<PAGE>
 


                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

                                 ____________

                                   FORM 10-K

                       FOR ANNUAL AND TRANSITION REPORTS
                    PURSUANT TO SECTIONS 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

(Mark One)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

For the fiscal year ended   December 31, 1998
                         ------------------------------------
                                        OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

                       Commission file number 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, MA 01821            02154 
----------------------------------------------      -----------------
(Address of Principal Executive Offices)                (Zip Code)

Registrant's telephone number, including area code: (978) 439-0300
                                                   ----------------

Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE

Indicate by check mark 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____


Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [_]

The Company is unable to determine the aggregate value of voting common stock
held by nonaffiliates of the registrant. There is no public market for the
Registrant's voting Common Stock.

Number of shares outstanding of the registrant's common stock as of March 31,
1999: 27,044,344 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>
 
                                    PART I

     The Business section and other parts of this Annual Report on Form 10-K
contain forward-looking statements that involve risks or uncertainties. The
Company's actual results may differ significantly from the results discussed in
the forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors Affecting Future Operating Results."

ITEM 1. BUSINESS.

     Physicians Quality Care, Inc., a Delaware corporation ("PQC" or the
"Company"), was incorporated in March 1995, and provides practice management
services for multi-specialty medical practice groups. The Company's objective is
to establish networks of primary and specialty care physicians and related
diagnostic and therapeutic support services which can provide comprehensive
healthcare services in targeted geographic areas.

     PQC's strategy has four central elements: (i) developing economies of scale
in support services for physician practices (i.e., administrative, billing and
clerical staff) and managed care contracts and geographic penetration by
affiliating with large numbers of qualified physicians in targeted geographic
areas; (ii) assisting the affiliated practices in providing cost-effective
healthcare to special populations; (iii) building comprehensive local healthcare
networks by developing contractual or strategic relationships with providers of
ancillary services such as home healthcare and weight and health management; and
(iv) improving the financial performance of affiliated physician's practices by
seeking to maximize the value of each physician encounter. To date, the Company
has focused upon developing its presence in western Massachusetts, northern
Connecticut, Maryland and Atlanta. The Company has experienced significant
financial difficulty and is currently exploring the possible restructuring or
unwinding of its affiliation with certain physician groups.

     The core of PQC's proposed integrated healthcare delivery system is its
affiliation with groups of physicians who enter into long-term management
agreements with the Company. The Company assumes responsibility for non-medical
aspects of an affiliated physician's practice and focuses its efforts on seeking
to increase revenues and improve operating margins, implementing management
information systems and negotiating managed care contracts. The physicians
remain responsible for, among other things, the medical, professional and
ethical aspects of their practices. By affiliating with the Company, physicians
have increased opportunity to access capital, continue to participate in the
profitability of their individual practices and, through stock ownership, share
a financial interest in the overall performance of the Company.
<PAGE>
 
Industry Overview
-----------------

     Traditionally, health insurance plans reimbursed providers on a fee-for-
service basis, a system that offered very little incentive for efficiency. In
recent years, the healthcare industry has undergone significant changes as both
the private and public sectors seek to slow spending growth. Since the early
1980s, much of the healthcare coverage in the U.S. has shifted to managed care
systems which offer cost savings in exchange for limiting the utilization of
services. Moreover, there has been a shift to prepaid insurance plans that offer
comprehensive healthcare services to enrollees and pay providers a fixed,
prepaid monthly premium. The most prevalent of these prepaid health insurance
alternatives is the health maintenance organization ("HMO"). To remain
competitive, HMOs and other similar payors seek to align themselves with the
most cost- and service-effective providers, generally channeling patient volume
to such providers.

     In the managed care environment, doctors must contract or affiliate with
leading insurers or healthcare networks in their practice area. The third-party
payors rely on primary care physicians to play a "gatekeeping" role and to make
important medical decisions for the patient. Many payors look to share the risk
of providing services through capitation arrangements which provide for fixed
payments for patient care over a specified period of time. In general, capitated
contracts pay a flat dollar amount per enrollee in exchange for the physician's
obligation to provide or arrange for the provision of a broad range of
healthcare services (including inpatient care) to the enrollee. A significant
difference between a capitated contract and traditional managed care contracts
is that the physician is sometimes responsible for both professional physician
services and many other healthcare services, e.g., hospital, laboratory, nursing
home and home health. The physician is not only the "gatekeeper" for enrollees,
but is also financially at risk for over-utilization and for the actuarial risk
that certain patients may consume significantly more healthcare resources than
average for patients of similar age and sex (such patients being referred to as
"high risk patients"). Although physicians often purchase reinsurance to cover
some of the actuarial risk associated with high risk patients, such insurance
typically does not apply with respect to the risk of over-utilization until a
relatively high level of aggregate claims has been experienced. If over-
utilization occurs with respect to a given physician's enrollees (or if the
physician's panel of enrollees includes a disproportionate share of high risk
patients not covered by reinsurance), the physician typically is penalized by
failing to receive some or all of the physician's compensation under the
contract that is contingent upon the attainment of negotiated financial targets,
or the physician may be required to reimburse the payor for excess costs. In
addition, a physician may be liable for over-utilization by other physicians in
the same "risk pool" and for utilization of ancillary, inpatient hospital and
other services when the physician has agreed contractually to manage the use of
those services. Under this payment system, primary care physicians have
important economic incentives to reduce costs by ensuring the efficient
utilization of other providers of care, shifting care to outpatient settings
where feasible, monitoring the progress of patients throughout the course of
treatment and encouraging preventive healthcare.

                                      -2-
<PAGE>
 
     In this environment, physicians are facing reimbursement pressures, greater
administrative burdens, increasing financial responsibility for the risk of
patient care, and a shift in demand from specialty to primary care. In addition,
legislative changes have substantially limited a physician's ability to maintain
an ownership interest in entities that provide ancillary services such as
outpatient laboratories, infusion centers and diagnostic and rehabilitation
facilities. These factors have all contributed to a moderation, if not
reduction, in the growth of many physicians' incomes. With greater oversight by
third-party payors, physicians are also facing a decrease in control over
medical decisions and the administration of their practices.

     In response to these changes in the marketplace, many physicians are
joining together to maintain clinical autonomy, create greater negotiating
leverage vis-a-vis HMOs and other third party payors and reduce escalating
administrative costs. Physicians also are increasingly abandoning traditional
private practice which typically has higher operating costs and little
purchasing power with suppliers and must spread overhead over a relatively small
revenue base in favor of affiliations with larger organizations. Three basic
groups have emerged as managers of physician practices each of which encompasses
several variations in format: hospitals, which may employ physicians directly or
provide support through a management services organization ("MSO"); insurance
companies, which may employ physicians directly through HMOs or may provide
management services through an affiliated MSO; and independent, investor-owned
physician practice management companies.

Company Strategy
----------------

     The Company believes that physician practice management companies ("PPMs"),
such as PQC, offer physicians significant advantages over other alternatives in
the industry consolidation. PPMs provide physicians with improved practice
management and an opportunity to participate in the growth of the PPM through
stock ownership while maintaining control over medical decisions. The physician
market is currently highly fragmented, and PPMs and other organizations
providing physicians with management alternatives have thus far captured only a
small portion of this potential market.

     In addition, the Company believes that because physicians can serve as
gatekeepers for patient care, they can exercise direct control over healthcare
spending and should be in a position to share in the savings generated by the
cost containment practices they adopt. For a fee or a percentage of the group's
earnings, a PPM provides physician groups with administrative and practice
management services that are needed for a physician group to realize these cost
savings and to seek to optimize contractual relationships with managed care
organizations, thus retaining some or most of the cost savings so generated.

     The central elements of the Company's strategy are to develop long-term
affiliations with physicians, focus on cost effective healthcare delivery to
special populations, and build comprehensive local healthcare networks. To date,
the Company has focused upon developing a network of affiliated physicians.

                                      -3-
<PAGE>
 
     Develop long-term affiliations with physicians. PQC seeks to affiliate with
physicians in solo or group practices by entering into contractual arrangements
pursuant to which PQC, or a professional corporation or professional association
affiliated with PQC, assumes management of non-medical aspects of the practices
(an "Affiliated Group"). Upon affiliation, PQC seeks to provide the physicians
with, among other things, increased opportunity to access capital, management
experience, improved information systems and increased opportunity to
participate in favorable managed care contracts. The Company intends to assist
affiliated physicians in improving clinical outcomes and seeks to keep medical
costs down by merging physicians into Affiliated Groups. The Company's structure
allows physicians to continue to practice in their existing locations with no
disruption to patient flow patterns while providing access to coordinated
ancillary services. By affiliating with PQC, physicians, through the revenue
sharing provisions of their employment agreements and the Services Agreements
between the Affiliated Group and PQC, continue to participate in the
profitability of their individual practices and, through stock ownership, share
a financial interest in the overall performance of the Company. Physicians
constitute a majority of the Board of the Directors of PQC and all local
advisory boards, which control such decisions as clinical protocols and
utilization review, payor relations and the addition of ancillary services.

     Balance of primary care physicians and specialists. PQC believes that a
successful system should be balanced between primary care physicians and
specialists to provide efficient coordination and utilization of the appropriate
levels of care, and PQC intends to seek to develop this balance in the physician
groups with which it affiliates. Of the 194 physicians affiliated with the
Company at December 31, 1998, 106 are engaged in primary care practices and 88
are engaged in specialist practices. The Company believes the industry trend
toward integrated delivery systems will result in an increasing demand for
primary care physicians because a higher degree of coordination of care and 
risk-sharing will be required than that which can be achieved in a system
controlled by specialists. The Company's strategy is to have the primary care
physician serve as the central manager in the patient system and to develop
effective coordination between specialists and the primary care physicians
within its network.

     Focus on special populations. PQC believes that the management of
healthcare costs for certain populations provides significant opportunities that
are not being addressed in the marketplace. The Company believes that special
populations, including the elderly, the disabled and those with debilitating
chronic or high-cost, complex diseases represent a minority of the population
but account for a disproportionately high percentage of the healthcare costs in
the United States due to the significantly greater need of such patients for
medical care compared to the population as a whole. The Company believes that a
significant portion of these costs can be avoided with effective case
management, use of information systems, and coordinated use of the full
continuum of healthcare. At present, a relatively

                                      -4-
<PAGE>
 
small percentage of these patients are enrolled under capitated contracts.
However, the Company believes that the cost pressures that fostered the
development of managed care for other segments of the population should have an
even more significant impact on the rapid development of managed care for such
patients. Through affiliation with physicians and academic experts who
specialize in geriatrics and medical conditions that disproportionately affect
these population segments, effective use of case management techniques designed
specifically for such populations, and management information systems, the
Company believes that its affiliated physicians should be able to manage cost
effectively the risks of providing care to these populations on a capitated
basis.

     Improved medical quality and performance. Over time, the Company intends
that its affiliated physicians will devise medical protocols and the Company
will perform outcome analyses, such that the most effective medical practices in
each network can be shared across physician groups. The Company is in the
process of establishing a quality assurance program that will incorporate peer
review, self-critiquing mechanisms, patient satisfaction surveys, continuing
medical staff development and regular continuing medical education seminars.
Once a large base of affiliated physicians at Affiliated Groups is established,
medical directors of each local care network will participate in the Company's
National Medical Advisory Board that will meet regularly to establish and review
medical standards, policies and procedures for all physicians affiliated with
the Company.

Affiliation Structure
---------------------

     General affiliation model. Although the details of each affiliation
transaction may differ, the Company has developed a general affiliation model
designed to capture the benefits of integration while preserving significant
physician autonomy (the "General Affiliation Model"). In the General Affiliation
Model, physicians initially affiliating with the Company in each geographic area
who will become stockholders of the Company transfer their practices by mergers
or asset sales to an Affiliated Group, a professional corporation ("PC") or
professional association ("PA") permitted to practice medicine under applicable
law. These physicians, along with other physicians in that geographic area who
subsequently become part of an Affiliated Group and become stockholders of the
Company (the "Stockholder Physicians"), execute an Employment Agreement with the
Affiliated Group at the time that they transfer their practice assets. The
Affiliated Group, in turn, enters into a Services Agreement, generally for
periods up to 40 years, with the Company pursuant to which the Company agrees to
provide the physicians in the Affiliated Group with comprehensive management
services in exchange for a fee. As consideration for transferring their
practices to and becoming employed by the Affiliated Group, Stockholder
Physicians receive shares of the Company's Class A Common Stock, $.01 par value
per share (the "Class A Common Stock"), and in some cases cash, the amount of
which is negotiated on an individual basis between each Stockholder Physician
and the Company. Physicians who are not stockholders of the Company may also be
employed by the Affiliated Group.

                                      -5-
<PAGE>
 
     The factors that the Company considers in selecting a physician or a
physician group for affiliation include the location of the practice, whether
the practice can be successfully integrated into an Affiliated Group, the
ability of the Company to assist the physician to increase billings and control
costs, the size of the practices, the compensation sought by the physician or
physician group, the nature of the physician's practice and the reputation of
the physician in the medical community.

     All of the outstanding capital stock of each Affiliated Group is held by a
Stockholder Physician designated by the Company (the "Affiliated Group
Stockholder"). At the time of the affiliation, the Affiliated Group Stockholder
enters into an agreement (the "Designation Agreement") with the Company and the
Affiliated Group pursuant to which he or she agrees to consult with the Company
in voting the stock of the Affiliated Group, agrees to transfer the stock of the
Affiliated Group without consideration to another licensed physician at the
direction of the Company and agrees to pay over to the Company any dividend or
distribution on the stock received from the Affiliated Group. The Designation
Agreement also provides that the stock of the Affiliated Group is automatically
transferred at the direction of the Company in the event that the Affiliated
Group Stockholder attempts to transfer it to a third party. The Designation
Agreement provides, however, that the Affiliated Group Stockholder is not
required to consult with the Company as to matters requiring the exercise of
professional medical judgment.

     The Employment Agreements contain certain restrictive covenants, including
covenants relating to noncompetition, confidentiality and nonsolicitation of
employees. Pursuant to these restrictive covenants, the Stockholder Physicians
agree, during the term of the employment agreement and for a one year period
thereafter, not to establish, operate or provide medical services in a specified
geographic region, subject to certain limited exceptions. In addition, the
Stockholder Physicians agree during the employment agreement and for a two year
period thereafter not to provide certain other services related to the practice
of medicine in the geographic region and not to solicit any employee or patients
of the Affiliated Group. Under current state laws and judicial decisions that
restrict the enforcement of non-competition agreements against physicians on
public policy grounds, the Company has no or limited ability to enforce the
covenants not to compete. Each Employment Agreement generally is terminable by
the Affiliated Group with respect to any individual Stockholder Physician upon
the death or disability of such Stockholder Physician or upon the occurrence of
certain events that either interfere with the ability of such Stockholder
Physician to practice medicine or significantly diminish the value of such
Stockholder Physician's affiliation to the Affiliated Group. Each Stockholder
Physician may terminate his or her Employment Agreement under certain
circumstances, including without cause upon six months notice to the Affiliated
Group. The Employment Agreements also contain terms permitting or requiring a
Stockholder Physician upon termination after certain material breaches of the
Affiliated Group's or the Company's obligations under the employment agreement
or the Services Agreement between PQC and the Affiliated Group, to repurchase
from the Affiliated Group the restrictive covenants and his or her practice
assets (i.e., office and examination equipment, in certain cases the lease for
premises at which the physician practices, patient lists and

                                      -6-
<PAGE>
 
records, and third party payor contracts) upon termination of employment. The
terms of such repurchase provision may not permit the Company to fully recover
its affiliation payments to the physician or reflect the cost of affiliation
transactions at the time of termination. To date, no Stockholder Physician has
terminated an employment agreement or repurchased any practice assets.

     Pursuant to the Services Agreement, the Company provides (or arranges for
the provision of) a comprehensive package of services to the Affiliated Group
and its physicians, including offices and facilities, equipment, nursing and
other non-physician professional support, administrative personnel, information
systems, comprehensive professional liability insurance and general management
and financial advisory services. The Company, on behalf of the physicians in the
Affiliated Group, supervises the billing of all patients, insurance companies
and third-party payors and negotiates all contracts and relationships with
payors. The physicians remain responsible for, among other things, the medical,
professional and ethical aspects of their practices.

     Generally under a Services Agreement, revenue from patient care is used to
pay practice expenses and a fee to PQC for its services and to fund one or more
pools from which physician compensation is paid (each a "Compensation Pool").
The basis for such allocation is negotiated separately with each group of
affiliating physicians. Because compensation of Stockholder Physicians is a
function of many factors including the financial performance of such physicians,
neither the Company nor an Affiliated Group can guarantee that a Stockholder
Physician will receive any minimum level of compensation, and the Stockholder
Physicians are not entitled to any compensation other than their allocated share
of the Compensation Pool.

     The Company believes that its General Affiliation Model offers a number of
advantages. For example, physicians remain in their pre-affiliation locations,
offering their patients the continuity and convenience of decentralized offices.
At the same time, laboratory and administrative services generally are provided
on a centralized basis, allowing the Affiliated Groups to achieve economies of
scale in purchasing and other administrative efficiencies.

     Each Affiliated Group maintains its own policy making structure, including
a Joint Policy Board and a Medical Advisory Board. The Joint Policy Board is
charged with, among other things, developing certain management and

                                      -7-
<PAGE>
 
administrative policies for the Affiliated Group, approving operating and
capital expenditure budgets, establishing fee schedules for services provided by
the Affiliated Group, approving the establishment of managed care contracts and
determining of the number and type of physicians required for the operation of
the Affiliated Group. Certain decisions that may have a material impact upon the
business, results of operation or financial condition of the Affiliated Group
must also be approved by the Affiliated Group Stockholder. The current Joint
Policy Boards are comprised of: the President of the Affiliated Group (selected
by the Affiliated Group Stockholder from physicians nominated by the Stockholder
Physicians), and an equal number of members selected by the Company and the
physician stockholders. The Medical Advisory Board, which is responsible for
providing medical input on managed care contracting by the Affiliated Group and
leading the development and dissemination of medical protocols among the
physicians, consists of the Medical Director of the Affiliated Group (selected
by the Affiliated Group Stockholder from physicians nominated by the Stockholder
Physicians) and other physicians elected by the Stockholder Physicians.

     Although the Affiliated Groups in the Springfield, Massachusetts area and
the greater Baltimore-Annapolis, Maryland generally track the General
Affiliation Model, the Company may depart to some extent or significantly from
it or pursue an altogether different approach in completing future physician
affiliations.

     The Springfield Affiliated Group. The Company has entered into affiliation
transactions with nine medical practices located in western Massachusetts,
consisting at December 31, 1998 of a total of 42 physicians, 35 of whom are
stockholders in the Company (the "Springfield Stockholder Physicians") and 7 of
whom are employed by the Springfield Affiliated Group as employees (the
"Springfield Affiliated Group"). Twenty-eight of the physicians are engaged in
primary care practices. Fourteen of the physicians are engaged in specialist
practices, including pulmonology, cardiology, oncology/hematology, infectious
disease, rheumatology and gastroenterology.

     Consistent with the General Affiliation Model, the Springfield Stockholder
Physicians, or the professional corporations and other entities with whom they
were affiliated, merged or sold their practice assets to the Springfield
Affiliated Group in exchange for an aggregate of approximately 3,164,738 shares
of Class A Common Stock of the Company and approximately $4.1 million in cash.
The 29 initial Stockholder Physicians entered into a three-year employment
agreement with the Springfield Affiliated Group, pursuant to which each
physician also received options to purchase 2,500 shares of Class A Common Stock
of PQC at an exercise price of $2.50 per share. The options expire on the
earlier of termination of employment or three years from commencement of
employment. The Physicians who subsequently affiliated with the Springfield
Affiliated Group entered into ten-year employment agreements with the
Springfield Affiliated Group. Four of these Springfield Physician Stockholders
each received options to purchase 37,500 shares of Class A Common Stock at an
exercise price of $1.00 per share which options are subject to certain vesting
conditions. Up to an additional $2.15 million, payable in Class A Common Stock
at $2.50 per share, was

                                      -8-
<PAGE>
 
available to be paid to certain physicians if certain revenue goals were met.
During 1998, $2.0 million of this 2.15 million was paid as additional
consideration in Class A Common Stock. The Springfield Affiliated Group in turn
entered into a 40-year services agreement with the Company pursuant to which the
Company (on behalf of the Springfield Affiliated Group) agreed to provide
management services to the Springfield Affiliated Group physicians.

     Under the Employment Agreements with the twenty-nine initial Springfield
Stockholder Physicians, revenues from patient care remaining after payment of
operating expenses, including expenses of the Springfield Affiliated Group
("Gross Margin") are allocated first between the Springfield Affiliated Group's
Compensation Pool (the "Springfield Compensation Pool") and the Springfield
Affiliated Group in a 95%/5% proportion until 95% of the base compensation of
the Springfield Stockholder Physicians is achieved, then to payment of certain
non-operating expenses, and then 80% to the Springfield Affiliated Group and 20%
to the Springfield Compensation Pool until the Springfield Affiliated Group has
been allocated $1.5 million, with any remaining Gross Margin being divided
evenly between the Springfield Affiliated Group and the Springfield Compensation
Pool. Under the Employment Agreements with the Springfield Stockholder
Physicians who subsequently affiliated with the Springfield Affiliate Group any
Gross Margin attributable to these physicians are allocated between the
Springfield Compensation Pool and the Springfield Affiliated Group in a 80%/20%
proportion until the physicians receive 80% of their base compensation, and then
to payment of certain non-operating expenses attributable to the Springfield
Affiliated Group, with any remaining Gross Margin being divided evenly between
the Springfield Compensation Pool and the Springfield Affiliated Group. The
allocation of Gross Margin to the Springfield Compensation Pool is calculated
separately for each fiscal period. If the Gross Margin for any such period is
negative, such negative amount constitutes an operating expense in the next
fiscal period. Pursuant to the Springfield Services Agreement, all amounts
allocated to the Springfield Affiliated Group in any fiscal period are remitted
to the Company.

