ATLANTIC INTEGRATED HEALTH INC, 10KSB40, 1999-03-29

ATLANTIC INTEGRATED HEALTH INC
10KSB40, 1999-03-29
OFFICES & CLINICS OF DOCTORS OF MEDICINE

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-KSB
(Mark One)

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the fiscal year ended December 31, 1998

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

For the transition period from ____________ to ____________.

COMMISSION FILE NO.: 333-5827

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ATLANTIC INTEGRATED HEALTH
INCORPORATED
(Name of small business issuer in its charter)

NORTH CAROLINA 56-1966823
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

1315 S. GLENBURNIE ROAD, SUITE A5, 28562
NEW BERN, NORTH CAROLINA (Zip Code)
(Address of principal executive offices)

Issuer's telephone number: (919) 514-0057

Securities registered under Section 12(b) of the Exchange Act: NONE.

Securities registered under Section 12(g) of the Exchange Act: NONE.

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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]

Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this Form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [X]

State issuer's revenues for its most recent fiscal year. $ 283,413

As of March 15, 1999, 312,500 Primary Class Common Shares, 454,000
Referral Class Common Shares and 4,000 Nonprofit Class Nonvoting Common Shares
of the Registrant were deemed outstanding, and the aggregate market value of the
issued and outstanding capital stock of the Registrant, excluding outstanding
shares beneficially owned by directors and executive officers, was $734,500.

DOCUMENTS INCORPORATED BY REFERENCE

None.
Transitional Small Business Disclosure Format (check one): YES [ ] NO [X]
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PART I

ITEM 1. BUSINESS.

GENERAL

Atlantic Integrated Health Incorporated (the "Company" or "Atlantic")
was incorporated as a business corporation on December 5, 1994 under the name
"Atlantic Primary Care, Inc." Atlantic is in the process of integrating,
economically and clinically, physicians practicing primarily in single-specialty
medical practice groups into a larger multi-specialty network of physicians and
medical practice groups. Atlantic is organized as an independent,
physician-owned and governed integrated medical practice group network.
Physicians participating in Atlantic's network provide primary and referral
specialty health care services to managed care health plan enrollees and other
patients. Atlantic seeks to improve the clinical performance and efficiencies of
individual physician and medical practice group operations by centralizing
specific administrative and purchasing functions and introducing management
tools, such as clinical pathways, utilization review and outcomes measurement.

As of March 15, 1999, Atlantic had entered into Medical Services
Provider Agreements covering over 500 physicians located in 21 counties of
Eastern North Carolina. The Medical Services Provider Agreements require
participating physicians to comply with key operating policies and procedures
established by Atlantic's physician Board of Directors. Additionally, as of
March 15, 1999, Atlantic through its wholly-owned subsidiary, The Beacon Company
("Beacon"), had entered into Facility Participation Agreements with seven
hospitals in Eastern North Carolina. The Facility Participation Agreements allow
Atlantic, through Beacon, to work with local hospitals on joint contracting
opportunities.

Atlantic derives its revenues from four main sources. The first are
fees paid by employers, managed care health plans, and other third-party payors
to access Atlantic's integrated provider network. The second are commissions and
fees paid by employers for health plan related administrative and consulting
services. The third are fees paid by vendors on behalf of participating
physicians for providing group purchasing and related services, and the last is
administrative service fees paid by participating medical practice groups.

Atlantic's strategy is to continue to develop a multi-specialty
Integrated Medical Group Network in Eastern North Carolina. In each targeted
community Atlantic plans to affiliate with local physicians who provide a
variety of medical specialty services. To implement its strategy, Atlantic
intends to pursue: (i) growth in its existing community markets; (ii) expansion
into new community markets through affiliation with physician medical practice
groups or existing provider networks; (iii) creation of contract relationships
with hospitals, health plans, and other third-party payors in the community
market areas; (iv) use of management information systems and electronic data
interchange; and (v) management activities to increase the efficiency of and
reduce costs associated with the operation of Atlantic's regional network.

Consistent with this strategy, Atlantic entered into certain agreements
with Kanawha HealthCare Solutions, Inc. and its parent Kanawha Insurance Company
("Kanawha") in February 1998. These agreements outline duties and
responsibilities of each organization to develop a variety of health plans to be
marketed to small and large employers in Atlantic's target markets. Initially,
the parties intended to develop and distribute health maintenance organization
("HMO"), preferred provider organization ("PPO") and third party administrator
health plan products. Since the agreements were executed,

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Kanawha has exited the HMO marketplace in North Carolina. However, Atlantic and
Kanawha are still working together to launch a PPO and jointly market their
health plan products to self-insured payors.

In connection with these agreements, Atlantic and Kanawha formed The
Beacon Company ("Beacon"). Beacon is licensed by the State of North Carolina as
an insurance agency and serves as the general agent for the sale of
Kanawha/Beacon health plan products. Initially, Atlantic and Kanawha each
purchased 1,000 shares of common stock of Beacon. However, in June 1998,
Atlantic purchased all of the 1,000 shares of Beacon common stock owned by
Kanawha in exchange for $1,000 cash and the issuance by Beacon of a convertible,
subordinated debenture in the principal amount of $90,000 (the "Debenture"). The
Debenture is due and payable on June 30, 2003 and bears interest at the rate of
6% per annum. The Debenture is convertible into 4% of Beacon's outstanding
common stock if Beacon completes a public offering of its common stock. Beacon
does not have any right to redeem the Debenture prior to maturity. Upon the
occurrence of an "Event of Default," as defined under the Debenture, the entire
unpaid principal and accrued interest will become immediately due and payable.

On October 19, 1996, Atlantic filed a Registration Statement on Form
SB-2 with the Securities and Exchange Commission (the "Commission"), pursuant to
which Atlantic registered for offer and sale under the federal securities laws
(i) 700,000 Primary Class Common Shares; (ii) 1,400000 Referral Class Common
Shares; and (iii) 150,000 Nonprofit Class Nonvoting Common Shares. The
Commission declared Atlantic's Registration Statement effective on December 30,
1996, and certain officers and directors of Atlantic commenced sale of
Atlantic's shares shortly thereafter. During the initial offering period which
closed on July 28, 1997, Atlantic sold 116,000 Primary Class Common Shares,
216,000 Referral Class Common Shares and no Nonprofit Class Nonvoting Common
Shares. On September 22, 1997, Atlantic filed a Post-Effective Amendment No. 2
to the Registration Statement. The Commission declared the Post-Effective
Amendment No. 2 effective on September 30, 1997. During the second offering
period which closed on April 28, 1998, Atlantic sold an aggregate of 26,000
Primary Class Common Shares, 76,000 Referral Class Common Shares and no
Nonprofit Class Nonvoting Common Shares. On June 24, 1998, Atlantic filed a
Post-Effective Amendment No. 3 and on August 7, 1998 a Post-Effective Amendment
No. 4 in response to the Commission's comments on Post-Effective Amendment No.
3. The Commission declared the Post-Effective Amendment No. 4 effective on
August 12, 1998. During the third offering period which closed on March 10,
1999, Atlantic sold an aggregate of 14,000 Primary Class Common Shares, 136,000
Referral Class Common Shares and 2,000 Nonprofit Class Nonvoting Common Shares.
Atlantic sold an aggregate of 156,000 Primary Class Common Shares, 428,000
Referral Class Common Shares and 2,000 Nonprofit Class Nonvoting Common Shares
since the Registration Statement was first declared effective on December 30,
1996. The net proceeds from Atlantic's Offering have been used for working
capital. Atlantic intends to file a Post-Effective Amendment No. 5 in April 1999
to continue the offering.

MISSION

The shareholders of Atlantic share the common vision that Atlantic is
to be a physician-owned and governed network of medical practice groups.
Atlantic's mission is to integrate, economically and clinically, physicians now
practicing primarily in single-specialty medical practice groups into a larger
multi-specialty group Integrated Medical Group Network to:

o integrate and coordinate multi-specialty patient care beginning at
the local community level;

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o improve the access, quality and cost effectiveness of health care
services delivered through the development of new health care
service delivery products that are competitive and responsive to the
changing requirements and opportunities of the marketplace;

o develop and implement network administrative, operating and
information systems required to improve the delivery of health care
services and patient outcomes;

o negotiate managed care (capitation, percentage of premium, and other
permitted risk sharing) health plan contracts and contracts with
other buyers of health care services; and

o develop the capability to provide additional ancillary services and
generate additional efficiencies in the delivery of outpatient
services.

To accomplish its mission, Atlantic is seeking well-defined, long-term
relationships with health plans and other buyers of health care services which
share its vision and commitment to influencing changes in the health care
delivery system that are positive for patients and helpful to health care
providers. Atlantic has developed and continues to develop working relationships
with hospitals and other health care providers in its geographic service region
of Eastern North Carolina, providing physicians the maximum flexibility to
provide patients with the best possible care.

INDUSTRY

Concerns over the accelerating cost of health care have resulted in the
increasing prominence of managed care. As markets have evolved from traditional
fee-for-service medicine to managed care, insurance companies and health care
providers have confronted market pressures to provide high quality health care
in a cost-effective manner. Purchasers of health care services bargain
collectively in an effort to reduce premiums and to bring about greater
accountability of health plans and providers with respect to accessibility,
choice of provider, quality of care and other indicators of consumer
satisfaction. The focus on cost-containment has placed small to mid-sized
physician groups and solo practices at a disadvantage because they typically
have higher operating costs and little purchasing power with suppliers; they
often lack and do not have the capital to purchase new technologies that can
improve quality and reduce costs; and they do not have the cost accounting and
quality management systems necessary for entry into sophisticated risk-sharing
contracts with payors.

Industry experts expect the health care delivery system to evolve into
a system in which the primary care physician, often part of a multi-specialty
group or network, is a key leader in managing and directing health care
expenditures. As a result of these developments, primary care physicians have
increasingly become the conduit for the delivery of medical care by acting as
"case managers" and directing referrals to certain specialists, hospitals,
alternate-site facilities and diagnostic facilities. By contracting directly
with payors, organizations that have both primary care and referral physician
leadership are able to reduce the administrative overhead expenses incurred by
medical practice groups and health plans and thereby reduce the cost of
delivering health care services.

As a result of the trends toward increased enrollment in managed care
health plans and physician membership in medical practice groups, health care
providers have sought to reorganize themselves into integrated health care
delivery systems that are better suited to this environment. Some physician
groups and networks are joining with hospitals and other institutional providers
in various ways to create

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vertically integrated delivery systems which provide medical and hospital
services ranging from community-based primary medical care to specialized
inpatient services. These health care delivery systems contract with health
plans to provide hospital and medical services to enrollees under full risk
contracts, through which providers assume the obligation of providing both the
professional and institutional components of covered health care services to the
plans enrollees.

In order to compete effectively in this emerging environment,
physicians are concluding that they must have control over the delivery and
financial impact of a broader range of health care services through the
acceptance of a global capitation. Moreover, physicians are increasingly
abandoning traditional private practice in favor of affiliations with larger
organizations and networks, like Atlantic, which offer experienced, innovative
management and management information systems.

Many payors and their intermediaries, including governmental entities,
look to network providers of physician services to develop and maintain quality
outcomes, management programs and patient care data. In addition, such payors
and intermediaries seek to share the risk of providing health care services
through capitation arrangements which provide for fixed payments for patient
care over a specified period of time. While the acceptance of greater
responsibility and risk provides the opportunity to retain and enhance market
share and operate at a higher level of profitability, medical practice groups
and independent physicians have determined that the acceptance of capitation
carries with it significant requirements for infrastructure, information
systems, capital, network resources and financial and medical management.
Physicians increasingly are turning to organizations, such as Atlantic, to
provide the resources necessary to function effectively in this environment.

BUSINESS STRATEGY

Atlantic's strategy focuses on business activities in four principal
areas:

1. FORMING A REGIONAL PHYSICIAN NETWORK.

Management of Atlantic believes that the majority of health care
services will continue to be delivered at the local community level in the
future, particularly primary medical care in rural regions, such as Eastern
North Carolina. Based on its experience and discussions with buyers of health
care services, management of Atlantic believes that the purchase of health care
services will increasingly be accomplished through contracts with regional
networks of physicians and other providers; and thus demand by buyers of health
care services will grow rapidly for a regional, high quality physician network
in Eastern North Carolina that is capable of sharing risk. Atlantic continues to
meet this market demand by selectively contracting with physicians in
communities throughout Eastern North Carolina. As of March 15, 1999, Atlantic
had entered into Medical Services Provider Agreements covering over 500
physicians located in 21 counties of Eastern North Carolina. Each participating
physician is credentialed through an established process that meets and/or
exceeds National Commission for Quality Assurance ("NCQA") guidelines. The
Medical Services Provider Agreement, entered into by all medical practice groups
participating in Atlantic, requires participating physicians to follow specific
administrative and clinical policies and procedures adopted by Atlantic's Board
of Directors.

2. DEVELOPING STRATEGIC ALLIANCES.

Atlantic believes that developing strategic relationships with
hospitals, other health care providers and insurance carriers, including HMOs,
improves the delivery of health care services and patient care. Atlantic
continues to actively pursue the development of such relationships.

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Atlantic's current and proposed agreements with hospital and other
providers strive to enhance the quality and efficiency of care to patients and
provide an integrated and coordinated continuum of care. Consistent with this
goal, Atlantic's current agreements with hospitals and other providers feature
discounted fee for service formulas. As Atlantic attempts to position itself
within a managed care market, Atlantic's proposed agreements with hospitals and
other providers will feature reimbursement formulas that align financial and
clinical incentives between physicians, hospitals, and other providers to best
meet patient care needs. As Atlantic physicians share permitted financial risk,
hospitals and other providers will be placed at risk for those aspects of health
care delivery that they most directly influence or control. As of March 15,
1999, Atlantic, through its subsidiary, Beacon, had entered into Facility
Participation Agreements with seven hospitals in Eastern North Carolina.

