<PAGE>
MD
------------
HEALTHSHARES
ANNUAL REPORT
TO SHAREHOLDERS
APRIL 1999
___________________________________________________________________
3029 South Sherwood Forest Blvd., Suite 200, Baton Rouge, LA 70816
<PAGE>
MD HEALTHSHARES CORPORATION
ANNUAL REPORT
April, 1999
_______________
MD HEALTHSHARES CORPORATION is pleased to present this Annual Report to the
shareholders of the Corporation to update you on the progress of the Company and
its subsidiary managed care organization, Patient's Choice. This report is
presented in advance of the Corporation's Annual Meeting, which is scheduled for
Saturday, May 15, 1999, in Baton Rouge.
MEMBERSHIP
A key measure of any plan's progress is its growth in membership, which is now
approaching 10,000 members, mostly in the New Orleans, Baton Rouge, Alexandria
and Shreveport markets. This represents a tremendous jump in membership from
November when our membership was approximately 3,000.
A significant factor in this increase was the conversion to Patient's Choice of
certain members associated with Advantage Health Plan (AHP). Under this
arrangement, which was approved by the Louisiana Department of Insurance, AHP
discontinued its HMO coverage on January 31, 1999. Patient's Choice offered
these members a continuation of coverage on a guaranteed issue basis, and more
than 4,500 members elected to place their coverage with the Company. The
conversion did not include AHP's business with the State Employees Group
Benefits Program or AHP's Medicare risk product. Under the arrangement, the
Company received a cash payment of $1.75 million from AHP. An important element
of this arrangement was the right of Patient's Choice to price this business at
actuarially sound rates. In addition to the increased membership, the conversion
created greater general awareness of the Company in our primary markets among
individuals, employers, brokers and providers.
INFRASTRUCTURE DEVELOPMENT
Much of the Company's energies over the past year focused on the development of
infrastructure and systems to accommodate anticipated rapid expansion and
growth.
Management Information System. Primary was the installation of a management
information and claims payment system. The cost of medical care is a key
indicator of a managed care company's performance. It is essential that a health
plan have immediate access to its data and the capability to shape data into the
reports needed to monitor the Company's performance. The system selected and
just recently installed is user-friendly and highly expandable for significant
increases in membership.
Claims Payment. Claims processing has also improved considerably with the
installation of the new system and the recruitment of a complete claims staff.
Now with the Company's own system and staff in place, we anticipate timely and
accurate processing of claims.
Staffing. The Company is dedicated to providing excellent service to its
customers and providers. To that end we have strengthened our staffing in all
areas with a professional staff of more than 40 individuals. We were fortunate,
because our staffing needs occurred as other managed care
<PAGE>
companies were in the process of moving systems out of state or reducing staff.
The Company benefited from a surplus of talented, experienced managed care staff
who were all anxious to join a new company with strong growth potential. All
areas of the Company have increased its staffing to accommodate the increasing
number of providers serving the plan and the growing number of members. Staffing
is carefully controlled through a key indicator monitoring system with review by
senior management to ensure that the Company maintains a lean level of staffing.
New Offices. The expansion of staff and systems required that MD HealthShares
and Patient's Choice move to a larger headquarters office in Baton Rouge. New
office space was located, and the Company now occupies the second floor of an
office building at 3029 South Sherwood Forest Boulevard. All shareholders are
welcome to visit the offices, meet the staff and observe operations.
MEDICAL AFFAIRS
The past year saw significant accomplishments in the Department of Medical
Affairs. The Medical Executive Committee, comprised of physician advisors from
each region and the chairs of its various committees, completed its training and
is now focused on the real business of medical management for the Company. The
department coordinated the development of 17 Specialty Advisory Work Groups,
which reviewed the guidelines used in the Company's medical management program.
These groups involved the active participation of more than 100 shareholders
from all regions of the state and in every major specialty. With this input, the
Board of Directors approved the Patient's Choice Medical Management Program in
October.
The department also worked with its shareholder psychiatrists to develop a
psychiatric network. Unlike most managed care companies, which "carve out"
mental health services to outside networks, Patient's Choice is working with its
shareholders to design and implement the psychiatric benefits associated with
its various plans. This included contracting with a statewide network to provide
the mental health professionals who complement the work of the psychiatrists.
