> <C> <C> <C>
Current:
Federal $ - $(12,039) $ 50,759 $(545,498)
State 456 456 15,367 456
----------------------------------- -----------
Total current 456 (11,583) 66,126 (545,042)
Deferred:
Federal (1,652) (20,117) (150,766) 649,272
State (493) (6,009) (45,034) 193,938
----------------------------------- -----------
Total deferred (2,145) (26,126) (195,800) 843,210
----------------------------------- -----------
Net provision (benefit) $(1,689) $(37,709) $(129,674) $ 298,168
=================================== ===========
</TABLE>
11
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
6. Income Taxes (continued)
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
The period
January 1, 1996
through
Year ended December 31 August 30
1993 1994 1995 1996
------------------------------------------------------- -----------------
Amount Rate Amount Rate Amount Rate Amount Rate
------------------------------------------------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Federal taxes at $11,670 35% $(34,740) 35% $(15,230) 35% $257,596 35%
statutory rates
Add (deduct):
State income tax,
net of federal
tax benefit
(37) 0 (3,609) 4 (19,284) 44 126,356 17
Effect of
valuation
allowance (13,322) (40) (95,160) 219
Other 640 (1) (20,658) (3)
------------------------------------------------------- -----------------
$(1,689) (5)% $(37,709) 38% $(129,674) 298% $363,294 (49)%
======================================================= =================
</TABLE>
At December 31, 1995, the Company had net operating loss carryforwards for tax
purposes of approximately $285,000 which expire beginning in 2005.
12
<PAGE>
Springfield Medical Associates, Inc.
Notes to Consolidated Financial Statements (continued)
7. Affiliation
On August 30, 1996, the Company consummated a long-term affiliation arrangement
with Physicians Quality, Inc. (PQC). Under this arrangement, the physicians
transferred their practices to, and became employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration paid to the physicians for the asset purchases and affiliations
was in a combination of cash and PQC common stock.
The results of operations for the period January 1, 1996 through August 30, 1996
do not reflect an annual physicians bonus accrual which the Company's physicians
elected not to receive prior to the affiliation arrangement with PQC.
13
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Audited Financial Statements
Year ended September 30, 1995 and the period
October 1, 1995 through August 30, 1996 (Unaudited)
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors...............................................1
Audited Financial Statements
Balance Sheets...............................................................2
Statements of Operations.....................................................3
Statements of Stockholder's Equity...........................................4
Statements of Cash Flows.....................................................5
Notes to Financial Statements................................................6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Alphonse F. Calvanese, M.D.,
P.C. (the Practice) as of September 30, 1995, and the related statements of
operations, stockholder's equity, and cash flows for the year then ended. These
financial statements are the responsibility of management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Alphonse F. Calvanese, M.D.,
P.C. at September 30, 1995, and the results of operations and cash flows for the
year then ended in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts
1
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Balance Sheets
<TABLE>
<CAPTION>
September 30 (Unaudited)
1995 August 30, 1996
-------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 95,529 $127,191
Accounts receivable, less allowance for
doubtful accounts of $4,123 in 1995 and
$4,078 in 1996 (unaudited) 35,899 32,564
Prepaid expenses 10,654
Deferred income taxes 3,857 2,684
-------------------------------
Total current assets 135,285 173,093
Property and equipment, net 2,048
-------------------------------
Total assets $137,333 $173,093
===============================
Liabilities and stockholder's equity
Current liabilities:
Accounts payable $ 4,424 $ 6,710
Deferred income taxes, current 14,380 17,287
Taxes payable 16,210
Accrued expenses, other 5,168
-------------------------------
Total liabilities 23,972 40,207
Common stock, no par value, 1,000 shares
authorized, issued and outstanding 4,000 4,000
Retained earnings 109,361 128,886
Stockholder's equity 113,361 132,886
-------------------------------
Total liabilities and stockholder's equity $137,333 $173,093
===============================
</TABLE>
See accompanying notes.
2
<PAGE>
Alphonse. F. Calvanese, M.D., P.C.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
October 1, 1995
Year ended through
September 30 August 30
1995 1996
-------------------------------------
<S> <C> <C>
Revenue:
Net patient service revenue $586,191 $538,671
Other income 972
Interest income 3,496 3,302
-------------------------------------
589,687 542,945
Operating expenses:
Salaries and wages--physicians 356,800 328,986
Salaries and wages--staff 58,493 53,556
Employee benefits--physicians 31,576 31,397
Employee benefits--staff 13,277 19,684
Supplies and other 80,684 67,071
Insurance 8,970 3,168
Depreciation 18,781 2,048
Provision for bad debts 4,123 4,078
-------------------------------------
Net operating expenses 572,704 509,988
-------------------------------------
Net income before income taxes 16,983 32,957
Income tax benefit expense 372 (13,432)
-------------------------------------
Net income $ 17,355 $ 19,525
=====================================
</TABLE>
See accompanying notes.
3
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Statements of Stockholder's Equity
<TABLE>
<S> <C>
Balance at September 30, 1994 $ 96,006
Net income 17,355
---------------
Balance at September 30, 1995 113,361
Net income (unaudited) 19,525
---------------
Balance at August 30, 1996 (unaudited) $132,886
===============
</TABLE>
See accompanying notes.
4
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
October 1, 1995
Year ended through
September 30 August 30
1995 1996
----------------------------------
<S> <C> <C>
Operating activities
Net income $ 17,355 $ 19,525
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 18,781 2,048
Deferred income taxes (828) 4,080
Changes in operating assets and
liabilities:
Accounts receivable, net (3,097) 3,335
Advance to officer 1,334
Prepaid expenses (10,654)
Accounts payable, accrued expenses
and other current liabilities 5,168 13,328
----------------------------------
Net cash provided by operating activities 38,713 31,662
Investing activity
Purchase of property and equipment (14,648)
----------------------------------
Net cash used in investing activity (14,648)
----------------------------------
Increase in cash 24,065 31,662
Cash at beginning of period 71,464 95,529
----------------------------------
Cash at end of period $ 95,529 $127,191
==================================
</TABLE>
See accompanying notes.
5
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Notes to the Financial Statements
September 30, 1995
1. Summary of Significant Accounting Policies
Description of Business
The medical practice of Alphonse F. Calvanese, M.D. (the Practice) is organized
under the laws of Massachusetts. The practice offers a variety of primary care
medical services in western Massachusetts.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Income Taxes
Deferred income taxes are provided for temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes.
Professional Liability Insurance
The practice has obtained professional liability coverage through commercial
insurance carriers on the claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Practice has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Practice.
6
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Notes to the Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
September 30
1995
------------
<S> <C>
Furniture, fixtures and equipment $133,350
Less accumulated depreciation 131,302
------------
$ 2,048
============
</TABLE>
3. Operating Leases
The Practice leases office space from a related party under an operating lease.
Total rental expense was $33,456 at September 30, 1995 and is included in
supplies and other on the statement of operations.
7
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Notes to the Financial Statements (continued)
4. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The Company is a cash-basis
taxpayer. Significant components of the Company's deferred tax liabilities and
assets were as follows:
<TABLE>
<CAPTION>
September 30
1995
------------
<S> <C>
Deferred tax liabilities:
Accounts receivable, net $(14,380)
Prepaid expenses, other
------------
Total deferred tax liabilities (14,380)
Deferred tax assets:
Accrued expenses, other 3,857
Net operating loss carryover
------------
Less valuation allowance
Net deferred tax assets 3,857
------------
Net deferred tax assets (liabilities) $(10,523)
============
</TABLE>
8
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Notes to the Financial Statements (continued)
4. Income Taxes (continued)
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
Year ended September 30
1995
-----------------------
<S> <C>
Current:
Federal
State $ 456
-----------------------
Total current 456
Deferred:
Federal (638)
State (190)
-----------------------
Total deferred $(828)
=======================
Net provision (benefit) $(372)
=======================
</TABLE>
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
September 30
1995
----------------
Amount Rate
----------------
<S> <C> <C>
Federal taxes at statutory rates $ 5,944 35 %
Add (deduct):
Federal taxes on income (124) (1)
Taxed at shareholder level
Effect of valuation allowance (6,018) (35)
Other (174) (1)
----------------
$ (372) (2)%
================
</TABLE>
9
<PAGE>
Alphonse F. Calvanese, M.D., P.C.
Notes to the Financial Statements (continued)
5. Affiliation
On August 31, 1996, the Practice consummated a long-term affiliation arrangement
with Physicians Quality Care, Inc. (PQC). Under this arrangement, the
physicians transferred their practices to, and became employees of, a newly
formed professional corporation that is affiliated with PQC. The aggregate
consideration paid to the physicians for the assets purchased and affiliations
was in a combination of cash and PQC common stock.
10
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Audited Financial Statements
Years ended December 31, 1994 and 1995 and
period January 1, 1996 through August 30, 1996 (Unaudited)
and nine months ended September 30, 1995 (Unaudited)
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors................................................1
Audited Financial Statements
Balance Sheets................................................................2
Statements of Operations......................................................3
Statements of Stockholder's Equity............................................4
Statements of Cash Flows......................................................5
Notes to Financial Statements.................................................6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Cardiology and Internal Medicine Associates, Inc.
We have audited the accompanying balance sheets of Cardiology and Internal
Medicine Associates, Inc. (the Group) as of December 31, 1995 and 1994, and the
related statements of operations, stockholder's equity, and cash flows for the
years then ended. These financial statements are the responsibility of the
Group's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cardiology and Internal
Medicine Associates, Inc. at December 31, 1995 and 1994, and the results of its
operations and its cash flows for each of the years then ended, in conformity
with generally accepted accounting principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts
1
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 August 30
1994 1995 1996
--------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash $ 43,264 $ 42,974 $ 85,681
Accounts receivable, less
allowance for doubtful
accounts of $17,928 in
1994, $28,680 in 1995 and
$26,191 in 1996 (unaudited) 132,713 157,341 139,085
Prepaid expenses 11,448 10,332 18,203
Due from related parties 1,500
Deferred income taxes 23,955 31,881 8,715
--------------------------------
Total current assets 211,380 244,028 251,684
Property and equipment, net 59,558 46,648 41,910
--------------------------------
Total assets $270,938 $290,676 $293,594
================================
Liabilities and owners' equity
Current liabilities:
Accounts payable $ 9,477 $ 22,339 $ 7,999
Accrued employee benefits 48,699 42,555
Accrued expenses, other 1,711 14,808 13,158
Deferred income taxes 57,664 67,070 62,916
Income tax payable 456 912 21,865
Current portion of notes
payable and line of credit 13,000 6,960
--------------------------------
Total current liabilities 131,007 154,644 105,938
Deferred income taxes,
noncurrent 5,448 2,426
Stockholder's equity:
Common stock, no par value,
12,500 shares authorized,
400 shares issued
and outstanding
Additional paid-in capital 1,000 1,000 1,000
Retained earnings 133,483 132,606 186,656
--------------------------------
134,483 133,606 187,656
--------------------------------
Total liabilities and owners'
equity $270,938 $290,676 $293,594
================================
</TABLE>
See accompanying notes.
2
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Nine months January 1
ended 1996 through
Year ended December 31 September 30 August 30
1994 1995 1995 1996
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Net patient service revenue $1,823,131 $1,909,307 $1,369,391 $1,211,521
Other income 26,654 24,078 18,339 17,235
Interest income 822 941 763 498
------------------------------------------------------------------
1,850,607 1,934,326 1,388,493 1,229,254
Operating expenses:
Salaries and wages--physicians 988,839 999,650 680,540 556,110
Salaries and wages--staff 303,453 328,573 245,321 220,902
Employee benefits--physicians 127,360 130,104 89,501 71,278
Employee benefits--staff 42,210 45,712 34,124 25,043
Supplies and other 325,514 343,163 236,402 217,411
Insurance 26,948 44,229 24,815 16,175
Interest 1,672 1,042 885 344
Depreciation 15,140 15,136 11,308 18,487
Provision for bad debts 17,928 28,680 25,000 26,191
------------------------------------------------------------------
Net operating expenses 1,849,064 1,936,289 1,347,896 1,151,941
------------------------------------------------------------------
Net income (loss) before income taxes 1,543 (1,963) 40,597 77,313
Income tax benefit (expense) 5,985 1,086 (9,859) (23,263)
------------------------------------------------------------------
Net income (loss) $ 7,528 $ (877) $ 30,738 $ 54,050
==================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Statements of Stockholder's Equity
<TABLE>
<CAPTION>
<S> <C>
Balance at December 31, 1993 $126,955
Net income 7,528
--------
Balance at December 31, 1994 134,483
Net income (loss) (877)
--------
Balance at December 31, 1995 133,606
Net income (unaudited) 54,050
--------
Balance at August 30, 1996 (unaudited) $187,656
========
</TABLE>
See accompanying notes.
4
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Nine months January 1
ended 1996 through
Year ended December 31 September 30 August 30
1994 1995 1995 1996
--------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating activities
Net income (loss) $ 7,528 $ (877) $ 30,738 $ 54,050
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 15,140 15,136 11,308 18,487
Deferred income taxes (6,441) (1,542) 7,942 16,586
Changes in operating assets and liabilities:
Accounts receivable, net 19,217 (24,628) 9,541 18,256
Prepaid expenses, due from related parties
and other current assets (40) (384) (3,726) 9,905
Accounts payable, accrued expenses and
other current liabilities 5,030 20,271 (29,397) (53,868)
--------------------------------------------------------------
Net cash provided by operating activities 40,434 7,976 26,406 63,416
Investing activities
Purchase of property and equipment (6,943) (2,226) (997) (13,749)
--------------------------------------------------------------
Net cash used in investing activities (6,943) (2,226) (997) (13,749)
Financing activities
Contribution of capital 250
Payments on notes payable and line of credit (9,819) (6,040) (4,500) (6,960)
--------------------------------------------------------------
Net cash used in financing activities (9,569) (6,040) (4,500) (6,960)
--------------------------------------------------------------
Increase (decrease) in cash 23,922 (290) 20,909 42,707
Cash at beginning of period 19,342 43,264 42,974 42,974
--------------------------------------------------------------
Cash at end of period $43,264 $ 42,974 $ 63,883 $ 85,681
==============================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 1,672 $ 1,042 $ 885 $ 344
==============================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Cardiology and Internal Medicine Associates, Inc. (CIMA) is a taxable entity
organized under the laws of Massachusetts. CIMA offers a variety of medical
services, including cardiology and primary care in Western Massachusetts.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Income Taxes
CIMA is taxable under the provisions of the Internal Revenue Code. Deferred
income taxes are provided for temporary differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes.
Professional Liability Insurance
CIMA has obtained professional liability coverage through commercial insurance
carriers on an occurrence basis. Management believes that there are no claims
that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. CIMA has negotiated several
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to CIMA.
6
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1994 1995
-----------------------
<S> <C> <C>
Furniture, fixtures and equipment $ 185,702 $ 187,928
Leasehold improvements 46,832 46,832
-----------------------
232,534 234,760
Less accumulated depreciation (172,976) (188,112)
-----------------------
$ 59,558 $ 46,648
=======================
</TABLE>
3. Line of Credit
CIMA has negotiated a line of credit with a local bank at an interest rate of
9.72%. This line of credit is secured by all of the practice's assets. At
December 31, 1994 and 1995 the outstanding balance on the line of credit was
$13,000 and $6,960, respectively. The available credit under this line was
$5,000 and $11,040 at December 31, 1994 and 1995.
7
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Notes to Financial Statements (continued)
4. Operating Leases
CIMA leases office space and certain equipment from a related party under
operating leases. Total rental expense was $97,622 in 1994 and 1995, and is
included in supplies and other in the accompanying combined statements of
operations. The following is a schedule by year of future minimum lease
payments under operating leases as of December 31, 1995:
<TABLE>
<S> <C>
1996 $97,622
1997 97,622
1998 97,622
1999 97,622
2000 89,487
</TABLE>
5. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Each member of CIMA is a cash-
basis taxpayer. Significant components of CIMA's deferred tax liabilities and
assets were as follows:
<TABLE>
<CAPTION>
December 31
1994 1995
---------------------
Deferred tax liabilities:
<S> <C> <C>
Accounts receivable, net $(53,085) $(62,937)
Prepaid expenses, other (4,579) (4,133)
---------------------
Total deferred tax liabilities (57,664) (67,070)
Deferred tax assets:
Accrued expenses, other 23,955 31,881
Accumulated depreciation (5,448) (2,426)
Net operating loss carryover 6,443 5,868
---------------------
24,950 35,323
Less valuation allowance (6,443) (5,868)
---------------------
Net deferred tax assets 18,507 29,455
---------------------
Net deferred tax liabilities $(39,157) $(37,615)
=====================
</TABLE>
8
<PAGE>
Cardiology and Internal Medicine Associates, Inc.
Notes to Financial Statements (continued)
5. Income Taxes (continued)
For financial reporting purposes, a valuation allowance of $16,107 and $14,669
at December 31, 1994 and 1995, respectively, has been recognized to offset
certain deferred tax assets since uncertainty exists with respect to future
realization of these tax assets.
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995
---------------------------
<S> <C> <C>
Current:
Federal - -
State $ 456 $ 456
---------------------------
Total current 456 456
Deferred:
Federal (4,960) (1,187)
State (1,481) (355)
---------------------------
Total deferred (6,441) (1,542)
---------------------------
Net provision (benefit) $(5,985) $(1,086)
===========================
</TABLE>
6. Affiliation
On August 30, 1996, CIMA consummated a long-term affiliation arrangement with
Physicians Quality, Inc. (PQC). Under this arrangement, the physicians
transferred their practices to, and became employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration paid to the physicians for the asset purchases and affiliations
was in a combination of cash and PQC common stock.
9
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Audited Financial Statements
Year ended December 31, 1995 and period
January 1, 1996 through August 30, 1996 (Unaudited)
and nine months ended September 30, 1995 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors............................................ 1
Audited Financial Statements
Balance Sheets............................................................ 2
Statements of Operations.................................................. 3
Statements of Partners' Capital........................................... 4
Statements of Cash Flows.................................................. 5
Notes to Financial Statements............................................. 6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of James F. Haines and William J.
Belcastro, Partnership as of December 31, 1995, and the related statements of
operations, partners' capital, and cash flows for the year then ended. These
financial statements are the responsibility of management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of James F. Haines and William J.
Belcastro, Partnership at December 31, 1995, and the results of its operations
and its cash flows for the year then ended, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts
1
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 August 30
1995 1996
-----------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 51,370 $ 68,410
Accounts receivable, less allowance
for doubtful accounts of $19,014
in 1995 and $13,372 in 1996
(unaudited) 60,592 51,144
Prepaid expenses 13,215 30,244
-----------------------------
Total current assets 125,177 149,798
Furniture and equipment, net 222,579 196,426
-----------------------------
Total assets $347,756 $346,224
=============================
Liabilities and owners' equity
Current liabilities:
Accounts payable $ 13,714 $ 9,271
Accrued expenses, other 6,857
Current portion of notes
payable and line of credit 50,032 50,032
-----------------------------
Total current liabilities 63,746 66,160
Notes payable 254,245 212,152
Partner's capital 29,765 67,912
-----------------------------
Total liabilities and partner's capital $347,756 $346,224
=============================
</TABLE>
See accompanying notes.
2
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Nine months January 1,
Year ended ended 1996 through
December 31 September 30 August 30
1995 1995 1996
------------------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $1,009,315 $771,080 $688,081
Other income 793 454
------------------------------------------------
1,010,108 771,080 688,535
Operating expenses:
Salaries and wages--physicians 459,386 310,266 307,549
Salaries and wages--staff 162,197 124,761 109,043
Employee benefits--physicians 62,678 47,158 52,646
Employee benefits--staff 12,000 9,003 501
Supplies and other 148,429 98,341 112,641
Insurance 30,262 20,557 15,783
Interest 25,230 23,125 12,600
Depreciation 63,909 48,308 26,153
Provision for bad debts 19,014 18,432 13,472
------------------------------------------------
Net operating expenses 983,105 699,951 650,388
------------------------------------------------
Net income $ 27,003 $ 71,129 $ 38,147
================================================
</TABLE>
See accompanying notes.
3
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Statements of Partners' Capital
<TABLE>
<S> <C>
Balance at December 31, 1994 $ 2,762
Net income 27,003
---------
Balance at December 31, 1995 29,765
Net income (unaudited) 38,147
---------
Balance at August 30, 1996 (unaudited) $67,912
=========
</TABLE>
See accompanying notes.
4
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Nine months January 1, 1996
Year ended ended through
December 31 September 30 August 30
1995 1995 1996
--------------------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $ 27,003 $ 71,129 $ 38,147
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation 63,909 48,308 26,153
Changes in operating
assets and liabilities:
Accounts receivable, net (10,101) (19,957) 9,448
Prepaid expenses, due from
related parties and
other current assets 5,614 15,335 (17,029)
Accounts payable, accrued
expenses and other
current liabilities 2,604 10,552 2,414
--------------------------------------------
Net cash provided by operating
activities 89,029 125,367 59,133
Investing activity
Purchase of property and equipment (63,462) (61,463) -
--------------------------------------------
Net cash used in investing activity (63,462) (61,463) -
Financing activities
Issuance of debt 58,500 58,500
Payments on notes payable and line
of credit (64,490) (48,876) (42,093)
--------------------------------------------
Net cash provided (used)
by financing activities (5,990) 9,624 (42,093)
--------------------------------------------
Increase in cash 19,577 73,528 17,040
Cash at beginning of period 31,793 31,793 51,370
--------------------------------------------
Cash at end of period $ 51,370 $105,321 $ 68,410
============================================
Supplemental disclosure of
cash flow information:
Cash paid during the
period for interest $ 25,230 $ 23,125 $ 12,600
============================================
</TABLE>
See accompanying notes.
5
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
The medical practice of James F. Haines and William J. Belcastro, Partnership
(the Partnership) is a general partnership organized under the laws of
Massachusetts. The practice offers primary care medical services in Western
Massachusetts.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Income Taxes
The Partnership is a nontaxable entity under the provisions of the Internal
Revenue Code. The taxable income or loss of the Partnership is allocated to the
partners and then is reported on the partners' individual tax returns.
Therefore, no provision for income taxes is included in these financial
statements.
Professional Liability Insurance
The Partnership has obtained professional liability coverage through commercial
insurance carriers on the claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Partnership has negotiated
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to the
Partnership.
6
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1995
-------------
<S> <C>
Furniture and equipment $584,858
Less accumulated depreciation 362,279
-------------
$222,579
=============
</TABLE>
7
<PAGE>
James F. Haines and William J. Belcastro, Partnership
Notes to Financial Statements
3. Notes Payable
The Partnership has various notes payable with a combined original principal
amount of $304,277 at December 31, 1995 payable in monthly installments of
principal and interest at interest rates ranging from 8.75% to 10.5% and secured
by all the Partnership's assets.
The following is a schedule of principal maturities on the notes as of December
31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $ 50,032
1997 30,535
1998 30,989
1999 28,324
2000 14,183
Thereafter 150,214
----------
$304,277
==========
</TABLE>
4. Employee Benefit Plans
The Partnership has a qualified defined contribution plans covering
substantially all employees. Contributions were determined based upon a
percentage of each eligible employee's compensation, as defined, and/or at the
discretion of management. Total contributions were $12,000 at December 31,
1995, and are included in employee benefits in the accompanying statement of
operations.
5. Affiliation
On August 30, 1996, the Partnership consummated a long-term affiliation
arrangement with Physicians Quality Care, Inc. (PQC). Under this arrangement,
the physicians transferred their practices to, and became employees of, a newly
formed professional corporation that is affiliated with PQC. The aggregate
consideration paid to the physicians for the assets purchased and affiliations
was in a combination of cash and PQC common stock.
8
<PAGE>
Jay M. Ungar, M.D.
Audited Financial Statements
Year ended December 31, 1995 and period
January 1 through August 30, 1996 (Unaudited) and
nine months ended September 30, 1995 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors............................................. 1
Audited Financial Statements
Balance Sheets............................................................. 2
Statements of Operations................................................... 3
Statements of Cash Flows................................................... 4
Notes to Financial Statements.............................................. 5
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Jay M. Ungar, M.D. as of
December 31, 1995, and the related statements of operations, and cash flows for
the year then ended. These financial statements are the responsibility of
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Jay M. Ungar, M.D. at December
31, 1995, and the results of operations and cash flows for the year then ended,
in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts
1
<PAGE>
Jay M. Ungar, M.D.
Balance Sheets
<TABLE>
<CAPTION>
December 31 (Unaudited)
1995 August 30, 1996
----------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 8,655 $24,645
Accounts receivable, less allowance
for doubtful accounts of $18,982 in
1995 and $16,733 in 1996
(Unaudited) 39,531 24,917
Prepaid expenses 4,500 4,939
Other current assets 18,000 18,000
----------------------------------
Total current assets 70,686 72,501
Property and equipment, net 328
----------------------------------
Total assets $71,014 $72,501
==================================
Liabilities and owners' equity
Current liabilities:
Accounts payable $ 7,700 $10,801
Accrued employee benefits 34,000 34,000
----------------------------------
Total current liabilities 41,700 44,801
Owners' equity 29,314 27,700
----------------------------------
Total liabilities and owners' equity $71,014 $72,501
==================================
</TABLE>
See accompanying notes.
2
<PAGE>
Jay M. Ungar, M.D.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Nine months (Unaudited)
Year ended ended January 1, 1996
December 31 September 30 through August 30
1995 1995 1996
-------------------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $575,448 $422,964 $337,054
Other income 727 26,451
Interest income 639 485 267
-------------------------------------------------
576,087 424,176 363,772
Operating expenses:
Salaries and wages--physicians 305,632 229,668 162,140
Salaries and wages--staff 108,172 81,128 94,957
Employee benefits--physicians 36,675 29,543 22,099
Employee benefits--staff 21,634 17,350 11,900
Supplies and other 66,895 49,012 43,460
Insurance 24,021 3,902 13,769
Depreciation 328
Provision for bad debts 18,982 14,236 16,733
-----------------------------------------------
Net operating expenses 582,011 424,839 365,386
-----------------------------------------------
Net loss $ (5,924) $ (663) $ (1,614)
===============================================
</TABLE>
See accompanying notes.
3
<PAGE>
Jay M. Ungar, M.D.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Nine months January 1
Year ended ended 1996 through
December 31 September 30 August 30
1995 1995 1996
---------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net loss $(5,924) $ (663) $(1,614)
Adjustments to reconcile
net loss to net cash
provided by operating
activities:
Depreciation 328
Changes in operating
assets and liabilities:
Accounts receivable, (258) 18,649 14,614
net
Other current assets 4,500 (439)
Accounts payable 3,101
---------------------------------------------------
Net cash provided (used) by (6,182) 22,486 15,990
operating activities
Cash at beginning of period 14,837 14,837 8,655
---------------------------------------------------
Cash at end of period $ 8,655 $37,323 $24,645
===================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Jay M. Ungar, M.D.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
The medical practice of Dr. Jay M. Ungar, M.D. (the Practice) is a sole
proprietorship which offers primary care medical services.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Professional Liability Insurance
The Practice has obtained professional liability coverage through commercial
insurance carriers on a claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The practice has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules.
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
5
<PAGE>
Jay M. Ungar, M.D.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Unaudited Combined Financial Statements
The unaudited financial statements at August 30, 1996 and for the nine months
ended September 30, 1995 and the period January 1, 1996 through August 30, 1996
have been prepared by management in accordance with generally accepted
accounting principles. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results of the interim periods are
not necessarily indicative of the results that may be expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
December 31
1995
-------------
Furniture, fixtures and equipment $24,072
Less accumulated depreciation 23,744
-------------
$ 328
=============
3. Affiliation
On August 31, 1996, Jay M. Ungar, M.D. consummated a long-term affiliation
arrangement with Physicians Quality Care, Inc. (PQC). Under this arrangement,
the physician transferred his practices to, and became an employee of, a newly
formed professional corporation that is affiliated with PQC. The aggregate
consideration paid to the physician for the asset purchases and affiliations was
in a combination of cash and PQC common stock.
6
<PAGE>
Western Massachusetts Medical Group, Inc.
Audited Financial Statements
Year ended November 30, 1995 and the period
December 1, 1995 through August 30, 1996 (Unaudited) and
nine months ended August 31, 1995 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors.............................................1
Audited Financial Statements
Balance Sheets.............................................................2
Statements of Operations...................................................3
Statements of Stockholder's Equity.........................................4
Statements of Cash Flows...................................................5
Notes to Financial Statements..............................................6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheets Western Massachusetts Medical
Group, Inc. as of November 30, 1995, and the related statements of operations,
stockholder's equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Group's management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Western Massachusetts Medical
Group, Inc. at November 30, 1995, and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
November 21, 1996
Boston, Massachusetts
1
<PAGE>
Western Massachusetts Medical Group, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
November 30 August 30
1995 1996
--------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 83,930 $ 32,358
Accounts receivable, less allowance for doubtful
accounts of $17,328 in 1995 and $19,079 in
1996 (unaudited) 84,601 93,174
Prepaid expenses 14,685 27,437
Due from related parties 1,342
Other current assets 23,839 25,288
Deferred income taxes 13,984 11,266
Income tax receivable 8,371
-------------------------
Total current assets 222,381 197,894
Property and equipment, net 83,426 72,229
-------------------------
Total assets $305,807 $270,123
=========================
Liabilities and stockholder's equity
Liabilities:
Accounts payable $ 34,734 $ 28,165
Deferred income taxes 39,715 48,244
Taxes payable 11,602
Current portion of notes payable and line of credit 8,251 8,730
-------------------------
Total current liabilities 94,302 85,139
Deferred income taxes 13,674 13,840
Notes payable 6,663 761
Stockholder's equity:
Common stock, no par value, 15,000 shares
authorized, 8,000 shares issued and
outstanding
Additional paid-in capital 400 400
Retained earnings 190,768 169,983
-------------------------
Total stockholder's equity 191,168 170,383
-------------------------
Total liabilities and stockholder's equity $305,807 $270,123
=========================
</TABLE>
See accompanying notes.
2
<PAGE>
Western Massachusetts Medical Group, Inc.
Statements of Operations
<TABLE>
<CAPTION>
Nine months December 1,
Year ended ended 1995 through
November 30 August 31 August 30
1995 1995 1996
---------------------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service
revenue $1,295,882 $ 966,099 $895,292
Interest income 1,909 1,647 919
---------------------------------------------------
1,297,791 967,746 896,211
Operating expenses:
Salaries and
wages--physicians 500,410 445,411 319,106
Salaries and wages--staff 293,891 261,590 189,341
Employee benefits--physicians 95,414 80,329 48,000
Employee benefits--staff 63,610 47,178 32,000
Supplies and other 288,002 205,495 270,770
Insurance 27,718 20,718 22,887
Interest 379 34 1,593
Depreciation 22,259 16,142 22,779
Provision for bad debts 17,328 14,191 19,079
---------------------------------------------------
Net operating expenses 1,309,011 1,091,088 925,555
---------------------------------------------------
Net loss before income taxes (11,220) (123,342) (29,344)
Income tax benefit 6,944 54,801 8,559
---------------------------------------------------
Net loss $ (4,276) $ (68,541) $(20,785)
===================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Western Massachusetts Medical Group, Inc.
Statements of Stockholder's Equity
<TABLE>
<CAPTION>
<S> <C>
Balance at November 30, 1994 $195,444
Net loss (4,276)
----------
Balance at November 30, 1995 191,168
Net loss (unaudited) (20,785)
----------
Balance at August 30, 1996 (unaudited) $170,383
==========
</TABLE>
See accompanying notes.
4
<PAGE>
Western Massachusetts Medical Group, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
December 1, 1995
Year ended Nine months ended through
November 30 August 31 August 30
1995 1995 1996
----------------------------------------------------
<S> <C> <C> <C>
Operating activities
Net loss $ (4,276) $(68,541) $(20,785)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation 22,259 16,142 22,779
Deferred income taxes (18,546) (55,257) (19,882)
Changes in operating assets and liabilities:
Accounts receivable, net 16,929 21,806 (8,573)
Prepaid expenses due from related parties
and other current assets (6,026) 2,025 (12,859)
Accounts payable, accrued expenses and
other current liabilities 22,787 64,049 4,753
----------------------------------------------------
Net cash provided (used) by operating activities 33,127 (19,776) (34,567)
Investing activity
Purchase of property and equipment (29,608) (23,991) (11,582)
----------------------------------------------------
Net cash provided (used) by investing activity (29,608) (23,991) (11,582)
Financing activities
Principal payments on long-term debt (4,456) (2,500) (5,423)
Issuance of debt 16,870 16,870
----------------------------------------------------
Net cash provided (used) by financing activities 12,414 14,370 (5,423)
----------------------------------------------------
Increase (decrease) in cash 15,933 (29,397) (51,572)
Cash at beginning of period 67,997 67,997 83,930
----------------------------------------------------
Cash at end of period $ 83,930 $ 38,600 $ 32,358
====================================================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 379 $ 34 $ 1,593
====================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements
November 30, 1995
1. Summary of Significant Accounting Policies
Description of Business
Western Massachusetts Medical Group, Inc. (the Group) is a taxable entity
organized under the laws of Massachusetts. The Group offers primary medical
services in Western Massachusetts.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred, while costs of betterments and renewals are capitalized.
Income Taxes
The Group is taxable under the provisions of the Internal Revenue Code. Deferred
income taxes are provided for temporary differences between the carrying amounts
of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes.
Professional Liability Insurance
The Group has obtained professional liability coverage through commercial
insurance carriers on the occurrence basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Group has negotiated numerous
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to the Group.
6
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
November 30
1995
-------------
<S> <C>
Furniture, fixtures and equipment $340,898
Less accumulated depreciation 257,472
-------------
Total $ 83,426
=============
</TABLE>
7
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements (continued)
3. Notes Payable
The Group has a note payable with an original principal amount of $16,870,
payable in monthly installments of principal and interest at 8.5% secured by the
Groups' respective assets. The principal balance outstanding under the notes
payable agreement is $14,914 at November 30, 1995.
The following is a schedule of principal maturities on the notes and line of
credit as of November 30, 1995:
<TABLE>
<S> <C>
1996 $ 8,251
1997 6,663
---------
Total $14,914
=========
</TABLE>
4. Operating Leases
The Group leases office space and certain equipment under operating leases.
Total rental expense was $66,572 in 1995, and is included in supplies and other
in the accompanying combined statements of operations.
5. Employee Benefit Plans
The Group has a qualified defined contribution plan or profit sharing plans
covering substantially all employees. Contributions were determined based upon
a percentage of each eligible employee's compensation, as defined and/or at the
discretion of management. Total contributions were $153,912 for the year ended
November 30, 1995, and are included in employee benefits in the accompanying
statements of operations.
8
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements (continued)
6. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Each member of the Group is a
cash-basis taxpayer. Significant components of the Group's deferred tax
liabilities and assets were as follows:
<TABLE>
<CAPTION>
November 30
1995
-------------
<S> <C>
Deferred tax liabilities:
Accounts receivable, net $(33,841)
Prepaid expenses, other (5,874)
-------------
Total deferred tax liabilities (39,715)
Deferred tax assets:
Accrued expenses, other 220
Net operating loss carryover 9,075
-------------
9,295
Less: valuation allowance 9,075
-------------
Net deferred tax assets 220
-------------
Net deferred tax liabilities $(39,495)
=============
</TABLE>
For financial reporting purposes a valuation allowance of $9,075 at November 30,
1995, has been recognized to offset certain deferred tax assets since
uncertainty exists with respect to future realization of these tax assets.
9
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements (continued)
6. Income Taxes (continued)
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
November 30
1995
--------------
<S> <C>
Current:
Federal $ 11,146
State 456
--------------
Total current 11,602
Deferred:
Federal (14,286)
State (4,260)
--------------
Total deferred (18,546)
--------------
Net provision (benefit) $ (6,944)
==============
</TABLE>
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
Year ended
November 30, 1995
--------------------------
Amount Rate
--------------------------
<S> <C> <C>
Federal taxes at statutory rates $(3,927) 35%
Add (deduct):
State tax, net of federal benefit (2,451) 22
Other (566) 5
--------------------------
$(6,944) 62%
==========================
</TABLE>
10
<PAGE>
Western Massachusetts Medical Group, Inc.
Notes to Financial Statements (continued)
7. Affiliation
On August 30, 1996, the Western Massachusetts Medical Group, Inc. consummated a
long-term affiliation arrangement with Physicians Quality Care, Inc. (PQC).
Under this arrangement, the physicians transferred their practices to, and
became employees of, a newly formed professional corporation that is affiliated
with PQC. The aggregate consideration paid to the physicians for the asset
purchases and affiliations was in a combination of cash and PQC common stock.
11
<PAGE>
Annapolis Medical Specialists, LLP
Audited Financial Statements
Years ended December 31, 1993, 1994 and 1995, and
nine months ended September 30, 1995 (Unaudited) and
nine months ended September 30, 1996 (Unaudited)
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors............................................ 1
Audited Financial Statements
Balance Sheet............................................................. 2
Statements of Operations.................................................. 3
Statements of Stockholder's Equity........................................ 4
Statements of Cash Flows.................................................. 5
Notes to Financial Statements............................................. 7
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheets of Annapolis Medical
Specialists, LLP (the Partnership) as of December 31, 1994 and 1995 and the
related statements of operations, partners capital, and cash flows each of the
three years in the period ended December 31, 1995. These financial statements
are the responsibility of management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Annapolis Medical Specialists,
LLP, at December 31, 1994 and 1995 and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
September 20, 1996
Boston, Massachusetts
<PAGE>
Annapolis Medical Specialists, LLP
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1994 1995 1996
-------------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash $ 46,706 $ 64,280 $203,974
Accounts receivable, less allowance
for doubtful accounts of $130,611
in 1994, $85,081 in 1995 and $98,887
in 1996 (unaudited) 399,774 357,906 362,742
Prepaids and other assets 35,726 40,773 57,267
-------------------------------------
Total current assets 482,206 462,959 623,983
Property and equipment, net 162,526 122,248 94,455
-------------------------------------
Total assets $644,732 $ 585,207 $718,438
=====================================
Liabilities and partners' capital
Current liabilities:
Accounts payable $150,693 $ 168,293 $292,830
Accrued employee benefits 54,821 84,117 73,498
Accrued expenses, other 36,518 46,594 52,264
Current portion of obligation
under capital lease 18,168 20,169 14,288
Current portion of notes payable 70,777 44,869
-------------------------------------
Total current liabilities 330,977 364,042 432,880
Notes payable 45,100
Obligation under capital lease 29,215 9,046
Partners' capital 248,582 334,368 378,393
Due from partners (9,142) (122,249) (92,835)
-------------------------------------
Total liabilities and partners' capital $644,732 $ 585,207 $718,438
=====================================
</TABLE>
See accompanying notes.
2
<PAGE>
Annapolis Medical Specialists, LLP
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Nine months ended
Year ended December 31 September 30
1993 1994 1995 1995 1996
---------------------------------------------------------------
Revenue:
<S> <C> <C> <C> <C> <C>
Net patient service revenue $3,565,656 $4,480,340 $5,190,789 $3,782,202 $4,233,015
Rental income 97,528 139,406 77,872 77,872
Other income 6,205 17,333 33,087 28,029 12,722
---------------------------------------------------------------
3,669,389 4,637,079 5,301,748 3,888,103 4,245,737
Operating expenses:
Salaries and wages--physicians 1,679,221 1,939,649 2,304,117 1,692,307 1,633,578
Salaries and wages--staff 898,693 1,075,985 1,268,605 971,359 1,048,364
Employee benefits--staff 39,616 57,612 73,434 54,053 32,889
Supplies and other 607,503 964,837 1,218,922 938,013 1,147,835
Insurance 57,765 65,505 74,107 56,602 61,427
Interest 22,747 21,825 12,988 10,861 4,657
Rent 222,761 227,663 238,897 171,607 214,321
Depreciation and amortization 63,306 60,686 63,883 47,912 44,835
Provision for bad debts 109,539 130,611 85,081 (27,654) 13,806
---------------------------------------------------------------
Net operating expenses 3,701,151 4,544,373 5,340,034 3,915,060 4,201,712
---------------------------------------------------------------
Net income (loss) $ (31,762) $ 92,706 $ (38,286) $ (26,957) $ 44,025
===============================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Annapolis Medical Specialists, LLP
Statements of Partners' Capital
<TABLE>
<CAPTION>
Total Partners'
Capital
-----------------
<S> <C>
Balance at December 31, 1992 $243,458
Capital contributions by newly admitted partner 25,144
Capital withdrawals by departing partner (24,907)
Net loss (31,762)
-----------------
Balance at December 31, 1993 211,933
Capital withdrawals by partners (56,057)
Net income 92,706
-----------------
Balance at December 31, 1994 248,582
Capital contributions by newly admitted partners 148,655
Capital withdrawals by partners (24,583)
Net loss (38,286)
-----------------
Balance at December 31, 1995 334,368
Net income (unaudited) 44,025
-----------------
Balance at September 30, 1996 (unaudited) $378,393
=================
</TABLE>
See accompanying notes.
4
<PAGE>
Annapolis Medical Specialists, LLP
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Nine months ended
Year ended December 31 September 30
1993 1994 1995 1995 1996
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating activities
Net income (loss) $(31,762) $ 92,706 $(38,286) $(26,957) $ 44,025
Adjustments to reconcile net income
(loss) to net cash provided by operating
activities:
Depreciation and amortization 63,306 60,686 63,883 47,912 44,835
Changes in operating assets and
liabilities:
Accounts receivable 26,782 (123,398) 41,868 (1,134) (4,836)
Other current assets (248) (4,141) (5,047) (4,707) (16,494)
Accounts payable, accrued
expenses and other current
liabilities 69,321 125,249 56,972 45,145 119,588
--------------------------------------------------------
Net cash provided by operating activities 127,399 151,102 119,390 60,259 187,118
Investing activity
Purchase of property and equipment, net (29,460) (24,124) (23,605) (9,110) (17,042)
--------------------------------------------------------
Net cash used in investing activity (29,460) (24,124) (23,605) (9,110) (17,042)
Financing activities
Contribution of capital 16,760 16,002 35,548 18,554 29,414
Withdrawals of capital (56,057) (24,583)
Payments on obligation under capital
lease (14,739) (16,364) (18,168) (13,446) (14,927)
Payments on notes payable (73,333) (77,365) (71,008) (54,108) (44,869)
--------------------------------------------------------
Net cash used in financing activities (71,312) (133,784) (78,211) (49,000) (30,382)
--------------------------------------------------------
Net increase (decrease) in cash 26,627 (6,806) 17,574 2,149 139,694
Cash at beginning of year 26,885 53,512 46,706 46,706 64,280
--------------------------------------------------------
Cash at end of year $ 53,512 $ 46,706 $ 64,280 $ 48,855 $203,974
========================================================
</TABLE>
5
<PAGE>
Annapolis Medical Specialists, LLP
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
(Unaudited)
Nine months ended
Year ended December 31 September 30
1993 1994 1995 1995 1996
--------------------------------------------------
<S> <C> <C> <C> <C> <C>
Supplemental disclosure of cash
flow information:
Interest paid $23,766 $21,671 $ 12,498 $ 15,494 $4,282
==================================================
Noncash transactions:
Issuance of note payable for
partner withdrawal $24,907 - - - -
==================================================
Issuance of notes receivable
for partner admission $25,144 - $122,249 $148,655 -
==================================================
</TABLE>
See accompanying notes.
6
<PAGE>
Annapolis Medical Specialists, LLP
Notes to Financial Statements
September 30, 1996
1. Summary of Significant Accounting Policies
Description of Business
Annapolis Medical Specialists, LLP (the Partnership) is a limited liability
partnership organized under the laws of Maryland. The Partnership offers a
variety of medical services, including cardiology, hematology/oncology,
infectious disease, pulmonary/critical care and internal medicine, in the
greater Annapolis, Maryland area.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred. Amortization of assets recorded under capital lease transactions is
included in depreciation expense.
Income Taxes
For tax purposes, Annapolis Medical Specialists, LLP is treated as a partnership
and a pass-through entity. The taxable income or loss of the practice is
allocated to the partners and reported on the partners' tax returns. Therefore,
no provision for income taxes is included in these financial statements.
Professional Liability Insurance
The Partnership has obtained professional liability coverage through commercial
insurance carriers on a claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Partnership has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Partnership.
7
<PAGE>
Annapolis Medical Specialists, LLP
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1994 1995
--------------------------
<S> <C> <C>
Furniture, fixtures and equipment $460,610 $479,773
Leasehold improvements 9,379 9,379
--------------------------
469,989 489,152
Less accumulated depreciation 307,463 366,904
--------------------------
$162,526 $122,248
==========================
</TABLE>
8
<PAGE>
Annapolis Medical Specialists, LLP
Notes to Financial Statements (continued)
3. Notes Payable
The Partnership has two notes payable with a combined original principal amount
of $324,907, payable in monthly installments of principal and interest at
interest rates ranging from 8.5% to prime plus 1.25%. The principal balance
outstanding of these notes payable was $115,877 and $44,869 at December 31, 1994
and 1995, respectively. The notes payable are scheduled to be paid in 1996.
The assets of the Partnership have been pledged as security interest to one of
the notes payable. The carrying amounts of the notes approximate their fair
value.
4. Capital Leases
The Partnership leases certain medical equipment under long-term leases and has
the option to purchase the equipment for a nominal cost at the termination of
the lease. Property, plant and equipment includes the following amounts for
leases that have been capitalized:
<TABLE>
<CAPTION>
1994 1995
----------------------
<S> <C> <C>
Furniture, fixtures and equipment $84,865 $84,865
Less accumulated depreciation 42,432 59,405
----------------------
Total $42,433 $25,460
======================
Future minimum lease payments for capital leases were as follows at
December 31, 1995:
1996 $22,284
1997 11,142
---------
Total minimum lease payments 33,426
Less amount representing interest 4,211
---------
Present value of net minimum lease payments 29,215
Less current maturities 20,169
---------
Long-term obligation $ 9,046
=========
</TABLE>
9
<PAGE>
Annapolis Medical Specialists, LLP
Notes to Financial Statements (continued)
5. Operating Leases
The Partnership leases office space and certain equipment under operating
leases. Total rental expense was $222,761, $227,663 and $238,897 in 1993, 1994
and 1995, respectively. The following is a schedule by year of future minimum
lease payments under operating leases as of December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $243,015
1997 85,954
1998 1,713
1999 1,428
----------
Total future minimum lease payments $332,110
==========
</TABLE>
6. Related Parties
Upon admission to the Partnership, a loan may be extended to new partners for
the value of their partnership interest. The loans have varying maturities with
interest rates set at prime plus 1%. The principal balance outstanding under
these notes receivable agreements were $9,142 and $122,249 at December 31, 1994
and 1995, respectively.
7. Employee Benefit Plans
The Partnership has a defined contribution plan and profit sharing plan covering
substantially all employees, excluding partners. Contributions are determined
based upon a percentage of each eligible employee's compensation, as defined
and/or at the discretion of management. Total contributions were $33,572,
$36,357 and $39,328 for the years ended December 31, 1993, 1994 and 1995,
respectively, and are included in employee benefits in the accompanying
statements of operations.
8. Pending Affiliation
The Partnership expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Partnership
will sell certain assets to, and the physicians will become employees of, a
newly formed professional corporation that is affiliated with PQC. In addition,
certain professional corporations that are partners of the Partnership may merge
into the newly formed professional corporation that is affiliated with PQC. The
aggregate consideration to be paid to the Partnership, the physicians and the
related professional corporations for the asset purchases and affiliations is
subject to working capital adjustments and is payable in cash and common stock
of PQC.
10
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Audited Financial Statements
Year ended December 31, 1995 and nine
months ended September 30, 1995 (Unaudited)
and September 30, 1996 (Unaudited)
Contents
<TABLE>
<S> <C>
Report of Independent Auditors............................................. 1
Audited Financial Statements
Balance Sheets............................................................. 2
Statements of Operations................................................... 3
Statements of Shareholders' Equity......................................... 4
Statements of Cash Flows................................................... 5
Notes to Financial Statements.............................................. 6
</TABLE>
75
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Drs. Fortier, Libber, Clemmens
& Weimer, P.A. as of December 31, 1995, and the related statements of
operations, shareholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drs. Fortier, Libber, Clemmens
& Weimer, P.A. at December 31, 1995, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
September 20, 1996
Boston, Massachusetts
1
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1995 1996
----------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 18,972 $ 22,021
Accounts receivable, less allowance
for doubtful accounts of $65,062 in
1995 and $63,640 in 1996 (unaudited) 149,264 145,989
Prepaid expenses 19,632 20,110
Deferred income taxes 28,134 35,528
----------------------------
Total current assets 216,002 223,648
Deferred income taxes, noncurrent 4,268 3,352
Property and equipment, net 88,521 69,891
----------------------------
Total assets $ 308,791 $ 296,891
============================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 47,309 $ 55,769
Accrued employee benefits 15,879 11,872
Accrued salaries and payroll taxes 32,486 21,479
Due to former shareholders, current
portion 27,241 27,955
Income taxes payable 4,393 8,093
Deferred income taxes 67,372 70,788
Line of credit 50,000 87,000
Current portion of obligation under
capital lease 3,005 3,005
Current portion of note payable to bank 17,955
----------------------------
Total current liabilities 265,640 285,961
Deferred income taxes, noncurrent 9,945 3,727
Due to former shareholders, noncurrent 46,120 25,061
Obligation under capital lease, less
current portion 7,664 5,376
Note payable, less current portion
Shareholders' equity:
Common stock, no stated par value,
300 shares outstanding 8,000 8,000
Additional paid-in capital 1,012 1,012
Retained earnings 108,539 105,883
----------------------------
117,551 114,895
Less treasury stock, at cost, 60 shares (138,129) (138,129)
----------------------------
Total shareholders' equity (20,578) (23,234)
----------------------------
Total liabilities and shareholders' equity $ 308,791 $ 296,891
============================
</TABLE>
See accompanying notes.
2
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
---------------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $2,107,977 $1,629,704 $1,710,430
Other income 87 33,436 17,671
Interest income 39,594 65 38
---------------------------------------------
2,147,658 1,663,205 1,728,139
Operating expenses:
Salaries and wages--physicians 506,336 340,281 373,649
Salaries and wages--staff 772,305 575,975 674,980
Employee benefits 3,267 2,258 2,070
Supplies and other 383,493 286,385 342,704
Rent 211,644 159,833 170,755
Insurance 116,194 82,542 75,404
Interest 14,191 9,773 11,196
Depreciation 29,303 21,977 21,977
Provision for bad debts 64,062 60,828 63,640
---------------------------------------------
Net operating expenses 2,100,795 1,539,852 1,736,375
---------------------------------------------
Net income (loss) before
income taxes 46,863 123,353 (8,236)
Income tax (provision) benefit (13,987) (55,989) 5,580
---------------------------------------------
Net income (loss) $ 32,876 $ 67,364 $ (2,656)
=============================================
</TABLE>
See accompanying notes.
3
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Statements of Shareholders' Equity
<TABLE>
<S> <C>
Balance at December 31, 1994 $ 14,805
Net income 32,876
Purchase of treasury stock (cash) (21,000)
Purchase of treasury stock (noncash) (47,259)
------------
Balance at December 31, 1995 (20,578)
Net loss (unaudited) (2,656)
------------
Balance at September 30, 1996 (unaudited) $(23,234)
============
</TABLE>
See accompanying notes.
4
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
---------------------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $ 32,876 $ 67,364 $ (2,656)
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation 29,303 21,977 21,977
Deferred income taxes 9,786 (1,952) (9,280)
Loss on sale of fixed assets 744
Changes in operating assets
and liabilities:
Accounts receivable, net (11,459) (3,976) 3,275
Other current assets 2,364 1,000 (478)
Accounts payable and
accrued expense 14,703 41,809 (2,854)
---------------------------------------------
Net cash provided by
operating activities 77,573 126,966 9,984
Investing activity
Purchase of property and
equipment (5,050) (4,836) (3,347)
---------------------------------------------
Net cash used in investing
activity (5,050) (4,836) (3,347)
Financing activities
Payments on lease obligation (2,299) (2,288) (2,288)
Payments on note payable
and line of credit (16,608) (67,955)
Purchase of treasury stock (21,000)
Proceeds from line of credit 87,000
Payments to former shareholders (23,898) (33,251) (20,345)
---------------------------------------------
Net cash used in financing
activities (63,805) (35,539) (3,588)
---------------------------------------------
Increase (decrease) in cash 8,718 86,591 3,049
Cash at beginning of period 10,254 10,254 18,972
---------------------------------------------
Cash at end of period $ 18,972 $ 96,845 $ 22,021
=============================================
Supplemental disclosure of
cash flow information:
Interest paid $ 10,570 $ 5,178 $ 9,810
=============================================
Income taxes paid $ 786 $ 428 $ 4,303
=============================================
Noncash transactions:
Issuance of note payable
for purchase of treasury
stock $ 47,259 - -
==============================================
</TABLE>
See accompanying notes.
5
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Drs. Fortier, Libber, Clemmens & Weimer, P.A. (Pediatrics) is a professional
association organized under the laws of Maryland. Pediatrics offers a variety
of medical services, including pediatrics and primary care, in the greater
Annapolis, Maryland area.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred. Amortization of assets recorded under capital lease transactions is
included in depreciation expense.
Income Taxes
Pediatrics is taxable under the provisions of the Internal Revenue Code.
Pediatrics files its federal and state income tax return on the cash basis
method of accounting. Deferred income taxes are provided for temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes (see Note 8).
Professional Liability Insurance
Pediatrics has obtained professional liability coverage through commercial
insurance carriers on the claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. Pediatrics has negotiated numerous
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to
Pediatrics.
6
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following at December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
Furniture, fixtures and equipment $137,575
Leasehold improvements 59,072
----------
196,647
Less accumulated depreciation 108,126
----------
$ 88,521
==========
</TABLE>
3. Note Payable and Line of Credit
Pediatrics had a note payable with a bank, payable in monthly installments of
principal and interest of $1,590, which matured during 1996. The note carried
interest at a rate of 9%. The principal balance outstanding under the note was
$17,955 at December 31, 1995.
7
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements (continued)
3. Note Payable and Line of Credit (continued)
Pediatrics had a $50,000 line of credit with a bank which carried an interest
rate of prime plus 2% (9% at December 31, 1995). The balance outstanding under
the line of credit was $50,000 at December 31, 1995.
In April 1996, Pediatrics entered into a secured demand note with a bank
providing financing up to $100,000. The note carries interest at prime plus 1%
and is secured by Pediatrics' receivables and equipment. The proceeds of the
new note were used to pay off the line of credit and note payable.
4. Capital Leases
Property, plant and equipment includes the following amounts for leases that
have been capitalized at December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
Equipment $14,430
Less accumulated amortization (3,779)
---------
$10,651
=========
Future minimum lease payments for capital leases were as follows as of
December 31, 1995:
Year ending December 31:
1996 $ 5,920
1997 4,984
1998 4,899
1999 816
---------
Total minimum lease payments 16,619
Less amount representing interest (5,950)
---------
Present value of net minimum lease payments $10,669
=========
</TABLE>
8
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements (continued)
5. Operating Leases
Pediatrics leases office space and certain equipment under operating leases.
Total rental expense was $211,644 in 1995. The following is a schedule by year
of future minimum lease payments under operating leases as of December 31, 1995:
<TABLE>
<S> <C>
1996 $ 198,822
1997 190,322
1998 190,322
1999 190,322
2000 190,322
Thereafter 285,483
------------
$1,245,593
============
</TABLE>
6. Related Parties
Pediatrics rents office space from entities owned by stockholders of Pediatrics.
Total rental expense incurred under these rental agreements was $198,549 in
1995. Lease commitments with related parties over the next five years are
included in the minimum lease payment disclosure in Note 5.
7. Employee Benefit Plans
Pediatrics has a qualified profit sharing plan covering substantially all
employees. Contributions are determined based upon a percentage of each
eligible employee's compensation, as defined and/or at the discretion of
management. Total contributions were $3,267 for the year ended December 31,
1995, and are included in employee benefits in the accompanying statements of
operations.
8. Income Taxes
Pediatrics accounts for income taxes using the liability method required by
Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for
Income Taxes."
9
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements (continued)
8. Income Taxes (continued)
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of
Pediatrics' deferred tax liabilities and assets were as follows at December 31,
1995:
<TABLE>
<S> <C>
Deferred tax liabilities:
Accounts receivable, net $59,706
Accrued expenses 7,666
Depreciation 9,945
---------
Total deferred tax liabilities 77,317
Deferred tax assets:
Accrued expenses 28,135
Capital lease 4,267
---------
Total deferred tax assets 32,402
---------
Net deferred tax liabilities $44,915
=========
</TABLE>
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows for the year ended December 31, 1995:
<TABLE>
<S> <C>
Current:
Federal $ 3,844
State 549
---------
Total current 4,393
Deferred:
Federal 8,371
State 1,223
---------
Total deferred 9,594
---------
$13,987
=========
</TABLE>
10
<PAGE>
Drs. Fortier, Libber, Clemmens & Weimer, P.A.
Notes to Financial Statements (continued)
8. Income Taxes (continued)
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows for the year ended December 31, 1995:
<TABLE>
<CAPTION>
Amount Rate
----------------
<S> <C> <C>
Federal taxes at statutory rates $16,403 35%
State income tax, net of federal tax benefit 958 2
Accounts receivable (3,374) (7)
----------------
$13,987 30%
================
</TABLE>
9. Pending Affiliation
Pediatrics expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, Pediatrics will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to Pediatrics is subject to working capital adjustments
and is payable in common stock of PQC.
11
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Audited Financial Statements
Year ended December 31, 1995 and nine months
ended September 30, 1995 (Unaudited) and
September 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors............................................. 1
Audited Financial Statements
Balance Sheets............................................................. 2
Statements of Operations................................................... 3
Statements of Shareholders' Equity (Deficit)............................... 4
Statements of Cash Flows................................................... 5
Notes to Financial Statements.............................................. 6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Drs. Goldgeier, Levine &
Friedman, P.A. as of December 31, 1995, and the related statements of
operations, shareholders' equity, and cash flows for the year then ended. These
financial statements are the responsibility of management. Our responsibility
is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drs. Goldgeier, Levine &
Friedman, P.A. at December 31, 1995, and the results of its operations and its
cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
September 20, 1996
Boston, Massachusetts
1
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1995 1996
----------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 50,187 $ 50,765
Accounts receivable, less allowance for doubtful
accounts of $78,208 in 1995 and $77,219 in 1996 155,852 156,858
(unaudited)
Prepaid expenses 1,394 1,987
Deferred income taxes 87,274 80,284
----------------------------------------
Total current assets 294,707 289,894
Deferred income taxes 6,593 5,536
Property and equipment, net 35,247 26,309
----------------------------------------
Total assets $ 336,547 $ 321,739
========================================
Liabilities and owners' equity
Current liabilities:
Accounts payable $ 172,207 $ 160,042
Accrued salaries, payroll taxes and employee benefits 57,894 52,462
Deferred income taxes 69,309 69,743
Current portion of obligation under capital lease 3,554 3,773
Current portion of notes payable to former shareholders 6,840
----------------------------------------
Total current liabilities 309,804 286,020
Deferred income taxes 812 2,062
Obligation under capital lease, less current portion 12,926 10,068
Notes payable to former shareholders
Shareholders' equity:
Common stock, par value 50,300 shares authorized,
180 shares issued and outstanding 9,000 9,000
Additional paid-in capital 42,662 42,662
Retained earnings (21,157) (10,573)
----------------------------------------
30,505 41,089
Less treasury stock, at cost, 60 shares (17,500) (17,500)
----------------------------------------
Total shareholders' equity 13,005 23,589
----------------------------------------
Total liabilities and shareholders' equity $ 336,547 $ 321,739
========================================
</TABLE>
See accompanying notes.