Atlantic continues its efforts to negotiate provider agreements with
managed care health plans and insurance companies desiring to do business in
Eastern North Carolina. Also, Atlantic continues to develop agreements with
managed care organizations or third party administrators, to facilitate the
offering of services by Atlantic medical practice groups to large partially and
fully self-insured employers.

Atlantic entered into certain agreements with Kanawha in February 1998.
These agreements outline duties and responsibilities of each organization to
develop a variety of health plans to be marketed to small and large employers in
Atlantic's target markets. Initially, the parties intended to develop and
distribute HMO, PPO and third party administrator health plan products. Since
the agreements were executed, Kanawha has exited the HMO marketplace in North
Carolina. However, Atlantic and Kanawha are still working together to launch a
PPO and jointly market their health plan products to self-insured payors. In
June 1998, Atlantic purchased all of Kanawha's ownership interest in Beacon. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview."

Affiliated physicians are required to honor the terms and conditions of
contracts entered into by Atlantic and approved by respective medical practice
groups of such physicians. However, Atlantic does not prejudice individual
participating physicians or medical practice groups from entering into direct
agreements with managed care health plans, insurance companies or other buyers
of health care services. Atlantic's standard Medical Services Provider Agreement
does provide, however, that Atlantic shall have the exclusive right, for a
period of 180 days to negotiate a new Network/Buyer Agreement with certain
buyers of health care services designated by Atlantic. In the event that
Atlantic does not enter into a Network/Buyer Agreement with a designated buyer
of health care services within 180 days, the affiliated physicians have the
right to contract with any buyer of health care services, regardless of whether
or not Atlantic has contracted with a particular plan.

The expectation is that through relationships with managed care health
plans and other buyers of health care services, Atlantic physicians will devote
greater resources to ensuring the wellness of patients, provide better quality
and cost-effective patient care and become more competitive in the health care
marketplace. As a result, it is anticipated that the overall cost of providing
care will be contained, rendering both Atlantic and the participating providers
more appealing to managed care health plans, other buyers of health care
services, and medical consumers.

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3. SEEKING IMPROVEMENTS IN HEALTH CARE SERVICE DELIVERY AND
OUTCOMES.

Atlantic is organized as a multi-specialty Integrated Medical Group
Network. The integration of the medical group practices and physicians creates
significant potential to enhance the quality and cost-effectiveness of care
provided to patients served by the network. One of Atlantic's goals is to
accomplish such integration through the systematic sharing of information,
coordination of care and such activities as the development and application of
clinical pathways and outcome measurements. Atlantic believes that information
technology is important to the growth of its integrated health care delivery
system and that the availability of detailed clinical data is fundamental to
quality control and cost containment.

Atlantic is monitoring the current developments in information and
telecommunications systems that will be able to link the central office of
Atlantic with the offices of certain participating physicians and medical
practice groups via the internet or other electronic means to facilitate the
collection and analysis of clinical and administrative data and the potential
development of a comprehensive health care database. The database is to combine
information about the cost and utilization of health care services rendered to
patients of the network. The information technology being monitored is designed
to permit immediate verification of the eligibility of patients for service
under various managed care health plans. The cost of linking Atlantic with the
offices of certain participating physicians and medical practice groups through
information and telecommunications systems will not result in any significant
charges to Atlantic and will likely cost participating physicians and medical
practice groups monthly fees; the exact amount of such fees will be dependent
upon the type of services desired by each physician and medical practice group.

Through analysis of data and appropriate sharing of pertinent
information with physicians, hospitals, patients, managed care plans and buyers
of health care services, Atlantic physicians should be able to reduce the risk
of providing unnecessary and inappropriate care. Equally important, these
systems and enhanced communications among providers, patients and purchasers,
will improve efforts to deliver quality service in a cost-effective manner and
document continuous improvements in health care service delivery and outcomes.
The information Atlantic desires to store in a database should allow
participating physicians systematically to develop and utilize clinical pathways
and outcome measurements and to address other quality-of-care issues. Although
management of Atlantic views this strategy as important, it realizes that this
strategy is a long-term goal and not one that management believes will be
achieved in the near future.

4. ENHANCING THE MANAGEMENT AND PERFORMANCE OF PARTICIPATING
PRACTICES.

Atlantic continues to expand the number of shared management services
it offers to participating physicians. While Atlantic expects that participating
physicians will continue to employ and directly supervise the various clinical,
reception, medical records and other support personnel required at each office
site, Atlantic believes that many other administrative-management services may
be provided more efficiently and on a cost-effective basis through centralized
resources in the network office.

To this end, Atlantic has developed and formed a group purchasing
program whereby participating physicians and medical practice groups may acquire
frequently utilized goods and services. Atlantic's main programs include
professional liability insurance, medical supplies, reference laboratory
services, telecommunications services and compliance with Occupational Safety
and Health Administration ("OSHA") training. Atlantic continues to issue
requests-for-proposals for office supplies and other business services and
information systems. Atlantic also continues to expand its consulting

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services to medical practice groups and physicians. These services include
physician recruitment, establishment of cross coverage arrangements and creating
a medical practice, opening a new office, or combining or merging practices.

In conjunction with its strategic planning efforts, Atlantic may
determine that it would be advantageous from a marketing and/or service
standpoint to sponsor the establishment of strategically located care centers or
physician offices in locations which would help attract new customers and
patients, or provide enhanced access to services for existing patients. As
appropriate, Atlantic will undertake to facilitate efforts by the affiliated
medical practices to recruit and hire physicians directly to staff such sites.

MEDICAL SERVICES PROVIDER AGREEMENTS, STRUCTURE AND OWNERSHIP AND MANAGEMENT

MEDICAL SERVICES PROVIDER AGREEMENTS: Affiliated medical practice
groups and physicians are linked to Atlantic and each other through Medical
Services Provider Agreements. Atlantic contracts with the physicians and the
affiliated medical practice groups for the provision of medical services and the
allocation of revenues and expenses and, in turn, contracts with managed care
health plans and insurance companies for marketing and enrollment services.
These agreements obligate Atlantic to allocate revenues among participating
physicians and medical practice groups in accordance with agreed upon formulae
and obligate the physicians and medical practice groups to provide medical
services and share certain risks of covering the costs of health care services
provided. In addition, the Medical Services Provider Agreements may require
participating physicians and medical practice groups to participate in an
administrative fee assessment program.

STRUCTURE AND OWNERSHIP: Atlantic is a North Carolina business
corporation organized to provide administrative services only and not to provide
medical services. Atlantic is owned by medical practice groups and physicians
who, directly or indirectly, enter into Medical Services Provider Agreements
with and become shareholders of Atlantic. A diagram of the structure and
ownership of Atlantic and its relationships with buyers of health care services
and participating physicians and medical practice groups is set forth below:

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MEDICAL PRACTICE GROUP/ HEALTH PLANS
PHYSICIAN SHAREHOLDERS OTHER BUYERS OF HEALTH CARE SERVICES
\ /
\ / -- Permitted Risk Sharing and
\ / Non-Risk Sharing Provider
\ / Agreements
\ /
---------------------------------------------
| ATLANTIC INTEGRATED HEALTH INCORPORATED |
| |
| -- Physician Board of Directors |
| -- Physician Officers |
| -- Lay Chief Operating Officer |
| -- Lay Chief Financial Officer |
| -- Committees |
| -- Administative Staff |
| -- Management Information System |
---------------------------------------------
/ \
/ \
Non-Exclusive Medical Services / \
Provider Agreement / \
/ \
/ \
- ----------------------------------- -----------------------------------
| MEDICAL GROUP/PHYSICIAN | | MEDICAL GROUP/PHYSICIAN |
| -- Own property and equipment | | |
| -- Employ support staff | | |
- ----------------------------------- -----------------------------------
/
/
/ -- Employment Agreement
/
/
Physician

Atlantic is owned by participating medical practice groups and
physicians, as depicted in the upper left corner of the diagram, and such
shareholders have elected the members of the Board of Directors, all of whom are
physicians. As depicted in the center box of the diagram, the officers of the
corporation are physicians, although the Chief Operating Officer and Chief
Financial Officer of Atlantic are lay persons experienced in the operation of
medical practice groups and managed care systems.

The Board of Directors has established a number of committees that are
advisory committees of the Board of Directors and oversee and recommend policies
and procedures concerning matters of general management, finance, marketing,
contracting, continuous quality improvement, utilization management and
management information systems. The members of such committees are primarily
physicians who are participants in the Atlantic network, although other
physicians and lay persons may also be designated members of the committees.

Atlantic will negotiate and enter into agreements on behalf of
participating physicians and medical practice groups with health plans and other
buyers of health care services, as depicted in the

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upper right corner of the diagram. Such health care services will be provided by
participating physicians and medical practice groups and their respective
physicians and other licensed professionals. The terms and provisions for the
rendering of the health care services, payment for such services, and the
sharing, by the participating physicians and medical practice groups, of the
risk of covering the costs of providing such health care services are included
in the Medical Services Provider Agreements, as depicted in the lower left
corner of the diagram. Physicians' employment relationships with their
respective medical practice groups will be maintained. The numbers of
participating physicians, their medical specialties and geographic locations,
are determined by the Board of Directors of Atlantic.

The structure and ownership of Atlantic have been designed to avoid
Atlantic and the participating medical practice groups being deemed an
"affiliated service group," as defined under the Internal Revenue Code. The
Board of Directors has structured Atlantic to avoid such "affiliated service
group" designation and to enable participating medical practice groups to
continue their existing qualified pension and profit sharing plans without any
adverse tax consequences. The Board of Directors believes that Atlantic and the
participating medical practice groups will not be an "affiliated service group"
because (a) Atlantic is organized as a business corporation; (b) Atlantic's
business is limited to providing administrative services (and will not
constitute practicing medicine); and (c) no individual physician is permitted to
own 5% or more of the outstanding capital stock of Atlantic. No assurance can be
provided, however, that the Internal Revenue Service or another regulatory
agency will not take the position that Atlantic, as it is structured, owned and
operated from time to time, will be an "affiliated service group."

MANAGEMENT: Because of the complex array of business activities that
Atlantic pursues, Atlantic has undertaken to retain qualified management
personnel and professional advisors to carry out the day-to-day work of managing
the network. The central network office is supervised by the Chief Operating
Officer who was selected by and is accountable to the Board of Directors.
Atlantic staff supports the Board of Directors and its committees; facilitates
strategic planning regarding the growth and development of network services;
manages shared practice management services provided or available to affiliated
physicians; assists the network in its efforts to obtain and manage risk
contracts with managed care health plans and other buyers of health care
services; and is responsible for developing management systems, including pro
forma financial schedules to facilitate the monitoring of revenues and
expenditures incurred by the network.

In addition to the Chief Operating Officer, Atlantic, as its grows in
size and function, will continue to develop its own staff with experience in
such areas as finance, marketing, health services/provider relations and
management information systems. The number and type of staff employed or
retained will evolve based on the size of the network, number of enrollees and
patients served and complexity of planning or management challenges.

Atlantic is still developing many of its business operations. As a
result, Atlantic contracts with consultants to assure that the array of
experience and expertise necessary to expand the network successfully is readily
available. Atlantic requires the on-going advice of attorneys, certified public
accountants and consulting actuaries.

PHYSICIAN SELECTION AND CREDENTIALING

To become a participating Atlantic physician, each physician must
complete the credentialing process which meets or exceeds guidelines promulgated
by the NCQA. Credentialing criteria have been developed to assure the inclusion
of desired numbers of physicians, as identified by specialty and

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geographic location, within the network; the compilation of information
concerning the cost and quality of services rendered by respective physicians;
and the confirmation by applicants of their willingness to adhere to policies
and procedures adopted by Atlantic's Board of Directors. Each participating
physician is required to complete successfully the credentialing process of
Atlantic.

Atlantic has contracted with National Provider Credentialing Service, a
Virginia corporation, to accomplish primary source verification and
electronically catalogue the information contained on each physician's
credentialing application. Atlantic commenced its credentialing program in July
1996.

PHYSICIAN REIMBURSEMENT, PHYSICIAN PAYMENTS, RISK MANAGEMENT

The Medical Services Provider Agreement entered into by each physician
and medical practice group participating in the Atlantic network is structured
to provide that: (i) participating physicians and medical practice groups render
required and appropriate medical services to designated patients; (ii) payment
for such medical services is to be made to participating physicians and medical
practice groups through programs determined by the Board of Directors; and (iii)
Atlantic coordinates and manages such provision of medical services, payment for
the medical services and the sharing of certain risk by the participating
physicians and medical practice groups related to the cost of providing the
required and appropriate medical services. Designation of primary care
physicians as "case managers" to coordinate patient care will vary depending on
the terms of the contracts entered into with buyers of health care services.

Atlantic has worked with and will continue to engage a professional
actuarial firm to work with the Board of Directors to develop common fee
schedules for the Atlantic network and to determine appropriate allocation of
capitation. In the event participating physicians and medical practice groups
are paid on a fee-for-service basis, Atlantic will endeavor to utilize a common
fee schedule and, as permitted and appropriate, will develop provisions for
holding back a portion of the fees paid to participating physicians and medical
practice groups in a contingency reserve fund. As determined by Atlantic's Board
of Directors and the terms and conditions of specific managed care health plan
contracts, a scheduled, periodic accounting of managed care health plan expenses
will be completed. The monetary amounts "held back" will be returned to the
participating physicians and medical practice groups to the extent that the
operating results permit. If a surplus still remains after all amounts held back
during the year from payments otherwise due physicians have been returned, such
surplus will be allocated among participating physicians in accordance with
criteria determined by the Board of Directors.

The allocation of administrative assessments, revenues, sharing of
risk, operating reserve deficits or other reimbursement/compensation limitations
described herein may vary among medical practice groups and individual providers
within a medical practice group.

THE ATLANTIC MEDICAL MANAGEMENT INFORMATION SYSTEM

Atlantic continues to evaluate information systems to provide
interactive health services and management information as described below.
Atlantic's management objective is to provide participating physicians with
access to appropriate data as patient care is rendered and evaluated. It is
contemplated that Atlantic and participating medical practice groups will be
linked electronically and that information will be delivered and shared through
electronic data interchange ("EDI"). No target date has been established for
implementation of an EDI system within the Atlantic network.