Other activities in the Department of Medical Affairs included:
. Retaining a Utilization Review Manager, Quality Review Manager, Managed
Care Coordinators, Intake Coordinators, and a full credentials department.
. Preparing and getting approved the Medical Quality Management Program, the
Quality Management/Quality Improvement work plan, and the delegated
credentialing policy.
. Initiating an educational program on Attention Deficit Hyperactivity
Disorder in cooperation with the Louisiana State Medical Society for CME
credit.
NETWORK DEVELOPMENT
The Company's network has been expanded in many regions beyond the original
shareholder providers. The Board of Directors approved this action after
extensive, detailed analysis of the Company's network, the existing gaps in
specialty and regional coverage, and in-depth comparison to networks of
competitive plans. This action was necessary in order for Patient's Choice to
more effectively market its plans and to offer a competitive network to
employers and individuals. The addition of these physicians and groups has
greatly enhanced the marketability of the Company's health plans.
2
<PAGE>
SALES AND MARKETING
Patient's Choice made considerable advances in its sales and marketing efforts.
The Company has weathered the initial skepticism of brokers and employers toward
any new plan in the market. Broker relationships have been strengthened and the
number of quotes submitted to the Company has increased significantly. Account
representatives have been added to more effectively market plans to large and
small groups and to work cooperatively with brokers and consultants. In
addition, the Company added an individual plan in late 1998, which has
successfully attracted additional members with minimal marketing expense.
In addition to the AHP business, the Company was selected by a national
consulting firm to be one of the HMO options for the East Baton Rouge Parish
School System The plan is also the exclusive health insurer for the Rapides
Parish Police Jury and Turner Professional Services, a professional employee
services firm. As these kinds of major groups become affiliated with Patient's
Choice, the Company gains additional attention from other employers and brokers
in each region. As a physician-owned managed care company, Patient's Choice has
benefited from shareholders that are willing to contact and visit employers and
large groups to demonstrate physician support for the Company.
MALPRACTICE INSURANCE DISCOUNT PROGRAM
The MD HealthShares malpractice insurance discount program, conducted in
cooperation with National Advantage Insurance Agency in Baton Rouge, has
successfully placed more than 325 shareholders in new insurance arrangements at
significant discounts in their professional liability insurance premiums.
Through this group purchasing program, National Advantage negotiates new
premiums with either LAMMICO or CNA. Some shareholders have saved as much as
one-half of their premium. If you have not had a quote through this service, it
is worth your time to investigate the possibilities. For more information,
contact our Provider Relations Department.
3
<PAGE>
MD HEALTHSHARES
CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997,
AND RELATED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS, STOCKHOLDERS' EQUITY (DEFICIT),
AND CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD
ENDED DECEMBER 31, 1998 AND INDEPENDENT AUDITORS' REPORT
4
<PAGE>
[LETTERHEAD OF DELOITTE & TOUCHE APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
MD HealthShares Corporation:
We have audited the accompanying consolidated balance sheets of MD HealthShares
Corporation and subsidiary as of December 31, 1998 and 1997, and the related
consolidated statements of operations and comprehensive loss, 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, such consolidated financial statements present fairly, in all
material respects, the financial position of the companies as of December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998 in conformity with
generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
- ---------------------------
March 1, 1999
5
<PAGE>
MD HEALTHSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,112,479 $ 1,408,901
Marketable securities (Note 2) 2,808,827 4,840,825
Premiums receivable 196,851 24,554
Advances to providers 35,000 -
