<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 June 30, 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
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
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 X 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:
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Number of shares outstanding of registrant's common stock as of June 30,
1999: 22,258,944 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.
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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 June 30, 1999 (Unaudited) and
December 31, 1998........................................................... 1
Unaudited Statements of Operations for the three and six
months ended June 30, 1999 and 1998......................................... 2
Unaudited Statements of Cash Flows for the six months
ended June 30, 1999 and 1998................................................ 3
Notes to unaudited financial statements six months ended
June 30, 1999 and 1998...................................................... 4
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................................................................................. 27
Exhibit Index.............................................................................. 27
</TABLE>
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
Physicians Quality Care, Inc.
Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
June 30, 1999 December 31, 1998
------------- -----------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and Cash Equivalents $ 1,034,613 $ 4,038,802
Restricted cash 1,058,663 1,248,655
Intercompany 5,750,243 6,884,020
Note receivable 3,891,000 -
Other current assets............................................ - 121,497
------------- -----------------
Total current assets 11,734,519 12,292,974
Investment in long term affiliation agreements, net 4,349,015 6,095,253
Property and equipment, net 307,616 395,768
Other assets.................................................... 59,144 407,421
------------- -----------------
Total assets $ 16,450,294 $ 19,191,416
============= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 520,167 $ 453,891
Accrued expenses 1,860,709 1,172,834
------------- -----------------
Total current liabilities............................................. $ 2,380,876 1,626,725
Common Stock, Subject to Put, 13,951,636 and 18,751,636 shares 31,391,182 42,191,181
authorized, issued and outstanding at June 30, 1999 and December 31,
1998, respectively
Stockholders' deficiency:
Preferred stock $.01 par value, 10,000,000 shares authorized, none issued
Class A Common Stock, $.01 par value, 75,000,000 shares authorized 93,198 93,052
9,319,808 and 9,305,208 shares issued at June 30, 1999 and
December 31, 1998, respectively
Class B-1 Common Stock, $.01 par value, 15,257,915 shares 28,093 28,093
authorized, 2,809,296 shares issues and outstanding
Class B-2 Common Stock, $.01 par value, 9,732,085 shares 17,907 17,907
authorized, 1,790,704 shares issued and outstanding
Class C Common Stock, $.01 par value, 13,846,155 shares authorized, 76,923 76,923
7,692,309 shares issued and outstanding
Class L Common Stock, $.01 par value 2,461,538 shares authorized, 24,615 24,615
issued and outstanding
Additional paid-in capital 70,255,720 59,452,218
Accumulated Deficit (87,808,095) (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........................................ (17,321,764) (24,626,490)
------------- -----------------
Total liabilities and stockholders' deficiency........................ $ 16,450,294 $ 19,191,416
============= =================
</TABLE>
See accompanying notes.
1
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Physicians Quality Care, Inc.
Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30 Ended June 30
1999 1998 1999 1998
-----------------------------------------------------
<S> <C> <C> <C> <C>
Management fee $ 572,971 570,364 $ 933,565 $ 1,419,998
Operating expenses:
Salaries and benefits 587,619 691,494 1,010,032 1,341,234
General and administrative expenses 486,779 856,252 949,503 1,767,894
Depreciation and amortization 85,465 608,800 175,830 1,046,221
------ ------- ------- ---------
Total expenses 1,159,863 2,156,546 2,135,365 4,155,349
Operating loss (586,892) (1,586,182) (1,201,800) (2,735,351)
Other income (expense):
Interest income 11,730 33,950 55,875 126,404
Loss of investment in subsidiary and affiliates (1,781,356) (1,130,488) (2,319,627) (2,018,829)
Interest expense - - (3,661) (4,818)
-----------------------------------------------------
(1,769,626) (1,096,538) (2,267,413) (1,897,243)
Loss before income taxes (2,356,518) (2,682,720) (3,469,213) (4,632,594)
Income tax (benefit) provision (44,541) - 29,709 -
-----------------------------------------------------
Net loss $(2,311,977) $(2,682,720) $(3,498,922) $(4,632,594)
=========== =========== =========== ===========
Net loss available to common stock $(2,311,977) $(7,222,214) $(3,498,922) $(9,172,090)
=========== =========== =========== ===========
Net loss per common share-basic $ (0.06) $ (0.18) $ (0.09) $ (0.23)
=========== =========== =========== ===========
Weighted average common shares outstanding 38,595,209 39,461,589 40,192,611 39,352,829
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
2
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Physicians Quality Care, Inc.
Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Six Months
Ended June 30,
1999 1998
---- ----
<S> <C> <C>
Operating Activities
Net loss $(3,498,922) $(4,632,594)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 175,830 1,046,221
Changes in operating assets and liabilities, net of effects of
business acquisitions:
Due from affiliated physician practices (523,293) (3,710,752)
Prepaid expenses and other assets 55,196 (159,543)
Accounts payable and accrued expenses 754,151 (519,916)
----------- -----------
Net cash used in operating activities............................ (3,037,038) (7,976,584)
Investing Activities
Purchase of property and equipment (2,537) (93,402)
Decrease/(increase) in restricted cash 189,992 (1,106,290)
Cash paid for affiliations....................................... (158,255) (50,000)
----------- -----------
Net cash provided by (used in) investing activities 29,200 (1,249,692)
Financing Activities
Proceeds from issuance of common stock, net of issuance costs.... 3,649 186,440
----------- -----------
Net cash provided by financing activities........................ 3,649 186,440
----------- -----------
Net decrease in cash and cash equivalents (3,004,189) (9,039,835)
Cash and cash equivalents at beginning of period................. 4,038,802 8,782,019
----------- -----------
Cash and cash equivalents at end of period....................... $ 1,034,613 $ (257,817)
=========== ===========
</TABLE>
See accompanying notes.
3
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Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Six Months Ended June 30, 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 June 30, 1999 and the results of operations for the six
months ended June 30, 1999. The results of operations for the six month
periods ended June 30, 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 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.
(3) Sales of Business and Restructuring
-----------------------------------
In 1999, the Company determined that it would not be able to achieve
positive cash flows under its current service agreements with the affiliated
medical practices. The Company also concluded that it did not have sufficient
financial resources to expand its operations or to continue to incur financial
losses at historical rates, including the rate incurred during the first six
months
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of 1999. To address this situation, the Company sold in May 1999 its interest
in Clinical Associates, P.A. (Flagship II) to the physicians affiliated with
Clinical Associates. The total proceeds to the Company from said sale were
$3,527,000, with the final installment of such payment being due in August 1999.
On July 1, 1999, $2,000,000 of the total proceeds was paid. A closing service
fee of $500,000 will also be paid.
The Company is also currently negotiating the potential sale of its
interest in physician practices of Flagship Health, PA. If such transactions are
completed, the Company will have discontinued, substantially all of its
operation in the Baltimore, Maryland area. At this time, the Company has not
entered into definitive agreements for the sale of such businesses and there can
be no assurance that any such agreements will be reached. The Company is also
conducting negotiations with the physicians affiliated with Medical Care
Partners, PC (Springfield) with the objective of either entering into a new
Services Agreement with such physicians or selling the Company's interest in
Medical Care Partners to such physicians. At this time, the Company has not
entered into a definitive agreement with respect to either Flagship Health or
Medical Care Partners and there can be no assurance that any such agreement will
be reached. There can be no assurance if a sale of Flagship Health and a
restructuring of the arrangements with Medical Care Partners are completed that
the Company's remaining operations will constitute a viable business. The
Company is also considering the sale of its interest in the Atlanta IPA
businesses (TLC Management Company and Total Quality Practice Management, Inc.).
If the Company sells all of the practices, it anticipates that such proceeds
will be substantially less than the liquidation preference on the Class B, C and
L Common Stock.
In light of its financial condition, the Company has taken significant
steps to reduce its operating expenses. Such actions, including staff reductions
and termination arrangements, have resulted in certain contractual obligations
that will be payable in future periods. These related actions were recorded as
part of a restructuring charge taken by the Company at December 31, 1998. The
Company believes the restructuring charge will be sufficient to cover these
obligations.
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. The following discussion
should be read in conjunction with the Company's Unaudited Financial Statements
and Notes thereto included elsewhere in this documents.
OVERVIEW
The Company was established to affiliate with and operate 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
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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. On October 24,
1997, the Company also acquired a 50% interest in Total Life Care and a 50%
interest in Total Quality Practice Management, Inc. Both companies are
developing IPA business located in Atlanta, Georgia.
