10-Q 1 plasticsurg_10q-0901.txt Securities and Exchange Commission Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED SEPTEMBER 30, 2001 COMMISSION FILE NUMBER 001-15431 THE PLASTIC SURGERY COMPANY (Exact Name of Registrant as Specified in its Charter) GEORGIA 58-2317410 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification Number) 509 E. MONTECITO STREET, 2ND FLOOR SANTA BARBARA, CALIFORNIA 93103 TELEPHONE: (805) 963-0400 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) 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[ ] As of November 1, 2001, the registrant had 5,517,252 shares of common stock outstanding. 1 THE PLASTIC SURGERY COMPANY FORM 10-Q FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 INDEX PART I FINANCIAL INFORMATION Item 1 Condensed Consolidated Financial Statements 3-5 Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000 3 Condensed Consolidated Statements of Operations (unaudited) for the Three Months Ended September 30, 2001 and 2000 and the Nine Months Ended September 30, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2001 and 2000 5 Notes to Condensed Consolidated Financial Statements 6-10 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 11-15 Item 3 Quantitative and Qualitative Disclosure About Market Risk 15 PART II OTHER INFORMATION Item 1 Legal Proceedings 16 Item 2 Changes in Securities and Use of Proceeds 16 Item 6 Exhibits and Reports on Form 8-K 17 2 PART I FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THE PLASTIC SURGERY COMPANY CONDENSED CONSOLIDATED BALANCE SHEETS September 30, 2001 December 31, (Unaudited) 2000 ------------- ------------- ASSETS CURRENT ASSETS: Cash, cash equivalents and restricted cash $ 984,330 $ 274,425 Accounts receivable, net 957,913 602,498 Current portion of notes receivable 309,771 31,872 Other current assets 606,307 238,925 ------------- ------------- Total current assets 2,858,321 1,147,720 ------------- ------------- Property and Equipment, net 1,111,739 1,291,903 Goodwill, net 14,500,819 15,028,216 Other Intangibles, net 233,333 329,849 Notes Receivable, net 476,571 526,899 Debt Issuance Costs, net 368,072 214,028 Other assets 889,666 19,291 ------------- ------------- $ 20,438,521 $ 18,557,906 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 6,555,744 $ 1,857,477 Accounts payable 1,058,221 647,668 Accrued payroll and payroll related 255,739 185,728 Accrued consulting expenses 118,000 406,395 Accrued expenses 107,430 383,059 ------------- ------------- Total current liabilities 8,095,134 3,480,327 LONG-TERM DEBT: 4,601,160 10,263,357 ------------- ------------- Total liabilities 12,696,294 13,743,684 Commitments and Contingencies SHAREHOLDERS' EQUITY: Common stock; no par value; 100,000,000 shares authorized, and 5,429,398 and 4,765,873 shares issued and outstanding at September 30, 2001 and December 31, 2000 -- -- Paid-in capital 49,735,676 46,699,717 Accumulated deficit (41,993,449) (41,885,495) ------------- ------------- Total shareholders' equity 7,742,227 4,814,222 ------------- ------------- $ 20,438,521 $ 18,557,906 ============= ============= The accompanying notes are an integral part of these condensed consolidated statements. 3 THE PLASTIC SURGERY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

THE PLASTIC SURGERY COMPANY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated statements. 5 THE PLASTIC SURGERY COMPANY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 (UNAUDITED) 1. BUSINESS AND ORGANIZATION GENERAL DESCRIPTION OF BUSINESS The Plastic Surgery Company (the "Company") acquires, develops, manages and/or operates elective cosmetic and laser surgery centers. The Company operates outside of the managed care market and provides private pay, fee-for-service cosmetic surgery and laser procedures through a retail network of surgery centers (the "Centers"). These services include cosmetic surgery, cosmetic laser skin treatments and physician-directed skin care which the Company plans to brand under the national umbrella of Personal Image Centers. The Company currently owns and/or manages 22 Centers located throughout the United States. Headquartered in Santa Barbara, California, the Company completed its initial public offering on December 10, 1999 and its common stock trades on the American Stock Exchange under the ticker symbol PSU. Basis of Presentation The consolidated financial statements included herein have been prepared in accordance with rule 10-01 of Regulation S-X. Pursuant to applicable regulations of the Securities and Exchange Commission (the "SEC"), the information at September 30, 2001 and for the three and nine-month periods ended September 30, 2001 and 2000 is unaudited. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. The financial statements reflect all elimination entries and normal adjustments that are necessary for a fair presentation of the results for the interim periods ended September 30, 2001 and September 30, 2000. In the opinion of management, the accompanying condensed financial statements include the accounts of the Company and all adjustments necessary to present fairly the Company's financial position at September 30, 2001 and December 31, 2000, and its results of operations and cash flows for the three and nine months ended September 30, 2001 and September 30, 2000. Operating results for interim periods are not necessarily indicative of the results for full years. These condensed consolidated financial statements should be read in conjunction with the financial statements of The Plastic Surgery Company and related notes thereto, and management's discussion and analysis related thereto, all of which are included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. The Company currently does not consolidate the operations of the practices that it manages because the arrangements do not meet the requirements for consolidation as set forth in Emerging Issues Task Force 97-2. The Company does consolidate the operations of its wholly owned subsidiaries. 