Interest receivable 54,524 55,095
Prepaid expenses 78,613 95,518
----------- -----------
Total current assets 5,286,294 6,424,893
----------- -----------
RESTRICTED DEPOSITS (Note 7) 1,000,000 1,000,000
EQUIPMENT, net of accumulated depreciation
of $65,326 in 1998 and $30,429 in 1997 141,908 75,971
OTHER 36,070 35,378
----------- -----------
TOTAL $ 6,464,272 $ 7,536,242
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Deferred income (Note 6) $ 1,750,000 $ -
Accounts payable and accrued expenses 424,636 122,268
Claims payable and reserves for incurred but
unreported claims (Note 10) 1,038,344 145,131
Deferred premium revenue 81,562 2,385
----------- -----------
Total current liabilities 3,294,542 269,784
----------- -----------
CONTINGENCIES (Note 7) - -
STOCKHOLDERS' EQUITY (Notes 3 and 8):
Junior preferred voting stock, $1.00 par value, liquidation
value $1,000, 7,500 shares authorized, 2,156 and 2,152
shares issued and outstanding in 1998 and 1997, respectively 2,156 2,152
Preferred stock, $1.00 par value, 2,000,000 shares
authorized, none issued and outstanding in 1998 and 1997 - -
Common Stock:
Class A non-voting, $0.10 par value, 8,000,000 shares
authorized, 1,076,600 and 1,075,000 shares issued
and outstanding in 1998 and 1997, respectively 107,660 107,500
Class B, $0.10 par value, 1 share authorized and outstanding
in 1998 and 1997 - -
Additional paid-in capital 11,757,859 11,732,023
Accumulated deficit (8,819,105) (4,590,455)
Treasury stock, at cost, 511 and 503 shares in 1998
and 1997, respectively (16,000) (8,000)
Accumulated other comprehensive income 137,160 23,238
----------- -----------
Total stockholders' equity 3,169,730 7,266,458
----------- -----------
TOTAL $ 6,464,272 $ 7,536,242
=========== ===========
</TABLE>
See notes to consolidated financial statements.
6
<PAGE>
MD HEALTHSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
REVENUE:
Premium revenue $ 3,805,223 $ 313,519 $ -
Investment income 298,916 448,592 222,666
----------- ----------- -----------
Total revenue 4,104,139 762,111 222,666
----------- ----------- -----------
EXPENSES:
Medical service expenses 3,927,899 331,905 -
Selling, general and administrative 4,346,971 3,255,385 1,570,448
Depreciation 57,919 26,605 3,825
Interest expense - - 10,862
----------- ----------- -----------
Total expenses 8,332,789 3,613,895 1,585,135
----------- ----------- -----------
NET LOSS (4,228,650) (2,851,784) (1,362,469)
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized gain (loss) on securities
available-for-sale:
Unrealized holding gains (losses) arising during
the year 87,134 23,238 (15,938)
Reclassification adjustment for losses included
in net loss 26,788 - 15,328
----------- ----------- -----------
Total other comprehensive income (loss) 113,922 23,238 (610)
----------- ----------- -----------
COMPREHENSIVE LOSS $(4,114,728) $(2,828,546) $(1,363,079)
=========== =========== ===========
NET LOSS PER COMMON SHARE - BASIC $(3.93) $(2.66) $(3.05)
=========== =========== ===========
WEIGHTED AVERAGE OUTSTANDING COMMON SHARES 1,076,433 1,072,267 446,308
=========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
7
<PAGE>
MD HEALTHSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK
--------------------------------------------------------------------
JUNIOR PREFERRED CLASS A CLASS B CLASS A
VOTING STOCK NO PAR VALUE NO PAR VALUE NON-VOTING
----------------------------------------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STOCKHOLDER'S DEFICIT, January 1, 1996 - $ - 1 $ 100 - $ - - $ -
ISSUANCE OF COMMON STOCK - - 2,142 11,826,306 1 100 - -
REDEMPTION OF COMMON STOCK - - (1) (100) - - - -
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - - - -
NET LOSS - - - - - - - -
------ ------- ------ ------------ ------ ------ --------- ---------
STOCKHOLDERS' EQUITY, December 31, 1996 - - 2,142 11,826,306 1 100 - -
RECAPITALIZATION (Note 3) 2,142 2,142 (2,142) (11,826,306) (1) (100) 1,071,000 107,100
ISSUANCE OF COMMON STOCK (Note 3) 10 10 - - - - 4,000 400
PURCHASE OF TREASURY STOCK (Note 3) - - - - - - - -
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - - - -
NET LOSS - - - - - - - -
------ ------- ------ ------------ ------ ------ --------- ---------
STOCKHOLDERS' EQUITY, December 31, 1997 2,152 2,152 - - - - 1,075,000 107,500
ISSUANCE OF COMMON STOCK (Note 3) 4 4 - - - - 1,600 160