In 1999, the Company determined that it would not be able to achieve
positive cash flows under its current service agreements with the affiliated
medical practices. The Company also concluded that it did not have sufficient
financial resources to expand its operations or to continue to incur financial
losses at historical rates, including the rate incurred during the first six
months of 1999. To address this situation, the Company sold in May 1999 its
interest in Clinical Associates, P.A. (Flagship II) to the physicians affiliated
with Clinical Associates. The total proceeds to the Company from said sale were
$3,527,000, with the final installment of such payment being due in August 1999.
On July 1, 1999, $2,000,000 of the total proceed was paid. A closing service fee
of $500,000 will also be paid.
The Company is also currently negotiating the potential sale of its
interest in the physician practices of Flagship Health, PA. If such transactions
are completed, the Company will have discontinued, substantially all of its
operation in the Baltimore, Maryland area. At this time, the Company has not
entered into definitive agreements for the sale of such businesses and there can
be no assurance that any such agreements will be reached. The Company is also
conducting negotiations with the physicians affiliated with Medical Care
Partners, PC (Springfield) with the objective of either entering into a new
Services Agreement with such physicians or selling the Company's interest in
Medical Care Partners to such physicians. At this time, the Company has not
entered into a definitive agreement with respect to either Flagship Health or
Medical Care Partners and there can be no assurance that any such agreement will
be reached. There can be no assurance if a sale of Flagship Health and a
restructuring of the arrangements with Medical Care Partners are completed that
the Company's maintaining operations will constitute a viable business. The
Company is also considering the sale of its interest in the Atlanta IPA
businesses (TLC Management Company and Total Practice Management, Inc.). If the
Company sells all of the practices, it anticipates that such proceeds will be
substantially less than the liquidation preference on the Class B, C and L
Common Stock.
In light of its financial condition, the Company has taken significant
steps to reduce its operating expenses. Such actions, including staff reductions
and termination arrangements, have resulted in certain contractual obligations
that will be payable in future periods. These related actions were recorded as
part of a restructuring charge taken by the Company at December 31, 1998. The
Company believes the restructuring charge will be sufficient to cover these
obligations.
6
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As of June 30, 1999, the Company had affiliations or IPA arrangements
with the following physicians:
Affiliated Physicians
Maryland Massachusetts Georgia
-------------- -------------------- -------------
Total: 56 42 0
IPA Physicians
Maryland Massachusetts Georgia(*)
-------------- -------------------- -------------
Total: 0 0 350
(*) Reflects number of physicians in IPA network in which the Company has a 50%
interest.
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 and terminated as of May 1999) PQC earned 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.
7
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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. During the six months
ended June 30, 1999, additional adjustments and reclassifications reduced the
carrying value to $4.3 million. Depending upon the outcome of negotiations with
affiliated physicians, additional write-downs are possible.
Results of Operations
Six Months ended June 30, 1999
Management fee income was approximately $934,000 for the first six
months of 1999 compared to approximately $1,420,000 during the first six months
of 1998. Each of the
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three affiliated groups were parties to their respective Services Agreement
during the entire period of both years, except that the Services Agreement with
Flagship Health II, PA ("Flagship II") terminated in May 1999. 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 gross
margins at the other affiliated physician practices. Management fee income is
expected to continue to decrease in future periods resulting from the
termination in May 1999 of affiliate arrangements with Flagship II and the other
anticipated termination of affiliate arrangements with the majority of
physicians affiliated with Flagship Health, PA. The Company's operating expenses
also declined significantly during the period, with salaries and benefits
declining from approximately $1,341,000 in the 1998 period to approximately
$1,010,000 for the first six months of 1999. This decline principally reflects
the reduction in staffing levels as the Company has reduced the size of its
corporate staff. General and administrative expenses declined from approximately
$1,768,000 during the first six months of 1998 to approximately $950,000 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 business development
activities. Depreciation and amortization declined by approximately $870,000 for
the first six months of 1999 compared to 1998. This reduction is attributable to
the $54.0 million 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 six months from approximately $2,735,000 in 1998 to
a loss of approximately $1,202,000 in 1999. After giving effect to non-operating
losses (principally loss of investment in subsidiaries and affiliates), the
Company had a net loss of approximately $3,499,000 for the first six months of
1999, compared to a loss of approximately $4,633,000 for the first six months of
1998.