2
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
---------------------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $1,913,452 $1,463,639 $1,464,199
Other income 63,681 37,201 25,610
Interest income 197 158 108
---------------------------------------------------
1,977,330 1,500,998 1,489,917
Operating expenses:
Salaries and wages 1,038,637 772,305 765,316
Employee benefits
Supplies and other 638,466 510,447 496,989
Rent 125,798 73,692 90,997
Insurance 44,194 36,566 28,298
Interest 1,023 1,747 1,175
Depreciation 11,752 8,937 9,609
Provision for bad debts 78,208 77,293 77,219
---------------------------------------------------
Net operating expenses 1,938,078 1,480,987 1,469,603
---------------------------------------------------
Net income (loss) before
income taxes 39,252 20,011 20,314
Income tax benefit
(expense) (17,768) (24,524) (9,730)
---------------------------------------------------
Net income (loss) $ 21,484 $ (4,513) $ 10,584
===================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Statements of Shareholders' Equity (Deficit)
<TABLE>
<S> <C>
Balance at December 31, 1994 $(8,479)
Net income 21,484
----------
Balance at December 31, 1995 13,005
Net income (unaudited) 10,584
----------
Balance at September 30, 1996 (unaudited) $23,589
==========
</TABLE>
See accompanying notes.
4
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
---------------------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $ 21,484 $ (4,513) $ 10,584
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Depreciation 11,752 8,937 9,609
Deferred income taxes 17,768 24,524 9,730
Changes in operating assets and
liabilities:
Accounts receivable, net (49,599) (50,756) (1,006)
Other current assets 2,751 2,750 (593)
Accounts payable, accrued expenses
and other current liabilities 28,020 7,879 (17,596)
---------------------------------------------
Net cash provided by (used in) operating
activities 32,176 (11,179) 10,728
Investing activity
Purchase of property and equipment (12,454) (7,701) (671)
---------------------------------------------
Net cash used in investing activity (12,454) (7,701) (671)
Financing activities
Payments on lease obligation (3,149) (2,639)
Payments on long-term note payable (14,129) (11,963) (6,840)
---------------------------------------------
Net cash provided by (used in) financing
activities (17,278) (11,963) (9,479)
---------------------------------------------
Increase (decrease) in cash 2,444 (30,843) 578
Cash at beginning of period 47,743 47,743 50,187
---------------------------------------------
Cash at end of period $ 50,187 $ 16,900 $ 50,765
=============================================
Supplemental disclosure of cash flow
information:
Interest paid $ 1,023 - $ 7,813
=============================================
Noncash transactions:
Capital lease transactions $ 19,629 - -
=============================================
</TABLE>
See accompanying notes.
5
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Drs. Goldgeier, Levine & Friedman, P.A. (the Company) is a professional
association organized under the laws of Maryland. The Company offers a variety
of medical services including pediatrics and primary care in the greater
Baltimore, Maryland area.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred. Amortization of assets recorded under capital lease transactions is
included in depreciation expense.
Income Taxes
The Company is taxable under the provisions of the Internal Revenue Code. The
Company files its federal and state income tax return on the cash basis method
of accounting. Deferred income taxes are provided for temporary differences
between financial and income tax reporting (see Note 8).
Professional Liability Insurance
The Company has obtained professional liability coverage through commercial
insurance carriers on the claims made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Company has negotiated numerous
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to the
Company.
6
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following at December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
Furniture, fixtures and equipment $197,778
Leasehold improvements 87,551
-------------
285,329
Less accumulated depreciation (250,082)
-------------
$ 35,247
=============
</TABLE>
3. Notes Payable to Former Shareholders
The Company has notes payable to former shareholders, payable in monthly
installments of principal and interest of $5,207 at interest rates ranging from
6% to 7%. The principal balance outstanding under these notes payable
agreements aggregated $6,840 at December 31, 1995.
7
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements (continued)
4. Capital Leases
Property, plant and equipment includes the following amounts for leases that
have been capitalized:
<TABLE>
<CAPTION>
December 31
1995
-------------
<S> <C>
Equipment $19,629
Less accumulated amortization (3,599)
-------------
$16,030
=============
Future minimum lease payments for capital leases were as follows as of
December 31, 1995:
Year ending December 31:
1996 $ 4,744
1997 4,744
1998 4,744
1999 4,744
2000 395
-------------
Net minimum lease payments 19,371
Less amount representing interest (2,891)
-------------
Present value of net minimum lease payments $16,480
=============
</TABLE>
8
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements (continued)
5. Operating Leases
The Company leases office space and certain equipment under operating leases.
Total rental expense was $125,798 in 1995. The following is a schedule by year
of future minimum lease payments under operating leases as of December 31, 1995:
<TABLE>
<S> <C>
1996 $124,455
1997 120,182
1998 112,654
1999 32,703
2000 2,198
Thereafter 183
--------------
$392,375
==============
</TABLE>
6. Employee Benefit Plans
The Company had a qualified profit sharing plan covering substantially all
employees. Contributions were determined based upon a percentage of each
eligible employee's compensation, as defined and/or at the discretion of
management. This plan was terminated in 1994.
7. Income Taxes
The Company accounts for income taxes utilizing the liability method required by
Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for
Income Taxes."
9
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements (continued)
7. Income Taxes (continued)
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax liabilities and assets were as follows at December 31,
1995:
<TABLE>
<S> <C>
Deferred tax liabilities:
Accounts receivable, net $ 62,309
Capital lease and other 7,000
Depreciation 812
----------------
Total deferred tax liabilities 70,121
Deferred tax assets:
Depreciation -
Accrued expenses 87,274
Capital lease and other 6,593
----------------
Total deferred tax assets 93,867
----------------
Net deferred tax liabilities $(23,746)
================
</TABLE>
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows for the year ended December 31, 1995:
<TABLE>
<S> <C>
Deferred:
Federal $15,547
State 2,221
----------------
Total deferred $17,768
================
</TABLE>
10
<PAGE>
Drs. Goldgeier, Levine & Friedman, P.A.
Notes to Financial Statements (continued)
7. Income Taxes (continued)
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows for the year ended December 31, 1995:
<TABLE>
<CAPTION>
Amount Rate
-----------------
<S> <C> <C>
Federal taxes at statutory rates $13,739 35%
Add (deduct):
State income tax, net of federal tax benefit 1,963 5
Other (404) (1)
Valuation allowance 2,470 6
-----------------
$17,768 45%
=================
</TABLE>
Net operating loss carryforwards available for tax purposes as of December 31,
1995 approximate $10,973, which expire beginning in 2005.
8. Pending Affiliation
The Company expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Company will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to the Company is subject to working capital
adjustments and is payable in cash and common stock of PQC.
11
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Audited Financial Statements
Year ended December 31, 1995 and
nine months ended September 30, 1995 (Unaudited)
and September 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors.............................................1
Audited Financial Statements
Balance Sheets.............................................................2
Statements of Operations...................................................3
Statements of Stockholders' Equity.........................................4
Statements of Cash Flows...................................................5
Notes to Financial Statements..............................................6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Koeppel, Rosen, Rudikoff,
M.D., P.C., as of December 31, 1995, and the related statement of operations,
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Koeppel, Rosen, Rudikoff, M.D.,
P.C. at December 31, 1995, and the results of its operations and its cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
November 18, 1996
Boston, Massachusetts
1
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1995 1996
---------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 15,745 $ 79,457
Accounts receivable, less allowance
for doubtful accounts of $49,373 and
$33,444 in 1995 and 1996 (unaudited),
respectively 121,486 47,295
Prepaids and other assets 9,396 10,308
---------------------------
Total current assets 146,627 137,060
Property and equipment, net 52,178 43,813
---------------------------
Total assets $198,805 $180,873
===========================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 15,583 $ 4,457
Accrued salaries and payroll taxes 4,490 25,090
Accrued employee benefits 20,613 51,948
Accrued expenses, other 14,418 10,719
---------------------------
Total current liabilities 55,104 92,214
Stockholders' equity:
Common stock, $.10 par value, 1,000
shares authorized, 600 shares issued
and outstanding 60 60
Additional paid-in capital 540 540
Retained earnings 143,101 88,059
---------------------------
Total stockholders' equity 143,701 88,659
---------------------------
Total liabilities and stockholders'
equity $198,805 $180,873
===========================
</TABLE>
See accompanying notes.
2
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
--------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $1,566,479 $1,130,194 $1,196,933
Other income 5,821 9,780 8,858
--------------------------------------
1,572,300 1,139,974 1,205,791
Operating expenses:
Salaries and wages--physicians 547,936 459,628 509,102
Salaries and wages--staff 270,611 236,898 220,864
Physician and staff benefits 71,548 9,477 53,410
Supplies and other 485,462 321,788 300,977
Insurance 44,611 26,103 29,903
Rent 23,947 13,890 12,203
Rent to related parties 53,300 45,287 39,975
Depreciation 10,378 5,713 8,455
Provision for bad debts 49,373 48,125 33,444
--------------------------------------
Net operating expenses 1,557,166 1,166,909 1,208,333
--------------------------------------
Net income (loss) $ 15,134 $ (26,935) $ (2,542)
======================================
</TABLE>
See accompanying notes.
3
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Total
Stockholders'
Equity
-------------
<S> <C>
Balance at December 31, 1994 $218,567
Net income 15,134
Dividends paid (90,000)
-------------
Balance at December 31, 1995 143,701
Net loss (unaudited) (2,542)
Dividends paid (unaudited) (52,500)
-------------
Balance at September 30, 1996 (unaudited) $ 88,659
=============
</TABLE>
See accompanying notes.
4
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
-----------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $ 15,134 $(26,935) $ (2,542)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation 10,378 5,713 8,455
Changes in operating assets and
liabilities:
Accounts receivable, net 48,926 91,260 74,191
Other current assets (419) (958) (1,002)
Accounts payable, accrued expenses
and other current liabilities 12,616 34,967 37,110
-----------------------------------
Net cash provided by operating
activities 86,635 104,047 116,212
Investing activity
Purchase of property and equipment (30,194) (23,403) -
-----------------------------------
Net cash used in investing activity (30,194) (23,403) -
Financing activity
Dividends paid (90,000) (60,000) (52,500)
-----------------------------------
Net cash used in financing activity (90,000) (60,000) (52,500)
-----------------------------------
Increase (decrease) in cash (33,559) 20,644 63,712
Cash at beginning of period 49,304 49,304 15,745
-----------------------------------
Cash at end of period $ 15,745 $ 69,948 $ 79,457
===================================
</TABLE>
See accompanying notes.
5
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
The medical practice of Koeppel, Rosen, Rudikoff, M.D., P.C, (the Company), is a
professional corporation organized under the laws of Maryland. The Company
offers a variety of medical services including cardiology, pediatrics, cancer
treatment, gastrointestinal and primary care.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred.
Income Taxes
The Company has elected, by consent of its shareholders, to be taxed as an S
Corporation under the provisions of the Internal Revenue Code (the Code).
Pursuant to the Code, S Corporations are taxed as pass-through entities. The
taxable income or loss of the Company is allocated to the Company's shareholders
and reported on the shareholders' tax returns. Accordingly, there is no
provision for income taxes included in these financial statements.
Professional Liability Insurance
The Company has obtained professional liability coverage through commercial
insurance carriers on a modified claims made basis, which excludes tail
coverage. Management believes that there are no claims that may result in a
loss in excess of amounts covered by its existing insurance.
6
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Company has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Company.
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited statements of operations for nine months ended September 30, 1996
and for the nine months ended September 30, 1995 have been prepared by
management in accordance with generally accepted accounting principles. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results of the interim periods are not necessarily indicative of the results
that may be expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1995
-------------
<S> <C>
Furniture, fixtures and equipment $55,550
Leasehold improvements 10,409
-------------
65,959
Less accumulated depreciation (13,781)
-------------
$52,178
=============
</TABLE>
7
<PAGE>
Koeppel, Rosen, Rudikoff, M.D., P.C.
Notes to Financial Statements (continued)
3. Lease Commitments
The Company leases office space and certain equipment under operating leases.
Total rental expense was $77,247 in 1995 which included $53,300 paid to related
parties (Note 5). The following is a schedule by year of future minimum lease
payments under operating leases as of December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $67,275
1997 3,575
---------
$70,850
=========
</TABLE>
4. Employee Benefit Plans
The Company has a qualified profit sharing plan covering substantially all
employees. Contributions are determined based upon a percentage of each
eligible employee's compensation, as defined and/or at the discretion of
management. Total contributions were $70,506 for the year ended December 31,
1995, and are included in physician and staff benefits in the accompanying
statement of operations.
5. Related Parties
The Company rents office space from related entities owned by shareholders of
the Company. Total rental expense paid under these rental agreements was
$53,300. Lease commitments over the next five years with related parties are
included in Note 3.
6. Pending Affiliation
The Company expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Company will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to the Company is subject to working capital
adjustments and is payable in common stock of PQC.
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Audited Financial Statements
Year ended December 31, 1995 and nine months ended
September 30, 1996 (Unaudited) and September 30, 1995 (Unaudited)
Contents
<TABLE>
<S> <C>
Report of Independent Auditors......................................... 1
Audited Financial Statements
Balance Sheets......................................................... 2
Statements of Operations............................................... 3
Statements of Stockholders' Equity..................................... 4
Statements of Cash Flows............................................... 5
Notes to Financial Statements.......................................... 6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheet of Drs. Pakula, Davick & Bogue,
P.A. as of December 31, 1995, and the related statements of operations,
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drs. Pakula, Davick & Bogue,
P.A. at December 31, 1995, and the results of its operations and its cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
November 18, 1996
Boston, Massachusetts
1
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1995 1996
----------------------------
<S> <C> <C>
Assets
Current assets:
Cash $ 18,863 $ 15,820
Accounts receivable, less allowance for
doubtful accounts of $17,523 and $27,749
in 1995 and 1996 (unaudited), respectively 84,361 98,387
Deferred income taxes 32,927 41,878
Cash surrender value of life insurance policy 57,444 78,927
----------------------------
Total current assets 193,595 235,012
Property and equipment, net 26,438 21,346
----------------------------
Total assets $220,033 $256,358
============================
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 48,370 $ 64,344
Accrued salaries and payroll taxes 12,910 13,677
Accrued employee benefits 3,699
Accrued expenses, other 9,992
Deferred income taxes 33,744 39,354
Due to related parties 7,421 11,101
----------------------------
Total current liabilities 106,144 138,468
Deferred income taxes, noncurrent 1,928 2,524
Due to related parties, noncurrent 50,949 42,870
Stockholders' equity:
Common stock, no par value, 5,000 shares
authorized, 300 shares issued and outstanding
Additional paid-in capital 24,217 24,217
Retained earnings 47,749 55,557
----------------------------
Total stockholders' equity 71,966 79,774
Due from shareholders (10,954) (7,278)
----------------------------
61,012 72,496
----------------------------
Total liabilities and stockholders' equity $220,033 $256,358
============================
</TABLE>
See accompanying notes.
2
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
----------------------------------------
<S> <C> <C> <C>
Revenue:
Net patient service revenue $868,084 $652,194 $725,335
Other income 17,912 9,463 39,857
Interest income 832 615 502
----------------------------------------
886,828 662,272 765,694
Operating expenses:
Salaries and wages--physicians 315,606 209,053 221,472
Salaries and wages--staff 241,064 214,556 212,129
Supplies and other 182,105 149,728 157,205
Insurance 89,213 59,069 72,230
Rent 56,215 35,103 73,284
Interest 4,027 2,850 4,334
Depreciation 11,834 9,943 5,532
Provision for bad debts 17,523 18,876 27,749
----------------------------------------
Net operating expenses 917,587 699,178 773,935
----------------------------------------
Net loss before income taxes (30,759) (36,906) (8,241)
Income tax benefit 12,304 8,307 2,746
----------------------------------------
Net loss $(18,455) $(28,599) $ (5,495)
========================================
</TABLE>
See accompanying notes.
3
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
<S> <C>
Balance at December 31, 1994 $ 70,421
Capital contributions 20,000
Net loss (18,455)
-------------
Balance at December 31, 1995 71,966
Capital contributions (unaudited) 13,303
Net income (unaudited) (5,495)
-------------
Balance at September 30, 1996 $ 79,774
=============
</TABLE>
See accompanying notes.
4
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1995 1995 1996
---------------------------------------
<S> <C> <C> <C>
Operating activities
Net income (loss) $(18,455) $(40,320) $ (5,495)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 11,834 9,943 5,532
Deferred income taxes (12,304) (8,307) (6,466)
Changes in operating assets and liabilities:
Accounts receivable, net (37,973) (33,383) (14,026)
Other current assets 287 13,105 (21,483)
Accounts payable, accrued expenses and other
current liabilities 35,125 39,062 26,755
---------------------------------------
Net cash used in operating activities (21,486) (19,900) (15,183)
Investing activity
Purchase of property and equipment (19,799) (18,822) (440)
---------------------------------------
Net cash used in investing activity (19,799) (18,822) (440)
Financing activities
Proceeds from issuance of long-term notes payable
from related parties 59,745 59,745
Payments on long-term notes payable to
related parties (1,375) (1,000) (4,399)
Proceeds from issuance of stock 5,000 5,000
Proceeds from notes receivable from shareholders 4,046 3,676
Capital contributions 13,303
---------------------------------------
Net cash provided by financing activities 67,416 63,745 12,580
---------------------------------------
Increase (decrease) in cash 26,131 25,023 (3,043)
Cash at beginning of period (7,268) (7,268) 18,863
---------------------------------------
Cash at end of period $ 18,863 $ 17,755 $ 15,820
=======================================
Noncash investing and financing activities:
Issuance of common stock for note receivable $ 15,000 $ 15,000 $ -
=======================================
Supplemental disclosure of cash flow information:
Interest paid $ 7,665 $ 2,850 $ 4,334
=======================================
</TABLE>
See accompanying notes.
5
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
The medical practice of Drs. Pakula, Davick & Bogue, P.A. (the Company) is a
professional association organized under the laws of Maryland. The Company
offers a variety of medical services, including cardiology, pediatrics, cancer
treatment, gastrointestinal and primary care.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred.
Income Taxes
The Company is taxable under the provisions of the Internal Revenue Code. The
Company files its federal and state income tax return on the cash basis of
accounting. Deferred income taxes are provided for temporary differences
between financial and income tax reporting (see Note 5).
Professional Liability Insurance
The Company has obtained professional liability coverage through commercial
insurance carriers on a claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Company has negotiated numerous
agreements with managed care organizations to provide physician services based
on fee schedules. No individual managed care contract is material to the
Company.
6
<PAGE>
Drs. Paluka, Davick & Boque, P.A.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
Unaudited Financial Statements
Unaudited statements of operations for nine months ended September 30, 1996 and
for the nine months ended September 30, 1995 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1995
-----------
<S> <C>
Furniture, fixtures and equipment $93,468
Less accumulated depreciation (67,030)
-----------
$26,438
===========
</TABLE>
7
<PAGE>
Drs. Paluka, Davick & Bogue, P.A.
Notes to Financial Statements (continued)
3. Lease Commitments
The Company leases office space and certain equipment under operating leases.
Total rental expense was $56,215 in 1995. The following is a schedule by year of
future minimum lease payments under operating leases as of December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
1996 $ 93,307
1997 96,737
1998 100,267
1999 103,961
2000 107,782
Thereafter 569,675
--------------
$1,071,729
==============
</TABLE>
4. Employee Benefit Plans
The Company has a qualified profit sharing plan covering substantially all
employees. Contributions are determined based upon a percentage of each eligible
employee's compensation, as defined, and/or at the discretion of management.
8
<PAGE>
Drs. Paluka, Davick & Bogue, P.A.
Notes to Financial Statements (continued)
5. Income Taxes
The Company accounts for income taxes using the liability method required by
Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for
Income Taxes."
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax liabilities and assets were as follows:
<TABLE>
<CAPTION>
December 31
1995
-----------
<S> <C>
Deferred tax liabilities:
Accounts receivable $33,744
Depreciation 1,928
-----------
Total deferred tax liabilities 35,672
Deferred tax assets:
Accrued expenses, other 25,992
Net operating loss carryover 6,935
-----------
Total deferred tax assets 32,927
-----------
Net deferred tax liabilities $ 2,745
===========
</TABLE>
Significant components of the provision for income taxes attributable to
continuing operations are as follows:
<TABLE>
<CAPTION>
Year ended
December 31
1995
-----------
<S> <C>
Deferred:
Federal $10,766
State 1,538
-----------
Total deferred $12,304
===========
Net provision
</TABLE>
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Notes to Financial Statements (continued)
5. Income Taxes (continued)
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
Year ended
December 31, 1995
------------------
Amount Rate
------------------
<S> <C> <C>
Federal taxes at statutory rates $(10,766) 35%
Add (deduct):
State income tax, net of federal
tax benefit (1,538) 5
Other--permanent differences 24,608 (23)
------------------
$ 12,304 17%
==================
</TABLE>
Net operating loss carryforwards available for tax purposes as of December 31,
1995 approximate $17,338, which expire beginning in 2005.
6. Related Parties
During 1995, an additional physician was admitted as an owner to the Company and
issued 100 shares of common stock in consideration of $20,000, paid by a note
in the amount of $15,000, with the remaining $5,000 contributed in cash by the
physician. The remaining balance on the $15,000 loan was $10,954 as of
December 31, 1995.
10
<PAGE>
Drs. Pakula, Davick & Bogue, P.A.
Notes to Financial Statements (continued)
6. Related Parties (continued)
The Company has four notes payable with a combined original principal amount of
$59,745, payable in monthly installments of principal and interest at interest
rates ranging from 6% to 7.2%. The principal balance outstanding of these notes
payable was $58,370 at December 31, 1995. The following is a schedule of
principal maturities on the notes as of December 31, 1995:
<TABLE>
<S> <C>
1996 $ 7,421
1997 10,911
1998 9,892
1999 10,393
2000 11,033
Thereafter 8,720
------------
$58,370
============
</TABLE>
7. Pending Affiliation
The Company expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Company will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to the Company is subject to working capital
adjustments and is payable in common stock of PQC.
11
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Audited Consolidated Financial Statements
Years ended December 31, 1993, 1994 and 1995 and
nine months ended September 30, 1995 (Unaudited) and
nine months ended September 30, 1996 (Unaudited)
<TABLE>
<CAPTION>
Contents
<S> <C>
Report of Independent Auditors.......................................1
Audited Consolidated Financial Statements
Consolidated Balance Sheets..........................................2
Consolidated Statements of Operations................................3
Consolidated Statements of Owners' Equity............................4
Consolidated Statements of Cash Flows................................5
Notes to Consolidated Financial Statements...........................6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying consolidated balance sheets of Park Medical
Associates, P.A. and Park Medical Labs, Inc. (the Companies) as of December 31,
1995 and 1994, and the related consolidated statements of operations, owners'
equity, and cash flows for each of the three years in the period ended December
31, 1995. These financial statements are the responsibility of the Companies'
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Park Medical
Associates, P.A. and Park Medical Labs, Inc. at December 31, 1995 and 1994, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1995, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
September 20, 1996
Boston, Massachusetts
1
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1994 1995 1996
-----------------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 95,342 $ 48,537 $ 194,719
Accounts receivable, less allowance
for doubtful accounts of $83,256,
$86,507 and $92,685 in 1994, 1995
and 1996 (unaudited), respectively 659,453 724,890 776,784
Prepaid expenses 38,086 46,286 13,450
Deferred income taxes 50,962 87,859 138,997
-----------------------------------------
Total current assets 843,843 907,572 1,123,950
Property and equipment, net (Note 2) 415,821 558,234 483,411
-----------------------------------------
Total assets $1,259,664 $1,465,806 $1,607,361
=========================================
Liabilities and owners' equity
Current liabilities:
Accounts payable $ 58,373 $ 109,111 $ 163,471
Accrued employee benefits 108,020 107,054 215,367
Accrued expenses, other 112,093 163,850 164,868
Deferred income taxes 196,954 227,615 242,924
Current portion of obligation
under capital leases 28,814 28,814
-----------------------------------------
Total current liabilities 475,440 636,444 815,444
Deferred income taxes, noncurrent 14,120 22,806 22,806
Obligation under capital leases 100,768 79,666
Owners' equity:
Preferred stock: $100 par value; 1,225
shares authorized; 1,020 shares
issued; 918, 918 and 1,020 shares
outstanding in 1994, 1995 and 1996
(unaudited), respectively 92,004 92,004 92,106
Common stock: Associates, $10 par
value; 3,000 shares authorized; 1,000
shares issued; 900, 900 and 1,000
shares outstanding in 1994, 1995 and
1996 (unaudited), respectively 9,200 9,200 9,300
Common stock: Laboratories, $1 par
value; 100,000 shares authorized; 9,000
shares issued and outstanding 9,000 9,000 9,000
Paid-in capital 32,761 32,761 32,761
Retained earnings 651,112 594,873 578,328
-----------------------------------------
794,077 737,838 721,495
Less treasury stock, at cost;
Preferred--204 shares in 1994 and
306 shares in 1995 and 1996; Common
Associates--200 shares in 1994 and
300 shares in 1995 and 1996; Common
Laboratories--0 in 1994, 1,000 in
1995 and 1996 (23,973) (32,050) (32,050)
-----------------------------------------
770,104 705,788 689,445
-----------------------------------------
Total liabilities and owners' equity $1,259,664 $1,465,806 $1,607,361
=========================================
</TABLE>
See accompanying notes.
2
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Consolidated Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Nine months ended
Year ended December 31 September 30
1993 1994 1995 1995 1996
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenue:
Net patient service revenue $3,479,064 $3,908,278 $4,380,661 $3,269,125 $3,321,600
Interest income 3,818 3,569 4,246 3,599 2,599
Other income 70,000 50,000 7,000
-----------------------------------------------------------------
3,482,882 3,911,847 4,454,907 3,322,724 3,331,199
Operating expenses:
Salaries and wages--physicians 1,057,000 1,158,000 1,423,265 1,158,270 1,092,485
Salaries and wages--staff 693,913 784,153 878,386 662,667 684,414
Physician and staff benefits 440,099 498,258 521,899 384,582 382,546
Supplies and other 774,719 839,965 855,456 623,507 692,363
Insurance 38,932 49,421 42,400 36,641 32,517
Rent 99,324 178,557 295,016 206,675 193,269
Depreciation and amortization 61,822 68,309 114,079 80,872 89,207
Provision for bad debts 169,217 201,366 233,695 175,271 155,485
-----------------------------------------------------------------
Net operating expenses 3,335,026 3,778,029 4,364,196 3,328,485 3,322,286
-----------------------------------------------------------------
Net income before income taxes 147,856 133,818 90,711 (5,761) 8,913
Income tax expense (benefit) 9,614 (25,055) 2,450 (14,689) 3,058
-----------------------------------------------------------------
Net income $ 138,242 $ 158,873 $ 88,261 $ 8,928 $ 5,855
=================================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Consolidated Statements of Owners' Equity
<TABLE>
<CAPTION>
Common Stock
-------------------------------- Total
Preferred Stock Associates Laboratories Paid-in Retained Treasury Owners'
Shares Amount Shares Amount Shares Amount Capital Earnings Stock Equity
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1993 714 $91,800 700 $9,000 7,000 $7,000 $32,761 $ 446,028 $(23,973) $ 562,616
Distributions (50,031) (50,031)
Net income 138,242 138,242
--------------------------------------------------------------------------------------------------
Balance at December 31, 1993 714 91,800 700 9,000 7,000 7,000 32,761 534,239 (23,973) 650,827
Issuance of preferred stock 204 204 204
Issuance of common stock 200 200 2,000 2,000 2,200
Distributions (42,000) (42,000)
Net income 158,873 158,873
--------------------------------------------------------------------------------------------------
Balance at December 31, 1994 918 92,004 900 9,200 9,000 9,000 32,761 651,112 (23,973) 770,104
Acquisition of treasury stock (8,077) (8,077)
Distributions (144,500) (144,500)
Net income 88,261 88,261
--------------------------------------------------------------------------------------------------
Balance at December 31, 1995 918 92,004 900 9,200 9,000 9,000 32,761 594,873 (32,050) 705,788
Issuance of preferred stock 102 102 102
(unaudited)
Issuance of common stock 100 100 100
(unaudited)
Distributions (unaudited) (22,400) (22,400)
Net income (unaudited) 5,855 5,855
--------------------------------------------------------------------------------------------------
Balance at September 30, 1996
(unaudited) 1,020 $92,106 1,000 $9,300 9,000 $9,000 $32,761 $ 578,328 $(32,050) $ 689,445
==================================================================================================
</TABLE>
See accompanying notes.
4
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Nine months ended
Year ended December 31 September 30
1993 1994 1995 1995 1996
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating activities
Net income $138,242 $ 158,873 $ 88,261 $ 8,928 $ 5,855
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 61,822 68,309 114,079 80,872 89,207
Deferred income taxes 9,614 (25,055) 2,450 74,646 (35,829)
Loss on sale of investments 6,897 5,747
Loss on disposal of fixed assets 3,812
Changes in operating assets
and liabilities:
Accounts receivable, net 4,433 (25,185) (65,437) (12,935) (51,894)
Other current assets (12,445) 4,239 (8,200) 17,478 32,836
Accounts payable and accrued
expenses 22,107 105,103 101,529 128,786 163,691
--------------------------------------------------------
Net cash provided by operating 230,670 295,843 232,682 297,775 203,866
activities
Investing activities
Cash proceeds from sale of 13,007 111,857
investments
Purchase of investments (36,110) (81,342)
Purchase of property and
equipment (14,048) (389,184) (111,530) (88,159) (14,384)
---------------------------------------------------------
Net cash used in investing
activities (37,151) (358,669) (111,530) (88,159) (14,384)
Financing activities
Issuance of stock 2,404 202
Purchase of treasury stock (8,077)
Distributions paid (50,031) (42,000) (144,500) (91,000) (22,400)
Payments on lease obligations (3,080) (3,228) (15,380) (8,018) (21,102)
---------------------------------------------------------
Net cash used in financing
activities (53,111) (42,824) (167,957) (99,018) (43,300)
---------------------------------------------------------
Net increase (decrease) in cash 140,408 (105,650) (46,805) 110,598 146,182
Cash and cash equivalents at
beginning of year 60,584 200,992 95,342 95,342 48,537
---------------------------------------------------------
Cash and cash equivalents at end
of year $200,992 $ 95,342 $ 48,537 $205,940 $194,719
=========================================================
Supplemental disclosure of cash
flow information:
Interest paid $ 692 $ 227 $ 7,962 $ 3,800 $ 7,236
=========================================================
Noncash transactions:
Acquisition of capital
leased equipment - - $ 144,962 $144,962 -
=========================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Park Medical Associates, P.A. and Park Medical Labs, Inc. (the Companies) are
taxable entities organized under the laws of Maryland. The Companies offer a
variety of medical services, including internal medicine, neurology and
obstetrics/gynecology, in the greater Baltimore, Maryland area.
Principles of Consolidation
The accompanying consolidated financial statements reflect the accounts of the
Companies. These Companies are affiliated through, and managed by, common
ownership. All significant intercompany accounts and transactions are
eliminated upon consolidation.
Cash Equivalents
Cash equivalents consist of cash in banks and an interest-bearing money market
accounts.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred. Amortization of assets recorded under capital leases is included in
depreciation expense.
Income Taxes
Park Medical Associates, P.A. is taxable under the provisions of the Internal
Revenue Code and files a separate cash-basis federal and state income tax
return, reporting only its own taxable income (loss) for the year. No provision
for federal income tax is required for Park Medical Laboratories since this
entity, with consent of its shareholders, has elected to be taxed as an S
corporation under the provisions of the Internal Revenue Code. Deferred income
taxes are provided for temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes (see Note 7).
6
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Professional Liability Insurance
The Companies have obtained professional liability coverage through commercial
insurance carriers on both the occurrence and claims-made basis. Management
believes that there are no claims that may result in a loss in excess of amounts
covered by its existing insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Companies have negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Companies.
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
7
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1994 1995
------------------------
<S> <C> <C>
Furniture, fixtures and equipment $ 945,132 $ 980,894
Capital leased equipment 144,962
Leasehold improvements 75,768
------------------------
945,132 1,201,624
Less accumulated depreciation and
amortization (529,311) (643,390)
------------------------
$ 415,821 $ 558,234
========================
</TABLE>
3. Capital Leases
The Companies lease certain medical equipment under long-term capital leases.
Future minimum lease payments for capital leases were as follows at December 31,
1995:
<TABLE>
<S> <C>
1996 $ 37,134
1997 37,134
1998 37,134
1999 37,134
2000 9,426
-----------
Total minimum lease payments 157,962
Less amount representing interest (28,380)
-----------
Present value of net minimum
lease payments 129,582
Less current maturities (28,814)
-----------
Long-term obligation $100,768
===========
</TABLE>
8
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
4. Operating Leases
The Companies lease office space and certain equipment under operating leases.
The lease of office space includes an annual escalation clause of 3.75% and is
noncancelable for a period of ten years, with two additional five-year renewal
options. Total rental expense was $99,324, $178,557 and $295,016 in 1993, 1994
and 1995, respectively.
The following is a schedule by year of future minimum lease payments under
operating leases as of December 31, 1995:
<TABLE>
<S> <C>
1996 $ 249,373
1997 258,692
1998 268,406
1999 278,495
2000 288,934
Thereafter 1,125,676
------------
Total future minimum lease payments $2,469,576
============
</TABLE>
5. Employee Benefit Plans
The Companies sponsor a profit-sharing plan covering all employees at least 21
years of age and having completed a minimum of one year of service.
Contributions were determined based upon a percentage of each eligible
employee's compensation, as defined, and/or at the discretion of management.
Participants become fully vested in their sixth year of service with the
Companies. Total contributions were $32,969, $41,024 and $57,168 for the years
ended December 31, 1993, 1994 and 1995, respectively, and are included in
employee benefits in the accompanying statement of operations.
6. Distributions
Under the provisions of the Internal Revenue Code, all taxable income of Park
Medical Laboratories is subject to taxation at the shareholder level.
Accordingly, the Company distributes cash to its shareholders in amounts which
equal taxable income reported by the Company. Distributions made in 1994, 1995
and 1996 represent taxable income of prior years.
9
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
7. Income Taxes
The Company accounts for income taxes using the liability method required by
Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for
Income Taxes."
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes.
Significant components of the Company's deferred tax liabilities and assets were
as follows:
<TABLE>
<CAPTION>
December 31
1994 1995
---------------------
<S> <C> <C>
Deferred tax liabilities:
Accounts receivable, net $176,796 $195,777
Prepaid expenses, other 20,158 31,838
Accelerated depreciation 14,120 22,806
---------------------
Total deferred tax liabilities 211,074 250,421
Deferred tax assets:
Accrued expenses, other 50,962 87,859
Capital loss carryforward 5,058 5,058
Net operating loss carryover 1,701 1,436
---------------------
57,721 94,353
Less valuation allowance (6,759) (6,494)
---------------------
Net deferred tax assets 50,962 87,859
---------------------
Net deferred tax liabilities $160,112 $162,562
=====================
</TABLE>
10
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
7. Income Taxes (continued)
Significant components of the provision (benefit) for income taxes attributable
to continuing operations are as follows:
<TABLE>
<CAPTION>
Year ended December 31
1993 1994 1995
---------------------------------------
<S> <C> <C> <C>
Deferred:
Federal $8,412 $(21,923) $2,144
State 1,202 (3,132) 306
---------------------------------------
Net provision (benefit) $9,614 $(25,055) $2,450
=======================================
</TABLE>
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
Year ended December 31
1993 1994 1995
-------------------------------------------------------
Amount Rate Amount Rate Amount Rate
-------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Federal taxes at statutory
rates $ 51,750 35% $ 46,836 35% $ 31,749 35%
Add (deduct):
Federal taxes on income
taxed at shareholder
level (35,191) (24) (69,113) (52) (29,635) (32)
State income tax, net of
federal tax benefit 782 1 (2,036) (2) 199 0
Effect of valuation
allowance (9,550) (6) 134 0 (265) 0
Other 1,823 1 (876) 0 402 0
-------------------------------------------------------
$ 9,614 7% $(25,055) (19)% $ 2,450 3%
=======================================================
</TABLE>
Net operating loss carryforwards for tax purposes available as of December 31,
1995 were $3,590, which expire beginning in 2007.
11
<PAGE>
Park Medical Associates, P.A. and Park Medical Labs, Inc.
Notes to Consolidated Financial Statements (continued)
8. Preferred Stock
Each share of Park Medical Associates' nonvoting preferred stock entitles its
holder to receive an annual cash dividend of $8.00 per share. Dividends on the
preferred stock are noncumulative and must be paid before any distributions are
made to the holders of Park Medical Associates' common stock.
In the event of the dissolution and liquidation of the corporation, the holders
of the preferred stock are entitled to receive out of funds available for
distributions to stockholders $100 for each share of preferred stock issued
before any distributions are made to the holders of Park Medical Associates'
common stock.
The Board of Directors may at any time on thirty days' written notice redeem any
part or all of the preferred stock at the redemption price of $105 per share.
Park Medical Associates has not declared any dividends on its preferred or
common stock since inception of the Company.
9. Pending Affiliation
The Companies expect to enter into a long-term affiliation agreement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Companies will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to the Companies for the merger is subject to working
capital adjustments and is payable in cash and common stock of PQC.
12
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Audited Financial Statements
Years ended December 31, 1994 and 1995, and
nine months ended September 30, 1995 (Unaudited)
and September 30, 1996 (Unaudited)
Contents
<TABLE>
<CAPTION>
<S> <C>
Report of Independent Auditors.......................... 1
Audited Financial Statements
Balance Sheets.......................................... 2
Statements of Operations................................ 3
Statements of Shareholders' Equity...................... 4
Statements of Cash Flows................................ 5
Notes to Financial Statements........................... 6
</TABLE>
<PAGE>
[LETTERHEAD OF ERNST & YOUNG LLP APPEARS HERE]
Report of Independent Auditors
The Board of Directors
Physicians Quality Care, Inc.
We have audited the accompanying balance sheets of Drs. Sigler, Roskes, Holden &
Schuberth, P.A. as of December 31, 1994 and 1995, and the related statements of
operations, shareholders' equity, and cash flows for the years then ended.
These financial statements are the responsibility of management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Drs. Sigler, Roskes, Holden &
Schuberth, P.A. at December 31, 1994 and 1995, and the results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
September 20, 1996
Boston, Massachusetts
1
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
December 31 September 30
1994 1995 1996
--------------------------------------
<S> <C> <C> <C>
Assets
Current assets:
Cash $109,949 $ 53,982 $210,458
Accounts receivable, less allowance for
doubtful accounts of $16,470 in 1994,
$15,035 in 1995 and $10,976 in 1996
(unaudited) 237,005 273,132 227,914
Prepaid expenses 29,261 50,201 55,242
Deferred income taxes 53,871 67,354 115,984
--------------------------------------
Total current assets 430,086 444,669 609,598
Deferred income taxes, noncurrent 18,125 20,974 10,262
Property and equipment, net 75,072 51,979 44,120
--------------------------------------
Total assets $523,283 $517,622 $663,980
======================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 58,077 $ 79,857 $151,920
Accrued employee benefits 62,005 23,742 50,512
Accrued salaries and payroll taxes 53,796 61,843 31,220
Accrued expenses, other 55,379 52,611 48,998
Deferred income taxes 106,506 129,332 113,263
Accrued physician bonuses 36,396
Escrow fees payable 56,784
Accrued income taxes 50,631
Current portion of obligation under capital lease 14,496 3,798
Current portion of note payable 12,000 12,000 10,000
--------------------------------------
Total current liabilities 362,259 363,183 549,724
Obligation under capital lease, less current portion 3,798 1
Note payable, less current portion 19,000 7,000
Deferred income taxes, noncurrent 210
Shareholders' equity:
Common stock 14,171 14,171 14,171
Additional paid-in capital 56,924 56,924 56,924
Retained earnings 80,826 90,248 57,066
--------------------------------------
151,921 161,343 128,161
Cost of treasury stock (13,905) (13,905) (13,905)
--------------------------------------
Total shareholders' equity 138,016 147,438 114,256
--------------------------------------
Total liabilities and shareholders' equity $523,283 $517,622 $663,980
======================================
</TABLE>
See accompanying notes.
2
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Statements of Operations
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1994 1995 1995 1996
-----------------------------------------------------
<S> <C> <C> <C> <C>
Revenue:
Net patient service revenue $2,735,139 $2,770,367 $2,093,288 $1,927,947
Other income 114,205 157,128 101,237 97,706
Interest income 29 4,385 2,758 1,646
-----------------------------------------------------
2,849,373 2,931,880 2,197,283 2,027,299
Operating expenses:
Salaries and wages--physicians 1,191,190 1,178,873 927,086 833,519
Salaries and wages--staff 457,581 502,896 456,094 457,331
Employee benefits--staff 208,460 212,182 158,639 150,512
Supplies and other 637,526 724,193 397,320 408,641
Rent 123,280 134,026 122,299 122,299
Insurance 121,314 115,707 59,423 67,906
Interest 4,569 3,312 2,619 1,016
Depreciation 37,049 29,949 22,462 11,638
Provision for bad debts 16,470 15,035 11,276 10,976
-----------------------------------------------------
Net operating expenses 2,797,439 2,916,173 2,157,218 2,063,838
-----------------------------------------------------
Net income (loss) before income taxes 51,934 15,707 40,065 (36,539)
Income tax provision (benefit) 21,264 6,283 11,128 (3,355)
-----------------------------------------------------
Net income (loss) $ 30,670 $ 9,424 $ 28,937 $ (33,184)
=====================================================
</TABLE>
See accompanying notes.
3
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Statements of Shareholders' Equity
<TABLE>
<CAPTION>
<S> <C>
Balance at December 31, 1993 $107,346
Net income 30,670
----------
Balance at December 31, 1994 138,016
Net income 9,424
----------
Balance at December 31, 1995 147,440
Net loss (unaudited) (33,184)
----------
Balance at September 30, 1996 (unaudited) $114,256
==========
</TABLE>
See accompanying notes.
4
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Statements of Cash Flows
<TABLE>
<CAPTION>
(Unaudited)
Year ended Nine months ended
December 31 September 30
1994 1995 1995 1996
---------------------------------------------------
<S> <C> <C> <C> <C>
Operating activities
Net income (loss) $ 30,670 $ 7,427 $ 28,937 $(31,912)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation 37,049 29,949 22,462 11,638
Deferred income taxes 21,190 6,283 11,128 (55,257)
Changes in operating assets and liabilities:
Accounts receivable, net (46,448) (36,127) (66,466) 45,218
Other current assets (1,701) (20,940) (36,073) (5,041)
Accounts payable and accrued expenses 27,770 (9,207) 234,049 208,408
---------------------------------------------------
Net cash provided (used) by operating
activities 68,530 (22,615) 194,037 173,054
Investing activity
Purchase of property and equipment (26,183) (6,856) (6,859) (3,779)
---------------------------------------------------
Net cash used in investing activity (26,183) (6,856) (6,859) (3,779)
Financing activities
Payments on capital lease obligation (13,452) (14,496) (9,000) (3,799)
Payments on note payable (12,000) (12,000) (12,245) (9,000)
---------------------------------------------------
Net cash used in financing activities (25,452) (26,496) (21,245) (12,799)
---------------------------------------------------
Increase (decrease) in cash 16,895 (55,967) 165,933 156,476
Cash at beginning of period 93,054 109,949 109,949 53,982
---------------------------------------------------
Cash at end of period $109,949 $ 53,982 $275,882 $210,458
===================================================
Supplemental disclosure of cash flow
information:
Interest paid $ 2,645 $ 2,423 $ 2,619 $ 1,016
===================================================
</TABLE>
See accompanying notes.
5
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements
December 31, 1995
1. Summary of Significant Accounting Policies
Description of Business
Drs. Sigler, Roskes, Holden & Schuberth, P.A. (the Company) is a taxable entity
organized under the laws of Maryland. The Company offers a variety of medical
services, including pediatrics and primary care, in the greater Baltimore,
Maryland area.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over the estimated useful
lives of the assets. Routine maintenance and repairs are charged to expense as
incurred. Amortization of assets recorded under capital lease transactions is
included in depreciation expense.
Income Taxes
The Company is taxable under the provisions of the Internal Revenue Code. The
Company files its federal and state income tax return on the cash-basis method
of accounting. Deferred income taxes are provided for temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes (see Note 7).
Professional Liability Insurance
The Company has obtained professional liability coverage through commercial
insurance carriers on the claims-made basis. Management believes that there are
no claims that may result in a loss in excess of amounts covered by its existing
insurance.
Net Patient Service Revenue
Net patient service revenue is reported at the estimated realizable amounts from
patients, third-party payors and others for services rendered. The Medicare and
Medicaid programs pay physician services based on fee schedules which are
determined by the related government agency. The Company has negotiated
numerous agreements with managed care organizations to provide physician
services based on fee schedules. No individual managed care contract is
material to the Company.
6
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements (continued)
1. Summary of Significant Accounting Policies (continued)
Risks and Uncertainties
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Unaudited Financial Statements
The unaudited financial statements as of September 30, 1996 and for the nine
months ended September 30, 1995 and 1996 have been prepared by management in
accordance with generally accepted accounting principles. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results of the
interim periods are not necessarily indicative of the results that may be
expected for a full year.
2. Property and Equipment
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31
1994 1995
--------------------
<S> <C> <C>
Furniture, fixtures and equipment $213,956 $217,093
Leasehold improvements 117,987 121,709
--------------------
331,943 338,802
Less accumulated depreciation (256,871) (286,823)
--------------------
$ 75,072 $ 51,979
====================
</TABLE>
3. Note Payable
The Company has a note payable with a bank payable in monthly installments of
$1,000, plus interest, with a final maturity date of July 10, 1997. The note
carries interest at the prime rate. The principal balance outstanding under the
note was $31,000 and $19,000 at December 31, 1994 and 1995, respectively.
7
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements (continued)
3. Note Payable (continued)
The following is a schedule of principal maturities on the notes and line of
credit as of December 31, 1995:
<TABLE>
<S> <C>
1996 $ 12,000
1997 7,000
----------
$ 19,000
==========
</TABLE>
4. Capital Leases
Property, plant and equipment includes the following amounts for leases that
have been capitalized at December 31:
<TABLE>
<CAPTION>
December 31
1994 1995
---------------------
<S> <C> <C>
Equipment $ 64,347 $ 64,347
Less accumulated amortization (48,240) (61,105)
---------------------
$ 16,107 $ 3,242
=====================
</TABLE>
5. Operating Leases
The Group leases office space and certain equipment under operating leases.
Total rental expense was $123,280 and $134,026 in 1994 and 1995, respectively.
The following is a schedule by year of future minimum lease payments under
operating leases as of December 31, 1995:
<TABLE>
<S> <C>
1996 $ 135,625
1997 138,822
1998 143,518
1999 148,540
2000 153,773
Thereafter 337,651
------------
Total future minimum
lease payments $1,057,929
============
</TABLE>
8
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements (continued)
6. Employee Benefit Plans
The Company has a qualified profit sharing plan covering substantially all
employees. Contributions are determined based upon a percentage of each
eligible employee's compensation, as defined and/or at the discretion of
management. Total contributions were $208,460 and $212,182 for the years ended
December 31, 1994 and 1995, respectively, and are included in employee benefits
in the accompanying statements of operations.
7. Income Taxes
The Company accounts for income taxes utilizing the liability method required by
Financial Accounting Standards Board (FASB) Statement No. 109, "Accounting for
Income Taxes."
Deferred income taxes reflect the net effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax liabilities and assets were as follows:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995
------------------------
<S> <C> <C>
Deferred tax liabilities:
Accounts receivable, net $ 94,802 $109,252
Accrued expenses 11,704 20,080
Depreciation 210
------------------------
Total deferred tax liabilities 106,716 129,332
Deferred tax assets:
Accrued expenses 53,871 67,354
Net operating loss carryover 10,807 12,803
Other 7,318 1,519
Depreciation 6,652
------------------------
Total deferred tax assets 71,996 88,328
------------------------
Net deferred tax liabilities $ 34,720 $ 41,004
========================
</TABLE>
9
<PAGE>
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements (continued)
7. Income Taxes (continued)
Significant components of the provision for income taxes attributable to
continuing operations are as follows:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995
------------------------
<S> <C> <C>
Current:
Federal
State $ 74
------------------------
Total current 74
Deferred:
Federal 18,451 $5,497
State 2,739 785
------------------------
Total deferred 21,190 6,282
------------------------
$21,264 $6,282
========================
</TABLE>
The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate to income before taxes is as
follows:
<TABLE>
<CAPTION>
Year ended December 31
1994 1995
------------------------------
Amount Rate Amount Rate
------------------------------
<S> <C> <C> <C> <C>
Federal taxes at statutory rates $18,177 35% $5,497 35%
Add (deduct):
State income tax, net of federal
tax benefit 2,597 5 786 5
Other 490 1
------------------------------
$21,264 41% $6,283 40%
==============================
</TABLE>
Net operating loss carryforwards for tax purposes as of December 31, 1995
approximate $32,008, which expire beginning in 2004.
Drs. Sigler, Roskes, Holden & Schuberth, P.A.
Notes to Financial Statements (continued)
8. Pending Affiliation
The Company expects to enter into a long-term affiliation arrangement with
Physicians Quality Care, Inc. (PQC). Under this arrangement, the Company will
merge with and into, and the physicians will become employees of, a newly formed
professional corporation that is affiliated with PQC. The aggregate
consideration to be paid to the Company is subject to working capital
adjustments and is payable in common stock of PQC.
10
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Clinical Associates, P.A.
We have audited the accompanying balance sheet of Clinical Associates, P.A. as
of June 30, 1994, and the related statements of income, changes in stockholders'
equity, and cash flows for the year then ended. 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 audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Clinical Associates, P.A. as of
June 30, 1994, and the results of its operations and its cash flows for the year
then ended in conformity with generally accepted accounting principles.
Scheiner, Mister & Grandizio, P.A.
December 9, 1994
Lutherville, Maryland
1
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS
<S> <C>
CURRENT ASSETS
Cash and Cash Equivalents $ 569,851
Accounts Receivable - Trade
(Less reserve for contractual allowances
and doubtful accounts of $2,550,108) (Note 1) 3,986,260
Loans Receivable - Officers (Note 3) 3,000
Other Receivables 20,355
Prepaid Expenses 340,307
----------
TOTAL CURRENT ASSETS 4,919,773
----------
PROPERTY AND EQUIPMENT
Leasehold Improvements 449,786
Furniture and Fixtures 474,998
Office Equipment 375,914
Medical Equipment 422,622
Equipment under Capital Leases (Note 5) 108,173
----------
Total 1,831,493
Less: Accumulated Depreciation 837,315
----------
Total Property and Equipment 994,178
----------
OTHER ASSETS
Deferred Income Tax Asset (Note 7) 14,198
Security Deposits 763
Goodwill - Net of Amortization (Note 2) 802
----------
TOTAL OTHER ASSETS 15,763
----------
TOTAL ASSETS $5,929,714
==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements
-2-
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C>
CURRENT LIABILITIES
Notes Payable - Related Parties (Note 4) $ 18,386
Current Maturities of Capital Lease Obligations (Note 5) 23,319
Accounts Payable 834,704
Allowance for Claims Incurred but not Reported 1,274,646
Current Portion of Lease Incentive (Note 6) 11,600
Deferred Income Tax Liability (Note 7) 1,137,265
Accrued Expenses and Other Current Liabilities 844,887
Income Taxes Payable (Note 11) 92,113
----------
TOTAL CURRENT LIABILITIES 4,236,920
----------
LONG-TERM LIABILITIES
Notes Payable - Related Parties,
Net of Current Portion (Note 4) 20,590
Obligation Under Capital Leases, Net of Current
Portion (Note 5) 22,177
Lease Incentive, Net of Current Portion (Note 6) 78,300
----------
TOTAL LONG-TERM LIABILITIES 121,067
----------
TOTAL LIABILITIES 4,357,987
----------
STOCKHOLDERS' EQUITY
Common Stock - Par Value - $1.00; authorized
100,000 shares; issued and outstanding
10,250 shares 10,250
Capital in Excess of Par 748,618
Retained Earnings 812,859
----------
TOTAL STOCKHOLDERS' EQUITY 1,571,727
----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $5,929,714
==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF INCOME
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1994
- --------------------------------------------------------------------------------
<S> <C>
NET PATIENT SERVICE REVENUE $34,555,200
-----------
Professional Care and Supplies 9,789,496
Salaries and Wages 15,297,130
Employee Health and Welfare 1,449,915
General and Administrative Expenses 6,683,282
Provision for Bad Debt 54,803
-----------
TOTAL EXPENSES 33,274,626
-----------
NET OPERATING INCOME 1,280,574
Other Income Net 160,804
-----------
NET INCOME BEFORE INCOME TAXES 1,441,378
-----------
PROVISION FOR INCOME TAXES
Current 143,553
Deferred 609,585
-----------
TOTAL PROVISION FOR INCOME TAXES 753,138
-----------
NET INCOME $ 688,240
===========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-3-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1994
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Capital in
Common Excess Retained
Stock of Par Earnings Total
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
BALANCE - BEGINNING OF
YEAR $ 10,750 $718,368 $ 249,620 $ 978,738
Purchase and Retirement
of Common Stock (1,000) (49,250) (125,001) (175,251)
Issuance of Common Stock 500 79,500 -0- 80,000
Net Income -0- -0- 688,240 688,240
-------- -------- --------- ----------
BALANCE - END OF YEAR $ 10,250 $748,618 $ 812,859 $1,571,727
======== ======== ========= ==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-4-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1994
- --------------------------------------------------------------------------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 688,240
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation 284,121
Amortization 1,600
Net (Gain) Loss on Sale and Disposal of
Property & Equipment 6,094
Net Loss on Sale of Investments 65,765
Deferred Income Taxes 609,585
(Increase) Decrease in Operating Assets:
Accounts Receivable (1,089,549)
Other Receivables 75,861
Prepaid Expenses (41,583)
Security Deposits 2,626
Increase (Decrease) in Operating Liabilities:
Accounts Payable and Allowance for Claims
Incurred but not Reported (444,099)
Lease Incentive Payable (11,600)
Accrued Expenses 483,121
Income Taxes Payable 92,113
-----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 722,295
-----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of Property and Equipment (416,535)
Proceeds from Disposal of Property and Equipment 95,662
Proceeds from Sale of Investments 976,676
Purchase of Investments (1,042,441)
-----------
NET CASH USED IN INVESTING ACTIVITIES (386,638)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal Payments on Debt and Obligations Under
Capital Lease (234,666)
Purchase and Retirement of Common Stock (175,251)
Issuance of Common Stock 80,000
-----------
NET CASH USED IN FINANCING ACTIVITIES (329,917)
-----------
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-5-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1994
- --------------------------------------------------------------------------------
<S> <C>
NET INCREASE IN CASH AND CASH EQUIVALENTS $ 5,740
Cash and Cash Equivalents - Beginning of Year 564,111
--------
CASH AND CASH EQUIVALENTS - END OF YEAR $569,851
========
Cash Paid During the Year for:
Interest $ 13,086
========
Income Taxes $ 51,624
========
</TABLE>
The independents auditors' report and the accompanying notes are an
integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 1: NATURE OF OPERATIONS AND CREDIT CONCENTRATIONS
- -------------------------------------------------------
Clinical Associates, P.A. (the Company) is a medical practice providing health
care services through various facilities located in Baltimore City and Baltimore
County, Maryland. The Company grants credit to patients, substantially all of
whom are local residents. The Company generally does not require collateral or
other security in extending credit; however, it routinely obtains assignment of,
or is otherwise entitled to receive, patients' benefits receivable under their
health insurance programs, plans or policies (e.g. Medicare, Medicaid, Blue
Cross, health maintenance organizations [HMO(s)] and commercial insurance
policies).
At June 30, 1994, the Company's receivables were as follows:
<TABLE>
<S> <C>
Medicare $1,865,304
Medicaid 190,937
Blue Shield 1,121,481
HMO(s) 591,886
Commercial Insurance and Other 2,766,773
----------
Total 6,536,381
Less: Reserve for Contractual Allowances
and Doubtful Accounts 2,550,108
----------
Accounts Receivable, Net $3,986,273
==========
</TABLE>
Amounts due from patients as a result of deductibles and co-payments under their
insurance policies are included in the balances due from the insurer in the
above.
During the fiscal year ended June 30, 1994, the Company received approximately
50% of its patient service revenues under the contracts with HMO(s).
Approximately 42% of patient service revenues were generated under HMO contracts
expiring in December 31, 1994. Another HMO contract, which automatically renews
for one year periods each July unless otherwise terminated, generated patient
service revenues of approximately 8% of the total.
-6-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Cash Equivalents
- ----------------
Cash and cash equivalents include investments with original maturities of three
months or less.
Accounts Receivable
- -------------------
The Company records a reserve for differences between fees billed and amounts
collectible from third party payors (contractual allowances) and for doubtful
accounts.
HMO Receivables
- ---------------
The Company's contracts with HMO(s) contain various provisions for risk sharing,
stop loss and coordination of benefits. These provisions result in settlements
after the end of each contract period. The Company has recorded an estimate of
the settlements due as of the end of the fiscal year. Differences between the
amounts estimated and the actual settlement are recorded in the year determined.
Medical Supplies
- ----------------
The Company expenses medical supplies as received.
Property and Equipment
- ----------------------
Property and Equipment are recorded at cost. Depreciation is recorded on a
straight-line basis over the estimated useful life of the equipment. Leasehold
improvements are depreciated over the remaining life of the lease. A summary of
depreciable lives used is as follows:
<TABLE>
<S> <C>
Leasehold Improvements Life of Lease
Furniture and Fixtures 7 - 10 Years
Office Equipment 5 - 7 Years
Medical Equipment 5 - 7 Years
</TABLE>
Accelerated depreciation methods are used for income tax purposes.
Goodwill
- --------
Goodwill is recorded at cost and amortized on a straight-line basis over a five
year period. Cost and accumulated amortization as of June 30, 1994, were $8,000
and $7,198, respectively.
-7-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont.)
- -----------------------------------------------------------
Allowance for Claims Incurred But Not Reported
- ----------------------------------------------
In connection with its agreements with HMO(s), the Company is liable for the
cost of services rendered to HMO members by outside providers. The Company
estimates the cost of services rendered but not yet billed to the Company based
on prior experience.