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The functions of core information systems selected are to include
e-mail, accounting applications, on-line verification of eligibility, database
collection and reporting, management of contracts, claims processing and
payment, referral authorization and statistical reporting. Atlantic and/or
medical practice groups will retain ownership of all data, information and
reports generated by and through the use of the information systems.

ADMINISTRATIVE FEE ASSESSMENT PROGRAM

The Medical Services Provider Agreement entered into by each
participating physician or medical practice group provides that Atlantic, in its
sole discretion and by determination of the Board of Directors, may require the
participating physicians and medical practice groups to provide financial
support to help defray Atlantic's operating expenses. Consistent with this
provision, Atlantic has the authority to bill the participating physicians and
medical practice groups or retain from revenues paid to Atlantic administrative
and management fees that are equal to 3% of the "net revenues" of Atlantic, as
defined in the Medical Services Providers Agreement. In addition, upon execution
of the Medical Services Provider Agreement, participating physicians and medical
practice groups who are referral specialists may be required to pay to Atlantic
an initial administrative and management fee up to $3,000 per referral
physician.

COMPETITION

The health care market is extremely competitive and undergoing rapid
change. Atlantic and its affiliated physicians and medical practice groups
compete with individual physicians and medical practice groups, HMOs, PPOs,
physician-hospital organizations, integrated delivery systems and physician
practice management companies. Many of Atlantic's competitors are significantly
larger and have substantially greater capital resources than Atlantic. Atlantic
believes that the principal competitive factors that will affect its ability to
contract with health plans and other buyers of health care services include
achievement of cost efficiencies through integrated operations, satisfaction of
the needs of target purchasers and achievement of superior customer/patient
satisfaction.

GOVERNMENT REGULATION

Various state and federal laws regulate the relationships among
providers for the provision of physician and other health care services, and as
a business in the health care industry, Atlantic is subject to these laws and
regulations. Management of Atlantic believes its operations are in material
compliance with applicable laws; however, Atlantic has not received any legal
opinion from counsel or any advisory opinions from regulators that its
operations are in material compliance with applicable laws. Many aspects of
Atlantic's business operations have not been the subject of state or federal
regulatory interpretation. Moreover, as a result of Atlantic's providing both
physician practice management services and medical support services, Atlantic
may be the subject of more stringent review by the regulatory authorities. There
can be no assurance that a review of Atlantic's or the affiliated physicians'
businesses by courts or regulatory authorities will not result in a
determination that could adversely affect the operations of Atlantic or the
affiliated physicians and medical practice groups. Moreover, no assurance can be
provided that new and more restrictive state or federal laws and regulations
will not be enacted or adopted.

The laws of many states prohibit business corporations such as Atlantic
from practicing medicine or employing physicians to practice medicine. Although
the State of North Carolina does not expressly prohibit the corporate practice
of medicine, it does require all persons practicing medicine to be licensed.

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Atlantic performs only non-medical administrative services, does not represent
to the public or its clients that it offers medical services and does not
exercise influence or control over the practice of medicine by the physicians
with whom it contracts. Accordingly, Atlantic believes that it is not in
violation of applicable state laws relating to the corporate practice of
medicine. However, the laws in most states, including the State of North
Carolina, regarding the corporate practice of medicine have been subjected to
limited judicial and regulatory interpretation; therefore, no assurances can be
given that Atlantic's activities will be found to be in compliance, if
challenged.

Federal and state laws regulate the relationships among providers of
health care services, physicians and other clinicians. These laws include the
fraud and abuse provisions of the Medicare and Medicaid statutes, which prohibit
the soliciting or receiving, or the offering or payment of remuneration, either
directly or indirectly, in return for or to induce a referral of items or
services for federal health care program patients including, among other
patients, Medicare and Medicaid patients. Federal and state statutes impose
restrictions on physician referrals of designated health services to entities
with which the physician has a financial relationship. These laws and applicable
regulations also regulate the submission of claims for the reimbursement of
physician services, or for services incident to those services, provided under
federal health care programs that are false or fraudulent. Violations of these
laws may result in substantial civil and criminal penalties, including civil
monetary penalties, exclusion from the participation in federal health care
programs, including, among other programs, the Medicare and Medicaid programs,
loss of licensure to practice medicine and other penalties. Such exclusion and
penalties, if applied to Atlantic's affiliated medical practice groups, could
have an adverse effect on Atlantic.

Extensive procedural and substantive changes to fraud and abuse and
reimbursement related provisions of federal law were enacted as part of the
Health Insurance Portability and Accountability Act of 1996 ("HIPAA") and the
Balanced Budget Act of 1997 ("BBA"). In part, the changes provided new funding
and other incentives to encourage more vigorous enforcement of existing law. In
addition, new criminal and civil penalty provisions were added, existing
requirements and penalties were extended to additional federal programs, and
changes were made to mandatory and permissive exclusion provisions. New criminal
violations relating to "health care fraud" and "federal health care offense"
were defined. New civil monetary penalties were added for actions such as
patterns of incorrect coding or billing for unnecessary services, offering
inducements to beneficiaries to obtain services from a particular provider, and
for contracting with, or employing, an individual who is excluded from
participation in a federal health care program. During 1998 alone, HIPAA and BBA
also have resulted in a very substantial number of proposed and final rules,
advisory opinions and other notifications.

Certain provisions of state and federal statutes, commonly referred to
as the "Anti-kickback Laws," prohibit the offer, payment, solicitation or
receipt of any form of remuneration either in return for the referral of
patients, or in return for the recommendation, arrangement, purchase, lease or
order of items or services that are covered by a "federal health care program."
For purposes of the Anti-kickback Law, a "federal health care program" includes
the Medicare and Medicaid programs and any other plan or program that provides
health benefits which are funded directly, in whole or in part, by the United
States Government. The Anti-kickback Laws are broad in scope and have been
broadly interpreted by courts in many jurisdictions. Read literally, the
statutes place at risk many otherwise legitimate business arrangements,
potentially subjecting such arrangements to lengthy, expensive investigations
and prosecutions initiated by federal and state governmental officials.

The federal government has published several final and proposed
regulations for the creation of certain "safe harbors" from prosecution under
the federal Anti-kickback Law, but some of Atlantic's

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operations do not satisfy the requirements for any of the "safe harbor"
exemptions. Management of Atlantic believes, however, that in the conduct of its
contemplated business operations Atlantic will not be in a position to make or
influence the referral of patients for goods or services and that such business
operations will not constitute or generate any violation of state or federal
Anti-kickback Laws. To the extent Atlantic is deemed by state or federal
authorities to be a separate provider of health care services, making referrals
to or receiving referrals from physicians or medical practice groups through its
Non-Exclusive Medical Provider Agreements, the financial arrangement under such
agreements could be subject to scrutiny and prosecution under the anti-kickback
laws. Violation of the Anti-kickback Laws 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, including
excluding violators from participation in federal health care programs, and
other criminal and civil penalties may be imposed pursuant to applicable state
laws.

Significant prohibitions against physician referrals were enacted,
subject to certain exemptions, 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. Effective January 1, 1995 and subject to certain
exemptions, Stark II prohibits a physician or a member of the physician's
immediate family from referring Medicare or Medicaid patients to an entity
providing "designated health services" in which the physician has an ownership
or investment interest, or with which the physician has entered into a
compensation arrangement. The designated health services include the provision
of clinical laboratory services, radiology, radiation therapy services and
supplies, physical and occupational therapy services, durable medical equipment
and supplies, parenteral and enteral nutrients, equipment and supplies,
prosthetics, orthotics and prosthetic devices and supplies, outpatient
prescription drugs, home health services and inpatient and outpatient hospital
services. The penalties for violation of Stark II include a prohibition on
Medicaid and Medicare reimbursement and civil penalties of as much as $15,000
for each violative referral and $100,000 for participation in a "circumvention
scheme." Since Atlantic is to provide administrative services only and is not to
provide any "designated health services" or other health services, management of
Atlantic believes that its business operations will not generate any violations
of the Stark legislation. While Atlantic believes it will be in compliance with
the Stark legislation, future regulations could require Atlantic to modify the
form of its relationships with the affiliated physician groups. For example,
proposed regulations implementing the Stark II laws were issued in January 1998,
but have yet to be finalized. Moreover, the violation of the Stark legislation
by any of Atlantic's affiliated medical practice groups could result in
significant fines and loss of reimbursement which would adversely affect
Atlantic.

Many states have adopted similar prohibitions against payments intended
to induce referrals of Medicaid and other patients. The State of North Carolina
has enacted statutes which prohibit the payment of fees to induce referrals and
prohibit referrals of patients by health care providers for certain designated
health care services to entities in which the health care provider or group
practice or any member of the group practice has an investment interest.
Sanctions which may be imposed for violations of such statutes include
discipline by the applicable professional licensing board, suspension or
revocation of the offending provider's license and substantial civil money
penalties. While Atlantic believes it will be in compliance with such state
laws, the existing or future laws or regulations could require Atlantic to
modify the form of its relationships with the affiliated physician groups.

Laws in all states regulate the business of insurance and the operation
of HMOs. The laws and regulations of the State of North Carolina, as interpreted
by the state's Department of Insurance ("DOI"), permit physician organizations,
such as Atlantic, to enter into risk sharing contracts only with licensed

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entities such as HMOs. Although Atlantic currently does not have any risk
sharing contracts, Atlantic may enter into such contracts in the future and at
such time may be subject to the HMO statute. A physician organization may also
become subject to regulation as a PPO or a URO. Although management of Atlantic
believes that its current operations fall outside of the oversight of the DOI,
no assurance can be provided, that the structure and operation of Atlantic and
its affiliated medical practice groups will not be challenged by the DOI or
other regulatory agencies. Any such challenge and any requirements that Atlantic
restructure its operations or qualify for an insurance license could have a
material effect on Atlantic's operations.

EMPLOYEES

As of March 15, 1999, Atlantic had five full-time employees, including
the Chief Operating Officer. Atlantic is not subject to any collective
bargaining agreements and believes that its employee relations are good.

ITEM 2. DESCRIPTION OF PROPERTY.

Atlantic's offices are located at 1315 S. Glenburnie Road, Suite A5,
New Bern, North Carolina 28562. Atlantic signed a one-year lease for
approximately 1,300 square feet at an aggregate monthly rent of approximately
$805 (including association fees). Atlantic plans to renew its lease in May
1999.

ITEM 3. LEGAL PROCEEDINGS.

There are no material pending legal, governmental, administrative or
other proceedings to which Atlantic is a party or of which any of its property
is the subject.

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

The Annual Meeting of Shareholders of Atlantic ("Annual Meeting") was
held on November 20, 1998. The following matters were voted on and approved by
Atlantic's shareholders at the Annual Meeting. The tabulation of votes with
respect to each of the following matters voted on at the Annual Meeting is set
forth as follows:

1. ELECTION OF DIRECTORS (1)

For Three-Year Term For Against Abstain Broker Non-Vote
- ------------------- --- ------- ------- ---------------

J. Philip Mahaney, M.D.* 208,000 0 0 0
Alice P. Seldon, M.D.** 216,000 0 0 0
Leo E. Waivers, M.D.* 208,000 0 0 0
Mark N. Dumas, M.D.* 208,000 0 0 0
Edwin P. Little, M.D.* 208,000 0 0 0
Michael J. Lobos, M.D.** 216,000 0 0 0

- -----------------------

* Primary Director
** Referral Director
*** OB/GYN Director

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(1) The vote of 65% of all of the issued and outstanding Primary Class Common
Shares is required to elect Primary Directors, and the holders of the
Primary Class Common Shares are the only shareholders allowed to vote on the
election of the Primary Directors. The vote of 65% of all of the issued and
outstanding Referral Class Common Shares is required to elect Referral
Directors and OB/GYN Directors, and the holders of Referral Class Common
Shares are the only shareholders allowed to vote on the election of Referral
Directors and OB/GYN Directors.

2. RATIFICATION OF ARTHUR ANDERSEN LLP AS AUDITORS FOR THE YEAR ENDING
DECEMBER 31, 1999.

For Against Abstain Broker Non-Vote
--- ------- ------- ---------------
424,000 0 0 0

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

There is no public or private trading market for Atlantic's Primary
Class Common Shares, Referral Class Common Shares and Nonprofit Class Nonvoting
Common Shares. The development of a trading market for such shares is precluded
for two reasons. First, ownership of such shares is restricted to certain
individuals and groups. For example, pursuant to Atlantic's Amended and Restated
Articles of Incorporation, Primary Class Common Shares may be held only by
Primary Care Physicians, which are defined in Atlantic's Bylaws, as amended, as
physicians who practice substantially (75% or more as determined by gross
practice revenues) in one or more of the primary care specialties of family
practice, general internal medicine, general pediatrics or general practice
("Primary Care Specialties"); are generally not board certified in any specialty
other than a Primary Care Specialty; and, if board certified in any other
specialty other than a Primary Care Specialty, generally do not hold themselves
out as practicing in any specialty other than the Primary Care Specialties,
which physicians, either directly or through a practice group, or practices,
have contracted with Atlantic to provide medical and other health care services
through contracts negotiated by Atlantic.

Pursuant to Atlantic's Amended and Restated Articles of Incorporation,
Referral Class Common Shares may be held only by physicians practicing primarily
in referral medical and surgical specialties other than Primary Care
Specialties, which physicians, either directly or through a practice group, or
practices, have contracted with Atlantic to provide medical and other health
care services through contracts negotiated by Atlantic.

Pursuant to Atlantic's Amended and Restated Articles of Incorporation,
Nonprofit Class Nonvoting Common Shares may be held only by nonprofit entities
or public (local, state or federal government) corporations engaged in the
delivery of health care services, which have contracted with Atlantic to provide
medical or other health care services through contracts negotiated by Atlantic.

