<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended March 31, 1999
--------------------------------------------
OR
X TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from to
------------------ ------------------
Commission file number 333-26137
------------------------
Physicians Quality Care, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware 04-3267297
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
700 Technology Park Drive, Billerica, Massachusetts 01821
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (978) 439-0323
-----------------------------
Not Applicable
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Indicate by check U whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X No
------- -------
APPLICABLE ONLY TO CORPORATE ISSUERS:
Number of shares outstanding of registrant's common stock as of March 31,
1999: 27,058,944 shares of Class A Common Stock, $.01 par value, 2,809,296
shares of Class B-1 Common Stock, $.01 par value, 1,790,704 shares of Class B-2
Common Stock, $.01 par value, 7,692,309 shares of Class C Common Stock, $.01 par
value and 2,461,538 shares of Class L Common Stock.
<PAGE>
PHYSICIANS QUALITY CARE, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I FINANCIAL INFORMATION
Item 1. Balance Sheets as of March 31, 1999,
December 31, 1998 ........................................ 1
Statements of Operations for the three months
ended March 31, 1999 and 1998 ............................ 2
Statements of Cash Flows for the three months
ended March 31, 1999 and 1998 ............................ 3
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ............ 5
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signatures ............................................................... 14
Exhibit
Index ................................................................... 16
</TABLE>
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
Physicians Quality Care, Inc.
Balance Sheets
(Unaudited)
March 31, 1999 December 31, 1998
----------------------------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and Cash Equivalents $ 1,509,141 $ 4,038,802
Restricted cash 1,102,412 1,248,655
Intercompany 8,376,921 6,884,020
Other current assets 204,038 121,497
---------------------------------
Total current assets 11,192,512 12,292,974
Investment in long term affiliation
agreements 5,936,815 6,095,253
Property and equipment, net 357,728 395,768
Other assets 563,536 407,421
---------------------------------
Total assets $ 18,050,591 $ 19,191,416
=================================
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 545,055 $ 453,891
Accrued Expenses 1,124,144 1,172,834
---------------------------------
Total current liabilities 1,669,199 1,626,725
Common Stock, Subject to Put, 18,751,636 42,191,181 42,191,181
shares authorized, issued and
outstanding at December 31, 1998
Stockholders' deficiency:
Preferred stock $.01 par value, 10,000,000
shares authorized, none issued
Class A Common Stock, $.01 par value, 93,198 93,052
75,000,000 shares authorized 9,319,808
and 9,305,208 shares issued at
March 31, 1999 and December 31, 1998,
respectively
Class B-1 Common Stock, $.01 par value, 28,093 28,093
15,267,915 shares authorized, 2,809,296
shares issued and outstanding
Class B-2 Common Stock, $.01 par value, 17,907 17,907
9,732,085 shares authorized, 1,790,704
shares issued and outstanding
Class C Common Stock, $.01 par value, 76,923 76,923
13,846,155 shares authorized, 7,692,309
shares issued and outstanding
Class L Common Stock, $.01 par value 24,615 24,615
2,461,538 shares authorized,
issued and outstanding
Additional paid-in capital 59,455,721 59,452,218
Accumulated Deficit (85,496,121) (84,309,173)
Less cost of 1,012,500 shares of
Class A Common Stock held in Treasury (10,125) (10,125)
---------------------------------
Total stockholders' deficiency (25,809,789) (24,626,490)
---------------------------------
Total liabilities and stockholders'
deficiency $ 18,050,591 $ 19,191,416
=================================
See accompanying notes.
</TABLE>
-1-
<PAGE>
Physicians Quality Care, Inc.
Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months
Ended March 31
1999 1998
------------------------------------
<S> <C> <C>
Management fee $ 360,593 $ 849,634
Operating expenses:
Salaries and benefits 422,413 649,740
General and administrative expenses 462,723 911,646
Depreciation and amortization 90,366 437,422
----------------------------
Total expenses 975,502 1,998,808
Operating loss (614,909) (1,149,174)
Other income (expense):
Interest income 44,145 92,455
Loss of investment in subsidiary and
affiliates (538,273) (888,346)
Interest expense (3,661) (4,818)
----------------------------
(497,789) (800,709)
----------------------------
Loss before income taxes (1,112,698) (1,949,883)
Income tax (benefit) provision 74,250
----------------------------
Net loss $ (1,186,948) $(1,949,883)
============================
Net loss available to common stock $ (1,186,948) $(6,489,379)
============================
Net loss per common share-basic $ (0.03) $ (0.17)
============================
Weighted average common shares
outstanding 41,807,762 39,242,861
============================
</TABLE>
See accompanying notes.