Deferred Income Taxes
- ---------------------
Deferred tax is provided in accordance with Statement No. 109 of the Financial
Accounting Standards Board. Deferred taxes result primarily from differences in
the timing of recognizing revenue and expenses, which are recorded on a modified
cash basis for tax purposes, and differences in depreciation rates (see note 7).
Stock Transactions
- ------------------
The Company offers stock to physicians who meet certain criteria. A portion of
the stock value is paid in cash with the balance paid through future services.
The Company's policy is to record the stock in the amount of the cash payment
only. Had the value of the services been considered, capital contributions in
excess of par would have been higher and retained earnings would have been
lower.
NOTE 3: RELATED PARTY TRANSACTIONS
- -----------------------------------
Some of the Company's stockholders are partners in a partnership which owns 50%
of 660 Associates, the landlord under several leases in which the Company was a
tenant. During the year ended June 30, 1994, the Company terminated its leasing
relationship with 660 Associates. Total rent expense and amounts paid to buy-
out leasing commitments totalled approximately $811,631.
Some of the Company's stockholders are partners in another partnership, which
owns 50% of Security MDC Associates Partnership, the landlord under another
lease in which the Company is the tenant. Annual rental under this lease is
approximately $215,000. This lease expires on July 31, 1995, and contains an
additional five year renewal option.
-8-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 3: RELATED PARTY TRANSACTIONS (Cont.)
- -------------------------------------------
Loans receivable from officers are non-interest bearing, unsecured and are due
over periods not exceeding 12 months.
The Company has notes payable to several stockholders and other related parties
bearing interest at 10% to 12% per annum, payable in monthly or quarterly
installments of principal and interest. (See note 4).
NOTE 4: NOTES PAYABLE
- ----------------------
Notes payable to stockholders and other related parties:
Notes payable to stockholders and other related parties - interest at
10 to 12%; monthly or quarterly payments of principal and interest
ranging from $484 to $1,108 payable through June, 1996.
<TABLE>
<S> <C>
$38,976
Less: Current Portion 18,386
-------
Non-Current Portion $20,590
=======
</TABLE>
Future maturities of the non-current portion of long term debt are as
follows:
<TABLE>
<S> <C>
Year ending June 30, 1996 $20,590
=======
</TABLE>
NOTE 5: CAPITAL LEASES
- -----------------------
The Company is the lessee of certain equipment under capital leases expiring in
various years through 1997.
Future minimum lease payments under capital leases are as follows:
<TABLE>
<S> <C>
Year Ending June 30, 1995 $ 26,912
1996 12,778
1997 11,714
--------
Total Commitment Under Capital Leases 51,404
Less: Amount Representing Interest 5,908
--------
Present Value of Future Minimum
Lease Payments 45,496
Less: Current Portion 23,319
--------
TOTAL LONG-TERM PORTION $ 22,177
========
</TABLE>
-9-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 5: CAPITAL LEASES (Cont.)
- -------------------------------
Following is a summary of equipment under capital leases:
<TABLE>
<S> <C>
Telecommunications Equipment $ 49,971
Medical Equipment 58,202
--------
108,173
Less: Accumulated amortization 68,352
--------
$ 39,821
========
</TABLE>
NOTE 6: LEASE INCENTIVE
- ------------------------
In connection with one of its lease agreements, the landlord assumed the
Company's obligations under an old lease. In accordance with generally accepted
accounting principles, the value of this incentive has been recorded as a
liability and is being amortized on a straight-line basis over the life of the
new lease. The current portion reflects the amount that will be amortized during
the year ending June 30, 1995.
NOTE 7: DEFERRED INCOME TAXES
- ------------------------------
The net deferred tax liability in the accompanying balance sheet includes the
following components as of June 30, 1994:
<TABLE>
<S> <C>
Deferred Tax Liability $1,188,446
Deferred Tax Asset (65,379)
Deferred Tax Asset Valuation Allowance -0-
----------
Net Deferred Tax Liability $1,123,067
==========
</TABLE>
The deferred tax liability arises primarily from differences in the timing of
recognition of patient service revenues and accrued expenses for tax purposes
and financial reporting purposes, and the excess of depreciation for tax
reporting purposes over the amount for financial purposes.
Temporary differences giving rise to the deferred tax asset consist of a capital
loss carryover for tax purposes, and lease expense as outlined in Note 6.
-10-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 8: 401(K) PLAN
- --------------------
Effective January 1, 1992, the Company implemented a 401(K) plan, amending and
restating in its entirety its former Target Benefit Plan and Trust, in order to
be in compliance with current pension regulations. All participants in the
former plan continued to participate in the 401(K) plan. Those not participating
in the former plan are eligible to participate in the 401(K) plan upon
completion of one year of service and attaining the age of 21. Employees may
elect to contribute up to 8% of their compensation annually, subject to dollar
limitations set by law. Under the plan the Company can elect to match a
percentage of the employees' contributions at its discretion. The Plan also
allows the Company to contribute a profit sharing amount, determined annually by
the Company. Participants are always 100% vested in their contributions to the
Plan. Vesting in the Company's contributions is 20% after two years of service,
increasing 20% annually with full vesting after six years of service. The Plan's
year end is December 31. Only those participants who are actively employed on
the last day of the plan year are eligible to participate in employer
contributions. At June 30, 1994, the Company estimated and contributed employer
matching contributions in excess of funding requirements in the amount of
$55,521. Total contributions to the Plan for the year ended June 30, 1994
amounted to $845,477.
NOTE 9: COMMITMENTS AND CONTINGENCIES
- --------------------------------------
Leases
- ------
The Company leases several buildings under operating leases expiring in various
years through March 31, 2002.
Minimum future rental payments under non-cancelable operating leases follow:
<TABLE>
<S> <C> <C>
Year Ended June 30, 1995 $ 1,350,953
1996 1,121,091
1997 1,085,761
1998 1,119,642
1999 1,125,943
Thereafter 5,542,033
-----------
TOTAL MINIMUM FUTURE RENTAL PAYMENTS $11,345,423
===========
</TABLE>
-11-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 9: COMMITMENTS AND CONTINGENCIES (Cont.)
- ----------------------------------------------
The Company is responsible for a proportionate share of operating expenses and
tax increases under several of its lease agreements. Several agreements also
call for rental increases based on changes in the Consumer Price Index or
specified amounts. Certain leases also provide for renewal options.
The Company also leases, on a month-to-month basis, other operating facilities.
Total lease expense for the above leases amounted to approximately $972,000.
See Note 3 for additional related party lease expense.
Agreements to Repurchase Stock
- ------------------------------
The Company has agreements with each of its stockholders, whereby the Company
will repurchase the stock upon the death, disability, or termination of the
stockholder's employment. The purchase price varies depending on the event
triggering the repurchase.
Litigation
- ----------
Malpractice claims have been asserted against the Company by various claimants
arising in the ordinary course of business. In the opinion of management, the
Company has adequate legal defenses or insurance coverage with respect to each
of these actions and does not believe that they will materially affect the
Company's results of operations or financial position.
Other claims asserted against the Company by former employees resulted in
settlements in the amount of $140,000, the amount of which is included in
accrued expenses at June 30, 1994. Outside council for the Company has advised
that the settlement disposes of this claim.
Assignment of Accounts Receivable
- ---------------------------------
In connection with its agreement with one HMO, the Company has assigned $500,000
of its accounts receivable to the HMO for the purpose of providing resources
sufficient to satisfy the Company's obligations to outside providers should the
Company fail to honor those obligations.
-12-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1994
- --------------------------------------------------------------------------------
NOTE 10: CREDIT RISK
- ---------------------
At June 30, 1994, the Company has deposits in a major financial institution
which exceed Federal Depository Insurance limits. This financial institution
has a strong credit rating and management believes that credit risk related to
these deposits is minimal.
The Company routinely invests its surplus operating funds in money market mutual
funds. These funds generally invest in highly liquid U.S. government and agency
obligations. Investments in money market funds are not insured or guaranteed by
the U.S. government; however, management believes that credit risk related to
these investments is minimal.
NOTE 11: INCOME TAXES
- ----------------------
Current income tax expense consists of the following for the year ended June 30,
1994:
<TABLE>
<S> <C>
Federal $ 35,845
State 7,708
--------
Subtotal 43,553
Prior Year 100,000
--------
TOTAL CURRENT INCOME TAXES $143,553
========
</TABLE>
Prior year tax expense consists of managements' estimate of income tax
liabilities due as a result of an Internal Revenue Service Audit for the year
ended June 30, 1992.
-13-
<PAGE>
[LETTERHEAD OF SCHEINER, MISTER & GRANDIZIO, P.A. APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Clinical Associates, P.A.
We have audited the accompanying balance sheet of Clinical Associates, P.A. as
of June 30, 1995, and the related statements of income, changes in stockholders'
equity, and cash flows for the year then ended. 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 audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that out audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Clinical Associates, P.A. as
of June 30, 1995, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
[SIGNATURE APPEARS HERE]
Scheiner, Mister & Grandizio, P.A.
November 17, 1995
Lutherville, Maryland
1
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
JUNE 30, 1995
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<S> <C>
CURRENT ASSETS
Cash and Cash Equivalents $ 407,043
Accounts Receivable (Less reserve for
contractual allowances and doubtful
accounts of $3,845,561) (Note 1) 3,751,175
Notes Receivable - Stockholders 41,111
Other Receivables 75,938
Prepaid Expenses 341,917
Income Taxes Receivable 46,040
----------
TOTAL CURRENT ASSETS 4,663,224
PROPERTY AND EQUIPMENT
Leasehold Improvements 535,499
Furniture and Fixtures 461,291
Office Equipment 418,180
Medical Equipment 584,073
Vehicles 12,434
Equipment under Capital Leases (Note 5) 108,173
----------
Total 2,119,650
Less: Accumulated Depreciation 911,187
----------
TOTAL PROPERTY AND EQUIPMENT 1,208,463
----------
OTHER ASSETS
Notes Receivable - Stockholders 156,389
----------
TOTAL ASSETS $6,028,076
==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements
2
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<S> <C>
CURRENT LIABILITIES
Notes Payable - Related Parties (Note 4) $ 47,683
Current Maturities of Capital Lease Obligations (Note 5) 11,035
Accounts Payable 509,249
Allowance for Claims Incurred but not Reported 1,190,000
Current Portion of Lease Incentive (Note 6) 11,600
Deferred Income Tax Liability (Note 7) 1,202,257
Accrued Expenses and Other Current Liabilities 795,879
----------
TOTAL CURRENT LIABILITIES 3,767,703
----------
LONG-TERM LIABILITIES
Notes Payable - Related Parties,
Net of Current Portion (Note 4) 6,250
Obligation Under Capital leases, Net of Current
portion (Note 5) 11,142
Lease Incentive, Net of Current portion (Note 6) 66,700
Deferred Income Taxes 41,709
----------
TOTAL LONG-TERM LIABILITIES 125,801
----------
TOTAL LIABILITIES 3,893,504
----------
STOCKHOLDERS' EQUITY
Common Stock - Par Value - $1.00; authorized
100,000 shares; issued and outstanding
10,408 shares 10,408
Capital in Excess of Par 1,085,460
Retained Earnings 1,038,704
----------
TOTAL STOCKHOLDERS' EQUITY 2,134,572
----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $6,028,076
==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF INCOME
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1995
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
NET PATIENT SERVICE REVENUE $36,526,122
-----------
EXPENSES
Professional Care and Supplies 9,270,120
Salaries and Wages 18,707,349
Employee Health and Welfare 1,750,600
General and Administrative Expenses 5,810,149
Provision for Bad Debt 860,862
-----------
TOTAL EXPENSES 36,399,080
-----------
NET OPERATING INCOME 127,042
Other Income Net 252,965
-----------
NET INCOME BEFORE INCOME TAXES 380,007
-----------
PROVISION FOR INCOME TAXES
Current 33,263
Deferred 120,899
-----------
TOTAL PROVISION FOR INCOME TAXES 154,162
-----------
NET INCOME $ 225,845
===========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-3-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Capital in
Common Excess Retained
Stock of Par Earnings Total
-------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BALANCE - BEGINNING OF
YEAR $ 10,250 $ 748,618 $ 812,859 $1,571,727
Purchase and Retirement
of Common Stock (250) 250 -0- -0-
Issuance of Common Stock 408 336,592 -0- 337,000
Net Income -0- -0- 225,845 225,845
-------- ---------- ---------- ----------
BALANCE - END OF YEAR $ 10,408 $1,085,460 $1,038,704 $2,134,572
======== ========== ========== ==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-4-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1995
- --------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 225,845
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation 236,921
Amortization 802
Net (Gain) Loss on Sale and Disposal of
Property & Equipment 1,422
Deferred Income Taxes 120,899
(Increase) Decrease in Operating Assets:
Accounts Receivable 235,085
Other Receivables (55,583)
Prepaid Expenses (1,610)
Income Taxes Receivable (46,040)
Security Deposits 763
Increase (Decrease) in Operating Liabilities:
Accounts Payable and Allowance for Claims
Incurred but not Reported (410,101)
Lease Incentive Payable (11,600)
Accrued Expenses (49,008)
Income Taxes Payable (92,113)
----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 155,682
----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of Property and Equipment (452,626)
Repayment of Stockholder Loans 5,500
----------
NET CASH USED IN INVESTING ACTIVITIES (447,126)
----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Long-Term Debt 44,421
Principal Payments on Debt and Obligations Under
Capital Lease (52,785)
Issuance of Common Stock 137,000
----------
NET CASH USED IN FINANCING ACTIVITIES 128,636
----------
NET DECREASE IN CASH AND CASH EQUIVALENTS $ (162,808)
Cash and Cash Equivalents - Beginning of Year 569,851
----------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 407,043
==========
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-5-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS (CONTINUED)
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1995
- --------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
- ------------------------------------------------
<TABLE>
<CAPTION>
Cash paid During the Year for:
<S> <C>
Interest $ 48,507
==========
Income Taxes $ 188,691
==========
</TABLE>
During the year ended June 30, 1995, the Company issued stock in
exchange for Notes Receivable in the amount of $200,000.
The independents auditors' report and the accompanying notes
are an integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 1: NATURE OF OPERATIONS AND CREDIT CONCENTRATIONS
- ------------------------------------------------------
Clinical Associates, P.A. (the Company) is a medical practice providing health
care services through various facilities located in Baltimore City and Baltimore
County, Maryland. The Company grants credit to patients, substantially all of
whom are local residents. The Company generally does not require collateral or
other security in extending credit; however, it routinely obtains assignment of,
or is otherwise entitled to receive, patients' benefits receivable under their
health insurance programs, plans or policies (e.g. Medicare, Medicaid, Blue
Cross, health maintenance organizations [HMO(s)] and commercial insurance
policies).
At June 30, 1995, the Company's receivables were as follows:
<TABLE>
<S> <C>
Medicare $2,610,499
Medicaid 248,351
Blue Shield 1,153,161
HMO(s) 455,463
Commercial Insurance and Other 3,129,262
----------
Total 7,596,736
Less: Reserve for Contractual Allowances
and Doubtful Accounts 3,845,561
----------
Accounts Receivable, Net $3,751,175
==========
</TABLE>
Amounts due from patients as a result of deductibles and co-payments under their
insurance policies are included in the balances due from the insurer in the
above.
During the fiscal year ended June 30, 1995, the Company received approximately
50% of its patient service revenues under the contracts with HMO(s).
Approximately 43% of patient service revenues were generated under HMO
contracts expiring in December 31, 1995. Another HMO contract, which
automatically renews for one year periods each July unless otherwise terminated,
generated patient service revenues of approximately 7% of the total.
-6-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------
Cash Equivalents
- ----------------
Cash and cash equivalents include investments with original maturities of three
months or less.
Accounts Receivable
- -------------------
The Company records a reserve for difference between fees billed and amounts
collectible from third party payors (contractual allowances) and for doubtful
accounts.
HMO Receivables
- ---------------
The Company's contracts with HMO(s) contain various provisions for risk sharing,
stop loss and coordination of benefits. These provisions result in settlements
after the end of each contract period. The Company has recorded an estimate of
the settlements due as of the end of the fiscal year. Differences between the
amounts estimated and the actual settlement are recorded in the year determined.
Medical Supplies
- ----------------
The Company expenses medical supplies as received.
Property and Equipment
- ----------------------
Property and Equipment are recorded at cost. Depreciation is recorded on a
straight-line basis over the estimated useful life of the equipment. Leasehold
improvements are depreciated over the remaining life of the lease. A summary of
depreciable lives used is as follows:
<TABLE>
<CAPTION>
Leasehold Improvements Life of Lease
<S> <C>
Furniture and Fixtures 7 - 10 Years
Office Equipment 5 - 7 Years
Medical Equipment 5 - 7 Years
</TABLE>
Accelerated depreciation methods are used for income tax purposes.
7
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
- --------------------------------------------------------------
Allowance for Claims Incurred But Not Reported
- ----------------------------------------------
In connection with its agreements with HMO(s), the Company is liable for the
cost of services rendered to HMO members by outside providers. The Company
estimates the cost of services rendered but not yet billed to the Company based
on prior experience.
Deferred Income Taxes
- ---------------------
Deferred tax is provided in accordance with Statement No. 109 of the Financial
Accounting Standards Board. Deferred taxes result primarily from differences in
the timing of recognizing revenue and expenses, which are recorded on a modified
cash basis for tax purposes, and differences in depreciation rates (see note 7).
Stock Transactions
- ------------------
The Company offers stock to physicians who meet certain criteria. A portion of
the stock value is paid in cash with the balance paid through future services.
The Company's policy is to record the stock in the amount of the cash payment
only. Had the value of the services been considered, capital contributions in
excess or par would have been higher and retained earnings would have been
lower.
NOTE 3: RELATED PARTY TRANSACTIONS
- ----------------------------------
Some of the Company's stockholders are partners in a partnership, which owns 50%
of Security MDC Associates Partnership, the landlord under a lease in which the
Company is the tenant. Annual rental under this lease is approximately $215,000.
This lease expires on July 31, 1995, and contains an additional five year
renewal option.
Notes receivable represent confessed judgment notes due from stockholders are
bearing interest at 7.5% per annum. Principal and interest payments are due
monthly through 1999.
The Company has notes payable to several stockholders and other related parties
bearing interest at 10% to 12% per annum, payable in monthly or quarterly
installments of principal and interest. (See note 4).
-8-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 4: NOTES PAYABLE
- ---------------------
Notes payable to stockholders and other related parties:
Notes payable to stockholders and other related parties - interest at 10
to 12%; monthly or quarterly payments of principal and interest ranging
from $484 to $1,250 payable through November 1996.
<TABLE>
<S> <C>
$53,933
Less: Current Portion 47,683
-------
Non-Current Portion $ 6,250
=======
</TABLE>
Future maturities of the non-current portion of long term debt are as follows:
Year ending June 30, 1996 $ 6,250
=======
Total interest expense for the year ended June 30, 1995 amounted to $48,256.
NOTE 5: CAPITAL LEASES
- ----------------------
The Company is the lessee of equipment under a capital lease expiring in the
year ending June 30, 1997.
Future minimum lease payments under the capital lease are as follows:
<TABLE>
<S> <C>
Year Ending June 30, 1996 $12,778
1997 11,714
-------
Total Commitment Under Capital Leases 24,492
Less: Amount Representing Interest 2,315
-------
Present Value of Future Minimum
Lease Payments 22,177
Less: Current Portion 11,035
-------
TOTAL LONG-TERM PORTION $11,142
=======
</TABLE>
-9-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 5: CAPITAL LEASES (Continued)
- ----------------------------------
Following is a summary of equipment under capital leases:
<TABLE>
<CAPTION>
<S> <C>
Telecommunications Equipment $ 49,971
Medical Equipment 58,202
---------
108,173
Less: Accumulated Amortization 89,987
---------
$ 18,186
=========
</TABLE>
NOTE 6: LEASE INCENTIVE
- -----------------------
In connection with one of its lease agreements, the landlord assumed the
Company's obligations under an old lease. In accordance with generally accepted
accounting principles, the value of this incentive has been recorded as a
liability and is being amortized on a straight-line basis over the life of the
new lease. The current portion reflects the amount that will be amortized during
the year ending June 30, 1996.
NOTE 7: DEFERRED INCOME TAXES
- -----------------------------
The net deferred tax liability in the accompanying balance sheet includes the
following components as of June 30, 1995:
<TABLE>
<CAPTION>
<S> <C>
Deferred Tax Liability $1,293,837
Deferred Tax Asset (49,871)
Deferred Tax Asset Valuation Allowance -0-
----------
Net Deferred Tax Liability $1,243,966
==========
</TABLE>
The deferred tax liability arises primarily from differences in the timing of
recognition of patient service revenues and accrued expenses for tax purposes
and financial reporting purposes, and the excess of depreciation for tax
reporting purposes over the amount for financial purposes.
Temporary differences giving rise to the deferred tax asset consist of a capital
loss carryover for tax purposes, and lease expense as outlined in Note 6.
-10-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 8: 401(K) PLAN
- -------------------
Effective January 1, 1992, the Company implemented a 401(K) plan, amending and
restating in its entirety its former Target Benefit Plan and Trust, in order to
be in compliance with current pension regulations. All participants in the
former plan continued to participate in the 401(K) plan. Those not participating
in the former plan are eligible to participate in the 401(K) plan upon
completion of one year of service and attaining the age of 21. Employees may
elect to contribute up to 8% of their compensation annually, subject to dollar
limitations set by law. Under the plan the Company can elect to match a
percentage of the employees' contributions at its discretion. The Plan also
allows the Company to contribute a profit sharing amount, determined annually by
the Company. Participants are always 100% vested in their contributions to the
Plan. Vesting in the Company's contributions is 20% after two years of service,
increasing 20% annually with full vesting after six years of service. The Plan's
year end is December 31. Only those participants who are actively employed on
the last day of the year are eligible to participate in employer contributions.
Total profit sharing plan expense for the year ended June 30, 1995 amounted to
$1,244,967.
NOTE 9: COMMITMENTS AND CONTINGENCIES
- -------------------------------------
Leases
- ------
The Company leases several buildings under operating leases expiring in various
years through March 31, 2002.
Minimum future rental payments under non-cancelable operating leases follow:
<TABLE>
<S> <C>
Year Ended June 30, 1996 $1,348,515
1997 1,397,582
1998 1,477,132
1999 1,616,043
2000 1,643,658
Thereafter 4,823,220
-----------
TOTAL MINIMUM FUTURE RENTAL PAYMENTS $12,306,150
===========
</TABLE>
-11-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 9: COMMITMENTS AND CONTINGENCIES (Continued)
- -------------------------------------------------
The Company is responsible for a proportionate share of operating expenses and
tax increases under several of its lease agreements. Several agreements also
call for rental increases based on changes in the Consumer Price Index or
specified amounts. Certain leases also provide for renewal options.
The Company also leases, on a month-to-month basis, other operating facilities.
Total lease expense for the above leases amounted to approximately $1,640,589.
Agreements to Repurchase Stock
- ------------------------------
The Company has agreements with each of its stockholders, whereby the Company
will repurchase the stock upon the death, disability, or termination of the
stockholder's employment. The purchase price varies depending on the event
triggering the repurchase.
Litigation
- ----------
Malpractice claims have been asserted against the Company by various claimants
arising in the ordinary course of business. In the opinion of management, the
Company has adequate legal defenses or insurance coverage with respect to each
of these actions and does not believe that they will materially affect the
Company's results of operations or financial position.
Assignment of Accounts Receivable
- ---------------------------------
In connection with its agreement with one HMO, the Company has assigned $500,000
of its accounts receivable to the HMO for the purpose of providing resources
sufficient to satisfy the Company's obligations to outside providers should the
Company fail to honor those obligations.
NOTE 10: CREDIT RISK
- --------------------
At June 30, 1995, the Company has deposits in a major financial institution
which exceed Federal Depository Insurance limits. This financial institution has
a strong credit rating and management believes that credit risk related to these
deposits is minimal.
The Company routinely invest its surplus operating funds in money market mutual
funds. These funds generally invest in highly liquid U.S. government and agency
obligations. Investments in money market funds are not insured or guaranteed by
the U.S. government; however, management believes that credit risk related to
these investments is minimal.
-12-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1995
- --------------------------------------------------------------------------------
NOTE 11: OTHER MATTERS
- ----------------------
The Company has available to finance future working capital needs a
line-of-credit facility in the amount of $500,000. Any borrowings against the
facility bear interest at the bank's prime rate plus 5/8 of one percent per
annum and are secured by the assets of the Company. No borrowings were made
against the line-of-credit as of June 30, 1995.
-13-
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Clinical Associates, P.A.
We have audited the accompanying balance sheet of Clinical Associates, P.A. as
of June 30, 1996, and the related statements of income, changes in stockholders'
equity, and cash flows for the year then ended. 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 audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Clinical Associates, P.A. as of
June 30, 1996, and the results of its operations and its cash flows for the year
then ended in conformity with generally accepted accounting principles.
Scheiner, Mister & Grandizio, P.A.
January 20, 1997
Lutherville, Maryland
1
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
CURRENT ASSETS
<S> <C>
Accounts Receivable (Less reserve for
contractual allowances and doubtful
accounts of $4,205,120) (Note 1) $ 4,340,420
Notes Receivable - Stockholders 63,333
Other Receivables 205,093
Prepaid Expenses 462,376
Income Taxes Receivable 43,999
-----------
TOTAL CURRENT ASSETS 5,115,221
-----------
PROPERTY AND EQUIPMENT
Leasehold Improvements 553,487
Furniture and Fixtures 424,934
Office Equipment 561,240
Medical Equipment 728,756
Vehicles 12,434
Equipment under Capital Leases (Note 5) 108,173
-----------
Total 2,389,024
Less: Accumulated Depreciation (1,175,810)
-----------
TOTAL PROPERTY AND EQUIPMENT 1,213,214
-----------
OTHER ASSETS
Notes Receivable - Stockholders 127,224
Cash - Restricted 139,574
-----------
TOTAL OTHER ASSETS 266,798
-----------
TOTAL ASSETS $ 6,595,233
===========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements
-2-
<PAGE>
CLINICAL ASSOCIATES, P.A.
BALANCE SHEET
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CURRENT LIABILITIES
<S> <C>
Current Maturities of Long-Term Debt $ 17,666
Current Maturities of Capital Lease Obligation (Note 5) 11,142
Accounts Payable 839,584
Allowance for Claims Incurred but not Reported 1,130,000
Current Portion of Lease Incentive (Note 6) 11,600
Deferred Income Tax Liability (Note 7) 1,259,546
Accrued Expenses and Other Current Liabilities 892,254
----------
TOTAL CURRENT LIABILITIES 4,161,792
----------
LONG-TERM LIABILITIES
Long-Term Debt, Less Current Maturities 17,667
Deferred Income Tax Liability 45,167
Lease Incentive, Net of Current Portion (Note 6) 55,100
----------
TOTAL LONG-TERM LIABILITIES 117,934
----------
TOTAL LIABILITIES 4,279,726
----------
STOCKHOLDERS' EQUITY
Common Stock - Par Value - $1.00; authorized
100,000 shares; issued and outstanding
10,598 shares 10,598
Capital in Excess of Par 1,130,930
Retained Earnings 1,173,979
----------
TOTAL STOCKHOLDERS' EQUITY 2,315,507
----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $6,595,233
==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF INCOME
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
NET PATIENT SERVICE REVENUE $36,767,258
-----------
EXPENSES
Professional Care and Supplies 7,946,706
Salaries and Wages 19,134,021
Employee Health and Welfare 1,808,054
General and Administrative Expenses 6,374,417
Provision for Bad Debt 1,440,090
-----------
TOTAL EXPENSES 36,703,288
-----------
NET OPERATING INCOME 63,970
Other Income Net 221,061
-----------
NET INCOME BEFORE INCOME TAXES 285,031
-----------
PROVISION FOR INCOME TAXES
Current 64,009
Deferred 60,747
-----------
TOTAL PROVISION FOR INCOME TAXES 124,756
-----------
NET INCOME $ 160,275
===========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-3-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Capital in
Common Excess Retained
Stock of Par Earnings Total
--------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
BALANCE - BEGINNING OF
YEAR $10,408 $1,085,460 $1,038,704 $2,134,572
Purchase and Retirement
of Common Stock (60) (14,940) (25,000) (40,000)
Issuance of Common Stock 250 60,410 -0- 60,660
Net Income -0- -0- 160,275 160,275
------- ---------- ---------- ----------
BALANCE - END OF YEAR $10,598 $1,130,930 $1,173,979 $2,315,507
======= ========== ========== ==========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-4-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C>
Net Income $ 160,275
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation and Amortization 280,246
Net (Gain) Loss on Sale and Disposal of
Property and Equipment 17,717
Deferred Income Taxes 60,747
(Increase) Decrease in Operating Assets:
Accounts Receivable (589,245)
Other Receivables (129,155)
Prepaid Expenses (120,459)
Income Taxes Receivable 2,041
Increase (Decrease) in Operating Liabilities:
Accounts Payable and Allowance for Claims
Incurred but not Reported (8,813)
Lease Incentive Payable (11,600)
Accrued Expenses 96,374
---------
NET CASH USED IN OPERATING ACTIVITIES (241,872)
---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of Property and Equipment (347,936)
Repayment of Stockholder Loans 46,943
Repayment of Related-Party Loans (53,933)
Proceeds from Sale of Equipment 45,222
Purchase of Investments 139,574
---------
NET CASH USED IN INVESTING ACTIVITIES (170,130)
---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from Long-Term Debt 53,000
Principal Payments on Long-Term Debt (17,559)
Principal Payments on Debt and Obligations Under
Capital Lease (11,142)
Issuance of Common Stock 20,814
Repurchase of Common Stock (40,154)
---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,959
---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (407,043)
Cash and Cash Equivalents - Beginning of Year 407,043
---------
CASH AND CASH EQUIVALENTS - END OF YEAR $ -0-
=========
</TABLE>
The independent auditors' report and the accompanying notes are an
integral part of these financial statements.
-5-
<PAGE>
CLINICAL ASSOCIATES, P.A.
STATEMENT OF CASH FLOWS (CONTINUED)
- --------------------------------------------------------------------------------
For the Year Ended June 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
- ------------------------------------------------
<S> <C>
Cash Paid During the Year for:
Interest $10,987
=======
Income Taxes $67,500
=======
</TABLE>
During the year ended June 30, 1996, the Company issued stock in exchange for a
Note Receivable in the amount of $40,000.
The independents auditors' report and the accompanying notes are an
integral part of these financial statements.
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 1: NATURE OF OPERATIONS AND CREDIT CONCENTRATIONS
- -------------------------------------------------------
Clinical Associates, P.A. (the Company) is a medical practice providing health
care services through various facilities located in Baltimore City and Baltimore
County, Maryland. The Company grants credit to patients, substantially all of
whom are local residents. The Company generally does not require collateral or
other security in extending credit; however, it routinely obtains assignment of,
or is otherwise entitled to receive, patients' benefits receivable under their
health insurance programs, plans or policies (e.g. Medicare, Medicaid, Blue
Cross, health maintenance organizations [HMO(s)] and commercial insurance
policies).
At June 30, 1996, the Company's receivables were as follows:
<TABLE>
<S> <C>
Medicare $2,401,197
Medicaid 256,224
Blue Shield 1,281,481
HMO(s) 646,827
Commercial Insurance and Other 3,959,811
----------
Total 8,545,540
Less: Reserve for Contractual Allowances
and Doubtful Accounts 4,205,120
----------
Accounts Receivable, Net $4,340,420
==========
</TABLE>
Amounts due from patients as a result of deductibles and co-payments under their
insurance policies are included in the balances due from the insurer in the
above.
During the fiscal year ended June 30, 1996, the Company received approximately
50% of its patient service revenues under the contracts with HMO(s).
Approximately 43% of patient service revenues were generated under HMO contracts
expiring in December 31, 1996. Another HMO contract, which automatically renews
for one year periods each July unless otherwise terminated, generated patient
service revenues of approximately 7% of the total.
Cash Equivalents
- ----------------
Cash and cash equivalents include investments with original maturities of three
months or less.
Estimates
- ---------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures.
-6-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 1: NATURE OF OPERATIONS AND CREDIT CONCENTRATIONS (Continued)
- -------------------------------------------------------------------
Advertising
- -----------
Advertising costs are charged to operations when incurred. Advertising expense
for the year ended June 30, 1996 amounted to $74,609.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Accounts Receivable
- -------------------
The Company records a reserve for differences between fees billed and amounts
collectible from third party payors (contractual allowances) and for doubtful
accounts.
HMO Receivables
- ---------------
The Company's contracts with HMO(s) contain various provisions for risk sharing,
stop loss and coordination of benefits. These provisions result in settlements
after the end of each contract period. The Company has recorded an estimate of
the settlements due as of the end of the fiscal year. Differences between the
amounts estimated and the actual settlement are recorded in the year determined.
Medical Supplies
- ----------------
The Company expenses medical supplies as received.
Property and Equipment
- ----------------------
Property and Equipment are recorded at cost. Depreciation is recorded on a
straight-line basis over the estimated useful life of the equipment. Leasehold
improvements are depreciated over the remaining life of the lease. A summary of
depreciable lives used is as follows:
<TABLE>
<S> <C>
Leasehold Improvements Life of Lease
Furniture and Fixtures 7 - 10 Years
Office Equipment 5 - 7 Years
Medical Equipment 5 - 7 Years
</TABLE>
Accelerated depreciation methods are used for income tax purposes.
Allowance for Claims Incurred But Not Reported
- ----------------------------------------------
In connection with its agreements with HMO(s), the Company is liable for the
cost of services rendered to HMO members by outside providers. The Company
estimates the cost of services rendered but not yet billed to the Company based
on prior experience.
-7-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
- ---------------------------------------------------------------
Deferred Income Taxes
- ---------------------
Deferred tax is provided in accordance with Statement No. 109 of the Financial
Accounting Standards Board. Deferred taxes result primarily from differences in
the timing of recognizing revenue and expenses, which are recorded on a modified
cash basis for tax purposes, and differences in depreciation rates (see note 7).
NOTE 3: RELATED PARTY TRANSACTIONS
- -----------------------------------
Some of the Company's stockholders are partners in a partnership, which owns 50%
of Security MDC Associates Partnership, the landlord under a lease in which the
Company is the tenant. Rent expense for the year ended June 30, 1996, amounted
to $213,455. The future minimum rentals due under this lease are included in
Note 9.
Notes receivable represent confessed judgment notes due from stockholders are
bearing interest at 7.5% per annum. Principal and interest payments are due
monthly through 1999.
NOTE 4: NOTES PAYABLE
- ----------------------
Note payable to First National Bank of Maryland - interest at 8.75%; monthly
principal payments of $1,472 plus interest; payable through July 1998; secured
by equipment financed.
<TABLE>
<S> <C>
$35,333
Less: Current Portion (17,667)
-------
Non-Current Portion $17,666
=======
</TABLE>
Future maturities of the non-current portion of long-term debt are as follows:
<TABLE>
<S> <C>
Year ending June 30, 1998 $17,666
=======
</TABLE>
Total interest expense on all debt for the year ended June 30, 1996 amounted to
$6,436.
NOTE 5: CAPITAL LEASES
- -----------------------
The Company is the lessee of equipment under a capital lease expiring in the
year ending June 30, 1997.
-8-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 5: CAPITAL LEASES (Continued)
- -----------------------------------
Future minimum lease payments under the capital lease are as follows:
<TABLE>
<S> <C>
Year Ending June 30, 1997 $ 11,714
--------
Total Commitment Under Capital Leases 11,714
Less: Amount Representing Interest 572
--------
Present Value of Future Minimum
Lease Payments 11,142
Less: Current Portion 11,142
--------
TOTAL LONG-TERM PORTION $ -0-
========
</TABLE>
Following is a summary of equipment under capital leases:
<TABLE>
<S> <C>
Telecommunications Equipment $ 49,971
Medical Equipment 58,202
--------
108,173
Less: Accumulated Amortization 108,173
--------
$ -0-
========
</TABLE>
NOTE 6: LEASE INCENTIVE
- ------------------------
In connection with one of its lease agreements, the landlord assumed the
Company's obligations under an old lease. In accordance with generally accepted
accounting principles, the value of this incentive has been recorded as a
liability and is being amortized on a straight-line basis over the life of the
new lease. The current portion reflects the amount that will be amortized
during the year ending June 30, 1997.
NOTE 7: DEFERRED INCOME TAXES
- ------------------------------
The net deferred tax liability in the accompanying balance sheet includes the
following components as of June 30, 1996:
<TABLE>
<S> <C>
Deferred Tax Liability $1,348,596
Deferred Tax Asset (43,883)
Deferred Tax Asset Valuation Allowance -0-
----------
Net Deferred Tax Liability $1,304,713
==========
</TABLE>
-9-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 7: DEFERRED INCOME TAXES (Continued)
- ------------------------------------------
The deferred tax liability arises primarily from differences in the timing of
recognition of patient service revenues and accrued expenses for tax purposes
and financial reporting purposes, and the excess of depreciation for tax
reporting purposes over the amount for financial purposes.
Temporary differences giving rise to the deferred tax asset consist of a capital
loss carryover for tax purposes, and lease expense as outlined in Note 6.
NOTE 8: 401(K) PLAN
- --------------------
Effective January 1, 1992, the Company implemented a 401(k) plan, amending and
restating in its entirety its former Target Benefit Plan and Trust, in order to
be in compliance with current pension regulations. All participants in the
former plan continued to participate in the 401(k) plan. Those not
participating in the former plan are eligible to participate in the 401(k) plan
upon completion of one year of service and attaining the age of 21. Employees
may elect to contribute up to 8% of their compensation annually, subject to
dollar limitations set by law. Under the plan the Company can elect to match a
percentage of the employees' contributions at its discretion. The Plan also
allows the Company to contribute a profit sharing amount, determined annually by
the Company. Participants are always 100% vested in their contributions to the
Plan. Vesting in the Company's contributions is 20% after two years of service,
increasing 20% annually with full vesting after six years of service. The
Plan's year end is December 31. Total profit sharing plan expense for the year
ended June 30, 1996 amounted to $1,084,417.
NOTE 9: COMMITMENTS AND CONTINGENCIES
- --------------------------------------
Leases
- ------
The Company leases several buildings under operating leases expiring in various
years through March 31, 2002.
Minimum future rental payments under non-cancelable operating leases follow:
<TABLE>
<S> <C> <C>
Years Ending June 30, 1997 $ 1,397,582
1998 1,477,132
1999 1,616,043
2000 1,643,658
2001 1,124,900
Thereafter 3,158,320
-----------
TOTAL MINIMUM FUTURE RENTAL PAYMENTS $10,417,635
===========
</TABLE>
-10-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 9: COMMITMENTS AND CONTINGENCIES (Continued)
- --------------------------------------------------
The Company is responsible for a proportionate share of operating expenses and
tax increases under several of its lease agreements. Several agreements also
call for rental increases based on changes in the Consumer Price Index or
specified amounts. Certain leases also provide for renewal options.
The Company also leases, on a month-to-month basis, other operating facilities.
Total lease expense for the above leases amounted to approximately $1,869,690.
Agreements to Repurchase Stock
- ------------------------------
The Company has agreements with each of its stockholders, whereby the Company
will repurchase the stock upon the death, disability, or termination of the
stockholder's employment. The purchase price varies depending on the event
triggering the repurchase.
Litigation
- ----------
Malpractice claims have been asserted against the Company by various claimants
arising in the ordinary course of business. In the opinion of management, the
Company has adequate legal defenses or insurance coverage with respect to each
of these actions and does not believe that they will materially affect the
Company's results of operations or financial position.
Assignment of Accounts Receivable and Cash Balances
- ---------------------------------------------------
In connection with its agreement with one HMO, the Company has assigned $500,000
of its accounts receivable to the HMO for the purpose of providing resources
sufficient to satisfy the Company's obligations to outside providers should the
Company fail to honor those obligations. The Company has also restricted cash
in the amount of approximately $140,000 as of June 30, 1996 in connection with
an agreement with another HMO.
NOTE 10: CREDIT RISK
- ---------------------
At June 30, 1996, the Company has deposits in a major financial institution
which exceed Federal Depository Insurance limits. This financial institution
has a strong credit rating and management believes that credit risk related to
these deposits is minimal.
The Company routinely invests its surplus operating funds in money market mutual
funds. These funds generally invest in highly liquid U.S. government and agency
obligations. Investments in money market funds are not insured or guaranteed by
the U.S. government; however, management believes that credit risk related to
these investments is minimal.
-11-
<PAGE>
CLINICAL ASSOCIATES, P.A.
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
June 30, 1996
- --------------------------------------------------------------------------------
NOTE 11: OTHER MATTERS
- -----------------------
The Company has available to finance future working capital needs a line-of-
credit facility in the amount of $500,000. Any borrowings against the facility
bear interest at the bank's prime rate plus 5/8 of one percent per annum and are
secured by the assets of the Company. No borrowings were made against the line-
of-credit as of June 30, 1996.
NOTE 12: INTERNAL REVENUE SERVICE EXAMINATION
- ----------------------------------------------
Subsequent to the balance sheet date, the Company was notified by the Internal
Revenue Service that an examination would be performed regarding a prior year's
corporate income tax return. As of the report date, the examination remains in
the preliminary stages.
-12-
<PAGE>
Clinical Associates, P.A.
Financial Statements (Unaudited)
Nine months ended March 31, 1997 and 1996
Contents
<TABLE>
<CAPTION>
Financial Statements
<S> <C>
Balance Sheet (Unaudited).....................................................1
Statements of Income (Loss) (Unaudited).......................................2
Statements of Cash Flows (Unaudited)..........................................3
Notes to Financial Statements (Unaudited).....................................4
</TABLE>
<PAGE>
Clinical Associates, P.A.
Balance Sheet (Unaudited)
March 31, 1997
<TABLE>
<CAPTION>
<S> <C>
Assets
Current assets:
Cash and cash equivalents $ 346,147
Accounts receivable (less reserve for
contractual allowances and doubtful
accounts of $3,565,466) 3,784,566
Notes receivable--stockholders 87,448
Other receivables 65,201
Prepaid expenses 265,411
Income taxes receivable 67,499
------------
Total current assets 4,616,272
Property and equipment, net of accumulated
depreciation of $1,384,000 1,229,174
Other assets:
Notes receivable--stockholders 164,377
Cash--restricted 153,483
------------
Total other assets 317,860
------------
Total assets $6,163,306
============
Liabilities and stockholders' equity
Current liabilities:
Current maturities of long-term debt $ 35,000
Current maturities of capital lease
obligation 11,142
Accounts payable 826,177
Allowance for claims incurred but not
reported 1,090,000
Current portion of lease incentive 11,600
Deferred income tax liability 1,304,713
Accrued expenses and other current
liabilities 487,541
------------
Total current liabilities 3,766,173
Long-term liabilities:
Long-term debt, less current maturities 39,084
Lease incentive, net of current portion 43,500
------------
Total long-term liabilities 82,584
------------
Total liabilities 3,848,757
Stockholders' equity:
Common stock, par value--$1.00,
authorized--100,000 shares, issued
and outstanding--10,902 shares 10,902
Capital in excess of par 1,380,634
Retained earnings 923,013
------------
Total stockholders' equity 2,314,549
------------
Total liabilities and stockholders' equity $6,163,306
============
</TABLE>
1
<PAGE>
Clinical Associates, P.A.
Statements of Income (Loss) (Unaudited)
<TABLE>
<CAPTION>
Nine months ended
March 31
1997 1996
----------------------------
<S> <C> <C>
Net patient service revenue $26,878,945 $28,219,561
Expenses:
Professional care and supplies 4,950,535 5,675,963
Salaries and wages 13,867,205 14,015,410
Employee health and welfare 1,285,687 1,257,022
General and administrative expenses 6,211,809 5,628,062
Provision for bad debts 940,937 998,167
----------------------------
Total expenses 27,256,173 27,574,624
----------------------------
Net operating (loss) income (377,228) 644,937
Other income, net 126,264 123,657
----------------------------
Net (loss) income before income taxes (250,964) 768,594
Provision for income taxes - 201,875
----------------------------
Net (loss) income $ (250,964) $ 566,719
============================
</TABLE>
2
<PAGE>
Clinical Associates, P.A.
Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
Nine months ended
March 31
1997 1996
-------------------------
<S> <C> <C>
Operating activities
Net income $ (250,964) $ 566,719
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 208,376 210,185
Deferred income taxes 112,367
(Increase) decrease in operating assets: 555,854 (103,523)
Accounts receivable 139,892 40,803
Prepaid expenses 196,965 (452,508)
Income taxes receivable (23,500) 46,040
Increase (decrease) in operating liabilities:
Accounts payable and allowance for claims
incurred but not reported (53,407) 93,023
Accrued expenses (404,714) (152,061)
-------------------------
Net cash provided by operating activities 368,502 361,045
Investing activities
Purchases of property and equipment (224,339) (222,383)
Repayment of stockholder loans (61,266) (7,917)
Purchase of investments (13,908) (1,083,535)
-------------------------
Net cash used in investing activities (299,513) (1,313,835)
Financing activities
Proceeds from long-term debt 38,751
Principal payments on debt and obligations under
capital lease (11,600)
Issuance of common stock 250,007 45,000
Proceeds from related entities 500,747
-------------------------
Net cash provided by financing activities 277,158 545,747
-------------------------
Net increase (decrease) in cash and cash equivalents 346,147 (407,043)
Cash and cash equivalents at beginning of year --- 407,043
-------------------------
Cash and cash equivalents at end of year $ 346,147 $ 0
=========================
</TABLE>
3
<PAGE>
Clinical Associates, P.A.
Notes to Financial Statements (Unaudited)
March 31, 1997
1. Basis of Presentation
The unaudited financial statements for the nine months ended March 31, 1997 and
1996 have been prepared by management in accordance with generally accepted
accounting principles. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results of the interim periods are
not necessarily indicative of the results that may be expected for a full year.
2. Nature of Operations
Clinical Associates, P.A. (the Company) is a medical practice, providing health
care services through various facilities located in Baltimore City and Baltimore
County, Maryland.
3. Affiliation
The Company is currently negotiating a long-term affiliation arrangement with
Physicians Quality, Inc. (PQC). Under this arrangement, the Company would
transfer its physician practices to, and its employees would become employees
of, Flagship Health, P.A., which is an affiliate of PQC. The aggregate
consideration paid to the Company for this affiliation would be a combination of
cash and PQC common stock.
4. Internal Revenue Service Examination -- Contingent Liabilities
At March 31, 1997, the Internal Revenue Service has issued a preliminary report
for the taxable years ending June 30, 1994, 1995 and 1996. The potential tax
liability could exceed $400,000. The Company is in the process of reviewing its
options with legal counsel.
4
<PAGE>
Physicians Quality Care, Inc.
Unaudited Pro Forma Balance Sheet
The Unaudited Pro Forma Combined Balance Sheet reflects the Equity
Financing as if the financing was consummated on March 31, 1997.
The Unaudited Pro Forma Balance Sheet may not be indicative of the results
that actually would have resulted had the above financing occurred as of the
date indicated, or of the future financial position of the Company. The
Unaudited Pro Forma Balance Sheet should be read in conjunction with the
accompanying Notes to the Unaudited Pro Forma Balance Sheet and the financial
statements of the affiliated practices included elsewhere in this Registration
Statement and Prospectus.
Physicians Quality Care, Inc.
Unaudited Proforma Balance Sheet
March 31, 1997
<TABLE>
<CAPTION>
Proforma
Equity
Historical Financing Proforma
PQC Adjustments PQC
-------------- --------------- --------------
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 65,544 $ 25,000,000(A) $ 25,065,544
Prepaid expenses 32,745 -- 32,745
Due from related parties 3,153,488 -- 3,153,488
Income tax receivable -- -- --
Other current assets 14,354 -- 14,354
------------ ------------ ------------
Total current assets 3,266,131 25,000,000 28,266,131
Long-term affiliation
agreements, net 34,435,087 -- 34,435,087
Deferred affiliation and
equity offering costs 21,397 -- 21,397
Property and equipment, net 661,018 -- 661,018
Other assets 368,324 -- 368,324
Deferred tax asset 608,171 -- 608,171
------------ ------------ ------------
36,093,997 -- 36,093,997
------------ ------------ ------------
Total assets $ 39,360,128 $ 25,000,000 $ 64,360,128
============ ============ ============
</TABLE>
Physicians Quality Care, Inc.
Unaudited Proforma Combined Balance Sheet
March 31, 1997
<TABLE>
<CAPTION>
Proforma
Equity
Historical Financing Proforma
PQC Adjustments PQC
------------- ------------- ------------
Liabilities and stockholders' equity (deficit)
<S> <C> <C> <C>
Current liabilities:
Accounts payable $ 1,641,167 $ 1,641,167
Accrued compensation 221,707 221,707
Accrued expenses 85,526 85,526
Current portion of note payable 3,000,000 3,000,000
Current portion of capital lease obligations 15,962 15,962
------------ ------------- ------------
Total current liabilities 4,964,362 4,964,362
Convertible promissory note
Note payable, less current maturities
Capital lease obligations, less current maturities 51,772 51,772
Deferred taxes 1,083,048 1,083,048
Commitments and contingencies
Common stock, subject to put
33,282,706 33,282,706
Stockholders' equity (deficit):
Capital Stock
Class A common stock 77,709 77,709
Class B-1 common stock 24,429 24,429
Class B-2 common stock 15,571 15,571
Class C common stock - $76,923 (A) 76,923
Preferred stock - - -
Additional paid-in capital 22,449,773 24,923,077 (A) 47,372,850
Accumulated earnings (deficit) (22,579,117) (22,579,117)
Less treasury stock (10,125) (10,125)
------------- ------------- ------------
Total stockholders equity (deficit) (21,760) 25,000,000 24,978,240
------------- ------------- ------------
Total liabilities and stockholders' equity (deficit) $ 39,360,128 $ 25,000,000 $ 64,360,128
============= ============= ============
</TABLE>
Physicians Quality Care, Inc.
Notes To Unaudited Pro Forma Balance Sheet
1. Basis of Presentation
The Unaudited Pro Forma Balance Sheet, assumes that the Equity Financing was
consummated on March 31, 1997.
2. Proforma Adjustments
(A) To reflect the issuance of 7,692,309 shares and the issuance of warrants to
purchase 7,692,309 shares of PQC Class C common stock for total
consideration of $25,000,000 in connection with the Equity Financing. A
value of $23,076,225 has been assigned to the Class C common stock and a
value of $1,923,775 has been assigned to the warrants.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the various expenses in connection with
the sale and distribution of the securities being registered. All amounts shown
are estimates except for the Securities and Exchange Commission registration
fee.
<TABLE>
<S> <C>
SEC Registration Fee.................................................................... $ 4,800
Blue Sky Fees and Expenses.............................................................. *
Accounting Fees and Expenses............................................................ *
Legal Fees and Expenses................................................................. *
Printing, Engraving and Mailing Expenses................................................ *
Miscellaneous........................................................................... *
-------
Total.......................................................................... $ *
=======
</TABLE>
- --------------------
*To be completed by amendment.
Item 14. Indemnification of Directors and Officers
Section 145 of the General Corporation Law of Delaware provides that a
corporation has the power to indemnify a director, officer, employee or agent of
the corporation and certain other persons serving at the request of the
corporation in related capacities against amounts paid and expenses incurred in
connection with an action or proceedings to which he or she is or is threatened
to be made a party by reason of such position, if such person shall have acted
in good faith and in a manner he or she reasonably believed to be in or not
opposed to the best interest of the corporation, and, in any criminal
proceedings, if such person had no reasonable cause to believe his or her
conduct was unlawful; provided that, in the case of actions brought by or in the
right of the corporation, no indemnification shall be made with respect to any
matter as to which such person shall have been adjudged to be liable to the
corporation unless and only to the extent that the adjudicating court determines
that such indemnification is proper under the circumstances.
Article SIXTH of the Registrant's Restated Certificate of Incorporation
provides that a director or officer of the Registrant (a) shall be indemnified
by the Registrant against all expenses (including attorneys' fees), judgments,
fines and amounts paid in settlement reasonably incurred in connection with any
litigation or other legal proceedings (other than an action by or in the right
of the Registrant) brought against such person by virtue of his or her position
as a director or officer of the Registrant if he or she acted in good faith and
in a manner he or she reasonably believed to be in or not opposed to the best
interests of the Registrant, and, with respect to any criminal action or
proceedings, had no reasonable cause to believe his or her conduct was unlawful
and (b) shall be indemnified by the Registrant against expenses (including
attorneys' fees) and amounts paid in settlement reasonably incurred in
connection with any action by or in the right of the Registrant if such person
acted in a manner he or she reasonably believed to be in or not opposed to the
best interests of the Registrant, except that no indemnification shall be made
with respect to any such matter as to which such director or officer shall have
been adjudged to be liable to the Registrant, unless and only to the extent that
a court determines that, despite the adjudication of liability but in view of
all the circumstances of the case, such person is fairly and reasonably entitled
to indemnity for such expenses as the court deems proper. Notwithstanding the
foregoing, to the extent that a director or officer has been successful, on the
merits or otherwise, such person shall be indemnified against all expenses
(including attorneys' fees) reasonably incurred by him in connection therewith.
Expenses incurred in defending a civil or criminal action, suit or proceedings
shall be advanced by the Registrant to a director or officer, at his or her
request, upon receipt of an undertaking by the director or officer to repay such
amount if it is ultimately determined that he or she is not entitled to
indemnification.
II-1
<PAGE>
Indemnification is required to be made unless the Registrant determines
(in the manner provided in the Restated Certificate of Incorporation) that the
applicable standard of conduct required for indemnification has not been met. In
the event of a determination by the Registrant that the director or officer did
not meet the applicable standard of conduct required for indemnification, or if
the Registrant fails to make an indemnification payment within 60 days after
such payment is claimed by such person, such person is permitted to petition a
court to make an independent determination as to whether such person is entitled
to indemnification. As a condition precedent to the right of indemnification,
the director or officer must give the Registrant notice of the action for which
indemnity is sought and the Registrant has the right to participate in such
action or assume the defense thereof.
Article SIXTH of the Registrant's Restated Certificate of Incorporation
further provides that the indemnification provided therein is not exclusive, and
provides that in the event that the Delaware General Corporation Law is amended
to expand the indemnification permitted to directors or officer, the Registrant
must indemnify those persons to the fullest extent permitted by such law as so
amended.
The Registrant intends to purchase a general liability insurance policy
which covers certain liabilities of directors and officers of the Registrant
arising out of claims based on acts or omissions in their capacity as directors
or officers.
Article FIFTH of the Registrant's Restated Certificate of Incorporation
provides that, except to the extent that the General Corporation Law of Delaware
prohibits the elimination or limitation of liability of directors for breaches
of fiduciary duty, no directors of the Registrant shall be personally liable to
the Registrant or its stockholders for monetary damages for any breach of
fiduciary duty as a director.
Item 15. Recent Sales of Unregistered Securities
The securities issued or sold by the Company since March 20, 1995, the
date of inception, which were not registered under the Securities Act are listed
below:
(i) In May 1995, the Company issued to an accredited investor a Warrant
to purchase 100,000 shares of Common Stock at $20,000 on or before December 31,
1995. The Warrant was not exercised.
(ii) From June 30, 1995 through March 10, 1997, the Registrant has
issued an aggregate of 726,586 options to purchase shares of Series A Common
Stock under the Registrant's 1995 Equity Incentive Plan (the "1995 Plan") and
90,000 options outside the 1995 Plan. At March 31, 1997, options to purchase
574,836 shares of Class A Common Stock are outstanding under the 1995 Plan.
(iii) On June 21, 1995, the Registrant issued an aggregate of 7,706,250
shares of the original common stock of the Company to its founders at a purchase
price of $0.01 per share. In February 1996, 1,012,500 shares were reacquired as
treasury stock and 6,693,750 shares were converted into Class A Common Stock on
August 30, 1996.
(v) In August 1996, the Company issued to certain accredited investors,
which notes were converted to 402,301 shares of Common Stock.
(vi) From June 30, 1995 through August 1, 1995, the Registrant issued
an aggregate 1,666,151 shares of Series A Preferred Stock and Warrants to
purchase 832,076 Series A Preferred Stock to accredited investors at a purchase
price of $2.40 per share, which shares were subsequently converted into
1,666,151 shares of Class A Common Stock on August 30, 1996.
(vii) On August 30, 1996, pursuant to an affiliation transaction with
seven medical practices, the Registrant issued 2,592,245 shares of Class A
Common Stock with a value of $2.50 per share, in consideration for such
transaction.
II-2
<PAGE>
(viii) Between August 30, 1996 and December 10, 1996, in connection
with a financing transaction with certain institutional investors, the
Registrant issued 2,442,866 shares of Class B-1 Common Stock at a purchase price
of $2.50 per share, 1,557,134 shares of the Class B-2 Common Stock at a purchase
price of $2.50 per share, and warrants.
(ix) On August 30, 1996, in connection with the sale of a convertible
promissory note and warrant dated June 30, 1995, the Registrant issued 625,000
shares of Series A Common Stock to Offshore Health Industries, Inc. at a
purchase price of $2.40 per share.
(x) On August 30, 1996, in connection with a financing, the Registrant
issued 402,300 shares of the Class A Common Stock to accredited investors at a
purchase price of $2.50 per share and warrants to purchase 201,150 Class A
Common Stock.
(xi) On December 11, 1996, pursuant to affiliation transactions with
medical practices, the Registrant issued 6,842,675 shares of Class A Common
Stock and 400,000 options to purchase shares of Class A Common Stock, in
consideration for such transactions.
(xii) On December 31, 1996 and February 11, 1997, the Registrant issued
a total of 614,000 shares of Class A Common Stock to investors at a purchase
price of $2.50 per share.
(x) On January 5, 1997, pursuant to an affiliation transaction with a
medical practice, the Registrant issued 440,000 shares of Class A Common Stock
with a value of $2.50 per share, in consideration for such transaction.
(xi) On February 12, 1997, pursuant to affiliation transactions with
medical practices, the Registrant issued 132,493 shares of Class A Common Stock
with a value of $2.50 per share in consideration for such transaction.
(xii) On February 14, 1997, pursuant to a Letter Agreement between the
Registrant and Bankers Trust Investment Partners, Inc. ("BTIP") the Registrant
issued 63,000 shares of Class B Common Stock to BTIP at a purchase price of
$2.50 per share.
(xiii) On April 18, 1997, the Registrant issued 600,000 shares of
Series B Common Stock and warrants to purchase 865,500 shares of Class B Common
Stock to the Bain Funds for $1.5 million in consideration.
(xiv) On June 23, 1997 the Registrant issued 7,692,309 shares of Class
C Common Stock and warrants to purchase 7,692,309 shares of Class C Common Stock
to certain Institutional Investors at $3.25 per share.
(xv) On June 30, 1997, the Registrant issued 667,800 shares of Class A
Common Stock to certain accredited investors at a purchase price of $2.50 per
share.