Second, all existing shareholders of Atlantic and purchasers of
Atlantic's Primary Class Common Shares, Referral Class Common Shares and
Nonprofit Class Nonvoting Common Shares are required to enter into Subscription
and Shareholder Buy/Sell Agreements, which restrict the sale of such shares and
provide Atlantic the right to repurchase such shares upon certain purchase
events at fair market value, as determined in the sole discretion of the Board
of Directors of Atlantic. Accordingly, so

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long as the charter provisions described above and the buy/sell provisions in
the Subscription and Shareholder Buy/Sell Agreements remain in effect,
development of a trading market for the Primary Class Common Shares, Referral
Class Common Shares and Nonprofit Class Nonvoting Common Shares is precluded.

As of March 15, 1999, there were 166 record holders of Atlantic's
Primary Class Common Shares, 227 record holders of Atlantic's Referral Class
Common Shares and two record holders of Atlantic's Nonprofit Class Nonvoting
Common Shares. No cash dividends were declared or paid by Atlantic on the
Primary Class Common Shares, Referral Class Common Shares or the Nonprofit Class
Nonvoting Common Shares during the years ending December 31, 1997 or 1998.

During the fiscal year ended December 31, 1998, Atlantic did not issue
any securities without registration under the Securities Act.

During the calendar year ended December 31, 1998, Atlantic sold an
aggregate of 10,000 Primary Class Common Shares, 108,000 Referral Class Common
Shares and no Nonprofit Class Nonvoting Common Shares. All classes of capital
stock were sold at $1.00 per share, and the total amount raised under the
offering for the year ended December 31, 1998 was $118,000. Atlantic estimates
that the total expenses incurred in connection with the Offering during 1998
were approximately $10,000, thereby resulting in $108,000 in net proceeds to
Atlantic for the year. As indicated in Atlantic's Registration Statement, all of
the expenses incurred in connection with the offering were paid to unrelated
parties or entities. The vast majority of the offering expenses were paid to
attorneys, accountants and financial printers. The balance of the net proceeds
received by Atlantic was used to fund general working capital purposes,
including payment of rent and the salaries of certain directors and officers.
See "Item 10--Executive Compensation."

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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

THIS FORM 10-KSB CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS. FOR THIS
PURPOSE, ANY STATEMENTS CONTAINED IN THIS FORM 10-KSB THAT ARE NOT STATEMENTS OF
HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING STATEMENTS. WITHOUT LIMITING
THE FOREGOING, WORDS SUCH AS "MAY," "WILL," "EXPECT," "BELIEVE," "ANTICIPATE,"
"ESTIMATE" OR "CONTINUE" OR THE NEGATIVE OR OTHER VARIATIONS THEREOF OR
COMPARABLE TERMINOLOGY ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
THESE STATEMENTS BY THEIR NATURE INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES,
AND ACTUAL RESULTS MAY DIFFER MATERIALLY DEPENDING ON A VARIETY OF FACTORS,
INCLUDING THOSE DESCRIBED UNDER THE CAPTION "IMPORTANT FACTORS TO CONSIDER."

THE FOLLOWING DISCUSSION OF THE RESULTS OF THE OPERATIONS AND FINANCIAL
CONDITION OF ATLANTIC SHOULD BE READ IN CONJUNCTION WITH ATLANTIC'S FINANCIAL
STATEMENTS AND THE RELATED NOTES THERETO.

OVERVIEW

Atlantic is an independent, physician-owned and governed, integrated
medical practice group network. Since its inception, Atlantic has focused its
efforts on providing administrative services to participating physicians and
medical practice groups and on developing a community-based, integrated health
care delivery system to provide quality, cost-effective health care to the
citizens of Eastern North Carolina.

Atlantic is in the process of integrating, economically and clinically,
physicians practicing primarily in single-specialty medical practice groups into
a larger multi-specialty network of physicians and medical practice groups.
Physicians participating in Atlantic's network provide primary and referral
specialty heath care services to managed care health plan enrollees and other
patients. Atlantic continues to develop strategic alliances with payors of
health care services and other health care providers to achieve greater
coordination of the delivery of and payment of health care services.

As of March 15, 1999, Atlantic had entered into Medical Services
Provider Agreements covering over 500 physicians located in 21 counties of
Eastern North Carolina. The Medical Services Provider Agreements require
participating physicians to comply with key operating policies and procedures
established by Atlantic's physician Board of Directors. Additionally, as of
March 15, 1999, Atlantic through its subsidiary, The Beacon Company, had entered
into Facility Participation Agreements with seven hospitals in Eastern North
Carolina. The Facility Participation Agreements allow Atlantic to work with
local hospitals on joint contracting opportunities.

Atlantic plans to continue to provide administrative, group purchasing
and other services to participating physicians and to collect fees for
performing such services during 1999. Management, however, believes that
Atlantic's long term success will result from its continued ability to generate

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revenues from managed care plans, HMOs, insurance carriers, employers and other
buyers of health care services for obtaining access to Atlantic's network and
health plan management services.

Atlantic continues to meet directly with the management of major
regional employers and their employee benefits consultants to discuss Atlantic's
network and health plan management services. Although no assurance can be given,
Atlantic believes that it will continue to generate income from access and
management fees paid by buyers of health care services in 1999. As of March 15,
1999, Atlantic had agreements with employers covering over 6,000 lives.

Atlantic entered into certain agreements with Kanawha in February 1998.
These agreements outline duties and responsibilities of each organization to
develop a variety of health plans to be marketed to small and large employers in
Atlantic's target markets. Initially, the parties intended to develop and
distribute HMO, PPO and third party administrator health plan products. Since
the agreements were executed, Kanawha has exited the HMO marketplace in North
Carolina. However, Atlantic and Kanawha are still working together to launch a
preferred provider organization and jointly market their health plan products to
self-insured payors.

In connection with these agreements, Atlantic and Kanawha formed The
Beacon Company. Beacon is licensed by the State of North Carolina as an
insurance agency and serves as the general agent for the sale of Kanawha/Beacon
health plan products. Initially, Atlantic and Kanawha each purchased 1,000
shares of common stock of Beacon. However, in June 1998, Atlantic purchased all
of the 1,000 shares of Beacon common stock owned by Kanawha in exchange for
$1,000 cash and the issuance by Beacon of a convertible, subordinated debenture
in the principal amount of $90,000. The Debenture is due and payable on June 30,
2003 and bears interest at the rate of 6% per annum. The Debenture is
convertible into 4% of Beacon's outstanding common stock if Beacon completes a
public offering of its common stock. Beacon does not have any right to redeem
the Debenture prior to maturity. Upon the occurrence of an "Event of Default,"
as defined under the Debenture, the entire unpaid principal and accrued interest
will become immediately due and payable.

Although the management of Atlantic finds it difficult to forecast when
exactly its operations will become profitable, management believes that
Atlantic's profitability is largely dependent upon several factors, including
(i) the number of physicians participating in Atlantic's network; and (ii) the
number of contracts and long-term relationships between Atlantic and managed
care health plans, insurance carriers, employers and other buyers of health care
services.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1997

Net revenue for 1998 of $283,413 was approximately equal to 1997
revenues of $283,240. While total revenues were constant from 1997 to 1998, the
change in the sources of 1998 revenue was more dramatic. Revenues generated from
group purchasing contracts increased from $30,889 in 1997 to $175,152 in 1998,
an increase of $144,263 or 467%. This increase was offset by a drop in network
development and access fees from $70,000 in 1997 to $30,532 in 1998, a decrease
of $39,468 or 57% and administrative fees paid from affiliated medical practice
groups which fell from $185,350 in 1997 to $72,771 in 1998. The declines in
these two categories were not disappointing to Atlantic because in 1998 the
network development and access fees were generated from 12 customers while 1997
revenue was derived from one. In addition, Atlantic has been working towards
reducing its reliance on administrative fees collected directly from its
affiliated medical practice groups.

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Operating expenses decreased from $456,086 in 1997 to $412,953 in 1998,
a decrease of $43,133 or 9%. This decrease was primarily attributable to a drop
in consulting fees which was partially offset by increases in all other
operating expenses.

Salaries and wages expense increased from $251,803 in 1997 to $291,410
in 1998, an increase of $39,607. This increase was primarily due to the addition
of provider relations and network marketing representatives along with customary
salary increases. Consulting fees decreased from $135,717 in 1997 to $21,063 in
1998, a decrease of $114,654. Consulting fees in 1997 were higher than in 1998
because of the costs associated with Atlantic's negotiation of contracts
associated with the Kanawha/Beacon transaction, drafting and negotiation of
facility contracts with hospitals and exploring alternatives for capitalizing
Beacon. Office and other expenses increased from $44,907 in 1997 to $67,246 in
1998, an increase of $22,339. The increase was due primarily to an increase in
telecommunications, printing and general office supplies. Atlantic's
rent/occupancy expense increased from $4,420 in 1997 to $10,018 in 1998 due to
the relocation of Atlantic's new headquarters. Depreciation and amortization
expense increased slightly due to the acquisition of depreciable office
equipment. Atlantic's recruiting and educational expenses increased from $6,781
in 1997 to $12,196 in 1998 because of increased network development activities.

Atlantic incurred a net loss of $126,980 in 1998 compared to a net loss
of $171,869 in 1997. Since inception, Atlantic has incurred an accumulated
deficit of $472,849. The decrease in net loss in 1998 was primarily due to a
decrease in consulting fees in 1998. Atlantic anticipates that its operating
losses will continue for at least the next two years.

LIQUIDITY AND CAPITAL RESOURCES

To date, Atlantic has financed its operations primarily through the
sale of equity securities and the collection of network development and access
fees and administrative fees.

On October 19, 1996, Atlantic filed a Registration Statement on Form
SB-2 with the Commission, pursuant to which Atlantic registered for offer and
sale under the federal securities laws (i) 700,000 Primary Class Common Shares;
(ii) 1,400000 Referral Class Common Shares; and (iii) 150,000 Nonprofit Class
Nonvoting Common Shares. The Commission declared Atlantic's Registration
Statement effective on December 30, 1996, and certain officers and directors of
Atlantic commenced sale of Atlantic's shares shortly thereafter. During the
initial offering period which closed on July 28, 1997, Atlantic sold 116,000
Primary Class Common Shares, 216,000 Referral Class Common Shares and no
Nonprofit Class Nonvoting Common Shares. On September 22, 1997, Atlantic filed a
Post-Effective Amendment No. 2 to the Registration Statement. The Commission
declared the Post-Effective Amendment No. 2 effective on September 30, 1997.
During the second offering period which closed on April 28, 1998, Atlantic sold
an aggregate of 26,000 Primary Class Common Shares, 76,000 Referral Class Common
Shares and no Nonprofit Class Nonvoting Common Shares. On June 24, 1998,
Atlantic filed a Post-Effective Amendment No. 3 and on August 7, 1998 a
Post-Effective Amendment No. 4 in response to the Commission's comments on
Post-Effective Amendment No. 3. The Commission declared the Post-Effective
Amendment No. 4 effective on August 12, 1998. During the third offering period
which closed on March 10, 1999, Atlantic sold an aggregate of 14,000 Primary
Class Common Shares, 136,000 Referral Class Common Shares and 2,000 Nonprofit
Class Nonvoting Common Shares. Atlantic sold an aggregate of 156,000 Primary
Class Common Shares, 428,000 Referral Class Common Shares and 2,000 Nonprofit
Class Nonvoting Common Shares since the Registration Statement was first
declared effective on December 30, 1996. Atlantic plans to file Post-Effective
Amendment No. 5 to

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continue the offering and add additional physicians to the Atlantic network. The
net proceeds from Atlantic's Offering have been used for working capital.

Atlantic had $138,237 and $112,817 in working capital at December 31,
1998 and 1997, respectively. Atlantic's cash and cash equivalents were $115,507
and $101,776 at December 31, 1998 and 1997, respectively. The increase in
Atlantic's working capital and cash balance is due to the increase in revenues
described above and Atlantic's stock offering. Depending upon the success of
Atlantic's stock offering, which Atlantic believes it will reactivate in the
second quarter of 1999, and the amount of future revenue derived from network
development and access fees, Atlantic believes that sufficient liquidity is
available to satisfy its working capital through December 31, 1999. In the event
that the Company's future stock sales and revenues derived from network
development and access fees are lower than projected, the Company anticipates
that it may charge its shareholders assessments, reduce staff or decrease
compensation paid to its officers.

Atlantic did not have any material commitments for capital expenditures
as of December 31, 1998.

IMPORTANT FACTORS TO CONSIDER

The following factors are important and should be considered carefully in
connection with any evaluation of Atlantic's business, financial condition,
results of operations and prospects.

LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT.

Atlantic was incorporated in December 1994 and has a limited operating
history. The business of Atlantic is subject to the risks inherent in the
establishment of a new business enterprise. Because Atlantic was recently formed
and has limited operations, it cannot provide prospective investors with the
type of information that would be available from an institution with a longer
history of operations. Atlantic's profitability will depend primarily upon the
efforts of the individual physicians and medical practice groups that are
participating providers of medical services pursuant to Medical Services
Provider Agreements with Atlantic. There is no assurance that Atlantic will ever
operate profitably. As a result of the substantial start-up expenditures that
have been and will continue to be incurred, Atlantic can be expected to continue
to incur operating losses during at least the next two years of operations.
Furthermore, any delays in commencing substantial business operations will
further increase start-up expenses and delay realization of potential revenues
and income. As of December 31, 1998, Atlantic had accumulated a deficit since
its inception in an amount equal to $472,849. As a result of Atlantic's
accumulated deficit, along with other matters, the report of Atlantic's
independent public accountants on Atlantic's financial statements contains an
explanatory paragraph concerning Atlantic's ability to continue as a going
concern.