     On April 30, 1999, the Springfield Affiliated Group (on behalf of the
Company) or a majority of the Springfield Shareholder Physicians may amend the
financial arrangements, effective as of August 30, 1999, such that the economic
terms of the Springfield Stockholder Physicians' employment agreements, taken as
a whole (and giving effect to any payments or other compensation received by the
Springfield Stockholder Physicians in connection with their affiliation), are
adjusted to reflect the terms being entered into by independent third parties
for similar affiliation and employment relationships at that time. Discussions
with the Springfield physicians regarding the potential restructuring of their
economic relationship with the Company are currently under way.

     The Flagship Affiliated Group. On December 11, 1996, pursuant to
affiliation transactions with the Company, 15 existing professional practices
located in the greater Baltimore-Annapolis, Maryland area, consisting of a total
of 55 physicians, transferred their practice assets to and became employed by
Flagship Health P.A., a Maryland professional association (the "Flagship
Affiliated Group"). In exchange for such affiliation, the physicians received a
combination of approximately $2.7 million in cash and 6,842,675 shares of

                                      -9-
<PAGE>
 
Class A Common Stock (the "Initial Flagship Affiliation"). On December 1, 1997,
Clinical Associates, P.A., a Maryland professional association ("Clinical
Associates"), which also had practices in the Baltimore area, was combined with
the Flagship Affiliated Group. The stockholders of Clinical Associates received
approximately $3.0 million in cash and 4,800,000 shares of Class A Common Stock.

     As of December 31, 1998, the Flagship Affiliated Group employed 152
physicians, of which 113 are stockholders of the Company and employees of the
Flagship Affiliated Group (the "Flagship Stockholder Physicians") and 39 are
employees of the Flagship Affiliated Group. Of the physicians employed by the
Flagship Affiliated Group, 78 are primary care or pediatric physicians and 74
are specialists. The specialist practices include pulmonology, cardiology,
oncology/hematology, infectious disease, rheumatology, gastroenterology,
neurology, dermatology, endocrinology, immunology, neurology, psychiatry,
obstetrics/gynecology, ophthalmology, orthopedics, otolaryngology, plastic
surgery, urology, general surgery and vascular surgery. The Flagship Affiliated
Group leases 28 practice locations in Maryland, some of which are leased from
the Flagship Stockholder Physicians.

     In order to effectuate the Flagship Affiliation, the Flagship Stockholder
Physicians, or the professional associations, business corporations and limited
liability partnerships with whom they were affiliated, transferred their
practice assets to the Flagship Affiliated Group by merger or by sale of assets.
The Company entered into a 40-year management services agreement with the
Flagship Affiliated Group (the "Flagship Services Agreement"), which entered
into Employment Agreements with each Flagship Stockholder Physician. In
addition, the Company entered into an agreement with the Flagship Affiliated
Group pursuant to which the Company agreed to grant options to purchase, subject
to certain conditions, up to 400,000 shares of Class A Common Stock to the
Flagship Stockholder Physicians.

     Pursuant to the Flagship Services Agreement and the Employment Agreements
with the Flagship Stockholder Physicians who initially affiliated with the
Flagship Affiliated Group (the "Initial Flagship Affiliated Physicians"),
revenues from patient services remaining after payment of third- party operating
expenses ("Net Margin") is allocated between the Flagship Stockholder
Physicians' Compensation Pool (the "Initial Flagship Compensation Pool") and
reimbursement of the Company's direct expenses relating to the Flagship
Affiliated Group, based on a ratio of such budgeted compensation to such
budgeted expenses. Once both the Company's direct expenses and the aggregate
base physician compensation have been fully satisfied, any remaining Net Margin
will be divided evenly between the Company and the Initial Flagship Compensation
Pool.

     The method for determining PQC's management fee and the compensation of the
Clinical Associates physicians differs from the model used in the Springfield
Affiliated Group and with the original Flagship physicians. Instead of a sharing
of gross margin after practice expenses, PQC is entitled to a percentage of
billings, net of uncollectible amounts and discounts ("Net Adjusted Billings").
The revenue splitting arrangements for the Clinical

                                     -10-
<PAGE>
 
Associates physicians differ based upon whether the revenue is derived from an
existing specialist practice, a primary care practice, future specialist
practices and the practices of physicians without established practices. Except
as provided below, Net Adjusted Billings in excess of baseline Net Adjusted
Billings reflecting the historical level billings for such physician subject to
reductions for changes in practice patterns ("Specialist Net Adjusted Billings")
from specialist (a specialist being a physician at least 80% of whose billings
are derived from a specialist practice) practices with respect to any fiscal
year will be allocated 35% to PQC and 65% to an account established with respect
to the Clinical Associates physicians and any future physicians included in the
same compensation arrangements (the "Account") until $3 million has been
allocated between the Account and PQC; and any remaining Specialist Billings
will be allocated 20% to PQC and 80% to the Account.

     Net Adjusted Billings by primary care, OB/GYN physicians and physicians
(whether primary care or specialist) added to the compensation arrangements in
the future in excess of the agreed upon baseline Net Adjusted Billings will be
allocated 20% to PQC and 80% to the Account. With respect to any physician
recruited to join Flagship who does not have a practice that is merged into
Flagship (and to certain physicians currently affiliated with Clinical
Associates ), 20% of the Incremented Amount shall be allocated to PQC.
"Incremented Amount" means the excess, if any, of Net Adjusted Billings
attributable to such physician over an amount equal to twice the average
compensation of physicians with a similar practice in the Baltimore metropolitan
area as reported by a standardized reporting source. Any Net Adjusted Billings
attributable to such physician less (A) the amounts allocated to PQC and (B) the
compensation payable to the physician under the physician's employment agreement
shall be allocated to the Account. Any revenue not included in Net Adjusted
Billings will be allocated to the Compensation Pool to offset practice expenses,
provided that if the ratio of practice expenses to practice revenue declines
below historical levels, revenues not included in Net Adjusted Billings will be
allocated equally to PQC and the Account. Net Margin from centralized laboratory
services (which for this purpose shall mean revenue from laboratory ancillary
services less (i) direct expenses of such laboratory ancillary services and (ii)
an allocation of Flagship overhead) attributable to the Clinical Associate
physicians will be allocated 80% to PQC and 20% to the Account. Net Margin from
incremental non-laboratory ancillary services will be allocated 50% to PQC and
50% to the Account together with the current Flagship Compensation Pool.

     The amount allocated to the Account is first used to pay the practice
expenses of the physicians whose compensation is paid through the Account. Any
remaining amount in the Account with respect to any fiscal year will be
distributed to the Clinical Associates physicians as their sole source of
compensation. The allocation of such compensation among the physicians is
determined by a committee elected by, or pursuant to a formula approved by, the
Clinical Associates physicians.

                                     -11-
<PAGE>
 
     The Agreements between PQC and the Clinical Associated Physicians include a
provision that penalizes PQC if certain revenue targets described below are not
met. Until there is no Shortfall (as defined below) or PQC completes a public
offering of the Company Common Stock at a price to the public of $9.00 or more
per share, the amount that would have been allocated to PQC pursuant to the
Services Agreement will be reduced by the Adjustment Amount and the amount that
is allocated to the Account will be increased by the Adjustment Amount.
"Shortfall" means the difference between $3.0 million and the aggregate increase
in Net Adjusted Billings over baseline Net Adjusted Billing by the specialist
physicians in Clinical Associates or who are subsequently added to the practice.
The "Adjustment Amount" is 45% of any Shortfall. Consequently, unless Net
Adjusted Billing increases by $3.0 million over historical levels, and
Adjustment Amount will be due.

     PQC has agreed with the stockholders of Clinical Associates that neither
PQC nor Flagship will merge with or into, become a subsidiary of, or sell
Flagship or all or substantially all of PQC's assets to, or grants governance
participation to, a Baltimore Health Care Entity without the approval of a
majority of the members of the Management Committee. A Baltimore Health Care
Entity means any hospital, medical group or other organization that principally
conducts its business in and derives its revenues from the delivery of
healthcare services in Maryland.

     In the event that PQC or any of its affiliates propose the establishment of
an independent provider association ("IPA") network in the Maryland Area, PQC is
required to obtain the approval of the Joint Policy Board with respect to the
structure, governance and financial arrangements of the IPA network, including
whether the Physicians in the Flagship Affiliated Group will participate in such
IPA network. PQC will be entitled to a fee of up to 10% of the aggregate revenue
of the IPA network, which fee PQC shall not be required to share with the
physicians employed by the Flagship Affiliated Group. Any residual profits of
the IPA network (in excess of the 10% fee) that are retained by PQC shall be
allocated 50% to PQC and 50% to the physicians in the Flagship Affiliated Group.

                                     -12-
<PAGE>
 
     In the event that prior to December 1, 2001, PQC has not completed an
underwritten initial public offering, the Clinical Associates physicians shall
have the right, within 45 days thereafter, to require PQC to repurchase the
Common Stock issued in the affiliation transaction with Clinical Associates at a
purchase price of $3.00 per share. PQC shall have the right to pay the purchase
price by a five (5) year non-interest bearing note. The principal payable with
respect to such note shall be reduced by the amount, if any, that the Clinical
Associates physicians' compensation between the issue date of the note and its
maturity exceeds the base compensation with respect to the Clinical Associates
physicians during that period.

     Atlanta IPA Affiliates.  The Company has acquired a 50% interest in two
related physician network management companies in Atlanta, Georgia. The two
entities, TLC Management Company, Inc. ("TLC") and Total Quality Practice
Management, Inc. ("Total Quality"), manage payor contracting for a 350-physician
network in Georgia. The network currently serves approximately 4,500 covered
lives. PQC's investment totals $5 million.  TLC and Total Quality are currently
seeking purchasers for the Company's interest in such entities  When the
Company's interest will be sold or if it can be sold on terms attractive to the
Company cannot be determined at this time.

Governmental Regulation
-----------------------

     As a participant in the healthcare industry, the Company's operations and
relationships, and the business and activities of its affiliated physicians,
will be subject to extensive and increasing regulation by a number of
governmental entities at the federal, state and local levels and by fiscal
intermediates appointed by various payors and other private brokers. The Company
will also be subject to laws and regulations relating to business corporations
in general. Because of the uniqueness of the structure of the relationship with
the physician groups, many aspects of the Company's business operations have not
been the subject of state or federal regulatory interpretation, and there can be
no assurance that a review of the business of the Company or its affiliated
physicians by courts or regulatory authorities will not result in a
determination that could adversely affect the operations of the Company or the

                                     -13-
<PAGE>
 
affiliated physicians. In addition, there can be no assurance that the
healthcare regulatory environment will not change so as to restrict the
Company's or the affiliated physicians' existing operations or their expansion.

     Prohibition on Corporate Practice of Medicine. The laws of most states,
including Massachusetts and Maryland, prohibit business corporations such as the
Company from practicing medicine or employing physicians to do so. The
contractual relationships the Company has entered into with the Affiliated
Groups attempt to comply with these laws. Because there is very limited judicial
or regulatory interpretation of the scope of the corporate practice of medicine
prohibition in most states, however, there can be no assurance that the
Company's contractual arrangements will be found to comply with such laws. Any
determination that the contractual relationships violate such laws could have a
material adverse effect on the Company, and there can be no assurance that the
Company would be able to restructure its arrangements on favorable terms or at
all.

     The Massachusetts Board of Registration in Medicine (the "BRM") has
proposed regulations that, if promulgated as proposed, might prohibit physicians
licensed within the Commonwealth of Massachusetts from entering into management
contracts with proprietary business entities unless a majority of the governing
board of those business entities are licensed physicians and certain other
conditions are met. The BRM also indicated that it may seek to limit
significantly the extent to which proprietary business entities may have control
or consultation rights with respect to medical decisions or business decisions
that may affect patient care, such as the amount of time each physician spends
with a patient. Extensive commentary has been filed in opposition to the
proposed regulations, and it is not known when or in what form final regulations
will be promulgated. The final regulations may have a material adverse effect on
the Company's relationship with the Springfield Affiliated Group and its ability
to operate in Massachusetts as currently contemplated. Comparable regulations
have not been proposed in Maryland, but there can be no assurance that such
regulations will not be proposed or adopted.

     Restrictions on Referrals and Fee-Splitting. In addition to prohibiting the
practice of medicine, numerous states prohibit entities such as the Company from
engaging in certain healthcare-related activities such as fee-splitting with
physicians or from making referrals to entities in which the referring physician
has an ownership interest. For example, Maryland has enacted legislation that
significantly restricts patient referrals for certain services, and requires
disclosure of ownership in businesses to which patients are referred and places
other regulations on healthcare providers. The Company has structured its
arrangements with the practices in the Flagship Affiliation to fit within the
group practice exemption contained in the Maryland act; however, investments or
contractual relationships with businesses not specifically operated by the
Flagship Affiliated Group would, in some cases, be prohibited. The Company
believes it is likely that other states will adopt similar legislation.
Accordingly, expansion of the operations of the Company to certain jurisdictions
may require it to comply with such jurisdictions' regulations which could lead
to structural and organizational

                                     -14-
<PAGE>
 
modifications of the Company's anticipated form of relationships with physician
groups. Such changes, if any, could have an adverse effect on the Company.

     Certain provisions of the Social Security Act, commonly referred to as the
"Anti-kickback Statute," prohibit the offer or receipt of any form of
remuneration in return for the referral of Medicare or state health program
(such as Medicaid) patients, or in return for the recommendation, arrangement,
purchase, lease, or order of items or services that are covered by Medicare or
state health programs. The Anti-kickback Statute is broad in scope and has been
broadly interpreted by courts in many jurisdictions. Read literally, the statute
places at risk many customary business arrangements, potentially subjecting such
arrangements to lengthy, expensive investigations and prosecutions initiated by
federal and state governmental officials. Many states have adopted similar
prohibitions against payments intended to induce referrals of state health
program and other third-party payor patients. While the Company has attempted to
structure its contractual relationships so as to comply with the Anti-kickback
Statute, there can be no assurance that such relationships do in fact comply
with the Anti-kickback Statute given the broad wording of the statute. While the
federal government has promulgated or proposed various "safe harbor" exceptions
to the Anti-kickback Statute, the Company does not expect its operations to fit
within any of the safe harbors. Violation of the Anti-kickback Statute is a
felony, punishable by fines up to $25,000 per violation and imprisonment for up
to five years. In addition, the Department of Health and Human Services may
impose civil penalties excluding violators from participation in Medicare or
state health programs.

     Significant prohibitions against physician referrals were enacted by
Congress in the Omnibus Budget Reconciliation Act of 1993. These prohibitions,
commonly known as "Stark II," amended prior physician self-referral legislation
known as "Stark I" by dramatically enlarging the field of physician-owned or
physician-interested entities to which the referral prohibitions apply. Stark II
prohibits, subject to certain exemptions, a physician or a member of his or her
immediate family from referring Medicare or state health program patients for
"designated health services" to an entity in which the physician has an
ownership or investment interest or with which the physician has entered into a
compensation arrangement including the physician's own group practice. The
designated health services include radiology and other diagnostic services,
radiation therapy services, physical and occupational therapy services, durable
medical equipment, parenteral and enteral nutrients, equipment, and supplies,
prosthetics, orthotics, outpatient prescription drugs, home health services, and
inpatient and outpatient hospital services. The penalties for violating Stark II
include a prohibition on payment by these government programs for services
rendered pursuant to such references and civil penalties of as much as $15,000
for each violative referral and $100,000 for participation in a "circumvention
scheme." In addition, the provider may be disqualified from participating in the
Medicare and state health care programs based on the submission of a false claim
or participation in a circumventive scheme. The Company has attempted to
structure its activities in compliance with Stark I and Stark II. However, the
Stark legislation is broad and the Stark I regulations are complex and do not
provide clear guidance on how Stark II will be interpreted. A finding that the
Company or its Affiliated Groups has violated Stark could have
     
                                     -15-
<PAGE>
 
a material adverse effect on the Company. In addition, future regulations or
clarification of the existing regulations could require the Company to modify
the form of its relationships with physician groups and may limit the Company's
ability to implement fully its plan for integrated care.

     Prohibition on False Claims. There are also state and federal civil and
criminal statutes imposing substantial penalties, including civil and criminal
fines and imprisonment, on healthcare providers who fraudulently or wrongfully
bill governmental or other third-party payors for healthcare services. The
federal law prohibiting false billings allows a private person to bring a civil
action in the name of the United States government for violations of its
provisions. There can be no assurance that the Company's activities will not be
challenged or scrutinized by governmental authorities. Moreover, technical
Medicare and other reimbursement rules affect the structure of physician billing
arrangements. Regulatory authorities might challenge the billing arrangements
with the Affiliated Groups and, in such event, the Company may have to modify
its relationship with physician groups. Noncompliance with such regulations may
adversely affect the operation of the Company and subject the Company and
Affiliated Groups to lost reimbursement, penalties and additional costs.

     Direct Provision of Healthcare Services. The Company plans to develop a
network of integrated healthcare services (other than acute care) in the future,
depending on market conditions. If the Company determines that it is
advantageous to provide such services through a wholly-owned subsidiary or other
controlled relationship, it is possible that one or more subsidiaries or
affiliates of the Company could become licensed providers of healthcare
services. Any such provider would have to comply with applicable regulatory
requirements. In addition, the direct provision of healthcare services by a
subsidiary or affiliate might increase the risk to the Company of regulatory or
other investigation or litigation.

     Healthcare Reform. A portion of the revenues of the Company's Affiliated
Groups is derived from payments made by governmental sponsored healthcare
programs (principally, Medicare and Medicaid). Government revenue sources are
subject to statutory and regulatory changes, administrative rulings,
interpretations of policy, determinations by fiscal intermediaries, and
government funding restrictions, all of which may materially decrease the rates
of payment and cash flow to physicians and other healthcare providers. The
federal Medicare program adopted a system of reimbursement of physician
services, known as the resource based relative value scale schedule ("RBRVS"),
which took effect in 1992 and is expected to be fully implemented by December
31, 1996. The Company expects that the RBRVS fee schedule and other future
changes in Medicare reimbursement will, in some cases, result in a reduction
from historical levels in the per patient Medicare revenue received by certain
of the Affiliated Groups with which the Company may contract, which in turn may
result in a decrease in revenues to the Company.

     In addition to current regulation, the United States Congress has
considered various types of healthcare reform, including comprehensive revisions
to the current healthcare

                                     -16-
<PAGE>
 
system. It is uncertain what legislative proposals will be adopted in the
future, if any, or what actions federal or state legislatures or third party
payors may take in anticipation of or in response to any healthcare reform
proposals or legislation. Healthcare reform legislation adopted by Congress
could result in lower payment levels for the services of physicians managed by
the Company and lower profitability of the Affiliated Groups, which could have a
material adverse effect on the operations of the Company.

     Insurance Laws. Laws in all states regulate the business of insurance and
the operation of HMOs. Many states also regulate the establishment and operation
of networks of healthcare providers. While these laws do not generally apply to
the hiring and contracting of physicians by other healthcare providers, there
can be no assurance that regulatory authorities of the states in which the
Company operates would not apply these laws to require licensure of the
Company's operations as an insurer, as an HMO or as a provider network.

     Antitrust Laws. Because the affiliated practice groups are not subsidiaries
of the Company and thus remain separate legal entities for antitrust purposes,
they may be deemed competitors subject to a range of antitrust laws which
prohibit anti-competitive conduct, including price fixing, concerted refusals to
deal and division of market. The Company intends to comply with such state and
federal laws as they may affect its development of integrated healthcare
delivery networks, but there is no assurance that the review of the Company's
business by courts or regulatory authorities will not result in a determination
that could adversely affect the operation of the Company and its affiliated
physician groups.

Competition
-----------

     The Company faces competition for both the recruitment and retention of
affiliated physicians. The market for affiliation with physicians is highly
competitive, and the Company expects this competition to increase. The Company
competes for physician affiliations with many other entities, some of whom have
substantially greater resources, greater name recognition and a longer operating
history than the Company and some of whom offer alternative affiliation
strategies which the Company may not be able to offer.

     The provision of physician practice management services is a highly
competitive business in which the Company will compete for contracts with
several national and many regional and local providers of such services. Certain
of the Company's competitors will have access to substantially greater resources
than the Company. Although the nature of the competition may vary, competition
is generally based on cost and quality of care.

     There can be no assurance that PQC will be able to compete effectively,
that additional competitors will not enter the market, or that such competition
will not make it more difficult to acquire the assets of multi-speciality
clinics on terms beneficial to PQC.

                                     -17-
<PAGE>
 
Employees
---------

     As of December 31, 1998, the Company had 49 employees and the Affiliated
Groups had 1094 employees, including 194 physicians.

ITEM 2. PROPERTIES.