Liquidity and Capital Resources
The Company's principal requirements for capital have been 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 $5.8 million due from the Affiliated Groups at June
30, 1999 compared to approximately $6.9 million at December 31, 1998. The
decrease reflects a decrease in the number of days that collections of the
affiliated groups remain outstanding, and the sale of Flagship II.
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The Company's liquidity position continued to decline during the first
six months of 1999. The Company's only source of capital during the period was
its operations. The Company used net cash of approximately $3.0 million in its
operations. Cash and cash equivalents declined from approximately $4.0 million
at December 31, 1998 to approximately $1.0 million at June 30, 1999. In light of
its financial condition, the Company has taken significant steps to reduce its
operating expenses. Such actions, including staff reductions and termination
arrangements, have resulted in contractual obligations that will be payable in
future periods. These related actions were recorded as part of a restructuring
charge taken by the Company at December 31, 1998. The Company believes the
restructuring charge will be sufficient to cover these obligations. The Company
anticipates that its future uses of cash will primarily be such expenses and the
funding of operating losses. In addition to cash available at June 30, 1999, the
Company will receive the remaining payments due from Flagship II during the
third fiscal quarter of 1999 and may receive payments in connection with the
sale of its interest in Flagship Health and Medical Care Partners (Springfield).
If both Medical Care Partners and Flagship Health are sold, such proceeds, after
payment of the Company's obligations, are expected to be less than the
liquidation preference on the Class B, C and L Common Stock. Consequently, if
the Company were to be dissolved, the holders of Class A Common Stock are
unlikely to be entitled to participate in the proceeds of the disposition of the
Company's businesses.
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 in each of its fiscal years and
through the second 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.
Restructuring
The Company has sold the operations of Flagship II and is in the
process of negotiating transactions to sell the assets of Flagship Health
and either to restructure the terms of the Company's fee under the Services
Agreements with Medical Care Partners (Springfield) or to sell Medical Care
Partner's 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 businesses (TLC Management Company and Total
Quality Practice Management, Inc.) that are 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
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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 original business plan.
If the Company continues to restructure its operations, additional funds would
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 or the Flagship Affiliated Group, 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
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
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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. During the past six months, the Company has
sought to reduce its staff and overhead. There can be no assurance that the
Company's systems, procedures, controls and staffing are adequate to support the
Company's operations. If the Company continues its affiliate relationships, 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 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
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<PAGE>
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, 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
13
<PAGE>
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, failure of a merger or mergers to qualify as tax-free
reorganizations could have a material adverse
14
<PAGE>
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.
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. To the extent
that the "put options" are likely to be exercised, the Company expects to fund
such repurchases from working capital, or other sources.
15
<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
16
<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: August 20, 1999 PHYSICIANS QUALITY CARE, INC.
By: /s/ Eugene M. Bullis
------------------------------
Eugene M. Bullis
Chief Financial Officer
and Senior Vice President
<PAGE>
EXHIBIT INDEX
Exhibits
- --------
27 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 6-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1999
<PERIOD-END> JUN-30-1999 DEC-31-1998
<CASH> 1,034,613 4,038,802
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 11,734,519 12,292,974
<PP&E> 307,616 395,768
<DEPRECIATION> 40,576 163,022
<TOTAL-ASSETS> 16,450,294 19,191,416
<CURRENT-LIABILITIES> 2,380,876 1,626,725
<BONDS> 0 0
31,391,182 42,191,181
0 0
<COMMON> 240,736 240,590
<OTHER-SE> 17,562,500 24,867,080
<TOTAL-LIABILITY-AND-EQUITY> 16,450,294 19,191,416
<SALES> 933,565 1,053,620
<TOTAL-REVENUES> 933,565 1,053,620
<CGS> 0 0
<TOTAL-COSTS> 2,135,365 61,640,612
<OTHER-EXPENSES> 2,319,627 4,775,826
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,661 4,818
<INCOME-PRETAX> (3,469,213) (65,073,998)
<INCOME-TAX> 29,709 (802,211)
<INCOME-CONTINUING> (3,498,922) (64,271,787)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (3,498,922) (64,271,787)
<EPS-BASIC> (0.09) (1.26)
<EPS-DILUTED> 0 0
</TABLE>