NEED FOR ADDITIONAL FINANCING

The use of proceeds from Atlantic's offering have been and will
continue to be used for general working capital purposes until Atlantic begins
generating additional operating revenues. Atlantic desires that a portion of the
proceeds of the offering be used to explore the desirability and feasibility of
organizing, licensing and operating an affiliate health maintenance organization
or other health plan. No assurance can be provided, however, that the Board of
Directors will determine to undertake any such study or to proceed with any such
organization or affiliate company organization and operation. Management
believes that if the anticipated fees are collected under the Administrative Fee
Assessment

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<PAGE>

Program and if Atlantic achieves its expected revenues and is able to manage its
expenses at budgeted levels, it will not require any significant additional
capital. If Atlantic's revenues are not sufficient to complete its initial
business development activities, Atlantic may adjust its medical services fee
arrangements, collect fees under the Administrative Fee Assessment Program and
seek to raise additional capital. There can be no assurance that Atlantic will
be successful in executing its business plan or that it will be able to increase
the fees charged to buyers of health care services or reduce the fees paid to
participating providers if it is unable to achieve profitable operations.
Atlantic plans to conduct additional offerings of shares of its capital stock as
it adds additional physicians to the Atlantic network. Such additional offerings
may result in dilution of the equity interests of Atlantic's shareholders. In
any event, there can be no assurance that Atlantic will be able to sell
additional shares or obtain any necessary additional financing on satisfactory
terms, or at all.

DEPENDENCE ON PHYSICIANS, MEDICAL PRACTICE GROUPS AND OTHER HEALTH CARE
PROVIDERS

Atlantic's profitability and long-range business plans will be
dependent upon its attracting and retaining the services of qualified individual
physicians, medical practice groups and other health care providers, especially
primary care medical practice groups. Atlantic will continue to enter into
Medical Services Provider Agreements with selected credentialed providers.
Although Atlantic believes that it will be able to enter into and maintain such
agreements with a sufficient number of providers, there can be no assurance that
Atlantic will be able to do so on a timely basis or under favorable terms.

DEPENDENCE ON LONG-TERM RELATIONSHIPS WITH MANAGED CARE HEALTH PLANS, INSURANCE
CARRIERS, EMPLOYERS AND OTHER BUYERS OF HEALTH CARE SERVICES

Atlantic's profitability and long-range business plans will be
dependent upon its entering into contracts and long-term relationships between
Atlantic and managed care health plans, insurance carriers, employers and other
buyers of health care services. Consistent with this strategy, Atlantic entered
into a series of agreements with Kanawha Insurance Company ("Kanawha") to
develop a variety of health plans to be marketed to small and large employers in
Atlantic's target markets. In connection with these agreements, Atlantic and
Kanawha formed The Beacon Company ("Beacon"). In June 1998, Atlantic purchased
all of Kanawha's ownership interest in Beacon. The development of Beacon and the
relationship among Atlantic, Beacon and Kanawha has consumed a significant
amount of time and energy of Atlantic's management, and there can be no
assurance that Atlantic and its subsidiaries will be successful in developing
such health plans or in securing new business opportunities for Atlantic.
Although Atlantic, through Beacon, entered into these agreements with Kanawha,
Atlantic continues to meet with managed care health plans and insurance
companies desiring to compete in the Eastern North Carolina marketplace for
enrollees. Additionally, Atlantic continues to develop agreements with managed
care organizations or third party administrators, to facilitate the offering of
services by Atlantic medical practice groups to large partially and fully
self-insured employers. Although Atlantic believes that it will be able to enter
into and maintain such relationships with a sufficient number of buyers of
health care services, there can be no assurance that Atlantic will be able to do
so on a timely basis or under favorable terms.

COMPETITION

The health care industry is very competitive. Atlantic and its
affiliated physicians and medical practice groups compete with individual
physicians and medical practice groups, HMOs, preferred provider organizations
("PPOs"), physician-hospital organizations, integrated delivery systems and
physician practice management companies. Many of Atlantic's competitors are
significantly larger and

21
<PAGE>

have substantially greater capital resources than Atlantic. There is no
assurance that Atlantic will be able to compete effectively against such
competitors. Even though Atlantic's competitors will include certain existing
managed health care plans, such as HMOs, Atlantic intends to market the services
of its integrated, multi-specialty group network to certain other managed health
care plans with which Atlantic will not compete. Atlantic's success and
profitability will be dependent, in part, on its ability to establish contract
relationships with existing health plan organizations, which will provide
Atlantic access to employer buyer coalitions and other insured and self insured
employer groups. Currently, Atlantic has one existing preferred provider
contract with an insurance company and numerous other contracts with
self-insured employers. Atlantic does not have long-term relationships with any
managed care health plan or other buyers of health care services. Continuing
consolidation of the participants in the health care industry could limit
Atlantic's opportunities to establish additional contracts and relationships.

AFFILIATED SERVICE GROUP

Section 414(m) of the Internal Revenue Code of 1986, as amended,
requires that all employees who are employed by members of an "affiliated
service group" be treated as employed by a single employer for purposes of
discrimination testing and certain other requirements imposed on qualified
employee benefit plans. Although Atlantic is organized as a business
corporation, with its business limited to the provision of administrative
services, Atlantic and participating medical providers within the Atlantic
network may be deemed to be an "affiliated service group." In the event Atlantic
and the participating medical providers are found to be an "affiliated service
group," Atlantic's organizational structure and contractual arrangements may
have to be modified. Notwithstanding any such possible modifications, if
Atlantic's or the medical providers' qualified employee benefit plans become
disqualified as a result of the "affiliated service group" issue, participating
physicians may suffer adverse income tax consequences, including immediate
taxation of the employer's contributions to the pension and profit sharing plans
which they and their respective medical providers sponsor.

ANTITRUST LAW

Federal and state antitrust laws prohibit practices that unreasonably
restrain competition. Atlantic believes that its proposed organizational
structure, contemplated contractual arrangements and business operations will be
lawful and will not violate current antitrust laws, even though Atlantic may not
meet the requirements of identified federal antitrust policy statement safety
zones or exemptions. Atlantic is still in its early stages of development, and
certain structures, programs and business operations required for the economic
and clinical integration of participating physicians and medical practice groups
have not been implemented. Many of such structures, programs and business
operations must be implemented and continued to satisfy certain antitrust
requirements, and no assurance can be provided that the requisite structures,
programs and business operations will be implemented in a timely manner and
continued. Moreover, evolving interpretations of antitrust laws and
corresponding statements of enforcement policy could make it necessary for
Atlantic to modify its organizational structure and/or restructure its
contractual arrangements or business operations. If Atlantic is found to be in
violation of federal or state antitrust laws, Atlantic may be subject to fines
of up to $10,000,000 or other sanctions. Even the mere assertion of a violation
of the antitrust laws could have a material adverse effect on Atlantic.

INSURANCE, HMO, PPO AND URO REGULATION

All entities classified as an "insurance company" under North Carolina
law are subject to various state laws regulating the business of insurance which
are enforced by the North Carolina Department of

22
<PAGE>

Insurance ("DOI"). If Atlantic's method for compensating physicians within the
Atlantic network includes the allocation to the medical practice groups of
deficits that result from Atlantic's payment arrangements with health plans and
other purchasers, Atlantic might be deemed an "insurance company" and, as a
result, be subject to North Carolina laws regulating insurance. Current North
Carolina insurance law requirements for insurance companies include, but are not
limited to, the payment of licensing fees, the filing of annual statements, and
the maintaining of certain capitalization and financial reserves. Failure to
comply with these or other requirements could result in the imposition of fines,
penalties, and the disqualification from doing business in North Carolina.

In addition to regulating traditional insurance companies, the DOI is
responsible for the regulation of HMOs, PPOs and utilization review
organizations ("UROs"). While there are no specific regulations governing
physician organizations, the DOI has taken the position that a physician network
organization could become subject to the HMO statute if the physician
organization enters into arrangements which involve the shifting or other
transfer of an "insurance risk." Although Atlantic currently does not have any
risk sharing contracts, nor does it plan to structure itself in such a fashion
as to be regulated by the DOI, Atlantic may enter into such contracts in the
future and at such time may become subject to these regulations. A physician
organization may also become subject to regulation as a PPO and a URO. Although
management of Atlantic believes that its current operations would not require it
to register as a PPO or a URO, no assurance can be given that the DOI would not
take a contrary position. Any challenge by the DOI and requirement that Atlantic
restructure its operations could have a material effect on Atlantic's
operations.

GOVERNMENT REGULATION

Federal and state laws regulate the relationships among providers of
health care services, physicians and other clinicians. These laws include the
fraud and abuse provisions of the Medicare and Medicaid statutes, which prohibit
the soliciting or receiving, or the offering or payment of remuneration, either
directly or indirectly, in return for or to induce a referral of items or
services for Medicare and Medicaid patients. Federal and state statutes impose
restrictions on physician referrals for designated health services to entities
with which the physician has a financial relationship. These laws and applicable
regulations also regulate the submission of claims for the reimbursement of
physician services, or for services incident to those services, provided under
federal health care programs that are false or fraudulent. Violations of these
laws may result in substantial civil and criminal penalties, including civil
monetary penalties, exclusion from the participation in the Medicare and
Medicaid programs, loss of licensure to practice medicine and other penalties.
Such exclusion and penalties, if applied to Atlantic's affiliated medical
practice groups, could have a material adverse effect on Atlantic.

Recently adopted health insurance reform legislation includes important
changes in federal laws regulating fraud and abuse. Statutory provisions
establishing criminal penalties, both fines and imprisonment, for intentionally
fraudulent activity in the provision of health services are included. Claims for
reimbursement that are improperly processed and submitted to federal programs
that result in inappropriately obtained reimbursement can result in civil
penalties. Moreover, persons who have an ownership interest or serve as officers
or managing employees of entities that are convicted or excluded from
participation in such federal programs for filing false or fraudulent claims
would also be subject to exclusion and civil penalties for each day the
individual maintains that interest. Finally, remuneration between organizations
and entities, which provide services to Medicare or Medicaid beneficiaries and
have a written risk sharing agreement, are exempted under Medicare and Medicaid
statutes that prohibit the payment or remuneration to induce or obtain
referrals. These statutes, if applied to Atlantic and its affiliated medical
practice groups, could have a material adverse effect on Atlantic.

23
<PAGE>

Moreover, the laws of many states prohibit physicians from splitting
fees with non-physicians and prohibit non-physician entities from practicing
medicine. Although Atlantic believes its operations as currently contemplated to
be conducted will be in material compliance with existing applicable federal and
state laws, there can be no assurance that Atlantic's existing Medical Services
Provider Agreements will not be successfully challenged as constituting the
unlicensed practice of medicine or that the enforceability of the provisions of
such agreements will not be limited.

There can be no assurance that review of Atlantic's business or the
affiliated physicians' businesses by state or federal courts or regulatory
authorities will not result in a determination that could adversely affect the
operations of Atlantic, the affiliated physicians and medical practice groups or
that the health care regulatory environment will not change so as to restrict
Atlantic's or the affiliated physicians' existing medical practice groups'
operations or their expansion.

In addition to extensive existing governmental health care regulation,
there are numerous initiatives at the federal and state levels for comprehensive
reforms affecting the payment for and availability of health care services.
Certain aspects of these health care proposals, such as further reductions in
Medicare and Medicaid payments and additional prohibitions on physician
ownership, directly or indirectly, of facilities to which they refer patients,
if adopted, could adversely affect Atlantic.

POTENTIAL LEGAL LIABILITIES

Atlantic's health care services involve determinations regarding health
insurance coverage, utilization management and maintenance of patient records.
Although Atlantic does not intend to deliver medical services, it may be forced
to defend medical malpractice or other tort claims made by persons who receive
medical services from participating physicians or medical practice groups. The
legal theories upon which persons might attempt to assert liability against
Atlantic or other comparable companies in the managed health industry continue
to evolve. There is no assurance that Atlantic will not be subject to liability
from litigation which might adversely affect Atlantic's business. Atlantic
currently does not maintain any insurance for such potential liabilities.
Atlantic intends to obtain such insurance at the time it enters into its first
contract with a managed care health plan; however, no assurance can be given
that Atlantic will ever obtain and maintain such insurance.

24
<PAGE>

ITEM 7. FINANCIAL STATEMENTS.

The following Consolidated Financial Statements and Independent Auditors' Report
are included herein on the pages indicated:
PAGE
----
Report of Arthur Andersen LLP......................................F-2

Consolidated Balance Sheets as of December 31, 1998 and 1997.......F-3

Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996...................................F-4

Consolidated Statements of Shareholders' Equity (Deficit)
for the years ended December 31, 1998, 1997 and 1996...............F-5

Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996...................................F-6

Notes to Consolidated Financial Statements..................F-7 - F-11

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

Not applicable.

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<PAGE>

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

(a) Directors, Executive Officers, Promoters and Control Persons
of Atlantic.

The directors and executive officers of Atlantic as of March 15, 1999
are as follows:

Name Age Position
---- --- --------

J. Philip Mahaney, Jr., M.D. 53 President and Chief Executive Officer
and Director*

John P. Emerick, M.D. 49 Treasurer and Director**

W. James Stackhouse, M.D. 49 Chairman of the Board and Director*

Robert H. Blake, III 40 Chief Operating Officer

Stephen W. Nuckolls 31 Chief Financial Officer

Michael L. Bramley, M.D. 51 Vice President and Director*

Charles J. Baio, M.D. 48 Director*

Graham A. Barden, III, M.D. 43 Director*

Mark N. Dumas, M.D. 47 Director*

A. Clark Gaither, M.D. 44 Director*

Frank L. Gay, M.D. 38 Director***

Robert A. Krause, M.D. 50 Director*

Edwin P. Little, M.D. 44 Director*

Michael J. Lobos, M.D. 39 Director**

Robert S. Meyer, M.D. 51 Secretary and Director*

Alice P. Selden, M.D. 46 Director**

Leo E. Waivers, M.D. 46 Director*

Daniel Whitley, Jr., M.D. 47 Director**

John A. Williams, III, M.D. 41 Director**

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<PAGE>

Kerry A. Willis, M.D. 39 Director*

- ------------------------------------

* Primary Director
** Referral Director
*** OB/GYN Director

J. PHILIP MAHANEY, JR., M.D. has served as President and Chief
Executive Officer of Atlantic since March 1996 and has served as a director of
Atlantic since December 1994. He is a family practice physician with Coastal
Carolina Health Care, P.A., a medical practice group located in New Bern, North
Carolina. Dr. Mahaney also serves as the Treasurer of Coastal Carolina Health
Care, P.A.