     The Company leases a 4,300 square foot facility in Billerica, Massachusetts
for its headquarters and also leases office space in Springfield, Massachusetts
and Baltimore, Maryland. The Springfield Affiliated Group leases approximately
46,000 square feet at 13 practice locations and the Flagship Affiliated Group
leases approximately 197,000 square feet at 41 practice locations. The
facilities leased by the Company and its Affiliated Groups are sufficient for
its current operations.

ITEM 3. LEGAL PROCEEDINGS.

     There were no legal proceedings pending against the Company on March 31,
1999.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     No matters were submitted to a vote of security holders of the Company,
through solicitation of proxies or otherwise, during the last quarter of the
year ended December 31, 1998.

                                     -18-
<PAGE>
 
                                    PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

     The Company did not issue or sell any equity securities during the quarter
ended December 31, 1998.

ITEM 6. SELECTED FINANCIAL DATA.

     The following selected financial data for the Company should be read in
conjunction with the financial statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Annual Report on Form 10K. The selected financial
data of the Company for the years ended December 31, 1996, December 31, 1997 and
December 31, 1998, have been derived from financial statements of the Company
which have been audited by Ernst & Young LLP, independent auditors.

                                     -19-
<PAGE>
 

<TABLE> 
<CAPTION> 
                                                                                        PQC
                                                      -----------------------------------------------------------------------     
                                                                                                              
                                                                                                                PERIOD FROM  
                                                                                                               MARCH 20, 1995
                                                       YEAR ENDED           YEAR ENDED         YEAR ENDED      (INCEPTION) TO
                                                       DECEMBER 31,        DECEMBER 31,        DECEMBER 31,     DECEMBER 31,
                                                           1998               1997                 1996            1995    
                                                      -----------------------------------------------------------------------
<S>                                                   <C>                <C>                 <C>               <C>
Management fees                                         $  1,053,620       $  2,501,135        $   225,470       $        -- 
                                                                                                                           
Operating Expenses:                                                                                                        
 Salaries and benefits                                     2,475,378          2,780,721          2,135,390                -- 
 General and administrative expenses                       3,300,520          3,447,685          2,423,089         2,061,737
 Depreciation and amortization                             2,201,955          1,379,321            229,171             6,704
 Impairment of investment in long-term                                                                                       
  affiliation agreements                                  53,662,759                 --                 --                --       
                                                      ----------------------------------------------------------------------- 
Total expenses                                            61,640,612          7,607,727          4,787,650         2,068,411
                                                      ----------------------------------------------------------------------- 
                                                                                                                           
Operating loss                                           (60,586,992)        (5,106,592)        (4,562,180)       (2,068,441)
                                                                                                                           
Other income (expense):                                                                                                    
 Interest income                                             293,638            492,888             90,160           108,177
 Loss of investment in subsidiary and affiliates          (4,775,826)        (1,773,000)          (411,786)               -- 
 Interest expense                                             (4,818)          (119,658)           (97,263)          (90,000)
 Gain on sale of equipment                                                          851                                    
                                                      ----------------------------------------------------------------------- 
                                                          (4,487,006)        (1,398,919)          (418,889)           18,177
                                                      ----------------------------------------------------------------------- 
                                                                                                                           
Loss before income taxes                                 (65,073,998)        (6,505,511)        (4,981,069)       (2,050,264)
Income tax (benefit) provision                              (802,211)          (795,281)            78,128            32,000 
                                                      ----------------------------------------------------------------------- 
                                                                                                                           
Net loss                                              $  (64,271,787)      $ (5,710,230)      $ (5,059,197)     $ (2,082,264)
                                                      ======================================================================= 
                                                                                                                           
Net loss available to common stock                    $  (50,341,647)      $(12,389,217)      $(19,496,045)     $ (2,082,264)
                                                      ======================================================================= 
                                                                                                                           
Net loss per common share - basic                     $        (1.26)      $      (0.41)      $      (1.81)     $      (0.27)
                                                      ======================================================================= 
</TABLE>
 
 
<TABLE>
                                                                     PQC
                                             ------------------------------------------------------
                                                                 DECEMBER 31,
                                             1998            1997           1996             1995  
                                             ------------------------------------------------------
                                                                   (in thousands)
<S>                                         <C>          <C>             <C>             <C>     
BALANCE SHEET DATA:                                                                                                        
                                                                                                                           
Cash and cash equivalents                      5,287       $  8,782        $    137        $  3,480
Net current assets                            12,293         12,886           1,916           3,501
Total assets                                  19,191         75,527          34,790           4,363
Total current liabilities                      1,627          4,230           2,776             850
Long-term obligations                            -0-            746             521           1,410
Class A Common Stock, subject to put          42,191         54,474          31,851              --
Total stockholders' equity (deficiency)      (24,626)        16,077            (358)          2,104
</TABLE>

   During 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 "Earnings Per Share" ("SFAS 128") which requires the restatement of
earnings per share calculations for all years presented. The adoption of SFAS
128 did not impact the Company's earnings per share calculation for 1995 and
1996. In the fourth quarter of 1998, the Company adopted Emerging Issues Task 
Force ("EITF") Issue No. 97-2 "Consolidation of Physician Practice Entities" 
which no longer permits, for display purposes, the presentation of the revenues
and expenses of the Affiliated Groups in the Company's statements of operations.
Accordingly, reclassifications have been made to all years presented to comply
with EITF 97-2 provisions. The adoption of EITF 97-2 did not impact the
Company's net loss or earnings per share calculations.

                                     -20-
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS.

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 TLC and a 50% interest in Total
Quality. Both companies are developing IPA business located in Atlanta, Georgia.
As of December 31, 1998, the Company had affiliations or IPA arrangements with
the following physicians:


                       Affiliated Physicians
                       --------------------- 
 
                 Maryland  Massachusetts  Georgia
                 --------  -------------  -------
Primary Care:          78             28        0
Specialist:            74             14        0
Total:                152             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.

     For a discussion of the fee and expense allocation arrangement between the
Company and each Affiliated Group, see "Item 1. Business - Affiliation
Structure."

     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

                                      -21-
<PAGE>
 
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.

BASIS OF PRESENTATION

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 the Joint Policy Board, the Company cannot demonstrate a 
controlling financial interest, as defined by EITF 97-2, in its Affiliated 
Groups, and therefore, does not consolidate the operating results and accounts
of the Affiliated Groups. Prior to the adoption of EITF 97-2, the Company, for  
display purposes, included the revenues and expenses of the Affiliated Groups in
its statements of operation. EITF 97-2 does not permit this display and,
accordingly, the Company has reclassified certain accounts in its statements of
operations for all years presented to conform with EITF 97-2 provisions. The
adoption of EITF 97-2 did not impact the current or any previously reported net
loss or net loss per common share.
     
RECENT NEGATIVE FINANCIAL DEVELOPMENTS

NEGOTIATIONS WITH AFFILIATED PHYSICIANS. During 1998, 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

                                      -22-
<PAGE>
 

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. See "Write-offs"
below. 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-OFFS. The Company has carried on its balance sheet a substantial amount of
goodwill (reflected on the balance sheet as "Investment in long-term affiliation
agreements"). In light of the Company's determination that it will not be able
to achieve a positive cash flow under the Services Agreements and the
negotiations to restructure the Services Agreements or to sell the practices
back to the affiliated physicians, the Company has determined that it is
appropriate to write down such investments to their anticipated realizable
value. The Company has also determined that the value of its investment in the
Atlanta IPA businesses is permanently impaired and has written down that
investment to reflect a likely loss upon its sale. In aggregate, the Company
wrote off a total of approximately $53.7 million on these investments, which
increased the Company's loss in 1998 to ($64.3 million)(including a loss of
$10.6 million, before the write-offs) and resulted in a total shareholders
deficit of ($24.6 million). While the Company believes that these write-offs
reflect the realizable value for the Company's affiliation arrangements and its
interests in the IPA businesses, depending upon the terms of any sale or
restructuring of such operations, additional losses may be incurred.


RESULTS OF OPERATIONS
---------------------
YEAR ENDED DECEMBER 31, 1998

     The Company did not complete any significant affiliation transactions in
1998 (although a few additional physician practices were added in Baltimore).
During 1998, the Company had Services Agreements in place with MCP, Flagship I
and Flagship II for a full year, while in 1997 only MCP and Flagship I were in
effect for the entire period. However, the Company's management fee income
decreased from approximately $2.5 million in 1997 to approximately $1.1 million
in 1998. Management fee revenue from MCP and Flagship declined moderately
reflecting decreasing operating margins at these practices during 1998 compared
to 1997. The Company incurred a net loss on its management fee arrangements with
Flagship II as fee income under the Services Agreement was more than offset by a
penalty fee payable by PQC for failure of revenues of the Flagship II practices
to increase. In negotiating the Services Agreement with Flagship II, the Company
guaranteed that certain revenue increases would occur as a result of the
affiliation arrangement. A material increase in revenues did not occur.

                                      -23-
<PAGE>
 

     Notwithstanding cost reduction measures imposed in the second half of 1998,
operating expense for 1998 increased to approximately $8.0 million from
approximately $7.6 million in 1997. An increase of approximately $0.8 million in
amortization expense (reflecting a full year of amortization of the Flagship II
investment) was only partially offset by reductions of approximately $0.3
million in salaries and approximately $0.1 million in general and administrative
expenses. These reductions reflect the Company's staff reductions and other cost
containment measures in the second half of 1998. The Company's share of losses
from the Atlanta IPA business also increased, which together with the losses of
the Affiliated Groups increased from approximately ($1.8 million) in 1997 to
approximately ($4.8 million) in 1998.

     Primarily, as a result of the reduction in management fee income and
increasing losses on the Atlanta IPA businesses, the Company's net loss
increased from approximately ($5.7 million) in 1997 to approximately ($10.6
million) in 1998. Including the write offs discussed above, the Company's net
loss for 1998 was approximately ($64.3 million).

YEARS ENDED DECEMBER 31, 1997 AND 1996

     During January and February 1997, the Company affiliated with 6 physicians
in the Springfield, Massachusetts area. The assets and liabilities of these
Springfield physicians were transferred to MCP and the physicians became
employees of MCP. On December 1, 1997, the Company entered into an affiliation
agreement with a physician practice consisting of 58 physicians located in the
Baltimore/Annapolis, Maryland area. The assets and liabilities of the
Baltimore/Annapolis physicians were transferred to Flagship Health II, P.A.
("Flagship II") and the physicians became employees of Flagship II.

     The completion of the Springfield and Baltimore area affiliations resulted
in the Company having management fees of approximately $2.5 million for the year
ended December 31, 1997 compared to approximately $0.2 million for the year
ended December 31, 1996. The increase in management fees was primarily due to
both the number and dates of affiliation of the Springfield and Baltimore
physicians. The revenues for 1996 were generated from the management of 32
physician practices from August 30, 1996 through December 31, 1996 and one month
of fee income from Flagship I physicians. The revenues for 1997 consisted of a
full year of management fees from both MCP and Flagship I as well as one month's
management fee from the 58 Flagship II physicians.

     Operating expenses increase from $4.8 million in 1996 to $7.6 million in
1997. There were several significant components to such increase. Amortization
increased from $0.2 million in 1996 to $1.2 million in 1997 reflecting a full
year's amortization of the goodwill from both the MCP and Flagship I
acquisitions. 1997 also included one month of amortization from the Flagship II
acquisition. Salaries and benefits increased from $2.1 million in 1996 to $2.8
million in 1997. This increase primarily reflected increase staffing levels with
the Company's expanding operations. General and administrative expenses
increased from $2.4 million to $3.4 million. While this increase is largely
attributable to the increasing scope of the Company's operations, it also
reflects increased cost for completed and potential acquisitions. The Company
incurred significant expenses in 1997 for acquisitions that were not completed.
The Company's loss on investments in subsidiaries(Flagship I, MCP and the
Atlanta IPA business) increase from ($0.4 million) to ($1.8 million) reflecting
the Company's share of losses from the IPA arrangements in Atlanta.

     The Company's net loss increased from approximately ($5.1 million) in 1996
to approximately ($5.7 million) in 1997 as increase in expenses from expanding
operations and acquisitions outpaced the increase in management fee income.

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

     The Company's principal requirements for capital are payments to physicians
in connection with affiliation transactions with the Company and its Affiliated
Groups, transaction costs associated with such affiliation transactions, working

                                      -24-
<PAGE>
 
 capital requirements for its Affiliated Groups and the funding of operating
 losses. The Company anticipates that its liquidity and capital resource
 requirements will be similar on a long-term and short-term basis. Due to its
 start-up status, the Company has incurred significant operating losses to date
 and does not have operating cash flow to fund growth or further losses. The
 Company'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, borrowing under a
 Credit Agreement with Bankers Trust Company (which terminated on January 31,
 1998) and cash generated by the operations of the Affiliated Groups.

     During 1998, 1997 and 1996, the Company paid aggregate consideration of
approximately $1.5, $23.9 and $29.5 million, respectively, in connection with
affiliation transactions. Of such amount, approximately $50,000 in 1998, $7.8
million in 1997 and $5.9 in 1996 was paid in cash and approximately $1.45
million in 1998, $15.8 million in 1997 and $23.6 in 1996 was paid in Class A
Common Stock. The majority of such payments were accounted for as an addition to
intangible assets, which represented $61.2 million of the Company's total assets
of $75.5 million at December 31, 1997 and which were written down to their
anticipated realizable value of approximately $6.1 million at December 31, 1998.
The Company is amortizing the intangible assets over 25 years. At such date, the
Company had total assets of approximately $19.2 million.


     Of the Company Common Stock outstanding at December 31, 1998, 18,751,636
shares of Class A Common Stock are subject to a put option which provides for
the put of the shares back to the Company at fair value upon the death or
disability of the holder. In addition, such shares are subject to a fair value
put option back to the Company at the later of the shareholder's retirement from
the Company or June 1998. Consequently, these 18,751,636 shares of Class A
Common Stock have been recorded at fair value at the time of issuance outside of
permanent equity in the accompanying balance sheet. Under the Company's
stockholder agreements, the Company may repurchase an aggregate of 15,917,217
shares of Class A Common Stock for fair value if the shareholder's termination
of employment with the Company is without cause or is by resignation, and for
the lower of cost or fair value if termination is with cause. The terms of such
repurchase provision may not permit the Company to fully recover its affiliation
payments to the physician or reflect the cost of affiliation transactions at the
time of termination. All of the above put and call provisions expire on the
closing of a public offering of the Company's common stock which results in net
proceeds to the Company of at least $50.0 million and which meets certain other
criteria. In addition to the previously discussed put options, the Flagship II
physicians have the right to require the Company to repurchase (in the form of a
five year non-interest bearing note) 4.8 million shares of Class A Common Stock
issued in the Flagship II affiliation at a purchase price of $3.00 per share if
the Company has not completed an underwritten initial public offering prior to
December 1, 2001. Because the Company's shares are subject to a number of
restrictions in the stockholders' agreements and will not trade until the
occurrence of such an offering, the Company believes it is a nonpublic entity
for compensation accounting purposes and, accordingly, has not recorded any
compensation expense for these puts and calls.

     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 $6.8 million and $4 million due from the Affiliated
Groups at December 31, 1998 and 1997, respectively.

     The Company's liquidity position continued to decline in 1998.  The Company
raised approximately $7.9 million from its institutional investors in
                                    
                                     -25-

                                     
<PAGE>
 
1998 through the issuance of Class L Common Stock. However, even with such
financing activities, the Company's cash and cash equivalents declined from
approximately $8.8 million at the end of 1997 to approximately $4 million at the
end of 1998. The Company's cash position has continued to decline since the end
of 1998.

     In light of its financial condition, the Company does not have any material
capital expenditures budgeted for 1999.

     As a result of the operating loss and write offs, the Company's
stockholders equity declined from $16.1 million at December 31, 1997 to a
stockholder's deficit of ($24.6 million) at December 31, 1998. On such dates,
approximately $54.4 million and $42.2 million, respectively, was held outside
shareholders' equity as Common stock subject to a put, as discussed above.

     If the restructuring negotiations discussed above are successfully
concluded, the Company cash and cash equivalents position is expected to
increase and a significant amount of Class A Common Stock (all or a substantial
portion of which is classified on the balance sheet as Common stock subject to a
put) would be retired. Should the unwind not occur or be unduly delayed,
management believes that it can significantly reduce cash outflows to its
Affiliated Groups in 1999 through the enforcement of affiliation agreement
provisions that have not been previously enforced, including the reduction of
physician compensation in order to recover working capital advances, and
therefore, still have sufficient resources to meet 1999 operating needs.


Impact of Year 2000
-------------------

     The Company is aware of issues associated with the programming code in
existing computer systems as the year 2000 approaches. The "Year 2000" problem
is pervasive and complex, as virtually every computer operation will be affected
in the same way by the rollover of the two digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail.

     The Company is utilizing both internal and external resources to identify,
correct or reprogram, and test its systems for Year 2000 compliance. It is
currently anticipated that all reprogramming efforts will be completed by July
31, 1999, allowing adequate time for testing. A preliminary assessment has
indicted that some of the Company's older personal computers and ancillary
software programs may not be Year 2000 compatible. The Company intends to either
replace or modify these computers and programs. The cost of this replacement is
not expected to be material as the shelf life of the Company's personal
computers is three to five years. The present financial systems are all Year
2000 compliant. The practice management system is 80% compliant and the Company
plans to move to a newer version of the software which is 100% compliant as part
of it's reprogramming efforts which will be completed by July 31, 1999. This
upgrade is provided under the Company's current software maintenance agreement
with its software vendor. All new software purchased will be 100% compliant.


     The Company is also obtaining confirmations from the Company's primary
vendors that plans are already in place to address processing of transactions in
the Year 2000. However, there can be no assurance that the systems of other
companies on which the Company's systems rely also will be converted in a timely
fashion or that any such failure to convert by another company would not have an
adverse effect on the Company's systems. Management is in the process of
completing the assessment of the Year 2000 compliance costs. However, based on
currently available information (excluding the possible impact of vendor systems
which management currently is not in a position to evaluate) as noted above,
management does not believe that these costs will have a material effect on the
Company's earnings.

Factors Affecting Future Operating Results
------------------------------------------

     History of Operating Losses

     The Company has incurred losses of each of its fiscal years through 1998.
The Company expects to incur operating losses for at least the immediate future.
The Company currently does not have significant resources to fund future

                                      -26-
<PAGE>
 
operating losses.  See "-- Need for Substantial Additional Capital." There can
be no assurance that the Company will achieve or maintain profitability.


     Restructuring

     As discussed under Managements Discussion of Results of Operations and
Financial Condition, 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.

     Risk that Future Affiliation Transactions Will Not Be Consummated; Costs of
Affiliation Transactions

     There can be no assurance that any future affiliation transactions will be
consummated. In consummating future affiliation transactions, the Company will
rely upon certain representations, warranties and indemnities made by sellers
with respect to the affiliation transaction, as well as its own due diligence
investigation. There can be no assurance that such representations and
warranties will be true and correct, that the Company's due diligence

                                      -27-
<PAGE>
 
will uncover all material adverse facts relating to the operations and financial
condition of the affiliated medical practices or that all of the conditions to
the Company's obligations to consummate these future affiliations will be
satisfied. Any material misrepresentations could have a material adverse effect
on the Company's financial condition and results of operations.

     The Company has incurred significant accounting, legal and other costs in
developing its affiliation structure and completing its initial affiliation
transactions. The Company's ability to enter into affiliation transactions with
a significant number of physicians and to achieve positive cash flow will be
adversely affected unless it is able to reduce the expenses associated with
future transactions. There can be no assurance that the Company will be able to
reduce transaction costs on a per affiliated physician basis in the future.

    Dependence upon Affiliated Medical Practices

    Although the Company does not and will not employ physicians or control the
medical aspects of the practices of the physicians employed by the Springfield
Affiliated Group, the Flagship Affiliated Group or similar Affiliated Groups,
the Company's revenue and profitability are directly dependent on the revenue
generated by the operation and performance of the affiliated medical practices.
The compensation to the Company under its Services Agreements with the
Affiliated Groups is based upon a percentage of the profits or revenues
generated by the Affiliated Groups' practices with a substantial portion of the
profits or revenues being allocated to the physicians until threshold levels of
income or revenues, based upon the physicians' historical compensation or
billings, are achieved. Accordingly, the performance of affiliated physicians
affects the Company's profitability and the success of the Company depends, in
part, upon an increase in net revenues from the practice of affiliated
physicians compared to historical levels. The inability of the Company's
Affiliated Groups to attract and retain patients, to manage patient care
effectively and to generate sufficient revenue or a material decrease in the
revenues of the Affiliated Groups would have a material adverse effect on the
financial performance of the Company. To the extent that the physicians
affiliated with the Company are concentrated in a limited number of target
markets, as is currently the case in western Massachusetts and Maryland,
deterioration in the economies of such markets could have a material adverse
effect upon the Company.

     Risks Related to Expansion of Operations

     Integration Risks. The Company has completed affiliation transactions with
the Springfield Affiliated Group and the Flagship Affiliated Group, and is
seeking to enter into Affiliations with additional physicians. In the
Springfield and Greater Baltimore-Annapolis areas and in other potential
affiliation markets, the Company is integrating physician practice groups that
have previously operated independently. The Company is still in the process of
integrating its affiliated practices. The Company may encounter difficulties in
integrating the operations of such physician practice groups and the benefits
expected from such affiliations

                             

                                      -28-
<PAGE>
 
may not be realized. Any delays or unexpected costs incurred in connection with
integrating such operations could have an adverse effect on the Company's
business, operating results or financial condition.