2. ACQUISITION In August 2001, the Company acquired a new cosmetic surgery center in West Palm Beach, Florida. The Company paid $165,000 cash and assumed the liabilities of the center. Pursuant to the terms of a Commission on Business Development Agreement among the Company and the former shareholders of the Florida Center, the Company used $165,000 of its restricted cash to pay for the purchase of the West Palm Beach Center. The former shareholders of the Florida Center manage the Center and receive a commission equal to ten percent (10%) of the revenues from the Center. 3. CASH, CASH EQUIVALENTS AND RESTRICTED CASH The restricted cash balance was $752,042 at September 30, 2001 and $118,048 at December 31, 2000. 6 4. PROPERTY AND EQUIPMENT Property and Equipment is stated at cost. Depreciation and amortization is provided using the straight-line method over the assets' estimated useful lives of two to seven years. Property and equipment consisted of the following:

5. NOTES RECEIVABLE The Company has unsecured notes receivable from plastic surgeons that were previously affiliated practices. The principal balances of these notes are $1,016,342 at September 30, 2001 and $788,771 at December 31, 2000. These notes bear interest at rates ranging from 6% to 8%. The Company has provided a reserve, in purchase accounting, of $230,000 for potential default of the notes receivable. 6. DEBT The Company's debt consisted of the following:

On August 7, 2001, the Company entered into a Loan Agreement with Pacific Mezzanine Fund and several other lenders whereby the Company issued and sold convertible promissory notes (the "Bridge Notes") in the aggregate principal amount of $791,000 and issued warrants (the "Warrants") for the purchase of 791,000 shares of Common Stock of the Company at an exercise price of $1.00 per share. The Bridge Notes become due and payable one year after issuance; provided, however, that any holder of such Bridge Notes may demand payment if the Company closes a private placement of securities with aggregate proceeds in excess of $4,000,000. Interest on the outstanding principal under the Bridge Notes accrues at the rate of 13.5% per annum and is payable in monthly installments during the term of the Bridge Notes. The Bridge Notes are also convertible at the election of the holders into a number of unregistered shares of the Company's Common Stock obtained by dividing the amount of outstanding principal and interest by $1.00 (the "Initial Conversion Price"). The Initial Conversion Price and the exercise price of the Warrants are subject to adjustment if, during the 12 month period following the closing date, the Company issues additional shares of Common Stock at a price per share less than the Initial Conversion Price and exercise price of the Warrants. In connection with the transactions above, the Company recorded beneficial conversion feature charges and debt discounts totaling approximately $450,000 against the notes payable. The Company is amortizing these amounts over the term of the notes. 7 In July 2001, several of the Company's founders and Pacific Mezzanine Fund agreed to enter into amendments to their respective promissory notes whereby the holders agreed that all payments of principal and/or interest due under such notes during the period commencing on July 31, 2001 and ending on December 31, 2001 in the aggregate amount of approximately $253,030 shall be paid by the Company's issuance of a number of unregistered shares of Common Stock obtained by dividing the amount of each such payment by 80% of the fair market value of one share of the Company's Common Stock on the due dates of such payments. The Company worked with independent investment bankers and performed a specific valuation analysis to determine the fair value of the unregistered shares being issued. As partial consideration for the holders to agree to enter into the amendments to their respective promissory notes, the Company issued to such holders warrants to purchase a number of shares of Common Stock based upon 0.23 warrant shares for each dollar of principal under the respective notes. The fair value of the stock and warrants in excess of the debt and accrued interest is recorded as an extraordinary loss on debt extinguishments for non-related parties. Amounts for related parties were recorded as additional paid in capital. 7. EARNINGS PER SHARE Basic earnings per share represents net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share represents net earnings divided by the weighted-average number of shares outstanding including the dilutive impact of common stock equivalents calculated using the treasury stock method. For all periods presented below, the difference between the weighted-average number of shares used in the basic computation compared to that used in the diluted computation was due to the dilutive impact of options and warrants to purchase common stock. The reconciliation of basic to diluted weighted-average shares is as follows:

8. DIVESTITURE OF AFFILIATED PRACTICE In March 2001, the Company divested the acquisitions and service agreements of one physician whose practice was initially acquired in a business combination accounted for using SAB 48. All the tangible and intangible assets originally transferred at the initial combination were returned. The net effect of the transaction was recorded in additional paid in capital. 9. CONVERSION OF ACCRUED EXPENSES In January 2001, the Company converted $156,000 of current accrued expenses into 60,000 shares of Company common stock and converted $150,000 of current accrued expenses into a five-year long-term note payable. In May 2001, officers of the Company exchanged $805,643 of accrued compensation for options to purchase 358,063 shares of Company common stock. 10. SEGMENT INFORMATION The Company has two reportable business segments, both in the medical industry: operation of personal image centers and management services for 8 affiliated practices. The reportable segments are based on the types of services provided. The Company operates personal image centers through its three wholly owned subsidiaries. These have been aggregated as a single reportable segment due to the similarities in economic characteristics, the services provided, the processes involved, the types of customers and the regulatory environment. Revenues from the operation of personal image centers are generated from the performance of surgical procedures for the three and nine months ended September 30, 2001. Revenues from management services to affiliated practices are generated from the affiliated surgeons participating in management agreements for the three and nine months ended September 30, 2001 and 2000, as well as the practice reimbursements from such affiliated practices. The Company evaluates performance based on several factors, of which the primary financial measures are revenues and operating income. The Company had no customers representing more than 10 percent of revenues. Substantially all of the Company's revenues were earned in the United States. All of the Company's long-lived assets reside in the United States. Summarized financial information concerning the Company's reportable segments is shown in the following table:

9 11. GOING CONCERN The Company's Report of Independent Public Accountants issued in connection with the December 31, 2000 consolidated financial statements was qualified as to the Company's ability to continue as a going concern. The Company has been advised by its Independent Public Accountants that, if prior to the completion of their audit of the Company's financial statements for the year ending December 31, 2001, the Company is unable to demonstrate its ability to fund operations and repay debt as it becomes due in the next 12 months, their auditor's report on those financial statements will be modified for the contingency related to the Company's ability to continue as a going concern. 12. CONVERSION OF AFFILIATED PRACTICE In May 2001, the Company converted an affiliated practice to a wholly owned subsidiary. The doctor originally working under a service agreement continues to perform procedures at the practice as an independent contractor. The Company purchased the assets and assumed certain liabilities of the practice in exchange for 97,952 shares of common stock valued at $220,000. The transaction was accounted for as a purchase and the fair value of the consideration received was allocated between inventory, fixed assets and goodwill. The Company recorded $305,951 of goodwill. 13. NEW AUTHORITATIVE LITERATURE In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141) and No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. The Company does not expect adoption of SFAS 141 to have a material impact on its financial position or results of operations. Under SFAS 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill will be subject to an annual assessment for impairment by applying a fair-value based test. The Company will adopt SFAS 142 on January 1, 2002. As of September 30, 2001, the Company has recorded goodwill on its balance sheet of $14,500,819. The related quarterly amortization expense totals $101,647 and will no longer be charged to operations beginning January 1, 2002. The Company has not yet determined if an impairment will be recognized upon adoption of this standard. In August 2001, the FASB issued SFAS Number 144, "Accounting for the Impairment on Disposal of Long-Lived Assets". The Company will adopt this standard January 1, 2002. Management does not expect adoption of the standard to have a material impact on its financial position or results of operation. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the "1934 Act"). Although the Company believes that its expectations are based on reasonable assumptions, there can be no assurance that its goals will be achieved. The important factors that could cause actual results to differ materially from those in the forward-looking statements herein include, without limitation, the ability to secure capital, and the related cost of such capital, needed to continue as a going concern and to fund its future growth, the ability to identify suitable acquisition candidates, regulatory development and changes in the United States healthcare system and medical profession that may affect the profitability or the enforceability of the agreements with the affiliated practices and the other factors detailed in the Annual Report on Form 10-K for the year ended December 31, 2000 filed with the Securities and Exchange Commission. OVERVIEW The Company acquires, develops and manages elective cosmetic and laser surgery centers. It operates outside of the managed care market and provides private pay, fee-for-service cosmetic surgery and laser procedures through a retail network of surgery centers (the "Centers"). These services include cosmetic surgery, cosmetic laser skin treatments and physician-directed skin care all "under one roof." The Company currently owns and/or manages 22 Centers located throughout the United States and Canada and has recently launched a national branding strategy in selected facilities under the name Personal Image Centers. During the third and fourth quarter of 2000, the Company converted an affiliated practice into a Personal Image Center and acquired the Florida Center for Cosmetic Surgery. In addition, the company converted an affiliated practice into a Personal Image Center during the second quarter of 2001. These transactions expanded the Company's ownership of Personal Image Centers whereby the company takes more control over the business aspects of the practice. The Company believes that the strategic conversions will allow it to focus additional efforts toward developing and growing surgery centers. Under its business services agreements the Company earns revenue from providing services and facilities to affiliated practices at Centers on a monthly basis as each affiliated practice collects its cash. The agreements provide that each affiliated practice will pay the Company fees based on a percentage of the net cash collected by that affiliated practice. The Company's revenue consists of the sum of the service fee and amounts equal to the operating expenses of the affiliated practice assumed by it under the business services agreements. The operating expenses of the affiliated practice that are the Company's responsibility and that it is legally obligated to pay include the following: o salaries, benefits, payroll taxes, workers compensation, health insurance and other benefit plans, and other direct expenses of non-medical employees that are the Company's employees located at the Centers; o direct costs of all employees or consultants that provide services to each of the Centers; o medical and office supplies; o lease or rent payments, utilities, telephone and maintenance expenses for the Center's facilities; o property taxes on Company assets located at the Centers; o property, casualty and liability insurance premiums, excluding malpractice insurance, is the responsibility of the affiliated practice; o surgeon recruiting expenses; and o advertising and expenses attributable to the promotion of the Centers. The Company assumes all of these expenses and pays the third-party provider of the goods and services. 11 The affiliated practices pay for any and all direct employment expenses, including benefits, for any surgeon or other employee that the Company is prohibited from employing by applicable law. In addition, the affiliated practices retain responsibility for the payment of expenses for continuing education, seminars, professional licenses, professional membership dues and malpractice insurance and all other expenses of any surgeon employed by the affiliate practice. RESULTS OF OPERATIONS Revenues. Revenues consist of affiliate costs that must be reimbursed to the Company, management fees under the business services agreement, and revenue from procedures performed at the Personal Image Centers in Fort Lauderdale and West Palm Beach, Florida, Raleigh, North Carolina, and Westport Connecticut. Revenues for the quarter ended September 30, 2001 were $8,124,557, $1,166,591 greater than the same period in 2000. This increase was negatively impacted by the reduced practice reimbursements and management fees attributable to certain under performing affiliate practices that were either unwound or discontinued. In addition, during the year we converted previously affiliated practices to Personal Image Centers whereby the Company took more control over all business aspects of the practice. For the nine months ended September 30, 2001, revenues were $26,292,167 compared to $22,459,273 for the same period in 2000. The quarterly revenue increases were also reflected in the year-to-date increases. Revenues for the three months and nine months ended September 30, 2001 were negatively affected by the events of September 11, 2001. For the first two months of the quarter, the Company's revenues reflected a 13% increases over the same two month periods in 2000. However, as a result of the events of September 11, the revenues reflected a significant decrease from the same period in 2000. The following tabular presentation reflects revenues by type of services:

Direct Expenses. Direct expenses consist of operating room costs at the Centers and the reimbursable expenses paid by us for the affiliated practices for salaries, wages and benefits, medical supplies, advertising and rent, paid as part of providing plastic surgery procedures in their facilities. Direct expenses for the quarter and nine months ended September 30, 2001 were $4,335,047 and $15,158,924, respectively. Comparable direct expenses for the same periods in 2000 were $4,033,459 and $12,580,049, respectively. These increases reflect an increase in the costs of procedures performed and in increase in the costs of medical supplies used at the Centers. The increases were partially offset by a decrease in other direct expenses such as salary, wages and benefits for employees of the Centers and advertising costs of the affiliate practices. Salaries, Wages and Benefits. Salaries, wages and benefits represent the labor-associated costs of employees at the corporate office and those employees at the Centers that are paid by the corporate office, the Centers, and reimbursed by affiliated practices. Salaries, wages and benefit expenses for the third quarter of 2001 were $1,468,188 and for the first nine months of 2001 were $3,561,803. The comparable 2000 results were $431,480 and $1,187,709, respectively. These increases are primarily due to more employees at the corporate offices and the acquisitions of the Personal Image Centers. 12 General Operating Expenses. General operating expenses consist primarily of administrative operating costs, non-rent facility costs, professional fees and overhead costs incurred by the corporate office, the Centers, and reimbursed by affiliated practices. General operating expenses for the quarter ended September 30, 2001 were $1,723,960, compared with $1,962,550 for the same quarter in 2000. General operating expenses for the nine months ended September 30, 2001 were $5,463,088, compared with $6,685,389 for the first nine months of 2000. These reductions are primarily due to reduced expenses related practice reimbursements offset in part by increased expenses resulting from the acquisition and operation of the Centers. Depreciation and Amortization. Depreciation expenses consist of depreciation of corporate assets and depreciation of the assets acquired from the affiliated practices. Depreciation expense for the third quarter of 2001 was $121,223 compared with $69,521 for the third quarter of 2000. Depreciation expense for the nine months ended September 30, 2001 and 2000 was $357,768 and $196,395, respectively. These increases reflect the additions to assets from acquisition of the affiliated practices and internal asset additions. Amortization expense consists of amortization of goodwill from the affiliated practices, intangible assets recorded as a result of its acquisition of the Florida Center and the acquisition of additional assets from affiliated practices in Raleigh, North Carolina and Westport, Connecticut. Amortization expense for the third quarter of 2001 was $310,022 compared with $168,348 for the third quarter of 2000. Amortization expense for the nine months ended September 30, 2001 and 2000 was $876,968 and $505,042, respectively. These increases primarily reflect the amortization of the goodwill associated with the acquisition of the Personal Image Center of Florida. Interest expense. Interest expense consists of the interest portion of note payments to the affiliated surgeons, interest on notes payable to consultants and employees, and interest on credit lines. Interest expense for the third quarter and first nine months of 2001 was $355,416 and $980,049, respectively. The interest expense for the similar periods in 2000 was $98,216 and $319,820, respectively. The higher interest expense primarily reflects the debt incurred in connection with the acquisition of the Personal Image Center of Florida and the Bridge Notes. Provision for income taxes. For the third quarter ended September 30, 2001, the credit for income taxes reflects an offset to the second quarter provision for the Personal Image Center of Florida as a result of the election to file a consolidated tax return in Florida. The provision for income taxes for the nine months ended September 30, 2001 reflects income taxes due and payable in various states. The provision for the third quarter and nine months ended September 30, 2000 related to the taxable income offset in part by utilization of net operating loss carry forwards from 1999. Net income or loss. The Company recognized net loss of $109,557 for the third quarter ended September 30, 2001 compared with net income of $182,220 for the third quarter ended September 30, 2000. Earnings were impacted by the increased cost of procedures and medical supplies, greater salaries, wages, and benefits expense, amortization expense, interest expense and extraordinary loss. Net loss for the first nine months of 2001 was $107,954, compared to net income of $920,584 in 2000. The earnings impact on the third quarter also impacted year-to-date operating results. LIQUIDITY AND CAPITAL RESOURCES Development and acquisition costs, capital expenditures and working capital requirements have been funded to date by cash generated through operations, borrowings and the issuance of common stock. As of September 30, 2001, the Company had cash, cash equivalents and restricted cash in the amount of $984,330, including restricted cash totaling $752,717. Pursuant to the Stock Purchase Agreement between the Company and the former shareholders of the Florida Center, the restricted cash is restricted until the Company pays the outstanding principal of the promissory notes issued pursuant to the Stock Purchase Agreement in the aggregate amount of $4,100,000 which becomes due and payable on January 1, 2002. During the first quarter of 2001, $280,000 of the restricted cash was loaned to the former shareholders of the Florida Center and $165,000 was used to acquire the surgery center in West Palm Beach, Florida. This loan is reflected in the current portion of notes receivable. Total Assets. Total assets were $20,438,521 at September 30, 2001 compared with $18,557,906 at December 31, 2000. Increases in all categories of current assets and other assets were offset, in part, by lower net fixed assets and goodwill reflecting the divestiture of several affiliated practices, depreciation and amortization 13 Working Capital. The working capital deficit of $5,236,813 at September 30, 2001 is greater than the deficit of $2,332,607 at December 31, 2000. This increase reflects the reclassification from long-term to current of the $4,100,000 note payable associated with the acquisition of the Florida Center. This note is due January 1, 2002. Cash Flows. Net cash flows provided by operating activities totaled $1,062,500 for the nine months ended September 30, 2001. The effects of depreciation and amortization expense and the non-cash interest payments positively affected cash flows. The net effects of the changes in various working capital accounts negatively impacted the net operating activities. For the nine months ended September 30, 2000, $51,906 was provided by operating activities. Cash flows were positively affected by net income and the effects of depreciation and amortization mostly offset by the negative effects of the changes in working capital accounts. Net cash used in investing activities was $303,118 for the nine months ended September 30, 2001. This primarily reflects the purchase of the West Palm Beach Center, the loan to the former owners of the Florida Center, and various other asset purchases offset, in part, by the proceeds from the unwinding of a transaction with one of the Company's affiliated practices and the receipt of notes receivable payments. For the nine months ended September 30, 2000, net cash was primarily used in investing activities to purchase property and equipment. Net cash provided by financing activities for the nine months ended September 30, 2001 was primarily due to proceeds from the Company's line of credit and the issuance of the Bridge Notes, offset primarily by the repayment of debt. For the same period in 2000, net cash used in financing activities was for the repayment of debt. Debt. Total debt at September 30, 2001 was $11,156,904, $963,930 less than $12,120,834 at December 31, 2000. This decrease primarily reflects the conversion during the year of various notes payable to employees and shareholders of $805,643 into stock options partly offset by the issuance of the Bridge Notes in connection with bridge financing during the third quarter ended September 30, 2001. The Company has a credit facilities totaling $296,932, of which only $165,199 is utilized at September 30, 2001. Going concern. The Company incurred losses from operations in two of the last three years. As of September 30, 2001, the Company had a working capital deficit of $5,236,813 that raises substantial doubt about its ability to continue as a going concern. In addition, all cash acquired and generated through the Florida Center for Cosmetic Surgery is restricted until the Company pays a $4,100,000 debt obligation due on January 1, 2002 to the former shareholders of the Florida Center for Cosmetic Surgery. Management's plans in regard to these items include the following: o The Company plans to sell additional equity securities and pursue financing arrangements o The Company has reduced portions of its fixed overhead expenses o In January 2001, the Company converted $156,000 of current accrued expenses into 60,000 shares of the Company's common stock o Management is working to restructure its obligations with debt holders o Management intends to focus additional efforts toward developing and growing surgery centers, in which the Company controls all business aspects of the centers There are no assurances that Management will be able to successfully complete a financing arrangement or that the ultimate amounts raised will meet the Company's cash flow needs and be sufficient to fund the Company's operations through 2001. In addition, there is no assurance that the Company will be able to successfully convert additional debt into common stock and reduce its current liabilities. Further, there is no assurance that the Company will be able to successfully develop and grow its affiliated practices or acquire or open new Centers. The failure of the Company to successfully achieve one or all of the 14 above items may have a material impact on the Company's financial position and results of operations. The accompanying financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. The Company's Report of Independent Public Accountants issued in connection with the December 31, 2000 consolidated financial statements was qualified as