JOHN P. EMERICK, M.D. has served as a director of Atlantic since August
1997. He is a self-employed psychiatrist in Morehead City, North Carolina where
he has worked since 1995. Dr. Emerick completed his psychiatric residency in
1979 and maintained a practice in Columbia, South Carolina prior to moving to
Morehead City. Dr. Emerick also serves as medical director of Companion Benefit
Alternatives, a division of Blue Cross and Blue Shield of South Carolina.

W. JAMES STACKHOUSE, M.D. has served as the Chairman of the Board of
Directors of Atlantic since April 1998. Prior to becoming Chairman, he served as
the Treasurer of Atlantic from November 1996 to April 1998. He is a physician
practicing internal medicine with Goldsboro Medical Specialists, P.A., a medical
practice group located in Goldsboro, North Carolina. Dr. Stackhouse has been a
physician with Goldsboro Medical Specialists, P.A. since 1981.

ROBERT H. BLAKE, III has been the Chief Operating Officer of Atlantic
since June 1996. From February 1994 to June 1996, he served as Assistant Vice
President, Managed Care Services of Acordia National, Inc., a health insurance
services company in Charleston, West Virginia. From July 1992 to June 1996, he
served as President of The Greenbrier Study Group, a health care consulting firm
in Charleston, West Virginia. From July 1993 to February 1994, Mr. Blake served
as a Managed Care Network and Provider Sponsored Health Plan Developer for
Newbridge, Inc./Health Economics Corporation.

STEPHEN W. NUCKOLLS has been the Chief Financial Officer of Atlantic
since April 1997. He also serves as the Chief Operating Officer of Coastal
Carolina Health Care, PA., a medical practice group located in New Bern, North
Carolina. From September 1995 to July 1996, Mr. Nuckolls served as Chief
Financial Officer of Blue Ridge Primary Care, Inc., an integrated medical group
of over 120 physicians based in Roanoke, Virginia which subsequently merged with
the Carilion Health System. From May 1990 to September 1995, Mr. Nuckolls was
employed by McGladrey & Pullen, LLC, an international accounting and consulting
firm.

MICHAEL L. BRAMLEY, M.D. has served as Vice President of Atlantic since
November 1996 and as a director of Atlantic since October 1996. He is a
practicing pediatrician with Greenville Pediatrics, P.A., a medical practice
group located in Greenville, North Carolina. Dr. Bramley has been with
Greenville Pediatrics, P.A. since 1976 and also serves as Secretary of
Greenville Pediatrics, P.A.

CHARLES J. BAIO, M.D. has served as a director of Atlantic since April
1997. He practices internal medicine with Wilson Medical Associate, P.A., in
Wilson, North Carolina. Dr. Baio has practiced medicine since 1984.

27
<PAGE>

GRAHAM A. BARDEN, III, M.D. FAAP has served as a director of Atlantic
since April 1997. He is a practicing pediatrician with Coastal Childrens'
Clinic, Inc., a pediatric practice group located in New Bern, North Carolina.
Dr. Barden has been a pediatrician with Coastal Childrens' Clinic, Inc. since
1986.

MARK N. DUMAS, M.D. has served as a director of Atlantic since November
1998. He practices internal medicine with Kinston Medical Specialists, P.A., in
Kinston, North Carolina where he has worked since 1986.

A. CLARK GAITHER, M.D. has served as a director of Atlantic since June
1995. He is a practicing physician with Goldsboro Family Physicians, P.A., a
medical practice group located in Goldsboro, North Carolina. He also serves as
President of Goldsboro Family Physicians, P.A. and has practiced medicine with
Goldsboro Family Physicians, P.A. since 1992.

FRANK L. GAY, M.D. has served as a director of Atlantic since June
1997. He has practiced obstetrics/gynecology with Greenville Obstetrics and
Gynecology, a division of Physicians East, P.A., a medical practice group
located in Greenville, North Carolina for over three years. Prior to joining
this group, Dr. Gay served as a staff Obstetrician/Gynecologist for the United
States Air Force for four years.

ROBERT A. KRAUSE, M.D. has served as a director of Atlantic since
December 1994. He is a self-employed family practitioner. He has served in such
a capacity since 1989.

EDWIN P. LITTLE, M.D. has served as a director of Atlantic since
November 1998. He has practiced family medicine in Pink Hill, North Carolina
since 1983. He was self-employed until he joined Kinston Medical Specialists,
P.A. in 1996.

MICHAEL J. LOBOS, M.D. has served as a director of Atlantic since
October 1998. He has practiced urology with Washington Urological Associates,
P.A. located in Washington, North Carolina since 1992.

ROBERT S. MEYER, M.D. has served as Secretary and as a director of
Atlantic since March 1996. Dr. Meyer is a self-employed family practice
physician. Dr. Meyer has practiced family medicine since 1978. Dr. Meyer is the
Chairman of the Board and Medical Director for Home Health and Hospice CARE,
Inc., a non-profit home health agency headquartered in Goldsboro, North
Carolina.

ALICE P. SELDEN, M.D. has served as a director of Atlantic since
November 1997. She practices general surgery with Johnston Surgical Associates,
P.A., a medical practice located in Smithfield, North Carolina. Dr. Selden has
practiced general surgery in Smithfield since 1986.

LEO E. WAIVERS, M.D. has served as a director of Atlantic since October
1996. He practices general internal medicine with Greenville Internal Medicine,
P.A., a medical practice group located Greenville, North Carolina. He serves as
President of Greenville Internal Medicine, P.A. and has practiced internal
medicine with Greenville Internal Medicine, P.A. since 1991.

DANIEL WHITLEY, JR., M.D. has served as a director of Atlantic since
August 1997. He is a practicing otolaryngologist with Goldsboro ENT Associates,
P.A. where he has practiced since completing his residency in 1988.

28
<PAGE>

JOHN A. WILLIAMS, III, M.D. has served as a director of Atlantic since
August 1997. He is a practicing cardiologist with Heart Center Cardiology, a
medical practice group located in New Bern, North Carolina. Prior to founding
his practice in 1994, Dr. Williams served as a lieutenant commander for four
years in the United States Navy Reserve Medical Corps in the Cardiovascular
Disease Division at the National Naval Medical Center in Bethesda, Maryland.

KERRY A. WILLIS, M.D. has served as a director of Atlantic since
December 1994 and the Chairman of the Board of Directors of The Beacon Company
(a wholly owned subsidiary of Atlantic) since April 1998. From March 1996 to
April 1998, Dr. Willis served as Chairman of the Board of Directors of Atlantic,
and from December 1994 to March 1996 as Vice President of Atlantic. He is a
family practice physician with East Carteret Family Medicine, P.A., a medical
practice group located in Beaufort, North Carolina. In addition, Dr. Willis
serves as the President of East Carteret Family Medicine, P.A.

(b) Section 16(a) Beneficial Ownership Reporting Compliance.

Not applicable.

ITEM 10. EXECUTIVE COMPENSATION.

The following table sets forth the cash and non-cash compensation for
the fiscal years ended December 31, 1997 and 1998 awarded to or earned by the
Chief Operating Officer and the President and Chief Executive Officer of
Atlantic. Other than the Chief Operating Officer, no executive officer of
Atlantic earned over $100,000 in the fiscal year ended December 31, 1998.

SUMMARY COMPENSATION TABLE

ANNUAL COMPENSATION
NAME AND -------------------------
PRINCIPAL POSITION YEAR SALARY BONUS
------------------ ---- ------- --------

J. Philip Mahaney, Jr., M.D. 1998 $24,000 $ 0
PRESIDENT AND CHIEF EXECUTIVE OFFICER 1997 24,000 0

Robert H. Blake, III 1998 96,000 15,000
CHIEF OPERATING OFFICER 1997 96,000 0

OPTIONS

No options have been granted to executive officers since Atlantic's
inception.

DIRECTOR COMPENSATION

The Chairman of the Board of Directors of Atlantic, W. James
Stackhouse, M.D., received $16,000 during 1998 in compensation for his services
to the Board from the time of his election in April 1998. Kerry A. Willis, M.D.,
the former Chairman of the Board of Directors of Atlantic and the current
Chairman of the Board of Directors of The Beacon Company, received $24,000
during 1998 in compensation for his services as Chairman of the Board of
Atlantic through April 1998 and as Chairman of The Beacon Company from April
1998 through December 1998. No other members of the Board of

29
<PAGE>

Directors of Atlantic currently receive compensation for their service on the
Board. They may be reimbursed by Atlantic for any out-of-pocket expenses
incurred in connection with their service on the Board.

In February 1999, the Board implemented a policy designed to compensate
shareholder and other physicians for their time and effort devoted to the
organization. While no compensation other than direct expenses will be paid by
Atlantic or The Beacon Company for attendance at Board or committee meetings,
Atlantic will compensate physicians at a rate of $75.00 per hour for performing
services on behalf of Atlantic or Beacon outside of such meetings.

EMPLOYMENT AGREEMENT

On June 1, 1996, Atlantic entered into an employment agreement with
Robert H. Blake, III under which Mr. Blake agreed to serve as the Chief
Operating Officer of Atlantic. The initial term of the agreement expired on
December 31, 1996 and contained provisions providing for the maintenance of
confidentiality of proprietary information of Atlantic. Atlantic and Mr. Blake
have orally extended the term of the Agreement beyond December 31, 1996 for an
indefinite period. Effective January 1, 1999 the Board of Directors increased
Mr. Blake's base salary to $99,840.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

The following tables set forth certain information regarding the
beneficial ownership of the Primary Class Common Shares, Referral Class Common
Shares and Nonprofit Class Nonvoting Common Shares of Atlantic, respectively, as
of March 15, 1999 for (i) each person known by Atlantic to beneficially own more
than 5% of any class of the shares of the capital stock of Atlantic, (ii) each
executive officer named in the Summary Compensation Table, (iii) each director
of Atlantic, and (iv) all directors and executive officers of Atlantic as a
group. Shares not outstanding but deemed beneficially owned by virtue of the
right of an individual or group to acquire them within 60 days are treated as
outstanding only when determining the amount and percentage owned by such
individual or group. Unless otherwise noted, each person or group identified has
sole voting and investment power with respect to the shares of capital stock
shown.

PRIMARY CLASS COMMON SHARES
PRIMARY
CLASS COMMON SHARES
BENEFICIALLY OWNED (1)(2)
-----------------------------
NAME AMOUNT PERCENT OF CLASS (3)
- --------------------------------------------- ------ -------------------
J. Philip Mahaney, Jr., M.D.................. 2,000 *
Robert H. Blake, III......................... 0 *
Charles J. Baio, M.D......................... 2,000 *
Graham A. Barden, III M.D.................... 2,000 *
Michael L. Bramley, M.D...................... 2,000 *
Mark N. Dumas, M.D. ......................... 2,000 *
John P. Emerick, M.D......................... 0 *
A. Clark Gaither, M.D........................ 2,000 *
Frank L. Gay, M.D............................ 0 *

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<PAGE>

Robert A. Krause, M.D........................ 2,000 *
Edwin P. Little, M.D. ....................... 2,000 *
Michael J. Lobos, M.D. ...................... 0 *
Robert S. Meyer, M.D......................... 2,000 *
Alice P. Selden, M.D......................... 0 *
W. James Stackhouse, M.D..................... 2,000 *
Leo E. Waivers, M.D.......................... 2,000 *
Daniel Whitley, M.D.......................... 0 *
John A. Williams, M.D........................ 0 *
Kerry A. Willis, M.D......................... 2,000 *

All directors and executive
officers as a group.......................... 24,000 7.7%
(20 persons)

- ---------------

* Less than 1% of the issued and outstanding Primary Class Common Shares.

(1) Shares not outstanding but deemed beneficially owned by virtue of the
right of a person or member of a group to acquire them within 60 days
are treated as outstanding only when determining the amount and percent
owned by such person or group.

(2) Unless otherwise noted, all of the shares shown are held by individuals
or entities possessing sole voting and investment power with respect to
such shares.

(3) Based on 312,500 Primary Class Common Shares outstanding as of March
15, 1998.

REFERRAL CLASS COMMON SHARES
REFERRAL CLASS COMMON SHARES
BENEFICIALLY OWNED (1)(2)
-----------------------------
NAME AMOUNT PERCENT OF CLASS (3)
- --------------------------------------------- ------ -------------------
J. Philip Mahaney, M.D....................... 0 *
Robert H. Blake, III......................... 0 *
Charles J. Baio, M.D......................... 0 *
Graham A. Barden, III, M.D................... 0 *
Michael L. Bramley, M.D...................... 0 *
Mark N. Dumas, M.D. ......................... 0 *
John P. Emerick, M.D......................... 2,000 *
A. Clark Gaither, M.D........................ 0 *
Frank L. Gay, M.D............................ 2,000 *
Robert A. Krause, M.D........................ 0 *
Edwin P. Little, M.D. ....................... 0 *
Michael J. Lobos, M.D. ...................... 2,000 *
Robert S. Meyer, M.D......................... 0 *
Alice P. Selden, M.D......................... 2,000 *
W. James Stackhouse, M.D..................... 0 *

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<PAGE>

Leo E. Waivers, M.D.......................... 0 *
Daniel Whitley, Jr., M.D..................... 2,000 *
John A. Williams, III, M.D................... 2,000 *
Kerry A. Willis, M.D......................... 0 *

All directors and executive
officers as a group.......................... 12,000 2.6%
(20 persons)

- ---------------

* Less than 1% of the issued and outstanding Referral Class Common
Shares.

(2) Unless otherwise noted, all of the shares shown are held by individuals
possessing sole voting and investment power with respect to such
shares.