PURCHASE OF TREASURY STOCK (Note 3) - - - - - - - -
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - - - -
NET LOSS - - - - - - - -
------ ------- ------ ------------ ------ ------ --------- ---------
STOCKHOLDERS' EQUITY, December 31, 1998 2,156 $2,156 - $ - - $ - 1,076,600 $107,660
====== ======= ====== ============ ====== ====== ========= =========
--------------
CLASS B ACCUMULATED
$0.10 PAR VALUE ADDITIONAL OTHER
--------------- PAID-IN ACCUMULATED TREASURY COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT STOCK INCOME TOTAL
STOCKHOLDER'S DEFICIT, January 1, 1996 - $ - $ - $ (376,202) $ - $ 610 $ (375,492)
ISSUANCE OF COMMON STOCK - - - - - - 11,826,406
REDEMPTION OF COMMON STOCK - - - - - - (100)
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - (610) (610)
NET LOSS - - - (1,362,469) - - (1,362,469)
------ ------ ------------ ------------ --------- ------------- -----------
STOCKHOLDERS' EQUITY, December 31, 1996 - - - (1,738,671) - - 10,087,735
RECAPITALIZATION (Note 3) - - 11,717,164 - - - -
ISSUANCE OF COMMON STOCK (Note 3) 1 - 14,859 - - - 15,269
PURCHASE OF TREASURY STOCK (Note 3) - - - - (8,000) - (8,000)
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - 23,238 23,238
NET LOSS - - - (2,851,784) - - (2,851,784)
------ ------ ------------ ------------ --------- ------------- -----------
STOCKHOLDERS' EQUITY, December 31, 1997 1 - 11,732,023 (4,590,455) (8,000) 23,238 7,266,458
ISSUANCE OF COMMON STOCK (Note 3) - - 25,836 - - - 26,000
PURCHASE OF TREASURY STOCK (Note 3) - - - - (8,000) - (8,000)
CHANGE IN UNREALIZED GAIN ON
AVAILABLE-FOR-SALE SECURITIES - - - - - 113,922 113,922
NET LOSS - - - (4,228,650) - - (4,228,650)
------ ------ ------------ ------------ --------- ------------- -----------
STOCKHOLDERS' EQUITY, December 31, 1998 1 $ - $11,757,859 $(8,819,105) $(16,000) $137,160 $ 3,169,730
====== ====== ============ ============ ========= ============= ===========
</TABLE>
See notes to consolidated financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
MD HEALTHSHARES CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
- ---------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,228,650) $(2,851,784) $(1,362,469)
Adjustments to reconcile net loss to cash flows from
operating activities:
Loss on sales of available-for-sale securities 26,788 -- 15,328
Depreciation 57,919 26,605 3,825
Changes in operating assets and liabilities:
Premiums receivable (172,297) (24,554) --
Advances to providers (35,000) -- --
Interest receivable 571 2,378 (54,984)
Prepaid expenses 16,905 52,229 (97,747)
Other (692) (30,153) (5,225)
Deferred income 1,750,000 -- --
Accounts payable and accrued expenses 302,368 (233,588) 314,918
Interest payable -- -- (4,500)
Claims payable and reserves for incurred but
unreported claims 893,213 145,131 --
Deferred premium revenue 79,177 2,385 --
--------- ---------- ----------
Net cash used in operating activities (1,309,698) (2,911,351) (1,190,854)
--------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities (8,782,118) (5,017,311) (355,663)
Sales of available-for-sale securities 10,901,250 199,724 540,480
Sales of restricted investments -- 71,777 --
Purchases of restricted investments -- -- (1,071,777)
Purchases of equipment (123,856) (88,732) (17,669)
--------- ---------- ----------
Net cash provided by (used in) investing activities 1,995,276 (4,834,542) (904,629)
--------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 26,000 15,269 11,826,406
Redemption of common stock -- -- (100)
Purchase of treasury stock (8,000) (8,000) --
Developmental funds provided by the medical community -- -- 585,250
Developmental funds returned to the medical community -- -- (1,041,960)
Repayment of LSMS note payable -- -- (175,462)
--------- ---------- ----------
Net cash provided by financing activities 18,000 7,269 11,194,134
--------- ---------- ----------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS 703,578 (7,738,624) 9,098,651
CASH AND CASH EQUIVALENTS, Beginning of year 1,408,901 9,147,525 48,874
--------- ---------- ----------
CASH AND CASH EQUIVALENTS, End of year $2,112,479 $ 1,408,901 $ 9,147,525
========= ========== ==========
NON-CASH INVESTING AND FINANCING TRANSACTION:
Change in unrealized gain on available-for-sale securities $ 113,922 $ 23,238 $ (610)
========= ========== ==========
</TABLE>
See notes to consolidated financial statements.
