<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 September 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
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Physicians Quality Care, Inc.
(Exact Name of Registrant as Specified in its Charter)
Delaware 04-3267297
(State or Other Jurisdiction (I.R.S. Employer
of 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 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:
Number of shares outstanding of registrant's common stock as of
September 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
Page
----
Part I FINANCIAL INFORMATION
Item 1. Balance Sheets as of September 30, 1999 (unaudited) and
December 31, 1998 1
Unaudited Statements of Operations for the three and nine
months ended September 30, 1999 and 1998 2
Unaudited Statements or Cash Flows for the nine months
ended September 30, 1999 and 1998 3
Notes to unaudited financial statements nine months ended
September 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 27
Index
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
<TABLE>
<CAPTION>
Physicians Quality Care, Inc. (Unaudited)
Balance Sheets September 30, 1999 December 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and Cash Equivalents $ 1,572,646 $ 4,038,802
Restricted cash 1,059,449 1,248,655
Intercompany 5,716,242 6,884,020
Note receivable 1,280,010 -
Other current assets 68,614 121,497
------------- ------------
Total current assets 9,696,961 12,292,974
Investment in long term affiliation agreements, net 4,286,374 6,095,253
Property and equipment, net 267,742 395,768
Other assets 59,144 407,421
------------- ------------
Total assets $ 14,310,221 $ 19,191,416
============= ============
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 312,256 $ 453,891
Accrued expenses 1,971,846 1,172,834
------------- ------------
Total current liabilities $ 2,284,102 1,626,725
Common Stock, Subject to Put, 13,951,636 and 18,751,636 shares authorized, 31,391,182 42,191,181
issued and outstanding at September 30, 1999 and December 31, 1998,
respectively
Stockholders' deficiency:
Preferred stock $.01 par value, 10,000,000 shares authorized, none 93,198 93,052
issued Class A Common Stock, $.01 par value, 75,000,000 shares
authorized 9,319,808 and 9,305,208 shares issued at September 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 76,923 76,923
authorized, 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 70,255,721 59,452,218
Accumulated Deficit (89,851,395) (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 (19,365,063) (24,626,490)
------------- ------------
Total liabilities and stockholders' deficiency $ 14,310,221 $ 19,191,416
============= ============
</TABLE>
See accompanying notes.
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Physicians Quality Care, Inc.
Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Management fee $ 5,101 $ 133,660 $ 938,665 $ 362,090
Operating expenses:
Salaries and benefits 474,257 442,981 1,484,289 1,784,214
General and administrative expenses 121,115 716,532 1,070,616 2,484,428
Depreciation and amortization 39,874 588,131 215,704 1,720,354
----------- ----------- ----------- ------------
Total expenses 635,246 1,747,644 2,770,609 5,988,996
----------- ----------- ----------- ------------
Operating loss (630,145) (1,613,984) (1,831,944) (5,626,906)
Other income (expense):
Interest income 37,999 98,819 93,874 225,223
Loss of investment in subsidiary and affiliates (1,467,191) (1,194,595) (3,786,819) (2,021,863)
Interest expense - - (3,661) (4,818)
----------- ----------- ----------- ------------
(1,429,192) (1,095,776) (3,969,606) (1,801,458)
----------- ----------- ----------- ------------
Loss before income taxes (2,059,337) (2,709,760) (5,528,550) (7,428,364)
Income tax (benefit) provision (52,847) (746,063) (23,138) (746,063)
----------- ----------- ----------- ------------
Net loss $(2,006,490) $(1,963,697) $(5,505,412) $ (6,682,301)
=========== =========== =========== ============
Net income (loss) available to common stock $(2,006,490) $16,453,439 $(5,505,412) $ 7,281,344
=========== =========== =========== ============
Net income (loss) per common share-basic $ (0.05) $ 0.40 $ $(0.14) $ $0.18
=========== =========== =========== ============
Weighted average common shares outstanding 37,012,791 41,589,306 40,733,686 40,106,514
=========== =========== =========== ============
Net income available to common stock $16,453,439 $ 7,281,344
=========== ============
Net income per common share-diluted $ 0.32 $ 0.14
=========== ============
Weighted average shares outstanding-diluted 50,685,887 50,264,579
=========== ============
</TABLE>
See accompanying notes.