-2-
<PAGE>
Physicians Quality Care, Inc.
Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months
Ended March 31
1999 1998
------------------------------------
<S> <C> <C>
Operating Activities
Net loss $ (1,186,948) $(1,949,883)
Adjustments to reconcile
net loss to net
cash used in operating activities:
Depreciation and amortization 90,366 437,422
Changes in operating assets and
liabilities, net of effects of
business acquisitions:
Due from affiliated physician practices (1,384,252) (2,888,191)
Other assets (80,401) (124,179)
Accounts payable and accrued expenses 42,474 (524,508)
Net cash used in operating ----------------------------
activities (2,518,761) (5,049,339)
Investing Activities
Purchase of property and
equipment (2,537) (324,259)
Decrease in restricted cash 146,243
Cash paid for affiliations (158,255) (50,000)
Net cash used in investing ----------------------------
activities (14,549) (374,259)
Financing Activities
Proceeds from issuance of
common stock, net of
issuance costs 3,649 191,440
Net cash provided by ----------------------------
financing activities 3,649 191,440
----------------------------
Net decrease in cash and
cash equivalents (2,529,661) (5,232,158)
Cash and cash equivalents
at beginning of period 4,038,802 8,782,019
----------------------------
Cash and cash equivalents
at end of period $ 1,509,141 $ 3,549,861
============================
See accompanying notes.
</TABLE>
-3-
<PAGE>
Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Three Months Ended March 31, 1999 and 1998
(1) Basis of Presentation
---------------------
The accompanying unaudited financial statements of Physicians Quality
Care, Inc., a Delaware corporation (the "Company"), have been prepared in
accordance with generally accepted accounting principles and in accordance with
Rule 10-01 of Regulation S-X.
In the opinion of management, the unaudited interim financial
statements contained in this report reflect all adjustments, consisting of only
normal recurring accruals which are necessary for a fair presentation of the
financial position as of March 31, 1999 and the results of operations for the
three months ended March 31, 1999. The results of operations for the three
month periods ended March 31, 1999 are not necessarily indicative of results for
the full year.
These unaudited financial statements, footnote disclosures and other
information should be read in conjunction with the financial statements and
notes thereto included in the Company's Registration Statement on Form S-1, as
amended (No. 333-26137), and the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1998.
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that effect the amounts reported in the accompanying financial
statements and notes. Actual results could differ from those estimates.
(2) New Accounting Standards
------------------------
In the fourth quarter of 1998, the Company adopted Emerging Issues Task
Force Issue 97-2, Consolidation of Physician Practice Entities ("EITF-97-2").
Due to the existence of a Joint Policy board at each affiliated physician
practices, the Company cannot demonstrate a controlling financial interest in
its affiliated physician practices, as defined by EITF 97-2, and therefore, does
not consolidate the operating results and accounts of the affiliated physician
practices. The adoption of EITF 97-2 resulted in reclassifications in certain
amounts presented in the accompanying statements of operations and cash flows
for the periods presented but did not impact the current or any previously
reported net loss or net loss per common share.
-4-
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
This Quarterly Report on Form 10-Q contains forward-looking statements
that involve a number of risks and uncertainties. There are a number of
important factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
under Factors Affecting Future Operating Results.