     While each Affiliation conforms to PQC's overall business plan, the
profitability, location and culture of the physician practices that have been
combined into Affiliated Groups are different in some respects. PQC's management
faces a significant challenge in its efforts to integrate and expand the
business of the Affiliated Groups. The need for management to focus upon such
integration and future Affiliations may limit resources available for the
day-to-day management of the Company's business. While management of the Company
believes that the combination of these practices will serve to strengthen the
Company, there can be no assurance that management's efforts to integrate the
operations of the Company will be successful. The profitability of the Company
is largely dependent on its ability to develop and integrate networks of
physicians from the affiliated practices, to manage and control costs and to
realize economies of scale. There can be no assurances that there will not be
substantial costs associated with such activities or that there will not be
other material adverse effects on the financial results of the Company as a
result of these integration and affiliation activities.

     The Company's ability to pursue new growth opportunities successfully will
depend on many factors, including, among others, the Company's ability to
identify suitable growth opportunities and successfully integrate affiliated or
acquired businesses and practices. There can be no assurance that the Company
will anticipate all of the changing demands that expanding operations will
impose on its management, management information systems and physician network.
Any failure by the Company to adapt its systems and procedures to those changing
demands could have a material adverse effect on the operating results and
financial condition of the Company.

     Need to Hire and Retain Additional Physicians

     The success of the Company is dependent upon its ability to affiliate with
a significant number of qualified physicians and the willingness of such
affiliated physicians to maintain and enhance the productivity of their
practices following affiliation with PQC. The market for affiliation with
physicians is highly competitive, and the Company expects this competition to
increase. The Company competes for physician affiliations with many other
entities, some of which have substantially greater resources, greater name
recognition and a longer operating history than the Company and some of which
offer alternative affiliation strategies which the Company may not be able to
offer. In addition, under current law the Company has no or only limited ability
to enforce restrictive covenants in the employment agreements with the
physicians with whom the Company affiliates. The Company is subject to the risk
that physicians who receive affiliation payments may discontinue such
affiliation with the Company, resulting in a significant loss to the Company and
a decrease in the patient base associated with such affiliated physicians. There
can be no assurance that PQC will be able to

                        

                                      -29-
<PAGE>
 
attract and retain a sufficient number of qualified physicians. If the Company
were unable to affiliate with and retain a sufficient number of physicians, the
Company's operating results and financial condition would be materially
adversely affected. A material increase in costs of affiliations could also
adversely affect PQC and its stockholders.

     Risk of Inability to Manage Expanding Operations

     The Company 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 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

                                      -30-
<PAGE>
 
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

                                      -31-
<PAGE>
 
with provider networks, managed care organization and other organized healthcare
systems, which often provided fixed fee schedules or capitation payment
arrangements which are lower than standard charges. Future profitability in the
changing healthcare environment, with differing methods of payment for medical
services, is likely to be affected significantly by management of healthcare
costs, pricing of services and agreements with payors. Because PQC derives its
revenues from the revenues generated by its affiliated physician groups, further
reductions in payment to physicians generally or other changes in payment for
healthcare services could have an adverse effect on the Company.

   Exposure to Professional Liability; Liability Insurance

   In recent years, physicians, hospitals and other participants in the
healthcare industry have become subject to an increasing number of lawsuits
alleging medical malpractice, negligent credentialing of physicians, and related
legal theories. Many of these lawsuits involve large claims and substantial
defense costs. There can be no assurance that the Company will not become
involved in such litigation in the future. Through its management of practice
locations and provision of non-physician healthcare personnel, the Company could
be named in actions involving care rendered to patients by physicians or other
practitioners employed by Affiliated Groups. In addition, to the extent that
affiliated physicians are subject to such claims, the physicians may need to
devote time to defending such claims, adversely affecting their financial
performance for the Company, and potentially having an adverse effect upon their
reputations and client base. The Company and the Affiliated Groups maintain
professional and general liability insurance, which is currently maintained at
$1 million per occurrence and $3 million annually for each affiliated physician.
Nevertheless, certain types of risks and liabilities are not covered by
insurance, and there can be no assurance that the limits of coverage will be
adequate to cover losses in all instances.

   Certain Federal Income Tax Considerations

   Physician groups which operated as 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

                                      -32-
<PAGE>
 
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.

   New Management; Dependence on Key Personnel

   The current management structure and the senior management team of the
Company have been in place for a relatively short time. As a development stage
company, PQC has experienced some turnover in staff, including two of the
founding officers.  Although the Company has entered into employment agreements
with certain of its other executives that contain covenants not to compete with
the Company, there can be no assurance that the Company will be able to retain
such key executives or its senior managers and employees. The inability to hire
and retain qualified personnel or the loss of the services of personnel could
have a material adverse effect upon the Company's business and future business
prospects.

   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.

                                      -33-
<PAGE>
 
   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 physicians 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.

   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.  For the reasons discussed under "Management's
Discussion and Analysis of Results of Operations," 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
     Not applicable.

                                      -34-
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     All financial statements required to be filed hereunder are filed as
Appendix A, are listed under Item 14(a) and are incorporated herein by
reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

     There have been no disagreements on accounting and financial disclosure
matters.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     The executive officers and directors of the Company and their ages as of
December 31, 1998 are as follows:

NAME                          AGE                      POSITION      
----                          ---                      --------       
 
Jerilyn P. Asher               56         Chief Executive Officer and Chairman
                                          of the Board
Alphonse Calvanese, M.D.       47         Director
Leslie Fang, M.D.(1)           53         Director
Ira Fine, M.D.                 50         Director                         
Arlan F. Fuller, Jr., M.D.     53         Executive Vice President, Medical 
                                          Affairs and Director
Stephen G. Pagliuca            43         Director 
Marc Wolpow                    40         Director
Timothy T. Weglicki (1)        47         Director 
Eugene Bullis                  53         Chief Operating Officer, Chief
                                          Financial Officer and Senior Vice
                                          President
John D. Stobo, Jr.             33         Director
Paul Bodnar, M.D.              48         Director
Richard Maffezzoli, M.D.       57         Director
 

_________________
(1)  Members of the Compensation Committee.

There is currently one vacancy on the Board.

     Directors, Executive Officers and Other Key Employees
     -----------------------------------------------------

     Jerilyn P. Asher is a founder of the Company and has served as Chief
Executive Officer and as Chairman of the Board since its inception. She has over
eighteen years of experience as a healthcare executive in both the public and
private sectors, with broad-based responsibilities for all aspects of
constituency building with physicians and payors, business

                                      -35-
<PAGE>
 
development, finance, operations, sales, marketing and federal and state
healthcare regulation. From 1994 to 1995, Ms. Asher served as President and a
member of the Board of Directors of Abbey Healthcare Group Incorporated
("Abbey"), a home healthcare provider. Ms. Asher was a founder and served as
President, Chief Executive Officer and Chairman of the Board of Directors from
1988 to 1995 and Executive Vice President from 1985 to 1988 of Protocare, Inc.,
a leading regional provider of home healthcare products and services. From 1978
to 1984, Ms. Asher served as Executive Director of United Cerebral Palsy of
Western Massachusetts, Inc., a multi-service agency providing direct care
services to persons of all ages with multiple disabilities.

   Alphonse Calvanese, M.D. has been a member of the Board of Directors of the
Company since November 1996 and President of the Springfield Affiliated Group
since August 1996. He has been in the private practice of medicine since 1981.
He received his B.S. from the University of Massachusetts and his M.D. from
Tufts Medical School. He completed his internship and residency at Baystate
Medical Center.

   Leslie Fang, M.D. has served as a member of the Board of Directors of the
Company and a member of the Board's compensation committee since its inception.
Dr. Fang has been Associate Director of the Hemodialysis Unit, Massachusetts
General Hospital since 1980 and an Assistant Professor of Medicine at Harvard
University Medical School since 1983. He is also Director of the Charles River
Plaza Dialysis Unit and a nationally recognized expert in the field of
nephrology. Dr. Fang received his B.S., M.S. and Ph.D. in physiology and
biophysics from the University of Illinois and his M.D. from Harvard University
Medical School. He completed his internship and residency at Massachusetts
General Hospital.

   Ira Fine, M.D. has been a member of the Board of Directors of the Company
since November 1996. He has been in the private practice of medicine for 16
years and has been the Chief, Division of Rheumatology at Sinai Hospital since
1988 and St. Joseph Medical Center in Baltimore since 1992. He is the Chairman
of the Board of The Physician Group. He is also an Assistant Professor of
Medicine at the University of Maryland School of Medicine and an Assistant
Professor of Medicine at the Johns Hopkins University School of Medicine. He
received his B.S. from the Virginia Polytechnic Institute and his M.D. from
University of Maryland School of Medicine. He completed his internship at
University of Maryland Hospital/Baltimore Veterans Administration Hospital, his
residency at University of Maryland Hospital and a fellowship in rheumatology at
the Johns Hopkins University School of Medicine.

                                      -36-
<PAGE>
 
from Brown University and his M.D. from George Washington University. He
completed his internship and residency at Johns Hopkins Hospital.

   Arlan F. Fuller, Jr., M.D. has served as Executive Vice President of Medical
Affairs and a member of the Board of Directors of the Company since its
inception. He also co-chairs the Company's National Medical Advisory Board, and
is responsible for organizing and directing the company's clinical systems. Dr.
Fuller has been an Associate Professor of Obstetrics and Gynecology at Harvard
University Medical School since 1987 and has been the Director of the
Gynecologic Oncology Service of Massachusetts General Hospital since 1985. Dr.
Fuller maintains a practice in gynecologic surgery and gynecologic oncology at
the Massachusetts General Hospital and is affiliated with the North Shore Cancer
and Medical Centers in Peabody and Salem, Massachusetts. In 1988, Dr. Fuller was
a founder and served as President of Massachusetts General Physicians
Corporation, the first organized physician group at the Massachusetts General
Hospital and a forerunner to the Massachusetts General Physicians Organization,
which manages group practices at the Massachusetts General Hospital. Previously,
Dr. Fuller was a member of the Board of Trustees of Partners Community
Healthcare, Inc., the primary care network and integrated health system which
includes the Massachusetts General Hospital and Brigham and Women's Hospital.
Dr. Fuller received his undergraduate degree from Bowdoin College and his M.D.
from Harvard University Medical School. He completed his internship at
Massachusetts General Hospital, his residencies at the former Boston Hospital
for Women (now the Brigham and Women's Hospital) and a fellowship in
gynecological oncology at Sloan-Kettering Memorial Cancer Center.

   Stephen G. Pagliuca has been a member of the Board of Directors of the
Company since August 1996. He has been with Bain Capital, Inc., where he is a
Managing Director, since 1989, and has actively invested in the medical and
information industries. Prior to joining Bain Capital, Inc., he was a partner at
Bain & Company, where he managed client relationships in the healthcare and
information services industries, including assisting clients in developing
acquisition strategies. He is chairman of the board of PhysioControl Corporation
and Dade International, Inc. and a director of Vivra, Inc., Coram Healthcare,
Gartner Group, Executone, Medical Specialities Group and Wesley-Jessen.

   Marc Wolpow has been a member of the Board of Directors of the Company since
August 1996. He joined Bain Capital, Inc. in 1990 and has been a Managing
Director since 1993. Previously he was a member of the corporate finance
department of Drexel Burnham Lampert, Inc. He is a director of American Pad &
Paper Corp., Miltex Instruments, Inc., Professional Services Industries, Inc.,
Paper Acquisition Corp. and Waters Corp.

   Timothy T. Weglicki has been a member of the Board of Directors of the
Company since June 1997. Mr. Weglicki has been a principal with ABS Partners II,
L.L.C., the general partner of ABS Capital Partners II, L.P., a private equity
fund, and related entities since December 1993. Prior to joining ABS Partners,
he was a Managing Director of Alex Brown & Sons, Inc., where he established and
headed its Capital Markets Group and prior thereto

                                      -37-
<PAGE>
 
headed the Firm's Equity Division, Corporate Finance Department, and Health Care
Investment Banking Group. Mr. Weglicki holds an M.B.A. from the Wharton Graduate
School of Business and a B.A. from the John Hopkins University. He is a director
of Eldertrust, VitalCom, Inc. and several privately held companies.

   Eugene M. Bullis has served as Chief Financial Officer and Senior Vice
President since March, 1998 and as Chief Operating Officer since September,
1998.  He is responsible for all financial and information system functions for
the Company.  Mr. Bullis joined the Company after serving as an independent
business consultant and interim executive with a number of technology companies,
including Computervision, NYNEX and Eastman Kodak.  From 1979 through 1989, he
served as a senior executive at Wang Laboratories, the final two years as Chief
Financial Officer and Treasurer.  Prior to joining Wang Laboratories, Mr. Bullis
was a partner in the public accounting firm, Ernst & Young LLP.  He holds a
Bachelor of Arts Degree in Business Administration from Colby College and is a
Certified Public Accountant.

   John D. Stobo, Jr. is a director of the Company. Mr. Stobo has been a
principal of ABS Partners II, L.L.C., the general partner of ABS Capital
Partners II, L.P. and related entities since 1993. From 1991 to 1993, Mr. Stobo
was a member of Alex Browns's health care and investment banking groups. Mr.
Stobo is a graduate of the University of California, San Diego and Johnson
School of Management at Cornell University. Additionally he is a director of
several privately-held companies.

   Paul Bodnar, M.D., serves as Senior Vice President for Managed Care and
Medical Director.  He also serves as Medical Director of the Mid-Atlantic
Region.  Prior to joining PQC, Dr. Bodnar served for ten years as the Medical
Director of Clinical Associates, a 90-member multi-specialty group practice, of
which he has been a practicing pediatrician since 1980.  Dr. Bodnar received his
Bachelor of Arts Degree from Johns Hopkins University and his M.D. from Columbia
University.  He completed his internship and residency at Johns Hopkins Hospital
and Sinai Hospital in Baltimore.

   Richard Maffezzoli, M.D. is the Director of Development and Analysis for PQC
and Chief Operating Officer of the Company's affiliates Flagship Health, P.A.
and Flagship Health II, P.A.  He was founder and President of Clinical
Associates, which at the time of the merger with PQC was a successful 90-member
health-professional group servicing approximately 60,000 pre-paid lives and
200,000 fee-for-service lives from 16 locations, and operated the company
profitably for 25 years with high patient satisfaction and low overhead.  He is
a graduate of the Johns Hopkins School of Medicine and received his A.B. from
Johns Hopkins University.  He remains active in the practice of internal
medicine and endocrinology.

ITEM 11. EXECUTIVE COMPENSATION.

   The following table sets forth compensation earned by (i) the Company's Chief
Executive Officer and (ii) the other executive officer of the Company whose
compensation was greater than $100,000 in the year ended December 31, 1998
(collectively, the "Named Executive Officers"):

                                      -38-
<PAGE>
 
                          SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>

                                                                               Long-Term     
                                                                              Compensation    
                                          Annual Compensation                  Awards (1)     
                                          -------------------                 ------------    
                                                                Securities      All Other        
                                                                Underlying    Compensation       
Name and Principal Position      Year   Salary ($)   Bonus ($)    Options (#)     ($)          
---------------------------      ----   ----------   ---------  ------------- ------------   
<S>                              <C>    <C>          <C>        <C>           <C> 
Jerilyn P. Asher.............    1998     259,615         --           --       3,314 (2)  
 Chief Executive Officer         1997     250,000         --           --       7,996 (3)  
                                 1996     250,000         --           --       9,647 (4)  
Dana Frank, M.D..............    1998     228,033 (5)             500,000                  
 President                       1997     220,325         --      300,000             --   
                                 1996     118,075         --           --             --   
Eugene M. Bullis.............    1998      98,960 (6)     --      900,000             --          
 Chief Operating Officer,
 Chief Financial Officer and
 Senior Vice President
 
Deborah L. Redd..............    1998     206,730 (7)     --      150,000             --        
 Chief Operating Officer,
 Flagship, Health
 
Alphonse F. Calvanese, M.D...    1998     415,488 (8) 50,000      500,000             --    
 President, Medical Care         1997     343,416         --      300,000             --
Partners
</TABLE>

----------------
(1)  The Company did not grant any restricted stock or stock appreciation rights
     during the year ended December 31, 1998.
(2)  Represents $3,314 paid in connection with an automobile allowance paid by
     the Company.
(3)  Represents $7,200 paid in connection with an automobile allowance and $796
     of compensatory group life insurance premiums paid by the Company.
(4)  Represents $7,200 paid in connection with an automobile allowance and
     $2,447 of compensatory group life insurance premiums paid by the Company.
(5)  Includes $96,838 and $120,325 for 1998 and 1997 respectively, paid as 
     salary for Dr. Frank's patient care practice.
(6)  Per his employment agreement consisting of a base salary payable in equal  
     monthly installments of 24,740 beginning September 1, 1998 and through     
     December 31, 1998 and a base salary of 225,000 per year thereafter.
(7)  Amount based on an annual salary of $250,000 from March 1, 1998. 
(8)  Includes $315,488 and $293,416 for 1998 and 1997 respectively, paid as 
     salary for Dr. Calvanese's patient care practice.

                             Employment Agreements
                             ---------------------

     The Company is a party to an employment agreement with Jerilyn P. Asher
pursuant to which Ms. Asher serves as Chief Executive Officer of the Company for
the three-year period ending June 21, 1998. The term of this Agreement was
extended to June 21, 1999. It is anticipated that Ms. Asher's employment
contract will be renewed for a one year period on financial terms that are
currently being negotiated. The term of the agreement will be automatically
extended for successive one-year terms, unless the Company notifies Ms. Asher to
the contrary at least 90 days prior to the expiration of the then current term.
For her services, Ms. Asher is entitled to an initial base salary of $250,000
per year (subject to periodic increases as determined by the Board) and is
eligible to receive bonuses under the Company's management incentive program, if
such a program is adopted, in an amount up to 100% of her base pay based upon
individual and Company performance. Pursuant to an amendment to the employment
agreement dated August 30, 1996, Ms. Asher waived the right to receive any
unpaid amounts of base salary and bonus to which she was entitled and had not
received as of August 1, 1996. Ms. Asher is also entitled to receive other
benefits available to the Company's senior management generally. Pursuant to a
stock restriction agreement executed as of the date of

                                      -39-
<PAGE>
 
the employment agreement, the Company issued 4,162,500 shares of Series A Common
Stock to Ms. Asher at a purchase price of $.01 per share, 346,875 of which
remain subject to vesting if Ms. Asher maintains her employment with the Company
until June 1998, which vesting will be accelerated in the event of a Change in
Control. A Change in Control is defined to include a person or group becoming
the beneficial owner of 50% or more of the outstanding voting securities of the
Company, certain changes to the composition of the Board of Directors, certain
mergers and a liquidation of the Company. A percentage of the vested shares (50%
in the case of termination for cause and 35% in the case of voluntary
termination) are subject to the Company's repurchase rights in certain
circumstances, including termination of Ms. Asher for "cause" or Ms. Asher's
voluntary resignation, at the fair market value at the time of repurchase.

   The Company may terminate Ms. Asher's employment at any time without cause
and upon 10 days' written notice with cause. Ms. Asher may terminate her
employment for any reason upon 90 days' written notice. If Ms. Asher's
employment is terminated by the Company without cause, or if Ms. Asher
terminates her employment for good reason, the Company must pay Ms. Asher an
amount equal to two times her annual salary. Cause, for purposes of the
termination provisions, means willful and continued failure to perform her
duties, willful engagement in misconduct materially injurious to the Company or
her conviction for a felony, fraud or embezzlement of the Company's property. In
addition, the Company must also make such payment if Ms. Asher's employment is
terminated at any time within 24 months after a "Change in Control" for any
reason other than (i) death or disability, (ii) by the Company for Cause or
(iii) by Ms. Asher other than for Good Reason.

   During the term of the agreement, the Company must nominate Ms. Asher to and
Ms. Asher will be eligible to serve on the Board of Directors. Ms. Asher also
agreed to standard non-competition and non-disclosure terms with the Company.

   The Company was also party to an employment agreement with Arlan F. Fuller,
pursuant to which Dr. Fuller serves as Executive Vice President, Medical
Information Systems and Academic Development of the Company for the three-year
period ending June 20, 1998. This contract was not extended beyond June 20,
1998. During the term of the agreement, Dr. Fuller was required to devote 40% of
his time to the Company and, for such services, was entitled to an initial base
salary of $175,000 per year (subject to periodic increases as determined by the
Board). Dr. Fuller reduced his base annual salary to $50,000 beginning in
December 1996. Pursuant to a stock restriction agreement executed as of the date
of the employment agreement, the Company issued 618,750 shares of Common Stock
to Dr. Fuller at a purchase price of $.01 per share. These shares are subject to
vesting based on individual performance and duration of employment, which
vesting will be accelerated in the event of a "Change in Control." The Company
may terminate Dr. Fuller's employment at any time with cause and upon 60 days'
notice without cause. Dr. Fuller may terminate his employment for any reason
upon 60 days' written notice.

                                      -40-
<PAGE>
 
   During the term of the agreement, the Company must nominate Dr. Fuller to and
Dr. Fuller will be eligible to serve on the Board of Directors. Dr. Fuller also
agreed to standard non-competition and non-disclosure terms with the Company.