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Physicians Quality Care, Inc. Statements of Cash Flows(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ended September 30,
-------------------------------
1999 1998
----------- ------------
<S> <C> <C>
Operating Activities
Net loss $(5,505,412) $ (6,596,296)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 215,704 1,720,354
Changes in operating assets and liabilities, net of effects of business
acquisitions:
Due from affiliated physician practices 584,958 (3,593,038)
Prepaid expenses and other assets 108,079 (52,860)
Accounts payable and accrued expenses 657,377 (737,781)
----------- ------------
Net cash used in operating activities (5,109,210) (10,005,683)
Investing Activities
Purchase of property and equipment (2,537) (108,922)
Decrease/(increase) in restricted cash 189,206 (1,235,797)
Proceeds from Note receivable 2,610,990 --
Cash paid for affiliations (158,255) (50,000)
----------- ------------
Net cash provided by (used in) investing activities 2,639,404 (1,394,719)
Financing Activities
Proceeds from issuance of common stock, net of issuance costs 3,650 8,004,856
----------- ------------
Net cash provided by financing activities 3,650 8,004,856
----------- ------------
Net decrease in cash and cash equivalents (2,466,156) (3,395,546)
Cash and cash equivalents at beginning of period 4,038,802 8,782,019
----------- ------------
Cash and cash equivalents at end of period $ 1,572,646 $ 5,386,473
=========== ============
</TABLE>
See accompanying notes.
5
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Physicians Quality Care, Inc.
Notes to Unaudited Financial Statements
Nine Months Ended September 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 September 30, 1999 and the results of operations for the nine
months ended September 30, 1999. The results of operations for the nine month
periods ended September 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 nine
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 Company is also in the process of selling its interest in the physician
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practices of Flagship Health, PA. If such transactions are completed, the
Company will have discontinued all operations in the Baltimore area. At this
time, the Company has entered into definitive agreements for the sale of three
Flagship Health physician practices and closed those transactions in December,
1999. The Company has entered into definitive agreements with a number of
additional Flagship Health physicians and the closings of these transactions are
expected to occur in January and February of 2000. There can be no assurance
that any agreements will be reached with any or all of these physician
practices.
At this time, the Company has reached a definitive agreement with the
physicians affiliated with Medical Care Partners with the objective of selling
the Company's interests in Medical Care Partners to such physicians. The
transactions with Medical Care Partners are expected to close in January and
February, 2000. There can be no assurance if the sale of the Flagship Health and
Medical Care Partners practices are completed that the Company's remaining
operations will constitute a viable business.
The Company has also been seeking to sell its interest in the Atlanta IPA
businesses (TLC Management Company and Total Quality Practice Management, Inc.),
if the Company sells all of the practices and its interests in the IPA
businesses, 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 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
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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 nine
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 Company is also currently in the process of selling its interest in the
physician practices of Flagship Health, PA. If such transactions are completed,
the Company will have discontinued all operations in the Baltimore area. At this
time, the Company has entered into definitive agreements for the sale of three
Flagship Health physician practices and closed those transactions in December,
1999. The Company has entered into definitive agreements with a number of
additional Flagship Health physicians and the closings of these transactions are
expected to occur in January and February of 2000. There can be no assurance
that any agreements will be reached with any or all of these physician
practices.
At this time, the Company has reached a definitive agreement with the
physicians affiliated with Medical Care Partners with the objective of selling
the Company's interests in Medical Care Partners to such physicians. The
transactions with Medical Care Partners are expected to close in January and
February, 2000. There can be no assurance if the sale of the Flagship Health and
Medical Care Partners practices are completed that the Company's remaining
operations will constitute a viable business.