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. In connection with the affiliation transactions, the assets and
liabilities of the physician practices were transferred to newly formed PCs or
PAs affiliated with the Company. Additional physicians have been subsequently
added to the Affiliated Groups. PQC is working with these groups of physicians
to improve operating practices and to obtain managed care contracts. On October
24, 1997, the Company also acquired a 50% interest in Total Life Care and a 50%
interest in Total Quality Practice Management. Both companies are developing IPA
business located in Atlanta, Georgia. As of March 31, 1999, the Company had
affiliations or IPA arrangements with the following physicians:
<TABLE>
<CAPTION>
Affiliated Physicians
---------------------------------
Maryland Massachusetts Georgia
-------- ------------- -------
<S> <C> <C> <C>
Primary Care: 78 28 0
Specialist: 74 14 0
Total: 152 42 0
<CAPTION>
IPA Physicians
---------------------------------
Maryland Massachusetts Georgia(*)
-------- ------------- -------
<S> <C> <C> <C>
Total: 0 0 350
</TABLE>
(*) Reflects number of physicians in IPA network in which the Company has a 50%
interest.
-5-
<PAGE>
Under the Company's contractual arrangements with its Affiliated
Groups, the Company can improve its management fee revenues by increasing the
patient care revenue of its Affiliated Groups, whether through improved billing
and operating efficiency, additional patient encounters or increased capitated
revenues, and controlling the expenses of Affiliated Groups. To the extent that
patient revenue increases at a greater rate than practice expenses, PQC's
management fee will increase. Conversely, if PQC is not able to control practice
expenses or assist the Affiliated Groups in increasing patient care revenue, PQC
will earn no or only a limited management fee. Under the arrangements with the
physicians formerly associated with Clinical Associates (which became effective
on December 1, 1997) PQC earns 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.
Recent Negative Financial Developments
Negotiations with Affiliated Physicians. During 1999, the Company has
continued to experience operating losses at an accelerating rate. The Company
does not currently believe that it will be able to achieve profitability under
its economic arrangements with the physician practices. To address its operating
losses, the Company has substantially reduced its corporate staff and overhead,
but these actions alone are not anticipated to result in positive cash flow. The
Company does not have sufficient capital reserves to fund operating losses at
current levels for the remainder of 1999. Because of the continuing operating
losses and the unavailability of additional equity financing from the Company's
institutional investors, the Company has been conducting negotiations with its
Affiliated Groups to restructure their economic relationship. The Company's
initial proposal was made to the physicians in November 1998 and did not obtain
support from the physicians. Under that proposal, the Company would have
received a fee of 7.5% of practice revenue and the physicians would have been
provided with a larger equity interest in the Company. In February 1999, the
Board of Directors concluded that the initial proposal did not constitute a
basis on which a restructuring could proceed. In light of the continuing losses
and deteriorating cash position, the Board directed management to negotiate with
each physician group proposals either (i) to restructure the contractual
arrangements with the affiliated physicians on terms that would provide the
Company with a fee that would at least cover the Company's operating expenses or
(ii) to sell the practices to the physicians upon terms that reflected at least
an arms length arrangement. The Board also considered other alternatives for
liquidating or disposing of the affiliated practices.
The negotiations between the Company and the affiliated physicians are
continuing regarding these proposals. While no assurance can be given as to the
outcome of such negotiations, the Company has entered into a non-binding letter
of intent to sell Flagship II for approximately $4 million. With respect to
Flagship I, the Company is exploring transfer ownership of the practices back to
the physicians. However, at this time no agreement has been reached. With
respect to MCP, the Company is negotiating arrangements for either (i) a new fee
structure, or (ii) a sale of the practices. It is possible that the negotiations
will result in the Company managing a smaller number of physician practices but
on economic terms that the Company believes may enable it to achieve a positive
cash flow. However, even if that is achieved, the Company believes that the
ongoing value of the Company has been substantially impaired. If these
negotiations result in a sale of some or all of the practices back to the
affiliated physicians, the Board of Directors would consider what options are
available to the Company, including a winding up of its affairs. The Company is
also considering the sale of its interest in the Atlanta IPA businesses. The
Company does not anticipate that the proceeds from the sale of all of the
practices and the IPA business would be sufficient to satisfy in full the
liquidation preference with respect to the Class B, C and L Common Stock.
Write-down of Intangible Assets
In connection with its Affiliations, the Company has recorded a
significant amount of intangible assets as the consideration paid to physicians
exceeds the value of the practice assets. At December 31, 1997, the Company had
intangible assets of approximately $61.2 million reflected on its balance sheet
as long-term affiliation agreements. The Company has written the value of such
intangibles down to $6.1 million at December 31, 1998. Depending upon the
outcome of negotiations with affiliated physicians, additional write-downs are
possible.