The shares of capital stock issued in the above transactions were
offered and sold in reliance upon the exemption from registration under Section
4(2) and Rule 152 under the Securities Act or Regulation D promulgated
thereunder, as transactions by an issuer not involving any public offering, or
Rule 701 promulgated under Section 3(b) of the Securities Act as transactions
pursuant to compensatory benefit plans and compensation as provided under such
Rule 701. The recipients of securities in each such transaction represented
their intentions to acquire the securities for investment only and not with a
view to or for sale in connection with any distribution thereof and appropriate
legends were affixed to the share certificates and warrants issued in such
transaction. All recipients had adequate access, through their relationships
with the Company, to information about the Registrant.
II-3
<PAGE>
Item 16. Exhibits
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
3.1+ Restated Certificate of Incorporation of the Registrant (as amended on June 23,
1997)
3.2+ Amended and Restated By-Laws of the Registrant (as amended on June 19, 1997)
4.1+ Specimen certificate for shares of Common Stock
4.2+ Amended and Restated Class B Common Stock and Warrant Purchase
Agreement dated June 20, 1997, between the Registrant and each of the
Institutional Investors
4.3+ Stockholders Agreement, dated August 30, 1996 (the "Stockholders Agreement),
among the Registrant, the Institutional Investors, each Management Stockholder
from time to time party thereto, each Physician Stockholder from time to time
party thereto and other existing stockholders from time to time party thereto
4.4+ Amendment No. 1 to Stockholders Agreement
4.5+ Amendment No. 2 to Stockholders Agreement
4.6+ Stockholders Agreement dated August 9, 1996 between the Registrant and certain
Springfield Stockholder Physicians.
4.7+ Registration Rights Agreement dated August 9, 1996, by
and among the Registrant and certain Springfield Stockholder Physicians.
5.1 Opinion of Hale and Dorr LLP
10.1+ 1995 Equity Incentive Plan form of non-statutory stock option agreement
10.2+ Management Agreement dated August 30, 1996, between the Registrant and Bain
Capital Partners V, L.P., a Delaware limited partnership
10.3+ Lease dated November 1995 between Shorenstein Management, Inc. as trustee for
SRI Two Realty Trust and the Registrant
10.4+ Lease dated December 9, 1996 between Steven M. Roberts, trustee of
Northernedge/Plant One Realty Trust and the Registrant
10.5+ Maryland Full-Service Office Lease of Camden Yards North Warehouse dated
October 12, 1995, by and between the Maryland Stadium Authority and the
Registrant
10.6+ Form of Merger Agreement dated December 11, 1996, among the Registrant, the
Flagship Affiliated Group and certain of the Flagship Stockholder Physicians
and their practices.
10.7+ Form of Asset Purchase Agreement dated December 11, 1996, among the
Registrant, the Flagship Affiliated Group and certain of the Flagship Stockholder
Physicians and their practices
10.8+ Form of Affiliated Agreement dated December 11, 1996, among the Registrant,
the Flagship Affiliated Group and certain of the Flagship Stockholder Physicians
</TABLE>
II-4
<PAGE>
<TABLE>
Exhibit
No. Description
- ------- -----------
<S> <C>
10.9+ Services Agreement dated December 11, 1996, between the Registrant and the
Flagship Affiliated Group (the "Flagship Service Agreement")
10.10+ Form of Employment Agreement dated December 11, 1996, between the Flagship
Affiliated Group and each Flagship Stockholder Physician
10.11+ Form of Shareholder Designation and Stock Transfer Agreement dated
December 11, 1996, among the Registrant, the Flagship Affiliated Group and the
Flagship Affiliated Group Stockholder, Laura M. Mumford, M.D.
10.12+ Form of Merger Agreement among the Registrant, the Springfield Affiliated
Group and the Springfield Stockholder Physicians and their practices
10.13+ Form of Asset Purchase Agreement among the Registrant, the Springfield
Affiliated Group and certain Springfield Stockholder Physicians
10.14+ Form of Employment Agreement between the Springfield Affiliated Group and
certain Springfield Stockholder Physicians, including General Terms and
Conditions of Employment for the Springfield Affiliated Group and Form of
Addendum thereto relating to the Springfield Stockholder Physicians
10.15+ Form of Affiliation Agreement dated August 30, 1996, among the Registrant, the
Springfield Affiliated Group and the Springfield Stockholder Physicians
10.16+ Services Agreement dated August 30, 1996, among the Registrant and the
Springfield Affiliated Group
10.17+ Shareholder Designation and Stock Transfer Agreement dated August 9, 1996,
among the Registrant, the Springfield Affiliated Group and the Springfield
Affiliated Group Stockholder, Jay Ungar, M.D.
10.18+ Credit Agreement dated January 16, 1997 among the Registrant, Banker's Trust
Company, as Agent, and various lending institutions
10.19+ Employment Agreement dated June 21, 1995 between the Registrant and Jerilyn
P. Asher, as amended in January 1996 and on August 30, 1996
10.20+ Employment Agreement dated June 21, 1995 between the Registrant and Arlan F.
Fuller, M.D., as amended in January 1996
10.21 Office Building Lease dated March 18, 1997, by and between Harbor Court
Associates and the Registrant
10.22 Amended and Restated Services Agreement dated July , 1997, among Flagship Health
II, P.A. ("Flagship II") and the Registrant
10.23 Agreement dated July 31, 1997 by and among the Registrant, Flagship, Flagship II and
the Stockholders and Optionholders of Clinical Associates
10.24 Merger Agreement dated July 31, 1997, between the Registrant, Flagship II, Clinical
Associates and the Stockholders and Optionholders of Clinical Associates.
10.25+ Amendment to the Management Agreement (Exhibit 10.2)
11.1 Statement regarding computation of earnings per share
21.1+ Subsidiaries of the Registrant
23.1 Consent of Hale and Dorr LLP (contained in Exhibit 5.1)
23.2 Consent of Ernst & Young LLP, Independent Auditors
24.1+ Power of Attorney (See Page II-7 to Registration Statement as originally filed)
27+ Financial Data Schedule
</TABLE>
............................
+ Previously filed.
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions continued in the Restated Certificate of
Incorporation and Amended and Restated By-Laws of the Registrant and the laws of
the State of Delaware, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
27 Financial Data Schedule
- ------------------
* To be filed by amendment.
</TABLE>
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions contained in the Restated Certificate of
Incorporation and Amended and Restated By-Laws of the Registrant and the laws of
the State of Delaware, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are
being made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by section
10(a)(3) of the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events
arising after the effective date of the registration
statement (or the most recent post-effective
amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the
information set forth in the registration statement.
Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the
total dollar value of securities offered would not
exceed that which was registered) and any deviation
from the low or high end of the estimated maximum
offering range may be reflected in the form of
prospectus filed with the Commission pursuant to
Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than a 20% change
in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the
effective registration statement.
(iii) To include any material information with respect to
the plan of distribution not previously disclosed in
the registration statement or any material change to
such information in the registration statement.
(2) That, for the purpose of determining any liability under
the Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-
effective amendment any of the securities being registered which remain
unsold at the termination of the offering
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
the Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, in the City of Waltham, Commonwealth of
Massachusetts, on the 11th day of August, 1997.
PHYSICIANS QUALITY CARE, INC.
By: /s/ Jerilyn P. Asher
--------------------------------------
Jerilyn P. Asher
Chief Executive Officer, Secretary and
Chairman of the Board
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Jerilyn P. Asher Chief Executive Officer, Secretary August 11, 1997
- ----------------------------------- and Chairman of the Board
Jerilyn P. Asher (Principal Executive Officer)
* Chief Financial Officer August 11, 1997
- ----------------------------------- (Principal Financial and
Samantha J. Trotman Accounting Officer)
* President and Director August 11, 1997
- -----------------------------------
Dana Frank, M.D.
* Executive Vice President, Medical August 11, 1997
- ----------------------------------- Affairs and Director
Arlan F. Fuller, Jr., M.D.
* Director August 11, 1997
- -----------------------------------
Alphonse Calvanese, M.D.
* Director August 11, 1997
- -----------------------------------
Leslie Fang, M.D.
* Director August 11, 1997
- -----------------------------------
Stephen G. Pagliuca
</TABLE>
II-8
<PAGE>
<TABLE>
Signature Title Date
--------- ----- ----
<S> <C> <C>
* Director August 11, 1997
--------------------------------
Marc Wolpow
* Director August 11, 1997
- ---------------------------------
Ira Fine, M.D.
* Director August 11, 1997
- ---------------------------------
Timothy T. Weglicki
*By Jerilyn P. Asher
Attorney-in-Fact
/s/ Jerilyn P. Asher
- ---------------------------------
Jerilyn P. Asher
</TABLE>
II-9
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
3.1+ Restated Certificate of Incorporation of the Registrant (as amended on June 23,
1997)
3.2+ Amended and Restated By-Laws of the Registrant (as amended on June 19, 1997)
4.1+ Specimen certificate for shares of Common Stock
4.2+ Amended and Restated Class B Common Stock and Warrant Purchase
Agreement dated June 20, 1997, between the Registrant and each of the
Institutional Investors
4.3+ Stockholders Agreement, dated August 30, 1996 (the "Stockholders Agreement),
among the Registrant, the Institutional Investors, each Management Stockholder
from time to time party thereto, each Physician Stockholder from time to time
party thereto and other existing stockholders from time to time party thereto
4.4+ Amendment No. 1 to Stockholders Agreement
4.5+ Amendment No. 2 to Stockholders Agreement
4.6+ Stockholders Agreement dated August 9, 1996 between the Registrant and certain
Springfield Stockholder Physicians.
4.7+ Registration Rights Agreement dated August 9, 1996, by
and among the Registrant and certain Springfield Stockholder Physicians.
5.1 *Opinion of Hale and Dorr LLP
10.1+ 1995 Equity Incentive Plan form of non-statutory stock option agreement
10.2+ Management Agreement dated August 30, 1996, between the Registrant and Bain
Capital Partners V, L.P., a Delaware limited partnership
10.3+ Lease dated November 1995 between Shorenstein Management, Inc. as trustee for
SRI Two Realty Trust and the Registrant
10.4+ Lease dated December 9, 1996 between Steven M. Roberts, trustee of
Northernedge/Plant One Realty Trust and the Registrant
10.5+ Maryland Full-Service Office Lease of Camden Yards North Warehouse dated
October 12, 1995, by and between the Maryland Stadium Authority and the
Registrant
10.6+ Form of Merger Agreement dated December 11, 1996, among the Registrant, the
Flagship Affiliated Group and certain of the Flagship Stockholder Physicians
and their practices.
10.7+ Form of Asset Purchase Agreement dated December 11, 1996, among the
Registrant, the Flagship Affiliated Group and certain of the Flagship Stockholder
Physicians and their practices
10.8+ Form of Affiliated Agreement dated December 11, 1996, among the Registrant,
the Flagship Affiliated Group and certain of the Flagship Stockholder Physicians
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
10.9+ Services Agreement dated December 11, 1996, between the Registrant and the
Flagship Affiliated Group (the "Flagship Service Agreement")
10.10+ Form of Employment Agreement dated December 11, 1996, between the Flagship
Affiliated Group and each Flagship Stockholder Physician
10.11+ Form of Shareholder Designation and Stock Transfer Agreement dated
December 11, 1996, among the Registrant, the Flagship Affiliated Group and the
Flagship Affiliated Group Stockholder, Laura M. Mumford, M.D.
10.12+ Form of Merger Agreement among the Registrant, the Springfield Affiliated
Group and the Springfield Stockholder Physicians and their practices
10.13+ Form of Asset Purchase Agreement among the Registrant, the Springfield
Affiliated Group and certain Springfield Stockholder Physicians
10.14+ Form of Employment Agreement between the Springfield Affiliated Group and
certain Springfield Stockholder Physicians, including General Terms and
Conditions of Employment for the Springfield Affiliated Group and Form of
Addendum thereto relating to the Springfield Stockholder Physicians
10.15+ Form of Affiliation Agreement dated August 30, 1996, among the Registrant, the
Springfield Affiliated Group and the Springfield Stockholder Physicians
10.16+ Services Agreement dated August 30, 1996, among the Registrant and the
Springfield Affiliated Group
10.17+ Shareholder Designation and Stock Transfer Agreement dated August 9, 1996,
among the Registrant, the Springfield Affiliated Group and the Springfield
Affiliated Group Stockholder, Jay Ungar, M.D.
10.18+ Credit Agreement dated January 16, 1997 among the Registrant, Banker's Trust
Company, as Agent, and various lending institutions
10.19+ Employment Agreement dated June 21, 1995 between the Registrant and Jerilyn
P. Asher, as amended in January 1996 and on August 30, 1996
10.20+ Employment Agreement dated June 21, 1995 between the Registrant and Arlan F.
Fuller, M.D., as amended in January 1996
10.21 Office Building Lease dated March 18, 1997, by and between Harbor Court
Associates and the Registrant
10.22 Amended and Restated Services Agreement dated July , 1997, among Flagship Health
II, P.A. ("Flagship II) and the Registrant
10.23 Agreement dated July 31, 1997 by and among the Registrant, Flagship, Flagship II and
the Stockholders and Optionholders of Clinical Associates
10.24 Merger Agreement dated July 31, 1997, between the Registrant, Flagship II, Clinical
Associates and the Stockholders and Optionholders of Clinical Associates.
10.25+ Amendment to the Management Agreement (Exhibit 10.2)
11.1 Statement regarding computation of earnings per share
21.1+ Subsidiaries of the Registrant
23.1 Consent of Hale and Dorr LLP (contained in Exhibit 5.1)
23.2 Consent of Ernst & Young LLP, Independent Auditors
24.1+ Power of Attorney (See Page II-7 to Registration Statement as originally filed)
27+ Financial Data Schedule
</TABLE>
............................
+ Previously filed.
Item 17. Undertakings
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions continued in the Restated Certificate of
Incorporation and Amended and Restated By-Laws of the Registrant and the laws of
the State of Delaware, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
<PAGE>
Exhibit 5.1
-----------
[LETTERHEAD OF HALE AND DORR LLP APPEARS HERE]
July 28, 1997
Physicians Quality Care, Inc.
950 Winter Street, Suite 2410
Waltham, Massachusetts 02154
Re: Registration Statement on Form S-1, File No. 333-26137
------------------------------------------------------
Ladies and Gentlemen:
This opinion is furnished to you in connection with a Registration
Statement on Form S-1 (File No. 333-26137) (the "Registration Statement") filed
with the Securities and Exchange Commission (the "Commission") under the
Securities Act of 1933, as amended (the "Securities Act"), for the registration
of 8,000,000 shares of Class A Common Stock, $0.01 par value per share (the
"Shares"), of Physicians Quality Care, Inc., a Delaware corporation (the
"Company").
We have examined and relied upon minutes of meetings of the stockholders
and the Board of Directors of the Company as provided to us by the Company,
stock record books of the Company as provided to us by the Company, the
Certificate of Incorporation and Bylaws of the Company, each as restated and/or
as amended to date, and such other documents as we have deemed necessary for
purposes of rendering the opinions hereinafter set forth.
In our examination of the foregoing documents, we have assumed the
genuineness of all signatures, the authenticity of all documents submitted to us
as originals, the conformity to original documents of all documents submitted to
us as certified or photostatic copies and the authenticity of the originals of
such latter documents.
We assume that the appropriate action will be taken, prior to the offer and
sale of the Share, to register and qualify the Shares for sale under all
applicable state securities or "blue sky" laws.
<PAGE>
Physicians Quality Care, Inc.
July 28, 1997
Page 2
We express no opinion herein as to the laws of any state or jurisdiction
other than the state laws of the Commonwealth of Massachusetts, the Delaware
General Corporation Law statute and the federal laws of the United States of
America.
Based upon and subject to the foregoing, we are of the opinion that the
Shares have been duly and validly authorized and issued and, when issued as
consideration for the business combination transactions contemplated by the
Registration Statement as amended or supplemented from time to time, will be
fully paid and nonassessable.
It is understood that this opinion is to be used only in connection with
the offer and sale of the Shares while the Registration Statement is in effect.
Please note that we are opining only as to the matters expressly set forth
herein, and no opinion should be inferred as to any other matters.
We hereby consent to the filing of this opinion with the Commission as an
exhibit to the Registration Statement in accordance with the requirements of
Item 601(b)(5) of Regulation S-K under the Securities Act and to the use of our
name therein and in the related Prospectus under the caption "Legal Matters."
In giving such consent, we do not hereby admit that we are in the category of
persons whose consent is required under Section 7 of the Securities Act or the
rules and regulations of the Commission.
Very truly yours,
/s/ Hale and Dorr LLP
HALE AND DORR LLP
<PAGE>
Exhibit 10.21
OFFICE BUILDING LEASE
---------------------
This lease, dated for reference purposes only, as of the 18th day of March,
1997, is entered into by and between HARBOR COURT ASSOCIATES, a Maryland general
partnership ("Landlord"), and PHYSICIANS QUALITY CARE, INC. ("Tenant");
PREAMBLE
--------
Landlord, in consideration of the rent to be paid and the covenants and
agreements to be performed by Tenant, as hereinafter set forth, does hereby
lease, demise, and let unto Tenant and Tenant hereby leases and accepts from
Landlord that certain office space in the "Building," as defined below, shown
and designated on the floor plan attached hereto as Exhibit "A" and incorporated
herein by this reference (the "Premises") for the "Term," as defined below,
unless sooner terminated as herein provided. The Premises are leased by
Landlord to Tenant and are accepted and are to be used and possessed by Tenant
upon and subject to the following terms, provisions, covenants, agreements, and
conditions.
1. PRINCIPAL LEASE PROVISIONS.
--------------------------
Each reference in this Lease to any of the terms described in this Article
1 shall mean and refer to the following; however, the other Articles of this
Lease contain numerous refinements and exceptions which qualify the provisions
of this Article; all other terms are as defined in this Lease:
1.1 Landlord's Address: c/o Mega Management Company
------------------- PO Box 68
Kannapolis, NC 28082
ATTN: Lynne Scott-Safrit
1.2 Tenant's Address: Physicians Quality Care, Inc.
----------------- 323 West Camden Street
Suite 675
Baltimore, MD 21201
1.3 Building: 575 South Charles Street
--------- Baltimore, Maryland 21201
1.4 (a) Rentable Square Footage of the Building:
---------------------------------------
71,731 square feet
(b) Rentable Square Footage of Retail Space:
---------------------------------------
9,124 square feet
<PAGE>
(c) Rental Square Footage of Office Space:
-------------------------------------
62,607 square feet
1.5 Area of Premises: 1,685 rentable square feet
----------------
1.6 Floor Number: Second (2nd)
-------------
1.7 Suite Number: 203
------------
1.8 Lease Term: Six (6) Months
----------
1.9 Estimated Commencement Date: April 1, 1997
---------------------------
1.10 Termination Date: September 30, 1997
-----------------
1.11 Initial Monthly Rental: U.S. Two Thousand Six Hundred
---------------------- and xx/100 Dollars ($2,600.00)
1.12 Tenant's Percentage:
--------------------
(a) 2.35 % of Building
(b) 0.00 % of Retail Space
(c) 2.69 % of Office Space
1.13 Security Deposit: U.S. Two Thousand Six Hundred
---------------- and xx/l00 Dollars ($2,600.00)
1.14 Brokers: None
-------
1.15 State: Maryland
-----
1.16 Use of Premises: General Office Use
---------------
2. PREMISES.
--------
2.1 Premises. Landlord hereby leases to Tenant and Tenant hereby
--------
leases from Landlord the Premises.
2.2 Common Areas. Tenant shall have, as appurtenant to the
------------
Premises, the non-exclusive right, in common with others, subject to reasonable
rules of general applicability to tenants of the Building from time to time made
by Landlord and of
2
<PAGE>
which Tenant is given notice, to the use of the following areas of the Building:
common entrances, lobbies, corridors, elevators, ramps, drives, service ways,
restrooms, and common walkways necessary to access to the Building (the "Common
Area"). Tenant hereby agrees that Landlord shall have the right, for the
purpose of accommodating other tenants of the Building, to increase or
decrease the configuration and dimensions or to otherwise alter the common
corridors on any floor so long as Tenant's access to the Premises, restrooms,
stairwells, and elevators is not prohibited thereby. Landlord reserves the right
from time to time: (a) to install, use, maintain, repair, replace, and relocate
for service to the Premises and/or other parts of the building pipes, ducts,
conduits, wires appurtenant fixtures, and mechanical systems, wherever located
in the Premises or the Building, and (b) to alter, close, or relocate Common
Areas or any facility therein.
3. TERM AND POSSESSION.
-------------------
3.1 Term. The term of this Lease shall be for a term commencing
----
on the Estimated Commencement Date as set forth in Section 1.9 and ending on the
Termination Date as set forth in Section 1.10, unless sooner terminated as
provided in this Lease.
3.2 Possession. Tenant agrees that if Landlord is unable to
----------
deliver possession of the Premises to Tenant on the Estimated Commencement Date,
Landlord shall not be liable for any damage caused thereby, nor shall this Lease
be void or voidable. Under such circumstances, the term of this Lease shall not
commence and the rent and payments for expenses which Tenant is obligated to pay
shall not commence until the Premises are ready for occupancy by Tenant and the
Termination Date of this Lease shall be based on the Lease Term as stated in
Section 1.8 of this Lease, unless such delay is the fault or responsibility of
Tenant. If Landlord tenders possession of the Premises to Tenant prior to the
Estimated Commencement Date, and if Tenant elects to accept such prior tender,
the term of this Lease shall commence on the date Tenant takes possession of the
Premises and all of the terms, covenants, and conditions of this Lease,
including the payment of rent and other expenses, shall be effective as of such
date. Notwithstanding the fact that the term of this Lease may commence earlier
than the Estimated Commencement Date, the term of this Lease shall end on the
Termination Date set forth in Section 1.10.
3.3 Acceptance of Premises. By taking possession of the Premises,
----------------------
Tenant accepts the Premises in its then "as is" condition and acknowledges that
the Premises and the Building are in good and satisfactory condition at the time
Tenant takes possession of the Premises.
3.4 Quiet Enjoyment. Upon Tenant's paying the rent and other
---------------
expenses provided in this Lease and observing and performing all of the terms,
covenants, and conditions to be observed and performed by Tenant hereunder,
Tenant shall peaceably
3
<PAGE>
and quietly hold, occupy, enjoy, manage, and operate the Premises without
hindrance or molestation by Landlord during the term of this Lease or by any
person or persons claiming under Landlord, subject to all of the provisions of
this Lease.
3.5 Security Deposit. On delivery to Landlord of a copy of this
----------------
Lease executed by Tenant, Tenant shall deposit with Landlord the amount set
forth in Section 1.13 as security for the performance by Tenant of its
obligations under this Lease. Landlord may apply all or any portion of such
security deposit in payment of any obligation of Tenant under this Lease in
default. If Landlord so applies any portion of such security deposit, Tenant
shall within ten (10) days after written demand from Landlord, restore such
deposit to the full amount provided in this Lease. Landlord shall not be
required to pay interest to Tenant on such security deposit or to keep such
security deposit separate from its general accounts. Such deposit shall be
returned to Tenant at the termination of the Lease if Tenant has discharged its
obligations under this Lease in full.
4. RENT.
----
4.1 Payment of Rent. Tenant shall pay the monthly Rental,
---------------
without any prior demand therefor and without any deduction or offset
whatsoever, in lawful money of the United States of America, to Landlord on the
first day of each calendar month during the term of this Lease as rent for the
Premises for such month. Tenant shall make payments of rent and other expenses
to Landlord at the Building Manager's office at the Building or at other such
address as Landlord may from time to time request in writing. If the term of
this Lease commences other than on the first day of a month or ends other than
on the last day of a month, the rent for a partial month shall be prorated on a
thirty (30) day month, based on the number of days in such month that this Lease
is in effect.
4.2 Monthly Rental. The Monthly Rental from the commencement
--------------
of the term of this Lease through December 31, 1997, shall be the Initial
Monthly Rental as provided in Section 1.11 hereof. The Monthly Rental for any
succeeding calendar year shall be determined by (i) multiplying the difference
between the Monthly Rental for the immediately preceding calendar year and
$1,476.67 by the CPI Adjustment for such year and (ii) adding to such amount
$1,476.67; however, in no event shall the Monthly Rental be less than the
Initial Monthly Rental. The CPI Adjustment for a calendar year shall be a
fraction, the numerator of which shall be the average CPI for the twelve months
ending with the September immediately preceding such calendar year and the
denominator of which shall be the average CPI for the twelve months ending with
the September before the September immediately preceding such calendar year. The
term "CPI" as used in this Lease shall mean the Consumer Price Index for All
Urban Customers - All Items - U.S. City Average (1967=100 or the then current
basis, if changed by the United States Department of Labor) published by the
United States Department of Labor, Bureau of Statistics. If the issuance of the
CPI by the federal government is
4
<PAGE>
discontinued, the Landlord shall use for the CPI the official index published by
a federal governmental agency which is most nearly equivalent to the CPI. If
no such index is available, then Landlord shall use such index or procedure
which reasonably reflects increases or decreases in consumer prices in the
United States. If the rental payments determined pursuant to this Section 4.2
exceed that allowed by the terms of any valid governmental restriction which
limits the amount of rent or if the rental payments described pursuant to this
Section 4.2 exceed any limitation otherwise imposed by this Lease, the amount of
rent or other payments shall be the maximum permitted by such governmental
restriction and by such limitation; however, all increases or decreases in rent
or other payments provided in this Lease shall be calculated thereafter based
upon the amount of the rent which would have been payable under the Lease as if
such government restriction or other limitation had not limited the rent payable
under the terms of this Lease. As used herein "calendar year" means a period
ending December 31.
5. ADDITIONAL EXPENSES.
-------------------
5.1 Additional Expenses Payable By Tenant. Tenant shall pay a
-------------------------------------
reasonable charge determined by Landlord for any utilities or services required
to be provided by Landlord by reason of any use by Tenant of any utilities or
services in excess of utilities or services customarily provided for general
office use in the Building or by reason of any recurrent use of the Premises at
any time other than the normal business hours of generally recognized business
days and shall also pay any costs reasonably incurred by Landlord to meter or
otherwise measure the amount of such utilities or services used by Tenant.
Tenant shall pay for any additional or unusual janitorial services required by
reason of Tenant's use of the Premises or by reason of improvements in the
Premises other than Landlord's "Building Standard" improvements. If the
replacement cost of improvements in the Premises in excess of such replacement
cost if only Landlord's "Building Standard" improvements were installed in the
Premises or Tenant's use or the conduct of business on the Premises or in the
Building, whether or not with Landlord's consent and whether or not otherwise
permitted by this Lease, results in any increase in premiums for the insurance
carried by Landlord with respect to the Building, Tenant shall pay any such
increase in premiums within ten (10) days after being billed by Landlord.
6. SERVICES AND UTILITIES.
----------------------
6.1 Services by Landlord. Landlord shall furnish to the Premises
--------------------
during such normal business hours of generally recognized business days such
amounts of air conditioning, heating, and ventilation as may be reasonably
necessary for the comfortable use and occupation of the Premises. Landlord
shall, at all times, furnish the Premises with elevator service and reasonable
amounts of electricity for normal lighting and office machines and shall furnish
water for lavatory and drinking purposes. Landlord shall provide janitorial
service equivalent to that furnished in comparable office buildings and
5
<PAGE>
window washing as reasonably required. Landlord shall replace fluorescent tubes
and ballasts in Landlord's building standard overhead fluorescent fixtures as
required. Tenant shall pay for replacement of all other tubes, ballasts, and
bulbs as required.
6.2 Maintenance and Repair by Landlord. Landlord shall maintain
----------------------------------
the Common Areas of the Building in a first-class condition, shall maintain the
plumbing, heating, ventilation, air conditioning, elevator, electrical, and
other mechanical systems of the Building in good working order, shall make
necessary repairs to the roof and the shell of the Building, and shall repair
promptly any damage to the Premises and the Building as provided in Section 10.
6.3 Interruption of Service. Landlord shall not be liable and the
-----------------------
Monthly Rental and other payment to Landlord shall not abate for interruptions
to the telephone, plumbing, heating, ventilation, air conditioning, elevator,
electrical, or other mechanical systems or cleaning services, by reason of
accident, emergency, repairs, alterations, improvements, or shortages or lack of
availability of materials or services. At any time during the term of this
Lease, any utilities or services may be conserved by Landlord without abatement
of rent or other expenses if undertaken by Landlord as required by any
governmental agency or in a reasonable effort to reduce energy or other resource
consumption.
7. USE AND OCCUPANCY BY TENANT.
---------------------------
7.1 Use by Tenant. Tenant shall use and occupy the Premises for
-------------
general office purposes as described in Section 1.16 and for no other purposes
without the prior written consent of the Landlord. Tenant shall operate its
business on the Premises during normal business hours and shall maintain
sufficient personnel on the Premises during normal business hours to receive and
supervise visitors to the Premises. Tenant shall furnish and decorate the
Premises in a manner consistent with its business and the other businesses in
the Building. Tenant shall not do or permit anything to be done in or about the
Premises which would constitute a nuisance to the other tenants or occupants of
the Building or significantly interfere with their use of any area of the
Building other than the Premises.
7.2 Rules and Regulations. Tenant and its employees, agents, and
---------------------
visitors shall observe faithfully the Rules and Regulations attached hereto as
Exhibit "B" and made a part hereof, and such other and further reasonable Rules
and Regulations as Landlord may from time to time adopt. Landlord shall not be
liable to Tenant for violation of any Rules and Regulations or the breach of any
provision in any lease by any other tenant or other party in the Building.
6
<PAGE>
8. MAINTENANCE, REPAIRS, AND ALTERATIONS.
-------------------------------------
8.1 Maintenance and Repair. During the term of this Lease,
----------------------
Tenant shall take good care of the Premises and fixtures therein and maintain
them in good order, condition, and repair in a quality and class equal to the
original work, ordinary and reasonable wear excepted. During the term of this
Lease, Tenant shall maintain at its own expense all plumbing facilities and the
area in which such plumbing facilities are located within the premises, except
the restrooms located in the core of the Building, in good order, condition and
repair as they are on the commencement of the term of this Lease, ordinary and
reasonable wear excepted. Upon surrender of the Premises to Landlord, Tenant
shall deliver the Premises to Landlord broom-clean in as good order, condition,
and repair as they are on the commencement of the term of this Lease, ordinary
and reasonable wear excepted. Without limiting the foregoing, Landlord may
require that any such maintenance or repairs be performed by Landlord at
Tenant's expense.
8.2 Alterations. Tenant shall not make nor permit to be made any
-----------
alterations or improvements to the Premises without obtaining Landlord's prior
written consent which shall not be unreasonably withheld, and then only by
contractors or mechanics approved by Landlord. Landlord shall generally consent
to alterations, additions, or improvements which do not affect the value of the
Premises significantly and which do not affect the structure or operation of the
Building. Tenant covenants and agrees that all work done by Tenant shall be
performed in full compliance with any and all applicable laws, statutes, rules,
orders, ordinances, regulations, and requirements of the federal, state, and
local governments, and all their departments and bureaus, as well as the
requirements of the Association of Fire Underwriters, or similar governing
insurance body. Unless otherwise approved by Landlord, all alterations,
additions, and improvements to the Premises shall be made by Landlord. Landlord
shall pay for the cost of any alterations, additions, and improvements to the
Premises only to the extent Landlord agrees to do so by a separate written
agreement with Tenant. Otherwise, Tenant shall pay all costs for such
additions, alterations, and improvements including any additions, alterations,
and improvements to the Premises required by any governmental agency during the
term of this Lease, which costs shall include a reasonable overhead and profit
charge by Landlord. Tenant shall report all costs incurred by Tenant for any
alterations, additions, or improvements made by Tenant to the Premises and shall
permit Landlord to examine all contracts and records relating to such
alterations, additions, or improvements. All alterations, additions, and
improvements to the Premises by Landlord or Tenant shall become part of the
realty and belong to Landlord and, at the end of the term hereof, shall remain
on the Premises without compensation of any kind to Tenant, except that any
trade fixtures which are installed and paid for by Tenant shall remain the
property of Tenant and may be removed by Tenant during the term of this Lease
provided Tenant repairs any damage to the remaining improvements of the Premises
caused by the removal of such fixtures. Moveable furniture and equipment of
Tenant shall remain the property of the Tenant.
7
<PAGE>
9. INSURANCE AND INDEMNIFICATION.
-----------------------------
9.1 Landlord's Insurance and Waiver. During the term of this Lease,
-------------------------------
Landlord shall obtain and keep in full force and effect fire and extended
coverage insurance with a vandalism and malicious mischief endorsement for the
Building and public liability insurance in such reasonable amounts with such
reasonable deductions as would be carried by a prudent owner of a similar
building in the area, or which the first mortgagee of the Building reasonably
deems necessary in connection with the operation of the Building. Landlord may
obtain insurance for the Building and the rents from the Building against such
other perils as Landlord reasonably considers appropriate. Tenant acknowledges
that it will not be a named insured in such policy and that it has no right to
receive any proceeds from any such insurance policies carried by Landlord.
9.2 Tenant's Insurance. During the entire term of the Lease,
------------------
Tenant shall obtain and keep in full force and effect, at its sole cost and
expense, the following insurance: (i) fire and extended coverage insurance with
a water damage and sprinkler damage endorsement and with a vandalism and
malicious mischief endorsement for property of Tenant located in the Building in
an amount not less than ninety percent (90%) of its cash value for any property
such as standard office furniture, furnishings, equipment, files, and supplies
and in an amount of one hundred percent (100%) of its cash value for any
properties such as cash, antiques, art objects, and jewelry, (ii) comprehensive
general liability insurance, including personal injury and property damage
insuring against all claims and liability arising out of the use or occupancy of
the Premises with limits as appropriate to Tenant's use of the Premises but not
less than $2,000,000, and (iii) insurance against interruption of Tenant's
business and loss of Tenant's business records in such amount as appropriate to
Tenant's business, unless Tenant shall provide, in writing, evidence of self
insurance pertaining to interruption of Tenant's business and loss of Tenant's
business records. All insurance policies shall provide that they cannot be
canceled without twenty (20) days prior written notice to Landlord and any other
person holding an interest in the Building designated by Landlord. Tenant shall
deliver copies of such policies to Landlord on request. Tenant may, by written
notice of such election to Landlord, elect to be a self-insurer of its property
such as office furniture, furnishings, equipment, files and supplies, cash,
securities, antiques, art objects, and jewelry and against interruption of
Tenant's business and loss of Tenant's business records. As an alternate to
copies of Tenant's insurance policies, Landlord agrees to accept certificates of
such insurance which are in a form satisfactory to Landlord.
9.3 Indemnification. Tenant hereby waives all claims against
---------------
Landlord, its agents and employees for loss, theft, or damage to equipment,
furniture, records, and other property on or about the Premises, for loss or
damage to Tenant's business or death or injury to persons on or about the
Premises or the Building, except to the extent
8
<PAGE>
caused by the active negligence or willful misconduct of Landlord, its agents or
employees. Tenant shall indemnify and hold harmless Landlord, its agents and
employees from and against any and all claims and liability for the loss, theft,
or damage to property on or about the Premises except Tenant's indemnification
shall not include an indemnification for liability for the active negligence or
willful misconduct of Landlord, its agents or employees. Tenant shall indemnify
and hold Landlord, its agents and employees harmless from and against any and
all claims and liability arising from any breach or default by Tenant in the
performance of any obligation of Tenant under this Lease or arising from the
negligence or willful misconduct of Tenant, its agents, employees, or visitors.
Landlord shall not be liable to Tenant for any negligence or act of any occupant
or invitee of any owner or occupant or invitee of any owner or occupant of any
property adjoining the Building other than Landlord, its agents and employees.
9.4 Waiver of Subrogation. Without limiting the obligation of
---------------------
Tenant to maintain insurance which permits waiver of subrogation (unless
otherwise approved in writing by Landlord), Landlord and Tenant hereby waive all
causes of action and rights of recovery against each other, against all
subtenants or assignees of Tenant, against all other tenants of the Building and
their assignees and sublessees and against any other person or entity holding an
interest in the Building (together, the "Affected Parties"), and against the
agents, officers, and employees of the Affected Parties, for any loss occurring
to the property of the Affected Parties resulting from any of the perils insured
against under any and all casualty insurance policies in effect at the time of
any such loss regardless of cause of origin of such loss, including the
negligence of the Affected Parties or the agents, officers, or employees of the
Affected Parties, to the extent of any recovery on such policies of insurance,
except to the extent that any of such policies of insurance are invalidated, in
whole or part, by said waiver, and so long as such policies of insurance shall
contain (and Landlord and Tenant hereby agree to use their best efforts to cause
such policies to contain), by endorsement or otherwise, a clause in such form or
having substantially the same effect as the following: "It is hereby stipulated
that this insurance shall not be invalidated in whole or in part should the
insured or any of them waive in writing prior to a loss any or all rights of
recovery against any person or entity for loss occurring to the property
described herein." Any self-insurance by Tenant shall be deemed to include such
waiver of subrogation against the Affected Parties. The obligation of Landlord
to use its best efforts to cause such policies to contain the above-described
clause shall not obligate Landlord to obtain such insurance from insurance
companies unacceptable to Landlord nor to incur premium charges therefor which
exceed one hundred ten percent (110%) of the premium charges for such insurance
which does not include such a clause. The obligation of Tenant to use its best
efforts to cause such policies to contain the above-described clause shall not
obligate Tenant to obtain such insurance for the benefit of the Affected Parties
other than Landlord from insurance companies unacceptable to Tenant nor to incur
premium charges therefor which exceed one hundred ten percent (110%) of the
premium charges for such insurance which does not include such a clause
benefitting the Affected Parties other than Landlord. Landlord shall promptly
notify Tenant in writing if such policies
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of Landlord do not contain the above-described clause. Tenant shall promptly
notify Landlord in writing if such policies of Tenant do not contain the above-
described clause, and in such event, Landlord shall promptly endeavor to notify
the other Affected Parties of such event.
10. DAMAGE OR DESTRUCTION
---------------------
10.1 Repair of Damage. If the Premises or the Building are
----------------
damaged or destroyed by fire or other casualty covered by the usual form of fire
and extended coverage, Landlord shall commence repair or restoration within
sixty (60) days of such damage or destruction and shall diligently pursue such
repair and restoration to completion unless this Lease is terminated as provided
herein. Landlord shall pay the cost of repair to any damage or destruction of
the Building or the Premises caused by the negligence or willful misconduct of
Landlord, its agents or employees. Tenant shall pay the reasonable cost of
repair of any damage or destruction of the Premises except to the extent caused
by defects in construction of the Building or the negligence or willful
misconduct of Landlord, its agents or employees. Tenant shall pay the reasonable
cost of repair of any damage or destruction of the Building caused by the
negligence or willful misconduct of Tenant, its employees, agents, or visitors.
The costs of repair of the Building or Premises shall include a reasonable
overhead and profit charge by Landlord. Tenant's obligation to pay the cost of
repairs for damage or destruction to the Premises or the Building shall be
reduced by any insurance proceeds payable to Landlord for such damage or
destruction, but only to the extent such insurance provides for a waiver of
subrogation which permits such reduction of Tenant's obligations. Tenant shall
vacate such portion of the Premises as Landlord reasonably requires to enable
Landlord to repair the Premises or Building.
10.2 Abatement. If the Premises are damaged or destroyed by fire
---------
or other casualty not caused by the negligence or willful misconduct of Tenant,
its agents, employees, or visitors, the Monthly Rental shall abate until such
damage or destruction is repaired in proportion to the reduction of the area of
the Premises usable by Tenant. Except as specifically provided in this Lease,
this Lease shall not terminate, Tenant shall not be released from any of its
obligations under this Lease, the rent and other expenses payable by Tenant
under this Lease shall not abate and Landlord shall have no liability to Tenant
for any damage or destruction to the Premises or the Building of any
inconvenience or injury to Tenant by reason of any maintenance, repairs,
alterations, decoration, additions, or improvements to the Premises or the
Building.
10.3 Termination by Landlord. If the Building is damaged or
-----------------------
destroyed, Landlord shall have the option to terminate this Lease within sixty
(60) days of such damage, if Landlord reasonably determines that the cost of
repair to the Building exceeds thirty percent (30%) of the value of the Building
exclusive of the land prior to such damage. If the Premises are damaged or
destroyed, Landlord shall have the option to terminate the term of this Lease
within sixty (60) days of the date of such damage or
10
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destruction if the cost of repair of the Premises, as reasonably determined by
Landlord, exceeds the insurance proceeds estimated by Landlord to be payable to
Landlord for such damage or destruction, unless the Tenant agrees in writing to
pay any cost of repairs of the Premises in excess of such insurance proceeds
within fifteen (15) days of receipt by Tenant of written notice from Landlord of
its intention to terminate this Lease pursuant to this sentence.
10.4 End of Term. Landlord shall not have any obligation to repair,
-----------
reconstruct or restore the Premises during the last twelve (12) months of the
term of this Lease or any extension thereof, as a result of any damage to the
Premises if the cost of any such repair, reconstruction, or restoration as
reasonably estimated by the Landlord exceeds the then Monthly Rental. If
Landlord elects not to repair the Premises of the Building pursuant to this
Section 10.4, Tenant may elect to terminate this Lease within thirty (30) days
of receipt of Landlord's notification of its election not to repair pursuant to
this Section 10.4. If Tenant elects to terminate this Lease as provided in this
Section, this Lease shall terminate thirty (30) days following the election by
Tenant to terminate this Lease. If Tenant does not elect to terminate this
Lease in such thirty (30) day period, the rent and other expenses payable by
Tenant shall not abate, Landlord may repair the Premises at Tenant's cost and
expense, and Tenant shall deposit with Landlord in advance an amount estimated
by Landlord as the cost of such repair.
11. CONDEMNATION.
------------
11.1 The term of this Lease shall terminate as to the portion of the
Premises taken or condemned by any authority under the power of eminent domain
or transferred by Landlord by agreement with such authority under threat of
condemnation, with or without any condemnation action being instituted, as of
date such authority requests possession of such portion of the Premises. The
Monthly Rental shall be adjusted in the proportion that the square footage of
the portion of the Premises taken bears to the total square footage of the
Premises prior to such taking. Tenant shall not be entitled to any
compensation, allowance, claim, or offset of any kind against the Landlord or
any condemning authority, as damages or otherwise, by reason of being deprived
of the Premises or by the termination of this Lease, except that Tenant shall be
entitled to such portion of any separate award for any improvements to the
premises paid for by Tenant in an amount not to exceed the unamortized cost of
such improvements with such costs amortized over the term of this Lease without
reference to any unexercised options. Any portion of the Building other than
the Premises taken by eminent domain or dedicated to public use shall upon such
taking or dedication be excluded from the area over which Tenant is granted
rights hereunder, and this Lease shall continue in full force and effect without
any reduction in rental.
11
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12. ASSIGNMENT, SUBLETTING, AND RECAPTURE.
-------------------------------------
12.1 Consent Required. Tenant shall deliver to Landlord promptly
----------------
following execution an executed copy of any assignment, sublease, or agreement
relating to the Premises, regardless of whether or not such assignment,
sublease, or agreement is permitted by this Lease or requires Landlord's
consent. Tenant shall not assign, sublease or otherwise transfer by operation
of law or otherwise this Lease or any interest herein without the prior written
consent of Landlord. If Tenant desires at any time to assign or otherwise
transfer this Lease or sublease all or a portion of the Premises, it shall first
notify Landlord of its desire to do so and shall submit in writing to Landlord:
(i) the name of the proposed assignee or sublessee, (ii) the nature of the
proposed assignee's or sublessee's business to be carried on in the Premises,
(iii) a copy of the proposed assignment or sublease and any other agreements to
be entered into concurrently with such assignment or sublease, and (iv) such
financial information as Landlord may reasonably request concerning the proposed
assignee or sublessee. Landlord may condition its consent to any assignment or
sublease on the execution by such assignee or sublessee of a written assumption
by such assignee or sublessee of the obligations of Tenant under this Lease. A
transfer of control of Tenant shall be deemed an assignment of this Lease and
shall be subject to all of the provisions of this Section. Tenant shall pay to
Landlord a reasonable fee and Landlord's expenses in reviewing such proposed
assignment or sublease. Landlord shall respond to Tenant's request to assign or
sublease this Lease in a timely manner. This Lease may not be assigned or
sublet without complying with the provisions of this Section in reliance on any
law relating to bankruptcy or debtor's rights generally unless adequate
assurance of future performance is provided Landlord including adequate
assurance of the source of rent and other expenses due under this Lease for the
entire term of this Lease and unless the assignee or sublessee and the proposed
use of the Premises by the assignee or sublessee are consistent with the type of
other tenants in the Building and the use by such tenants of their Premises.
12.2 Prohibitions. Partial assignments of Tenant's interest in this
------------
Lease as prohibited. Any sale, assignment, encumbrance or other transfer of
this Lease and any subleasings or occupation of the Premises which does not
comply with the provisions of this Section shall be void and shall be a default
under this Lease.
12.3 Payments to Landlord. Tenant shall pay to Landlord promptly
--------------------
following receipt the amount by which the value of any consideration received by
Tenant from any such assignments exceeds Tenant's unamortized cost of tenant
improvements in the Premises. Tenant shall pay to Landlord promptly following
receipt the amount by which all sublease rental and other payments received by
Tenant from any subtenant or any other person occupying any portion of the
Premises exceeds the total of the rental or other amounts payable by Tenant
pursuant to Section 4 for the portion of the Premises subleased with the rental
or other amounts payable by Tenant for the Premises allocated on the basis of
square footage. The provisions of this Section
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shall apply regardless of whether or not such assignment, subleasing or
occupation is made in compliance with the terms of this Lease. Any payments made
to Landlord pursuant to this Section, or Landlord's acceptance or endorsement
thereof, shall not constitute a consent to any assignment, subleasing or
occupation or cure any default under this Lease.
12.4 Recapture. If Tenant requests Landlord's consent to any
---------
assignment or sublease of this Lease, Landlord shall have the right, to be
exercised by giving written notice to Tenant within thirty (30) days of receipt
by Landlord of the information concerning such assignment or sublease required
by Section 12.1 to terminate this Lease effective as of the date Tenant proposes
to assign this Lease or sublease all or a portion of the Premises. On
termination of this Lease by Landlord pursuant to this Section, Landlord shall
pay to Tenant the unamortized cost of any tenant improvements to the Premises
paid by Tenant, with such costs amortized over the term of this Lease without
reference to any unexercised options. Landlord's right to terminate this Lease
on assignment or sublease shall not terminate as a result of Landlord's consent
to the assignment of this Lease or sublease of all or a portion of the Premises,
or Landlord's failure to exercise this right with respect to an assignment or
sublease.
12.5 No Release. Landlord's consent to any sale, assignment,
----------
encumbrance, subleasing, occupation or other transfer shall not release Tenant
from any of Tenant's obligations hereunder or be deemed to be a consent to any
subsequent assignment, subleasing or occupation. The collection or acceptance
of rent or other payment by Landlord from any person other than Tenant shall not
be deemed the acceptance of any assignee or subtenant as the Tenant hereunder or
a release of Tenant from any obligation under this Lease. If any assignee,
sublessee or successor of Tenant defaults in the performance of any obligation
under this Lease, Landlord may proceed directly against Tenant without the
necessity of exhausting any remedies against such assignee, sublessees or
successors. Landlord may consent to subsequent assignments or subleasing of
this Lease or amendments or modifications of this Lease with the assignee,
sublessees or successors of Tenant without notifying Tenant or such assignee,
sublessee or successors and without obtaining their consent and such action
shall not relieve Tenant or such assignee, sublessee or successors of any
liability under this Lease.
13. DEFAULT AND REMEDIES.
--------------------
13.1 Events of Default. The occurrence of any one or more of the
-----------------
following events shall constitute an Event of Default: (i) the failure by Tenant
to make any payment of rent or any other payments required to be made by Tenant
under this Lease when due if such failure continues for ten (10) days after
written notice by Landlord to Tenant of such failure; (ii) the failure by Tenant
to observe or perform any of the provisions of this Lease to be observed or
performed by the Tenant if such failure continues for a period of ten (10) days,
or such other period if this Lease specifically provides a different period for
a particular failure, after written notice by Landlord to
13
<PAGE>
Tenant of such failure, provided, however, that with respect to any failure
which cannot reasonably be cured within ten (10) days, an Event of Default shall
not be considered to have occurred if Tenant commences to cure such failure
within such ten (10) day period and continues to proceed diligently with the
cure of such failure; (iii) the failure by Tenant to pay its obligations as they
become due; the making of any general assignment or general arrangement for the
benefit of creditors by Tenant, or the filing by or against Tenant of a petition
to have Tenant adjudged bankrupt or a petition for reorganization or arrangement
under bankruptcy law or law affecting creditor's rights unless, in the case of a
petition filed against Tenant, such petition is dismissed within sixty (60)
days; the appointment of a trustee or a receiver to take possession of the
Premises where possession is not restored to Tenant within thirty (30) days; or
the attachment, execution or other judicial seizure of substantially all of
Tenant's assets located at the Premises or of Tenant's interest in this Lease,
where such seizure is not discharged in thirty (30) days; or (iv) Tenant
transfers or agrees to transfer this Lease or possession of all or any portion
of the Premises without Landlord's prior written consent.
13.2 Remedies. On the occurrence of an Event of Default, Landlord may
--------
at any time thereafter, with or without notice or demand and without limiting
Landlord in the exercise of a right or remedy which Landlord may have by reason
of such default or breach, do the following:
(i) Landlord may elect to continue the term of this Lease in full force and
effect and not terminate Tenant's right to possession of the Premises, in which
event Landlord shall have the right to enforce any rights and remedies granted
by this Lease or by law against Tenant, including, without limitation, the right
to collect when due rental or other sums payable hereunder. Landlord shall not
be deemed to have elected to terminate this Lease unless Landlord gives Tenant
written notice of such election to terminate. Landlord's acts of maintenance or
preservation of the Premises or efforts to relet the Premises shall not
terminate this Lease.
(ii) Landlord may elect by written notice to Tenant to terminate this Lease
at any time after the occurrence of an Event of Default, and in such event
Landlord may, at Landlord's option, declare this Lease and Tenant's right to
possession of the Premises terminated, re-enter the Premises, remove Tenant's
property therefrom and store it for Tenant's account and at Tenant's expense
(but Landlord shall not be required to effect such removal), eject all persons
from the Premises and recover damages from Tenant as hereinafter provided. Any
such re-entry shall be permitted by Tenant without hindrance. Landlord shall
not thereby be liable in damages for such re-entry or be guilty of trespass,
forcible entry or unlawful detainer. If Landlord elects to so terminate this
Lease and Tenant's right to possession or if this Lease and Tenant's right to
possession are terminated by operation of law, such termination shall cancel all
Tenant's options, if any, to extend or renew the term of this Lease.
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<PAGE>
(iii) Landlord may notify any subtenant of the Premises of the existence
of an Event of Default by Tenant in writing and thereafter all rent or other
amounts due from any subtenant of the Premises shall be paid to Landlord and
Landlord shall apply such rent or other amounts in payment of the amounts due
from Tenant under this Lease. The delivery of such notice to any subtenant and
the collection of such rent or other amounts by Landlord shall not terminate
this Lease.
13.3 Damages on Termination. On Termination of this Lease by reason
----------------------
of Tenant's breach, Landlord may recover as damages from Tenant, in addition to
all other remedies available, but without repeating or otherwise duplicating any
remedy heretofore granted to Landlord, an amount equal to the present value,
discounted by the then current discount rate at the Federal Reserve Bank of
Richmond, of the difference between the rent or other sums payable by Tenant to
Landlord for the term of this Lease after the date of termination, as if this
Lease were still in effect, and the reasonable rental value of the Premises for
such period as proved by Tenant. On termination of this Lease by reason of
Tenant's breach, Landlord may also recover as damages from Tenant all of the
rent or other sums payable by Tenant pursuant to this Lease after the date of
termination, as if this Lease were still in effect, until such time as Landlord
has released the entire Premises, reduced by any rent or other payments which
Landlord receives for the use of any portion of the Premises prior to releasing
the entire Premises. On termination of this Lease by reason of Tenant's breach,
Landlord may also recover as damages from Tenant that portion of any leasing
commissions paid or payable by Landlord applicable to the unexpired term of this
Lease and all costs incurred in releasing the Premises including advertising
costs, the costs of refurbishment and alterations of the Premises and the cost
of any concessions which the Landlord gives to release the Premises. If Landlord
releases the Premises following a termination by reason of Tenant's breach, the
rent charged by Landlord on such releasing shall be deemed to be the rental
value of the Premises for the purpose of calculation of the damages which
Landlord may recover from Tenant.
13.4 Late Charge. If Tenant fails to make any payment of rent,
-----------
expenses or other amounts required of Tenant under this Lease within ten (10)
days of the date such amount is due as set forth in this Lease, then, in
addition to any other amounts recoverable by Landlord hereunder, Tenant shall
pay Landlord a late charge in an amount equal to $0.06 for each dollar past due.
If Tenant fails, on three (3) separate occasions, to make any payment of rent,
expenses or other amounts required of Tenant under this Lease within three (3)
days of the date each such payment is due, then for the remainder of the Lease
Term, Tenant shall pay a late charge in an amount equal to $0.06 for each dollar
past due if Tenant thereafter fails to pay any payment of rent or other amount
required under this Lease promptly when due. Such late charge shall be due
notwithstanding the fact that no notice is given by Landlord to Tenant of such
failure to pay. Notwithstanding the foregoing, if on three (3) separate
occasions Tenant has received notice from Landlord that it has failed to pay
rent, expenses or other amounts promptly when due, Tenant shall pay Monthly
Rental for the balance of the term of this
15
<PAGE>
Lease on a quarterly basis, in advance, on the first day of each such quarter.
Landlord and Tenant agree that it would be extremely difficult and impractical
to fix the actual damages sustained by Landlord for such default and that the
late charge or quarterly rental payment set forth in this Section is a
reasonable estimate of such damages at this time. Landlord anticipates that
such damage would include the administrative costs and expenses, the cost of
arranging for borrowed funds and attorneys' fees. The late charge provided in
this Section shall be the sole damages which Landlord may recover from Tenant
for the delay by Tenant in making any payment within ten (10) days from the date
such payment is due until thirty (30) days after the date such payment is due,
but this Section shall not limit Landlord's right to recover any other amount
due pursuant to this Lease, Landlord's damages equivalent to the amount of the
rent or other payments if this Lease is terminated, Landlord's damages or costs
for Tenant failure to pay for a period beyond thirty (30) days from the date
such payment is due, Landlord's cost and expense in connection with any
litigation and Landlord's right to any other remedy such as terminating this
Lease, recovering possession of the Premises or injunctive relief.
13.5 Past Due Obligations. All amounts which Tenant is obligated to
--------------------
pay Landlord pursuant to this Lease or when due shall bear interest at the
maximum interest rate chargeable by law, not to exceed twenty percent (20%) per
annum from the due date until paid, unless otherwise specifically provided
herein. If a late charge is due with respect to such amount pursuant to Section
13.4, such interest shall commence to accrue thirty (30) days following the date
such amount is due. The payment of such interest shall not excuse or cure any
default by Tenant under this Lease.
13.6 Non-Exclusive Remedies. The remedies of Landlord set forth in
----------------------
this Section 13 shall not be exclusive, but shall be cumulative and in addition
to all rights and remedies now or hereafter provided or allowed by law or
equity, including, but not limited to, the right of Landlord to seek and obtain
an injunction and the right of Landlord to damages in addition to those
specified herein, except that the provisions of Section 13.4 shall limit
Landlord's right to damages as specified therein. Tenant hereby expressly waives
any and all rights of redemption granted by or under any present or future law
if Tenant is evicted or dispossessed for any cause or if Landlord obtains
possession of the Premises by reason of the breach by Tenant of any of its
obligations under this Lease. Tenant hereby expressly waives (i) the service of
any notice in writing of intention to re-enter or to institute legal proceedings
to that end and (ii) any right which Tenant may have to a jury trial in
connection with any such legal proceedings.
13.7 General Landlord Cure Provision. In the event Tenant defaults in
-------------------------------
the performance of any of the terms, covenants, or conditions of this Lease, or
fails to comply with any of the laws, statutes, ordinances, rules, orders,
regulations or requirements of any governmental authority, then in such case
Landlord shall have the immediate right, in addition to all rights and remedies
outlined in this Section 13, to cure such default or noncompliance for the
account of and at the cost and expense of Tenant,
16
<PAGE>
and the full amount so expended by Landlord, plus interest at the rate of
fifteen percent (15%) per annum thereon, shall immediately be due and owing by
Tenant to Landlord as additional rent hereunder.
14. ADDITIONAL RIGHTS OF LANDLORD.
-----------------------------
14.1 Entry by Landlord. Landlord and its agents and employees shall
-----------------
have the right to enter the Premises at all times, to examine the same, to make
such maintenance and repairs of the Premises and such maintenance, repairs,
alterations, decorations, additions and improvements to other portions of the
Building as Landlord requires and to show the Premises at reasonable times to
prospective tenants during the last six (6) months of the term of this Lease.
Landlord may erect, use and maintain pipes and conduits in and through the
Premises provided such pipes and conduits do not detract from the appearance of
the Premises. Landlord shall take reasonable precautions to minimize the
disruption to Tenant of any entry to the Premises by Landlord as provided in
this Section.
14.2 Building Planning. Landlord shall have the right at any time
-----------------
during the term of this Lease, upon giving Tenant sixty (60) days notice in
writing, to provide and furnish Tenant with like space elsewhere in the Building
of approximately the same size and area as the Premises and to remove and place
Tenant in such new space at Landlord's sole cost and expense. On such
relocation, the terms and conditions of this Lease shall remain in full force
and effect, save and except that the Premises shall be in such new location
within the Building, a revised Exhibit "A" shall become part of this Lease and
shall reflect the location of the new space, Section 1 of this Lease shall be
amended to include and state all correct data as to the new space, and the
Monthly Rental shall be reduced, but not increased, by the reduction of the Area
of Premises, if any, on such relocation. However, if the new space does not meet
with Tenant's approval, Tenant shall have the right to cancel this Lease upon
giving Landlord thirty (30) days written notice within ten (10) days of receipt
of Landlord's notification.
14.3 Transfer by Landlord. Landlord may transfer its interest in the
--------------------
Premises and this Lease without the consent of Tenant, at any time and from time
to time. The obligations of Landlord pursuant to this Lease shall be binding
upon Landlord and its successors only during their respective period of
ownership except that Landlord and its successors shall be relieved of their
obligation to refund security deposits and other funds to Tenant which they have
received from Tenant or a predecessor Landlord only to the extent they transfer
such amounts to their respective transferees. In addition, Landlord may lease
any portion of the Building to others on such terms and for such purposes as
Landlord considers appropriate and may terminate or modify leases with others
for any portion of the Building without any obligation to Tenant and without
relieving Tenant of any obligation under this Lease.
17
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14.4 Default by Landlord. Landlord shall not be liable to Tenant if
-------------------
Landlord is unable to fulfill any of its obligations under this Lease if
Landlord is prevented, delayed or curtailed from so doing by reason of any cause
beyond Landlord's reasonable control. Landlord shall not be in default unless
Landlord fails to perform obligations required of Landlord within a reasonable
time, but in no event later than thirty (30) days after written notice by Tenant
to Landlord, specifying Landlord's failure to perform such obligation; provided,
however, that if the nature of Landlord's obligation is such that more than
thirty (30) days are required for performance, then Landlord shall not be in
default if Landlord commences performance within such thirty (30) day period and
thereafter diligently prosecutes its efforts to satisfy such obligation.