to the Company's ability to continue as a going concern. The Company has been advised by its Independent Public Accountants that, if prior to the completion of their audit of the Company's financial statements for the year ending December 31, 2001, the Company is unable to demonstrate its ability to fund operations and repay debt as it becomes due in the next 12 months, their auditor's report on those financial statements will be modified for the contingency related to the Company's ability to continue as a going concern. NEW AUTHORITATIVE LITERATURE In June 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards No. 141, "Business Combinations" (SFAS 141) and No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). SFAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. The Company does not expect adoption of SFAS 141 to have a material impact on its financial position or results of operations. Under SFAS 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill will be subject to an annual assessment for impairment by applying a fair-value based test. The Company will adopt SFAS 142 on January 1, 2002. As of September 30, 2001, the Company has recorded goodwill on its balance sheet of $14,500,819. The related monthly amortization expense totals $101,647 and will no longer be charged to operations beginning January 1, 2002. The Company has not yet determined if an impairment will be recognized upon adoption of this standard. In August 2001, the FASB issued SFAS Number 144, "Accounting for the Impairment on Disposal of Long-Lived Assets". The Company will adopt this standard January 1, 2002. Management does not expect adoption of the standard to have a material impact on its financial position or results of operation. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company's primary financial instrument subject to market risk are line-of-credit agreements with maximum availability at September 30, 2001 of $296,932. The lines-of-credit are secured by principal operating assets and personally guaranteed by certain members of management. The lines-of-credit bear variable interest rate equal to the Prime rate published in the Wall Street Journal plus 1 percentage point. (9.5 percent at December 31, 2000) The primary exposures relating to these financial instruments result from changes in the interest rates. At September 30, 2001, $165,199 was outstanding and no amounts were outstanding on these lines at December 31, 2000. At September 30, 2001, a hypothetical ten-percentage point increase in short-term interest rates would result in a reduction of $12,000 in annual pre-tax earnings. The estimated reduction is based on the bank debt at its September 30, 2001 level if the credit lines were completely used. 15 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On June 28, Samuel Wurster ("Wurster") and the Aesthetic Institute of North Carolina ("AINC") filed a lawsuit in Superior Court in Wake County North Carolina against The Plastic Surgery Company of North Carolina ("PSCNC"), the Company, and Lisa Franklin ("Franklin"). Wurster is a plastic surgeon and AINC's principal shareholder. Franklin is an employee of PSCNC. During the third quarter ended September 30, 2001, this suit was dismissed by the Court. As of September 30, 2001, the Company is not a party to any litigation that if adversely determined would have an adverse effect on its operations. Many of the founding Centers and some owned Centers have pending litigation arising in the ordinary course of business. If the Company acquired the stock of a Center in a stock purchase or merger transaction, it assumes the liabilities of the Center, including litigation, prior to the transaction. The Company intends to vigorously defend any and all litigation. The Company maintains general liability insurance for it and on behalf of its affiliated Centers and where permitted by applicable law and insurers, will be named as an additional insured under the policies of the affiliated Centers. The affiliated surgeons maintain professional liability insurance covering the delivery of health services. Also, the Company is indemnified under the business services agreements for liabilities it incurs as a result of the performance of medical services by affiliated surgeons. Successful malpractice claims against affiliated Centers could have a material adverse effect on its profitability. Although the Company believes it has adequate liability insurance coverage, there can be no assurance that a pending or future claim or claims will not be successful or, if successful, will not exceed the limits of available insurance coverage. There can also be no assurance that coverage will continue to be available at acceptable costs and on favorable terms. ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS (C) SALES OF UNREGISTERED SECURITIES On August 7, 2001, the Company entered into a Loan Agreement with Pacific Mezzanine Fund and several other lenders whereby the Company issued and sold convertible promissory notes (the "Bridge Notes") in the aggregate principal amount of $791,000 and Warrants (the "Warrants") to purchase 791,000 shares of the Company's Common Stock at an exercise price of $1.00 per share. The Bridge Notes become due and payable one year after issuance; provided, however, that any holder of such Bridge Notes may demand payment if the Company closes a private placement of securities with aggregate proceeds in excess of $4,000,000. Interest on the outstanding principal under the Bridge Notes accrues at the rate of 13.5% per annum and is payable in monthly installments during the term of the Bridge Notes. The Bridge Notes are also convertible at the election of the holders into a number of unregistered shares of the Company's Common Stock obtained by dividing the amount of outstanding principal and interest by $1.00 (the "Initial Conversion Price"). The Initial Conversion Price and the exercise price of the Warrants are subject to adjustment if, during the 12 month period following the closing date, the Company issues additional shares of Common Stock at a price per share less than the Initial Conversion Price. In July 2001, several of the Company's founders and Pacific Mezzanine Fund agreed to enter into amendments to their respective promissory notes whereby the holders agreed that all payments of principal and/or interest due under such notes during the period commencing on July 31, 2001 and ending on December 31, 2001 in the aggregate amount of approximately $253,030 shall be paid by the Company's issuance of a number of unregistered shares of Common Stock obtained by dividing the amount of each such payment by 80% of the fair market value of one share of the Company's Common Stock on the due dates of such payments. As partial consideration for the holders to agree to enter into the amendments to their respective promissory notes, the Company issued to such holders warrants to purchase a number of shares of Common Stock based upon 0.23 warrant shares for each dollar of principal under the respective notes. The foregoing transactions did not involve any underwriters, underwriting discounts or commissions, or any public offering, and the Company believes that the transactions were exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof. 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: 4.1 Form of First Amended to Promissory Note, each dated July 20, 2001, by and between The Plastic Surgery Company and certain holders of existing promissory notes. 4.2. Form of Convertible Promissory Note, each dated August 7, 2001, issued by The Plastic Surgery Company to certain lenders as more fully described in the Loan Agreement by and among The Plastic Surgery Company and the lenders listed therein (see Loan Agreement at Exhibit 10.2). 4.3 Form of Warrant, each dated August 7, 2001, issued by The Plastic Surgery Company to certain lenders as more fully described in the Loan Agreement by and among The Plastic Surgery Company and the lenders listed therein (see Loan Agreement at Exhibit 10.2). 4.4 Amended and Restated Investor Rights Agreement, dated August 7, 2001, by and among The Plastic Surgery Company, Pacific Mezzanine Fund, L.P., Nathan Bell, John LeRoy, Dennis Condon and William Brad Winegar. 10.1 Amendment No. 1 to December 2000 Loan Agreement, dated August 7, 2001, by and between The Plastic Surgery Company and Pacific Mezzanine Fund, L.P. 10.2 Loan Agreement, dated August 7, 2001, by and between The Plastic Surgery Company and the lenders listed therein. 10.3 Amendment No. 1 to August 2001 Loan Agreement, dated September 9, 2001, by and between The Plastic Surgery Company and the lenders listed therein. (b) REPORTS ON FORM 8-K. There were no reports on From 8-K filed during the reporting period. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the 1934 Act, we have duly caused this Form 10-Q to be signed on behalf of the undersigned, thereunto duly authorized, on August 14, 2001. THE PLASTIC SURGERY COMPANY By: /s/ Dennis E. Condon -------------------------------------------------- Dennis E. Condon President, Chief Executive Officer and Director Pursuant to the requirements of the 1934 Act, this report has been signed below by the following persons in the capacities indicated and on the date indicated.

18 EXHIBIT INDEX Number Description ------ ----------- 4.1 Form of First Amended to Promissory Note, each dated July 20, 2001, by and between The Plastic Surgery Company and certain holders of existing promissory notes. 4.2. Form of Convertible Promissory Note, each dated August 7, 2001, issued by The Plastic Surgery Company to certain lenders as more fully described in the Loan Agreement by and among The Plastic Surgery Company and the lenders listed therein (see Loan Agreement at Exhibit 10.2). 4.3 Form of Warrant, each dated August 7, 2001, issued by The Plastic Surgery Company to certain lenders as more fully described in the Loan Agreement by and among The Plastic Surgery Company and the lenders listed therein (see Loan Agreement at Exhibit 10.2). 4.4 Amended and Restated Investor Rights Agreement, dated August 7, 2001, by and among The Plastic Surgery Company, Pacific Mezzanine Fund, L.P., Nathan Bell, John LeRoy, Dennis Condon and William Brad Winegar. 10.1 Amendment No. 1 to December 2000 Loan Agreement, dated August 7, 2001, by and between The Plastic Surgery Company and Pacific Mezzanine Fund, L.P. 10.2 Loan Agreement, dated August 7, 2001, by and between The Plastic Surgery Company and the lenders listed therein. 10.3 Amendment No. 1 to August 2001 Loan Agreement, dated September 9, 2001, by and between The Plastic Surgery Company and the lenders listed therein. 19

PLASTIC SURGERY CO 10-Q