-6-
<PAGE>
Results of Operations
Three Months ended March 31, 1999
Management fee income was approximately $360,000 for the first three
months of 1999 compared to approximately $850,000 during the first three months
of 1998. Each of the three affiliated groups were parties to their respective
Services Agreement during the entire period of both years. The decline in 1999
is principally attributable to the reduction in the fee payable by Flagship II
due to a shortfall in incremental income, as well as declines in revenues at the
Company's other affiliated physician practices. The Company's operating expenses
also declined significantly during the period, with salaries and benefits
declining from approximately $650,000 for the first three months of 1998 to
approximately $422,000 for the first three months of 1999, which decline
reflects the reduction in staffing levels as the Company has reduced the size of
its corporate staff. General and administrative expenses declined from
approximately $912,000 during the first three months of 1998 to approximately
$463,000 during the corresponding period in 1999. The decline in general and
administrative expenses reflects cost saving measures undertaken by the Company,
the smaller scope of the Company's corporate activities, reduced office rent as
the Company moved to a smaller and less expensive facility and reduced
development activities. Depreciation and amortization declined by approximately
$347,000 for the first three months of 1999 compared to 1998 reflecting the
significant write down of goodwill at the end of 1998. Since the reduction in
expenses outpaced the reduction in management fees, the Company narrowed the
operating loss in the first quarter from approximately $1,150,000 in 1998 to a
loss of approximately $615,000 in 1999. After giving effect to non-operating
losses (principally loss of investment in subsidiaries and affiliates) Company
had a net loss of approximately $1,187,000 for the first three months of 1999,
compared to a loss of approximately $1,950,000 for the first three months of
1998.
Liquidity and Capital Resources
The Company's principal requirements for capital have been 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. Due to its start-up status, the Company has
incurred significant operating losses to date and does not have operating cash
flow to fund growth or further losses. The Company's principal sources of
capital to date have been the issuance of Class B, Class C Common Stock and
Class L Common Stock to certain institutional investors, issuances of Class A
Common Stock to Physician Stockholders, other issuances of Class A Common Stock
to private investors and cash generated by the operations of the Affiliated
Groups.
Working capital existing at the date of affiliation has generally been
retained in the practices. Therefore, additional working capital investment is
generally only required to the extent billing processing is slowed during payor
administrative changes after an affiliation and also to fund growth of revenues.
The Company has a total of $8.4 million due from the Affiliated Groups at March
31, 1999 compared to approximately $6.9 million at December 31, 1998. The
increase reflects an increase in the number of days that collections of the
affiliated groups remain outstanding.
The Company's liquidity position continued to decline during the first
quarter of 1999. The Company's only source of capital during the period was its
operations. The Company used net cash of approximately $2.5 million in its
operations. Cash and cash equivalents declined from approximately $3.5 million
at December 31, 1998 to approximately $1.5 million at March 31, 1999. The
Company anticipates the continued losses will cause that net cash position to
continue to decline unless offset by proceeds from the sale of affiliated
practices or improvements in the collections at affiliated groups.
In light of its financial condition, the Company does not have any
material capital expenditures budgeted for 1999.
Factors Affecting Future Operating Results
History of Operating Losses
The Company has incurred losses for each of its fiscal years and
through the first quarter of 1999. The Company expects to incur operating
losses for at least the immediate future. The Company currently does not have
significant resources to fund future operating losses. See "-- Need for
Substantial Additional Capital." There can be no assurance that the Company will
achieve or maintain profitability.
-7-
<PAGE>
Restructuring
The Company is in the process of negotiating transactions either to
restructure the terms of the Company's fee under the Services Agreements or to
sell the practices back to the affiliated physicians. Even if the Company
succeeds in such efforts, the Company will not have significant capital
resources and anticipates that it would receive proceeds from the sale of the
practices and the Atlanta IPA business that is substantially less than the
liquidation preferences on the Class B, C and L common stock. Consequently, if
the Company were to liquidate its assets and dissolve the Company, it is likely
that the holders of Class A Common Stock would not receive any proceeds in such
dissolution. If the Company were to negotiate revised Service Agreements with
one or more groups of affiliated physicians, there can be no assurance that the
Company will not continue to incur losses or that it will continue to be a
viable, long-term business.