Tenant may not offset against any rent or other amount due from Tenant under
this Lease any amount due or claimed to be due to Tenant from Landlord whether
arising pursuant to this Lease or otherwise. Any notice to Landlord by Tenant
of Landlord's default under this Lease shall also be concurrently provided by
registered or certified mail, to any holder of a mortgage or similar security
instrument covering the Premises, whose address shall have been furnished to
Tenant ("Mortgagee Notice"). The Mortgagee's Notice shall offer such mortgagee
a reasonable opportunity to cure the default, including the time to obtain
possession of the Premises by power of sale or judicial foreclosure, if such
action should be necessary to cure Landlord's default.
14.5 Subordination. This Lease is subject and subordinate to all
-------------
ground or underlying leases, mortgages and deeds of trust which now affect the
Building or any part of the Building and to all renewals, modifications,
consolidations, replacements and extensions thereof. This Lease may, at the
option of Landlord, be subordinate to any ground or underlying leases,
mortgages, deeds of trust or other lien which may hereafter affect the Building
or any part thereof and Tenant will execute and deliver upon the demand of
Landlord from time to time any and all instruments desired by Landlord,
subordinating, in the manner requested by Landlord, this Lease to such lease,
mortgage, deed of trust or other lien, provided such lease, mortgage, deed of
trust or lien provides that in the event of termination of such lease or
foreclosure of such mortgage, deed of trust or lien, any successor to any
interest of Landlord in the Building will not disturb Tenant's possession of the
Premises if Tenant attorns to such successor as Landlord and otherwise performs
its obligations under this Lease. Tenant agrees that Tenant shall attorn to any
Landlord under any ground lease affecting the Building in the event of the
termination or cancellation of such ground lease or to any purchaser upon
foreclosure or sale pursuant to any lien. In the event of termination of such
ground lease or foreclosure of such mortgage, deed or trust or other lien, any
successor to any interest of Landlord in the Building shall have no liability to
repay to Tenant any security deposit paid to any prior Landlord. Landlord may
from time to time grant or declare such restrictions or covenants as may be
reasonably required by Landlord or adopt and record such parcel maps,
subdivision maps or condominium plans as may be reasonably required by Landlord
relating to all or any portion of the Building and the provisions of all such
documents shall be senior to this Lease and Tenant shall sign any of such
documents upon receipt of Landlord provided such documents do not unreasonably
18
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interfere with the use of the Premises by Tenant as permitted by this Lease.
Tenant acknowledges the right of the holder of any first mortgage or other first
security interest in all or any part of the Building to subordinate its first
mortgage or other first security interest either in whole or in part to this
Lease. Tenant agrees at any time, and from time to time, upon not less than
five (5) days notice, to execute, acknowledge and deliver to such holder the
Tenant's agreement to such subordination in such form as such holder may
require. Without limiting the generality of the foregoing, the form of
subordination of the first mortgage or other first security interest may provide
that it does not affect, is not applicable to, and expressly excludes the
following: (i) the prior right, claim and lien of the first mortgage or first
security interest in, to and upon any award or other compensation heretofore or
hereafter to be made for any taking by eminent domain of any part of the
Building, and to the right of disposition thereof in accordance with the
provisions of the first mortgage or first security interest; (ii) the prior
right, claim and lien of the first mortgage or first security interest in, to
and upon any proceeds payable under all policies of fire and rent insurance upon
the Building, or any part thereof, and as to the right of disposition thereof in
accordance with the terms of the first mortgage or first security interest; and
(iii) any lien, right, power or interest, if any, which may have arisen or
intervened in the period between the recording of the first mortgage or first
security interest and the execution of this Lease, or any lien or judgment which
may arise at any time under the terms of this Lease.
14.6 Lender's Rights. On receipt of written request from Landlord,
---------------
Tenant shall enter into a written agreement with Landlord and any ground lessor
or any holder of any encumbrance on the Building in a form satisfactory to such
ground lessor or holder which provides as follows: (i) Tenant shall attorn to
such ground lessor or encumbrancer on termination of its ground lease or
foreclosure of its encumbrance; (ii) without the written approval of such ground
lessor or encumbrancer, Tenant shall not make any payments to Landlord more than
thirty (30) days prior to the date such payment is due pursuant to this Lease,
Tenant shall not subordinate its interest in this Lease to any subsequent ground
lease or encumbrance, and Landlord may not terminate this Lease or modify this
Lease and; (iii) any subordination, termination or modification in violation of
such agreement shall be invalid.
14.7 Estoppel Certificate. Tenant shall upon ten (10) days written
--------------------
notice from Landlord execute, acknowledge and deliver to Landlord a statement in
writing (i) certifying that this Lease is unmodified and in full force and
effect or, if modified, stating the nature of such modifications and certifying
that this Lease as so modified is in full force and effect; (ii) acknowledging
that there are not, to Tenant's knowledge, any uncured defaults on the part of
the Landlord hereunder, or specifying such defaults if any are claimed; (iii)
setting forth the date of commencement of rents and the date of expiration of
the term of this Lease and setting forth any options of Tenant to extend the
term of this Lease, the nature of such options and whether any such options have
been exercised by Tenant; and (iv) stating the amount of security deposit made
by Tenant to Landlord and amount and period covered by any prepayments of rents
or other charges
19
<PAGE>
by Tenant. Any such statement may be relied upon by any then existing or
prospective lessor, purchaser or encumbrancer of all or any portion of the real
property of which the Premises are a part.
14.8 Financial Information. From time to time from the date of
---------------------
execution of this Lease through the term of this Lease, Tenant shall upon five
(5) days prior written notice from Landlord, provide Landlord with a current
financial statement and financial statements of the two (2) years prior to the
current financial statement year. Such statement shall be prepared in accordance
with generally accepted accounting principles, consistently applied, and, if
such is the normal practice of Tenant, shall be audited by an independent
certified public accountant.
15. MISCELLANEOUS.
-------------
15.1 Brokers. Tenant represents and warrants to Landlord that it has
-------
not had dealings with any broker or finder other than as listed in Section 1.14
hereof in locating the Premises and that it knows of no other person who is or
might be entitled to a commission, finder's fee or other like payment in
connection herewith and does hereby indemnify and agree to hold Landlord
harmless from and against any and all claims, liabilities and expenses that
Landlord may incur should such representation and warranty be incorrect.
Landlord agrees to indemnify and hold Tenant harmless from any claims or
liability to any broker or other person arising out of or relating to any
agreement by Landlord to pay a brokerage commission, finder's fee or like
payment to such broker or such person relating to the leasing of the Premises;
provided, however, that Landlord shall not be obligated to Tenant for any claims
or liability to any broker or other person with whom Tenant has dealing
concerning the Building whose identity Tenant has failed to disclose to Landlord
as required by this Section 15.1.
15.2 Holding Over. If Tenant, with or without Landlord's consent,
------------
remains in possession of the Premises or any part thereof after the expiration
of the term hereof such occupancy shall be a tenancy from month-to-month upon
all the provisions of this Lease, except that (a) the Monthly Rental during such
tenancy shall be payable at two hundred percent (200%) of the Monthly Rental for
the last month of the term, and (b) all options and rights of first refusal, if
any, granted under the term of this Lease shall be terminated and be of no
further effect during such month-to-month tenancy. Tenant hereby expressly
waives (i) the service of any notice in writing of intention to re-enter or to
institute legal proceedings to that end, and (ii) any right which Tenant may
have to a jury trial in connection with any such legal proceedings.
15.3 Performance. All payments to be made under this Lease shall be
-----------
made without prior legal notice or demand unless otherwise provided herein, in
legal currency of the United States of America. Time is hereby made of the
essence of each and every one and all of the terms, covenants and conditions to
be kept, observed or performed under this Lease.
20
<PAGE>
15.4 Notices. Any notices required or permitted to be given under this
-------
Lease shall be in writing and may be delivered personally or by certified mail
to the Landlord at the address set forth in Section 1.1 and to Tenant at the
address set forth in Section 1.2. A copy of any notice to Landlord shall also
be mailed to Murdock Management Company, 575 South Charles Street, Baltimore,
Maryland 21201, and to such other parties as such addresses as Landlord requests
in writing. Any notice given by mail shall be deemed received two (2) business
days following the date such notice and the required copies are mailed as
provided in this Section. Either party may change its address for purposes of
this Section by giving the other party written notice of the new address in the
manner set forth above. Any notice required by this Lease shall be deemed to
constitute the notice required by the laws of the State set forth in Section
1.15 above.
15.5 Merger. There shall be no merger of this Lease or of the leasehold
------
estate hereby created with the fee estate in the Premises or any part thereof by
reason of the fact that the same person, firm, corporation or other legal entity
may acquire or hold, directly or indirectly, this Lease or the leasehold estate
and the fee estate in the Premises or any interest in such fee estate without
the prior written consent of the holders of any mortgages or similar security
instruments covering the leased Premises.
15.6 Termination. On termination of the Lease, Tenant shall execute and
-----------
deliver to Landlord immediately upon Landlord's request a quitclaim deed in
recordable form transferring to Landlord any interest of Tenant in the Premises.
15.7 Applicable Laws. This Lease shall be governed by and construed in
---------------
accordance with the laws of the State set forth in Section 1.15 above.
15.8 Professional Fees. If Tenant or Landlord brings any action for any
-----------------
damages or other relief against the other or for a declaration or determination
of any matter relating to this Lease, including a suit by Landlord for the
recovery of rent or other payments from Tenant or for possession of the
Premises, the losing party shall pay to the prevailing party a reasonable sum
for attorneys', architects', engineers', brokers' and other professionals' fees
in such suit, and such obligation shall be incurred on commencement of any
action whether or not such action is prosecuted to judgment or final
determination.
15.9 Modification. This Lease and any other written agreements dated as
------------
of the date of this Lease contain all of the terms and conditions agreed upon by
the Landlord and Tenant with respect to the Premises and the Building. All
prior negotiations correspondence and agreements are superseded by this Lease
and any other contemporaneous documents. No officer or employee of any party
has any authority to make any representation or promise not contained in this
Lease and other contemporaneous documents, and each of the parties hereto agrees
that it has not
21
<PAGE>
executed this Lease in reliance upon any representation or promise not set forth
in this Lease or such contemporaneous documents. This Lease may not be modified
or changed except by written instrument signed by Landlord and Tenant.
Notwithstanding the foregoing, if, in connection with obtaining construction,
interim or permanent financing for the Building, the Lender shall request
reasonable modifications in this Lease as a condition to such financing, Tenant
shall not unreasonably withhold, delay or defer its consent therefor, provided
that such modifications do not increase the obligations of Tenant hereunder or
materially adversely affect the leasehold interest hereby created or Tenant's
rights hereunder.
15.10 Relationship of Parties. Neither the method of computation of rent
-----------------------
nor any other provisions contained in this Lease nor any acts of the parties
shall be deemed or construed by the parties or by any third person to create the
relationship of principal and agent or of partnership or of joint venture or of
any association between Landlord and Tenant, other than the relationship of
Landlord and Tenant.
15.11 Waiver. The acceptance of rent or other payments by Landlord, or
------
the endorsement or statement on any check or any letter accompanying any check
or other payment shall not be deemed an accord or satisfaction or a waiver of
any obligation of Tenant regardless of whether or not Landlord had knowledge of
any breach of such obligation. Failure to insist on compliance with any of the
terms, covenants or conditions hereof shall not be deemed a waiver of such
terms, covenants or conditions nor shall any waiver or relinquishment of any
right or power hereunder, at any one time or more times, be deemed a waiver or
relinquishment of such rights and powers at any other time or times or under any
other circumstance(s).
15.12 Partial Invalidity. If any term or provision of this Lease or the
------------------
application thereof to any person or circumstances shall to any extent be
invalid or unenforceable the remainder of this Lease or the applications of such
term or provision to persons or circumstances other than those as to which it is
invalid or unenforceable shall not be affected thereby, and each term and
provision of this Lease shall be valid and enforced to the fullest extent
permitted by law.
15.13 Interpretations. Any uncertainty or ambiguity existing herein
---------------
shall not be interpreted against either party because such party prepared any
portion of this Lease, but shall be interpreted according to the application of
rules of interpretation of contracts generally.
15.14 Successors and Assigns. This Lease shall be binding upon and shall
-----------------------
inure to the benefit of the parties hereto and their respective permitted heirs,
representatives, successors and assigns.
15.15 Tenant as Partnership. If a partnership or more than one legal
----------------------
person executes that Lease as Tenant, (i) each partner is jointly and severally
liable for
22
<PAGE>
keeping, observing and performing all the terms, covenants, conditions,
provisions and agreements of this Lease to be kept, observed or performed by
Tenant, and (i) the term "Tenant" as used in this Lease shall mean and include
each of them jointly and severally and the act of or notice from, or notice or
refund to, or the signature of, any one or more of them, with respect to this
Lease, including but not limited to, any renewal, extension, expiration,
termination or modification of this Lease, shall be binding upon each and all of
the persons constituting Tenant with the same force and effect as if each and
all of them have so acted or so given or received such notice or refund or so
signed. Termination of Tenant, if a partnership, shall be deemed to be an
assignment jointly to all of the partners, who shall thereafter be subject to
the terms of this Lease is if each and all such former partners had initially
signed this Lease as individuals.
15.16 Tenant as Corporation. If Tenant executes this Lease as a
---------------------
corporation, then Tenant and the persons executing this Lease on behalf of
Tenant represent and warrant that the individuals executing this Lease on
Tenant's behalf are duly authorized to execute and deliver this Lease on its
behalf in accordance with a duly adopted resolution of the board of directors of
Tenant, a copy of which is to be delivered to Landlord on execution hereof, and
in accordance with the By-Laws of Tenant, and that this Lease is binding upon
Tenant in accordance with its terms.
15.17 Partners' Liability. It is understood that Harbor Court Associates
-------------------
is a Maryland general partnership. All obligations of Harbor Court Associates
hereunder are limited to the net assets of Harbor Court Associates from time to
time. No partner of Harbor Court Associates or of any successor partnership,
whether now or hereafter a partner, shall have any personal responsibility for
the obligations of Landlord hereunder.
15.18 Recordation. Tenant covenants that it will not, without Landlord's
------------
prior written consent, record this Lease or offer this Lease for recordation.
If at any time, Landlord or any mortgagee of Landlord's interest in the Leased
Premises shall require the recordation of this Lease, such recordation shall be
at Landlord's expense. If at any time Tenant shall require the recordation of
this Lease, such recordation shall be at Tenant's expense. If the recordation
of this Lease shall be required by any valid governmental order or if any
governmental authority having jurisdiction in the matter shall assess and be
entitled to collect transfer taxes or documentary stamp taxes, or both transfer
taxes and documentary stamp taxes on this lease, Tenant will execute such
acknowledgements as may be necessary to effect such recordation, and pay, upon
request of Landlord, all recording fees, transfer taxes and documentary stamp
taxes payable on or in connection with this Lease or such recordation.
15.19 Exhibits. All exhibits, riders and schedules, if any, attached
---------
hereto shall be deemed a part of this Lease.
23
<PAGE>
IN WITNESS WHEREOF, the parties hereto hereby execute this Lease, as of the
day and year first above written.
LANDLORD:
WITNESS: HARBOR COURT ASSOCIATES,
a Maryland General Partnership
By: Murdock Development Corporation, a
General Partner
- ------------------------------ By: /s/
---------------------------------
Title: Vice President
TENANT:
WITNESS: PHYSICIANS QUALITY CARE, INC.
- ------------------------------ By: /s/ Torrey C. Brown, M.D.
----------------------------------
Title:
24
<PAGE>
RIDER
-----
TO LEASE, dated for reference purposes as of the 18th day of March,
1997, by and between HARBOR COURT ASSOCIATES, as "Landlord" and PHYSICIANS
QUALITY CARE, INC., as "Tenant" (the "Lease").
16. ADDITIONAL AGREEMENTS.
---------------------
16.1 Initial Monthly Rental. In addition to the Security Deposit set
----------------------
forth in Section 1.13, Tenant shall pay upon execution of this Lease the amount
set forth in Section 1.11 hereof ($2,600.00) which shall be applied against
the first Monthly Rental due under this Lease.
16.2 Monthly Rental. Notwithstanding anything to the contrary contained
---------------
in Section 4.2 of this Lease;
(a) The CPI Adjustment for any "succeeding" calendar year shall not
exceed 1.06 nor shall it be less than 1.03.
16.4 Option to Extend Term. Provided that Tenant has timely and faith-
---------------------
fully performed its obligations under this Lease throughout the term hereof,
timely exercises this right as hereinafter provided, and is not in default at
the time of exercise of such right or at the commencement of any extension
period, Tenant shall have the right to extend the term of this Lease for one (1)
period of six (6) months on the same terms and conditions as contained in this
Lease.
Not later than forty-five (45) days prior to the date the term of this
Lease would otherwise expire, Tenant shall notify Landlord in writing of its
election to exercise the right to extend the term hereof as provided above. The
right to extend the term of this Lease shall terminate if not timely exercised
as herein provided.
During such extension period, Landlord and Tenant shall have the option to
terminate this Lease by notifying the other party in writing thirty (30) days
prior to the termination date.
16.5 Construction of Premises.
------------------------
Tenant hereby acknowledges that Tenant has inspected the Premises, see
Suite Plan (Exhibit "C"), prior to execution of this Lease. Tenant agrees to
accept the Premises in its "as-is" condition, except that prior to Tenant's
occupancy and Lease Commencement, Landlord agrees to make the following
improvements to the Premises at Landlord's expense, "Landlord's Work":
(a) provide two (2) duplex electrical outlets in private office number 5;
1
<PAGE>
(b) rekey the main entrance door and provide keys to Tenant;
(c) provide building signage to include Tenant suite sign, 1st floor
directory strip, 2nd floor directory listing, and Tenant directional
sign.
(d) paint the entire Premises;
(e) install new carpet and vinyl base.
IN WITNESS WHEREOF, the parties hereto hereby execute this Rider as of the
date of the Lease.
LANDLORD:
WITNESS: HARBOR COURT ASSOCIATES,
a Maryland General Partnership
By: Murdock Development Corporation Inc.
- ------------------------------ By: /s/
-----------------------------------
Title: Vice President
TENANT:
WITNESS:
- ------------------------------ By: /s/ Torrey C. Brown, M.D.
-----------------------------------
Title:
2
<PAGE>
PARKING AGREEMENT
-----------------
This Agreement, dated as of MARCH 18, 1997, is entered into by and
between HARBOR COURT ASSOCIATES and PHYSICIANS QUALITY CARE, INC.
Reference is made to that certain Lease dated as of MARCH 18, 1997,
by and between HARBOR COURT ASSOCIATES, as "Landlord" therein, and PHYSICIANS
QUALITY CARE, INC. as "Tenant" therein (the "Lease"). For so long as the Lease
is in full force and effect, HARBOR COURT ASSOCIATES, for itself and any
successor, owner and operator of the parking facility situate on Parcel 3 as
shown on the Amended Subdivision Plat of Harbor Court, agrees to permit
PHYSICIANS QUALITY CARE, INC. and its successors in interest as Tenant pursuant
to the Lease and Tenant's employees (collectively "Customer") to park an
aggregate of two (2) cars within the said parking facility in unreserved,
unassigned spaces or in such specific or general areas thereof as from time to
time may be designated by such owner or the parking operator, and otherwise
subject to such rules, regulations, waiver of liability and other operating
policies, as same may change from time to time, applicable to monthly parking
provided to the public generally in such parking facility. Customer shall pay
the monthly rate for such parking from time to time applicable; provided,
however, that one (1) of such parked car(s) will be at no cost to Tenant during
the first six (6) months of the term of the Lease.
IN WITNESS WHEREOF, HARBOR COURT ASSOCIATES and PHYSICIANS QUALITY
CARE, INC. have executed this Agreement as of the date first above written.
HARBOR COURT ASSOCIATES
By: Murdock Development Corporation, Inc.
By: /s/
---------------------------------------------
Title:
PHYSICIANS QUALITY CARE, INC.
By: /s/ Torrey C. Brown, M.D.
---------------------------------------------
Title:
1
<PAGE>
Exhibit 10.22
AMENDED AND RESTATED
SERVICES AGREEMENT
AMONG
FLAGSHIP HEALTH, P.A.,
FLAGSHIP HEALTH II, P.A.
and
PHYSICIANS QUALITY CARE, INC.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
1. APPOINTMENT OF PQC; RETENTION OF CLINICAL AUTHORITY........................1
1.1 Appointment and Authority.............................................1
-------------------------
1.2 Retention of Authority................................................2
----------------------
2. OBLIGATIONS OF MEDICAL GROUP...............................................2
2.1 Physician Personnel...................................................2
-------------------
2.2 Credentialing of Medical Group Physicians.............................2
-----------------------------------------
2.3 Employment and Engagement of Medical Group Physicians.................2
-----------------------------------------------------
(a) General..........................................................2
-------
(b) Pods.............................................................3
----
(c) Form of Agreements...............................................3
------------------
(d) Medical Group Physician Qualifications...........................3
--------------------------------------
2.4 Licensing and Accreditation...........................................3
---------------------------
2.5 Supervision and Direction of Clinical Staff...........................4
-------------------------------------------
2.6 Liability Insurance...................................................4
-------------------
2.7 Medical Records.......................................................4
---------------
2.8 Assignment of Intellectual Property...................................5
-----------------------------------
3. OBLIGATIONS OF PQC.........................................................5
3.1 General...............................................................5
-------
3.2 Facilities............................................................5
----------
3.3 Equipment and Office Furnishings......................................6
--------------------------------
3.4 Personnel and Payroll.................................................6
---------------------
3.5 Borrowings............................................................6
----------
3.6 Supplies and Inventory................................................7
----------------------
3.7 Contracts.............................................................7
---------
3.8 Budgets...............................................................8
-------
(a) General Preparation Principles...................................8
------------------------------
(b) Approval of Budgets..............................................8
-------------------
(c) Reporting.......................................................10
---------
3.9 Preparation of Tax Returns...........................................10
--------------------------
3.10 Charges..............................................................10
-------
3.11 Billing and Collection...............................................10
----------------------
3.12 Payment of Accounts and Indebtedness.................................10
------------------------------------
3.13 Power of Attorney for Billing and Payment of Accounts................11
-----------------------------------------------------
3.14 Other Billings and Charges...........................................12
--------------------------
3.15 Insurance............................................................12
---------
3.16 Other Administrative Services........................................13
-----------------------------
3.17 Development of Integrated Health Services............................13
-----------------------------------------
3.18 Advertising and Public Relations.....................................14
--------------------------------
4. MANAGEMENT FEE; FINANCIAL ARRANGEMENTS....................................14
</TABLE>
-i-
<PAGE>
<TABLE>
<S> <C>
5. TERM AND TERMINATION......................................................14
5.1 Term.................................................................14
----
5.2 Termination on Default...............................................14
----------------------
5.3 Effect of Termination................................................15
---------------------
6. JOINT POLICY BOARD; CERTAIN PROVISIONS REGARDING GOVERNANCE OF
MEDICAL GROUP.................................................................16
6.1 Joint Policy Board...................................................16
------------------
(a) Representation..................................................16
--------------
(b) Authority and Responsibility....................................17
----------------------------
(c) ................................................................18
(d) ................................................................19
(e) ................................................................19
(f) Voting; Procedures..............................................20
------------------
6.2 Medical Advisory Board...............................................21
----------------------
6.3 The President of Medical Group.......................................21
------------------------------
6.4 The Medical Director of Medical Group................................23
-------------------------------------
6.5 Operating Manager....................................................24
-----------------
7. INTELLECTUAL PROPERTY.....................................................24
8. RESTRICTIVE COVENANTS.....................................................24
8.1 Noncompetition.......................................................24
--------------
8.2 Ancillary Enterprise.................................................25
--------------------
8.3 Non-solicitation of Employees and Patients...........................25
------------------------------------------
8.4 Enforcement of Medical Group Physician Employment Agreements.........25
------------------------------------------------------------
8.5 Remedies.............................................................25
--------
9. MISCELLANEOUS.............................................................26
9.1 Exclusivity..........................................................26
-----------
9.2 Names; Trademarks....................................................26
-----------------
9.3 Independent Contractors..............................................26
-----------------------
9.4 [Reserved]...........................................................26
----------
9.5 Severability.........................................................26
------------
9.6 Waiver...............................................................26
------
9.7 Notices..............................................................27
-------
9.8 Entire Agreement.....................................................27
----------------
9.9 Amendment............................................................27
---------
9.10 Successors and Assigns...............................................27
----------------------
9.11 Governing Law........................................................27
-------------
9.12 Headings.............................................................27
--------
9.13 No Obligation to Third Parties.......................................27
------------------------------
9.14 Contract Modifications for Prospective Legal Events..................28
---------------------------------------------------
9.15 Availability of Certain Documents....................................28
---------------------------------
9.16 Gender...............................................................29
------
</TABLE>
-ii-
<PAGE>
<TABLE>
<S> <C>
APPENDIX A.....................................................................1
- ----------
APPENDIX B.....................................................................1
- ----------
SCHEDULE B-1...................................................................8
- ------------
APPENDIX C.....................................................................1
- ----------
APPENDIX D.....................................................................1
- ----------
EXHIBIT A......................................................................1
- ---------
</TABLE>
-iii-
<PAGE>
FLAGSHIP HEALTH, P.A.
FLAGSHIP HEALTH II, P.A.
SERVICES AGREEMENT
This Agreement (this "Agreement") is made as of November 30, 1996, and
amended and restated as of July 31, 1997, by and among Physicians Quality Care,
Inc., a Delaware corporation ("PQC"), Flagship Health II, P.A., a Maryland
Professional corporation ("Flagship II") and Flagship Health, P.A., a Maryland
professional association ("Flagship I" and collectively with Flagship II,
"Medical Group"). (All capitalized terms not defined below in this Agreement
shall have the meanings set forth in Appendix A or B attached hereto.)
WHEREAS, Medical Group has entered into a business arrangement with
PQC in order to help effectuate the parties' mutual vision of establishing a
high quality, competitive, cost-effective health care delivery system, as part
of which Medical Group and PQC will work together to enhance the efficiency of
the business aspects of Medical Group's practice, to promote the quality of care
and patient satisfaction, and to create sufficient economies of scale to permit
Medical Group to undertake risk-based managed care obligations;
WHEREAS, Medical Group engages in the provision of medical and
surgical services through its physicians (each a "Medical Group Physician" and
collectively the "Medical Group Physicians"), who currently practice in a number
of divisions (each a "Pod"), each of which may have one (1) or more Practice
Locations; and
WHEREAS, Medical Group wishes to retain PQC to provide or arrange for
comprehensive management, administrative and other support services to manage
Medical Group and each Pod in order better to serve its patients, enhance
efficiency, and improve financial results of operation of the Medical Group's
activities.
NOW, THEREFORE, in consideration of the mutual covenants and premises
herein contained, the parties hereby agree as follows:
1. APPOINTMENT OF PQC; RETENTION OF CLINICAL AUTHORITY
1.1 Appointment and Authority. Medical Group hereby appoints and
-------------------------
engages PQC as Medical Group's sole and exclusive business manager and PQC
accepts such appointment and engagement on and subject to the terms and
conditions set forth in this Agreement. Subject to the terms of this Agreement,
including applicable requirements of consultation and prior approval of the
Joint Policy Board, PQC shall have the authority and responsibility to: (i)
manage all business operations of Medical Group in an efficient and cost-
effective manner; (ii) provide or arrange for such services in any manner as
PQC, in the exercise of its reasonable business judgment, deems appropriate to
meet the day-to-day requirements of the business functions of Medical Group; and
(iii) negotiate and execute, on behalf of Medical Group, all contracts that, in
the exercise of PQC's reasonable business judgment, are necessary and
appropriate for the business and affairs of Medical Group, subject, in the case
of Payor Contracts, to the approval of the Joint Policy Board.
-1-
<PAGE>
1.2 Retention of Authority. Notwithstanding anything to the contrary
----------------------
in this Agreement, Medical Group will have exclusive authority and control over
the provision of medical services, including all diagnoses, treatment and
ethical determinations with respect to patients. All diagnoses, treatments,
procedures and other medical and professional services shall be provided and
performed exclusively by or under the supervision of a physician employed or
otherwise engaged by Medical Group who meets the qualifications set forth in
this Agreement. It is acknowledged that PQC is not authorized nor qualified to
engage in any activity that constitutes the practice of medicine. To the
extent, if any, that any act or service of PQC under this Agreement is
determined to constitute the practice of medicine, the performance of such act
or service by PQC shall be deemed waived and excused by Medical Group.
2. OBLIGATIONS OF MEDICAL GROUP
2.1 Physician Personnel. Medical Group, subject to oversight by the
-------------------
Medical Advisory Board, shall be solely responsible for all determinations with
respect to an individual physician concerning the recruitment, hiring,
termination, Credentialing, training and supervision of such physician. PQC
shall not exercise any control over nor have any responsibility for Medical
Group Physicians or other Clinical Staff (as defined in Section 2.5) with
respect to the provision of clinical services.
2.2 Credentialing of Medical Group Physicians. Medical Group,
-----------------------------------------
through the Medical Advisory Board, shall credential its physicians in
conformity with the requirements imposed under state and federal law and by the
terms of any third party payment agreement to which the Medical Group is bound.
Medical Group shall assure that each Medical Group Physician at all times is:
(i) duly licensed to practice medicine by the applicable state within the
Geographic Area (as defined in Section 10.10 of Appendix A); and (ii) a member
in good standing of the medical staffs of hospitals designated from time to time
by the Joint Policy Board or as may be necessary in connection with the
participation in one (1) or more Payor Contracts negotiated on Medical Group's
behalf by PQC. No physician other than those Medical Group Physicians who meet
the requirements and qualifications of this Agreement, including without
limitation Section 2.3, shall be permitted: (a) to use or occupy the Pod
Practice Locations, except as approved by the Joint Policy Board; or (b) except
as may be required to assure appropriate medical care (e.g., locum tenens
coverage), to render services to patients of Medical Group. New physicians may
be employed by Medical Group, or physician groups or practices may be acquired
by Medical Group, subject to approval of the Joint Policy Board and the Medical
Advisory Board.
2.3 Employment and Engagement of Medical Group Physicians.
-----------------------------------------------------
(a) General. During the term of this Agreement, Medical Group,
-------
through its Pods, shall operate and maintain a full-time
practice of medicine providing primary care, medical and
surgical specialty services and such other services as are
agreed upon by the Joint Policy Board and PQC. Medical
Group shall engage a sufficient number of Medical Group
Physicians to provide services to patients of Medical Group
during the normal office hours of the Practice Locations
and to provide
-2-
<PAGE>
after hours coverage for all patients of Medical Group
whether on an inpatient or outpatient basis (it being
agreed that the practice patterns in effect as of the
Effective Date are acceptable to PQC and Medical Group);
provided, however, that a Pod may close its practice to new
patients for such period as the Joint Policy Board and
Medical Advisory Board may determine to be necessary in the
event the Pod has reached capacity.
(b) Pods. Each Medical Group Physician hired or otherwise
----
engaged by Medical Group shall be a member of a Pod and
shall provide services at the Practice Locations associated
with that Pod.
(c) Form of Agreements. Medical Group shall maintain
------------------
employment agreements with all Medical Group Physicians
(individually, an "Employment Agreement"). Such Employment
Agreements shall be in substantially the form attached
hereto as Annex A-1 with respect to Medical Group
Physicians who are assigned to a Pod that was created prior
to July 31, 1997 (each a "Founding Pod"), and in
substantially the form attached hereto as Annex A-2 with
respect to Medical Group Physicians who are assigned to a
Pod that is created on or after July 31, 1997 (each an
"Additional Pod"), in each case with such changes as may be
agreed upon by PQC and Medical Group and approved by the
Joint Policy Board. Except as otherwise expressly provided
in this Agreement, Medical Group shall not amend any
Employment Agreements nor waive any rights thereunder
without the prior written approval of PQC. Except as
otherwise expressly provided in this Agreement, Medical
Group shall not offer, agree to or amend any salary,
benefit or other compensation terms with a Medical Group
Physician except as expressly approved by PQC in writing.
(d) Medical Group Physician Qualifications. Medical Group
--------------------------------------
shall assure that each Medical Group Physician meets at all
times each of the qualifications set forth in the approved
form of Employment Agreement (subject to any exceptions
that are approved by PQC and the Joint Policy Board in
connection with individual Employment Agreements) and to
any other qualifications reasonably established by the
Medical Advisory Board and PQC. In the event that any
disciplinary, malpractice or other actions are initiated
against any Medical Group Physician, the Medical Group,
through the Medical Advisory Board, shall immediately
inform PQC of such action and shall inform PQC of the
underlying facts and circumstances.
2.4 Licensing and Accreditation. Medical Group, through the Medical
---------------------------
Advisory Board, shall ensure that all Medical Group Physicians maintain such
licenses and certifications as are reasonably necessary for the provision of
medical services by Medical Group and all Medical Group Physicians in a manner
that complies with all laws and applicable third-party payor requirements.
Medical Group shall obtain and maintain such
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<PAGE>
additional licenses and accreditation as the Medical Advisory Board and PQC
mutually determine are advisable. Medical Group shall conduct its medical
practice in compliance with all applicable laws and all applicable contractual
requirements.
2.5 Supervision and Direction of Clinical Staff. (As used in this
-------------------------------------------
Agreement, the term "Clinical Staff" shall mean nurses and any other non-
physician clinical personnel and shall not include Medical Group Physicians or
any other physician.) Medical Group Physicians shall supervise and direct the
Clinical Staff. Medical Group shall assure that all Clinical Staff members
perform only those duties permitted by applicable law and regulation to be
performed by such personnel, and only under such supervision and in such a
manner as permitted by applicable law and regulation.
2.6 Liability Insurance. Medical Group shall assure that each
-------------------
Medical Group Physician maintains in effect a policy of professional liability
insurance in accordance with the Medical Group Physician's employment agreement.
Medical Group shall maintain in effect a policy of comprehensive general
liability and professional liability insurance in the minimum amount of
$1,000,000 per occurrence or claim and $3,000,000 annual aggregate, or such
greater amount as is required by the Joint Policy Board or by law, to cover
Medical Group, Medical Group Physicians and Clinical Staff. In addition,
Medical Group shall maintain in effect (i) comprehensive general liability
insurance with limits and a deductible reasonably determined by PQC and the
Joint Policy Board and (ii) property damage insurance covering all Practice
Locations and equipment with limits and deductibles reasonably determined by PQC
and the Joint Policy Board. Each such policy shall name PQC as an additional
insured. As set forth in Section 3.15, PQC shall be responsible for
administering Medical Group's insurance policies required under this
Section 2.6.
2.7 Medical Records. Medical Group, through its Pods, shall maintain
---------------
and cause each Medical Group Physician to maintain accurate and complete patient
records in accordance with all applicable laws and regulations. Such records
shall be maintained by Medical Group in a manner sufficient to enable PQC, on
behalf of Medical Group, to bill and collect for the services provided by
Medical Group and Medical Group Physicians. Subject to the requirements of
applicable law, Medical Group shall permit PQC to access the patient records to
perform its duties under this Agreement, including, without limitation, billing
and collection services. All patient medical records relating to services
rendered by Medical Group and Medical Group Physicians shall be and remain the
property of Medical Group.
Medical Group hereby grants to PQC the exclusive right to develop and
commercialize any statistical data base or other quality assurance, utilization
review or medical management data base or software program derived from Medical
Group's medical records (collectively, "Medical Data") and agrees to include in
all patient consent forms a mutually agreeable provision permitting the
commercialization of such Medical Data; provided, however, that PQC shall in all
events delete or otherwise disguise any patient identifying information such as
the name or street address of a patient and comply with all applicable laws
concerning patient confidentiality. If PQC determines to commercialize any
Medical Data derived solely from medical records of Medical Group, then PQC
shall offer to Medical Group a right of first refusal to participate in the
effort to commercialize such Medical Data on terms consistent with those set
forth in Section 3.17 with respect to the
-4-
<PAGE>
development of Integrated Health Services. If PQC determines to commercialize
any Medical Data derived from both Medical Group and other PQC-managed physician
practices, PQC shall offer to Medical Group and the other PQC-managed practices
a right of first refusal to participate in the effort to commercialize such
Medical Data. The terms of such commercialization between PQC, on one hand, and
the Medical Group and the other PQC-managed practices (the "Physicians' Share"),
on the other hand, shall be consistent with those set forth in Section 3.17 with
respect to the development of Integrated Health Services. Prior to entering
into any arrangement to commercialize such Medical Data with the Medical Group
and other PQC-managed practices acting jointly, PQC shall solicit the advice of
the Medical Advisory Board, which may make a recommendation to PQC's National
Medical Advisory Board, concerning an allocation of Physicians' Share of
revenue, expenses, profits and losses from such commercialization between
Medical Group and any other medical group or entity also contributing data,
software or other resources to the commercialization effort. Such allocation
shall be made in a manner that is fair and not inconsistent with PQC's
legitimate business objectives and its obligations to its shareholders. The
recommendation, if any, of the National Medical Advisory Board shall be
considered by PQC in reaching its determination concerning any commercialization
of Medical Data and the allocation of proceeds thereof, but ultimate decision-
making authority with respect to such commercialization and any recommended
allocation of proceeds thereof shall remain exclusively within the discretion of
the Board of Directors of PQC and Medical Group shall have no right to any
allocation of proceeds except and to the extent, if any, authorized by the Board
of Directors of PQC after consultation as set forth in this Section 2.7.
2.8 Assignment of Intellectual Property. Medical Group hereby
-----------------------------------
assigns to PQC (i) any Intellectual Property rights that Medical Group acquires
or develops during the term of this Agreement and (ii) agrees to cause each
Medical Group Physician to assign to PQC such Intellectual Property rights as
may be specified in, and subject to the terms of, the applicable employment
agreement, as the case may be.
3. OBLIGATIONS OF PQC
3.1 General. Subject to Medical Group's control of the practice of
-------
medicine, PQC shall have authority and responsibility to conduct, supervise and
manage the day-to-day business operation of Medical Group and shall be
responsible for providing the services set forth in this Section 3 to Medical
Group. All services, facilities, furniture, fixtures and equipment provided by
PQC under this Agreement shall be in a manner consistent with community
standards for a medical practice of similar size. Notwithstanding anything in
this Agreement to the contrary, the parties realize that development of
appropriate reporting systems for financial and utilization information and
similar tools designed to support the efficient management and development of
Medical Group should be a collaborative process between the parties, and
accordingly the parties agree to work together to develop such tools,
particularly during the initial months following the Effective Date.
3.2 Facilities. PQC shall arrange for Medical Group to use the
----------
premises at the locations listed on Schedule 2 which may be amended by PQC from
----------
time to time (collectively, the "Practice Locations"), subject to the terms of
any leases for the premises entered into from time to time by Medical Group or
PQC, as the case may be, and subject to
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<PAGE>
approval of the Joint Policy Board. PQC shall provide or arrange for routine
maintenance and cleaning services for the Practice Locations required to cause
the Practice Locations to satisfy the standard set forth in Section 3.1.
3.3 Equipment and Office Furnishings. PQC shall arrange for Medical
--------------------------------
Group to have use of such equipment and office furnishings reasonably deemed
necessary by PQC, in consultation with the Joint Policy Board, for the operation
of Medical Group at each Practice Location (the "Equipment") in a manner
consistent with community standards for a medical practice of similar
characteristics. PQC shall arrange for reasonable and necessary repair and
maintenance of the Equipment. In connection with PQC's obligation hereunder,
Medical Group shall notify PQC immediately upon becoming aware of any Equipment
in need of repair.
3.4 Personnel and Payroll. PQC shall arrange for the provision to
---------------------
Medical Group of all administrative personnel deemed necessary by PQC, in
consultation with the Joint Policy Board, for the operation of Medical Group
(the "Administrative Staff"). PQC shall also arrange for the provision to
Medical Group of all Clinical Staff reasonably deemed necessary by PQC, in
consultation with Medical Group and the Joint Policy Board, for the efficient,
professional operation of Medical Group. All members of the Clinical Staff
shall be employees of Medical Group. All members of the Administrative Staff on
the Effective Date shall be employees of Medical Group. Subject to the
provisions of Section 2.5 and this Section and in consultation with Medical
Group and the Joint Policy Board, PQC shall be responsible for recruiting,
hiring, discharging and determining the compensation, benefits and conditions of
employment of the Administrative Staff and Clinical Staff. PQC shall perform
all payroll and payroll accounting transactions for the Administrative Staff,
the Clinical Staff and the Medical Group Physicians. Any member of the
Administrative Staff and Clinical Staff may, upon assignment by PQC following
consultation with the affected Pods, provide services to more than one (1) Pod.
If any Medical Group Physician is dissatisfied with the services of any employee
who provides services for such Medical Group Physician at a Practice Location,
PQC, after consultation with the Joint Policy Board, shall in good faith
determine whether the performance of that employee could be brought to
acceptable levels through counsel and assistance, or whether the employment of
such employee should be terminated. If PQC determines to retain such employee
and the Medical Group Physician is still dissatisfied with such employee's
services after a two (2) month period, PQC shall either relocate such employee
or otherwise cease to use such employee unless PQC reasonably determines that
such termination may expose Medical Group to liability.
3.5 Borrowings.
----------
(a) All borrowings of Medical Group shall be subject to prior
approval by the Joint Policy Board. Upon receipt of such
approval to borrow funds on behalf of Medical Group, PQC
shall arrange for such borrowing on behalf of Medical Group
on terms approved by the Joint Policy Board pursuant to
Section 6. 1(b)(i) and in accordance with the Practice
Expense definition set forth provisions in Section 10.27 of
Appendix A. In addition to or in lieu of the foregoing, and
subject always to prior
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<PAGE>
approval by the Joint Policy Board, PQC may make loans to
Medical Group from time to time to fund capital
expenditures or working capital of the Medical Group, in
each case on such terms and conditions as are agreed upon
by the parties and the Joint Policy Board. The making of
any such loan shall be at the sole discretion of PQC
provided that PQC shall commit to fund loans for working
capital purposes of the Medical Group in an amount
determined from time to time by the Joint Policy Board
which amount shall not exceed $1,000,000.
(b) In the event that during the Fiscal Periods ended December
31, 1997 and December 31, 1998, Medical Group does not
receive distributions with respect to a Founding Pod under
Appendix B hereto equal to the full Baseline Amount (as
defined in Section 10.2 of Appendix A) (minus the amount
necessary to pay all Deductible Expenses) due to (a) a
failure by PQC to assist Medical Group in establishing
additional revenue sources from services other than
professional services so as to increase Practice Revenues,
or (b) such other cause as may be approved by the Joint
Policy Board, PQC shall loan to Medical Group with respect
to the Founding Pods an amount not to exceed an aggregate
of $1,000,000 at any one time outstanding on a non-interest
bearing basis to cover such shortfalls in Baseline Amount,
and in no event shall PQC Direct Expenses be included in
determining whether a shortfall in Baseline Amount exists
(the "Loan"). The Loan shall be carried on the balance
sheet of Medical Group and shall be repaid in successive
Fiscal Periods from the first available dollars of Net
Margin allocable to Medical Group with respect to the
Founding Pods. In the event PQC undertakes a public
offering of securities at any time prior to which the Loan
has been repaid in full, the parties agree to consider in
good faith whether interest on the Loan should be assessed
at a fair market interest rate in order to comply with then
applicable health care laws.
3.6 Supplies and Inventory. PQC shall be responsible for all
----------------------
inventory systems of Medical Group at each Practice Location and for the
ordering, purchasing and maintenance of all supplies and inventory necessary for
the operation of Medical Group. All drugs shall be purchased and maintained by
Medical Group or, at PQC's discretion and to the extent consistent with
applicable law, on behalf of Medical Group by PQC.
3.7 Contracts. PQC shall negotiate and administer contracts for
---------
equipment, materials, supplies and data processing services for the Medical
Group and for each Pod. PQC shall seek, review, evaluate and negotiate Payor
Contracts on behalf of Medical Group. Medical Group agrees to enter into and be
bound by all such Payor Contracts negotiated on its behalf by PQC; provided,
however, that any such Payor Contract must be approved in advance by the Joint
Policy Board in the manner contemplated by Section 6.1. The Payor Contracts
listed on Schedule 3.7 shall be deemed to be approved by the Joint Policy Board.
-------- ---
If required by applicable law, such contracts will be entered into in the name
of Medical Group. PQC shall arrange for administrative support appropriate to
fulfill reporting requirements under Payor Contracts, such as eligibility
verification and financial and utilization reporting.
-7-
<PAGE>
3.8 Budgets.
-------
(a) General Preparation Principles.
------------------------------
(i) PQC, acting through the Operating Manager in cooperation with a
Physician representative (the "Representative") of the Pod, shall
have responsibility for the preparation of budgets for each Pod (a
"Pod Budget").
(ii) Each Pod Budget shall consist of an operating budget (revenues and
expenses) and an annual capital expenditures budget, prepared on an
accrual basis of accounting and in conformity with generally accepted
accounting principles.
(iii) PQC shall prepare, with input from the Joint Policy Board, budget
guidelines ("Budget Guidelines") that PQC shall then follow in the
preparation of each Pod Budget. Examples of possible Budget
Guidelines include but are not limited to the following:
(A) each Pod Budget shall be constructed on management
policies that enable the Pod to achieve its financial
goals (profit from operations);
(B) each Pod Budget shall provide specific detail sufficient
for the Pod Physicians and PQC to evaluate and prioritize
changes in programs and capital expenditures;
(C) each Pod Budget period shall be for a twelve (12) month
period ending December 31 or, for the initial Pod Budget
for each newly formed Pod, such shorter period ending
December 31 as is appropriate; and
(D) each Pod Budget shall be prepared on a pre-physician
compensation, pre-management fee and pre-tax basis.
(iv) PQC shall prepare the initial Pod Budgets for each Pod using
available historical financial information. PQC shall follow the
Budget Guidelines and identify budget preparation assumptions that
deviate from the acquired medical group's historical financial
information. Subsequent Pod Budgets shall be prepared in a similar
manner by PQC (on the basis of the prior year's results) and take
into account deviations from the Pod Budget that occurred in the
prior year.
(b) Approval of Budgets. The Joint Policy Board shall have the
-------------------
responsibility for and authority to approve each Pod Budget. PQC
shall submit each Pod Budget to the Joint Policy Board for approval
on a timely basis. Once approved in accordance with this Section
3.8(b),
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<PAGE>
all of PQC, Pod and Pod Physicians shall be bound by the terms of the
approved Pod Budget for the following twelve (12) month period or
such lesser period as may be provided for in the Budget Guidelines,
subject only to any modifications suggested by PQC and/or Pod
Physicians and approved by the Joint Policy Board. At any point
during a Fiscal Period, including for example if the actual Physician
Pod Practice Revenues less actual Physician Pod Practice Expenses is
below budgeted levels for such Physician Pod or if there is an actual
or projected negative Net Margin the Joint Policy Board may review
the budgets for such Physician Pod and make such changes to such
budgets, including the aggregate Pod Distributions (as defined in
Section 3 of Appendix A to the Employment Agreements), as the Joint
Policy Board deems to be appropriate. All capital and operating
budgets, and changes thereto, also shall be subject to the approval
of PQC. The Joint Policy Board shall not unreasonably withhold its
approval of a Pod Budget but if such approval is not forthcoming, the
following process shall prevail so that the Pod may remain open to
treat patients:
(i) If, prior to the commencement of any budget period, the Joint Policy
Board has not yet approved the Pod Budget, then PQC and Medical Group
will work diligently in good faith to obtain such approval. Until
such approval is obtained, the following procedures shall apply:
(A) as to any disputed line items, the immediately preceding
budget period's Pod Budget shall be controlling until such
time, if any, as agreement is reached on the amounts to be
allocated to such disputed line items, except that:
(1) non-recurring extraordinary items shall not be
continued from the Pod Budget for the immediately
preceding budget period;
(2) if items such as lease payments or payroll taxes are
subject to an automatic increase, such increases
shall be effective at the increased rate; and
(3) for items such as personnel salaries, the total
salary number shall be adjusted to take into account
changes in the number and classifications of
personnel members employed or contracted; and
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<PAGE>
(B) as to any line items which are not in dispute, the
new Pod Budget submitted by PQC shall be effective
for the new budget period.
(c) Reporting. PQC shall establish and administer the accounting
---------
procedures and control for Medical Group and the Pods in
accordance with generally accepted accounting principles. PQC
shall have the responsibility to prepare and submit to each Pod
and to the Joint Policy Board as soon as practicable after the
end of each month, but in any event within forty-five (45) days
of the end of each month, management reports designed to convey
Pod and Medical Group financial performance for the month and
on a year-to-year basis. PQC shall design the management
reports to highlight actual financial performance and actual to
budget variances in the Pod's financial performance.
Additionally, PQC shall from time to time attempt to identify,
discuss with the Joint Policy Board and implement appropriate
management intervention to counter adverse financial trends.
3.9 Preparation of Tax Returns. PQC shall prepare any and all
--------------------------
required tax returns of Medical Group but shall not have responsibility for
preparation of individual tax returns or other tax returns (e.g., IRS forms W-
2s, 5500s, etc.) for any Medical Group Physician or for any entity of which such
Medical Group Physician was a shareholder, partner, member, or employee prior to
the date of execution of this Agreement.
3.10 Charges. PQC shall advise Medical Group on the establishment,
-------
maintenance and revision of a schedule of charges for physician services,
ancillary services, supplies, medication and all other services rendered by
Medical Group through each Pod. Revisions to the fee schedule of a Pod must be
approved by the Joint Policy Board.
3.11 Billing and Collection. PQC shall provide or arrange for such
----------------------
billing and collection services as are reasonably necessary to attempt to
collect in a timely manner all Practice Revenues, including without limitation
all allowable charges resulting from Medical Group's provision of all billable
items and services.
3.12 Payment of Accounts and Indebtedness.
------------------------------------
(a) PQC shall review the payables of Medical Group and shall cause
payment of any undisputed amounts thereof to be made out of the
funds of Medical Group. In addition to billing, collecting and
payment services, PQC shall manage the cash and cash equivalents
of Medical Group.
(b) All Practice Revenues shall be deposited in one or more bank
accounts maintained in the name of and owned by Medical Group
(collectively, the "Medical Group Account") but managed solely
by PQC in accordance with the terms of this Agreement and the
applicable Pod's budgets. A separate Medical Group Account shall
be established for
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<PAGE>
the Founding Pods (the "Founding Pod Medical Group Account") and
the Additional Pods (the "Additional Pod Medical Group
Account"). The bank in which the Medical Group Account is
maintained shall be federally insured and shall be selected by
PQC subject to approval by the Joint Policy Board. A
representative of PQC shall be the authorized signatory for the
Medical Group Account. Medical Group hereby appoints the Medical
Group Shareholder as an additional authorized signatory for the
Medical Group Account. Medical Group covenants that it will not
permit any funds to be withdrawn from the Medical Group Account
except as authorized by PQC in accordance with the terms of this
Agreement.
3.13 Power of Attorney for Billing and Payment of Accounts. Medical
-----------------------------------------------------
Group hereby exclusively authorizes PQC to take the following actions for and on
behalf of and in the name of Medical Group throughout the term of this Agreement
and thereafter in accordance with Section 5:
(a) bill, in Medical Group's name, under its provider number
when obtained and on its behalf, and until such time as
Medical Group has obtained its provider number, bill, in
the Medical Group Physicians, names under their respective
provider numbers and on their behalf, all claims (including
co-payments due from patients) for reimbursement or
indemnification from all other Payors, fiscal
intermediaries or patients for all covered items and
services provided by Medical Group or by the Medical Group
Physicians to patients;
(b) take possession of and endorse in the name of the Medical
Group Physicians or Medical Group, all cash, notes, checks,
money orders, insurance payments, and any other instruments
received as payment of accounts receivable (and Medical
Group will cause an individual Medical Group Physician who
receives any payments for the benefit of Medical Group
directly, to deliver such amounts promptly to PQC for
deposit in the Founding Pod Medical Group Account or the
Additional PQC Medical Group Account, as the case may be,
and Medical Group covenants to transfer and deliver
promptly to PQC for deposit in the applicable Medical Group
Account, all funds received by Medical Group from patients
or Payors for medical services), all such funds to be
deposited directly into a Medical Group Account and to be
applied in a manner consistent with this Agreement;
(c) deposit all collections directly into the applicable
Medical Group Account and to make withdrawals from such
Medical Group Account for such purposes as are permitted by
this Agreement;
(d) in Medical Group's name and on its behalf, and in the
Medical Group Physicians' names and on behalf of each of
them, as necessary, collect and receive all accounts
receivable generated by such billings and
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<PAGE>
claims for reimbursement, place such accounts for
collection, settle and compromise claims and institute
legal action for the recovery of accounts (it being agreed
that Medical Group shall write-off amounts of uncollected
billings at the request of a Medical Group Physician to the
extent contemplated in the Employment Agreement); Medical
Group shall cooperate fully with PQC in facilitating such
collections and in collecting accounts receivable
transferred to PQC for deposit in the Medical Group Account
by Medical Group, including endorsement of checks and
delivery to PQC of all revenues in whatever form, received
from patients or Payors on their behalf, and completion of
all forms necessary for the collection of said monies; and
(e) sign checks on behalf of Medical Group and make withdrawals
from the Medical Group Accounts for payments specified in
this Agreement and as requested from time to time by
Medical Group.
In addition to the foregoing, Medical Group, to the extent not
prohibited by law, hereby grants to PQC an exclusive power of attorney and
appoints PQC its exclusive true and lawful attorney in fact to take each of the
actions specified in Sections (a) through (e) above for and on behalf of and in
the name of Medical Group throughout the term of this Agreement and thereafter
in accordance with Section 5.
Upon request of PQC, Medical Group shall, and shall cause each of the
Medical Group Physicians to, execute and deliver to PQC and to each financial
institution wherein Medical Group or PQC maintains an account, such additional
documents or instruments (including one (1) or more powers of attorney naming
PQC as its or their, as the case may be, exclusive true and lawful attorney in
fact) as may be necessary or desirable to evidence or effect the authority or
the power of attorney or both granted to PQC pursuant to this Section.
3.14 Other Billings and Charges. PQC shall serve as Medical Group's
--------------------------
exclusive billing agent. Medical Group covenants that neither it nor any
Medical Group Physician shall bill or submit a statement of charges to, or enter
into any agreement or, except in the event of an emergency, any undertaking
with, any patient, third person or entity for the provision of items and
services (with or without consideration), nor shall it make any surcharge for
care without the prior written authorization and approval of PQC.
3.15 Insurance. PQC, on behalf of Medical Group, shall negotiate,
---------
obtain, and maintain with such licensed insurance companies as are reasonably
acceptable to the Joint Policy Board the policies of general liability, fire and
property insurance that satisfy the requirements of Section 2.6. PQC shall
furnish certificates of insurance to Medical Group evidencing the coverage set
forth in this section upon request by Medical Group. Subject to approval by the
Joint Policy Board, PQC may arrange for a group professional liability insurance
policy covering Medical Group Physicians that would satisfy Medical Group's
obligations under 2.6. The liability insurance coverage maintained as of the
date of this Agreement by PQC with respect to its own operations is set forth on
Schedule 3.15. PQC shall advise the Joint Policy Board of any material decrease
- -------- ----
in the amount or scope of such insurance coverage.
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<PAGE>
3.16 Other Administrative Services. In addition to the business and
-----------------------------
administrative services specifically described above in this Section 3, PQC
shall be responsible for providing all other administrative services necessary
to the business operations of Medical Group, including without limitation human
resource services, administrative support for Medical Group's recruitment
efforts, management information systems (including development on a uniform data
base across all Pods), accounting services and systems, and advertising, sales
and marketing services.
3.17 Development of Integrated Health Services. Neither PQC nor any
-----------------------------------------
Affiliate shall provide Integrated Health Services in the Geographic Area unless
PQC gives Medical Group the option to be the exclusive provider of these
services, as provided in this Section. To that end, if PQC or one (1) of its
Affiliates proposes to provide any Integrated Health Service in the Geographic
Area, PQC shall notify Medical Group and the Joint Policy Board of the nature of
the service and the terms upon which PQC or its Affiliate proposes to provide
the service, and the Joint Policy Board, on behalf of Medical Group, shall have
forty-five (45) days during which to elect to participate in the provision of
such Integrated Health Service in the Geographic Area on such terms as are
mutually acceptable to the Joint Policy Board and PQC. Any such proposal shall
specify the proposed manner in which the net revenues (meaning all receipts from
such Integrated Health Services less all expenses attributable to such
Integrated Health Services, determined in accordance with generally accepted
accounting principles) shall be allocated between Medical Group and PQC, but to
the extent permitted by law in any event such proposal shall offer to Medical
Group the right to receive an allocation to the Variable Distribution Pool (as
defined in the Employment Agreements) of at least fifty percent (50%) of the net
revenues attributable to such Integrated Health Service provided that as a
condition thereof Medical Group shall agree that a percentage of any net loss
attributable to such Integrated Health Service equal to the percentage of net
revenues attributable to such Integrated Health Service shall be offset against
amounts otherwise allocable to Medical Group under Appendix B in any one (1) or
more Fiscal Periods thereafter occurring. PQC agrees to use its reasonable
efforts to structure any proposal for the provision of Integrated Health
Services in the Geographic Region in a manner so that the allocation to Medical
Group contemplated by the forgoing sentence is in accordance with applicable
law. Medical Group shall not agree to participate in any Integrated Health
Service or fail to elect to participate in such Integrated Health Service except
as approved by and on such terms as have been approved by the Joint Policy
Board. If Medical Group does not elect to participate in such Integrated Health
Service in the Geographic Area within such forty-five (45) day period, PQC may,
but shall not be obligated to, provide such Integrated Health Service directly
or through another Affiliate or subsidiary (but in no event through or with any
outside third party without the prior consent of the Joint Policy Board) and
Medical Group shall have no right to participate in the revenues or income from
such Integrated Health Service; provided, however, that PQC shall not directly
-------- -------
or indirectly provide such Integrated Health Service if within such forty-five
(45) day period the Medical Advisory Board reasonably determines and notifies
PQC that the provision of such services have not been determined to be
clinically efficacious, are clinically dangerous, or would otherwise adversely
affect the reputation of PQC and/or Medical Group as to quality of care and;
provided, further, that PQC shall not directly or indirectly provide any
- -------- -------
Integrated Health Services in the Geographic Area if all of the PQC
Representatives on the
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<PAGE>
Joint Policy Board voted against Medical Group participating in such Integrated
Health Service.
3.18 Advertising and Public Relations. PQC shall design and
--------------------------------
implement local public relations and advertising programs, subject to approval
by the Joint Policy Board. In the event that there is any adverse incident
involving Medical Group or any Medical Group Physician or patient, any public
statement and announcement by or on behalf of Medical Group or any Medical Group
Physician shall be approved in advance by PQC.