   The Company has entered into employment agreements with Dr. Calvanese and Dr.
Frank.  These agreements have initial terms, commencing in 1998, of four years,
and are renewable thereafter by agreement between the parties.  In the event
that the agreements are not extended for at least a one year period, the company
is obligated to make a severance payment of up to $175,000, in the case of Dr.
Frank, up to $200,000 in the case of Dr. Calvanese.  The Agreement with Dr.
Frank provides for a base salary of $100,000 per annum, provided that his
minimum compensation from the Company or its affiliates must not be less than
$220,000 per year.  The Agreement with Dr. Calvanese provides for a base salary
of $50,000 per annum, provided that his minimum compensation from the Company or
its affiliates must not be less than $430,000 per year.

   In the event that the employment agreements are terminated by the Company
without cause or by the employee for good reason, the employee is entitled to
severance payments for a period of at least two years.  The Company may
terminate the employment agreements for cause, which means (i) material failure
to perform duties to the Company, (ii) intentional misconduct or (iii)
conviction of a felony or for fraud, provided that in the event of a termination
pursuant to clause (i) the employee is entitled to severance payment equal to
one years salary or two years if the termination is following a change in
control.

   The Company also has entered into an employment agreement with Eugene M.
Bullis pursuant to which he acts as senior vice president and chief financial
officer of the Company.  It is anticipated that Mr. Bullis will enter into a new
employment arrangement in 1999 on financial terms that are currently being
negotiated.  The agreement has an initial term of 24 months commencing in March
1998, which is automatically extended for one year in the event of a change of
control of the Company occurring during the last 12 months of the term of the
agreement.  The agreement provides for a base salary payable in equal monthly
installments of $24,740.00 beginning September 1, 1998 and through December 31,
1998 and a base salary of $225,000 per year thereafter.  On the first
anniversary date of the agreement, if Mr. Bullis has remained in the continuous
employment of the Company, he shall receive a bonus in the amount of $100,000.
From and after December 31, 1999, Mr. Bullis will be eligible to receive annual
bonus payments of up to 100% of base salary based upon the achievement of
certain performance targets.  The Company has issued Mr. Bullis options for
750,000 shares of Class A Common Stock at an exercise price of $3.00) which
shall vest in equal annual installments of 187,500 shares commencing on April 1,
1999.  In addition, Mr. Bullis is entitled to receive an additional grant of
options for 150,000 shares of Class A Common Stock at an exercise price of $3.00
per share on April 1, 1999 if certain performance targets are met.  In the event
that Mr. Bullis is terminated without cause, he is entitled to severance
payments equal to one years salary.  "Cause" means (i) the material failure to
perform his duties with the Company or (ii) misconduct materially injurious to
the Company.  In the event that Mr. Bullis is terminated within one year after a
change in control, he is entitled to receive one years salary and the $100,000
bonus referred to above (unless already paid by the Company,) and all options
granted shall be vested.

Options Grants Table
--------------------

   The following sets forth, as to the Named Executive Officers, information
concerning stock options granted in the year ended December 31, 1998.

                                      -41-
<PAGE>
 
                       OPTION GRANTS IN LAST FISCAL YEAR


<TABLE>
<CAPTION>
                                       INDIVIDUAL GRANTS 
                    ------------------------------------------------------   
                      NUMBER OF    % OF TOTAL
                     SECURITIES      OPTIONS
                     UNDERLYING     GRANTED TO    EXERCISE
                       OPTION      EMPLOYEES IN     PRICE       EXPIRATION       GRANT
NAME                 GRANTED (#)   FISCAL YEAR    ($/SH)(1)       DATE(2)      DATE VALUE
------------        ------------   ------------   ---------     ----------     ----------
<S>                 <C>            <C>            <C>           <C>           <C> 
Jerilyn P. Asher....         --           --            --              --             --
Dana Frank..........    500,000 (3)    13.60%        $2.25        06/22/08      1,125,000
Eugene M. Bullis....    900,000 (4)    24.49%        $2.25        06/22/08      2,025,000
Deborah L. Redd.....    150,000 (5)     4.08%        $3.75        06/22/08        562,500
Alphonse                                         
Calvanese, M.D......    500,000 (3)    13.60%        $2.25        06/22/08      1,125,000
</TABLE> 
_________________                                     
(1)  The exercise price is equal to the fair market value of the Company's
     Common Stock on the date of grant.

(2)  The expiration date of an option is the tenth anniversary of the date on
     which the option was originally granted.

(3)  Of these stock options, 300,000 stock options vest immediately and the
     remaining stock options vest in two equal annual installments commencing on
     the first anniversary of the date on which the option was originally
     granted.

(4)  Of these stock options, 225,000 vest immediately and the remaining stock
     options vest in three equal annual installments commencing on the first
     anniversary of the date on which the option was originally granted. Of the
     options vesting over the three annual installments, 50,000 per year are
     vested contingent on the achievements of performance criteria established
     by the Company.

(5)  Of these stock options, 37,500 stock options vest immediately and the
     remaining stock options vest in three equal annual installments commencing
     on the first anniversary of the date on which the option was originally
     granted.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

     The following table sets forth the number of shares of capital stock of the
Company beneficially owned as of January 1, 1999 by (i) each owner who is known
by the Company to beneficially own 5% or more of any class of voting stock, (ii)
each of the Company's directors, (iii) each of the Company's Named Executive
Officers and (iv) all directors and executive officers as a group. Except as
otherwise indicated, the named owner has sole voting and investment power with
respect to all shares beneficially owned.

                                      -42-
<PAGE>
 
                           POC TABLE OF COMMON STOCK
                           -------------------------                   
<TABLE> 
<CAPTION> 
                                                                                     Class C Common Stock/2/    
                                                                                   -----------------------------
                                                                                                                               
                                                  Percentage                        Percentage                         Percentage   
Name and Address of Beneficial     Number of       of Class        Number of         of Class        Number of          of Class    
Owner                               Shares        Outstanding       Shares          Outstanding        Shares          Outstanding  
------------------------------   -------------   -------------   -------------     -------------     -----------      --------------
<S>                              <C>             <C>             <C>               <C>               <C>              <C>          
Bain Capital Funds c/o                 --               --       11,015,000/3/          100.0%       3.076,924/4,/5/       33.3%    

Bain Capital, Inc...........                                                                                             
Two Copley Plaza                                                                                                               
Boston, MA 02116                                                                                                               
                                                                                                                               
Goldman Sachs Funds.........           --               --             --                 --         3,076,924/4,/5/       33.3% 
c/o Goldman Sachs & Co.                                                                                                        
85 Broad Street 
New York, MA 100
                                                                                                                               
ABS Capital Partners, II,              --               --             --                 --         9,160,004/6/          74.6%
L.P. Funds..................                                                                                                   
One South Street  
Baltimore, MD 21201  
                    
Offshore Health                  1,582,500/7/          6.1%            --                 --               --               --     
Industries, Inc.                                                                                                               
Two Park Plaza                                                                                                                 
Boston, MA 02110                                                                                                               
                                                                                                                               
Jerilyn P. Asher............     3,849,832/8/         14.6%            --                 --               --               --     
                                                                                                                               
Arlan F. Fuller, Jr., M.D...       618,750             2.4%            --                 --               --               --     
                                                                                                                               
Samantha J. Trotman.........       150,000/9/           *         1,729,016/10/          15.7%             --               --     
                                                                                                                               
Alphonese F. Calvanese, M.D.       313,007/11/          *              --                 --               --               --     
                                                                                                                               
Leslie Fang, M.D............           --               --             --                 --               --               --     
                                                                                                                               
Ira Fine, M.D...............       113,316              *              --                 --               --               --     
                                                                                                                               
Dana Frank, M.D.............       272,904/12/          *              --                 --               --               --     
                                                                                                                               
Stephen G. Pagliuca/13/.....           --               --       11,015,000/3/          100.0%       3.076,924/4,/5/        33.3% 
                                                                                                                               
Marc Wolpow/13/.............           --               --       11,015,000/3/          100.0%       3,076,924/4,/5/        33.3%
                                                                                           
<CAPTION> 

                                                                       Total Common Stock
                                       Class L Common                 Assuming Conversion
                                            Stock                    to Class A /1//2//15/
                                 -----------------------------   -------------------------------
                                    Number        Percentage        Number of      Percentage of
Name and Address of Beneficial        of            of Class         Common           Common
Owner                               Shares        Outstanding        Stock             Stock
------------------------------   -------------   -------------   -------------     -------------
<S>                              <C>             <C>             <C>               <C>
Bain Capital Funds c/o              615,385            25.0%       15,322,694            30.0%
Bain Capital, Inc.............                                                                    
Two Copley Plaza                                                                       
Boston, MA 02116                                                                       
                                                                                       
Goldman Sachs Funds...........      461,538            18.75%       4,000,000             8.3%
c/o Goldman Sachs & Co.                                                                            
85 Broad Street                                                                        
New York, MA 10004                                                                     
                                                                                       
ABS Capital Partners, II,         1,374,487            55.83%      11,908,978            23.1%
L.P. Funds....................                                                                    
One South Street                                                                       
Baltimore, MD 21201                                                                    
                                                                                       
Offshore Health                        --                --         1,582,500             3.8%  
Industries, Inc.                                                                            
Two Park Plaza                                                                         
Boston, MA 02110                                                                       
                                                                                       
Jerilyn P. Asher..............         --                --         3,849,832             9.4%
                                                                                                    
Arlan F. Fuller, Jr., M.D.....         --                --           618,750             1.6%
                                                                                       
Samantha J. Trotman...........         --                --          1,879,016            4.8%
                                                                                                     
Alphonese F. Calvanese, M.D...         --                --            313,007             *
                                                                                       
Leslie Fang, M.D..............         --                --               --               *
                                                                                       
Ira Fine, M.D.................         --                --            113,316             *
                                                                                       
Dana Frank, M.D...............         --                --            272,904             *
                                                                                       
Stephen G. Pagliuca /13/......         --                --         15,322,694           30.0%       
                                                                                                    
Marc Wolpow/13/...............         --                --         15,322,694           30.0% 
</TABLE>
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                    Class C Common Stock/2/  
                                                                                    ----------------------   
                                                 Percentage                         Percentage                       Percentage  
Name and Address of Beneficial     Number of       of Class        Number of         of Class        Number of         of Class   
Owner                               Shares        Outstanding        Shares        Outstanding         Shares        Outstanding 
------------------------------   -------------   -------------   -------------     -------------    -------------   ------------- 
<S>                              <C>             <C>             <C>               <C>              <C>             <C> 
Timothy T. Weglecki                    --             --                                            9,160,004/14/        74.6%  
                                                                                                             
John D. Stobo, Jr                      --             --                --                --        9,160,004/14/        74.6%  
                                                                                                         
Richard Maffezzoli, M. D.            94,585           --                --                --              --               --   
                                                                                                         
Paul Bodnar, M. D.                   94,585           --                --                --              --               --   


All directors and executive
officers as a group (10 persons)
(31, 594, 579/15/ shares or 
83.9% assuming conversion of      5,317,809          19.8%   
Class B, Class C and Class 
L Common Stock into Class A 
Common Stock)                    

<CAPTION> 

                                                                       Total Common Stock           
                                        Class L Common                 Assuming Conversion          
                                            Stock                     to Class A /1//2//16/                  
                                 -----------------------------   -------------------------------
                                    Number        Percentage     Number of         Percentage of            
Name and Address of Beneficial        of           of Class        Common             Common                
Owner                               Shares        Outstanding       Stock              Stock                
------------------------------   -------------   -------------   -------------     -------------              
<S>                              <C>             <C>             <C>               <C>       
Timothy T. Weglecki                 1,374,487        55.83%        11,908,978           23.1% 
                                                                                                                                
John D. Stobo, Jr                   1,374,487        55.83%        11,908,978           23.1%    
                                                                                                                               
Richard Maffezzoli, M. D.               --             --              94,585             * 
                                                                           
Paul Bodnar, M. D.                      --             --              94,585             *


All directors and executive
officers as a group (10 persons)
(31, 594, 579/15/ shares or 
83.9% assuming conversion of     
Class B, Class C and Class 
L Common Stock into Class A 
Common Stock)                    
</TABLE> 
___________________________
* Less than 1%
<PAGE>
 
1.   Reflects the percentage of shares of Class A, Class B, Class C and Class L
     Common Stock.  The Class B, Class C and Class L Common Stock of the Company
     are convertible at the option of the holder into Class A Common Stock.

2.   Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission.  In computing the number of shares
     beneficially owned by a person and the percentage ownership of that person,
     shares of the Company's capital stock subject to options or warrants held
     by that person that are exercisable on or before December 31, 1998 are
     deemed outstanding.  Such shares, however, are not deemed outstanding for
     purposes of computing the ownership of each other person.

3.   Includes warrants to purchase 6,415,000 shares of Class B Common Stock.

4.   Does not include 6,153,846 shares of Class C Common Stock or warrants to
     purchase 6,153,846 shares of Class C Common Stock which other Institutional
     Investors are entitled to purchase pursuant to the Equity Facility.

5.   Includes warrants to purchase 1,538,462 shares of Class C Common Stock.

6.   Includes warrants to purchase 4,580,002 shares of Class C Common Stock.

7.   Includes warrants to purchase 332,500 shares of Class A Common Stock.

8.   Includes warrants to purchase 52,082 shares of Class A Common Stock.

9.   Consists of options to purchase shares of Class A Common Stock.

10.  Includes an aggregate of 722,059 shares of Class B Common Stock and
     1,006,957 shares of Class B Common Stock issuable upon outstanding warrants
     held by BCIP Associates and BCIP Trust Associates.  Ms. Trotman is a
     general partner of BCIP Associates and BCIP Trust Associates.  As such, Ms.
     Trotman may be deemed to own beneficially shares owned by BCIP Associates
     and BCIP Trust Associates, although Ms. Trotman disclaims beneficial
     ownership of any such shares.

11.  Includes options to purchase 100,625 shares of Class A Common Stock.

12.  Includes options to purchase 100,000 shares of Class A Common Stock.

13.  Includes an aggregate of 4,600,000 shares of Class B Common Stock
     beneficially owned by the institutional investors affiliated with Bain
     Capital (11,015,000 shares on a fully diluted basis), 1,538,426 shares of
     Class C Common Stock and 615,385 shares of Class L Common Stock (1,230,777
     on a fully diluted basis (assuming a 2-to-1 conversion rate on the Class L
     Common Stock)).  Each of Mr. Pagliuca and Mr. Wolpow is a Managing Director
     of Bain Capital, which manages each of the institutional investors.  Bain
     Capital is a limited partner in the partnership which is the general
     partner of Bain Capital Fund V, L.P. and Bain Capital Fund V-B, L.P., and a
     general partner of BCIP Associates and BCIP Trust Associates.  As such,
     Messrs. Pagliuca and Wolpow may be deemed to own beneficially shares owned
     by such institutional investors, although each of Mr. Pagliuca and Mr.
     Wolpow disclaims beneficial ownership of any such shares.

14.  Includes 4,580,002 shares of Class C Common Stock, and 1,374,487 shares of
     Class L Common Stock (2,748,974 shares of Class C Common Stock on a fully
     diluted basis (assuming a 2-to-1 conversion rate on the Class L Common
     Stock)) beneficially owned by ABS Capital Partners II, L.P.  Mr. Weglicki
     is a managing member of ABS Partners II, L.L.C., which manages ABS Capital
     Partners II, L.P.  Mr. Stobo is a vice president of ABS Capital Partners
     II, L.L.C.  As such Mr. Weglicki and Mr. Stobo may be deemed to own
     beneficially shares owned by ABS Capital Partners II, L.P., although Mr.
     Weglicki disclaims beneficial ownership of such shares.

15.  See Notes 1, 3, 4, 5 and 8 through 14 above.

16.  The conversion rate is determined pursuant to a formula and amounts
     reflected in the table assume all accrued dividends have been paid and that
     no Class L adjustment is necessary.  If the full Class L adjustment is
     required, the conversion rate would be 5.12 rather than the 2 to 1 as
     reflected in the table.

                                     -43-
<PAGE>
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     Certain Relationships and Related Transactions.  Through June 20, 1997,
     ----------------------------------------------                         
pursuant to an agreement between the Company and its institutional investors
(the "Equity Facility"), the institutional investors affiliated with Bain
      ---------------                                                    
Capital purchased an aggregate of 4,600,000 shares of Class B Common Stock and
warrants exercisable for 6,415,000 shares of Class B Common Stock for an
aggregate purchase price of $11,500,000. On June 23, 1997, the Company issued
7,692,309 shares of Class C Common Stock and Warrants to purchase 7,692,309
shares of Class C Common Stock to the institutional investors affiliated with
Bain Capital, Goldman Sachs & Co., ABS Capital Partners (the "Institutional
Investors") for an aggregate consideration of $25 million.  On July 14, 1998,
the Institutional Investors acquired 2,461,538 shares of Class L Common Stock
for aggregate consideration of $8 million.  In connection with the Equity
Financing, the Company entered into a Management Agreement dated as of August
30, 1996 with BCPV, pursuant to which the Company will pay BCPV (or an affiliate
designated by BCPV) a management fee of $750,000 per year, plus 1% of any
financings from parties other than affiliates of Bain Capital, for services
including advice in connection with financings and financial, managerial and
operational advice in connection with day-to-day operations (the "Management
Agreement"). The Company is also obligated to pay certain expenses, not to
exceed $250,000 per year without the Company's consent, of BCPV, Bain Capital
and the Institutional Investors in connection with the Management Agreement.
Effective June 30, 1998, the Company's obligation to pay a fee under the
Management Contract was terminated, provided that, in the event of a merger or
public offering, the Company is obligated to pay from the proceeds of such sale
accrued but unpaid management fees.  Each of Stephen G. Pagliuca and Marc Wolpow
is a Director of the Company, a limited partner of BCPV, which is the general
partner of Bain Capital Fund V, L.P. and Bain Capital Fund V-B, L.P., and a
general partner of BCIP Associates, L.P. and BCIP Trust Associates, L.P., and a
Managing Director of Bain Capital, which manages each of the institutional
investors.

     Alphonse F. Calvanese, M.D., is a director of the Company and transferred
his practice to the Springfield Affiliated Group for which he received his
allocable portion of the total consideration paid to the physicians who
transferred their practices to the Springfield Affiliated Group. Ira T. Fine,
M.D., Dana H. Frank, M.D., Paul Z. Bodnar, M.D. and Richard Maffezzoli, M.D.,
each a Director of the Company, are members of medical practice groups which
transferred their practice assets to the Flagship Affiliated Group for which
they received the allocated part of the total consideration paid to physicians
who transferred their practices to the Flagship Affiliated Group. Each of Drs.
Calvanese, Fine, Frank, Maffezzoli and Bodnar are also officers of the Company
and receives compensation for the Company and its affiliates. Each of Drs.
Calvanese, Fine, Frank, Maffezzoli and Bodnar have also been granted options to
purchase shares of the Company's Class A Common Stock.


                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

     (a) The following documents are included:

1.   The following financial statements (and related notes) of the Company are
     included:

                                     -44-
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                              Page
     <S>                                                                      <C> 
     Report of Independent Accountants......................................    1
                                                                             
     Balance Sheets at December 31, 1998 and 1997...........................    2
                                                                             
     Statements of Operations for the Years Ended December 31,               
     1998, 1997 and 1996....................................................    3
                                                                               
     Statements of Stockholders' Equity (Deficiency) and Common Stock 
     Subject to Put for the Years Ended December 31, 1998, 1997 and 1996....    4
                                                                               
     Statements of Cash Flows for the Years Ended December 31,                 
     1998, 1997 and 1996....................................................    6
                                                                               
     Notes to the Financial Statements......................................    7
</TABLE> 

2.   The schedule listed below and the Report of Independent Accountants on
     financial statement schedule are filed as part of this Annual Report on
     Form 10-K:

          All schedules are omitted as the information required is inapplicable
          or the information is presented in the financial statements or the
          related notes.

3.   The Exhibits listed in the Exhibit Index immediately preceding the Exhibits
     filed as a part of this Annual Report on Form 10-K.

     (b)  The following current report on Form 8-K was filed by the Company
during the last quarter of the year ended December 31, 1998.

          None

     There are no trademarks mentioned in this Annual Report on Form 10-K.

                                     -45-
<PAGE>
 
                                  SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

PHYSICIANS QUALITY CARE, INC.


                              By: /s/ Jerilyn P. Asher
                                  ----------------------------------------
                                  Jerilyn P. Asher
                                  Chief Executive Officer, Secretary
                                  and Chairman of the Board (Principal
                                  Executive Officer)

Date: April 15, 1999

   Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.