The Company has also been seeking to sell its interest in the Atlanta IPA
businesses (TLC Management Company and Total Quality Practice Management, Inc.),
if the Company sells all of the practices and its interests in the IPA
businesses, 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.
8
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As of September 30, 1999, the Company had affiliations or IPA arrangements
with the following physicians:
<TABLE>
<CAPTION>
Affiliated Physicians
Maryland Massachusetts Georgia
<S> <C> <C> <C>
Total: 56 42 0
IPA Physicians
Maryland Massachusetts Georgia
Total: 0 0 350
</TABLE>
(*) Reflects number of physicians in IPA network in which the Company has a 50%
interest.
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 nine months
ended September 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
Nine Months ended September 30, 1999
Management fee income was approximately $939,000 for the first nine months
of 1999 compared to approximately $362,000 during the first nine months of 1998.
Each of the 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.
Management fee income is expected 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 and Medical Care Partners PC. The
Company's operating expenses also declined significantly during the period, with
salaries and benefits declining from approximately $1,784,000 in the 1998 period
to approximately $1,484,000 for the first nine 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 $2,484,000 during the first nine months of 1998 to
approximately $1,071,000 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
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approximately $1,505,000 for the first nine 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 nine
months from approximately $5,627,000 in 1998 to a loss of approximately
$1,832,000 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 $5,505,000 for the first nine months of 1999, compared to a
loss of approximately $6,682,000 for the first nine 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 $5.7 million due from the Affiliated Groups at
September 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.
The Company's liquidity position continued to decline during the first nine
months of 1999. The Company's only source of capital during the period was its
operations. The Company used net cash of approximately $2.4 million in its
operations. Cash and cash equivalents declined from approximately $4.0 million
at December 31, 1998 to approximately $1.6 million at September 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
September 30, 1999, the Company will receive payments in connection with the
sale of its interest in Flagship Health and Medical Care Partners. 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.
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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
third 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 Medical Care
Partners 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 (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.
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. 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.
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
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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.
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 nine 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.
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 are parties to
certain capitated contracts with third party payors, such as insurance
companies. 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").
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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.
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 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
13
<PAGE>
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 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
14
<PAGE>
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, the Equity Facility or other sources.
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
15
<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: January 25, 2000 PHYSICIANS QUALITY CARE, INC.
By: /s/ Eugene M. Bullis
--------------------------
Eugene M. Bullis
Chief Financial Officer
and Senior Vice President
16
<PAGE>
EXHIBIT INDEX
Exhibits
- --------
27 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> SEP-30-1999 DEC-31-1998
<CASH> 1,572,646 4,038,802
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 9,696,961 12,292,974
<PP&E> 267,742 395,768
<DEPRECIATION> 119,690 163,022
<TOTAL-ASSETS> 14,310,221 19,191,416
<CURRENT-LIABILITIES> 2,284,102 1,626,725
<BONDS> 0 0
31,391,182 42,191,181
0 0
<COMMON> 240,736 240,590
<OTHER-SE> 19,605,799 24,867,080
<TOTAL-LIABILITY-AND-EQUITY> 14,310,221 19,191,416
<SALES> 938,665 1,053,620
<TOTAL-REVENUES> 938,665 1,053,620
<CGS> 0 0
<TOTAL-COSTS> 2,770,609 61,640,612
<OTHER-EXPENSES> 3,786,819 4,775,826
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,661 4,818
<INCOME-PRETAX> (5,528,550) (65,073,998)
<INCOME-TAX> 23,138 (802,211)
<INCOME-CONTINUING> (5,505,412) (64,271,787)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,505,412) (64,271,787)
<EPS-BASIC> (0.14) (1.26)
<EPS-DILUTED> 0 0
</TABLE>