4. MANAGEMENT FEE; FINANCIAL ARRANGEMENTS
In consideration for the services furnished by PQC to Medical Group
under this Agreement and in order to encourage the cost-effective management of
the Medical Group, PQC shall be entitled to receive, and Medical Group hereby
agrees to pay PQC, an aggregate management fee calculated under the formulas set
forth in Appendix B-1 with respect to the Founding Pods and B-2 with respect to
the Additional Pods hereto.
5. TERM AND TERMINATION
5.1 Term. The term of this Agreement shall commence on the date
----
first written above and shall continue until the date forty (40) years
thereafter, unless terminated earlier in accordance with this Agreement. After
the expiration of the initial forty (40) year term, this Agreement shall
automatically renew for successive forty (40) year terms unless sooner
terminated in accordance with the provisions hereof.
5.2 Termination on Default.
----------------------
(a) Either party shall be entitled to terminate this Agreement
if the other party fails to perform in any material respect
any material obligation required of it hereunder, and such
default continues for sixty (60) days after the giving of
written notice by the nondefaulting party, specifying the
nature and extent of such default; provided, however, that
-------- -------
the non-defaulting party shall not be entitled to terminate
this Agreement if the defaulting party commences the cure of
such default within the first sixty (60) day period and
thereafter diligently and in good faith continues to cure
such default until completion.
(b) Termination at election of PQC. PQC shall be entitled to
terminate this Agreement upon written notice to Medical
Group if:
(i) a law firm with a nationally recognized expertise in health
care law and acceptable to PQC and the Joint Policy Board
renders an opinion to PQC, with a copy provided to the Joint
Policy Board, stating that a material provision of this
Agreement is in violation of applicable law, and the parties
do not agree to amend this Agreement pursuant to Section
9.14 hereof to cure such violation; or
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<PAGE>
(ii) any court or regulatory agency enters an order finding a
material provision of this Agreement is in violation of
applicable laws and the parties do not agree to amend this
Agreement pursuant to Section 9.14 hereof to cure such
violation; or
(iii) PQC is prevented by Medical Group or any person under the
Medical Group's direction or control, from entering any
material portion of the Pod Practice Locations considered on
any aggregate basis, and such inability to enter such
premises continues for more than forty-eight (48) hours
after notice thereof to the Joint Policy Board.
(c) Termination by Medical Group. Notwithstanding Section
5.2(a), Medical Group may terminate this Agreement (if and
only if such termination has been approved by the Joint
Policy Board) for the reasons set forth below:
(i) upon written notice to PQC of the failure of PQC to remit
any funds or make any payments required under this Agreement
when due and continued failure to remit those funds or make
the payment after thirty (30) days notice of such failure to
PQC unless the amount of such payment is being contested in
good faith; or
(ii) a law firm with a nationally recognized expertise in health
care law and acceptable to PQC and the Joint Policy Board
renders an opinion to the Medical Group, with a copy
provided to the Joint Policy Board, stating that a material
provision of this Agreement is in violation of applicable
law, and the parties do not agree to amend this Agreement
pursuant to Section 9.14 hereof to cure such violation; or
(iii) any court or regulatory agency enters an order finding a
material provision of this Agreement is in violation of
applicable laws, and the parties do not agree to amend this
Agreement pursuant to Section 9.14 hereof to cure such
violation.
Medical Group shall take appropriate action to terminate this
Agreement pursuant to this Section (c) if recommended by the Joint
Policy Board.
5.3 Effect of Termination. Upon termination of this Agreement pursuant
---------------------
to this Section 5:
(a) PQC and Medical Group shall cooperate and continue to perform
their obligations under this Agreement as may be necessary to
ensure the provision of proper care to patients under
treatment, consistent with applicable law concerning
continuation of benefits under Payor Contracts, until
appropriate alternative arrangements are made.
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<PAGE>
(b) Medical Group and PQC shall cooperate to ensure the
appropriate billing and collection for all health care items
and services provided by Medical Group prior to the effective
date of termination, and any proceeds of such billings or
collections shall be retained by Medical Group and/or paid to
PQC in accordance with the terms of this Agreement.
(c) Any amounts due and owing to PQC under any loan to Medical
Group shall become immediately due and payable, subject to
offset for amounts owed hereunder by PQC to Medical Group.
(d) Medical Group shall reimburse PQC for all drug and
pharmaceutical inventory retained by Medical Group following
termination to the full extent of funds advanced by PQC for
the purchase of such inventory pursuant to Section 3.6.
(e) Provisions of this Agreement shall survive any termination if
so provided herein or if necessary or desirable fully to
accomplish the purposes of such provision.
(f) PQC shall use its reasonable efforts to have Medical Group
continue to participate in any Payor Contracts with respect to
which PQC and not Medical Group is the contracting party.
6. JOINT POLICY BOARD; CERTAIN PROVISIONS REGARDING GOVERNANCE OF MEDICAL
GROUP
6.1 Joint Policy Board. Medical Group and PQC shall establish and
------------------
maintain the Joint Policy Board, which shall have the representation,
responsibility and authority described below.
(a) Representation. For purposes of this Agreement, "Physician
--------------
Members" means only those Medical Group Physicians whose
Employment Agreement permits them to share in Net Revenues as
provided in Appendix B-1 or B-2 and, for purposes of this
Section 6.1, such other non-physician healthcare providers
that are employees of Medical Group as the Joint Policy Board
shall designate from time to time. The Joint Policy Board
shall consist of nine (9) individuals: four (4) elected by
plurality vote of the Physician Members (the "Medical Group
Representatives"), at least one of whom must be a primary
care physician and at least one of whom shall be a
specialist; four (4) appointed by PQC (the "PQC
Representatives"), and the President of Medical Group (who
shall serve ex-officio with vote). Each Medical Group
Representative shall be a physician selected until June 30,
2000 for a one year term and thereafter for a three (3) year
term by Physician Members; provided, however, that new
members of the Joint Policy Board shall be selected as of
July 31, 1997 (the "Effective Date"); that
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<PAGE>
with respect to the 12 month period ending on the first
anniversary of the Effective Date two (2) of the Medical
Group Representatives shall be selected by the Founding Pods
and two (2) of the Medical Group Representatives shall be
selected by the Additional Pods; that with respect to the
next succeeding twelve month period, the Medical Group
Representatives shall include at least two (2) Physician
Member assigned to a Founding Pod and at least two (2)
Physician Member assigned to an Additional Pod and, in each
case, selected by the Physician Members of the Founding and
Additional Pods voting as a single group; and that with
respect to any period beginning on or after the second
anniversary of the Effective Date, the Medical Group
Representatives shall be any Physician Member meeting the
above criteria selected by the Founding and Additional Pods
voting as a single group. Each Medical Group Representative
may serve an unlimited number of terms and shall serve until
a successor is selected. The PQC Representatives shall be
appointed from time to time by PQC and shall include the
chief operating officer of Medical Group. The Medical Group
Representatives shall select, from among the physicians who
are members of the Joint Policy Board, the Chair of the Joint
Policy Board. The Medical Director shall be provided with
notice of and shall be entitled to attend meetings of the
Joint Policy Board but shall not be entitled, unless the
Medical Director is also a Medical Group Representative or a
PQC Representative, to vote on any matter before the Joint
Policy Board.
(b) Authority and Responsibility. The Joint Policy Board shall be
----------------------------
responsible for periodically reviewing and making any
appropriate recommendations to PQC and the Board of Directors
of Medical Group regarding the operations of Medical Group,
and, to the extent expressly provided in this Agreement,
shall have the right to approve certain decisions by Medical
Group and PQC. Any amendment of this Agreement that would
limit or otherwise materially diminish the authority or
responsibility of the Joint Policy Board, including without
limitation any changes to this Section 6 or Appendices B-1 or
B-2, shall require the prior approval of the Joint Policy
Board. In addition, the following actions shall require the
affirmative vote of a majority of the members of the Joint
Policy Board:
(i) approval of all budgets and borrowings pursuant to Section
6.1;
(ii) approval of the number and type of physicians required for
the efficient operation of Medical Group;
(iii) review and approval of all advertising and other marketing of
the services performed by Medical Group;
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<PAGE>
(iv) approval of Integrated Health Services and the scope of
those services to be provided by Medical Group as
contemplated by Section 3.17;
(v) approval of the formation, maintenance and/or termination of
relationships with institutional health care providers and
payors, including Payor Contracts in accordance with Section
3.7;
(vi) approval of all contracts material to Medical Group,
including all amendments to real property leases in effect
as of the date of this Agreement, and all the terms of and
amendments to real property leases entered into after such
date governing the space utilized by any Medical Group
Physician;
(vii) consideration and determination of non-clinical matters
raised by Medical Group Physicians;
(viii) approval of fee schedules and charges;
(ix) approval of business and strategic plans;
(x) approval of the Operating Manager;
(xi) approval of Medical Group's termination of a Medical Group
Physician on the basis of disability;
(xii) approval of any change in the Baseline Amount (as defined in
Section 10.2) to reflect the addition or termination of
Medical Group Physicians; and
(xiii) approval of the modification or waiver of the restrictive
covenants applicable to any Medical Group Physician.
The Joint Policy Board may consult with Medical Group, PQC and any
Medical Group Physician before taking any action specified in this Section
6.1(b), but, except as otherwise provided in this Agreement, neither the
recommendations of Medical Group, PQC nor any Medical Group Physician shall be
binding on the Joint Policy Board. Any determination of the Joint Policy Board
pursuant to (i), (ii), (iii), (iv), (v), (vi), (xii) and (xiii) shall not be
effective unless approved by the Medical Group Shareholder.
(c) Certain Matters Requiring Supermajority Approval.
------------------------------------------------
Notwithstanding anything in Section 6.1(b) to the contrary,
approval of any action with respect to the following matters
shall require the approval of two thirds of the members of
the Joint Policy Board (including during the first two years
after the Effective Date at least one (1) Medical Group
Representative from a Founding Pod and at least (1) Medical
Group Representative from an Additional Pod and thereafter,
at least one Physician Representative):
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<PAGE>
(i) changes in existing physician practice patterns;
(ii) any reimbursement contract providing for compensation to
Medical Group at below market rates;
(iii) the addition of new physicians; and
(iv) any significant budgetary changes or any material changes
in the governance or financial provisions of this Agreement
following a Change in Control Transaction.
(d) Certain Matters Regarding Medical Advisory Board Recommendation.
---------------------------------------------------------------
Notwithstanding anything in this Section 6.1 to the contrary, the
Joint Policy Board shall not be authorized to take any action with
respect to the following matters unless requested by the Medical
Advisory Board:
(i) referrals of patients' accounts to collection agencies and
development and execution of courtesy and write-off
policies;
(ii) technical procedures pursued by a Medical Group Physician
(as long as appropriate credential requirements are
satisfied);
(iii) non-monetary aspects of quality assurances and
credentialing decisions, including dismissal for quality
assurance reasons of any healthcare professional; and
(iv) the determination for quality assurance or credentialing
reasons to terminate any Employment Agreement in the form
attached hereto as Exhibit A-2 pursuant to Sections
8(c)(i), (B), (C), (D), (E), (F), (G), (K) or (L) of such
Employment Agreement; provided, however, that a
determination that termination of an Employment Agreement
pursuant to Sections 8(c)(i)(C), (F), (G), (K) or (L) of
such Employment Agreement is in the best interests of
Medical Group for any other reason, including the
reputation, financial results or financial condition of
Medical Group, may be made by the Joint Policy Board
without recommendation by the Medical Advisory Board.
(e) Medical Advisory Board Recommendations Regarding New Physicians.
---------------------------------------------------------------
(i) Notwithstanding anything in this Section 6.1 to the contrary,
the Joint Policy Board shall not authorize the employment of any
additional physicians (other than in connection with the merger of
a physician group into Medical Group) unless the Joint Policy Board
shall have sought the recommendation of the Medical Advisory Board
whether the addition of such physicians is advisable on the basis
of the reputation and ability of the proposed physician and the
compatibility of such physician with the existing Medical Group
Physicians with the same
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<PAGE>
area of practice. In making its recommendation to the Joint Policy
Board, the Medical Advisory Board shall consult with Medical Group
Physicians in similar practice areas as the proposed additional
physician. If the Medical Advisory Board recommends the physician,
the Joint Policy Board shall be free to approve an Employment
Agreement with such physician. If the Medical Advisory Board
recommends that a physician not be approved by the Joint Policy
Board, the Medical Advisory Board must recommend to the Joint
Policy Board, within six months of the initial request by the Joint
Policy Board, another physician with the same speciality or
practice area and whose Baseline Net Adjusted Billings would be
comparable to the physician proposed by the Joint Policy Board who
is prepared to become a Medical Group Physician. The Medical
Advisory Board shall act expeditiously in considering whether to
recommend any physician to the Joint Policy Board. If the Medical
Advisory Board fails to make such a recommendation within the six
month period, the Joint Policy Board shall be free to offer
employment to the physician originally proposed to the Medical
Advisory Board if Medical Advisory Board recommended against such
physician on the basis of lack of compatibility with existing
Medical Group Physicians or the Medical Advisory Board made no
determination.
(ii) Notwithstanding anything in this Section 6.1 to the contrary,
the Joint Policy Board shall not authorize the employment of any additional
physicians in connection with the merger of a physician group into Medical
Group unless the Joint Policy Board shall have sought the recommendation of
the Medical Advisory Board whether the addition of such physicians is
advisable on the basis of the reputation and ability of the proposed
physician(s) and the compatibility of such physician(s) with the existing
Medical Group Physicians with the same area of practice. The Medical
Advisory Board must make a recommendation to approve or reject the
employment of such physician(s) within 30 days of being advised of the
proposed transaction. In reaching its recommendation, the Medical Advisory
Board shall only consider the reputation and ability of the proposed
physicians and the compatibility of such physicians with the existing
Medical Group Physicians with the same area of practice. The Medical
Advisory Board may consult with Medical Group Physicians in similar
practice areas as the proposed additional physician. If the Medical
Advisory Board recommends the physician(s) or fails to make a
recommendation with the thirty-day period, the Joint Policy Board shall be
free to approve Employment Agreement(s) with such physician(s).
(f) Voting; Procedures.
------------------
(i) Each Medical Group Representative shall have one (1) vote and
shall have the right to grant his proxy to another Medical Group
Representative. Each of the PQC Representatives and the President
of Medical Group shall have one (1) vote and shall
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<PAGE>
have the right to grant his proxy to another member of the Joint
Policy Board. Except as provided in clause (c)(ii) below, no
action of the Joint Policy Board shall be effective unless
authorized by a majority (or, in the case of matters set forth in
Sections 6.1(c), by two-thirds) of the members of the Joint
Policy Board. A quorum of the Joint Policy Board shall consist of
at least three (3) Medical Group Representatives and three (3)
PQC Representatives, present in person or by proxy; provided,
however, that if a meeting is called and a quorum cannot be
obtained within thirty (30) days of notice of such meeting, then
the quorum requirement shall be automatically reduced for the
first meeting thereafter to a majority of the members of the
Joint Policy Board, present in person or by proxy.
(ii) The Joint Policy Board shall meet from time to time when a
meeting is called by the chair or by three (3) or more members of
the Joint Policy Board upon at least five (5) days' written
notice to the other members of the Joint Policy Board, which
notice requirement may be waived with respect to any member of
the Joint Policy Board by the attendance at such meeting. The
Joint Policy Board may also hold meetings by telephone or act by
written consent according to procedures established by the Joint
Policy Board. Minutes shall be kept of all formal actions taken
by the Joint Policy Board. The Joint Policy Board may appoint a
secretary who is not a member of the Joint Policy Board.
6.2 Medical Advisory Board. A Medical Advisory Board shall be
----------------------
established, which shall be responsible for: (i) providing medical advice to
Medical Group on managed care contracting, including oversight of all
utilization review, risk management, and peer review functions required by any
Payor Contract; (ii) developing and disseminating, subject to Medical Group's
approval, medical protocols and quality and outcome measures for Medical Group
and the Physicians; (iii) advising Medical Group with respect to the number and
qualifications of physicians required for the efficient operation of Medical
Group's practice; (iv) overseeing the recruitment by Medical Group and
credentialing of new physicians; and (v) whether to recommend that the Joint
Policy Board consider the matters set forth in Section 6.1(d). The Medical
Advisory Board shall consist of seven (7) members. The members of the Medical
Advisory Board shall be the Medical Director of Medical Group and six (6) other
licensed physicians elected by a plurality vote of the Physician Members, of
whom three (3) shall be primary care physicians and three (3) shall be engaged
in a specialist practice. The Medical Director of Medical Group shall act as
chair of the Medical Advisory Board.
6.3 The President of Medical Group.
------------------------------
(a) Medical Group shall appoint, in the manner set forth in (b)
below, a physician to act as President of Medical Group who shall
work in
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<PAGE>
conjunction with PQC in order to implement the policies
established by the Joint Policy Board. Such individual shall also
be an employee of PQC. Subject to the direction and supervision
of the Medical Group Shareholder, the duties of the President
shall include, without limitation:
(i) interfacing with representatives from the national corporate
offices of PQC;
(ii) implementing the business and strategic plans of Medical Group
and overseeing the business operation of Medical Group; and
(iii) working with PQC representatives in negotiating and interfacing
with Payors and other regulatory agencies.
The Medical Group Shareholder shall determine the salary and fringe
benefits of the President.
(b) Subject to the By-Laws of Medical Group (which shall not be
amended to reduce the rights of the Medical Group Physicians
under this section without the prior consent of a majority of the
Physician Members), the Physician Members shall nominate by
plurality vote three (3) candidates, who shall be Physician
Members, for the position of President, and the Medical Group
Shareholder shall select one (1) candidate from among such
nominees to be President. In the event that there is a vacancy in
the position of President at any time for any reason, the Medical
Group Shareholder shall have the authority to appoint a person to
serve as interim President until another person is duly appointed
in accordance with the above specified procedures. The President
shall serve part-time in this capacity until such time as his
responsibilities warrant full-time employment status.
Notwithstanding the foregoing, the President shall be a Medical
Group Physician active in the practice of medicine, until such
time as the President's responsibilities warrant full-time
employment status with the Medical Group. Medical Group may
remove the President at any time in the event that the employment
agreement between the President and PQC is terminated, but in
such event the position of President may be filled by Medical
Group Shareholder for an interim period only until a successor to
the position of President has been appointed in accordance with
the provisions of this Section 6.3(b). Medical Group shall assist
in the development of procedures for the nomination, appointment
and replacement of the President in such a manner as to ensure a
smooth transition period in the medical practice of any
individual who assumes the position of the President.
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<PAGE>
6.4 The Medical Director of Medical Group.
-------------------------------------
(a) Medical Group shall hire and appoint a physician to act as Medical
Director to provide guidance and advice to Medical Group on clinical
issues. The duties of the Medical Director shall include, without
limitation:
(i) interfacing with the National Medical Advisory Board of PQC and
representing Medical Group on the PQC National Medical Advisory Board;
(ii) chairing the Medical Advisory Board;
(iii) providing medical advice on managed care contracting by Medical Group;
(iv) leading the development and dissemination of medical protocols, quality
and outcome measures; and
(v) overseeing the recruitment and credentialing of new physicians.
The Medical Group Shareholder shall determine the salary and fringe benefits of
the Medical Director.
(b) Subject to the By-Laws of Medical Group (which shall not be amended to
reduce the rights of the Medical Group under this Section without the
prior consent of a majority of Physician Members), the Physician Members
shall nominate by plurality vote three (3) candidates who shall be
Physician Members for the position of Medical Director, and the Medical
Group Shareholder shall select one (1) candidate from among such nominees
to be Medical Director. In the event that there is a vacancy in the
position of Medical Director at any time for any reason, the Medical
Group Shareholder shall have the authority to appoint a person to serve
as interim Medical Director until another person is duly appointed in
accordance with the above specified procedures. The Medical Director
shall serve part-time in this capacity until such time as his
responsibilities warrant full-time employment status. Notwithstanding the
foregoing, the Medical Director shall be a Medical Group Physician active
in the practice of medicine, until such time as the Medical Director's
responsibilities warrant full-time employment status with the Medical
Group. Medical Group shall assist in the development of procedures for
the nomination, appointment and replacement for the Medical Director in
such a manner as to ensure a smooth transition period in the medical
practice of any individual who assumes the position of the Medical
Director. The Physician Members shall have the right to remove the
Medical Director upon a two-thirds (2/3) vote of all Physician Members,
but in such event the position of
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<PAGE>
Medical Director may be filled only in accordance with the provisions of
this Section 6.4(b).
6.5 Operating Manager. Subject to the reasonable approval of the Joint
-----------------
Policy Board, PQC shall retain a full-time non-physician employee to serve as an
operating manager (the "Operating Manager"). The Operating Manager shall manage
and administer all of the day-to~day business transactions necessary for the
operation of Medical Group. PQC shall determine the salary and fringe benefits
of the Operating Manager, who shall be an employee of PQC. At the direction,
supervision and control of PQC, the Operating Manager shall implement the
policies established by Medical Group and the Joint Policy Board and shall
generally perform the duties and have the responsibilities of an administrator.
7. INTELLECTUAL PROPERTY
Medical Group acknowledges that PQC will continually develop Intellectual
Property and that Medical Group may have access to and use Intellectual Property
during the term of this Agreement. Medical Group agrees that, except as
required for the proper operation of the medical practice in accordance with
applicable law and the terms of this Agreement, it will not, directly or
indirectly, use or disclose any Intellectual Property. Medical Group
understands and agrees that this restriction will continue to apply after the
termination of this Agreement for any reason.
Medical Group agrees that all Intellectual Property to which it has access
as a result of its relationship with PQC under this Agreement is and shall
remain the sole and exclusive property of PQC. Except as required for the
proper operation of the medical practice in accordance with applicable law and
the terms of this Agreement, Medical Group will not copy any documents, tapes or
other media containing Intellectual Property ("Documents"). Medical Group will
return to PQC immediately after this Agreement terminates, and at such other
times as may be specified by PQC, all Documents and copies of Documents.
Medical Group shall use its best efforts to assure that all Medical Group
Physicians and other employees and agents of Medical Group are aware of and
comply with the restrictions on disclosure and use of Intellectual Property set
forth in this Section. (For purposes of this Section, references to PQC shall
be deemed to refer to PQC and any Affiliates.)
8. RESTRICTIVE COVENANTS
The parties recognize that the services to be provided by PQC hereunder
shall be feasible only if Medical Group operates an active medical practice to
which the physicians associated with Medical Group devote their full time and
attention. Accordingly, the parties hereto agree as follows:
8.1 Noncompetition. During the term of this Agreement, Medical Group
--------------
shall not, without the prior written consent of PQC, establish, operate or
provide physician or other medical services at any medical office, clinic or
other health care facility providing services similar to those provided by
Medical Group, PQC or any Affiliate of PQC, within the Geographic Area.
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<PAGE>
8.2 Ancillary Enterprise. During the term of this Agreement, except as
--------------------
permitted by this Agreement, Medical Group shall not provide any of the
additional services that have been approved by the Joint Policy Board and PQC as
"Integrated Health Services" or any other services provided by PQC. For two
(2) years after termination of this Agreement, except as permitted by this
Agreement, Medical Group shall not provide any of the additional services that
have been approved by the Joint Policy Board and PQC as "Integrated Health
Services" or any other services provided by PQC, within fifteen (15) miles of
any Pod Practice Location.
8.3 Non-solicitation of Employees and Patients. During the term of this
------------------------------------------
Agreement and for a two (2) year period thereafter, Medical Group shall not
recruit, solicit or induce or attempt to induce, any employee or employees of
PQC to terminate their employment with, or otherwise cease their relationship
with, PQC. During the term of this Agreement and for a one (1) year period
thereafter, Medical Group shall not solicit, attempt to divert or to take away,
the business or patronage of any of the patients, clients, customers or
accounts, or prospective patients, clients, customers or accounts of PQC or any
of its Affiliates.
8.4 Enforcement of Medical Group Physician Employment Agreements. Medical
------------------------------------------------------------
Group shall enforce the Employment Agreements of Medical Group Physicians,
including, without limitation, restrictive covenants and liquidated damages
provisions contained in such agreements. In the event that, after a request by
PQC, Medical Group does not pursue any remedy that may be available to it by
reason of a breach or default of the restrictive covenants and liquidated
damages provisions or any other provision of any Employment Agreement, upon the
request of PQC, and Medical Group shall assign to PQC such causes of action and
any other rights it has related to such breach or default and shall cooperate
with and provide reasonable assistance to PQC with respect thereto.
8.5 Remedies. PQC and Medical Group acknowledge and agree that a remedy
--------
at law for any breach or attempted breach of the provisions of this Section 8
shall be inadequate, and, therefore, either party shall be entitled to specific
performance and injunctive or other equitable relief in the event of any such
breach or attempted breach, in addition to any other rights or remedies
available to either party at law or in equity or under the Employment
Agreements, including without limitation provisions thereunder relating to the
repurchase by the Medical Group and/or the Medical Group Physicians of certain
assets. Each party hereto waives any requirement for the securing or posting of
any bond in connection with the obtaining of any such injunctive or other
equitable relief. If any provision of this Section 8 relating to the
restrictive period, scope of activity and the territory described therein shall
be declared by a court of competent jurisdiction to exceed the maximum time
period, scope of activity restricted or geographical area such court deems
reasonable and enforceable under applicable law, the time period, scope of
activity restricted and area of restriction held reasonable and enforceable by
the court shall thereafter be the restrictive period, scope of activity
restricted and the territory applicable to such provision of this Section 8.
The invalidity or non-enforceability of any provision of this Section 8 in any
respect shall not affect the validity or enforceability of the remainder of this
Section 8 or of any other provisions of this Agreement.
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<PAGE>
9. MISCELLANEOUS
9.1 Exclusivity. During the term of this Agreement, PQC shall be the
-----------
exclusive provider to Medical Group of the types of services to be provided
under this Agreement by PQC (the "Management Services"). During the Term,
Medical Group shall not establish, operate, or provide medical services or
practice medicine at a medical office, clinic or other health care facility
anywhere except at offices, clinics and facilities at which PQC is the exclusive
provider of Management Services; provided, however, that the Medical Group may
provide (i) services at hospital and other facilities unaffiliated with PQC so
long as PQC retains the sole right to provide Management Services in connection
with all activities conducted by Medical Group at such hospitals and other
facilities and (ii) the services set forth on Schedule 9.1. Except in
connection with any Integrated Health Services which PQC is permitted to provide
itself or through an Affiliate pursuant to Section 3.8 or except as two-thirds
of the members of the Joint Policy Board shall otherwise approve, neither PQC
nor any Affiliate may, during the term of this Agreement, provide to any other
person or entity which is located or doing business in the Maryland Area, the
management or other services to be provided by PQC pursuant to this Agreement or
any medical or other medical related services of the type provided by Medical
Group or Clinical Associates on the Effective Date, including the management of
capitated contracts. If during the term of this Agreement, either PQC or any
Affiliate proposes to establish an IPA in the Maryland Area, the terms set forth
in Appendix E shall apply to such IPA unless another arrangement is approved by
two-thirds of the members of the Joint Policy Board. For purposes of this
Section 9.1, "Maryland Area" means the state of Maryland and the following
counties in the Commonwealth of Pennsylvania: .
9.2 Names; Trademarks. Medical Group and the Pods shall conduct their
-----------------
professional practice under the name or names mutually agreed upon by PQC and
Medical Group and subject to the terms of applicable trademark licenses between
PQC and Medical Group.
9.3 Independent Contractors. For the purpose of this Agreement and for
-----------------------
all services to be provided hereunder, each party will be, and will be deemed to
be, independent contractors and not (except to the limited extent provided in
Sections 3.7, 3.13 and 3.14) employees or agents of the other party.
9.4 [Reserved]
--------
9.5 Severability. If any provision of this Agreement is found by a court
------------
of competent jurisdiction to be void, invalid or unenforceable, the same will
either be reformed to comply with applicable law or stricken if not so
conformable, so as not to affect the validity or enforceability of the remainder
of this Agreement.
9.6 Waiver. Failure of either party to enforce a right under this
------
Agreement will not act as a waiver of that right or the ability to later assert
that right relative to the particular situation involved.
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<PAGE>
9.7 Notices. Any notice required to be given pursuant to the terms and
-------
provisions of this Agreement shall be in writing and shall be sent by certified
mail, return receipt requested, postage prepaid or by reputable overnight
delivery service, to PQC and Medical Group at their respective places of
business as designated from time to time by the parties and to the Joint Policy
Board at the address of its Chair. Notices shall be effective the second day
after mailing (in the case of certified mail) or the first day after mailing (in
the case of overnight delivery). A copy of any notice given to Medical Group
shall be addressed to the President of Medical Group with a copy to PQC.
9.8 Entire Agreement. This Agreement, together with all appendices,
----------------
schedules and exhibits attached hereto, constitutes the entire agreement among
the parties pertaining to the subject matter hereof and supersedes all prior and
contemporary agreements, understandings, negotiations, and discussion, whether
oral or written, of the parties respecting the subject matter hereof. All
appendices, schedules and exhibits attached hereto are hereby made a part of
this Agreement.
9.9 Amendment. Except as specifically provided elsewhere in this
---------
Agreement, no change or modification of this Agreement shall be valid unless the
same shall be in writing and signed by an authorized officer of Medical Group
and PQC and shall have been approved by the Joint Policy Board. Except as
specifically provided elsewhere in this Agreement, no waiver of any material
provision of this Agreement shall be valid unless the same shall be in writing
and signed by an authorized officer of Medical Group and PQC and shall have been
approved by the Joint Policy Board.
9.10 Successors and Assigns. PQC shall have the right to assign its rights
----------------------
and obligations under this Agreement to any entity controlled by, controlling or
under common control with PQC. Except as set forth in the prior sentence,
neither PQC nor Medical Group may assign its rights or delegate its obligations
under this Agreement without the prior written consent of the other party. This
Agreement shall be binding upon and shall inure to the benefit of the parties
hereto and their respective transferees, successors and assigns.
9.11 Governing Law. This Agreement will be construed and enforced in
-------------
accordance with the laws of the State of Maryland. Each of the parties hereto
submits to the exclusive jurisdiction of the United States federal district
courts seated in that state and agrees that process may be served upon it if it
cannot otherwise be served in such state by registered or certified mail
addressed as provided for notices under this Agreement.
9.12 Headings. Headings in this Agreement are inserted for convenience
--------
only and are not to be considered in construing the provisions hereof.
9.13 No Obligation to Third Parties. Except as expressly set forth in this
------------------------------
Section 9.13, none of the obligations and duties of PQC or Medical Group under
this Agreement shall in any way or in any manner be deemed to create any
obligation of PQC or of the Medical Group to, or any rights in, any person or
entity not a party to this Agreement. Notwithstanding the foregoing, in
accordance with and subject to the terms of the provisions of the Employment
Agreements between the Medical Group Physicians and Medical Group, the Medical
Group Physicians are hereby made third party beneficiaries of and may enforce
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<PAGE>
the obligations of PQC hereunder (as the same may be amended from time to time
in accordance with the provisions of Section 9.9 hereof) by any means, at law or
in equity, all in accordance with any procedural requirements set forth in the
said Employment Agreements; it being expressly agreed that this Agreement may be
amended by the parties in accordance with Section 9.9 without the consent of the
Medical Group Physicians. In the event that a dispute arises between PQC and
Medical Group, or between PQC, Medical Group and a Medical Group Physician, that
is not to be resolved by the Joint Policy Board under this Agreement or the
Employment Agreements, the parties to the dispute shall submit the dispute to
binding arbitration in Baltimore, Maryland. Each of PQC and Medical Group (in
the case of a dispute between PQC and Medical Group) or PQC and the Medical
Group Physician (in the case of a dispute between PQC or Medical Group and a
Medical Group Physician) shall select, within 30 days of the notice of the other
party's's election to arbitrate, one arbitrator, who shall not be affiliated
with PQC, Medical Group or any Medical Group Physician. Each of the arbitrators
so selected shall select, within 10 days of their selection, select a third
arbitrator. Each of the parties to the arbitration shall present their case to
the arbitrators within 30 says of the selection of the final arbitrator. All
disputes shall be settled by the vote of a majority of the arbitrators. The
arbitration shall be conducted in accordance with the rules of the American
Arbitration Association.
9.14 Contract Modifications for Prospective Legal Events. In the event (a)
---------------------------------------------------
any state or federal laws or regulations, now existing or enacted or promulgated
after the Effective Date are interpreted by judicial decision, a regulatory
agency, or legal counsel with a nationally recognized expertise in the field of
law in question in such a manner as to indicate that this Agreement or any
provision hereof may be in violation of such laws or regulations, or (b) the
Financial Accounting Standards Board, Emerging Issues Task Force or other
applicable accounting standard setting entity promulgates standards or issues a
consensus that would prevent PQC from consolidating for financial statement
presentation purposes all Practice Revenues of Medical Group on PQC's
consolidated financial statements, then PQC shall propose to the Joint Policy
Board and Medical Group for their approval such amendments to this Agreement as
necessary to conform the Agreement to all applicable law and preserve the
underlying economic and financial arrangements between PQC and Medical Group
without substantial economic detriment to either PQC or Medical Group. Any such
amendment approved by the Joint Policy Board and Medical Group shall be binding
upon Medical Group, and Medical Group hereby consents to any such amendment. To
the extent any act or service required of PQC should be construed or deemed, by
any governmental authority, agency or court, to constitute the practice of
medicine by PQC, the performance of said act or service by PQC shall be deemed
waived and forever unenforceable and the provisions of this Section 9.14 shall
be applicable. To the fullest extent permitted by law, Medical Group hereby
waives and agrees not to assert illegality as a defense to the enforcement of
this Agreement or any provision hereof, instead, any such purported illegality
shall be resolved pursuant to the terms of this Section 9.14.
9.15 Availability of Certain Documents. The parties agree, to the extent
---------------------------------
required by law necessary to permit receipt of reimbursement for services by
Medical Group, to make available to the Secretary of Health and Human Services,
the Comptroller General of the General Accounting Office, or their authorized
representatives, any books, documents and
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<PAGE>
records in their possession relating to the nature and extent of the costs of
services hereunder for a period of four (4) years after the provision of such
services.
9.16 Gender. References herein to the masculine shall be deemed to refer
------
to the feminine or neuter gender as the context may require.
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<PAGE>
IN WITNESS WHEREOF, the parties have caused this Agreement to be executed
as of the date first written above.
FLAGSHIP HEALTH, P.A. PHYSICIANS QUALITY CARE, INC.
("PQC")
By: By:
-------------------------------- ------------------------------
Laura M. Mumford, M.D. Jerilyn P. Asher
President Chief Executive Officer
FLAGSHIP HEALTH II, P.A.
By:
--------------------------------
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<PAGE>
APPENDIX A
-----------
DEFINITIONS
10.1. As used in this Agreement, the following terms shall have the
meanings set forth below:
10.2. "Affiliate" or "Affiliates" means with respect to any person, a
--------- ----------
person that directly or indirectly through one (1) or more intermediaries
controls, or is controlled by or is under common control with, such person.
10.3. "Baseline Amount" means with respect to the Founding Pods the sum of
---------------
Eight Million, Four Thousand, Six Hundred Fifty Six Dollars ($8,004,656). The
Baseline Amount shall be adjusted from time to time as determined by the Joint
Policy Board and Medical Group (i) to reflect the addition of new Physicians to
the Founding Pods or the termination or resignation of any Medical Group
Physician included in a Founding Pod or (ii) to reflect such other factors as
PQC and the Joint Policy Board shall mutually agree to be appropriate, in
consultation with the Medical Group Compensation Committee, as appropriate.
10.4. "Baseline Net Adjusted Billings" with respect to each Medical Group
------------------------------
Physician in an Additional Pod shall mean initially the amount set forth as the
Baseline Net Adjusted Billings in an appendix to the Medical Group Physician's
employment agreement with Medical Group, which amount is based upon such
physician's estimated Net Adjusted Billings as an employee of Clinical
Associates for the fiscal year ended June 30, 1997. PQC shall have the right to
adjust such initial Baseline Net Adjusted Billings amount to reflect such
physician's actual Net Adjusted Billings as an employee of Clinical Associates
for the fiscal year ended June 30, 1997 as soon as such information is
available. Baseline Net Adjusted Billings for a Medical Group Physician shall
also be adjusted by PQC for changes in practice patterns (i.e., weekly hours
worked, part time status), which changes shall be notified by Medical Group and
the Medical Group Physician to PQC immediately; provided that Baseline Net
Adjusted Billings shall be adjusted back in the event that the practice patterns
of the physicians return to their original status. PQC shall be entitled to
review each Medical Group Physician's Baseline Net Adjusted Billings at the end
of each Fiscal Year. PQC shall be entitled, without the approval of the Joint
Policy Board, to reduce the Baseline Net Adjusted Billings of Medical Group
Physicians engaged in a primary care practice (including OB/GYN) to reflect the
Net Adjusted Billings of such Medical Group Physicians in the event that average
fee for service collections for such primary care Medical Group Physicians as a
percentage of fee for service billings declines by more than 5% compared to the
percentage realized by such primary care Medical Group Physicians for the year
ended June 30, 1997; provided, however, that the amount of such reduction shall
only be equal to the excess of the actual percentage decline over 5%. PQC shall
also be entitled, without the approval of the Joint Policy Board, to reduce the
Baseline Net Adjusted Billings of Medical Group Physicians engaged in a
specialist practice to reflect then current Net Adjusted Billings for such
Medical Group Physicians in the event that average fee for service collections
for such specialist Medical Group Physicians as a percentage of fee for service
billings declines by more than 5% compared to the percentage realized by such
specialist Medical Group
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<PAGE>
Physicians for the year ended June 30, 1997; provided, however, that the amount
of such reduction shall only be equal to the excess of the actual percentage
decline over 5%.
10.5. "Book Value" means the value of an asset, after deduction for any
----------
depreciation or amortization, reflected on a balance sheet prepared in
accordance with generally accepted accounting principles.
10.6. "Change in Control Transaction" means any transaction or series of
-----------------------------
related transactions pursuant to which a single person or entity or a group of
entities under common control acquire more than 50% of the capital stock of PQC;
provided, however, that a Change in Control Transaction shall not be deemed to
have occurred if Bain Capital, Inc or its affiliates acquires 50% or more of the
outstanding capital stock of PQC or becomes entitled to exercise or exercises
management control of PQC pursuant to the terms of PQC's Articles of
Incorporation.
10.7. "Deductible Expenses" with respect to any Fiscal Period shall mean,
-------------------
when used with respect to any Pod, an amount equal to (i) any income tax Medical
Group is required to pay or withhold with respect to Medical Group Physicians
assigned to such Pod, (ii) the cost of any pension and any other benefits not
included in Practice Expenses, in each case that are provided to such Medical
Group Physicians and (iii) any Discretionary Expenses; provided, however, that
the parties agree and understand that Deductible Expenses may include items that
are not deductible for income tax purposes, and PQC makes no representation as
to the deductibility of such items for purposes of income tax liabilities of any
Medical Group Physician or Medical Group.
10.8. "Discretionary Expenses" means, during the Fiscal Period ended
----------------------
December 31, 1996, any increase in actual staffing or other expenses, including
Physician Pod Practice Expenses, above the levels set forth in Appendix D to
this Agreement, subject to adjustment in successive Fiscal Periods pursuant to
approval by the Joint Policy Board as part of the budgetary process contemplated
in Appendix A to the form of Employment Agreement attached hereto. With respect
to any Fiscal Period commencing after December 31, 1996, Discretionary Expenses
means any personnel, operating and other expenses, including Physician Pod
Practice Expenses, over and above the standard levels developed by the Joint
Policy Board and approved by PQC and included in a Pod's annual operating
budget, as adjusted from time to time in accordance with Appendix B attached
hereto or the terms of any Employment Agreement. In addition, "Discretionary
Expenses" shall include for a given Pod any liability for federal, state, local
or other taxes attributable to the merger into Medical Group (or attributable to
taxable periods preceding the merger) of any entity owned by one or more Medical
Group Physicians practicing in such Pod; provided, however that there shall be
excluded any such tax liability if and to the extent that Medical Group or PQC
has received payment from the Physician Members of the applicable Pod pursuant
to the indemnification provisions of any agreement of merger pursuant to which
the said merger has occurred; and provided, further that if any such
Discretionary Expense arises prior to an initial public offering of PQC stock,
the Joint Policy Board may recommend to PQC that it consider taking steps to
finance such taxes or otherwise stage the imposition of such Discretionary
Expenses over a period of three years, which recommendation shall be subject to
the Board of Directors of PQC.
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<PAGE>
10.9. "Effective Date" means July 31, 1997.
--------------
10.10. "Fiscal Period" means the twelve (12) month or shorter period
-------------
ending on December 31 of each year.
10.11. "Geographic Area" means the states of Maryland, Delaware,
---------------
Pennsylvania (including all areas within a 15 mile radius of Philadelphia),
Virginia, West Virginia, and the District of Columbia
10.12. "Gross Margin" means, for any Fiscal Period, the excess (or
------------
deficit) of Practice Revenues over Practice Expenses.
10.13. "Including" or "to include" any item shall mean containing or to
--------- ----------
contain such item as part of a whole, without any implied exclusion of other
items.
10.14. "Incremental Amount" means the excess, if any, of Net Adjusted
------------------
Billings attributable to a Medical Group Physician over the Market Compensation
for such physicians. "Market Compensation" means an amount equal to twice the
average compensation of physicians with a similar practice in the Baltimore
metropolitan area as reported by a standardized reporting source selected by the
Joint Policy Board.
10.15. "Integrated Health Services" means any business that Medical Group
--------------------------
or PQC establishes in the Geographic Area, whether directly or through a
subsidiary, that (i) provides medical or medical related services that are not
traditionally performed by physicians or physician practices at medical offices
(it being agreed that in-office laboratory and other ancillary services
performed by the Medical Group Physicians on the Effective Date of this
Agreement shall be deemed to be medical services and are not Integrated Health
Services) and (ii) are determined to be Integrated Health Services by PQC,
Medical Group, and the Joint Policy Board.
10.16. "Intellectual Property" means all (i) patents, patent applications,
---------------------
patent disclosures and all related continuation, continuation-in-part,
divisional, reissue, re-examination, utility model, certificate of invention and
design patents, registrations and applications for registrations, (ii)
trademarks, services marks, trade dress, logos, trade names and corporate names
and registration and applications for registration thereof, (iii) copyrights and
registrations and applications for registration thereof, (iv) mask works and
registrations and applications for registration thereof, (v) computer software,
data and documentation, (vi) trade secrets and confidential business
information, whether patentable or non-patentable and whether or not reduced to
practice, know-how, clinical product and service processes and techniques,
research and development information, medical protocols, copyrightable works,
financial, marketing and business data, pricing and cost information, business
and marketing plans and customer and supplier lists and information, (vii) other
proprietary rights relating to the foregoing (including, without limitations,
remedies against infringement thereof and rights of protection of interest
therein under the laws of all jurisdictions) and (viii) copies and tangible
embodiments thereof; provided, however, that there is excluded from the
definition of "Intellectual Property" any information (a) previously known to or
under development by a Medical Group Physician and listed on an Appendix to his
Employment Agreement, (b)
A-3
<PAGE>
generally known in the health care industry, or (c) obtained by a Medical Group
Physician from a third party lawfully possessing such Intellectual Property
10.17. "Medical Group Shareholder" means the individual or individuals in
-------------------------
whose name the shares of Medical Group have been issued.
10.18. "Net Adjusted Billings" shall have the meaning set forth in
---------------------
Schedule 10.18 attached hereto, as such schedule shall be amended from time to
- --------------
time by the Joint Policy Board.
10.19. "Net Margin" means, for any Fiscal Period, the excess (or deficit)
----------
of Gross Margin less the sum of (i) the Baseline Amount, and (ii) PQC Direct
Expenses.
10.20. "Non-Established Physician" shall mean any Medical Group Physician
-------------------------
assigned to an Additional Pod (i) who did not have an established practice that
is merged into the Medical Group, (ii) listed in Schedule B-2, or (iii) whose
------------
Baseline Net Adjusted Billings would be less than the Market Compensation (as
defined in 10.13) for such physician; provided, however, that a Medical Group
Physician shall cease to be a Non-Established Physician on the basis of clauses
(i) or (ii) above at such time as the Joint Policy Board determines to be
appropriate.
10.21. "Payor" shall mean any insurer, health maintenance organization,
-----
preferred provider organization, self-insured employer, labor union or other
organization or entity that arranges for the delivery of health care services to
enrollees or patients, including the Medicare and Medicaid programs and
including independent practice associations, physician-hospital organizations,
medical groups and other licensed providers.
10.22 "Payor Contracts" shall mean the contracts, agreements and
---------------
arrangements between Medical Group and Payors for the provision of health care
items and services.
10.23. "Physician Draw" shall mean, with respect to each Physician, for
--------------
each Fiscal Period (prorated for any partial Fiscal Periods) the amount of cash
to be advanced to Physician on a bi-weekly or monthly basis as an interim
payment of, in the case of the Founding Pods, the portion of Gross Margin and
Net Margin due to Physician hereunder, and in the case of the Additional Pods,
the Available Amount. Physician Draw shall be subject to change from time to
time in accordance with the provisions of Appendix B hereof. For purposes of the
Fiscal Period commencing January 1, 1996, the Physician Draw shall be, for each
Physician, the amount set forth on Schedule B-1 attached to this Agreement.
10.24. "Pod Physician" shall mean, with respect to a Pod, all Medical
-------------
Group Physicians who are assigned to the Pod.
10.25. "Pod Practice" or "Pod" shall mean, with respect to a Pod, the
------------ ---
medical practice of Medical Group as conducted through the Pod: (i) a Pod
Practice Location, or (ii) a group of Pod Practice Locations, or (iii) a
functional line of business such as a laboratory, and in the case of clause (ii)
or (iii), as approved by the Joint Policy Board to function as a distinct
reporting unit within Medical Group.
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<PAGE>
10.26. "Pod Practice Locations" shall mean, with respect to a Pod, all
----------------------
Practice Locations assigned to the Pod.
10.27. "PQC Direct Expenses" or "Direct Expenses" shall mean all actual
------------------- ---------------
direct expenses of PQC incurred in connection with providing management services
to Medical Group under this Agreement calculated in accordance with generally
accepted accounting principles, including rent, utilities, cleaning, and other
occupancy costs attributable to PQC's Baltimore office or any other office in
the Geographic Area maintained for the purpose of supporting one (1) or more Pod
Practice Locations (together with PQC's Baltimore office, the "Area Offices");
salary and benefit expense for PQC's employees providing services to benefit any
one (1) or more of the Pod Practice Locations; depreciation and amortization of
equipment located at the Area Offices except depreciation and amortization with
respect to the assets initially acquired by PQC or Medical Group from Medical
Group Physicians on their practices; telephone, facsimile, and similar
communication charges (including the cost of any so-called tie-line from the
Area Offices to the office housing the principal central computer system for
physician practice sites managed by PQC or any of its affiliates); maintenance
and repair costs for the Area Offices and equipment located therein; insurance
related to the Area Offices and PQC's employees based in any such office or any
one (1) or more of the Pod Practice Locations; professional services (including
legal and accounting) related directly to the Area Offices or any of the Pod
Practice Locations; office supplies used by PQC's Area Offices or any of PQC's
employees located at any of the Pod Practice Locations; and other expenses
incurred by PQC with the consent of the Joint Policy Board.
10.28. "Practice Expenses" shall mean, with respect to a Pod, the
-----------------
following expenses:
(a) Salaries, fringe benefits, and employment taxes and insurance (or self
insured losses) of all Administrative Staff and Clinical Staff (as defined in
Sections 3.4 and 2.5 of this Agreement) and physicians who are not Medical Group
Physicians, whether employees or independent contractors, working at or for the
direct benefit of the Pod Practice Locations; and employment taxes and expenses
for a standard package of health and disability insurance approved by the
parties prior to the Effective Date and for up to $50,000 of term life insurance
coverage for Pod Physicians;
(b) The direct cost (excluding any general and administrative overhead of PQC)
of any other management, administrative or professional services provided at or
in connection with the Pod Practice that are incurred by PQC or Medical Group,
including management, billing and collections, business office consultation,
accounting and legal services for the Pod Practice;
(c)
(i) The cost of capital (including actual interest on indebtedness
incurred by or on behalf of Medical Group but only to the extent actual interest
is incurred from a third party other than Bain Capital), to finance or refinance
obligations of Medical Group related to the Pod Practice, to purchase medical or
nonmedical equipment for the Pod Practice (other than those assets, if any,
purchased by PQC as part of the initial acquisition of
A-5
<PAGE>
the medical practice that served as the basis of the Pod) or to provide working
capital or finance new ventures of Medical Group related to the Pod Practice;
(ii) depreciation and amortization charges to be paid to PQC, the amounts
of which shall be set forth in the Pod Budget or for costs of capital described
in Section 10.27(e)(i) of this Appendix A, or, if in excess of the budgeted
amount, is agreed upon by PQC and the Joint Policy Board (expressly excluding
any depreciation and amortization charges relating to assets, if any, purchased
by PQC as part of the initial acquisition of the medical practice that served as
the basis of the Pod;
(d) Occupancy costs attributed be the Pod Practice (whether principal,
interest, depreciation, taxes or rent) incurred in obtaining, improving,
developing, leasing, operating, maintaining; replacing and preserving office
space and equipment for the Pod Practice, including janitorial services, refuse
disposal and medical waste disposal;
(e) Direct costs incurred in obtaining, leasing, operating, maintaining and
replacing computer systems and software located at the Pod Practice Locations,
including billing systems, outcomes reporting systems and financial reporting
systems and the cost of so-called tielines;
(f) All utilities, including but not limited to telephone service (including
business calls on cellular telephones), answering services, electricity, heat,
water, and sewer that are used at the Pod Practice Locations;
(g) Postage, facsimile, collection and credit verification costs incurred for
the Pod Practice;
(h) Pharmaceuticals, x-ray and laboratory expenses (both in-house and other)
for the Pod Practice;
(i) Medical supplies for the Pod Practice;
(j) All office supplies for the Pod Practice;
(k) Copying charges for the Pod Practice;
(l) Professional journals and books, professional dues and memberships, and
magazine and newspaper subscriptions for the Pod Practice;
(m) Continuing Medical Education expenses for the Pod Physicians, within
guidelines approved by the Joint Policy Board;
(n) Direct advertising, accounting and legal expenses incurred in connection
with the Pod Practice;
(o) Insurance expenses, including but not limited to (1) general liability,
fire, and property for each Pod Practice Location and (2) professional liability
insurance for Pod
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<PAGE>
Physicians and for Clinical Staff while providing services in connection with
the Pod Practice; provided, that, in the event that PQC causes Pod R to change
professional liability insurance carriers, Practice Expenses shall not include
the cost of coverage to the extent, but only to the extent, that the aggregate
cost of the new professional liability policy and the nose and/or tail coverage
exceeds the cost of the professional liability coverage maintained by the
physicians in Rod R on the Effective Date;
(p) Any casualty losses suffered by Medical Group that are related to the Pod
Practice to the extent that such losses are not reimbursed by any third party
responsible therefor or through insurance;
(q) A pro rata share calculated on the basis of the ratio of the number of Pod
Physicians to the number of Medical Group Physicians or such other reasonable
allocation methodology as PQC may develop from time to time and as may be
approved by the Joint Policy Board, of expenses incurred by PQC and included
within a budget approved by the Joint Policy Board for Medical Group as a whole
(excluding any corporate-related general and administrative overhead of PQC),
for example, Medical Group-wide management information system expenses,
malpractice costs for Medical Group as a whole (as opposed to individual
physicians), accounting and pension plan services, Medical Group tax return
preparation, and providing or arranging for other necessary administrative,
accounting and legal services. Overhead of Medical Group and PQC included in
Practice Expenses shall be allocated by PQC and the Joint Policy Board among the
Additional and Founding Pods in an equitable manner that (i) does not penalize
the Additional Pods for (a) the higher historical overhead expenses of the
Founding Pods compared to Pod R and (b) increased overhead expense incurred by
Medical Group to improve the profitability of the Founding Pods and (ii) does
not penalize the Founding Pods for increased overhead expense due to the
Additional Pods.
(r) With respect to Pod R, 100% (subject to the limitations set forth in
Section 7.5(a) of the Merger Agreement between Flagship II, Clinical Associates
and PQC) of any Damages (as defined in the Merger Agreement ) arising out of, or
relating to, the conduct of the business of Clinical Associates prior to August
1, 1997, except to the extent that PQC recovers such Damages pursuant to Article
VII of the Merger Agreement.
29. "Practice Revenues" with respect to a Pod, the amount equal to all
-----------------
revenues of Medical Group attributable to the Pod Practice or assigned by the
Pod Physicians pursuant to their Employment Agreements with the Medical Group,
net of federal, state and local income taxes of Medical Group, adjustments for
uncollectible accounts, Medicare, Medicaid and other contractual allowances,
discounts, workers' compensation adjustments, professional courtesies and other
reductions in collections, including: (a) all professional fees and other
charges actually recorded each month on an accrual basis of accounting under
generally accepted accounting principles as a result of medical services
rendered by Medical Group through the Pod and the Pod Physicians, whether
rendered in an outpatient or inpatient setting; (b) the technical component of
fees earned with respect to services rendered by Medical Group through the
Medical Group Pod (including all fees for technical and ancillary services and
all facility fees and similar charges); (c) all collections from managed care
organizations and Payors, or payments made in respect of enrollees of such
managed care organizations or
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<PAGE>
Payors, including payments made periodically on a per member basis for the
partial or total medical needs of a subscribing member, and any co-payments and
incentive bonuses, management fees and other amounts received and fees paid in
respect of services provided by or through the Pod as a result of a capitation
plan or risk-sharing arrangement; (d) grants, fees and other payments in
connection with basic or clinical research conducted by Pod Physicians or under
grant programs, whether publicly or privately funded, including grants or
programs for the care of special patient populations; (e) consulting fees of Pod
Physicians, including without limitation honoraria, witness fees and like
amounts; (f) fees and payments for workers compensation evaluations or
independent medical examinations; (g) all coordination of benefits, patient co-
payments or deductibles and third-party liability recoveries; and (h) any other
revenues from the practice of medicine or provision of health care items and
services of any kind, except to the extent that the parties may otherwise agree
in writing). With respect to Pod R, Practice Revenues shall also include,
without duplication of the foregoing, all revenues earned with respect to Pod R
from sources of revenue that were included in the revenues of Clinical
Associates prior to the Closing Date. Notwithstanding the foregoing, Practice
Revenues shall not include any income unrelated to any of the foregoing items
that is personal to a Pod Physician and unrelated to the provision of health
care or ancillary services (e.g., personal dividend or trust income), and
provided further that the Joint Policy Board may approve in writing the
retention by a Pod Physician of limited honoraria and similar amounts.
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APPENDIX B-1
------------
FINANCIAL ARRANGEMENTS
FOUNDING PODS
-------------
1. General. As set forth in greater detail below and subject to all of the
-------
conditions and provisions hereof, the parties agree that the aggregate
compensation to be paid to PQC for services rendered under this Agreement with
respect to the Founding Pods shall equal the sum of (1) all PQC Direct Expenses
which are incurred in connection with the provision of services to Medical Group
and (2) additional compensation equal to fifty percent (50%) of Net Margin of
the Founding Pods. This Appendix B-1 also provides for the priority of
application of Practice Revenues of the Founding Pods to various categories of
expenditures.
2. Application of Practice Revenues of the Founding Pods.
-----------------------------------------------------
Practice Revenues of the Founding Pods shall be applied to expenses and other
required distributions under this Agreement in the following order of priority:
(a) Step 1 - Practice Revenues of the Founding Pods shall be applied to pay
--- ------
Practice Expenses of the Founding Pods.
(b) Step 2 - Any Gross Margin attributable to the Founding Pods remaining
--- ------
after Step 1 above shall next be applied to payment of (i) the Baseline Amount
(minus the amount necessary to pay all Deductible Expenses of the Founding Pods)
and (b) PQC Direct Expenses on a proportional basis equal to the ratio of (i)
the Baseline Amount to (ii) PQC Direct Expenses as approved by the Joint Policy
Board for the then current Fiscal Period or in the absence of approval of a
budget for the then current Fiscal Period, in the ratio set forth on Schedule B-
1 attached to this Agreement. By way of example only and not as a limitation,
if the Baseline Amount is $12 million and budgeted PQC Direct Expenses allocated
to the Founding Pods are $1 million, then under this Step 2 12/13ths or 92.31%
of each dollar of Gross Margin shall be allocated to Medical Group for payment
of the Baseline Amount and the remaining 1/13th or 7.69% of each dollar of Gross
Margin shall be allocated to PQC.
(c) Step 3 - After completion of Step 2, any remaining Net Margin
--- ------
attributed to the Founding Pods shall be allocated fifty percent (50%) to
Medical Group for distribution to the Medical Group Physicians in the Founding
Pods and fifty percent (50%) to PQC as additional compensation hereunder.
Subject to review by the Joint Policy Board, PQC shall calculate the amounts
of Gross Margin and Net Margin to be allocated to each of Medical Group and PQC
under this Section 2. If the Gross Margin is negative in any Fiscal Period,
such negative amount shall constitute Practice Expenses of the Founding Pods for
the next following Fiscal Period. In the event Net Margin is negative in the
Fiscal Periods ending December 31, 1997 or December 31, 1998, PQC may be
obligated to make a loan to Medical Group in accordance with the provisions of
Section 3.5 of the Agreement.
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<PAGE>
3. Payment of Physician Draw. On a bi-weekly basis, PQC shall distribute to
-------------------------
Medical Group from the Founding Pod Medical Group Account referred to in Section
3.12 of this Agreement an amount equal to one twenty-sixth of the budgeted
aggregate Physician Draw (minus the amount necessary to pay all Deductible
Expenses) for distribution by Medical Group; provided, however, if (a) at any
time during a Fiscal Period, PQC determines that the amount of Practice Revenues
allocated to the payment of aggregate Physician Draw under this Appendix B-1 for
any Fiscal Period may be less than ninety-five percent (95%) of the budgeted
aggregate Physician Draw of Medical Group Physicians in the Founding Pods for
such Fiscal Period, or (b) if PQC or the Joint Policy Board determines (1) the
aggregate Practice Expenses of a Founding Pod for such Fiscal Period will exceed
the aggregate budgeted Practice Expenses of such Founding Pod for such Fiscal
Period, or (2) the aggregate Practice Revenues of a Founding Pod will be less
than the aggregate budgeted Practice Revenues of such Founding Pod, PQC may, and
upon direction from the Joint Policy Board, shall, reduce the aggregate
Physician Draw in such manner as PQC determines to be appropriate. Subject to
the provisions of Section 3.5 of this Agreement, the aggregate Physician Draw of
Medical Group Physicians in the Founding Pods shall be adjusted to reflect the
addition of new Medical Group Physicians to a Founding Pod or the termination or
resignation of any Medical Group Physician assigned to a Founding Pod or to
reflect such other factors as PQC and the Joint Policy board shall mutually
agree to be appropriate. PQC may, but shall not be required to, advance money
to the Compensation Pool as defined in Appendix A to the Employment Agreement to
fund such Physician Draw.