<TABLE> 
<CAPTION> 
Signature                                           Title                     Date
---------------------------------    -----------------------------------   -----------
<S>                                  <C>                                   <C> 
/s/ Jerilyn P. Asher                 Chief Executive Officer, Secretary    April 15, 1999
---------------------------------                                  
Jerilyn P. Asher                     and Chairman of the Board     
                                     (Principal Executive Officer) 

/s/ Eugene M. Bullis                 Chief Operating Officer, Chief        April 15, 1999
---------------------------------                                      
Eugene M. Bullis                     Financial Officer and Senior          April 15, 1999 
                                     Vice President (Principal         
                                     Financial and Accounting Officer)     

/s/ Arlan F. Fuller, Jr., M.D.       Executive Vice President, Medical     April 15, 1999
---------------------------------                         
Arlan F. Fuller, Jr., M.D.           Affairs and Director 

/s/Alphonse Calvanese, M.D.          Director                              April 15, 1999
---------------------------------
Alphonse Calvanese, M.D.
</TABLE>

                                     -46-
<PAGE>
 

<TABLE> 
<S>                                  <C>                                   <C> 
/s/ Leslie Fang, M.D.                Director                              April 15, 1999
---------------------------------                                               
Leslie Fang, M.D.                                                               
                                                                                
/s/ Stephen G. Pagliuca              Director                              April 15, 1998
---------------------------------                                               
Stephen G. Pagliuca                                                             
                                                                                
/s/ Mark Wolpow                      Director                              April 15, 1999
---------------------------------                                               
Mark Wolpow                                                                     
                                                                                
/s/ Ira Fine, M.D.                   Director                              April 15, 1999
---------------------------------                                               
Ira Fine, M.D.                                                                  
                                                                                
/s/ Timothy T. Weglicki              Director                              April 15, 1999
---------------------------------                                                    
Timothy T. Weglicki                                                                  
                                                                                     
/s/ John Stobo                       Director                              April 15, 1999
---------------------------------                                                    
John Stobo                                                                           
                                                                                     
/s/ Paul Bodnar, M.D.                Director                              April 15, 1998
---------------------------------                                                    
Paul Bodnar, M.D.                                                                    
                                                                                     
/s/ Richard Maffezzoli, M.D.         Director                              April 15, 1999
---------------------------------
Richard Maffezzoli, M.D.
</TABLE>

     SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE ACT.

                                     -47-
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Audited Financial Statements


                    Years ended December 31, 1998 and 1997



                                   CONTENTS

<TABLE>
<CAPTION>
<S>                                                                   <C>
Report of Independent Auditors......................................  1
 
Audited  Financial Statements
 
Balance Sheets......................................................  2
Statements of Operations............................................  3
Statements of Stockholders' Equity (Deficiency) and Common
Stock Subject to Put................................................  4
Statements of Cash Flows............................................  6
Notes to Financial Statements.......................................  7
</TABLE>
<PAGE>
 
                        Report of Independent Auditors


The Board of Directors
Physicians Quality Care, Inc.


We have audited the accompanying balance sheets of Physicians Quality Care, Inc.
(the Company) as of December 31, 1998 and 1997, and the related statements of
operations, stockholders' equity (deficiency) and common stock subject to put,
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Physicians Quality Care, Inc.
as of December 31, 1998 and 1997 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.

As more fully described in Note 2, in 1998 the Company changed its accounting
policy to conform to the consensus reached by the Emerging Issues Task Force on 
its Issue No. 97-2, "Consolidation of Physician Practice Entities".
 


Boston, Massachusetts
April 6, 1999

<PAGE>
 
                         Physicians Quality Care, Inc.

                                 Balance Sheets

<TABLE>
<CAPTION>
                                                                             DECEMBER 31
                                                                         1998            1997
                                                                     ----------------------------
<S>                                                                  <C>              <C>
ASSETS
Current assets:
 Cash and cash equivalents                                           $  4,038,802    $  8,782,019
 Restricted cash                                                        1,248,655
 Due from affiliated physician practices                                6,884,020       3,999,164
 Prepaid expenses and other current assets                                121,497         105,043
                                                                     ----------------------------
Total current assets                                                   12,292,974      12,886,226
                                                                                                 
Investment in long-term affiliation agreements, less accumulated                                 
 amortization of $3,432,441 and $1,394,987 in 1998 and 1997,                                     
 respectively                                                           6,095,253      61,176,704
Property and equipment, net                                               395,768       1,327,860
Other assets                                                              407,421         136,181
                                                                     ----------------------------
                                                                                                 
Total assets                                                         $ 19,191,416    $ 75,526,971
                                                                     ============================
                                                                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)                                                
Current liabilities:                                                                              
 Accounts payable                                                    $    453,891    $  1,218,766
 Accrued expenses                                                       1,172,834       3,010,959
                                                                     ----------------------------
Total current liabilities                                               1,626,725       4,229,725
                                                                                                 
Deferred taxes                                                                            746,062
                                                                                                 
Commitments and contingencies                                                                    
                                                                                                 
Common stock, subject to put, 18,751,636 and 18,157,982 shares                                   
 authorized, issued and outstanding at December 31, 1998 and                                     
 1997,  respectively                                                   42,191,181      54,473,947
                                                                                                 
                                                                                                 
Stockholders' equity (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, 9,305,208 and 8,505,208 shares issued
  at December 31, 1998 and 1997, respectively                              93,052          85,052
 Class B-1 common stock, $.01 par value, 15,267,915 shares                                       
  authorized, 2,809,296 shares issued and outstanding                      28,093          28,093
 Class B-2 common stock, $.01 par value, 9,732,085 shares                                        
  authorized, 1,790,704 shares issued and outstanding                      17,907          17,907
 Class C common stock, $.01 par value, 13,846,155 shares                                         
  authorized, 7,692,309 shares issued and outstanding                      76,923          76,923
 Class L common stock, $.01 par value 2,461,538 shares                                           
  authorized, issued and outstanding                                       24,615          
 Additional paid-in capital                                            59,452,218      49,846,913
 Accumulated deficit                                                  (84,309,173)    (33,967,526)
 Less treasury stock, at cost, 1,012,500 shares                           (10,125)        (10,125)
                                                                     ----------------------------
Total stockholders' (deficiency) equity                               (24,626,490)     16,077,237
                                                                     ----------------------------
 
Total liabilities and stockholders' equity (deficiency)              $ 19,191,416    $ 75,526,971
                                                                     ============================
</TABLE>

See accompanying notes.

                                                                               2
<PAGE>
 
                         Physicians Quality Care, Inc.

                           Statements of Operations



<TABLE>
<CAPTION>
                                             YEAR ENDED          YEAR ENDED          YEAR ENDED
                                            DECEMBER 31         DECEMBER 31         DECEMBER 31
                                                1998                1997                1996
                                           ------------------------------------------------------
 
<S>                                        <C>                    <C>                 <C>
Management fees                             $    1,053,620        $  2,501,135        $    225,470
 
Operating expenses:
 Salaries and benefits                           2,475,378           2,780,721           2,135,390
 General and administrative expenses             3,300,520           3,447,685           2,423,089
 Depreciation and amortization                   2,201,955           1,379,321             229,171
 Impairment of investment in long-term
  affiliation agreements                        53,662,759
                                        ----------------------------------------------------------- 
Total expenses                                  61,640,612           7,607,727           4,787,650
                                        -----------------------------------------------------------
 
Operating loss                                 (60,586,992)         (5,106,592)         (4,562,180)
 
Other income (expense):
 Interest income                                   293,638             492,888              90,160
 Loss of investment in subsidiary and           (4,775,826)         (1,773,000)           (411,786)
  affiliates
 Interest expense                                   (4,818)           (119,658)            (97,263)
 Gain on sale of equipment                                                 851
                                        -----------------------------------------------------------
                                                (4,487,006)         (1,398,919)           (418,889)
                                        -----------------------------------------------------------
 
Loss before income taxes                       (65,073,998)         (6,505,511)         (4,981,069)
Income tax (benefit) provision                    (802,211)           (795,281)             78,128
                                        -----------------------------------------------------------
 
Net loss                                    $  (64,271,787)       $ (5,710,230)       $ (5,059,197)
                                        ===========================================================
Net loss available to common stock          $  (50,341,647)       $(12,389,217)       $(19,496,045)
                                        ===========================================================

 Net loss per common share - basic          $        (1.26)       $      (0.41)       $      (1.81)
                                        ===========================================================
</TABLE>

See accompanying notes.

                                                                               3
<PAGE>
 
                         Physicians Quality Care, Inc.

                      Statements of Stockholders' Equity (Deficiency)
                        and Common Stock Subject to Put
 
                 Years ended December 31, 1998, 1997 and 1996
 
 



<TABLE> 
<CAPTION> 
                                                     ---------------------------------------------------------------------------- 
                                                           COMMON STOCK       CLASS A COMMON STOCK        CLASS B-1 COMMON STOCK   
                                                     ---------------------------------------------------------------------------- 
                                                        SHARES      AMOUNT     SHARES        AMOUNT        SHARES          AMOUNT  
                                                     ---------------------------------------------------------------------------- 
<S>                                                  <C>           <C>         <C>           <C>           <C>             <C>     
Balance at December 31, 1995                           7,706,250   $ 77,063                                                        
Purchase of treasury shares                                                                                                        
Recapitalization in connection with                                                                                                
    restatement of Charter                            (7,706,250)   (77,063)   7,706,250    $ 77,063                               
Reclassification of common stock in                                                                                                
    connection with recapitalization                                           (5,897,914)    (58,980)                             
Accretion of common stock subject to                                                                                               
    put to fair value                                                                                                              
Issuance of Class A common stock upon                                                                                              
   conversion of Series A convertible                                                                                              
   preferred stock                                                              1,666,151      16,662                              
Issuance of Class A common stock                                               10,604,221     106,041                              
Reclassification of common stock                                                                                                   
     subject to put                                                            (6,842,675)    (68,426)                             
Issuance of Class B-1 and B-2 common                                                                                               
    stock for cash, net of issuance costs                                                                                          
    of $2,051,095                                                                                          2,442,866       $24,429 
Payment received from stockholder                                                                                                  
Net loss                                                                                                                           
                                                    -------------------------------------------------------------------------------
Balance at December 31, 1996                                   -           -    7,236,033      72,360      2,442,866        24,429 
Issuance of Class A common stock, net                                                                                              
   of issuance cost $108,475                                                    6,686,568      66,866                              
Reclassification of common stock                                                                                                   
   subject to put to fair value                                                (5,417,393)    (54,174)                             
Issuance of Class B-1 and B-2 common                                                                                               
   stock for cash                                                                                            366,430     3,664     
Accretion of common stock subject to                                                                                               
  put to fair value                                                                                                                
Issuance of Class C common stock for cash                                                                                          
  net of issuance cost of $742,088                                                                                                 
Options issued at below fair value in                                                                                              
    connection with affiliation                                                                                                    
Net loss                                                                                                                           
                                                   -------------------------------------------------------------------------------
 
<CAPTION>  
                                                  ---------------------------------------------------------------------------
                                                                                                      SERIES A CONVERTIBLE      
                                                  CLASS B-2 COMMON STOCK       CLASS C COMMON           PREFERRED STOCK        
                                                  ---------------------------------------------------------------------------  
                                                  SHARES          AMOUNT     SHARES      AMOUNT      SHARES        AMOUNT     
                                                  ---------------------------------------------------------------------------
<S>                                               <C>             <C>        <C>         <C>         <C>          <C>  
Balance at December 31, 1995                                                                          1,666,151   $ 3,750,609  
Purchase of treasury shares                                                                                                    
Recapitalization in connection with                                                                                            
    restatement of Charter                                                                                                     
Reclassification of common stock in                                                                                            
    connection with recapitalization                                                                                           
Accretion of common stock subject to                                                                                           
    put to fair value                                                                                                          
Issuance of Class A common stock upon                                                                                          
   conversion of Series A convertible                                                                                          
   preferred stock                                                                                   (1,666,151)   (3,750,609) 
Issuance of Class A common stock                                                                                               
Reclassification of common stock                                                                                               
     subject to put                                                                                                            
Issuance of Class B-1 and B-2 common                                                                                           
    stock for cash, net of issuance costs                                                                                      
    of $2,051,095                                 1,557,134        $15,571                                                     
Payment received from stockholder                                                                                              
Net loss                                                                                                                       
                                                  -----------------------------------------------------------------------------
Balance at December 31, 1996                      1,557,134         15,571            -         -             -             -
Issuance of Class A common stock, net                                                                                          
   of issuance cost $108,475                                                                                                   
Reclassification of common stock                                                                                               
   subject to put to fair value                                                                                                
Issuance of Class B-1 and B-2 common                                                                                           
   stock for cash                                   233,570          2,336                                                     
Accretion of common stock subject to                                                                                           
  put to fair value                                                                                                            
Issuance of Class C common stock for cash                                                                                      
  net of issuance cost of $742,088                                            7,692,309   $76,923                              
Options issued at below fair value in                                                                                          
    connection with affiliation                                                                                                
Net loss                                                                                                                    
                                                   ----------------------------------------------------------------------------

<CAPTION> 
                                                                                                           
                                                                                                                                 
                                           --------------------------------------------------------------------------------------
                                                                    ADDITIONAL                                         TOTAL     
                                              TREASURY STOCK         PAID IN      ACCUMULATED      DUE FROM      STOCKHOLDERS'
                                           -------------------                                                                   
                                           SHARES        AMOUNT     CAPITAL        DEFICIT       STOCKHOLDERS  EQUITY (DEFICIENCY)
                                           --------------------------------------------------------------------------------------
<S>                                        <S>          <C>         <C>            <C>             <C>         <C>          
Balance at December 31, 1995                                        $   420,000    $ (2,082,264)    $ (61,875)     $   2,103,533 
Purchase of treasury shares                (1,012,500)  $(10,125)                                       10,125                    
Recapitalization in connection with                                                                                              
    restatement of Charter                                                                                                       
Reclassification of common stock in                                                                                              
    connection with recapitalization                                   (248,958)                                         (307,938) 
Accretion of common stock subject to                                                                               
    put to fair value                                                               (14,436,848)                      (14,436,848)
Issuance of Class A common stock upon                                                                                             
   conversion of Series A convertible                                                                                             
   preferred stock                                                    3,733,947                                                   
Issuance of Class A common stock                                     26,341,989                                        26,448,030 
Reclassification of common stock                                                                                                  
     subject to put                                                 (17,038,261)                                      (17,106,687)
Issuance of Class B-1 and B-2 common                                                                               
    stock for cash, net of issuance costs                                                                          
    of $2,051,095                                                     7,908,905                                         7,948,905
Payment received from stockholder                                                                       51,750             51,750
Net loss                                                                             (5,059,197)                       (5,059,197)
                                            -------------------------------------------------------------------------------------
Balance at December 31, 1996                (1,012,500)  (10,125)    21,117,622     (21,578,309)             -           (358,452)
Issuance of Class A common stock, net                                                                            
   of issuance cost $108,475                                         18,718,611                                        18,785,477
Reclassification of common stock                                                                                 
   subject to put to fair value                                     (15,889,309)                                      (15,943,483) 
Issuance of Class B-1 and B-2 common                                                                             
   stock for cash                                                     1,494,000                                         1,500,000
Accretion of common stock subject to                                                                             
  put to fair value                                                                  (6,678,987)                       (6,678,987)
Issuance of Class C common stock for cash                                                                        
  net of issuance cost of $742,088                                   24,180,989                                        24,257,912
Options issued at below fair value in                                                                            
    connection with affiliation                                         225,000                                           225,000
Net loss                                                                             (5,710,230)                       (5,710,230)
                                         ----------------------------------------------------------------------------------------

<CAPTION> 
                                                COMMON
                                              ----------
                                                STOCK
                                               SUBJECT
                                              
                                                TO PUT
                                              ----------
<S>                                           <C>     
Balance at December 31, 1995                  
Purchase of treasury shares                   
Recapitalization in connection with           
    restatement of Charter                    
Reclassification of common stock in           
    connection with recapitalization            $  307,938
Accretion of common stock subject to          
    put to fair value                           14,436,848
Issuance of Class A common stock upon         
   conversion of Series A convertible         
   preferred stock                            
Issuance of Class A common stock              
Reclassification of common stock              
     subject to put                             17,106,687
Issuance of Class B-1 and B-2 common          
    stock for cash, net of issuance costs     
    of $2,051,095                             
Payment received from stockholder             
Net loss                                          
                                              ------------
Balance at December 31, 1996                    31,851,473
Issuance of Class A common stock, net         
   of issuance cost $108,475                  
Reclassification of common stock              
   subject to put to fair value                 15,943,483
Issuance of Class B-1 and B-2 common          
   stock for cash                             
Accretion of common stock subject to          
  put to fair value                              6,678,991
Issuance of Class C common stock for cash     
  net of issuance cost of $742,088            
Options issued at below fair value in         
    connection with affiliation               
Net loss                                      
                                              ------------
</TABLE>
<PAGE>
 
                         Physicians Quality Care, Inc.

                Statements of Stockholders' Equity (Deficiency)
                  and Common Stock Subject to Put (continued)
 


<TABLE>
<CAPTION> 
                                                           COMMON STOCK         CLASS A COMMON STOCK      CLASS B-1 COMMON  STOCK
                                                        --------------------------------------------------------------------------
                                                         SHARES      AMOUNT     SHARES        AMOUNT      SHARES           AMOUNT   

                                                        --------------------------------------------------------------------------
<S>                                                     <C>          <C>        <C>           <C>         <C>            <C>      
Balance at December 31, 1997                                  -      $   -      8,505,208     $ 85,052    2,809,296     $28,093   
Issuance of Class A common stock, net                                                                                             
   of issuance cost $157,059                                                    1,393,654       13,937                            
Reclassification of common stock                                                                                                  
   subject to put to fair value                                                  (593,654)      (5,937)                           
Issuance of Class L common stock, net                                                                                             
   of issuance cost $205,018                                                                                                      
Adjustment to reduce common stock                                                                                                 
   subject to put to fair value                                                                                                   
Net loss                                                                                                                          
                                                        --------------------------------------------------------------------------
                                                                                                                                  
Balance at December 31, 1998                                  -      $   -      9,305,208     $ 93,052    2,809,296     $28,093   
                                                        ==========================================================================
                                                                                                                                
<CAPTION>                                                                                                                       
                                                       CLASS B-2 COMMON STOCK      CLASS C COMMON STOCK      CLASS L COMMON     
                                                      --------------------------------------------------------------------------
                                                       SHARES          AMOUNT     SHARES          AMOUNT   SHARES      AMOUNT 
                                                      --------------------------------------------------------------------------
<S>                                                   <C>             <C>         <C>            <C>       <C>         <C> 
Balance at December 31, 1997                           1,790,704      $17,907     7,692,309      $76,923   
Issuance of Class A common stock, net                                                                                         
   of issuance cost $157,059                                                                                                  
Reclassification of common stock                                                                                              
   subject to put to fair value                                                                                               
Issuance of Class L common stock, net                                                                                         
   of issuance cost $205,018                                                                                2,461,538  $   24,615
Adjustment to reduce common stock                                                                            
   subject to put to fair value                                                                                                   
Net loss
                                                      ---------------------------------------------------------------------------
                                                       
Balance at December 31, 1998                           1,790,704      $17,907     7,692,309      $76,923    2,461,538  $   24,615 
                                                      ===========================================================================
                                                                                                                                
<CAPTION> 
                                                                                                                                
                                                 SERIES A CONVERTIBLE                              ADDITIONAL                   
                                                   PREFERRED STOCK          TREASURY STOCK          PAID-IN      ACCUMULATED   
                                                 ---------------------------------------------
                                                 SHARES       AMOUNT      SHARES        AMOUNT      CAPITAL         DEFICIT     
                                                 ----------------------------------------------------------------------------
<S>                                              <C>          <C>       <C>          <C>          <C>            <C> 
Balance at December 31, 1997                          -       $    -    (1,012,500)  $(10,125)    $ 49,846,913   $(33,967,526)  
Issuance of Class A common stock, net                                                                                           
   of issuance cost $157,059                                                                         3,476,375                  
Reclassification of common stock                                                                                                
   subject to put to fair value                                                                     (1,641,437)                 
Issuance of Class L common stock, net                                                                                           
   of issuance cost $205,018                                                                         7,770,367                  
Adjustment to reduce common stock                                                                                               
   subject to put to fair value                                                                                    13,930,140   
Net loss                                                                                                          (64,271,787)  
                                                 ----------------------------------------------------------------------------
                                                                                                                                
Balance at December 31, 1998                          -       $    -    (1,012,500)  $(10,125)    $ 59,452,218   $(84,309,173)  
                                                 ============================================================================

<CAPTION> 
                                                                                  COMMON      
                                                                   TOTAL          STOCK   
                                                   DUE FROM     STOCKHOLDERS'     SUBJECT 
                                                 STOCKHOLDERS EQUITY DEFICIENCY    TO PUT    
                                                 --------------------------------------------
<S>                                              <C>          <C>                <C> 
Balance at December 31, 1997                     $          -   $   16,077,237   $ 54,473,947
Issuance of Class A common stock, net            
   of issuance cost $157,059                                         3,490,312                            
Reclassification of common stock                 
   subject to put to fair value                                     (1,647,374)     1,647,374             
Issuance of Class L common stock, net            
   of issuance cost $205,018                                         7,794,982              - 
Adjustment to reduce common stock                
   subject to put to fair value                                     13,930,140    (13,930,140)   
Net loss                                                           (64,271,787)                       
                                                 --------------------------------------------
                                                 
Balance at December 31, 1998                     $          -     ($24,626,490)  $ 42,191,181
                                                 ============================================
</TABLE>

See accompanying notes.   
<PAGE>
 
                         Physicians Quality Care, Inc.