(3) Based on 454,000 Referral Class Common Shares outstanding as of March
15, 1999.

NONPROFIT CLASS NONVOTING COMMON SHARES
NONPROFIT CLASS NONVOTING COMMON
SHARES BENEFICIALLY OWNED(1)(2)
-----------------------------
NAME AMOUNT PERCENT OF CLASS (3)
- --------------------------------------------- ------ -------------------
Rural Health Group, Inc.(4).................. 2,000 50.0%
Aurora Medical Center(5)..................... 2,000 50.0%
J. Philip Mahaney, M.D....................... 0 *
Robert H. Blake, III......................... 0 *
Charles J. Baio, M.D......................... 0 *
Graham A. Barden, III, M.D................... 0 *
Michael L. Bramley, M.D...................... 0 *
Mark N. Dumas, M.D. ......................... 0 *
John P. Emerick, M.D......................... 0 *
A. Clark Gaither, M.D........................ 0 *
Frank L. Gay, M.D............................ 0 *
Robert A. Krause, M.D........................ 0 *
Edwin P. Little, M.D. ....................... 0 *
Michael J. Lobos, M.D. ...................... 0 *
Robert S. Meyer, M.D......................... 0 *
Alice P. Selden, M.D......................... 0 *
W. James Stackhouse, M.D..................... 0 *
Leo E. Waivers, M.D.......................... 0 *
Daniel Whitley, Jr., M.D..................... 0 *

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<PAGE>

John A. Williams, III, M.D................... 0 *
Kerry A. Willis, M.D......................... 0 *

All directors and executive
officers as a group.......................... 0 *
(20 persons)

- ---------------
* Less than 1% of the issued and outstanding Nonprofit Class Nonvoting
Common Shares.

(2) Unless otherwise noted, all of the shares shown are held by individuals
or entities possessing sole voting and investment power with respect to
such shares.

(3) Based on 4,000 Nonprofit Class Nonvoting Common Shares outstanding as
of March 15, 1999.

(4) Rural Health Group, Inc.'s principal address is P.O. Box 644, Jackson,
North Carolina 27845.

(5) The principal address of Aurora Medical Center, a division of Beaufort
County Hospital, is P.O. Box 639, Aurora, North Carolina 27806.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

All shareholders of the Primary Class Common Shares and the Referral
Class Common Shares of Atlantic are required to enter into, or practice medicine
through a medical practice group that has entered into, a Medical Services
Provider Agreement with Atlantic. Correspondingly, each member of the Board of
Directors has entered into or has agreed to enter into or practices medicine
through a medical practice group, of which he or she is a shareholder, which has
entered into or has agreed to enter into, a Medical Services Provider Agreement.
In addition, upon execution of the Medical Services Provider Agreement,
participating physicians and medical practice groups who are referral
specialists are required to pay to Atlantic an initial administrative and
management fee up to $3,000 per Referral Physician. As of the date hereof, it is
not possible to determine the amount which will be paid to the respective
physicians or medical practice groups pursuant to the terms of the Medical
Services Provider Agreement.

In January 1997, Atlantic entered into a written lease with New Bern
Family Practice Center, P.A., of which Dr. Mahaney, Atlantic's President and
Chief Executive Officer, is a shareholder and Treasurer. The lease expired
December 31, 1997 and was extended on a month-to-month basis to May 1998.
Monthly rent was approximately $520.00. Prior to this arrangement, Atlantic
occupied the space rent free pursuant to an oral lease entered into in March
1996. In May 1998, Atlantic moved its offices to 1315 S. Glenburnie Road, Suite
A5, New Bern, North Carolina 28562, and signed two one-year leases for an
aggregate of approximately 1,300 square feet at an aggregate monthly rent of
approximately $805 (including association fees).

Atlantic entered into certain agreements with Kanawha in February 1998.
These agreements outline duties and responsibilities of each organization to
develop a variety of health plans to be

33
<PAGE>

marketed to small and large employers in Atlantic's target markets. Initially,
the parties intended to develop and distribute HMO, PPO and third party
administrator health plan products. Since the agreements were executed, Kanawha
has exited the HMO marketplace in North Carolina. However, Atlantic and Kanawha
are still working together to launch a preferred provider organization and
jointly market their health plan products to self-insured payors.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits.

The exhibits to this Report are listed on the Exhibit Index on page E-1
below. A copy of any of the exhibits listed or referred to above will be
furnished at a reasonable cost to any person who was a shareholder of Atlantic
as of December 31, 1998, upon receipt from any such person of a written request
for any such exhibit. Such request should be sent to Atlantic Integrated Health
Incorporated, 1315 S. Glenburnie Road, Suite A5, New Bern, North Carolina 28562;
Attn.: Shareholder Information.

The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual Report on
Form 10-KSB:

A. Employment Agreement between Atlantic and Robert H. Blake III,
effective as of June 1, 1996 (incorporated by reference to
Exhibit 10.6 to Atlantic's Registration Statement on Form SB-2
(File No. 333-5826)).

(b) Reports on Form 8-K.

No reports on Form 8-K were filed during the fourth quarter of the
fiscal year ended December 31, 1998.

34
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND SUBSIDIARY

CONSOLIDATED FINANCIAL STATEMENTS AS OF
DECEMBER 31, 1998, 1997 AND 1996
TOGETHER WITH REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Atlantic Integrated Health Incorporated and Subsidiary:

We have audited the accompanying consolidated balance sheets of Atlantic
Integrated Health Incorporated and Subsidiary (a North Carolina corporation) as
of December 31, 1998 and 1997, and the related consolidated statements of
operations, changes in stockholders' equity (deficit) 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Atlantic Integrated
Health Incorporated and Subsidiary 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.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has yet to generate revenue in
excess of expenses and has an accumulated deficit at December 31, 1998, of
$472,849, which raises substantial doubt about its ability to continue as a
going concern. The 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.

/s/ Arthur Andersen LLP

Charlotte, North Carolina,
March 12, 1999.

F-2
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND AFFILIATE

SHEETS -- DECEMBER 31, 1998 AND 1997

<TABLE>
<CAPTION>
ASSETS 1998 1997
---------------------------------- --------- ---------
<S> <C> <C>
CURRENT ASSETS:
Cash $ 115,507 $ 101,776
Accounts receivable, less allowance for uncollectible accounts
of $5,000 in 1998 and 1997 64,934 30,505
Prepaid expenses 3,562 5,297
--------- ---------
Total current assets 184,003 137,578
INVESTMENT 0 1,000
OFFICE EQUIPMENT, net 6,803 9,322
DEFERRED COSTS 82,711 17,107
--------- ---------
$ 273,517 $ 165,007
========= =========

LIABILITIES AND STOCKHOLDERS'
EQUITY
----------------------------------
CURRENT LIABILITIES - Accounts payable $ 45,766 $ 24,761
--------- ---------
LONG-TERM DEBT - Convertible debenture and accrued interest 92,700 0
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes 1 and 5)
STOCKHOLDERS' EQUITY:
Common stock - $1 par value-
Primary class, authorized 1,000,000 shares; 302,500 and
292,500 shares issued and outstanding in 1998 and
1997, respectively 302,500 292,500
Referral class, authorized 1,800,000 shares; 370,000 and
262,000 shares issued and outstanding in 1998 and
1997, respectively 370,000 262,000
Nonprofit class, nonvoting, authorized 200,000 shares;
2,500 shares issued and outstanding in 1998 and 1997,
respectively 2,500 2,500
Additional paid-in capital 74,000 74,000
Syndication costs (105,000) (95,000)
Stock subscription and stockholder notes receivable (36,100) (49,885)
Accumulated deficit (472,849) (345,869)
--------- ---------
Total stockholders' equity 135,051 140,246
--------- ---------
$ 273,517 $ 165,007
========= =========
</TABLE>

The accompanying notes to consolidated financial statements
are an integral part of these balance sheets.

F-3
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND AFFILIATE

CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
REVENUE $ 283,413 $ 283,240 $ 58,927
--------- --------- ---------
EXPENSES:
Consulting fees 21,063 135,717 72,664
Salaries and wages 291,410 251,803 85,799
Relocation expenses 0 0 8,013
Recruiting and education 12,196 6,781 13,472
Office expense and other 67,246 44,907 17,210
Rent 10,018 4,420 4,000
Interest 2,700 0 0
Depreciation and amortization 8,320 7,458 1,473
Provision for uncollectible accounts 0 5,000 0
--------- --------- ---------
Total expenses 412,953 456,086 202,631
--------- --------- ---------
OPERATING LOSS (129,540) (172,846) (143,704)
INTEREST INCOME 2,560 977 0
--------- --------- ---------
NET LOSS $(126,980) $(171,869) $(143,704)
========= ========= =========

NET LOSS PER BASIC COMMON SHARE $ (.20) $ (.41) $ (1.31)
BASIC AVERAGE COMMON SHARES OUTSTANDING 620,167 416,688 109,875
========= ========= =========
</TABLE>

The accompanying notes to consolidated financial statements
are an integral part of these balance sheets.

F-4
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND AFFILIATE

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

COMMON STOCK ADDITIONAL
----------------------- PAID-IN SYNDICATION
SHARES AMOUNT CAPITAL COSTS
------- --------- --------- ---------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995 91,000 $ 91,000 $ 24,000 $ 0
Issuance of common stock for $1 per share 100,000 100,000 0 0
Collections of stock subscription receivable 0 0 0 0
Syndication costs 0 0 0 (75,000)
Net loss for the year ended December 31, 1996 0 0 0 0
Capital contributions 0 0 50,000 0
------- --------- --------- ---------
BALANCE, December 31, 1996 191,000 191,000 74,000 (75,000)
Issuance of common stock for $1 per share 372,000 372,000 0 0
Collections of stock subscription receivable 0 0 0 0
Write-off of stock subscription receivable (6,000) (6,000) 0 0
Syndication costs 0 0 0 (20,000)
Net loss for the year ended December 31, 1997 0 0 0 0
------- --------- --------- ---------
BALANCE, December 31, 1997 557,000 557,000 74,000 (95,000)
Issuance of common stock for $1 per share 118,000 118,000 0 0
Syndication costs 0 0 0 (10,000)
Net loss for the year ended December 31, 1998 0 0 0 0
------- --------- --------- ---------
BALANCE, December 31, 1998 675,000 $ 675,000 $ 74,000 $(105,000)
======= ========= ========= =========
</TABLE>

[WIDE TABLE CONTINUED FROM ABOVE]

<TABLE>
<CAPTION>
STOCK
SUBSCRIPTION
AND STOCKHOLDER ACCUMULATED
NOTES RECEIVABLE DEFICIT TOTAL
--------- --------- ---------
<S> <C> <C> <C>
BALANCE, December 31, 1995 $ (64,500) $ (30,296) $ 20,204
Issuance of common stock for $1 per share 0 0 100,000
Collections of stock subscription receivable 46,125 0 46,125
Syndication costs 0 0 (75,000)
Net loss for the year ended December 31, 1996 0 (143,704) (143,704)
Capital contributions 0 0 50,000
--------- --------- ---------
BALANCE, December 31, 1996 (18,375) (174,000) (2,375)
Issuance of common stock for $1 per share (49,885) 0 322,115
Collections of stock subscription receivable 12,375 0 12,375
Write-off of stock subscription receivable 6,000 0 0
Syndication costs 0 0 (20,000)
Net loss for the year ended December 31, 1997 0 (171,869) (171,869)
--------- --------- ---------
BALANCE, December 31, 1997 (49,885) (345,869) 140,246
Issuance of common stock for $1 per share 13,785 0 131,785
Syndication costs 0 0 (10,000)
Net loss for the year ended December 31, 1998 0 (126,980) (126,980)
--------- --------- ---------
BALANCE, December 31, 1998 $ (36,100) $(472,849) $ 135,051
========= ========= =========
</TABLE>

The accompanying notes to consolidated financial statements
are an integral part of these balance sheets.

F-5
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND AFFILIATE

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(126,980) $(171,869) $(143,704)
Adjustments to reconcile net loss to net cash used in
operating activities-
Depreciation and amortization 8,320 7,458 1,473
Provision for uncollectible accounts 0 5,000 0
Increase in accounts receivable (34,429) (35,505) 0
Decrease (increase) in prepaid expenses 1,736 (5,297) 0
Noncash contributions of capital 0 0 50,000
Increase in accrued interest payable 2,700 0 0
Increase (decrease) in accounts payable 21,005 (53,492) 1,906
--------- --------- ---------
Net cash used in operating activities (127,648) (253,705) (90,325)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of office equipment (1,240) (9,217) (3,334)
Purchase of investment, net of cash acquired 20,834 (1,000) 0
Payment of organization costs 0 0 (5,044)
--------- --------- ---------
Net cash provided by (used in) investing
activities 19,594 (10,217) (8,378)
--------- --------- ---------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Proceeds from issuance of common stock 121,785 302,115 146,125
Collection of stock subscription receivable 0 12,375 0
--------- --------- ---------
Net cash provided by financing activities 121,785 314,490 146,125
--------- --------- ---------
NET INCREASE IN CASH 13,731 50,568 47,422
CASH, beginning of year 101,776 51,208 3,786
--------- --------- ---------
CASH, end of year $ 115,507 $ 101,776 $ 51,208
========= ========= =========
SUPPLEMENTAL DISCLOSURES:
Syndication costs financed through accounts payable $ 0 $ 20,000 $ 75,000
Write-off of subscriptions receivable 0 6,000 0
Common stock issued in exchange for notes 18,235 49,885 0
========= ========= =========
ACQUISITION OF THE BEACON COMPANY:
Fair market value of development costs acquired $ 70,166 $ 0 $ 0
Assumption of subordinated convertible debenture 90,000 0 0
========= ========= =========
</TABLE>

The accompanying notes to combined financial statements
are an integral part of these statements.