4. Payment of Variable Distribution Pool. Within forty-five (45) days of the
-------------------------------------
end of each of the first three (3) calendar quarters in each Fiscal Period, PQC
shall advise Medical Group's Compensation Committee (as defined in Employment
Agreements) of the amount (the "Variable Distribution"), if any, of Net Margin
allocable to Medical Group under Section 2 of this Appendix B-1 that has not
been used, or is not reasonably anticipated by PQC to be needed for Medical
Group to fund, all amounts required to be funded by Section 3. PQC shall
disburse to Medical Group from the Founding Pod Medical Group Account referred
to in Section 3.12 of this Agreement the amount of the Variable Distribution,
which shall be distributed to the Medical Group Physicians in the Founding Pods
in such manner consistent with law as is described in Section 4 of Appendix A to
the Employment Agreements.
5. Annual Reconciliation of Distributions. Within sixty (60) days after the
--------------------------------------
end of each year, PQC shall (i) total and report Practice Revenues and Practice
Expenses for each of the Founding Pods, (ii) total and report aggregate Practice
Revenues for all Founding Pods and aggregate Practice Expenses for all Founding
Pods, (iii) total and report PQC Direct Expenses, (iv) total and report all
amounts advanced as Physician Draws and Variable Distributions with respect to
the Founding Pods, (v) total and report the level of Gross Margin, whether
positive or negative, and (vi) total and report the level of Net Margin, whether
positive or negative (taking into account any adjustments necessary in the event
that distributions during the said Fiscal Period or any prior Fiscal Periods
have resulted in an over-advancement or under-advancement of funds). Each
Founding Pod, as a Discretionary Expense of its Medical Group Physicians, may
inspect Medical Group's books and records and PQC's books and records in order
to verify the amount and proper calculation of the sums to be determined
hereunder. PQC may not charge any Pod or Physician Member any access or similar
fee in connection with any request to review books and records. If such
B-2
<PAGE>
independent accounting presents a report identifying a departure in such
financial reports from generally accepted accounting principles, which departure
has had a material adverse effect on the revenues allocated to Physician Group,
PQC shall reimburse the Physician Members for the cost of such report.
6. Distribution in Event of Actual or Anticipated Negative Gross Margin. In
--------------------------------------------------------------------
the event that for any calendar quarter, Gross Margin is a negative number or in
the event either party gives notice to the other that there is reason to believe
Gross Margin may be a negative number, PQC shall promptly propose a remedial
plan of action to the Joint Policy Board and the parties agree to cooperate in
good faith in order to implement such remedial plan or such other corrective
action as shall be approved by the Joint Policy Board. At PQC's sole
discretion, PQC may elect to advance working capital funds to Medical Group in
such amounts and at such times, and from time to time, as PQC shall determine
necessary to satisfy aggregate Practice Expenses for all Founding Pods, such
advances to be treated as loans, the repayment of which shall be required in
accordance with the definition of "Practice Expenses" in Section 10.27 of
Appendix A hereto. In the event PQC shall elect not to make advances sufficient
to satisfy aggregate Practice Expenses for all Founding Pods and Medical Group
has not otherwise satisfied Practice Expenses from its own resources, either
party shall have the right to terminate this Agreement upon thirty (30) days'
written notice.
7. Manner of Payment of Final Reconciliation. Within seventy (70) days after
-----------------------------------------
the end of the Fiscal Period, Medical Group and PQC shall make such payments, if
any, to each other as may be required under the provisions of this Appendix B-1.
Medical Group covenants to distribute any amounts to the Medical Group
Physicians in a manner that complies with all applicable law.
8. Manner of Payment of PQC Direct Expenses and Compensation to PQC. PQC
----------------------------------------------------------------
shall arrange for the payment of PQC Direct Expenses and the compensation to PQC
itself in accordance with the terms of this Appendix and is hereby authorized to
make withdrawals from the Founding Pod Medical Group Account for such amounts at
the time or times that the amounts become due. Medical Group hereby authorizes
PQC to make such withdrawals from the Founding Pod Medical Group Account for
accrued but unpaid PQC Direct Expenses and compensation owed to PQC under the
provisions of this Appendix B-1 after termination of this Agreement.
B-3
<PAGE>
APPENDIX B-2
------------
FINANCIAL ARRANGEMENTS
ADDITIONAL PODS
---------------
1. General. As set forth in greater detail below and subject to all of the
-------
conditions and provisions hereof, the parties agree that the aggregate
compensation to be paid to PQC for services rendered under the Agreement with
respect to the Additional Pods shall be the aggregate of the amounts determined
in paragraphs 2, 3, 4, 5, 6 and 7 below.
A Revenue Flow table is attached as Schedule B-2.
Practice Revenue Attributable to Net Adjusted Billings.
2. Pod R Specialists. Net Adjusted Billings with respect to Physicians with
-----------------
specialists practice (a specialist being a physician at least 80% of whose
billings are derived from a specialist practice, excluding OB/GYN and mental
health) in Pod R on the Effective Date ("Net Adjusted Specialists Billings") for
any Fiscal Year shall, except as provided in Section 4 of this Appendix B-2, be
allocated between PQC and Medical Group in the following order of priority:
(a) Step 1 - Net Adjusted Specialist Billings shall be allocated to the
------
Additional Pod Medical Group Account until an amount equal to the Baseline
Net Adjusted Billings for Medical Group Physicians with specialist
practices in Pod R on the Effective Date has been allocated to the
Additional Pod Medical Group Account.
(b) Step 2 - The next $3 million (or any lesser amount, if there shall not be
------
$3 million of additional Net Adjusted Specialist Billings) of Net Adjusted
Specialist Billing shall be allocated 35% to PQC as compensation for its
services and 65% to the Additional Pod Medical Group Account.
(c) Step 3 - Any Net Adjusted Specialist Billings that remains unallocated
------
after Steps 1 and 2, shall be allocated 20% to PQC as compensation for its
services and 80% to the Additional Pod Medical Group Account.
3. Other Physicians. Net Adjusted Billings with respect to primary care
----------------
physicians and any physicians with specialist practices who is not subject to
paragraph 2 or 4 ("Net Adjusted Physician Billings") for any Fiscal Year shall,
except as provided in Section 4 of this Appendix B-2, shall be allocated between
PQC and Medical Group in the following order of priority:
(a) Step 1 - Net Adjusted Physician Billing shall be allocated to Additional
------
Pod Medical Account until an amount equal to the Baseline Adjusted Net
Billings for primary care Group Medical Physicians and Group Medical
Physicians with specialist practices who are not subject to paragraphs 2
or 4 has been allocated to the Additional Pod Medical Group Account.
B-4
<PAGE>
(b) Step 2 - Any Net Adjusted Physician Billing not allocated in Step 1 shall
------
be allocated 20% to PQC as compensation for its services under this
Agreement and 80% to the Additional Pod Medical Group Account.
4. Non-Established Physicians. With respect to any Non-Established Physician,
--------------------------
20% (unless a different percentage is approved by the Joint Policy Board) of the
Incremental Amount with respect to such physician shall be allocated to PQC as
compensation for its services under this Agreement and the remaining Net
Adjusted Billings with respect to such Medical Group Physician (less the
compensation payable to the Non-Established Physician under the Non-Established
Physician's employment agreement with Medical Group) shall be allocated to the
Additional Pod Medical Group Account.
Practice Revenue Not Attributable to Net Adjusted Billings.
5. Revenue not included in Net Adjusted Billings. Any Practice Revenues of
----------------------------------------------
the Additional Pods for any fiscal year that are not included in Net Adjusted
Billings ("Other Revenues") shall be allocated to Additional Pod Medical Group
Account, provided, however, if Practice Expenses are less than [__% to be
included based upon historical Net Adjusted Billings] ("Historical Overhead") of
Practice Revenue, PQC shall be allocated an amount equal to 50% of (x) Other
Revenue multiplied by (y) the difference between Historical Overhead and
Overhead for such fiscal year. Overhead shall be calculated in the manner set
forth on Schedule B-2(b).
Ancillary Revenue
6. Laboratory Services. Net Margin from centralized laboratory services
--------------------
(which for purposes of this paragraph 6 shall mean revenue from laboratory
ancillary services less (i) direct expenses of such laboratory ancillary
services and (ii) an allocation of overhead of the Medical Group, which
allocation, or the methodology used to make such allocation, shall be approved
by the Joint Policy Board) attributable to Additional Pods will be allocated 80%
to PQC and 20% to the Additional Pods Medical Group Account.
7. Non- Laboratory Ancillary Services. Net Margin from incremental non-
-----------------------------------
laboratory ancillary services other than the non-laboratory ancillary services
listed in Schedule 10.17 (which for purposes of this paragraph 7 shall mean
--------------
revenue of non-laboratory ancillary services less (i) direct expenses from such
non-laboratory ancillary services and (ii) an allocation of Medical Group
overhead, which allocation, or the methodology used to make such allocation,
shall be approved by the Joint Policy Board) will be allocated 50% to PQC and
50% in the aggregate to the Found Pod Medical Group Account and the Additional
Pod Medical Group Account.
B-5
<PAGE>
Certain Practice Expenses
8. Certain Expense Not Practice Expenses. Expenses of administrative staff
--------------------------------------
and support services included within Clauses (a) and (b) of the definition of
Practice Expenses shall not be deemed to be Practice Expense of Pod R to the
extent, but only to the extent, that the costs of such administrative staff and
support services are in excess of historical levels for Clinical Associates and
such increase in costs is specifically attributable to (x) services performed by
such administrative staff for Pods other than Pod R and not to the addition of
physicians to Pod R or change in the market costs for such services or labor
rates or (y) additional support services to which Pod R, acting reasonably,
shall have objected at the time their implementation was proposed by PQC.
Medical Group Account
9. Allocation of Net Adjusted Billings to Medical Group Account. Amounts
-------------------------------------------------------------
allocable to the Additional Pod Medical Group Account pursuant to paragraphs 2,
3, 4, 5, 6 and 7 (to the extent the allocation in made to the Additional Pods)
shall first be used to pay all Practice Expenses of the Additional Pods. Any
amount remaining after the payment of Practice Expenses shall be available for
distribution to Medical Group Physicians in the Additional Pods.
10. Payment of Physician Draw. On a monthly basis, PQC shall distribute to
-------------------------
Medical Group from the Additional Pod Medical Group Account referred to in
Section 3.12 of this Agreement an amount equal to one twelfth of the budgeted
aggregate Physician Draw of Medical Group Physicians in the Additional Pods
(minus the amount necessary to pay all Deductible Expenses) for distribution by
Medical Group; provided, however, if (a) at any time during a Fiscal Period, PQC
determines that the amount of Net Adjusted Billings allocated to the Medical
Group pursuant to this Appendix B-2 net of Practices Expenses (the "Available
Amount") for any Fiscal Period may be less than ninety-five percent (95%) of the
budgeted aggregate Physician Draw for such Fiscal Period with respect to the
Medical Group Physicians in the Additional Pods, or (b) if PQC or the Joint
Policy Board determines (1) the aggregate Practice Expenses of an Additional Pod
for such Fiscal Period will exceed the aggregate budgeted Practice Expenses for
such Additional Pod for such Fiscal Period, or (2) the aggregate Net Adjusted
Billings allocable to the Medical Group with respect to an Additional Pod will
be less than the aggregate budgeted Net Adjusted Billings allocable to the
Medical Group with respect to such Additional Pod, PQC may, and upon direction
from the Joint Policy Board, shall, reduce the aggregate Physician Draw with
respect to the Additional Pods in such manner as PQC determines to be
appropriate. Subject to the provisions of Section 3.5 of this Agreement, the
aggregate Physician Draw with respect to the Additional Pods shall be adjusted
to reflect the addition of new Medical Group Physicians to an Additional Pod or
the termination or resignation of any Medical Group Physician from an Additional
Pod or to reflect such other factors as PQC and the Joint Policy board shall
mutually agree to be appropriate. PQC may, but shall not be required to,
advance money to the Compensation Pool as defined in Appendix A to the
Employment Agreement to fund such Physician Draw.
B-6
<PAGE>
11. Payment of Variable Distribution Pool. Within forty-five (45) days of
-------------------------------------
the end of each of the first three (3) calendar quarters in each Fiscal Period,
PQC shall advise Medical Group's Compensation Committee (as defined in
Employment Agreements) of the amount (the "Variable Distribution"), if any, of
the Available Amount that has not been used, or is not reasonably anticipated by
PQC to be needed for Medical Group to fund, all amounts required to be funded by
paragraph 8. PQC shall disburse to Medical Group from the Additional Pod
Medical Group Account referred to in Section 3.12 of this Agreement the amount
of the Variable Distribution, which shall be distributed to the Medical Group
Physicians in the Additional Pod in such manner consistent with law as is
described in Section 4 of Appendix A to the Employment Agreements.
12. Annual Reconciliation of Distributions. Within sixty (60) days after the
--------------------------------------
end of each year, PQC shall (i) total and report Net Adjusted Billings and
Practice Expenses for each Additional Pod, (ii) total and report aggregate Net
Adjusted Billings and Practice Expenses for all Additional Pods, (iii) total and
report all amounts advanced as Physician Draws and Variable Distributions with
respect to the Additional Pods. Each Additional Pod, as a Discretionary Expense
of its Medical Group Physicians, may inspect Medical Group's books and records
and PQC's books and records in order to verify the amount and proper calculation
of the sums to be determined hereunder. PQC may not charge any Pod or Physician
Member any access or similar fee in connection with any request to review books
and records. If such independent accounting presents a report identifying a
departure in such financial reports from generally accepted accounting
principles, which departure has had a material adverse effect on the revenues
allocated to Physician Group, PQC shall reimburse the Physician Members for the
cost of such report.
13. Manner of Payment of Final Reconciliation. Within seventy (70) days
-----------------------------------------
after the end of the Fiscal Period, Medical Group and PQC shall make such
payments, if any, to each other as may be required under the provisions of this
Appendix B-2. Medical Group covenants to distribute any amounts to the
Physicians in a manner that complies with all applicable law.
14. Manner of Payment of Compensation to PQC. PQC shall arrange for the
----------------------------------------
payment of the compensation to PQC itself in accordance with the terms of this
Appendix B-2 and is hereby authorized to make withdrawals from the Medical Group
Account for such amounts at the time or times that the amounts become due.
Medical Group hereby authorizes PQC to make such withdrawals from the Additional
Pod Medical Group Account for compensation owed to PQC under the provisions of
this Appendix B-2 after termination of this Agreement.
B-7
<PAGE>
SCHEDULE B-1
------------
I. Name of Physician Physician Draw for Fiscal Period Ending
----------------- ---------------------------------------
December 31, 1996
-----------------
[See Section 6 of Appendix A to the Employment Agreements with the Physician
Members.]
II. Ratio of Baseline Amount to budgeted PQC Direct Expenses
B-8
<PAGE>
APPENDIX C
----------
LIST OF PHYSICIANS
------------------
<TABLE>
<CAPTION>
Name of Pod Partner Physicians Employed Physicians
- ------------- ------------------ -------------------
<S> <C> <C>
Pod A
Pod B
Pod C
Pod D
Pod E
Pod F
Pod G
Pod H
Pod I
Pod J
Pod K
Pod L
Pod M
Pod N
Pod O
Pod P
Pod Q
Pod R
</TABLE>
C-1
<PAGE>
APPENDIX D
----------
[Discretionary Expense Levels]
D-1
<PAGE>
APPENDIX E
----------
IPA Arrangements
In the event that PQC or any of its Affiliates propose the establishment of an
IPA network in the Maryland Area, PQC shall be required to obtain the approval
of two-thirds of the members of the Joint Policy Board with respect to the
structure, governance and, subject to the agreements in this Appendix E,
financial arrangements of the IPA network, including whether the Medical Group
Physicians will participate in such IPA network. PQC and Medical Group agree
that the following financial arrangements are acceptable to Medical Group and
the Medical Group Physicians. PQC shall be entitled to a fee (other than with
respect to the Medical Group Physicians) of up to 10% of the aggregate revenue
of the IPA network (provided that such a fee is reflective of market rates for
IPA management fees at the time that the IPA network is established), which fee
PQC shall not be required to share with Medical Group or any Medical Group
Physician; the Medical Group Physicians shall be entitled to participate in the
IPA network on a full capitated dollar basis; and residual profits of the IPA
network (in excess of the 10% fee) that are retained by PQC shall be allocated
50% to PQC and 50% to Medical Group.
D-2
<PAGE>
EXHIBIT A
---------
E-1
<PAGE>
Exhibit 10.23
-------------
AGREEMENT
Agreement entered into as of July 31, 1997 by and among Physicians Quality
Care, Inc., a Delaware corporation ("PQC"), Flagship Health, P.A., a Maryland
professional association ("Flagship I"), Flagship Health II, P.A. ("Flagship II"
and collectively with Flagship I, "Flagship"), and the physicians listed on the
signature page of this Agreement who are former stockholders and optionholders
(the "Stockholders") of Clinical Associates, a Maryland professional
association.
This Agreement provides for certain understandings between the Stockholders,
PQC and Flagship in connection with the Amended and Restated Services Agreement
between PQC and Flagship and the Employment Agreements between each Stockholder
and Flagship.
Now, therefore, in consideration of the representations, warranties and
covenants herein contained, the parties agree as follows. Capitalized terms
used in this Agreement and not defined in this Agreement shall have the meaning
assigned to them in the Services Agreement.
1. Addition of Founding Medical Group Physicians to Additional Pod
---------------------------------------------------------------
Compensation Model. The Services Agreement provides for a different
- ------------------
compensation methodology for the Founding Pods and the Additional Pods. As a
part of their long-term business goals, PQC and Flagship may determine that it
is in their best interest to merge the compensation arrangements of the Founding
Pods into the compensation arrangements for the Additional Pods. While PQC and
Flagship shall have no obligation to do so, PQC and Flagship shall have the
right to amend the Services Agreement, including Appendices B-1 and B-2 thereto,
to merge the compensation arrangements of the Founding Pods into the
compensation arrangements for the Additional Pods; provided that such merger and
its material terms are approved by PQC and two-thirds of the Stockholders who
continue to be Medical Group Physicians at such time. In the event that the
compensation arrangements for the Founding Pods and the Additional Pods are
merged, PQC shall provide a guarantee (which shall be in a form acceptable to
two-thirds of the Stockholders, acting reasonably) to the Stockholders that for
a two year period (commencing on the date of the merger of the compensation
arrangements for at least ten physicians in one or more Founding Pods into the
compensation arrangements for the Additional Pods) that the compensation of each
Stockholders who continues to be a Medical Group Physician will not be less than
the Physician Draw for such Stockholders as in effect at the time of such
merger; provided that the guarantee shall provide for reduction of the
guaranteed Physician Draw for the Stockholders to reflect declines, if any, in
productivity and billing. At the end of the two-year period covered by the
guarantee, the Services Agreement shall be amended, if requested by two-thirds
of the members of the Management Committee, to establish a separate Medical
Group Account and Compensation Pool with respect to Pod R.
2. Option to Amend Purchase Price. Within six months after the
------------------------------
Effective Date, the Stockholders, by the approval of two-thirds of the
Stockholders, shall have the right to
<PAGE>
elect to receive up to an additional 2,000,000 shares of Class A Common Stock of
PQC (the "Common Stock") as additional consideration for the merger of Clinical
Associates into Flagship. As a condition to receipt of such additional shares,
the Stockholders must agree to amend, effective upon delivery of such Common
Stock, the Services Agreement and their Employment Agreements so that an
additional $760,000 (or such proportionately reduced amount if less than
2,000,000 shares of Common Stock are elected) with respect to each fiscal year
is payable to PQC from the amount that would otherwise be allocated pursuant to
Appendix B-2 of the Services Agreement to the Additional Pod Medical Group
Account.
3. Right to Additional Compensation in the Event of a Shortfall. With
------------------------------------------------------------
respect to each fiscal year during the Shortfall Period (as defined below), the
amount that would have been allocated to PQC pursuant to Appendix B-2 of the
Services Agreement shall be reduced by the Adjustment Amount and the amount that
is allocated to the Additional Pod Medical Group Account shall be increased by
the Adjustment Amount; provided, however, that if with respect to any fiscal
year there is no Shortfall (as defined below) or PQC completes a public offering
of its Common Stock at a price to the public of $9.00 or more per share, this
Section 3 shall be of no further effect and no further adjustment shall be made
pursuant to this Section 3 during any subsequent fiscal year. "Shortfall Period"
shall mean every fiscal year commencing after December 31, 1997 to and including
the earlier of (i) the first fiscal year in which there is no Shortfall or (ii)
the fiscal year immediately preceding the date of the closing of a public
offering of Common Stock with a price to the public of $9.00 or more.
"Shortfall" shall mean the difference, if a positive amount, between $3 million
and the aggregate increase in Net Adjusted Billings over Baseline Net Adjusted
Billings by the specialist physicians in any Additional Pod; provided, however,
that there shall not be deemed to be a Shortfall in the event that there is less
than $3 million increase in Net Adjusted Billings because the specialist
physicians in the Additional Pods do not have the capacity to accept (unless the
Additional Pods are attempting in good faith to add physicians with the
applicable speciality and do add such additional capacity within six months of
notification from PQC), or were otherwise unwilling to accept (provided that PQC
shall give the Management Committee one month to cure any such unwillingness to
accept new patients if such refusals to accept new patients are isolated
occurrences and are not recurring), such referrals. "Adjustment Amount" with
respect to any fiscal year shall be equal to (i) 45% of the Shortfall for such
fiscal year less the Laboratory Allocation. The Laboratory Allocation with
respect to each fiscal year shall be equal to the Net Margin from Laboratory
Services allocated to Pod R under the Services Agreement. The amount of any
Shortfall, Laboratory Allocation and Adjustment Amount shall be calculated as
soon as practicable after the end of each fiscal year. Any reallocation on the
basis of an Adjustment Amount shall be made on or prior to the date that the
Additional Pod Medical Group Account is to be distributed to the physicians in
the Additional Pods under the Services Agreement.
4. Option to Sell Shares to PQC. In the event that on the fourth
----------------------------
anniversary of the Effective Date PQC has not completed an underwritten initial
public offering, each Stockholder shall have the right to require PQC to
repurchase the Common Stock issued to such Stockholder pursuant to the Merger
Agreement at a purchase price of $3.00 per share
-2-
<PAGE>
(subject to adjustment for stock splits and combination). PQC shall have the
right to pay the purchase price in the form of a five (5) year non-interest
bearing note. The principal payable with respect to each such note issued to a
Stockholder shall be reduced each year that the note is outstanding by the
amount, if any, that such Stockholder's compensation from Flagship during such
year exceeds the Stockholders' Physician Draw for such year. The election to
have PQC repurchase the Common Stock must be made within 45 days of the fourth
anniversary of the Effective Date.
5. Board Representation. PQC agrees that it will use its best efforts
--------------------
to cause two physicians nominated by the Stockholders to be elected to PQC's
Board of Directors. In addition, the Stockholders shall be entitled until such
time as PQC completes an initial public offering to appoint a representative who
will have the right to notice of and to be present at regularly scheduled
meetings of the PQC Board.
6. Billing Services for Pod R. PQC and Flagship agree that neither
--------------------------
PQC nor Flagship shall materially change the billing methodology used on the
Effective Date with respect to Pod R or replace any senior level supervisory
personnel used on the Effective Date by Pod R in billing and collections without
the approval of a majority of the Members of the Management Committee.
7. Operating Policies. PQC and Flagship intend that the operating
------------------
policies set forth on Annex A to this Agreement will be adopted by the Joint
Policy Board as soon as practicable after the Effective Date. PQC agrees that
the PQC Representatives to the Joint Policy Board will vote in favor of the
adoption of such policies.
8. Publicity Budget. PQC and Flagship agree that the Flagship
----------------
publicity budget for the first twelve months after the Effective Date shall be
at least $1,000,000 , $250,000 of which shall be a Practice Expense of Pod R.
9. Pod R Management Committee. The Stockholders agree that Pod R
--------------------------
shall establish a Management Committee that shall primarily be responsible for
overseeing the relationship between PQC, Flagship and the Medical Group
Physicians assigned to Pod R and for taking the actions expressly contemplated
by this Agreement. The membership and rules governing the Management Committee
will be determined from time to time by the Medical Group Physicians assigned to
Pod R. PQC and Flagship agree to work with Pod R in establishing the Management
Committee.
10. Certain Changes in Control. PQC agrees that neither PQC nor
--------------------------
Flagship will (i) merge or consolidate with or into, (ii) joint venture with,
(iii) sell or lease all or substantially all of their assets to, (iv) grants
governance participation to, (v) become managed by, or (vi) sell a controlling
interest in the stock of Flagship or PQC to, a Baltimore Health Care Entity
without the approval of a majority of the members of the Management Committee.
A Baltimore Health Care Entity means any hospital, medical group or other
organization that principally conducts its business in and derives its revenues
from the
-3-
<PAGE>
delivery of healthcare services in Maryland, but shall not include any physician
group that enters into an affiliation transaction with PQC.
11. No Third Party Beneficiaries. This Agreement shall not confer any
----------------------------
rights or remedies upon any person other than PQC, Flagship and the Stockholders
and their respective successors and permitted assigns.
12. Entire Agreement. This Agreement (including the documents
----------------
referred to herein) constitutes the entire agreement among the parties and
supersedes any prior understandings, agreements, or representations by or among
the parties, written or oral, with respect to the subject matter hereof.
13. Counterparts. This Agreement may be executed in two (2) or more
------------
counterparts, each of which shall be deemed an original but all of which
together shall constitute one (1) and the same instrument.
14. Headings. The section headings contained in this Agreement are
--------
inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Agreement.
15. Notices. All notices, requests, demands, claims, and other
-------
communications hereunder shall be in writing. Any notice, request, demand,
claim, or other communication hereunder shall be deemed duly delivered two (2)
business days after it is sent by registered or certified mail, return receipt
requested, postage prepaid, or one (1) business day after it is sent via a
reputable nationwide overnight courier service, in each case to the intended
recipient as set forth below:
If to the Stockholders:
- -----------------------
To the last known home address of each Stockholder as maintained in the records
of Flagship with a copy to:
Epstein, Backer & Green, P.C.
1227 25th Street, N.W.
Washington, DC 20037-1156
Attention: Mark Lutes, Esq.
-4-
<PAGE>
If to PQC or Flagship:
- ----------------------
Physicians Quality Care, Inc.
950 Winter Street
Suite 2410
Waltham, MA 02154
Attention: Jerilyn Asher
With a copy to:
David C. Phelan, Esq.
Hale and Dorr
60 State Street
Boston, MA 02109
Any party may give any notice, request, demand, claim, or other communication
hereunder using any other means (including personal delivery, expedited courier,
messenger service, telecopy, telex, ordinary mail, or electronic mail), but no
such notice, request, demand, claim, or other communication shall be deemed to
have been duly given unless and until it actually is received by the party for
whom it is intended. Any party may change the address to which notices,
requests, demands, claims, and other communications hereunder are to be
delivered by giving the other Parties notice in the manner herein set forth.
16. Governing Law. This Agreement shall be governed by and construed
-------------
in accordance with the internal laws (and not the law of conflicts) of the State
of Maryland.
17. Amendments and Waivers. No amendment of any provision of this
----------------------
Agreement shall be valid unless the same shall be in writing and signed by PQC,
Flagship and two-thirds of the Stockholders. No waiver by any party of any
default, misrepresentation, or breach of warranty or covenant hereunder, whether
intentional or not, shall be deemed to extend to any prior or subsequent
default, misrepresentation, or breach of warranty or covenant hereunder or
affect in any way any rights arising by virtue of any prior or subsequent such
occurrence.
18. Severability. If any term, provision, covenant or restriction of
------------
this Agreement is held by a court of competent jurisdiction to be invalid, void
or unenforceable, the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
19. Expenses. Except as otherwise expressly provided herein, each
--------
party to this Agreement shall pay its own costs and expenses in connection with
the transactions contemplated hereby.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date first above written.
-5-
<PAGE>
PHYSICIANS QUALITY CARE, INC.
-------------------------------
By: Jerilyn P. Asher
Title: Chief Executive Officer
FLAGSHIP HEALTH, P.A.
-------------------------------
By:
Title:
FLAGSHIP HEALTH II, P.A.
-------------------------------
By:
Title:
-6-
<PAGE>
SHAREHOLDERS:
----------------------------------
----------------------------------
----------------------------------
----------------------------------
----------------------------------
----------------------------------
----------------------------------
----------------------------------
-7-
<PAGE>
Exhibit 10.24
MERGER AGREEMENT
Agreement entered into as of July 31, 1997 by and among Physicians
Quality Care, Inc., a Delaware corporation ("PQC"), Flagship Health II, P.A., a
Maryland professional association ("Flagship"), Clinical Associates, a Maryland
professional association (the "Company"), and the Stockholders ("the
Stockholders") and Optionholders (the "Optionholders") of the Company listed on
Schedule I hereto. Flagship, PQC, the Company, the Stockholders and the
Optionholders are referred to collectively herein as the "Parties."
This Agreement contemplates a merger of Flagship into the Company. In
such merger, the Stockholders will receive cash and/or shares of PQC Class A
Common Stock, par value $0.01 per share (the "Common Stock"), in exchange for
their capital stock of the Company.
Now, therefore, in consideration of the representations, warranties and
covenants herein contained, the Parties agree as follows.
ARTICLE I
THE MERGER
1.1 The Merger. Upon and subject to the terms and conditions of this
----------
Agreement, Flagship shall merge with and into the Company (with such merger
referred to herein as the "Merger") at the Effective Time (as defined below).
From and after the Effective Time, the separate corporate existence of Flagship
shall cease, and the Company shall continue as the surviving corporation in the
Merger (the "Surviving Corporation"). The "Effective Time" shall be the time at
which the Company and Flagship file the Articles of Merger or other appropriate
documents prepared and executed in accordance with the relevant provisions of
the Maryland General Corporation Law (the "Articles of Merger") with the
Department of Assessments of Taxation of the State of Maryland. The Merger shall
have the effects set forth in (S)3-114 of the Maryland General Corporation Law.
1.2 The Closing. The closing of the transactions contemplated by this
-----------
Agreement (the "Closing") shall take place at the offices of PQC in Baltimore,
Maryland, commencing at 9:00 a.m. local time on July 31, 1997 or on such
mutually agreeable date as soon as practicable after the satisfaction or waiver
of all conditions to the obligations of the Parties to consummate the
transactions contemplated hereby (the "Closing Date").
1.3 Actions at the Closing. At the Closing: (a) the Company, the
----------------------
Stockholders and the Optionholders shall deliver to Flagship and PQC the various
certificates, instruments and documents referred to in Article V; (b) Flagship
and
<PAGE>
PQC shall deliver to the Company, the Stockholders and the Optionholders the
various certificates, instruments and documents referred to in Article VI; (c)
the Company and Flagship shall file with the Department of Assessments of
Taxation of the State of Maryland the Articles of Merger; (d) each Stockholder
shall deliver to Flagship for cancellation the certificates representing his
Shares (as defined in Section 1.5(a) below); (e) each Optionholder shall deliver
to Flagship for cancellation the Options (as defined in Section 1.5(a) below);
and (f) each Stockholder and Optionholder shall receive [the amount of cash (by
check) and/or the number of shares of Common Stock with an assumed value][the
number of options to purchase Common Stock], as determined and provided in
Section 1.12, as set forth opposite such Stockholder's or Optionholder's name on
Schedule 1.3 attached hereto (the "Merger Consideration"). PQC shall not be
- ------------
required to deliver the Merger Consideration to a Stockholder or Optionholder
until such Stockholder or Optionholder has executed and delivered: (i) the
Stockholder Agreement attached as Exhibit A hereto, (ii) the Letter Agreement
attached as Exhibit D hereto, (iii) a cross indemnity and release agreement
previously delivered by the Company to the Stockholder and Optionholder and (iv)
the stock certificates of the Company or options held by such Stockholder or
Optionholder endorsed in favor of Flagship II.
1.4 Additional Action. The Surviving Corporation may, at any time
-----------------
after the Effective Time, take any action, including executing and delivering
any document, in the name and on behalf of either the Company or Flagship, in
order to consummate the transactions contemplated by this Agreement.
1.5 Conversion of Securities. At the Effective Time, by virtue of the
------------------------
Merger and without any action on the part of any Party or the holder of any of
the following securities:
(a) Each share of common stock of the Company (collectively, the
"Shares") held by the Stockholders or held in the Company's treasury immediately
prior to the Effective Time and each outstanding option to acquire common stock
of the Company (the "Options") held by the Optionholder shall be canceled and
retired without payment of any consideration therefor, other than the payment of
the Merger Consideration to the Stockholders as set forth in Section 1.3;
(b) Each share of common stock, $5.00 par value per share, of
Flagship issued and outstanding immediately prior to the Effective Time shall be
cancelled and retired without payment of consideration therefor; and
(c) The Stockholder of Flagship shall receive 1,000 shares of
the Common Stock, par value $____ per share of the Company, which shall
constitute all of the issued and outstanding capital stock of the Surviving
Corporation as of and after the Effective Time.
-2-
<PAGE>
1.6 Dissenting Stockholder. Each Stockholder represents that such
----------------------
Stockholder has voted the Shares owned beneficially or of record by such
Stockholder in favor of the adoption of this Agreement and the Merger and,
consequently, shall not be entitled to, and shall not, demand and perfect
appraisal rights in accordance with (S)3-201, et. seq. of the Maryland General
Corporation Law.
1.7 Articles of Incorporation. The Articles of Incorporation of the
-------------------------
Surviving Corporation shall be the same as the Articles of Incorporation of
Flagship immediately prior to the Effective Time.
1.8 Bylaws. The bylaws of the Surviving Corporation shall be the
------
same as the bylaws of Flagship immediately prior to the Effective Time.
1.9 Directors and Officers. The directors and officers of the
----------------------
Surviving Corporation as of the Effective Time shall be those officers and
directors specified on Schedule 1.9.
------------
1.10 No Further Rights. From and after the Effective Time, except as
-----------------
provided in Section 1.5(c), no Shares of the Company or Flagship shall be deemed
to be outstanding, and holders of certificates formerly representing Shares
shall cease to have any rights with respect thereto except as provided herein or
by law.
1.11 Closing of Transfer Books. At the Effective Time, the stock
-------------------------
transfer books of the Company and Flagship shall be closed and no transfer of
Shares shall thereafter be made. If, after the Effective Time, certificates
formerly representing Shares are presented to the Surviving Corporation, they
shall be canceled and exchanged for the Merger Consideration as set forth in
Section 1.3.
1.12 PQC Common Stock.
----------------
(a) The parties agree that the per share fair market value of
the Common Stock to be included in the Merger Consideration shall be Three
Dollars ($3.00).
(b) The Stockholders agree to enter into, and the shares of
Common Stock shall be subject to, the Stockholders Agreement dated as of August
30, 1996, by and among PQC and certain of its Stockholders, as amended and in
effect from time to time (the "Stockholders Agreement") attached hereto as
Exhibit A.
- ---------
(c) Each Stockholder represents, warrants and covenants to PQC
as follows:
-3-
<PAGE>
(i) The Stockholder has received a copy of the Prospectus,
dated as of July __, 1997, with respect to PQC and the Common Stock and has had
such opportunity as the Stockholder has deemed adequate to obtain from
representatives of PQC such information as is necessary to permit the
Stockholder to evaluate the merits and risks of the Stockholder's investment in
PQC.
(ii) The Stockholder has sufficient experience in business,
financial and investment matters to be able to evaluate the risks involved in
the acquisition of the shares of Common Stock and to make an informed investment
decision with respect to such acquisition or has relied upon professional
business, legal and investment advisers and consultants that the Stockholder
reasonably believes have the necessary skills and experience to evaluate the
investment on behalf of the Stockholder.
(iii) The Stockholder can afford a complete loss of the
value of the shares of Common Stock and is able to bear the economic risk of
holding such Common Stock for an indefinite period.
(iv) The Stockholder understands that: (A) the Common Stock
have not been registered under the Securities Exchange Act of 1934 and is not
listed on any national securities exchange, (B) no public trading market in the
Common Stock currently exists or is expected to develop, (C) the Common Stock is
subject to restrictions upon transfer under the Stockholders Agreement and (D)
PQC shall not be subject to the information reporting requirements of the
Securities Exchange Act of 1934 and, consequently, financial and other
information regarding PQC may not be available.
(v) A legend substantially in the following form will be
placed on the certificate representing the Common Stock:
"The shares of stock represented by this
certificate are subject to restrictions on
transfer and requirements of sale set forth in
the Stockholders Agreement dated as of
August 30, 1996, as amended and in effect
from time to time. The Company will furnish
a copy of such agreement to the holder of this
certificate without charge upon written
request. The shares of stock represented by
this certificate were originally issued to, or
issued with respect to shares originally issued
to the following Physician Stockholder:
---------"
-4-
<PAGE>
(d) PQC's Registration Statement on Form S-1 with respect to the
Common Stock filed with the Securities and Exchange Commission has been declared
effective under the Securities Act of 1933. PQC has made all necessary filings
with the Securities Division of the State of Maryland with respect to the Common
Stock.
1.13 Certain Tax Agreements. The Parties intend to adopt this
----------------------
Agreement and Merger as a tax-free reorganization under Section 368(a) of the
Internal Revenue Code of 1986, as amended, (the "Code"). The Parties shall not
take a position on any tax return or engage in any activities inconsistent with
this Section 1.13. Without limiting the foregoing each Stockholder agrees that:
(a) Such Stockholder has not sold, exchanged, transferred or
disposed of or received any shares of the Company's capital stock in
contemplation of the Merger except as disclosed on Schedule 1.13 attached
-------- ----
hereto, and such Stockholder has no present intent to sell, exchange, transfer,
dispose of or receive the Company's capital stock in contemplation of the
Merger, nor has such Stockholder entered into any discussions or negotiations
with regard to the possible sale, exchange, transfer or other disposition of
such capital stock.
(b) Such Stockholder is not subject to any obligation to sell,
exchange, transfer or otherwise dispose of all or any of the Common Stock of PQC
to be received by such Stockholder in the Merger. Such Stockholder has not
entered into any discussions or negotiations with regard to the possible sale,
exchange, transfer or other disposition of all or any of the Common Stock. Such
Stockholder has no plan or intent to engage in any transaction or arrangement
that would reduce such Stockholder's risk of ownership in any way, including
without limitation a short sale, hedging transaction or otherwise, with respect
to all or any of such Common Stock.
1.14 Adjustments to Merger Consideration. (a) The Merger Consideration
-----------------------------------
shall be reduced on a dollar for dollar basis to the extent that the Net Assets
(as defined in Section 5.15) of the Company as of the Closing Date is less than
$2,314,519.
(a) The Merger Consideration shall be reduced in the event
that less than all of the Stockholders enter into Employment Agreements with
Flagship on the Closing Date in the form attached hereto as Exhibit B. The
amount of such reduction with respect to each physician who does not enter into
such Employment Agreement shall equal 50% of the Merger Consideration set forth
on Schedule 1.3
-5-
<PAGE>
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company, the Stockholders and the Optionholders, who join herein
individually (not jointly) and subject to the limitations contained in Section
7.5, represent and warrant to Flagship and PQC that the statements contained in
this Article II are true and correct, except as set forth in the disclosure
schedule attached hereto (the "Disclosure Schedule"), as of the date hereof and
as of the Effective Time. Each representation or warranty made by a Stockholder
or Optionholder herein regarding the Stockholders or Optionholder of the Company
shall be deemed to have been made only with respect to the Stockholder or
Optionholder making the representation or warranty and not with respect to any
other Stockholder or Optionholder. The Disclosure Schedule shall be arranged in
paragraphs corresponding to the numbered and lettered paragraphs contained in
this Article II, and the disclosures in any paragraph of the Disclosure Schedule
shall qualify only the corresponding paragraph in this Article II.
2.1 Organization, Qualification and Corporate Power. The Company is a
-----------------------------------------------
professional association duly organized, validly existing and in corporate and
tax good standing under the laws of the State of Maryland and has all power and
authority to carry on the businesses in which it is engaged and to own and use
the properties owned and used by it. The Company has furnished to PQC true and
complete copies of its Articles of Incorporation and Bylaws, each as amended and
as in effect on the date hereof. The Company is not in default under or in
violation of any provision of its Articles of Incorporation or Bylaws. Except as
set forth in Schedule 2.1 hereto, the Company has no subsidiaries or any equity
------------
interest in any corporation, partnership, joint venture or other entity.
2.2 Capitalization. Schedule 2.2 accurately sets forth (i) the
-------------- ------------
authorized and outstanding capital stock of the Company and (ii) all outstanding
Options. Schedule 2.2 sets forth a complete and accurate list of all
------------
Stockholders and Optionholders of the Company, indicating the numbers of Shares
and Options held by each Stockholder and Optionholder. Other than the
Stockholders and the Optionholders, no person or entity owns or has the right to
acquire any capital stock, options, or other securities of the Company. The
Shares are all of the issued and outstanding shares of capital stock of the
Company and each Share is duly authorized, validly issued, fully paid,
nonassessable and free of all preemptive rights. Other than the Options, there
are no outstanding or authorized options, warrants, rights, agreements or
commitments to which the Company is a party or which are binding upon the
Company providing for the issuance, disposition or acquisition of any of its
capital stock. There are no outstanding or authorized stock appreciation,
phantom stock or similar rights with respect to the Company. There are no
agreements, voting trusts, proxies or understandings with respect to the voting,
or registration under the
-6-
<PAGE>
Securities Act of 1933, of any Shares. All of the issued and outstanding Shares
and Options were issued in compliance with applicable federal and state
securities laws.
2.3 Authorization. This Agreement and the other agreements, documents
-------------
and instruments to be executed and delivered by the Company pursuant hereto and
the consummation by the Company of the transactions contemplated hereby and
thereby have been approved by all required corporate action, including approval
by the Board of Directors of the Company and all of the Stockholders. No further
corporate or other proceedings on the part of Company are necessary to authorize
this Agreement or the other agreements, documents and instruments to be executed
and delivered by the Company pursuant hereto or the transactions contemplated
hereby or thereby.
2.4 Valid and Binding Agreement. The Company and each Stockholder and
---------------------------
Optionholders have the necessary power and authority to enter into this
Agreement and the other agreements, documents and instruments to be executed and
delivered by the Company or any Stockholder and Optionholder pursuant hereto,
and to carry out the transactions contemplated hereby and thereby. Assuming due
authorization, execution and delivery thereof by Flagship and PQC, this
Agreement and each of the other agreements, documents and instruments to be
executed and delivered by the Company, the Stockholders or Optionholders
pursuant hereto will constitute valid and binding agreements of the Company, the
Stockholders and/or Optionholders enforceable against the Company and/or the
Stockholders and/or Optionholders as the case may be, in accordance with their
terms, except to the extent that enforceablitity is limited by bankruptcy or
similar laws or by general principles of equity.
2.5 No Violation. Except as set forth in Schedule 2.5 hereto, neither
------------ ------------
the execution and delivery of this Agreement or the other agreements, documents
and instruments to be executed and delivered by the Company , the Stockholders
or the Optionholders pursuant hereto nor the consummation by the Company or the
Stockholders of the transactions contemplated hereby or thereby: (a) will
violate any provision of the charter documents or Bylaws of the Company, each as
currently in effect; (b) subject to obtaining the required consents and
approvals described in Schedule 2.6, will violate or conflict with any
------------
applicable statute, law, ordinance, rule, regulation, order, judgment or decree
except that no representation or warranty is made under this section with regard
to laws referred to in Section 2.22; or (c) subject to obtaining the required
consents and approvals described in Schedule 2.6, will violate or conflict with
------------
or constitute a default (or an event which, with notice or lapse of time, or
both, would constitute a default) under, or will result in the termination of,
or accelerate the performance required by, or result in the creation of any
Security Interest (as defined in Section 2.12) upon any of the properties of the
Company under, any contract, commitment, understanding, arrangement, agreement
or restriction of any kind by which the properties of the Company are bound or
-7-
<PAGE>
affected, or to which the Company or any Stockholder is a party except for any
such violation, conflict or default that would not have a Material Adverse
Effect. The term "Material Adverse Effect" as used in this Agreement shall mean
any change or effect or any prospective change or effect that, individually or
when taken together with other changes or effects, is or is reasonably likely
(whether now or after the Effective Time) to be materially adverse to the
medical practice conducted by the Stockholders (the "Practice"), the financial
condition or results of operation of the Company, Flagship or PQC, the financial
arrangements contemplated by the Employment Agreements (as defined in Section
5.16(a)), the value to Flagship or PQC of their affiliation with the Company and
the Stockholders or any Party's ability to consummate the transactions
contemplated herein.
2.6 Consents; Filings. Except as set forth in Schedule 2.6 hereto, no
----------------- ------------
registration or filing with, or consent, approval, permit, authorization or
action by, any third-party (including, without limitation, any federal, state,
local, foreign or other governmental agency, instrumentality, commission,
authority, board or body or other person or entity (a "Governmental Entity") is
required in connection with the execution and delivery by the Company, any
Stockholder or any Optionholder of this Agreement or the other agreements,
documents and instruments to be executed and delivered by Company, any
Stockholder or Optionholder pursuant hereto or the consummation by the Company,
the Stockholders or the Optionholders of the transactions contemplated hereby or
thereby.
2.7 Financial Statements. The Company has delivered to Flagship and
--------------------
PQC the balance sheets and statements of income of the Company for and as at the
fiscal years ended June 30, 1994, 1995 and 1996 (the "Financial Statements") and
the fiscal period ended March 31, 1997 (the "Interim Financial Statements"), and
such balance sheets and statements of income have been prepared in accordance
with generally accepted accounting principles consistently applied, are true,
complete and accurate and fairly present the financial condition and results of
operations for and as at the end of the periods therein referred to on a stand-
alone basis.
2.8 Undisclosed Liabilities. To the best knowledge of the Company,
-----------------------
the Stockholders and the Optionholders, the Company has no liabilities or
obligations (whether known or unknown, whether absolute or contingent, whether
liquidated or unliquidated and whether due or to become due), except for (a)
liabilities shown on the balance sheet referred to in Section 2.7 for the period
ended March 31, 1997, (the "Most Recent Balance Sheet") or otherwise listed on
Schedule 2.8(a) as being assumed by Flagship as part of the Merger, or (b)
- ---------------
liabilities which have arisen since the most recent Financial Statements in the
Ordinary Course of Business (as defined in Section 2.12).
2.9 No Material Adverse Change. Except as set forth in Schedule 2.9
-------------------------- ------------
hereto, to the best knowledge of the Company, no event with respect to the
Company
-8-
<PAGE>
or the Practice involving a Material Adverse Effect has occurred since the date
of the Financial Statements.
2.10 Compliance with Law. To the best knowledge of the Company, the
-------------------
Stockholders and the Optionholders, the Company has complied with, and the
Practice has been conducted in compliance with, all applicable laws, regulations
and other requirements of all national governmental authorities, of all states,
municipalities and other political subdivisions and agencies thereof, having
jurisdiction over the Company, the Stockholders or the Optionholders, including
without limitation, all such laws, regulations and requirements relating to
antitrust, consumer protection, employee benefit, equal opportunity, health,
occupational safety, pension, pollution or environmental protection matters,
except for such noncompliance as would not have a Material Adverse Effect.
Neither the Company, any Stockholder nor any Optionholder has received any
notification of any asserted present or past failure to comply with such laws,
rules or regulations.
2.11 Tax Matters.
-----------
(a) The Company has filed in a timely manner all Tax Returns
(as defined below) that it was required to file and all such Tax Returns were
correct and complete in all material respects. The Company has timely paid all
Taxes (as defined below) that are shown to be due on any such Tax Returns. The
unpaid Taxes of the Company for tax periods through the date of the Most Recent
Balance Sheet do not exceed the accruals and reserves for Taxes set forth on the
Most Recent Balance Sheet (excluding any accruals and reserves for deferred
Taxes established to reflect timing difference between book and Tax income). The
Company does not have any actual or potential liability for any Tax obligation
of any taxpayer (including without limitation any affiliated group of
corporations or other entities that included the Company during a prior period)
other than the Company. All Taxes that the Company is or was required by law to
withhold or collect have been duly withheld or collected and, to the extent
required, have been paid to the proper Governmental Entity. For purposes of this
Agreement, "Taxes" means all taxes, charges, fees, levies or other similar
assessments or liabilities, including without limitation income, gross receipts,
ad valorem, premium, value-added, excise, real property, personal property,
sales, use, transfer, withholding, employment, payroll and franchise taxes
imposed by the United States of America or any state, local or foreign
government, or any agency thereof, or other political subdivision of the United
States or any such government, and any interest, fines, penalties, assessments
or additions to tax resulting from, attributable to or incurred in connection
with any tax or any contest or dispute thereof. For purposes of this Agreement,
"Tax Returns" means all reports, returns, declarations, statements or other
information required to be supplied to a taxing authority in connection with
Taxes.
-9-
<PAGE>
(b) The Company has delivered to PQC correct and complete
copies of all federal income Tax Returns, examination reports and statements of
deficiencies assessed against or agreed to by the Company during the past five
years. Except as disclosed on Schedule 2.11, no examination or audit of any Tax
Returns of the Company by any Governmental Entity is currently in progress or,
to the knowledge of the Company, threatened or contemplated. The Company has not
waived any statute of limitations with respect to Taxes or agreed to an
extension of time with respect to a Tax assessment or deficiency.
(c) The Company is not a "consenting corporation" within the
meaning of Section 341(f) of the Code, and none of the assets of the Company are
subject to an election under Section 341(f) of the Code. The Company has not
been a United States real property holding corporation within the meaning of
Section 897(c)(2) of the Code during the applicable period specified in Section
897(c)(1)(A)(ii) of the Code. The Company is not a party to any Tax allocation
or sharing agreement.
(d) The Company is not nor has ever been a member of an
"affiliated group" of corporations (within the meaning of Section 1504 of the
Code).
(e) The Company is not a party to any agreement, contract,
arrangement or plan that has resulted or would result, separately or in the
aggregate, in the payment of any "parachute payments" within the meaning of
Section 280G of the Code.
2.12 Assets. The Company owns or leases all tangible assets necessary
------
for the conduct of the Practice. Each such tangible asset is free from material
defects, has been maintained in accordance with normal industry practice, is in
good operating condition and repair (subject to normal wear and tear) and is
suitable for the purposes for which it presently is used. Except as disclosed on
Schedule 2.12, no asset of the Company (tangible or intangible) is subject to
- -------------
any Security Interest. The term "Security Interest" means any mortgage, pledge,
security interest, encumbrance, charge or other lien (whether arising by
contract or by operation of law), other than (i) mechanics', materialmen's and
similar liens, (ii) liens arising under worker's compensation, unemployment
insurance, social security, retirement and similar legislation and (iii) liens
on goods in transit incurred pursuant to documentary letters of credit, in each
case arising in the ordinary course of business consistent with past practice
(including with respect to frequency and amount) (the "Ordinary Course of
Business").
2.13 Leases.
------
(a) Schedule 2.13 contains a complete and accurate listing of
-------------
all leases (the "Leases") pursuant to which the Company leases real or personal
property, which listing sets forth a general description of the leased property
or items, the
-10-
<PAGE>
term, the annual rent, any and all renewal options, and any requirements for the
consent of third parties to assignments thereof. To the knowledge of the
Company, all such Leases are valid, binding and enforceable in accordance with
their terms and are in full force and effect; no event of default has occurred
which (whether with or without notice, lapse of time or both or the happening or
occurrence of any other event) would constitute a default thereunder on the part
of the Company; and the Company has no knowledge of the occurrence of any event
of default which (whether with or without notice, lapse of time or both or the
happening or occurrence of any other event) would constitute a default
thereunder by any other party.
(b) Except for Leases listed on Schedule 2.13, there are no
-------------
leases, subleases, licenses, occupancy agreements, options, rights, concessions
or other agreements or arrangements, written or oral, granting to any person the
right to purchase, use or occupy any facility occupied by the Company.
(c) With respect to each Lease, the Company has and will
transfer to Flagship at the Closing an unencumbered interest in the leasehold
interest covered thereby. The Company enjoys peaceful and undisturbed possession
of all the leased real property, and the Company has in all material respects
performed all the obligations required to be performed by it through the date
hereof.
2.14 Contracts and Commitments.
-------------------------
(a) Schedule 2.14 sets forth a complete and accurate list of
-------------
all contracts known to the Company, the Stockholders or the Optionholders after
reasonable investigation which have been entered into by the Company or any
Stockholder relating to the Practice and still in effect as of the date hereof
(the "Contracts"), of the following categories:
(i) Managed care contracts and other contracts with third-
party payors;
(ii) Employment or similar contracts and severance
agreements;
(iii) Contracts (other than Leases set forth on Schedule
--------
2.13) relating to the Company or the Practice which are not cancelable without
- ----
liability on thirty (30) calendar days (or less) notice;
(iv) Options with respect to any property, real or
personal, whether the Company is the grantor or grantee thereunder;
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<PAGE>
(v) Contracts involving expenditures or liabilities,
actual or potential, in excess of one thousand dollars ($1,000) or otherwise
material to the Practice or the Company;
(vi) Promissory notes, loans, agreements, indentures,
evidences of indebtedness, letters of credit, guarantees, or other instruments
relating to an obligation to pay money, individually in excess of or in the
aggregate in excess of one thousand dollars ($1,000), whether the Company shall
be the borrower, lender or guarantor thereunder or whereby any properties of the
Company are pledged;
(vii) Contracts containing covenants limiting the freedom
of the Company or any officer, director, employee, or Stockholder of the
Company, to engage in any line of business or compete with any person; and
(viii) Any Contract with the United States, state or local
government or any agency or department thereof.
The Company has made available to PQC true, correct and complete copies within
the Company's, a Stockholder's or an Optionholder's possession of, and all
records relating to, all of the Contracts listed on Schedule 2.14, including all
-------------
amendments and supplements thereto.
(b) Absence of Breaches or Defaults. To the knowledge of the
-------------------------------
Company or any Stockholder or Optionholder, all of the Contracts are valid and
in full force and effect. To the knowledge of the Company, or any Stockholder or
Optionholder, the Company and the Stockholders have duly performed all of its or
their obligations under the Contracts, and no violation of, or default or
breach, under any Contracts by the Company or any other party has occurred
except for any violations, defaults, or breaches that would not have a Material
Adverse Effect and neither Company nor any other party, to the best of Company's
or any Stockholder's knowledge after due inquiry, has repudiated any provisions
thereof.
2.15 Permits. The Company, the Stockholders and any other physicians
-------
employed by the Company have all licenses, permits, franchises, approvals,
authorizations, consents or orders of, or filings with ("Permits") any
Governmental Entity or any other person, necessary or desirable to conduct the
Practice as now being conducted, except where the failure to obtain such Permits
would not have a Material Adverse Effect. All Permits of the Company, each
Stockholder and any other physicians employed by the Company are valid and in
full force and effect and are listed on Schedule 2.15. Except as disclosed on
-------------
Schedule 2.15, no notice to, declaration, filing or registration with, or Permit
- -------------
or consent from, any governmental or regulatory body or authority, or any other
person or entity, is required to be made or obtained by the Company or any
Stockholder in connection with the execution, delivery or performance of this
Agreement and the consummation of the transactions
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<PAGE>
contemplated hereby, except as set forth on Schedule 2.15. No Stockholder has
-------------
suffered any loss, revocation, suspension, expiration without renewal or other
failure to keep in full force and effect and good standing the Stockholder's
membership on the medical staff of the hospitals listed for such Stockholder on
Schedule 2.23, or any material license, certification, accreditation, clinical
- -------------
privilege or other right or authorization necessary for the unrestricted
practice of medicine by the Stockholder or for the conduct of the Practice as
previously conducted.
2.16 Books and Records. The Company has made and kept (and given
-----------------
Flagship and PQC access to) books and records (including patient lists) and
accounts, which, in reasonable detail, accurately and fairly reflect the
activities of the Company.
2.17 Litigation. Except as set forth on Schedule 2.17, there is not,
---------- -------------
and during the past five (5) years there has not been any, action, order, writ,
injunction, judgment or decree outstanding or any claim, suit, litigation,
proceeding, labor dispute, arbitral action, governmental audit or investigation
(collectively, "Actions") pending or, to the best of the Company's, any
Stockholder's or any Optionholder's knowledge threatened (a) against, related to
or affecting (i) the Company, any of the Stockholders, any of the Optionholders,
the Practice or the assets of the Company, (ii) any officers, directors or
employees of the Company as such, or (iii) any Stockholder of the Company in
such Stockholder's capacity as a Stockholder of the Company; (b) seeking to
delay, limit or enjoin the transactions contemplated by this Agreement; (c) that
involves the risk of criminal liability (other than minor traffic violations);
or (d) in which the Company is a plaintiff. Neither the Company, any Stockholder
or any Optionholder is in default with respect to or subject to any judgment,
order, writ, injunction or decree of any court or governmental agency, and there
are no unsatisfied judgments against the Company, any of the Stockholders, any
of the Optionholders, the Practice or the Company's assets.
2.18 Transactions with Certain Persons. Except as set forth on
---------------------------------
Schedule 2.18, no officer, director or employee of the Company nor any member of
- -------------
any such person's immediate family is presently, or within the past two (2)
years has been a party to any transaction with the Company relating to the
Practice with an aggregate annual value of more than twenty thousand dollars
($20,000) (provide that all transactions in an amount less than $20,000 that are
not set forth on Schedule 2.18 were at fair market value) to the Company or the
-------------
other parties thereto, including, without limitation, any contract, agreement or
other arrangement (a) providing for the furnishing of services by, (b) providing
for the rental of real or personal property from, or (c) otherwise requiring
payments to (other than for services as officers, directors or employees of the
Company) any such person or corporation, partnership, trust or other entity in
which any such person has an interest as a Stockholder, officer, director,
trustee or partner, except that the Company provides certain medical services to
employees and family members as set forth on Schedule 2.18.
-------------
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<PAGE>
2.19 Insurance. Schedule 2.19 contains a complete and accurate list of all
--------- -------------
policies or binders of fire, liability, title, worker's compensation,
malpractice and other forms of insurance (showing as to each policy or binder
the carrier, policy number, coverage limits, expiration dates, annual premiums
and a general description of the type of coverage provided) maintained by the
Company on any of its assets, the Stockholders, the Practice or the Company's
employees. Such insurance provides, and during such period provided, coverage to
the extent and in the manner as may be required by applicable law and by any and
all Contracts known to the Company or any Stockholder to which the Company, or
any of its physicians or other employees is a party. The Company is not in
default under any of such policies or binders, and the Company has not failed to
give any notice or to present any claim under any such policy or binder in a due
and timely fashion. No insurer has advised the Company that it intends to reduce
coverage, increase premiums or fail to renew an existing policy or binder.
Except as disclosed in Schedule 2.19, there are no outstanding unpaid claims
under any such policies or binders. All policies and binders are in full force
and effect on the date hereof and shall be kept in full force and effect through
the Closing Date.
2.20 Brokers. The Company is not obligated to pay, nor has the Company
-------
retained any broker or finder or other person who is entitled to, any broker's
or finder's fee or any other commission or financial advisory fee based on any
agreement or understanding made by the Company in connection with the
transactions contemplated hereby.