Need for Substantial Additional Capital
The Company required substantial capital resources to obtain the
necessary scale to become profitable and to fulfill its business plan. If the
Company continues to expand, 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.
The Company has no committed external sources of capital and does not
anticipate that it will obtain additional financing from the institutional
investors which have previously invested in the Company. Without the consent of
the director elected by the stockholders of the Class B-1 Common Stock (the
"Class B-1 Director"), the director elected by the stockholders of the Class B-2
Common Stock (the "Class B-2 Director," and together with the Class B-1 Director
the "Class B Directors") and the directors elected by the holders of Class C
Common Stock (the "Class C Directors"), the Company may not obtain additional
financing through external borrowings or the issuance of additional securities.
The issuance of additional capital stock could have an adverse effect on the
value of the shares of common stock held by the then existing stockholders.
There can be no assurance that the Class B Directors and Class C Directors will
approve such capital raising activities or that the Company will be able to
raise additional capital when needed on satisfactory terms or at all. The
failure to obtain additional financing when needed and on appropriate terms
could have a material adverse effect on the Company.
Dependence upon Affiliated Medical Practices
Although the Company does not and will not employ physicians or
control the medical aspects of the practices of the physicians employed by the
Springfield Affiliated Group, 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 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
-8-
<PAGE>
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.
Risk of Inability to Manage Expanding Operations
The Company has sought to expand its operations rapidly, which has
created significant demands on the Company's administrative, operational and
financial personnel and systems. 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.
Potential Regulatory Restraints Upon the Company's Operations
The healthcare industry is subject to extensive federal and state
regulation. Changes in the regulations or interpretations of existing
regulations could have a material adverse effect on the Company's business,
financial condition and results of operations.
Risks of Capitated Contracts
The physician groups with which the Company is affiliated and proposes
to affiliate are parties to certain capitated contracts with third party payors,
such as insurance companies. The Company intends to seek to expand the capitated
patient base of its Affiliated Groups, particularly for Medicare enrollees. In
general, risk contracts pay a flat dollar amount per enrollee in exchange for
the physician's obligation to provide or arrange for the provision of a broad
range of healthcare services (including in-patient care) to the enrollee. A
significant difference between a full risk capitated contract and traditional
managed care contracts is that the
-9-
<PAGE>
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 Company is pursuing
a strategy of seeking increased participation in capitated contracts for all of
its affiliated physicians. As the percentage of the Company's revenues derived
from capitated contracts increases, the risk of the Company experiencing losses
under capitated contracts increases. As the revenues from capitated contracts
became of increasing importance to PQC and its Affiliated Groups, the Company
will review the financial attractiveness of reinsurance arrangements.
Medical providers, such as the Affiliated Groups, are experiencing
increasing pricing pressure in negotiating capitated contracts while facing
increased demands on the quality of their services. If these trends continue,
the costs of providing physician services could increase while the level of
reimbursement could grow at a lower rate or decrease. Because the Company's
financial results are dependent upon the profitability of such capitated
contracts, the Company's results will reflect the financial risk associated with
such capitated contracts. Liabilities or insufficient revenues under capitated
and other risk-sharing arrangements could have a material adverse effect on the
Company.
Risks of Changes in Payment for Medical Services
The profitability of the Company may be adversely affected by Medicare
and Medicaid regulations, cost containment decisions of third party payors and
other payment factors over which PQC and its Affiliated Groups have no control.