9
<PAGE>
MD HEALTHSHARES CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND PRINCIPLES OF CONSOLIDATION - MD HealthShares Corporation
("MDH") was incorporated on July 18, 1995 for the purpose of creating a
health maintenance organization ("HMO") and other healthcare financing
vehicles that provide medical services to HMO enrollees of the HMO and other
types of plans, primarily through contractual arrangements with a network of
hospitals and physicians located in the state of Louisiana. On October 2,
1996, MDH created Patient's Choice, Inc. ("PCI"), a wholly-owned subsidiary
organized to operate on a state-wide basis an independent practice
association HMO, and to administer on a state-wide basis a preferred provider
organization ("PPO"). The Company is engaged primarily in one segment, which
is the provision of medical services to managed care enrollees. The
accompanying consolidated financial statements include the accounts of the
MDH and PCI ("the Company"). Material intercompany balances and transactions
are eliminated in consolidation.
COMPREHENSIVE INCOME (LOSS) - The Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130)
effective January 1, 1998 and has provided the required information for all
periods presented. SFAS No. 130 establishes standards for reporting and
display of comprehensive income (loss) and its major components.
Comprehensive income (loss) includes net loss and other comprehensive income
(loss) which, in the case of the Company, includes only unrealized gains and
losses on securities available-for-sale.
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 disclosure of contingent assets and liabilities at the date
of the financial statements. Estimates also affect the reported amounts of
revenue and expenses during the reporting period. Actual results could
differ from those estimates, the most significant of which relate to incurred
but unreported claims for medical services.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include investments in
highly liquid debt instruments with a maturity of three months or less when
purchased, excluding restricted investments.
MARKETABLE SECURITIES - Marketable securities have been categorized as
available-for-sale and, as a result, are stated at fair value with the
unrealized holding gains and losses reported as accumulated other
comprehensive income within stockholders' equity. All marketable securities
are available for current operations and, therefore, have been classified as
current assets.
RESTRICTED INVESTMENTS - Restricted investments at December 31, 1998 and
1997, which are comprised of certificates of deposit, are recorded at cost
which approximates fair value.
EQUIPMENT - Equipment is recorded at cost, less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the respective equipment, which lives range from 3 to 10
years.
10
<PAGE>
RESERVES FOR INCURRED BUT UNREPORTED CLAIMS - The Company provides reserves
for estimated incurred but unreported physician, hospital, and pharmacy
services rendered to enrolled members during the period. These reserves are
determined by the use of completion factors applied to historical lag
patterns and cost trends. Medical cost adjustments to current period
estimates will be reflected in the operations of future periods and changes
in these estimates could be significant.
REVENUE RECOGNITION - Premium revenues are recognized in the period in which
members are entitled to health care services. Premiums collected in advance
are deferred.
MEDICAL SERVICE EXPENSES - The Company has contractual agreements with
independent physicians, hospitals, pharmacies, and others to provide
comprehensive health care services to enrollees and their eligible
dependents. Contracts with participating physicians provide for
reimbursement for health care services at less than 100% of their established
fees.
REINSURANCE - The Company is covered under a medical reinsurance agreement
that generally provides coverage for 80 percent of eligible hospital services
in excess of $50,000 per member per year. Reinsurance premiums are reported
as health care costs, and reinsurance recoveries are reported as a reduction
of related health care costs. Reinsurance premiums were approximately
$38,000, $3,000 and $-0- in 1998, 1997, and 1996, respectively. No such
recoveries were recorded during 1998, 1997 or 1996.