2.21 Benefit Plans.
-------------
(a) Except as set forth in Schedule 2.21, the Company is not a
-------------
party to any pension, retirement, profit sharing, savings, bonus, incentive,
deferred compensation, group health insurance or group life insurance plan or
any similar obligation (an "Employee Benefit Plan"), or to any collective
bargaining agreement or other contract, written or oral, with any trade or labor
union, employees; association or similar organization. Except as set forth in
Schedule 2.21, the Company does not have any obligations to provide to its
- -------------
active employees or current retirees any post-retirement non-pension benefits.
No Stockholder has any present intention of discontinuing the Stockholder's
medical practice with the Company except to become an employee of Flagship.
(b) To the knowledge of the Company or any Stockholder or
Optionholder, the Company (i) is and has been in compliance in all material
respects with all applicable laws respecting employment and employment
practices, terms and conditions of employment, and wages and hours, (ii) has
made all contributions required to be made under any state unemployment or
disability laws or regulations and has accrued the amount of any such
contribution required for any period prior to the Closing Date which is not yet
due and payable and (iii) is not engaged in any
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<PAGE>
unfair labor practice, and there are no arrears in the payment of wages or taxes
with respect to employees.
(c) Except as set forth in Schedule 2.21, no employee has any
-------------
claims pending against Company (whether under any law, any employment agreement
or otherwise) on account of or for: (i) overtime pay, other than overtime pay
for the current payroll period, (ii) wages or salary (excluding bonuses and
amounts accruing under pension and profit sharing plans) for any period other
than the current payroll period, (iii) vacation, time off or pay in lieu of
vacation or time off, other than that earned in respect of the current fiscal
year, (iv) any violation of any statute, ordinance or regulation relating to
minimum wages or maximum hours of work or (v) the Employee Retirement Income
Security Act of 1974, as amended ("ERISA").
(d) Except as set forth on Exhibit 2.21 (which liabilities will be
------------
discharged on or prior to the Closing Date) the Company is not, and neither PQC
nor Flagship shall be, pursuant to any employment agreement, employee benefit
plan or other law, arrangement or understanding, obligated to pay or be liable
for the payment of any compensation (including accrued vacation), severance pay
or other benefit (including any disability benefit or payment or any unfunded
liabilities relating to pension benefits) by reason of the voluntary or
involuntary termination at or prior to the Effective Time of employment of any
employee, or the consummation of the transactions contemplated by this
Agreement.
(e) To the knowledge of the Company and any Stockholder or
Optionholder, each employee benefit plan of the Company intended to be qualified
under Section 401(a) of the Code has received a favorable determination letter
and the Company or any entity which, within the last five (5) years, has been
under common control or affiliated with Company (an "ERISA Affiliate") within
the meaning of Section 414(b), (c) or (m) of the Code, and each employee benefit
plan of the Company is in compliance in all material respects with the
requirements prescribed by any and all statutes, orders or governmental rules or
regulations currently in effect, including, but not limited to, ERISA and the
Code, applicable to such employee benefit plans and the Company is in compliance
in all material respects with its obligations under the terms of such plans.
None of the employee benefit plans are subject to Title IV of ERISA. Neither the
Company nor any ERISA Affiliate has ever been obligated to contribute to any
"multi-employer plan" as such term is defined in Section III(37) of ERISA. No
employee benefit plan of the Company or any ERISA Affiliate has engaged in any
prohibited transaction as such term is defined in Section 4975 of the Code or
Section 406 of ERISA.
2.22 Fraud and Abuse; Stark Law. Except as set forth in Schedule 2.22
-------------------------- -------------
hereto, to the knowledge of the Company or any Stockholder or Optionholder,
neither the Company, any of the Stockholders, any of the Optionholders, nor any
other persons or entities providing professional services for the Practice, have
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<PAGE>
engaged in any activities which are prohibited under 42 U.S.C. (S)1320a-7b or 42
U.S.C. (S)1395nn et seq., or the regulations promulgated thereunder pursuant to
-- ---
such statutes, or related state or local statutes or regulations, or which are
prohibited by rules of professional conduct, including but not limited to the
following: (i) knowingly and willfully making or causing to be made a false
statement or representation of a material fact in any application for any
benefit or payment; (ii) knowingly and willfully making or causing to be made
any false statement or representation of a material fact for use in determining
rights to any benefit or payment; (iii) failure to disclose knowledge by a
claimant of the occurrence of any event affecting the initial or continued right
to any benefit or payment on its own behalf or on behalf of another, with intent
to fraudulently secure such benefit of payment; (iv) knowingly and willfully
soliciting or receiving any remuneration (including any kickback, bribe or
rebate), directly or indirectly, overtly or covertly, in cash or in kind or
offering to pay or receive such remuneration (a) in return for referring an
individual to a person for the furnishing or arranging for the furnishing of any
item or service for which payment may be made in whole or in part by Medicare or
Medicaid, or (b) in return for purchasing, leasing, or ordering or arranging for
or recommending purchasing, leasing, or ordering any good, facility, service, or
item for which payment may be made in whole or in part by Medicare or Medicaid;
and (v) referring a patient for Designated Health Services (within the meaning
of 42 U.S.C. (S)1395nn) when the referring physician has a financial
relationship with the entity to which the referral is made in the absence of an
applicable exception under 42 U.S.C. (S)1395nn.
2.23 Hospital Privileges. Schedule 2.23 hereto lists all of the hospitals
------------------- -------------
at which each Stockholder is a member of the medical staff.
2.24 Employment Agreements. No event permitting termination under the
---------------------
Employment Agreements, if they were in effect at such time of such event, shall
have occurred at any time prior to the Closing Date. Except as set forth on
Schedule 2.24, no Stockholder has any current intention of terminating an
- -------------
Employment Agreement with Flagship prior to the termination of its initial five
(5) year term (provided, that, the foregoing shall in no way limit any
Stockholder's rights pursuant to Section 3 of the letter agreement among PQC,
Flagship and the Stockholder dated as of the Closing Date).
2.25 Powers of Attorney. Except as set forth in Schedule 2.25, there are
------------------
no outstanding powers of attorney executed on behalf of the Company.
2.26 Employees. Schedule 2.26 contains a list of all employees of the
--------- -------------
Company, other than the Stockholders, along with the position and the rate of
compensation of each such person. To the knowledge of the Company, any of the
Stockholders, or any of the Optionholders, no employee or group of employees has
any plans to terminate employment with the Company or not to continue as an
employee of the Surviving Corporation after the Effective Time. The Company is
not
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<PAGE>
a party to or bound by any collective bargaining agreement, nor has it
experienced any strikes, grievances, claims of unfair labor practices or other
collective bargaining disputes.
2.27 Environmental Matters.
---------------------
(a) To the knowledge of the Company, or any Stockholder or
Optionholder, the Company has complied with all applicable Environmental Laws
(as defined below). There is no pending or, to the knowledge of the Company or
any Stockholder, threatened civil or criminal litigation, written notice of
violation, formal administrative proceeding, or investigation, inquiry or
information request by any Governmental Entity, relating to any Environmental
Law involving the Company. For purposes of this Agreement, "Environmental Law"
means any federal, state or local law, statute, rule or regulation or the common
law relating to the environment or occupational health and safety, including
without limitation any statute, regulation or order pertaining to (i) treatment,
storage, disposal, generation and transportation of industrial, toxic or
hazardous substances or solid or hazardous waste; (ii) air, water and noise
pollution; (iii) groundwater and soil contamination; (iv) the release or
threatened release into the environment of industrial, toxic or hazardous
substances, or solid or hazardous waste, including without limitation emissions,
discharges, injections, spills, escapes or dumping of pollutants, contaminants
or chemicals; (v) underground and other storage tanks or vessels, abandoned,
disposed or discarded barrels, containers and other closed receptacles; (vi)
health and safety of employees and other persons; and (vii) manufacture,
processing, use, distribution, treatment, storage, disposal, transportation or
handling of pollutants, contaminants, chemicals or industrial, toxic or
hazardous substances or oil or petroleum products or solid or hazardous waste.
As used above, the terms "release", and "environment" shall have the meaning set
forth in the federal Comprehensive Environmental Compensation, Liability and
Response Act of 1980 ("CERCLA").
(b) To the knowledge of the Company, or any Stockholder or
Optionholder, there have been no releases of any Materials of Environmental
Concern (as defined below) into the environment at any parcel of real property
or any facility formerly or currently owned, operated or controlled by the
Company. With respect to any such releases of Materials of Environmental
Concern, the Company has given all required notices to Governmental Entities
(copies of which have been provided to PQC in its due diligence process). The
Company is not aware of any releases of Materials of Environmental Concern at
parcels of real property or facilities other than those owned, operated or
controlled by the Company that could reasonably be expected to have an impact on
the real property or facilities owned, operated or controlled by the Company.
For purposes of this Agreement, "Materials of Environmental Concern" means any
chemicals, pollutants or contaminants, hazardous substances (as such term is
defined under CERCLA), solid wastes and hazardous
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<PAGE>
wastes (as such terms are defined under the federal Resources Conservation and
Recovery Act), toxic materials, oil or petroleum and petroleum products.
(c) Set forth in Schedule 2.27 is a list of all environmental
-------------
reports, investigations and audits relating to premises currently or previously
owned or operated by the Company (whether conducted by or on behalf of the
Company or a third party, and whether done at the initiative of the Company or
directed by a Governmental Entity or other third party) which the Company has
possession of or access to.
2.28 Disclosure. No representation or warranty by the Company, the
----------
Stockholders or the Optionholders contained in this Agreement or in any other
document delivered to Flagship or PQC in connection with their due diligence
investigation of the Company, taken as a whole, contains or will contain any
untrue statement of a material fact or omits or will omit to state any material
fact necessary, in light of the circumstances under which it was or will be
made, in order to make the statements herein or therein not misleading. The
Company, the Stockholders and the Optionholders have disclosed to PQC all
material information relating to the Practice, the Company, the Stockholders and
the Optionholders and the transactions contemplated by this Agreement.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF PQC
AND FLAGSHIP
Each of Flagship and PQC jointly and severally represents and warrants to
the Company, the Stockholders and the Optionholders as of the date hereof and as
of the Effective Time as follows:
3.1 Organization. Each of Flagship and PQC is a corporation duly
------------
organized, validly existing and in good standing under the laws of the
jurisdictions of their incorporation, and each of Flagship and PQC has the power
and authority to carry on its business as presently being conducted. PQC has
provided the Company with complete and accurate copies of the Certificate of
Incorporation and bylaws of PQC and the Articles of Incorporation and bylaws of
Flagship. Flagship and PQC each is duly qualified and is in good standing as a
foreign corporation in each jurisdiction where the nature of its business,
properties or other activities requires it to be qualified.
3.2 Capitalization of Flagship and PQC. The authorized capital stock of
----------------------------------
PQC consists of 140,000,000 shares of Class A Common Stock, par value $0.01 per
share, of which 20,151,864 Class A shares are outstanding, 6,727,043 shares of
Class B- 1 Common Stock, par value $0.01 per share of which 2,809,296 shares are
-18-
<PAGE>
outstanding, 4,287,957 shares of Class B-2 Common Stock, par value $0.01 per
share, of which 1,790,704 shares are outstanding, 27,692,309 shares of Class C
Common Stock of which 7,692,309 are outstanding and 10,000,000 shares of
Preferred Stock, par value $0.01 per share, of which no shares are outstanding.
Except for Physicians Quality Care of Massachusetts, Inc. and Physician Quality
Care of Maryland, Inc., PQC is not the owner of record of the equity securities
of any issuer. On the Closing Date, Flagship's authorized capital stock will
consist of 1,000 shares of common stock, $5.00 par value per share, of which
1,000 shares will be outstanding. Except as set forth in Schedule 3.2, there are
------------
not, and on the Closing Date there will not be, outstanding (i) any options,
warrants or other rights to purchase any capital stock of PQC or Flagship; (ii)
any securities convertible into or exchangeable for shares of such stock; or
(iii) any other commitments of any kind for the issuance of additional shares of
capital stock or options, warrants or other securities of PQC or Flagship.
Except as disclosed on Schedule 3.2, there are no agreements, voting trusts,
------------
proxies or understandings with respect to the voting, or registration under the
Securities Act of 1933 of any shares of PQC or Flagship except for the
Stockholders Agreement and the Shareholder Designation and Stock Transfer
Agreement by and among PQC, Flagship and the sole shareholder of Flagship dated
as of the date hereof (the "Designation Agreement").
3.3 Authorization. The execution and delivery of this Agreement and the
-------------
other agreements, documents and instruments to be executed and delivered by
Flagship and PQC pursuant hereto and the consummation by Flagship and PQC of the
transactions contemplated hereby and thereby will, on the Closing Date, have
been authorized by all necessary corporate action on the part of PQC and
Flagship.
3.4 Valid and Binding Agreement. Each of Flagship and PQC has the
---------------------------
necessary power and authority to enter into this Agreement and the other
agreements, documents and instruments to be executed and delivered by Flagship
and PQC pursuant hereto, and to carry out the transactions contemplated hereby
and thereby. When fully executed and delivered, this Agreement and each of the
other agreements, documents and instruments to be executed and delivered by
Flagship and PQC pursuant hereto will constitute valid and binding agreements of
Flagship and PQC, enforceable against them in accordance with their terms,
except to the extent that enforceability is limited pursuant to bankruptcy or
similar laws or by general principles of equity.
3.5 No Violation. Neither the execution and delivery of this Agreement or
------------
the other agreements, documents and instruments to be executed and delivered by
Flagship and PQC pursuant hereto nor the consummation by Flagship and PQC of the
transactions contemplated hereby or thereby (a) will violate any provision of
the Certificate of Incorporation or bylaws of PQC or the Articles of
Incorporation or bylaws of Flagship, each as currently in effect, (b) will
violate or conflict with any applicable statute, law, ordinance, rule,
regulation, order, judgment or decree, except
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<PAGE>
that no representation or warranty is made under this Section with regard to the
laws referred to in Section 3.9, or (c) will violate any contract or commitment
which violation would have the effect of preventing PQC or Flagship from
performing its obligations hereunder or preventing PQC or Flagship or any of
their respective affiliates from consummating the transactions contemplated
herein and in the agreements and instruments to be executed and delivered by
Flagship and PQC and their respective affiliates in connection therewith.
3.6 Consents; Filings. Except as set forth in Schedule 3.6, no
-----------------
registration or filing with, or consent, approval, permit, authorization or
action by, any third party (including, without limitation, any federal, state,
local, foreign or other governmental agency, instrumentality, commission,
authority, board or body or other person or entity) is required to be made by
Flagship or PQC in connection with the execution and delivery by Flagship and
PQC of this Agreement or the other agreements, documents and instruments to be
executed and delivered by Flagship and PQC pursuant hereto or the consummation
by Flagship and PQC of the transactions contemplated hereby or thereby.
3.7 Capital Stock. All shares of Common Stock issued to any Stockholder in
-------------
connection with the transactions contemplated by this Agreement shall be duly
authorized, validly issued, fully paid and nonassessable and not subject to any
preemptive rights created by statute, PQC's Certificate of Incorporation or
bylaws, or any agreement (other than the Stockholders Agreement) to which PQC is
a party or by which PQC is bound. The shares of Common Stock included in the
Merger Consideration are being issued pursuant to PQC's Registration Statement
on Form S-1, which has been declared effective by the Securities and Exchange
Commission and the Securities Division of the State of Maryland.
3.8 Brokers. Neither PQC nor Flagship is obligated to pay, nor has PQC or
-------
Flagship retained any broker or finder or other person who is entitled to, any
broker's or finder's fee or any other commission or financial advisory fee based
on any agreement or understanding made by PQC or Flagship in connection with the
transactions contemplated hereby.
3.9 Fraud and Abuse; Stark Law. Neither Flagship nor PQC has engaged in
--------------------------
any activities which are prohibited under 42 U.S.C. (S)1320a-7b or 42 U.S.C.
(S)1395nn et seq., or the regulations promulgated thereunder pursuant to such
statutes, or related state or local statutes or regulations, or which are
prohibited by rules of professional conduct, including but not limited to the
following: (i) knowingly and willfully making or causing to be made a false
statement or representation of a material fact in any application for any
benefit or payment; (ii) knowingly and willfully making or causing to be made
any false statement or representation of a material fact for use in determining
rights to any benefit or payment; (iii) failure to disclose knowledge by a
claimant of the occurrence of any event affecting the initial or continued right
to any
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<PAGE>
benefit or payment on its own behalf or on behalf of another, with intent to
fraudulently secure such benefit of payment; (iv) knowingly and willfully
soliciting or receiving any remuneration (including any kickback, bribe or
rebate), directly or indirectly, overtly or covertly, in cash or in kind or
offering to pay or receive such remuneration (a) in return for referring an
individual to a person for the furnishing or arranging for the furnishing of any
item or service for which payment may be made in whole or in part by Medicare or
Medicaid, or (b) in return for purchasing, leasing, or ordering or arranging for
or recommending purchasing, leasing, or ordering any good, facility or item for
which payment may be made in whole or in part by Medicare or Medicaid; and (v)
referring a patient for Designated Health Services (within the meaning of 42
U.S.C. (S)1395nn) when the referring physician has a financial relationship with
the entity to which the referral is made in the absence of an applicable
exception under 42 U.S.C. (S)1395nn.
3.10 Litigation. Except as set forth on Schedule 3.10, there is not, and
---------- -------------
during the past five (5) years there have not been any Actions pending or, to
the best of Flagship and PQC's knowledge: (a) threatened against, related to or
affecting (i) PQC or Flagship, (ii) any officers, directors or employees of
Flagship or PQC as such, or (iii) any shareholder of Flagship or PQC in such
shareholder's capacity as a shareholder of Flagship or PQC; (b) seeking to
delay, limit or enjoin the transactions contemplated by this Agreement; (c) that
involves the risk of criminal liability; or (d) in which Flagship or PQC is a
plaintiff. Neither Flagship nor PQC is in default with respect to or subject to
any judgment, order, writ, injunction or decree of any court or governmental
agency, and there are no unsatisfied judgments against Flagship or PQC.
3.11 Disclosure. No representation or warranty by Flagship or PQC
----------
contained in this Agreement or in any other document delivered to the Company in
connection with its due diligence investigation of Flagship or PQC, including
the Prospectus dated June __, 1997, together with any amendment or supplement
thereto provided to the Company prior to the Class Date, taken as a whole,
contains or will contain any untrue statement of a material fact or omits or
will omit to state any material fact necessary, in light of the circumstances
under which it was or will be made, in order to make the statements herein or
therein not misleading.
ARTICLE IV
COVENANTS
4.1 Reasonable Efforts to Close. Each of Company, the Stockholders, the
---------------------------
Optionholders, Flagship and PQC shall use its or their respective reasonable
efforts to proceed to the closing of the transactions contemplated hereby and to
satisfy any of the conditions precedent to the other Parties' obligations set
forth in Articles V and VI to the extent such conditions are within such Party's
control.
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<PAGE>
4.2 Notices and Consents. The Company and each Stockholder shall use its
--------------------
best efforts to obtain, at its expense, all such waivers, permits, consents,
approvals or other authorizations from third parties and Governmental Entities,
and to effect all such registrations, filings and notices with or to third
parties and Governmental Entities, as may be required by or with respect to the
Company or any Stockholder in connection with the transactions contemplated by
this Agreement, including without limitation those listed in Schedule 2.6.
------------
4.3 Conduct of Business. Without the prior written consent of PQC (which
-------------------
consent shall not be unreasonably withheld), the Company shall not and the
Stockholders shall not permit the Company to:
(a) take any action to amend the Company's Articles of
Incorporation or bylaws or other organizational documents;
(b) issue any stock, bonds or other corporate securities or grant
any option or issue any warrant to purchase or subscribe to any of such
securities or issue any securities convertible into such securities or authorize
the transfer of any of its outstanding capital stock;
(c) split, combine or reclassify any shares of its capital stock;
declare, set aside or pay any dividend or other distribution (whether in cash,
stock or property or any combination thereof) in respect of its capital stock;
or make any payment under the Company's Stockholder Benefits Plan or similar
Plan if such payment would cause, or is reasonably expected to cause, the
Company to fail to satisfy any of the conditions to Closing in Article V of this
Agreement.
(d) incur any obligations or liabilities (absolute or contingent)
greater than one thousand dollars ($1,000) in the aggregate, except current
liabilities incurred and obligations under contracts entered into in the
Ordinary Course of Business;
(e) acquire, sell, lease, encumber or dispose of any assets or
property, corporation, partnership, association or other business, other than
purchases and sales of assets in the Ordinary Course of Business;
(f) discharge or satisfy any Security Interest or pay any
obligation or liability other than in the Ordinary Course of Business;
(g) mortgage or pledge any of its property or assets or subject any
such assets to any Security Interest;
(h) take any action or fail to take any action within their
respective control and permitted by this Agreement with the knowledge that such
action or failure to take action would result in (i) any of the representations
and warranties of
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<PAGE>
the Company and the Stockholders set forth in this Agreement becoming untrue or
(ii) any of the conditions to the Merger set forth in Article V not being
satisfied;
(i) merge or consolidate with or into any corporation or other
entity;
(j) make, accrue or become liable for any bonus, profit sharing or
incentive payment, except for accruals under existing plans, if any, or increase
the rate of compensation payable or to become payable by it to any of its
officers, directors or employees, other than increases in the Ordinary Course of
Business consistent with past practice;
(k) make any election or give any consent under the Code or the tax
statutes of any state or other jurisdiction or make any termination, revocation
or cancellation of any such election or any consent or compromise or settle any
claim for past or present tax due;
(l) waive any rights of material value;
(m) modify, amend, alter or terminate any of its executory
contracts of a material value or which are material in amount;
(n) take any act or permit to occur any omission constituting a
breach or default under any contract, indenture or agreement by which it or its
properties are bound;
(o) fail to use its reasonable efforts to: (i) preserve the
possession and control of its assets and the Practice; (ii) keep in faithful
service its present officers and employees; (iii) preserve the goodwill of its
patients, suppliers, agents, brokers and others having business relations with
it; and (iv) keep and preserve its business existing on the date hereof until
after the Closing Date;
(p) fail to operate its business and maintain its books, accounts
and records in the customary manner and in the Ordinary Course of Business and
maintain in good repair its business premises, fixtures, machinery, furniture
and equipment;
(q) enter into any leases, contracts, agreements or understandings
which are required to be performed in whole or in material part after the
Closing Date;
(r) engage any new employee except in the Ordinary Course of
Business;
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<PAGE>
(s) materially alter the terms, status or funding condition of any
Employee Benefit Plan; or
(t) commit or agree to do any of the foregoing in the future.
4.4 Access to Management, Properties and Records. From the date of this
--------------------------------------------
Agreement until the Closing Date, the Company shall afford the officers,
attorneys, accountants and other authorized representatives of PQC and Flagship
free and full access upon reasonable notice and during normal business hours to
all management personnel, offices, properties, books and records of the Company,
and all properties under the management of the Company and all records relating
thereto, so that PQC and Flagship may have full opportunity to make such
investigation as they shall desire to make of the management, business,
properties and affairs of the Company and the properties under the management of
the Company, and PQC shall be permitted to make abstracts from, or copies of,
all such books and records. The Company shall furnish to PQC such financial and
operating data and other information as to the business of the Company as PQC
shall reasonably request.
4.5 Taxes. The Company will, on a timely basis, file all Tax Returns for
-----
and pay any and all taxes which shall become due on or prior to the Closing
Date.
4.6 Compliance with Laws. The Company, the Stockholders and the
--------------------
Optionholders will comply in all material respects with all laws and regulations
which are applicable to it or each of them and the Practice or to the conduct of
its Practice and will perform and comply in all material respects with all
contracts, commitments and obligations by which it or each of them is bound.
4.7 Exclusive Dealing. None of the Company, the Stockholders or the
-----------------
Optionholders will not, directly or indirectly, through any officer, director,
agent or otherwise, (a) solicit, initiate or encourage submission of proposals
or offers from any person relating to any affiliation transaction between the
Company, the Stockholders or the Optionholders and any health care company or
practice management company or any acquisition or purchase of all or a material
portion of the assets of the Company, or any equity interest in the Company or
any equity investment, merger, consolidation or business combination with the
Company, or (b) participate in any discussions or negotiations regarding, or
furnish to any other person, any non-public information with respect to, or
otherwise cooperate in any way with, or assist or participate in, facilitate or
encourage, any effort or attempt by any other person to do or seek any of the
foregoing except to inform such person of the Company's obligations hereunder.
4.8 Notice of Breaches. The Company, Stockholders and Optionholders shall
------------------
promptly deliver to PQC written notice of any event or development that would
(a) render any statement, representation or warranty of the Company in this
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Agreement (including the Disclosure Schedule) inaccurate or incomplete in any
material respect, or (b) constitute or result in a breach by the Company,
Stockholders or Optionholders of, or a failure by the Company, Stockholders or
Optionholders to comply with, any agreement or covenant in this Agreement
applicable to such Party. PQC or Flagship shall promptly deliver to the Company
written notice of any event or development that would (i) render any statement,
representation or warranty of PQC or Flagship in this Agreement inaccurate or
incomplete in any material respect, or (ii) constitute or result in a breach by
PQC or Flagship of, or a failure by PQC or Flagship to comply with, any
agreement or covenant in this Agreement applicable to such Party. No such
disclosure shall be deemed to avoid or cure any such misrepresentation or
breach.
4.9 Severance Obligations. The Company shall satisfy all severance
---------------------
obligations related to each person employed by the Company prior to or at the
Closing Date who is, or as a consequence of the transactions contemplated by
this Agreement will be, entitled to any severance or compensation from the
Company, any Stockholder or any Optionholder.
4.10 Confidentiality. All information not previously disclosed to the
---------------
public or generally known to persons engaged in the respective businesses of the
Company, the Practice, Flagship or PQC which shall have been furnished by PQC or
the Company to the other Party in connection with the transactions contemplated
hereby or as provided pursuant to this Agreement shall not be disclosed to any
person other than their respective employees, directors, attorneys, accountants
or financial advisors or other than as expressly contemplated herein or as
required by law or legal process. In the event that the transactions
contemplated by this Agreement shall not be consummated, all such information
which shall be in writing shall upon request be returned to the Party furnishing
the same, including, to the extent reasonably practicable, all copies or
reproductions thereof which may have been prepared, and none of the Parties,
without the consent of PQC and the Company, shall at any time thereafter
disclose to third parties, or use, directly or indirectly, for its or their own
benefit, any such information, written or oral, about the business of the other
Party hereto.
4.11 Provision of Certain Closing Date Financial Information. Two (2) days
-------------------------------------------------------
prior to the Closing Date, the Company shall deliver to Flagship and PQC a
certificate setting forth in detail to the best of the Company's knowledge; (i)
all liabilities of the Company, including liabilities for accrued vacation and
any Employee Benefit Plan (as defined in Section 2.21) that shall accrue on or
before the Closing Date but shall remain unpaid on the Closing Date; (ii) all
prepaid expenses of the Company that relate to a period subsequent to the
Closing Date; (iii) all cash, cash equivalents and accounts receivables expected
to be reflected in accordance with generally accepted accounting principals on
the Company's records on the Closing
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<PAGE>
Date; and (iv) the Net Worth (as defined in Section 5.15) of the Company as of
the Closing Date.
4.12 Continuing Obligation to Inform. From time to time prior to the
-------------------------------
Closing, the Parties shall deliver or cause to be delivered to the other Parties
supplemental information concerning events subsequent to the date hereof which
would render any statement, representation or warranty in this Agreement or any
information contained in any Schedule inaccurate or incomplete in any material
respect at any time after the date hereof until the Closing Date.
ARTICLE V
CONDITIONS TO FLAGSHIP'S AND PQC'S OBLIGATIONS
The obligation of each of Flagship and PQC to consummate the Merger is
subject to the satisfaction on the Closing Date of the following conditions
precedent, each of which may be waived in writing by Flagship and PQC:
5.1 Approval of Merger. This Agreement and the Merger shall have been
------------------
unanimously approved by the Board of Directors of the Company and the
Stockholders and no Stockholder shall be entitled to exercise appraisal rights.
5.2 Continued Truth of Representations and Warranties of The Company;
-----------------------------------------------------------------
Compliance with Covenants and Obligations. The representations and warranties of
- -----------------------------------------
the Company, the Stockholders and Optionholders shall be true on and as of the
Closing Date as though such representations and warranties were made on and as
of such date, except for any changes permitted by the terms hereof or consented
to in writing by Flagship and PQC. The Company and the Stockholders shall have
performed and complied with all terms, conditions, covenants, obligations,
agreements and restrictions required by this Agreement to be performed or
complied with by it prior to or at the Closing Date.
5.3 No Proceedings or Litigation. No action by any Governmental Entity or
----------------------------
other person shall have been instituted or threatened which questions the
validity or legality of the transactions contemplated hereby and which could
reasonably be expected to result in a Material Adverse Effect. There shall not
be any statute, rule or regulation that makes the Merger or the other
transactions contemplated hereby illegal or otherwise prohibited.
5.4 Material Changes. Between June 30, 1996 and the Closing, there shall
----------------
not have been any material adverse change in the business, prospects, operations
or conditions of the Company or the Practice.
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<PAGE>
5.5 Stockholders Agreement. The Stockholders and Optionholders shall have
----------------------
become parties to and be in compliance with the Stockholders Agreement.
5.6 Due Diligence. The Company, the Stockholders and the Optionholders
-------------
shall have provided to PQC and Flagship access to all material and information
requested by PQC and Flagship to conduct a thorough due diligence review of all
aspects of the Company and the Practice. PQC and Flagship shall be satisfied
with such review, both in scope and substance.
5.7 Real Estate Arrangements. PQC shall have entered into leases,
------------------------
subleases or assignments of leases for each of the existing premises of the
Company, which leases shall be in form and on terms satisfactory to PQC.
5.8 Government and Third Party Approvals. The transactions contemplated
------------------------------------
by this Agreement shall have been approved by all government agencies and third
parties from whom such approval is required, including, but not limited to, Bain
Capital, Inc. and Bankers Trust Company.
5.9 Corporate Approvals. This Agreement and the transaction contemplated
-------------------
hereby shall have been approved by the Boards of Directors of PQC and Flagship,
the Joint Policy Board of Flagship, the Class B shareholders of PQC and, to the
extent required, by the physicians affiliated with Flagship.
5.10 Financing. PQC shall have obtained the financing equal to the cash
---------
included in the Merger Consideration from affiliates of Bain Capital, Inc. or
other sources acceptable to PQC.
5.11 S-1 Registration Statement. The Securities and Exchange Commission
--------------------------
and the Securities Division of the State of Maryland shall have declared
effective PQC's Registration Statement on Form S-1.
5.12 Employment Agreements. At least 80% of the Stockholders (and all of
---------------------
the Stockholders listed on a Schedule 5.12) shall have entered into Employment
Agreements with Flagship in the form attached hereto as Exhibit B.
5.13 Amendment to Services Agreement. Flagship and PQC shall have entered
-------------------------------
into an Amended and Restated Services Agreement in substantially the form
attached hereto as Exhibit C.
---------
5.14 Net Asset Test. On the Closing Date, the Company shall have cash,
--------------
cash equivalents and accounts receivable of at least $ and a Net Assets (being
total assets less total liabilities, in each case determined in accordance with
generally accepted accounting principals) equal to at least $2,314,519. Since
the date of the
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<PAGE>
Interim Financial Statements, the Company shall not have incurred any
liabilities other than in the Ordinary Course of Business.
5.15 Closing Deliveries. Simultaneously with the Closing, the Company, the
------------------
Stockholders and the Optionholders shall deliver or cause to be delivered to PQC
the following:
(a) an Instrument of Joinder to Stockholders Agreement executed by
each of the Stockholders in a form reasonably acceptable to PQC;
(b) certificates of duly authorized officers of the Company, dated
the Closing Date, setting forth the resolutions of the Board of Directors and
Stockholders of the Company authorizing the execution and delivery by the
Company of this Agreement and the consummation of the transactions contemplated
hereby, and certifying that such resolutions were duly adopted and have not been
rescinded or amended;
(c) a report of a reputable lien search firm indicating that there
are no liens of record against any of the Company's assets (except for liens
which are (i) acceptable to Flagship and PQC in their sole discretion or (ii)
arising under equipment leases listed on Schedule 5.15);
-------------
(d) a release from any party with a mortgage or lien on any of the
assets of the Company, except for liens which, pursuant to subsection (c) of
this Section 5.16, are acceptable to Flagship and PQC;
(e) the consents of all parties necessary for the consummation of
the Merger and to consummate the other transactions contemplated by this
Agreement;
(f) a tax lien waiver, if required, from the Comptroller of the
Treasury of the State of Maryland; and
(g) such other agreements, consents and documents as PQC and
Flagship shall reasonably request in connection with (i) their due diligence
investigation of the Company, (ii) the affiliation of the Stockholders with
Flagship and PQC, (iii) the transactions contemplated by this Agreement and the
Employment Agreements.
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<PAGE>
ARTICLE VI
CONDITIONS TO OBLIGATIONS OF THE COMPANY,
THE STOCKHOLDERS AND THE OPTIONHOLDERS
The obligations of Company, the Stockholders and the Optionholders under
this Agreement are subject to the fulfillment, at the Closing Date, of the
following conditions precedent, each of which may be waived in writing in the
sole discretion of Company:
6.1 Continued Truth of Representations and Warranties of PQC and
------------------------------------------------------------
Flagship; Compliance with Covenants and Obligations. The representations and
- ---------------------------------------------------
warranties of Flagship and PQC shall be true on and as of the Closing Date as
though such representations and warranties were made on and as of such date,
except for any changes permitted by the terms hereof or consented to in writing
by the Company. Flagship and PQC shall have performed and complied with all
terms, conditions, covenants, obligations, agreements and restrictions required
by this Agreement to be performed or complied with by it prior to or at the
Closing Date.
6.2 No Proceedings or Litigation. No action by any Governmental Entity or
----------------------------
other person shall have occurred or shall have been instituted or threatened
which questions the validity or legality of the transactions contemplated hereby
and which could reasonably be expected to result in a Material Adverse Effect.
There shall not be any statute, rule or regulation that makes the Merger or the
other transactions contemplated hereby illegal or otherwise prohibited.
6.3 Offers of Employment. Flagship shall have extended offers of
--------------------
employment upon the same financial terms as the employee received from the
Company on the date of execution hereof, subject to any subsequent changes
acceptable to the Company and PQC, to the persons listed on Schedule 6.3.
------------
6.4 Real Estate Arrangements. PQC shall have entered into leases,
------------------------
subleases or assignments of leases for each of the existing premises of the
Company, which leases shall be in form and on terms satisfactory to PQC.
6.5 Government and Third Party Approvals. The transactions contemplated
------------------------------------
by this Agreement shall have been approved by all government agencies and third
parties from whom such approval is required, including, but not limited to, the
Class B shareholders of PQC and Bankers Trust Company.
6.6 Corporate Approvals. This Agreement and the transaction contemplated
-------------------
hereby shall have been approved by the Boards of Directors of PQC and Flagship,
the Joint Policy Board of Flagship, the Class B shareholders of PQC and, to the
extent required, by the physicians affiliated with Flagship.
-29-
<PAGE>
6.7 Financing. PQC shall have obtained the financing equal to the cash
---------
included in the Merger Consideration.
6.8 S-1 Registration Statement. The Securities and Exchange Commission
--------------------------
shall have declared effective PQC's Registration Statement on Form S-1.
6.9 Letter Agreement. PQC, Flagship and the Stockholders shall have
----------------
entered into the Letter Agreement ("Letter Agreement") attached hereto as
Exhibit D.
6.10 Amendment to Services Agreement. Flagship and PQC shall have entered
-------------------------------
into an Amended and Restated Services Agreement in substantially the form
attached hereto as Exhibit C.
---------
6.11 Material Changes. Between March 31, 1997, and the Closing, there
----------------
shall not have been any Material Adverse Change in the business, prospects,
operations or conditions of Flagship or PQC.
6.12 Due Diligence. PQC shall have provided to the Company access to all
-------------
material and information requested by the Company to conduct a thorough due
diligence review of all aspects of PQC. The Company shall be satisfied with such
review, both in scope and substance.
6.13 Physicians. Flagship shall have offered to enter into Employment
----------
Agreements with each of the Stockholders in the form attached hereto as
Exhibit B.
6.14 Deliveries by PQC. Simultaneously with the Closing, PQC shall deliver
-----------------
or cause to be delivered to the Stockholders and Optionholders the following:
(a) the Merger Consideration.
(b) certificates of duly authorized officers of Flagship and PQC,
dated the Closing Date, setting forth the resolutions of the Board of Directors
of Flagship and PQC authorizing the execution and delivery by Flagship and PQC
of this Agreement and the consummation of the transactions contemplated hereby,
and certifying that such resolutions were duly adopted and have not been
rescinded or amended;
(c) such other instruments, consents and documents as the Company
shall reasonably request in connection with (i) its due diligence investigation
of PQC and (ii) the transactions contemplated by this Agreement.
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<PAGE>
ARTICLE VII
INDEMNIFICATION
7.1 Indemnification.
---------------
(a) The Stockholders and Optionholders, severally and not jointly,
shall indemnify, defend, and hold harmless PQC, Flagship and their respective
subsidiaries and affiliates and their directors, officers, employees and agents
or the successor of any of the foregoing (collectively, the "PQC Indemnified
Parties"), and reimburse the PQC Indemnified Parties for, from and against all
payments, demands, claims, suits, judgments, liabilities, losses, costs, damages
and expenses, including, without limitation, interest, penalties and reasonable
attorneys' fees, disbursements and expenses (collectively, "Damages"), imposed
on or incurred by any PQC Indemnified Party which relate to or arise out of:
(i) breach of any representation and warranty of, or
covenant or agreement to be performed by, the Company, any Stockholder or any
Optionholder, in each case contained in this Agreement or the Stockholders
Agreement;
(ii) failure of any Stockholder to have good, valid and
marketable title to the issued and outstanding Shares held by such Stockholder,
free and clear of all liens, claims, pledges, options, adverse claims or charges
of any nature whatsoever;
(iii) any claim by a Stockholder, an Optionholder or former
Stockholder or Optionholder of the Company, or any other person, firm,
corporation or entity, seeking to assert, or based upon: (A) ownership or rights
to ownership of any shares of stock of the Company; (B) any rights of a
Stockholder, including any options, preemptive rights or rights to notice or to
vote; (C) any rights under the Articles of Incorporation or bylaws of the
Company; or (D) any claim that such Stockholder's shares were wrongfully
repurchased by the Company;
(iv) any Tax liabilities arising out of the operation of the
Company prior to the Closing Date provided however, that with respect to any
Stockholder, there is excluded from Section 7.1 (a)(iv) any amounts actually
deducted as a Deductible Expense of such Stockholder under Section 10.4 of
Appendix A of the Services Agreement;
(v) the conduct of the Practice prior to the Closing Date,
except for liabilities described in Section 2.8(a) or reflected in the
Settlement Date Financial Certificate required by Schedule 1.14;
--------------
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<PAGE>
(vi) any liability of the Company incurred prior to the
Closing Date that is not described in Schedule 2.8(a); and
---------------
(vii) any liability incurred by PQC or Flagship relating to
agreements or obligations of the Company or any Stockholder, whether written or
oral, that are not specifically identified on the Disclosure Schedule.
(b) PQC and Flagship shall indemnify and hold harmless the Company
and the Stockholders and their respective agents or the successors of any of the
foregoing (collectively, the "Company Indemnified Parties") and together with
the PQC Indemnified Parties (the "Indemnified Parties"), and reimburse such
Company Indemnified Parties for, from, and against all Damages imposed on or
incurred by such Company Indemnified Parties which relate to or arise out of any
breach of any representation or warranty of, or covenant or agreement to be
performed by, PQC or Flagship, in each case contained in this Agreement.
7.2 Method of Asserting Claims.
--------------------------
(a) An Indemnified Party shall give prompt written notice to an
indemnifying party (the "Indemnifying Party") of any payments, demands, claims,
suits, judgments, liabilities, losses, costs, damages or expenses (a "Claim") in
respect of which such Indemnifying Party has a duty to provide indemnity to such
Indemnified Party under this Article VII, except that any delay or failure so to
notify the Indemnifying Party only shall relieve the Indemnifying Party of its
obligations hereunder to the extent, if at all, that it is prejudiced by reason
of such delay or failure.
(b) If a Claim is brought or asserted by a third party (a "Third-
Party Claim"), the Indemnifying Party shall assume the defense thereof,
including the employment of counsel reasonably satisfactory to the Indemnified
Party and the payment of all expenses. The Indemnified Party shall have the
right to employ separate counsel in such Third-Party Claim and participate in
the defense thereof, but the fees and expenses of such counsel shall be at the
expense of the Indemnified Party. In the event that the Indemnifying Party,
within twenty (20) days after written notice of any Third-Party Claim, fails to
assume the defense thereof, or in the event the Indemnifying Party fails to
demonstrate, to the reasonable satisfaction of the Indemnified Party, that it
has sufficient assets to meet its indemnification obligations hereunder, the
Indemnified Party shall have the right to undertake the defense, compromise or
settlement of such Third-Party Claim for the account of the Indemnifying Party.
Anything in this Section 7.2(b) to the contrary notwithstanding, the
Indemnifying Party shall not, without the Indemnified Party's prior written
consent, settle or compromise any Third-Party Claim or consent to the entry of
any judgment with respect to any Third-Party Claim which would have any adverse
effect on the Indemnified Party, except as provided immediately below. The
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<PAGE>
Indemnifying Party may, without the Indemnified Party's prior written consent,
settle or compromise any such Third-Party Claim or consent to entry of any
judgment with respect to any Third-Party Claim which requires solely money
damages paid by the Indemnifying Party and which includes as an unconditional
term thereof the release by the claimant or the plaintiff of the Indemnified
Party from all liability in respect of such Third-Party Claim.
(c) With respect to any Claim other than a Third Party Claim, the
Indemnifying Party shall have thirty (30) days from receipt of written notice
from the Indemnified Party of such Claim within which to respond thereto. If the
Indemnifying Party does not respond within such thirty (30) day period, the
Indemnifying Party shall be deemed to have accepted responsibility to make
payment and shall have no further right to contest the validity of such Claim.
If the Indemnifying Party notifies the Indemnified Party within such thirty (30)
day period that it rejects such Claim in whole or in part, the Indemnified Party
shall be free to pursue such remedies as may be available to the Indemnified
Party under applicable law.
7.3 Survival. All representations, warranties, covenants and agreements
--------
made by the Parties herein or in any instrument or document furnished in
connection herewith shall survive the Closing and any investigation at any time
made by or on behalf of the Parties hereto. All such representations and
warranties and the Stockholders' obligations pursuant to Section 7.1(a)(i) and
the obligations of PQC and Flagship pursuant to Section 7.1(b) shall expire on
the third anniversary of the Closing Date, except for Claims, if any, asserted
in writing prior to such second anniversary, which shall survive until satisfied
in full or otherwise finally resolved. The obligation of the Stockholders
pursuant to Section 7-1(a)(ii), (iii), (iv), (v), (vi) and (vii) shall survive
until six (6) months after the expiration of the applicable statute of
limitations with respect thereto. All Claims and actions for indemnity pursuant
to this Article VII shall be asserted or maintained in writing by a Party hereto
on or prior to the expiration of such periods.
7.4 Set-off and Recoupment. (a) Any amount or amounts due from any
----------------------
Indemnifying Party to PQC under this Article VII may be paid to PQC, at PQC's
option, by set-off or recoupment against any amounts due to the Indemnifying
Party pursuant to this Agreement or pursuant to any agreement between the
Indemnifying Party and PQC, Flagship or any of their respective affiliates. Any
such set-off will be without prejudice to PQC's right to pursue any other
remedies at law or in equity available to it.
7.5 Limitation on Indemnification.
-----------------------------
(a) Notwithstanding any other term or condition contained herein or
in any other agreement or instrument referred to herein, the indemnification
obligations
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<PAGE>
of each Stockholder under Section 7.1(a)(i) - (vii) shall be limited, in the
aggregate, to the dollar value on the Closing Date of the Merger Consideration
paid to such Stockholder reduced by any amount deducted as a Deductible Expense
of such Stockholder under Section 10.4 of Appendix A of the Services Agreement
resulting from any Tax Liabilities of the Company, if, but only if, the Company
has filed all tax returns based on the good faith determination of its
accountants and paid all taxes shown to be due thereon through the taxable year
ending on the date of the Merger.
(b) Notwithstanding any other term or condition contained herein,
PQC shall not be entitled to any indemnification pursuant to Section 7.1(a)(v),
(vi) or (vii) with respect to any Damages where the indenmitor (or in the case
of the Company, a member of the management committee) did not have knowledge of
the liability giving raise to such Damages prior to the Closing Date, if, and
only if, an amount equal to 100% of such Damages (subject to the limitation in
Section 7.5(a)) is included as a Practice Expense of Pod R pursuant to the
Services Agreement and PQC or Flagship, as in the case may be, is actually
reimbursed for 100% of such Damages (subject to the limitation in Section
7.5(a)) in accordance with terms of the Services Agreement. Notwithstanding any
other term or condition contained herein, PQC shall not be entitled to any
indemnification pursuant to Section 7.1(a) with respect to the tax liability set
forth on Schedule 7.5(b) provided that PQC is reimbursed for such tax liability
over a period of three years (or such longer period as the Internal Revenue
Service may agree) out of the Pod R Account as such term is defined in the
Services Agreement.
(c) No Indemnified Party shall be indemnified and held harmless
under this Article VII from and against any Damages unless the Damages exceed on
a cumulative basis an amount equal to $250,000, in which case an Indemnitor
shall be liable only for Damages in excess of $250,000. The foregoing limitation
shall apply to the Company, Stockholders, and Optionholders in the aggregate and
not individually.
ARTICLE VIII
TERMINATION
8.1 Optional Termination. This Agreement may be terminated and the
--------------------
transaction contemplated herein abandoned at any time prior to the Closing as
follows:
(a) by the mutual consent of the Company, PQC and Flagship;
(b) by the Company, upon a material breach of any representation,
warranty, covenant or agreement on the part of PQC or Flagship set forth in this
Agreement, or if any representation or warranty of PQC or Flagship has become
materially untrue, in either case such that any of the conditions set forth in
Article VI
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<PAGE>
would be incapable of being satisfied by July 31, 1997; provided, that in any
case, a willful breach will be deemed to cause such conditions to be incapable
of being satisfied for purposes of this paragraph (b). Any breach on the part of
PQC or Flagship of the representations and warranties contained in Article III
or the covenants contained in Article IV, which permits termination of this
Agreement shall permit the Company, the Stockholders and the Optionholders to
immediately terminate any other agreement between PQC or Flagship and the
Company, any of the Stockholders.
(c) by PQC and Flagship upon a material breach of any
representation, warranty, covenant or agreement on the part of the Company, the
Stockholders or the Optionholders set forth in this Agreement, or if any
representation or warranty of the Company has become materially untrue, in
either case such that any of the conditions set forth in Article V would be
incapable of being satisfied by July 31, 1997; provided, that in any case, a
willful breach will be deemed to cause such conditions to be incapable of being
satisfied for purposes of this paragraph (c). Any breach on the part of the
Company, the Stockholders or the Optionholders of the representations and
warranties contained in Article II or the covenants contained in Article IV,
which permits termination of this Agreement shall permit PQC and Flagship to
immediately terminate any other agreement between the Company, the Stockholder
or the Optionholder and PQC or Flagship; or
(d) by either Party if the Closing shall not have occurred by July
31, 1997, or such other date agreed to by the Parties.
8.2 Effect of Termination. In the event this Agreement is terminated as
---------------------
provided above, (a) each of PQC, Flagship, the Stockholders, the Optionholders
and the Company shall, upon another Party's request, deliver to such other Party
all documents previously delivered (and copies thereof in its possession)
concerning one another and the transactions contemplated hereby as required by
Section 4.10 above, and (b) none of the Parties nor any of their respective
Stockholders, directors, officers or agents shall have any liability to the
other Parties, except for any deliberate breach or deliberate omission resulting
in a material breach of any of the provisions of this Agreement. In such case,
the breaching Party shall be liable only for the expenses and costs of the
non-breaching Party, and in no event shall either Party be liable for
anticipated profits or consequential damages. After termination each Party shall
keep confidential all information provided by the others pursuant to this
Agreement which is not in the public domain, shall exercise the same degree of
care in handling such information as it would exercise with similar information
of its own, and shall return any such information upon another Party's request.
ARTICLE IX
MISCELLANEOUS
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<PAGE>
9.1 Press Releases and Announcements. No Party shall issue any press
--------------------------------
release or public disclosure relating to the subject matter of this Agreement
without the prior written approval of the other Parties; provided, however, that
-------- -------
any Party may make any public disclosure it believes in good faith is required
by law or regulation (in which case the disclosing Party shall advise the other
Parties and provide them with a copy of the proposed disclosure prior to making
the disclosure).
9.2 No Third Party Beneficiaries. This Agreement shall not confer any
----------------------------
rights or remedies upon any person other than the Parties and their respective
successors and permitted assigns; provided, however, that the provisions in
--------
Article I concerning payment of the Merger Consideration are intended for the
benefit of the Stockholders and Optionholder.
9.3 Entire Agreement. This Agreement (including the documents referred to
----------------
herein) constitutes the entire agreement among the Parties and supersedes any
prior understandings, agreements, or representations by or among the Parties,
written or oral, with respect to the subject matter hereof.
9.4 Succession and Assignment. This Agreement shall be binding upon and
-------------------------
inure to the benefit of the Parties named herein and their respective successors
and permitted assigns. No Party may assign either this Agreement or any of its
rights, interests, or obligations hereunder without the prior written approval
of each of the other Parties.
9.5 Counterparts. This Agreement may be executed in two (2) or more
------------
counterparts, each of which shall be deemed an original but all of which
together shall constitute one (1) and the same instrument.
9.6 Headings. The section headings contained in this Agreement are
--------
inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Agreement.
9.7 Notices. All notices, requests, demands, claims, and other
-------
communications hereunder shall be in writing. Any notice, request, demand,
claim, or other communication hereunder shall be deemed duly delivered two (2)
business days after it is sent by registered or certified mail, return receipt
requested, postage prepaid, or one (1) business day after it is sent via a
reputable nationwide overnight courier service, in each case to the intended
recipient as set forth below:
If to the Company or the Stockholders:
- -------------------------------------
To the last known home address of each Stockholder as maintained in the records
of Flagship with a copy to:
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<PAGE>
Epstein, Becker & Green, P.C.
1227 25th Street, N.W.
Washington, DC 20037-1156
Attention: Mark Lutes, Esq.
If to PQC or Flagship:
- ---------------------
Physicians Quality Care, Inc.
950 Winter Street
Suite 2410
Waltham, MA 02154
Attention: Jerilyn Asher
With a copy to:
David C. Phelan, Esq.
Hale and Dorr
60 State Street
Boston, MA 02109
Any Party may give any notice, request, demand, claim, or other communication
hereunder using any other means (including personal delivery, expedited courier,
messenger service, telecopy, telex, ordinary mail, or electronic mail), but no
such notice, request, demand, claim, or other communication shall be deemed to
have been duly given unless and until it actually is received by the Party for
whom it is intended. Any Party may change the address to which notices,
requests, demands, claims, and other communications hereunder are to be
delivered by giving the other Parties notice in the manner herein set forth.
9.8 Governing Law. This Agreement shall be governed by and construed in
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accordance with the internal laws (and not the law of conflicts) of the State of
Maryland.
9.9 Amendments and Waivers. The Parties may mutually amend any provision
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of this Agreement at any time prior to the Effective Time. No amendment of any
provision of this Agreement shall be valid unless the same shall be in writing
and signed by all of the Parties. No waiver by any Party of any default,
misrepresentation, or breach of warranty or covenant hereunder, whether
intentional or not, shall be deemed to extend to any prior or subsequent
default, misrepresentation, or breach of warranty or covenant hereunder or
affect in any way any rights arising by virtue of any prior or subsequent such
occurrence.
9.10 Severability. If any term, provision, covenant or restriction of this
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Agreement is held by a court of competent jurisdiction to be invalid, void or
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unenforceable, the remainder of the terms, provisions, covenants and
restrictions of this Agreement shall remain in full force and effect and shall
in no way be affected, impaired or invalidated.
9.11 Expenses. Except as otherwise expressly provided herein, each
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Party to this Agreement shall pay its own costs and expenses in connection with
the transactions contemplated hereby.
9.12 Further Assurances. From time to time, at the request of any Party
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hereto and without further consideration, the other Parties will execute and
deliver to such requesting Party such documents and take such other action (but
without incurring any material financial obligation) as such requesting Party
may reasonably request in order to consummate more effectively the transactions
contemplated hereby.
9.13 Specific Performance. Each of the Parties acknowledges and agrees
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that one (1) or more of the other Parties would be damaged irreparably in the
event any of the provisions of this Agreement are not performed in accordance
with their specific terms or otherwise are breached. Accordingly, each of the
Parties agrees that the other Parties shall be entitled to an injunction or
injunctions to prevent breaches of the provisions of this Agreement and to
enforce specifically this Agreement and the terms and provisions hereof in any
action instituted in any court of the United States or any state thereof having
jurisdiction over the Parties and the matter, in addition to any other remedy to
which it may be entitled, at law or in equity.
9.14 Construction. The language used in this Agreement shall be deemed to
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be the language chosen by the Parties hereto to express their mutual intent, and
no rule of strict construction shall be applied against any Party. Any reference
to any federal, state, local, or foreign statute or law shall be deemed also to
refer to all rules and regulations promulgated thereunder, unless the context
requires otherwise.
9.15 Incorporation of Exhibits and Schedules. The Exhibits and Schedules
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identified in this Agreement are incorporated herein by reference and made a
part hereof.
9.16 Gender. All references herein to the masculine gender shall be deemed
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to include the feminine or neuter gender as appropriate.
9.17 Table of Cross-References. The following defined terms have the
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meaning set forth in the respective locations within this Agreement set forth
below:
"Actions" Section 2.17
"Affiliated Group" Section 2.11(d)
"Articles of Merger" Section 1.1
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<PAGE>
"CERCLA" Section 2.27(a)
"Claim" Section 7.2(a)
"Code" Section 1.13
"Closing" Section 1.2
"Closing Date" Section 1.2
"Common Stock" Preamble
"Company" Preamble
"Company Indemnified Parties" Section 7.1(b)
"Consenting Corporation" Section 2.11(c)
"Contracts" Section 2.14(a)
"Damages" Section 7.1(a)
"Disclosure Schedule" Article II
"ERISA" Section 2.21(c)
"ERISA Affiliate" Section 2.21(e)
"Effective Time" Section 1.1
"Employee Benefit Plan" Section 2.21(a)
"Employment Agreements" Section 5.12(a)
"Environment" Section 2.27(a)
"Environmental Law" Section 2.27(a)
"Financial Statements" Section 2.7
"Flagship" Preamble
"Governmental Entity" Section 2.6
"Indemnified Parties" Section 7.1(b)
"Indemnifying Party" Section 7.2(a)
"Interim Financial Statements" Section 2.7
"Leases" Section 2.13(a)
"Material Adverse Effect" Section 2.5
"Material of Environmental Concern" Section 2.27(b)
"Merger" Section 1.1
"Merger Consideration" Section 1.3
"Multi-Employer Plan" Section 2.21(e)
"Ordinary Course of Business" Section 2.12
Optionholders Preamble
"PQC" Preamble
"PQC Indemnified Parties" Section 7.1(a)
"Parachute Payments" Section 2.11(e)
"Parties" Preamble
"Permits" Section 2.15
"Practice" Section 2.5
"Release" Section 2.27(a)
"Security Interest" Section 2.12
"Shares" Section 1.5(a)
"Stockholders" Preamble
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<PAGE>
"Surviving Corporation" Section 1.1
"Tax Returns" Section 2.11(a)
"Taxes" Section 2.11(a)
"Third Party Claim" Section 7.2(b)
[BALANCE OF THIS PAGE LEFT BLANK INTENTIONALLY]
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<PAGE>
IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as
of the date first above written.
PHYSICIANS QUALITY CARE, INC.
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By: Jerilyn P. Asher
Title: Chief Executive Officer
FLAGSHIP HEALTH, P.A.
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By:
Title:
CLINICAL ASSOCIATES, P.A.
By:
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Its:
<PAGE>
CLINICAL ASSOCIATES
STOCKHOLDERS:
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CLINICAL ASSOCIATES
OPTIONHOLDERS
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<PAGE>
Exhibit 11.1 - Computation of Earnings Per Share
Physicians Quality Care, Inc.
<TABLE>
<CAPTION>
Period from March 20, Three months Three months
1995 (inception) to Year ended ended ended
December 31, December 31, March 31, March 31,
Primary and Fully-diluted earnings per share (1) 1995 1996 1996 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net loss $2,082,264 $ 4,973,188 $ 1,419,395 $ 1,086,817
Accretion on common stock subject to fair value put (2) 14,436,848 -- --
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Net loss available to common stockholders $2,082,264 $19,410,036 $ 1,419,395 $ 1,086,817
=============================================================================
Weighted average common shares outstanding 7,706,250 10,785,605 7,706,250 24,756,907
=============================================================================
Primary and fully-diluted loss per common share $ 0.27 $ 1.80 $ 0.18 $ 0.04
=============================================================================
</TABLE>
(1) The effect of options, warrants and convertible securities are not
considered as it would be antidilutive.
(2) Calculated as follows:
<TABLE>
<S> <C>
Per share fair value of common stock
at December 31, 1996 $2.50
Recorded per share value .01
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Per share accretion adjustment $2.49
Common shares subject to fair value put 5,797,930
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$14,436,848
===========
</TABLE>
<PAGE>
Exhibit 23.2
Consent of Ernst & Young LLP, Independent Auditors
We consent to the reference to our firm under the caption "Summary Financial
Data" and "Selected Financial Data" and to the use of our reports:
. dated March 28, 1997 as it relates to Physicians Quality Care, Inc.
. dated November 21, 1996 as it relates to Springfield Medical Associates,
Inc., Alphonse F. Calvanese, M.D., P.C., Cardiology and Internal Medicine
Associates, Inc., James F. Haines and William J. Belcastro, Partnership,
Jay M. Ungar, M.D. and Western Massachusetts Medical Group, Inc.
. dated September 20, 1996 as it relates to Annapolis Medical Specialists,
LLP, Drs. Fortier, Libber, Clemmens & Weimer, P.A., Drs. Goldgeier, Levine
& Freidman, P.A., Park Medical Associates, P.A. and Park Medical Labs,
Inc., and Drs. Sigler, Roskes, Holden & Schuberth, P.A.
. dated November 18, 1996 as it relates to Koeppel, Rosen, Rudikoff, M.D.,
P.C. and Drs. Pakula, Davick & Bogue, P.A.
all included in Amendment No. 2 to the Registration Statement (Form S-1, No.
333-26137) and related Prospectus of Physicians Quality Care, Inc. for the
registration of 8,000,000 shares of its common stock.
/s/ Ernst & Young LLP
Boston, Massachusetts
August 11, 1997