                            Statements of Cash Flows


<TABLE>
<CAPTION>
                                                                  YEAR ENDED        YEAR ENDED       YEAR ENDED
                                                                  DECEMBER 31      DECEMBER 31       DECEMBER 31
                                                                    1998              1997              1996
                                                                ------------------------------------------------
<S>                                                             <C>                 <C>              <C>
OPERATING ACTIVITIES                                        
Net income (loss)                                               $(64,271,787)     $(5,710,230)       $(5,059,197)
Adjustments to reconcile net income (loss) to net cash                                             
 used in operating activities:                                                                     
  Depreciation and amortization                                    2,201,955        1,379,321            229,171
  Impairment of investment in long-term affiliation                                                 
   agreements                                                     53,662,759                       
                                                                                                   
  Deferred taxes                                                    (746,062)         281,185            464,877
  Interest accretion on convertible promissory note                                                       90,000
  Changes in operating assets and liabilities, net of                                              
   effects of business acquisitions:                                                               
     Due from affiliated physician practices                      (1,210,933)      (5,618,398)        (2,935,779)
     Other assets                                                     24,197         (614,070)            11,402
     Accounts payable and accrued expenses                          (486,016)         540,064          1,672,530
     Income taxes payable                                                             (69,708)            37,708
                                                                ------------------------------------------------
Net cash used in operating activities                            (10,825,887)      (9,811,836)        (5,489,288)
                                                                                                   
INVESTING ACTIVITIES                                                                               
Purchase of property and equipment                                  (167,690)      (1,657,453)          (120,218)
Increase in restricted cash                                       (1,248,655)                      
Cash paid for affiliation costs                                      (34,856)      (1,016,096)        (1,839,274)
Cash paid for affiliations                                          (300,924)      (7,277,412)        (5,880,974)
                                                                ------------------------------------------------
Net cash used in investing activities                             (1,752,125)      (9,950,961)        (7,840,466)
                                                                                                   
FINANCING ACTIVITIES                                                                               
Proceeds from issuance of common stock, net of                                                     
issuance costs                                                     7,834,795       28,599,906          8,309,655
Proceeds from bridge financing                                                                         1,000,000
(Payment on) proceeds from note payable                                              (200,000)           200,000
Proceeds from repayment of shareholder loan                                                               51,750
Decrease  in deferred financing costs                                                  79,536            438,942
Payments on capital lease obligations                                                 (71,552)           (13,448)
                                                                ------------------------------------------------
Net cash provided by financing activities                          7,834,795       28,407,890          9,986,899
                                                                ------------------------------------------------
Net (decrease) increase in cash and cash equivalents              (4,743,217)       8,465,093         (3,342,855)
Cash and cash equivalents at beginning of period                   8,782,019          136,926          3,479,781
                                                                ------------------------------------------------
                                                                                                   
Cash and cash equivalents at end of period                      $  4,038,802      $ 8,782,019        $   136,926
                                                                ================================================
</TABLE>

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Cash paid for interest was $5,000, $120,000 and $7,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.

Cash paid for income taxes was $110,000, $230,000 and $32,000 for the year ended
December 31, 1998, 1997 and 1996, respectively.

During 1998, 1997 and 1996, $3,450,000, $15,943,000 and $23,587,000,
respectively, was paid in connection with affiliations in the form of Class A
common stock.

During 1998, the Company transferred certain fixed assets with net book value of
$792,000 to an affiliated physicians practice.

During 1996, the Company converted a bridge loan and a promissory note payable
totaling $2,500,000 into shares of Class A common stock.

See accompanying notes.

                                                                               6
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements

                               December 31, 1998


1.  BUSINESS AND ORGANIZATION

Formed in March 1995, Physicians Quality Care, Inc. (PQC or the Company)
provides complete practice management for multi-specialty medical practice
groups.  The Company's objective is to establish and manage networks of
specialty and primary care physicians and related diagnostic and therapeutic
support services which can provide comprehensive health care services in
targeted geographic areas.

During 1996 and 1997, the Company completed affiliations with physician
practices in Springfield, Massachusetts, and in the Baltimore/Annapolis,
Maryland area.  Prior to August 30, 1996, the Company's operations consisted
primarily of seeking affiliations with physician practices and negotiating the
terms of the affiliations and management agreements with such physician
practices.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

IMPAIRMENT CHARGE AND BASIS OF PRESENTATION

The Company periodically reviews its investment in long-term affiliation
agreements to assess whether recoverability and impairments would be recognized
in the statements of operations if a permanent impairment were determined to
have occurred. In April 1999, the Company's Board of Directors approved a plan
to unwind long-term affiliation agreements with its Affiliated Groups in
Baltimore, Maryland, and restructure the long-term affiliation agreement with
its Affiliated Group in Springfield, Massachusetts. The unwind transactions are
expected to occur in April and August of 1999 and are to provide for the
repurchase by affiliated physicians or affiliated practices assets of certain
practices, require repayment of working capital advances made to the Affiliated
Groups by the Company and include termination fees to be paid to the Company.
The Company has entered into an agreement with an Affiliated Group to close one
of the unwind transactions by April 30, 1999. The restructuring transaction is
expected to occur in June 1999 and also provides for the repurchase of certain
assets of the physician practice, and replaces the existing long-term
affiliation agreement with a new management services agreement. The purchase
price paid to the Company will consist of payments for the book value of the
assets to be purchased by the practices, less the practice liabilities as of the
closing date of the transaction, repayments of working capital advances and
termination fees. When the unwind and restructuring transactions are
consummated, the Company expects to receive net consideration after cost of
disposal of $10.8 million and to reacquire 16,098,467 shares of its common
stock. In a separate transaction the Company has proposed the sale of its equity
investment in Atlanta, Georgia (see note 3).

In connection with the proposed unwind and restructuring transactions and the
sale of its equity investment, the Company has reduced its investment in long-
term affiliation agreements to its fair value at December 31, 1998 resulting in
a charge to operations of $53.7 million.

For the year ended December 31, 1998, the Company incurred a loss from
operations of approximately $60.6 million and used net cash of $10.8 million to
support operations. Management believes that the cash proceeds from the unwind
and restructuring transactions described above and existing cash balances at
December 31, 1998 will be sufficient to fund operating needs through December
31, 1999. Should the unwind and restructuring transactions not occur or be
unduly delayed, management believes that it can significantly reduce cash
outflows to its Affiliated Groups in 1999 through the enforcement of affiliation
agreement provisions that have not been previously enforced, including the
reduction of physician compensation in order to recover working capital
advances, and therefore still have sufficient resources to meet 1999 operating
needs.

                                                                               7
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



MANAGEMENT FEES

Management fees represent amounts allocated to the Company based on a percentage
of Affiliated Group revenue in excess of physician baseline compensation.
Affiliated Group revenue represents net patient service revenue less amounts
retained by physician practices.  The amounts retained by Affiliated Group
represent amounts paid to the physicians pursuant to the service agreements
between the Company and the physician practices and the Affiliated Group
practice expenses.  Physician baseline compensation is determined based on an
agreed-upon percentage (80% to 95%) of the physicians' historic compensation
levels, but is subject to reduction if physician practice net revenues are
insufficient to cover the baseline compensation. The net profits for one of the
Company's Affiliated Groups are first allocated to the Company up to 5% of the
net profits.  Net profits remaining after the first allocation are then
allocated 80% to the Company and 20% to the physician groups up to $1.5 million.
Net profits remaining after the second allocation are then allocated equally
between the Company and the physician groups.  The net profits for the other two
Affiliated Groups are allocated equally between the Company and the physician
groups.

Under the service agreements, the Company provides each Affiliated Group with a
comprehensive package of services, including office and facilities, equipment,
nursing and other non-physician professional support, administrative support,
information systems, comprehensive professional liability insurance, and general
management and financial advisory services.  The Company also bills all
patients, insurance companies and third-party payors and negotiates all
contracts and relationships with payors.

                                                                               8
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with a maturity of three
months or less at the time of purchase to be cash equivalents.  The carrying
amount reported in the balance sheet for cash and cash equivalents approximates
its fair value.

RESTRICTED CASH

Restricted cash represents amounts issued under letters of credit and amounts
held in escrow as results of certain pending affiliation agreements.

PROPERTY AND EQUIPMENT

Property and equipment is carried at cost.  Depreciation is calculated using the
straight-line method over the useful lives of the assets.

PROFESSIONAL LIABILITY INSURANCE

The Company has obtained professional liability coverage for the Physician
Practices through commercial insurance carriers on either a claims-made or
occurrence basis.  The Company has purchased additional insurance to cover the
tail portion of the claims made policies.  Management believes that there are no
claims that may result in a loss in excess of amounts covered by its existing
insurance.

INVESTMENT IN LONG-TERM AFFILIATION AGREEMENTS

The Company enters into long-term affiliation arrangements with physician
practices, and through mergers and asset purchases, the assets and liabilities
of the physician practices are transferred to a professional corporation
affiliated with the Company (Affiliated Group).  Each Affiliated Group has a
nine member Joint Policy Board that is responsible for final decisions related
to management and administrative policies for the overall operations of the
Affiliated Group including decisions regarding scope of services, patient
acceptance policies and procedures, pricing of services, negotiation and
execution of contracts and approval of operating and capital budgets.  Four
members of the Joint Policy Board are appointed by the Company and four members
are appointed by the Affiliated Group.  The President, who is the ninth member
of the Joint Policy Board, is appointed by the Company; however, the Company may
only select the President from three physicians nominated by physicians employed
by the affiliated group. Therefore, the Company cannot exercise exclusive
authority over the decision making process of the Joint Policy Board. 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 the Joint Policy Board, the Company cannot demonstrate a
controlling financial interest, as defined by EITF 97-2, in its Affiliated
Groups, and therefore, does not consolidate the operating results and accounts
of the Affiliated Groups. Prior to the adoption of EITF 97-2, the Company, for
display purposes, included the revenues and expenses of the Affiliated Groups in
its statements of operation. EITF 97-2 does not permit this display, and
therefore the adoption of EITF 97-2 resulted in reclassifications in certain
amounts presented in the accompanying statements of operations and cash flows
for all periods presented but did not impact the current or any previously
reported net loss or net loss per common share.

The cost of the long-term affiliation agreements in excess of the underlying
equity of the Affiliated Groups is being amortized on a straight-line basis over
25 years.



                                                                               9
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



STOCK COMPENSATION ARRANGEMENTS

As permitted under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123) the Company accounts for
its stock compensation arrangements under the provisions of APB Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25).  Because the exercise price
of options granted during 1998, 1997 and 1996 equals the fair value of the
underlying stock at date of grant, no compensation expense is required under APB
25.

The Company has adopted disclosure-only provisions of SFAS 123.  These
provisions require the Company to disclose pro forma net income and earnings per
share amounts as if compensation expense related to grants of stock options were
recognized based on new fair value accounting rules.

Net Loss Per Common Share

Basic net loss per share of common stock is computed by dividing the net loss
available to common stock by the weighted-average number of common shares
outstanding during each period presented.  Diluted loss per share is not
presented because the effect would be antidilutive.

                                                                              10

<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



RISKS AND UNCERTAINTIES

The preparation of financial statements in conformity with generally accepted 
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the 
financial statements and the reported amounts of revenues and expenses during 
the reporting period. Actual results could differ from those estimates.

RECLASSIFICATION

Certain amounts in the 1996 and 1997 financial statements have been reclassed
for the basis of presenting corresponding items in the comparative financial
statements.

3.  INVESTMENT IN LONG-TERM AFFILIATION AGREEMENTS

Springfield

On January 1, 1997, the Company entered into long-term affiliation arrangements
with 2 physician practices (5 physicians) located in Western Massachusetts (the
Springfield Affiliation).  On August 30, 1996, the Company entered into long-
term affiliation arrangements with 7 physician practices (32 physicians) located
in Western Massachusetts (the Springfield Affiliation).  In connection with
these transactions, the assets and liabilities of the physician practices were
transferred to a professional corporation affiliated with the

                                                                              11
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


3.  INVESTMENT IN LONG-TERM AFFILIATION AGREEMENTS (CONTINUED)

Company, Medical Care Partners, P.C. (MCP) and the physicians became employees
of MCP.  The aggregate consideration paid to the physicians for the 1997
affiliation was approximately $2.5 million, of which  $831,000 was paid in cash,
$1.4 million was paid by the issuance of 572,493 shares of Class A common stock,
and $225,000 was paid by the issuance of options to purchase shares of common
stock at below fair value.  The aggregate consideration paid to the physicians
for the 1996 affiliation was approximately  $9.7 million, of which  $3.2 million
was paid in cash and $6.5 million was paid by the issuance of 2,592,245 shares
of Class A common stock. Up to an additional $2.15 million, payable in Class A
common stock, was available to be paid to certain physicians if revenue goals
were met.  During 1997, $2.1 million of additional consideration was accrued
based on the achievement of these goals, of which $2 million was paid by the
issuance of 800,000 shares of Class A common stock in 1998.  In addition, 29
physicians each received 2,500 options to purchase common stock at an exercise
price equal to fair value.

Baltimore

On December 1, 1997, the Company entered into a long-term affiliation
arrangement with a physician practice (58 physicians) located in the
Baltimore/Annapolis, Maryland area (the Flagship II Affiliation).  In connection
with this transaction, the assets and liabilities of the physician practices
were transferred to a newly formed professional corporation affiliated with the
Company, Flagship Health II, P.A. (Flagship II) and the physicians became
employees of Flagship II.  The aggregate consideration paid to the physicians
for the affiliation was approximately $17.4 million, of which $3 million was
paid in cash and $14.4 million was paid by the issuance of 4,800,000 shares of
Class A common stock.

On December 11, 1996, the Company entered into long-term affiliation
arrangements with 15 physician practices (59 physicians) located in the
Baltimore/Annapolis, Maryland area.  In connection with this transaction, the
assets and liabilities of the physician practices were transferred to a newly
formed professional corporation affiliated with the Company, Flagship Health I,
P.A. (Flagship I) and the physicians became employees of Flagship I.  The
aggregate consideration paid to the physicians for the affiliation was
approximately $19.8 million, of which $2.7 million was paid in cash and $17.1
million was paid by the issuance of 6,842,675 shares of Class A common stock.
During 1997, the Company issued 44,900 shares of Class A common stock to the
Flagship I physicians totaling $112,000 for the settlement of working capital
adjustments.

                                                                              12
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)

3.  INVESTMENT IN LONG-TERM AFFILIATION AGREEMENTS (CONTINUED)

As described in Note 2, the Company does not consolidate the operating results
or accounts of the affiliated physician practices for financial reporting
purposes.  Accordingly, its investments in these long-term affiliation
agreements are accounted for in a manner similar to that used in the application
of the equity method of accounting.

The allocation of the costs of the 1997 and 1996 affiliations were as follows:

<TABLE>
<CAPTION>
                                                            1997 AFFILIATIONS
                                              -------------------------------------------
                                                    SPRINGFIELD           FLAGSHIP II
                                              -------------------------------------------
<S>                                           <C>                         <C>
Cash                                                     $   30,000
Fixed assets                                                 21,000           $ 1,171,000
Other current assets                                        150,000             4,100,000
Intangibles                                               2,327,000            15,795,000
Accounts payable                                            (12,000)             (905,000)
Other liabilities                                           (29,000)           (2,762,000)
                                              -------------------------------------------
                                                          2,487,000            17,399,000
Other affiliation costs                                     115,000               461,000
                                              -------------------------------------------
 
Investment in long-term affiliation agreements           $2,602,000           $17,860,000
                                              ===========================================
</TABLE>

<TABLE>
<CAPTION>
                                                            1996 AFFILIATIONS
                                              -------------------------------------------
                                                    SPRINGFIELD            FLAGSHIP I
                                              -------------------------------------------
<S>                                           <C>                          <C>
Cash                                                    $   336,000           $   443,000
Fixed assets                                                317,000               955,000
Other current assets                                      1,346,000             4,260,000
Intangibles                                               9,037,000            16,371,000
Accounts payable                                           (190,000)             (677,000)
Other liabilities                                        (1,138,000)           (1,592,000)
                                              -------------------------------------------
                                                          9,708,000            19,760,000
Other affiliation costs                                   1,238,000             1,711,000
                                              -------------------------------------------
 
Investment in long-term affiliation agreements          $10,946,000           $21,471,000
                                              ===========================================
</TABLE>

                                                                              13
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


3.  INVESTMENT IN LONG-TERM AFFILIATION AGREEMENTS (CONTINUED)

Other

On October 24, 1997, the Company acquired a 50% interest in TLC Management
Company (TLC), a medical management company and a 50 % interest in Total Quality
Practice Management, Inc. (TQP), a practice management company providing
Medicare risk management services. Both companies are based in Atlanta, GA.
Total aggregate consideration was $4 million paid in cash and an obligation to
issue a $1 million letter of credit. As of December 31, 1998, the letter of
credit was issued and held in restricted cash. The Company has accounted for the
transaction using the equity method of accounting for investments in common
stock. For the year ended December 31, 1998 and 1997, the net loss in investment
was $713,001 and $98,269, respectively. The Company has entered into
negotiations with TLC and TQP to sell back its 50% interest in both entities.
The Company has received a non binding proposal for consideration of the release
of collateral associated with the $1 million letter of credit and $1.5 million
in cash. Accordingly, the Company has reduced its equity investment by $1.8
million in anticipation of the proceeds of at least $2.5 million from the sale.

4.  PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                             1998                1997
                                                  ---------------------------------------
<S>                                               <C>                        <C>
Equipment                                                  $ 558,138         $1,504,452
Furniture and fixtures                                        16,108             10,863
Office equipment                                              37,110             32,753
Leasehold improvements                                        11,383                  -
                                                  ---------------------------------------
                                                             622,739          1,548,068
Less accumulated depreciation                               (226,971)          (220,208)
                                                  ---------------------------------------
 
                                                           $ 395,768         $1,327,860
                                                  =======================================
</TABLE> 

Depreciation expense was $164,501, $182,968 and $30,537 for years ended December
31, 1998, 1997 and 1996.

5.  TRANSACTIONS WITH RELATED PARTIES

The balance in due from affiliated physician practices represents management
fees due under service agreements with the Affiliated Groups and working capital
advances to the Affiliated Groups.

                                                                              14
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)


5.  TRANSACTIONS WITH RELATED PARTIES (CONTINUED)

The following summarizes the amounts due from related parties:

<TABLE>
<CAPTION>
                                                                DECEMBER 31
                                                          1998                1997
                                                    ---------------------------------
<S>                                                 <C>                    <C>
MCP                                                     $3,000,000         $2,963,851
Flagship I                                               2,608,735            651,608
Flagship II                                              1,275,285            383,705
                                                    ---------------------------------
 
                                                        $6,884,020         $3,999,164
                                                    =================================
</TABLE>

During the year ended December 31, 1996, the Company entered into affiliation
transactions with three of its directors who are physicians.  The physicians
received 498,602 shares of Class A common stock, 2,500 options to acquire Class
A common stock, with an exercise price of $2.50 per share and cash in the amount
of $315,000 as consideration for the affiliations.

On August 30, 1996, the Company entered into a Management Agreement with Bain
Capital Partners V, L.P. (Bain), an affiliate of the Company's Institutional
Investors (see Note 7).  Pursuant to the Management Agreement, the Company had
agreed to pay Bain a management fee of $750,000, plus 1% of any financings from
parties other than affiliates of Bain, for services including advice in
connection with financings and financial, managerial and operational advice in
connection with day-to-day operations.  The Company was obligated to pay
certain expenses, not to exceed $100,000 per year without the Company's consent,
of Bain and its affiliates in connection with the Management Agreement. This
Management Agreement was terminated on June 30, 1998.

6.  LEASES

The Company maintains operating leases for property and certain office
equipment.  The property lease contains escalation clauses and requires payments
of certain utilities and taxes over established base amounts.

Operating lease expense amounted to $232,475, $201,799 and $221,732 in 1998,
1997, and 1996, respectively.

                                                                              15
<PAGE>
 
                         Physicians Quality Care, Inc.

                   Notes to Financial Statements (continued)



6.  LEASES (CONTINUED)

Future minimum payments under noncancelable operating leases consisted of the
following at December 31, 1998:

<TABLE>
<CAPTION>
                                                              OPERATING
                                                               LEASES
                                                            -------------
 
<S>                                                         <C>
1999                                                          $ 82,938
2000                                                            83,997
2001                                                            85,057
2002                                                            84,125
2003                                                            71,840
                                                            -------------
 
                                                              $407,957
                                                            =============
</TABLE>

7.  STOCKHOLDERS' EQUITY

Preferred Stock
---------------

During June 1995, the Company issued 1,666,151 shares of Series A Convertible
Preferred Stock (Preferred Stock), par value $.01, that was converted to Class A
common stock on a one-for-one basis, in connection with the recapitalization
discussed below. Warrants to purchase 416,538 shares of Common Stock at $2.40
per share were issued upon the closing of the sale of the Preferred Stock.
Warrants to purchase an additional 416,538 shares of common stock were required
to be issued to the holders of the Preferred Stock in the event that the Company
did not complete an initial public offering on or before June 30, 1996.
Accordingly, on August 30, 1996, the Company  issued an additional 416,538
warrants at $2.40 per share. A total value of $300,000 were assigned to these
warrants.

In connection with the recapitalization, the Company authorized 10 million
shares of $.01 par value preferred stock.


                                                                              16
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


7.  STOCKHOLDERS' EQUITY (CONTINUED)

Common Stock
------------

The Company has five classes of common stock: Class A, Class B-1, Class B-2,
Class C and Class L. The primary difference between these five classes is voting
rights. Holders of Class A, Class B-1, Class B-2 and Class C common shares are
entitled to elect two, one, one and two members of the Company's Board of
Directors, respectively. The remaining seven directors are elected collectively
by the holders of Class A, Class B-1, Class B-2, Class C and Class L common
shares, with each share having a single vote. Holders of Class C common stock
are also holders of Class L common stock.



Effective August 30, 1996, the Company recapitalized.  All shares of then-
existing common stock were canceled and replaced with Class A common shares.