F-6
<PAGE>

ATLANTIC INTEGRATED HEALTH INCORPORATED AND AFFILIATE

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996

1. ORGANIZATION AND CONTINUITY OF OPERATIONS:

Atlantic Integrated Health Incorporated, a North Carolina corporation (the
Company), was organized on December 5, 1994. The Company acquired The Beacon
Company (Beacon) during 1998 (see Note 4). The Company is an independent,
physician-owned and governed medical practice group network, organized to
provide administrative services to participating physicians and medical practice
groups. Currently, the Company is in the process of integrating, economically
and clinically, physicians now practicing primarily in single specialty practice
groups into a larger multi-specialty network of medical practice groups.

The Company operated in the development stage until late in 1996 when it began
to generate operating revenue. Since inception, the Company has expended
significant funds on raising capital, developing a business plan, addressing
other organizational matters and resolving legal and administrative matters.
Operating losses have resulted in an accumulated deficit of $472,849 at December
31, 1998. If the Company does not realize additional revenue in the near future,
it will require additional capital which may not be available.

The success of the Company is dependent upon its ability to maintain and expand
its integrated network of physicians and to further its managed care contracting
efforts. As such, the Company's ability to continue as a going concern is
dependent upon many factors, the most significant of which include:

o Being able to compete against established competitors with
substantially greater capital resources.

o Being able to maintain and expand its network of qualified
physicians and other health care providers.

o Being able to operate in an evolving regulatory environment,
particularly with respect to antitrust laws, fraud and abuse and
other anti-referral laws, insurance regulation and healthcare
reform.

Management's plans to address the above matters include:

o Seeking improvements in the delivery of healthcare services in order
to enhance the quality and cost-effectiveness of care provided to
patients served by the participating physician network.

F-7
<PAGE>

o Integrating and coordinating the delivery of healthcare services by
participating medical practice groups.

o Developing a flexible organizational structure that will meet the
requirements of an evolving regulatory environment.

In October 1996, the Company filed a registration statement on Form SB-2 with
the Securities and Exchange Commission registering for sale shares of common
stock under federal securities laws. The minimum offering requirements were met
and the offering was extended through July 28, 1997. On September 22, 1997, the
Company filed Post-Effective Amendment #2 to the Company's Registration
Statement on Form SB-2 to update the prospectus to extend the offering period
through April 28, 1998. The Commission declared Post-Effective Amendment #2
effective on September 30, 1997. On June 24, 1998, the Company filed a
Post-Effective Amendment No. 3 to its Registration Statement on Form SB-2 to
extend its stock offering which terminated on April 28, 1998. On August 7, 1998,
the Company filed a Post-Effective Amendment No. 4 to its Registration Statement
in response to comments received from the Securities and Exchange Commission.
The Securities and Exchange Commission declared the Post-Effective Amendment No.
4 effective on August 12, 1998. Since the initial offering period which began
December 30, 1996, the Company sold an aggregate of 146,000 Primary Class Common
Shares, 344,000 Referral Class Common Shares and no Nonprofit Class Nonvoting
Common Shares. The Company sold an aggregate of 156,500 Primary Class Common
Shares, 26,000 Referral Class Common Shares and 2,500 Nonprofit Class Nonvoting
Common Shares during the period from inception of the Company through the
initial offering period under federal and state securities offering exemptions.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and
Beacon. All significant intercompany accounts and transactions have been
eliminated in consolidation.

OFFICE EQUIPMENT

Office equipment acquisitions are recorded at cost. Depreciation is provided for
each class of depreciable asset and is computed using accelerated methods over
the estimated economic useful lives. These lives range from five to seven years.

DEFERRED COSTS

Deferred costs consist of costs incurred in connection with establishing the
legal structure of the Company and the development of Beacon service lines.
These costs are being amortized over a period of five years.

F-8
<PAGE>

SYNDICATION COSTS

Certain fees and expenses relating to the sale of common stock were charged
against stockholders' equity.

USE OF ESTIMATES

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 and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.

RECENT ACCOUNTING PRONOUNCEMENT

Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of Start-up
Activities," issued in April 1998, provides guidance on the financial reporting
of start-up costs and organization costs. SOP 98-5 applies to all
nongovernmental entities and requires costs of start-up activities and
organization costs to be expensed as incurred. SOP 98-5 will be effective for
the Company for the fiscal year beginning January 1, 1999. As of December 31,
1998, the Company and Beacon had approximately $83,000, net of amortization, of
organization and start-up costs. Initial application of SOP 98-5 will be
reported as a cumulative effect of a change in accounting principle.

RECLASSIFICATIONS

Certain amounts in the 1996 and 1997 financial statements have been reclassified
in order to conform to the 1998 presentation.

3. STOCK SUBSCRIPTION AND STOCKHOLDER NOTES RECEIVABLE:

The stock subscription and stockholder notes receivable consists of amounts due
from stockholders at December 31, 1998 and 1997, related to the issuance of
shares of the Company's $1 par common stock at a price of $1.00 per share.

4. INVESTMENT:

The Company, in conjunction with Kanawha Insurance Company (Kanawha), formed
Beacon in January 1997 and each contributed $1,000 of capital for a 50% interest
in Beacon. Beacon plans to market and sell health care services and related
employee benefit products, primarily in eastern North Carolina. The Company
accounted for its investment on the equity method.

F-9
<PAGE>

On June 24, 1998, the Company purchased all of the shares of common stock of
Beacon held by Kanawha in exchange for $1,000 cash and the issuance by Beacon of
a convertible, subordinated debenture in the principal amount of $90,000 (the
Debenture). The Debenture is due and payable on June 30, 2003, and bears
interest at the rate of 6% per annum. The Debenture is convertible into 4% of
Beacon's outstanding common stock if Beacon completes a public offering of its
common stock. Beacon does not have any right to redeem the Debenture prior to
maturity. Upon the occurrence of an Event of Default, as defined under the
Debenture, the entire unpaid principal and accrued interest will become
immediately due and payable.

As a result, Beacon has been consolidated with the Company as of December 31,
1998, and for the period from June 24, 1998, through December 31, 1998.

5. BUY/SELL AGREEMENTS:

Stockholders are required to enter into a buy/sell agreement pursuant to which
the Company will have the option to repurchase the holders' shares under certain
circumstances. Such circumstances will include those in which the holder ceases
to be unconditionally licensed to practice medicine in the State of North
Carolina, ceases to meet the credentialing standards of the Company, ceases to
be actively engaged in the practice of medicine or ceases to be affiliated with
the Company through a medical services provider agreement.

6. MEMORANDUM OF UNDERSTANDING:

On May 23, 1996, the Company entered into a Memorandum of Understanding (MOU)
with several other eastern North Carolina-based providers. The purpose of the
MOU was to provide a medium through which participating entities could work
jointly to develop a business plan for the development and operation of a
management services organization. Pursuant to the provisions of the MOU, the
Company contributed $15,000 in cash along with certain organizational materials
previously developed by the Company. Additionally, the Company performed certain
services on behalf of the project and incurred direct costs of approximately
$78,000. The Company was reimbursed for these expenses in accordance with the
terms specified in the MOU.

7. INCOME TAXES:

The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." This
statement requires the use of the liability method of accounting for deferred
income taxes. Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax reporting purposes.

F-10
<PAGE>

At December 31, 1998 and 1997, the Company had net operating loss carryforwards
of approximately $404,000 and $277,000, respectively, for income tax purposes.
No deferred tax asset has been recorded by the Company as the realization of
such an asset is uncertain at this time. The net operating loss carryforwards
begin expiring in 2010 for federal income tax purposes.

8. RELATED-PARTY TRANSACTIONS:

The Company's chief executive officer and Board chairman have provided
management services and office space at no cost to the Company. The estimated
fair market value of these items has been accounted for as expenses (salaries
and wages and rent) and contributions of capital in the accompanying
consolidated financial statements. The estimated fair market of services
provided under this arrangement was $46,000 for the year ended December 31,
1996. The estimated fair market value of office space provided for the year
ended December 31, 1996, was $4,000. Effective January 1, 1997, the Company
began reimbursing the officers for the estimated fair market value of services
and office space provided by them. The amounts incurred for services and office
space provided under these arrangements was $48,000 and $4,304, respectively,
for the year ended December 31, 1997, and $64,000 and $1,038, respectively, for
the year ended September 31, 1998.

The Company entered into an arrangement with Beacon to provide network
development services. Revenue under this arrangement was $70,000 for the year
ended December 31, 1997. In addition, the Company recognized $72,711 and
$185,350 in revenue from its referral class shareholders for administrative
service fees related to group purchasing, contracting and other services
provided for the years ended December 31, 1998 and 1997, respectively.

F-11
<PAGE>

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

ATLANTIC INTEGRATED HEALTH
INCORPORATED

By: /s/ J. Philip Mahaney, Jr., M.D.
------------------------------------
President and Chief Executive Officer
(principal executive officer)
March 26, 1999

By: /s/ Stephen W. Nuckolls
------------------------------------
Stephen W. Nuckolls
Chief Financial Officer
(principal financial and accounting officer)
March 26, 1999

In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
indicated and on the dates indicated.

Signature and Title

/s/ J. Philip Mahaney, Jr., M.D.
----------------------------------------
J. Philip Mahaney, Jr., M.D.
President and Chief Executive Officer
and Director
March 26, 1999

/s/ W. James Stackhouse, M.D.
----------------------------------------
W. James Stackhouse, M.D.
Chairman of the Board and Director
March 26, 1999

/s/ Charles J. Baio, M.D.
----------------------------------------
Charles J. Baio, M.D.
Director
March 26, 1999

/s/ Graham A. Barden, III M.D.
----------------------------------------
Graham A. Barden, III M.D.
Director
March 26, 1999

35
<PAGE>

/s/ Michael L. Bramley, M.D.
----------------------------------------
Michael L. Bramley, M.D.
Vice President and Director
March 26, 1999

/s/ Mark N. Dumas, M.D.
----------------------------------------
Mark N. Dumas, M.D.
Director
March 26, 1999

/s/ John P. Emerick, M.D.
----------------------------------------
John P. Emerick, M.D.
Treasurer and Director
March 26, 1999

/s/ A. Clark Gaither, M.D.
----------------------------------------
A. Clark Gaither, M.D.
Director
March 26, 1999

----------------------------------------
Frank L. Gay, M.D.
Director
March __, 1999

/s/ Robert A. Krause, M.D.
----------------------------------------
Robert A. Krause, M.D.
Director
March 26, 1999

/s/ Edwin P. Little, M.D.
----------------------------------------
Edwin P. Little, M.D.
Director
March 26, 1999

----------------------------------------
Michael J. Lobos, M.D.
Director
March __, 1999

/s/ Robert S. Meyer, M.D.
----------------------------------------
Robert S. Meyer, M.D.
Secretary and Director
March 26, 1999

36
<PAGE>

----------------------------------------
Alice P. Selden, M.D.
Director
March __, 1999

----------------------------------------
Leo E. Waivers, M.D.
Director
March __, 1999

----------------------------------------
Daniel Whitley, Jr., M.D.
Director
March __, 1999

/s/ John A. Williams, III, M.D.
----------------------------------------
John A. Williams, III, M.D.
Director
March 26, 1999

/s/ Kerry A. Willis, M.D.
----------------------------------------
Kerry A. Willis, M.D.
Chairman of the Board and Director
March 26, 1999

37
<PAGE>

SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT
TO SECTION 15(d) OF THE EXCHANGE ACT BY NON-REPORTING ISSUERS

Atlantic has not sent an annual report or proxy materials to security
holders as of the date hereof. If and when such a report or proxy materials is
sent to security holders, Atlantic shall furnish copies of such material to the
Commission.

38
<PAGE>

ATLANTIC INTEGRATED HEALTH
INCORPORATED

Exhibit Index to Annual Report on
Form 10-KSB
For Fiscal Year Ended December 31, 1998

ITEM NO. DESCRIPTION METHOD OF FILING
- -------- ----------- ----------------

3.1 Amended and Restated Articles of Incorporation of (1)
Atlantic

3.2 Bylaws of Atlantic, as amended (1)

4.1 Specimen form of Atlantic's Primary Class Common (1)
Share Certificate

4.2 Specimen form of Atlantic's Referral Class Common (1)
Share Certificate

4.3 Specimen form of Atlantic's Nonprofit Class (1)
Nonvoting Common Share Certificate

10.1 Form of Subscription and Shareholder Buy/Sell (1)
Agreement (Primary Class Common Shareholder)

10.2 Form of Subscription and Shareholder Buy/Sell (1)
Agreement (Referral Class Common Shareholder)

10.3 Form of Subscription and Shareholder Buy/Sell (1)
Agreement (Nonprofit Class Nonvoting Common
Shareholder)

10.4 Form of Non-Exclusive Medical Services Provider (1)
Agreement (Primary Physicians)

10.5 Form of Non-Exclusive Medical Services Provider (1)
Agreement (Referral Physicians)

10.6 Employment Agreement between Atlantic and Robert H. (1)
Blake III effective as of June 1, 1996

10.7 Form of Facility Participation Agreement (2)

10.8 Contract and Lease dated April 23, 1998 between (3)
Atlantic and Joseph E. Thomas

10.9 Contract and Lease dated April 23, 1998 between (3)
Atlantic and Village Cedars, Inc.

10.10 Convertible, Subordinated Debenture in the (4)
principal amount of $90,000 of The Beacon
Company.

27.1 Financial Data Schedule Filed herewith

E-1
<PAGE>

- ---------------

(1) Incorporated by reference to exhibits contained in Atlantic's
Registration Statement on Form SB-2 (File No. 333-5826).

(2) Incorporated by reference to Exhibit 10.7 contained in Atlantic's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997
(File No. 333-5826).

(3) Incorporated by reference to exhibits contained in Atlantic's
Post-Effective Amendment No. 3 to Atlantic's Registration Statement on
Form SB-2 (File No. 333-5826).

(4) Incorporated by reference to Exhibit 10.11 contained in Atlantic's
Post-Effective Amendment No. 4 to Atlantic's Registration Statement on
Form SB-2 (File No. 333-5826).

E-2

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