The federal Medicare program has undergone significant legislative and
regulatory changes in the reimbursement and fraud and abuse areas, including the
adoption of RBRVS schedule for physician compensation under Medicare, which may
have a negative impact on PQC's revenue. Efforts to control the cost of
healthcare services are increasing. PQC's Affiliated Groups contract with
provider networks,
-10-
<PAGE>
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 PCs in Springfield prior to
affiliating with the Company were merged into the Springfield Affiliated Group,
with stockholders of each PC receiving shares of Class A Common Stock of the
Company and cash in exchange for their capital stock in the PC. Physician groups
which operated as PAs in the greater Baltimore-Annapolis area prior to
affiliating with the Company were similarly merged into the Flagship Affiliated
Group, with stockholders of each PA receiving shares of Class A Common Stock of
the Company and cash in exchange for their capital stock in the PA. Each such
merger is intended to qualify as a "reorganization" under Section 368(a) of the
Internal Revenue Code of 1986, as amended (the "Code"), in which case no gain or
loss would generally be recognized by the PC or PA or the stockholders (other
than as cash received) of the PC or PA. The Company has not sought or obtained a
ruling from the Internal Revenue Service or an opinion of counsel with respect
to the tax treatment of the mergers of PCs or PAs into the Springfield or
Flagship Affiliated Groups. The Company does not believe that the Internal
Revenue Service is issuing rulings at this time on transactions using the
Company's affiliation structure. If a merger were not to so qualify, the
exchange of shares would be taxable to the stockholders of the PC or PA, and the
consideration (net of asset basis) issued in connection with the merger would be
taxable to the Affiliated Group into which such PC or PA was merged. Because of
such tax liability,
-11-
<PAGE>
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.
Risk of the Unavailability of the Equity Facility
The remaining amount under the Class B and Class C Stock Purchase
Agreement (the "Equity Facility') with certain institutional inventors
("Institutional Investors") 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 $0.50 or $1.25 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.
Risks from Put and Other Rights Held by Certain Stockholders
Each physician and management stockholder who is a party to the
Stockholders Agreement, dated as of August 30, 1996 (the "Stockholder's
Agreement"), has the right to require PQC to purchase the Common Stock owned by
such stockholder at fair market value upon their death or disability. Pursuant
to the Stockholders Agreement, fair market value, as determined by the Board of
Directors, reflects an arms-length private sale. In determining the fair market
value, the Board is to consider recent arms-length sales by the Company and the
stockholders, as well as other factors considered relevant. While the
Stockholders Agreement does not limit the Board's discretion, such other factors
may include changes, since the last arms-length sale, in the Company's financial
conditions or prospects and any valuation studies conducted by management of the
Company or independent valuation experts. Under the Stockholder Agreement, the
Board is not permitted to discount the fair market value of the Common Stock to
reflect the fact that the Common Stock being sold constitutes less than a
majority of the outstanding shares. The put option is only triggered by death or
disability (and in a few instances retirement) and will terminate upon the
completion of a public offering which results in at least $50.0 million in gross
revenues to the Company and which meets certain other criteria. The physician
affiliated with Clinical Associates 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
underwritten initial public offering within four years. The exercise of such
right could have a material adverse effect upon the Company. 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.
-12-
<PAGE>
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit Index
27 Financial Data Schedule
(b) Reports on Form 8-K: None
-13-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: PHYSICIANS QUALITY CARE, INC.
By: /s/ Eugene M. Bullis
-------------------------
Eugene M. Bullis
Chief Financial Officer
and Senior Vice President
-14-
<PAGE>
EXHIBIT INDEX
Exhibits
- --------
27 Financial Data Schedule
-15-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> MAR-31-1999 DEC-31-1998
<CASH> 1,509,141 4,038,802
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 11,192,512 12,292,974
<PP&E> 357,728 395,768
<DEPRECIATION> 40,576 163,022
<TOTAL-ASSETS> 18,050,591 19,191,416
<CURRENT-LIABILITIES> 1,669,199 1,626,725
<BONDS> 0 0
42,191,181 42,191,181
0 0
<COMMON> 240,736 240,590
<OTHER-SE> 26,050,525 24,867,080
<TOTAL-LIABILITY-AND-EQUITY> 18,050,591 19,191,416
<SALES> 360,593 1,053,620
<TOTAL-REVENUES> 360,593 1,053,620
<CGS> 0 0
<TOTAL-COSTS> 975,502 61,640,612
<OTHER-EXPENSES> 538,273 4,775,826
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,661 4,818
<INCOME-PRETAX> (1,112,698) (65,073,998)
<INCOME-TAX> 4,250 (802,211)
<INCOME-CONTINUING> (1,186,948) (64,271,787)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,186,948) (64,271,787)
<EPS-PRIMARY> (0.03) (1.26)
<EPS-DILUTED> 0 0
</TABLE>