RISKS AND UNCERTAINTIES - The Company's business could be impacted by
continuing price pressure on new and renewal business, the Company's ability
to effectively control health care costs, additional competitors entering the
Company's markets, federal and state legislation in the area of health care
reform, and governmental licensing regulations of HMOs and insurance
companies. Changes in these areas could adversely impact the Company's
operations in the future.
DEVELOPMENTAL FUNDS PROVIDED BY THE MEDICAL COMMUNITY - Prior to the offering
of 2,142 shares of common stock at $6,000 per share to licensed physicians
who are members of the Louisiana State Medical Society ("LSMS") and whose
principal residences and medical offices (if a practicing physician) are
located in Louisiana, MDH solicited voluntary contributions ("developmental
funds") from the medical community to fund the Company's developmental
(primarily consulting) costs. The Board of Directors resolved to repay all
such developmental funds when the minimum number of shares (2,000) was
issued. Accordingly, such developmental funds (which were non-interest
bearing) were reflected in the 1995 financial statements as developmental
funds provided by the medical community. MDH ceased solicitation of such
developmental funds on February 14, 1996. In December 1996, MDH repaid all
of its developmental funds ($1,041,960) that were provided by the medical
community.
NET LOSS PER COMMON SHARE - BASIC - Basic earnings per share ("EPS") excludes
dilution and is computed by dividing earnings available to common
stockholders by the weighted-average number of common shares outstanding for
the period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. Diluted EPS is computed similarly
to fully diluted EPS pursuant to APB Opinion No. 15.
EMPLOYEE BENEFIT PLAN - All employees meeting eligibility requirements may
participate in the Company's defined contribution plan (the "Plan"). The
Plan is qualified under Internal Revenue Code Section 401(k). Matching
contributions to the Plan are discretionary and determined by the Board of
Directors. For the year ended December 31, 1998, the Company contributed
$27,665 to the Plan through matching contributions. The Company pays
substantially all expenses associated with the Plan.
11
<PAGE>
INCOME TAXES - There are temporary differences in reporting certain expenses
for financial statement and federal income tax purposes. The Company has net
operating loss carryforwards at December 31, 1998 of approximately $7.7
million, which may be used to offset taxable income in future years. Such
carryforwards expire in varying amounts from 2010 to 2018.
Reclassifications - Certain amounts in prior years' consolidated financial
statements have been reclassified to conform to the 1998 presentation.
2. MARKETABLE SECURITIES
Marketable securities at December 31, 1998 and 1997 include the following:
1998
--------------------------------------------
FAIR UNREALIZED UNREALIZED
VALUE GAIN LOSS COST
Marketable equity securities $ 820,423 $163,575 $62,073 $ 718,921
U.S. government and agency
securities 351,154 1,132 167 350,189
Corporate notes 1,637,250 36,661 1,968 1,602,557
---------- -------- ------- ----------
$2,808,827 $201,368 $64,208 $2,671,667
========== ======== ======= ==========
1997
--------------------------------------------
FAIR UNREALIZED UNREALIZED
VALUE GAIN LOSS COST
Marketable equity securities $ 769,137 $47,442 $24,204 $ 745,899
U.S. government and agency
securities 2,549,046 - - 2,549,046
Corporate notes 1,522,642 - - 1,522,642
---------- ------- ------- ----------
$4,840,825 $47,442 $24,204 $4,817,587
========== ======= ======= ==========
For the purpose of determining gross realized gains and losses, the cost of
securities sold is based upon specific identification. The debt securities
above have contractual maturities ranging from one to ten years.
3. STOCKHOLDERS' EQUITY
On August 17, 1996, MDH completed a public offering of 2,142 shares of its
Class A common stock, at a public offering price of $6,000 per share (the
"Offering"). The net proceeds from the Offering of approximately $11.8
million is being used to operate on a state-wide basis an independent
practice association model HMO, and to organize and administer on a state-
wide basis a PPO.