On August 30, 1996, 402,301 of Class A common shares were issued in connection
with the conversion of a bridge loan.  The bridge loan, in the amount of $1.0
million, (1) was outstanding during July and August 1996;  (2) bore interest at
10.25% and (3) was convertible into Class A common shares at a conversion rate
of $2.50 per share.  Warrants to purchase 201,150 shares of common stock at
$5.00 per share were issued in connection with the bridge loan.

During August 1996, 625,000 shares of Class A common stock were issued in
connection with the conversion of a promissory note.

In connection with the Springfield Affiliation described in Note 3, on August
30, 1996, the Company issued 1,587,863 Class B-1 common shares, 1,012,137 Class
B-2 common shares and warrants to purchase 3,750,500 shares of Class B common
stock at $2.50 per share to the Institutional Investors in exchange for cash
proceeds of $6.5 million, which after issuance costs of approximately $1.4
million, netted to approximately $5.1 million.

                                                                              17
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


7.  STOCKHOLDERS' EQUITY (CONTINUED)

In connection with the Baltimore Affiliation described in Note 3, on December
11, 1996, the Company issued 855,003 Class B-1 common shares, 544,997 Class B-2
common shares and warrants to purchase 1,799,000 shares of Class B common stock
at $2.50 per share to the Institutional Investors in exchange for cash proceeds
of $3.5 million, which after issuance costs of approximately $640,000, netted to
approximately $2.9 million.

In April 1997, the Company issued 366,430 Class B-1 common shares, 233,570 Class
B-2 common shares and warrants to purchase 865,500 shares of Class B common
stock at $2.50 per share to the Institutional Investors in exchange for cash
proceeds of $1.5 million.

In connection with the Flagship II Affiliation described in Note 3, on June 30,
1997, the Company issued 7,692,309 Class C common shares and warrants to
purchase 7,692,309 shares of Class C common stock at $3.25 per share to the
Institutional Investors in exchange for cash proceeds of $25 million, which
after issuance costs of approximately $700k, netted to approximately $24.3
million.

In July 1998, the Company issued 2,461,538 Class L common shares at $3.25 per
share to the holders of Class C common stock in exchange for cash proceeds of
$8.0 million, which after issuance costs of approximately $205,000, netted to
approximately $7.8 million.  In connection with the issuance of Class L common
stock, the exercise price of the outstanding Class B and Class C warrants were
reduced from $2.50 to $0.50 and $3.25 to $1.25, respectively.  Upon the
occurrence of a public offering, merger, consolidation, liquidation or winding
up of the Company, or a sale or other transfer of all or substantially all of
the Company's assets, or certain other conditions brought about by partial
redemption of Class L common stock, Class L common stock automatically converts
into Class A common stock.

                                                                              18
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


7.  STOCKHOLDERS' EQUITY (CONTINUED)

Puts and Calls
--------------

Of the Company's outstanding common stock, 18,751,636 shares as of December 31,
1998 are subject to a put option which provides for the put of the shares back
to the Company at fair value upon the death of the holder.  Additionally, such
shares are subject to a fair value put option back to the Company at the later
of the shareholder's retirement from the Company or June 1998.  Consequently,
these common shares have been recorded at fair value outside of permanent equity
in the accompanying balance sheet.

Under shareholder agreements as of December 31, 1998, the Company has the right
to purchase 15,917,217 shares of common stock for fair value if the
shareholder's termination from the Company is without cause or is by
resignation, and for the lower of cost or fair value if termination is with
cause.

All of the above put and call provisions expire on the date of a Qualified
Public Offering (QPO), defined as a public offering of the Company's common
stock with proceeds to the Company of at least $50 million.

In addition to the previously discussed put options, the Flagship II physicians
have the right to require the Company to repurchase (in the form of a five year
non-interest bearing note) 4.8 million shares of Class A common stock issued in
the Flagship II affiliation (Note 3) at a purchase price of $3.00 per share if
the Company has not completed an underwritten initial public offering prior to
December 1, 2001.

Because the Company's shares are subject to a number of restrictions in the
shareholders' agreements and will not trade until the occurrence of a QPO, the
Company believes it is a nonpublic entity for compensation accounting purposes
and, accordingly, has not recorded any compensation expense for these puts and
calls.  As noted above, at the date of the QPO, the put and call provisions of
the shareholder agreements will expire.

                                                                              19
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


7.  STOCKHOLDERS' EQUITY (CONTINUED)

Warrants
--------

At December 31, 1998, warrants to purchase shares of Class A, Class B and Class
C common stock  were outstanding as follows:

<TABLE>
<CAPTION>
            NUMBER                  PRICE               EXPIRATION
           OF SHARES              PER SHARE                DATE
     -------------------------------------------------------------------
     <S>                          <C>                   <C>
           20,000                  $2.40                   2000
          201,150                   5.00                   2003
          416,538                   2.40                   2000
          416,538                   2.40                   2001
        6,415,000                   0.50                   2003
           50,000                   3.00                   2003
        7,692,309                   1.25                   2004
</TABLE>

Shares Reserved for Future Issuance
-----------------------------------

At December 31, 1998, the Company has reserved 19,954,326 shares of Common Stock
for future issuance for the following purposes:

<TABLE>
     <S>                                               <C>
     Equity incentive plan                                4,742,791
     Warrants                                            15,211,535
                                                       -------------
      
                                                         19,954,326
                                                       =============
</TABLE>

                                                                              20
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


8.  EARNINGS PER SHARE

The following table sets forth the computation of earnings per share:

<TABLE>
<CAPTION>
                                               1998                1997               1996
                                       ---------------------------------------------------------
<S>                                    <C>                       <C>                <C>
Numerator:
Net loss                                     $(64,271,787)       $ (5,710,230)      $ (5,059,197)
Adjustment to common stock subject to
 put to fair value                             13,930,140          (6,678,987)       (14,436,848)
                                       ---------------------------------------------------------
Numerator for basic earnings per
 share-income available to common
 stockholders                                 (50,341,647)        (12,389,217)       (19,496,045)
 
Denominator for basic earnings per
 share-weighted-average shares                 39,797,572          30,335,607         10,785,605
                                       ---------------------------------------------------------
 
Basic earnings per share                     $      (1.26)       $      (0.41)      $      (1.81)
                                       =========================================================
</TABLE>

The effect of options (note 9) and warrants (Note 7) are not considered as it
would be anti-dilutive.  At December 31, 1998, these securities, if converted,
could potentially dilute basic earnings per common share in the future.

9.  EMPLOYEE COMPENSATION PLANS

Equity Incentive Plan
---------------------

The Company's 1995 Equity Incentive Plan provides the opportunity for employees,
consultants, officers and directors to be granted options to purchase, receive
awards or make direct purchases of up to 8.5 million shares of the Company's
common stock.  Options granted under the Plan may be "Incentive Stock Options"
or "Nonqualified Options" under the applicable provisions of the Internal
Revenue Code.

Incentive Stock Options are granted at the fair market value of the Company's
common stock at the date of the grant as determined by the Board of Directors.
Incentive Stock Options granted to employees who own more than 10% of the voting
power of all classes of stock will be granted at 110% of the fair market value
of the Company's common stock at the date of the grant.  Nonqualified options
may be granted at amounts up to the fair market value of the Company's common
stock on the date of the grant, as determined by the Board of Directors.

                                                                              21
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


9.  EMPLOYEE COMPENSATION PLANS (CONTINUED)

Pro forma information regarding net income and earnings per share, as if the
Company had used the fair value method of SFAS 123 to account for stock options
issued under its equity incentive plan is presented below.  The fair value for
these options was estimated at the date of grant using the "minimum value
method" prescribed by SFAS 123.  The following weighted-average assumptions were
used to determine the fair value for 1998, 1997 and 1996, respectively: a risk-
free interest rate of 4.0%, 6.1% and 6.2%, an expected dividend yield of 0% each
year, and a weighted-average expected life of the options of one year.

<TABLE>
<CAPTION>
                                                      1998                1997                1996
                                               ---------------------------------------------------------
<S>                                            <C>                     <C>                 <C>
Pro forma net loss available for common stock       $(50,895,743)       $(13,379,027)       $(19,541,921)
Pro forma basic loss per share                      $      (1.28)       $      (0.44)       $      (1.81)
</TABLE>

A summary of the Company's stock option activity and related information is as
follows:

<TABLE>
<CAPTION>
                                             YEAR ENDED                           YEAR ENDED                          YEAR ENDED
                                         DECEMBER 31, 1998                    DECEMBER 31, 1997                   DECEMBER 31, 1996
                                ----------------------------------------------------------------------------------------------------
                                                   WEIGHTED-AVERAGE               WEIGHTED-AVERAGE               WEIGHTED-AVERAGE
                                                      EXERCISE                        EXERCISE                       EXERCISE 
                                     SHARES            PRICE          SHARES            PRICE        SHARES            PRICE 
                                ----------------------------------------------------------------------------------------------------
<S>                             <C>                <C>                <C>         <C>                <C>         <C> 
Outstanding at beginning                                                                                           
of period                              2,710,795             $ 2.25          811,012        $ 0.95       476,086            $ 0.10
Granted                                3,663,953               2.25        2,181,033          2.69       346,676              2.12
Exercised                                (87,500)             (0.11)         (90,375)        (0.04)                      
Forfeited                             (1,544,457)             (2.40)        (190,875)        (1.97)      (11,750)            (0.08)
                                ----------------------------------------------------------------------------------------------------
                                                                                                                         
Outstanding at end of period           4,742,791                           2,710,795        $ 2.25       811,012            $ 0.95
                                ================                   =================              ==============         
                                                                                                                         
Exercisable at period end                491,052                             600,099                     140,487         
                                ================                   =================              ==============         
Weighted-average fair value                                                                                              
 of options granted during                                                                                               
 period                                    $0.09                               $0.85                    $   0.69      
</TABLE>

                                                                              22
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


9.  EMPLOYEE COMPENSATION PLANS (CONTINUED)

The following table summarizes information about stock options outstanding at
December 31, 1998:

<TABLE>
<CAPTION>
                                                                       WEIGHTED-AVERAGE
                                                   OPTIONS              REMAINING LIFE
  EXERCISE PRICE      OPTIONS OUTSTANDING        EXERCISABLE               (YEARS)
------------------------------------------------------------------------------------------
<S>                   <C>                        <C>                   <C>
      $0.01                152,586                 149,586                    6.5
       0.25                  1,000                     750                    6.7
       0.85                108,676                  54,338                    7.1
       1.00                300,000                  37,500                    8.7
       2.25              2,201,600                       0                    9.5
       2.50              1,497,100                 156,150                    9.0
       3.00                 91,829                  24,395                    9.7
       3.25                240,000                  68,333                    8.8
       3.75                150,000                       0                    9.5
</TABLE>

All options granted vest ratably over a range of three to four years.

Profit Sharing Plan
-------------------

The Board of Directors of the Company approved the adoption of a qualified
401(k) profit sharing plan (the Plan) for all employees of the Company and MCP
meeting certain eligibility requirements.  Under the Plan, the participants may
make contributions to the Plan of up to 15% of their compensation, up to the
Internal Revenue Service limitation.  Effective December 1, 1996, the Company
and MCP may make discretionary contributions to the Plan as  determined by the
Board of Directors.  The Company did not make contributions to the Plan during
1998, 1997 and 1996.

                                                                              23
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


10.  INCOME TAXES

The Company consolidates the affiliated physician practices for Federal and
State income tax purposes.

Significant components of the provision for income taxes are as follows:

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31
                                                       1998                  1997
                                             -----------------------------------------
<S>                                          <C>                             <C>
Current:
  Federal
  State                                                $ (56,149)            $ 111,123
                                             -----------------------------------------
                                                         (56,149)              111,123
Deferred:
  Federal                                               (634,152)             (770,443)
  State                                                 (111,910)             (135,961)
                                             -----------------------------------------
                                                        (746,062)             (906,404)
                                             -----------------------------------------
 
Total benefit                                          $(802,211)            $(795,281)
                                             =========================================
</TABLE>

Deferred income taxes arise principally from temporary differences related to
capitalized start-up costs, depreciation, net operating losses, certain
accruals, and a change from the cash to accrual method of accounting for tax
purposes.  The components of the Company's deferred taxes are as follows:

<TABLE>
<CAPTION>
                                                                      DECEMBER 31
                                                                 1998               1997
                                                       ------------------------------------
<S>                                                    <C>                      <C>
Deferred tax liabilities:
 Adjustment of cash basis practices to accrual basis           $  (860,220)     $(1,475,782)
 Fixed assets differences                                       (1,496,874)        (514,408)
                                                       ------------------------------------ 
Total deferred tax liabilities                                  (2,357,094)      (1,990,190)
 
Deferred tax assets:
 Other accrued liabilities                                         606,250          194,225
 Other (charitable contribution carryover)                          11,479            9,617
 Capitalized start-up costs                                        332,274          498,410
 Allowance for doubtful accounts                                   418,166          282,122
 Net operating loss carryover                                    6,945,103        3,660,488
                                                       ------------------------------------
                                                                 8,313,272        4,644,862
 Less valuation allowance                                       (5,956,178)      (3,400,734)
                                                       ------------------------------------
Net deferred tax assets                                          2,357,094        1,244,128
                                                       ------------------------------------
 
Net deferred tax liabilities                           $                 -      $  (746,062)
                                                       ====================================
</TABLE>

                                                                              24
<PAGE>
 
                         Physicians Quality Care, Inc.

                         Notes to Financial Statements (Continued)


10.  INCOME TAXES (CONTINUED)

The difference between the provision for income taxes and the amount computed by
applying the statutory federal income tax rate is as follows:

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31
                                                     1998                            1997
                                         ------------------------------------------------------------
<S>                                      <C>                    <C>         <C>                 <C>
Federal taxes at statutory rates             $(22,125,159)       34.0%      $(2,211,874)         34.0%
 
Add (deduct):
 State income taxes, net of federal
  benefit                                      (3,006,419)        4.6          (300,555)          4.6
 
 Change in valuation allowance
  attributable to operations                    2,555,444        (3.9)        1,290,750         (19.8)
  Impairment of investment in 
  long-term affiliation agreements             22,039,883       (33.8)
Other permanent differences                        31,604        (0.0)
 Goodwill                                                                       402,404          (6.2)
 Other                                           (297,564)        0.5            23,994          (0.4)
                                         ------------------------------------------------------------
 
                                              $  (802,211)        1.4%      $  (795,281)         12.2%
                                         ============================================================
</TABLE>

At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $9,151,000 which expire through the
year 2012.  The utilization of net operating losses may be subject to limitation
under the change in stock ownership rules of the Internal Revenue Code.  For
financial reporting purposes, a valuation allowance of $5,956,178 and $3,400,734
at December 31, 1998 and 1997, respectively, has been recognized to offset the
deferred tax assets, including these carryforwards, since uncertainty exist with
respect to future realization of such carryforwards.  The 1998 increase in the
valuation allowance of $2,555,444 is comprised of an increase in the allowance
of $3,301,510 relating to the creation of deferred tax assets in the current
period that may not be realized in future periods, and a decrease of $746,066
relating to the utilization of a portion of these deferred tax assets to offset
acquired deferred tax liabilities unable to be offset by preacquisition deferred
tax assets.

                                                                              25
<PAGE>
 
                                 EXHIBIT INDEX
                                 -------------

<TABLE>
<CAPTION>
Exhibit No.                          Description                                     Page
-----------        -------------------------------------------------------------     -----
<S>                <C>                                                               <C> 
    3.1(1)     --  Restated Certificate of Incorporation of the Registrant (as
                   amended on June 23, 1997)
 
    3.2(1)     --  Amended and Restated By-Laws of the Registrant (as amended on
                   June 19, 1997)
 
    4.1(1)     --  Specimen certificate for shares of Class A Common Stock
 
    4.2(1)     --  Amended and Restated Class B Common Stock and Warrant
                   Purchase Agreement dated June 20, 1997, between the
                   Registrant and each of the Institutional Investors
 
    4.3(1)     --  Stockholders Agreement, dated August 30, 1996 (the
                   "Stockholders Agreement"), among the Registrant, the
                   Institutional Investors, each Management Stockholder from
                   time to time party thereto, each Physician Stockholder from
                   time to time party thereto and other existing stockholders
                   from time to time party thereto

    4.4(2)     --  Waiver of Rights and Amendment Under Stockholders Agreement
 
    4.5(2)     --  Amendment No. 2 to the Stockholders Agreement
 
    4.6(1)     --  Stockholders Agreement dated August 9, 1996 between the
                   Registrant and certain Springfield Stockholder Physicians

    4.7(1)     --  Registration Rights Agreement dated August 9, 1996, by and
                   among the Registrant and certain Springfield Stockholder
                   Physicians
 
   10.1(1)     --  1995 Equity Incentive Plan
 
   10.2(1)     --  Management Agreement dated August 30, 1996, between the
                   Registrant and Bain Capital Partners V, L.P., a Delaware
                   limited partnership (the "Management Agreement")

   10.3(1)     --  Lease dated November 1995 between Shorenstein Management,
                   Inc. as trustee for SRI Two Realty Trust and the Registrant

   10.4(1)     --  Lease dated December 9, 1996 between Steven M. Roberts,
                   trustee of Northernedge/Plant One Realty Trust and the
                   Registrant
</TABLE> 

                                       1
<PAGE>
 
<TABLE>
  <S>              <C> 
   10.5(1)     --  Maryland Full-Service Office Lease of Camden Yards North
                   Warehouse dated October 12, 1995, by and between the Maryland
                   Stadium Authority and the Registrant

   10.6(1)     --  Form of Merger Agreement dated December 11, 1996, among the
                   Registrant, the Flagship Affiliated Group and certain of the
                   Flagship Stockholder Physicians and their practices
 

   10.7(1)     --  Form of Asset Purchase Agreement dated December 11, 1996,
                   among the Registrant, the Flagship Affiliated Group and
                   certain of the Flagship Stockholder Physicians and their
                   practices

   10.8(1)     --  Form of Affiliated Agreement dated December 11, 1996, among
                   the Registrant, the Flagship Affiliated Group and certain of
                   the Flagship Stockholder Physicians

   10.9(1)     --  Services Agreement dated December 11, 1996, between the
                   Registrant and the Flagship Affiliated Group (the "Flagship
                   Service Agreement")
 
   10.10(1)    --  Form of Employment Agreement dated December 11, 1996, between
                   the Flagship Affiliated Group and each Flagship Stockholder
                   Physician
 
   10.11(1)    --  Form of Shareholder Designation and Stock Transfer Agreement
                   dated December 11, 1996, among the Registrant, the Flagship
                   Affiliated Group and the Flagship Affiliated Group
                   Stockholder, Laura M. Mumford, M.D.

   10.12(1)    --  Form of Merger Agreement among the Registrant, the
                   Springfield Affiliated Group and the Springfield Stockholder
                   Physicians and their practices

   10.13(1)    --  Form of Asset Purchase Agreement among the Registrant, the
                   Springfield Affiliated Group and certain Springfield
                   Stockholder Physicians
 
   10.14(1)    --  Form of Employment Agreement between the Springfield
                   Affiliated Group and certain Springfield Stockholder
                   Physicians, including General Terms and Conditions of
                   Employment for the Springfield Affiliated Group and Form of
                   Addendum thereto relating to the Springfield Stockholder
                   Physicians
</TABLE> 

                                       2
<PAGE>
 
<TABLE>
   <S>             <C>    
   10.15(1)    --  Form of Affiliation Agreement dated August 30, 1996, among
                   the Registrant, the Springfield Affiliated Group and the
                   Springfield Stockholder Physicians
 
   10.16(2)    --  Services Agreement dated August 30, 1996, among the
                   Registrant and the Springfield Affiliated Group

   10.17(1)    --  Shareholder Designation and Stock Transfer Agreement dated
                   August 9, 1996, among the Registrant, the Springfield
                   Affiliated Group and the Springfield Affiliated Group
                   Stockholder, Jay Ungar, M.D.
 
   10.18(1)    --  Credit Agreement dated January 16, 1997 among the Registrant,
                   Banker's Trust Company, as Agent, and various lending
                   institutions
 
  *10.19(1)    --  Employment Agreement dated June 21, 1995 between the
                   Registrant and Jerilyn P. Asher, as amended in January
                   1996 and on August 30, 1996
 
  *10.20(1)    --  Employment Agreement dated June 21, 1995 between the
                   Registrant and Arlan F. Fuller, M.D., as amended in
                   January 1996
 
   10.21(1)    --  Office Building Lease dated March 18, 1997, by and
                   between Harbor Court Associates and the Registrant

   10.22(2)    --  Amended and Restated Services Agreement dated July
                   1997, among Flagship Health II, P.A. ("Flagship II") and
                   the Registrant
 
   10.23(2)    --  Agreement dated July 31, 1997 by and among the
                   Registrant, Flagship, Flagship II and the Stockholders and
                   Optionholders of Clinical Associates, P.A.

   10.24(2)    --  Merger Agreement dated July 31, 1997, between the
                   Registrant, Flagship II, Clinical Associates and the
                   Stockholders and Optionholders of Clinical Associates

   10.25(2)    --  Amendment to the Management Agreement, dated
                   April 18, 1997
 
   21.1(2)     --  Subsidiaries of the Registrant
 
   27          --  Financial Data Schedule
</TABLE> 

_____________
(*)  Management contract or compensatory plan or arrangement filed as an exhibit
     to this Form pursuant to Item 14(c) of Form 10-K.
(1)  Incorporated herein by reference from the Company's Registration Statement
     on Form S-1 (File No. 333-26137).
(2)  Incorporated by reference from the Company's Form 10-K for the year ended
     December 31, 1997.

                                       3