12
<PAGE>
Until March 22, 1997, the initially authorized common stock of MDH consisted
of Class A and Class B common stock. No person could own of record or
beneficially more than one share of Class A stock. The Class A and Class B
common stock could not be sold, assigned, transferred or otherwise disposed
of by any person unless, in the case of the Class A common stock, MDH failed
to exercise its right of first refusal. The right of first refusal specified
that MDH could purchase the Class A common stock from any person at the
lesser of the book value per share or the seller's cost to purchase the
stock. The Class B common stock, which was issued on November 23, 1996,
could, at MDH's option and discretion, be redeemed for $100 upon written
request of the Class B common stockholder, which was the LSMS. Additionally,
the Class A and Class B common stockholders elected twelve and three,
respectively, of the fifteen Directors of MDH.
On March 22, 1997, MDH's stockholders approved a plan of recapitalization and
amendments to MDH's articles of incorporation. In connection therewith,
7,500 shares of Junior Preferred Voting Stock, 2,000,000 shares of Preferred
Stock and 8,000,000 shares of Class A Non-voting Stock were authorized.
Additionally, all of MDH's 2,142 outstanding shares of Class A Common Stock
were canceled, and each former share of Class A Common Stock was converted
into one share of Junior Preferred Voting Stock and 500 shares of Class A
Non-voting Common Stock.
The Junior Preferred Voting Stock is the principal voting security of MDH.
The other voting security of MDH, one share of Class B Common Stock, is held
by the LSMS. The Class B Common stockholder elects three of the fifteen
directors of MDH and votes along with the other voting stockholders on all
matters voted upon by the stockholders. The Junior Preferred Voting
stockholders elect twelve of the fifteen directors of MDH.
No dividends may be paid on the Junior Preferred Voting Stock. Additionally,
MDH's bylaws prohibit the donation of Junior Preferred Voting Stock and
permit the resale or other transfer of Junior Preferred Voting Stock only to
persons who are licensed Louisiana physicians and LSMS members, and who do
not already own a share of Junior Preferred Voting Stock, unless MDH
exercises its right of first refusal. The right of first refusal specifies
that MDH may purchase, at its option, the Junior Preferred Voting Stock from
any person for the liquidation value of $1,000.
The Class A Non-voting Common Stock may receive dividends when and if
declared by MDH. MDH's bylaws permit the resale of or other transfer of
Class A Non-voting Common Stock only to persons who are licensed Louisiana
physicians and LSMS members. Resale or other transfer of the shares of Class
A Non-voting Common Stock is prohibited until each holder's shares are
released from the resale prohibition as follows:
NUMBER OF
SHARES RELEASED
March 22, 1998 100
March 22, 1999 200
March 22, 2000 200
-----
500
=====
Furthermore, ownership by any person of more than two percent of the
outstanding shares of Class A Non-voting Common Stock is prohibited; however,
MDH may issue up to six percent of the outstanding Class A Non-voting Common
Stock to executive officers of the Company pursuant to its stock-based
compensation plan (see Note 8).
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<PAGE>
During 1998 and 1997, the Company sold four and ten units of capital stock
which were comprised of four and ten shares, respectively, of Junior
Preferred Voting Stock and 1,600 and 4,000 shares, respectively, of Class A
Non-voting Common Stock. The average number of outstanding common shares for
1998 and 1997 reflects these transactions.
During 1998 and 1997, the Company also purchased eight and three units of
capital stock comprised of eight and three shares, respectively, of Junior
Preferred Voting Stock and 500 shares of Class A Non-voting Common Stock in
1997. These shares are accounted for as treasury stock.
4. RELATED PARTY TRANSACTIONS
Certain members of the LSMS's board of directors are members of the board of
directors of MDH. On September 6, 1995, MDH purchased a feasibility study
for the development of a physician-owned, state-wide HMO from the LSMS for
$175,462. This purchase was effected by the issuance of a note payable to
the LSMS. The note payable provided for interest at a rate of 8.0 percent
per annum and was payable in equal annual installments (including interest)
of $98,394 on September 5, 1996 and 1997. On October 9, 1996, MDH repaid the
outstanding principal and accrued interest of $15,345 related to this note
payable.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash and cash equivalents - The carrying amount approximates fair value
because of the nature of these instruments.
Marketable securities - The fair values of marketable securities are
estimated based on quoted market price for those or similar investments.
Restricted investments - Restricted investments, which are comprised of
certificates of deposit, are recorded at cost which approximates fair value.
The estimated fair values of the Company's financial instruments at December
31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------ -----------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
<S> <C> <C> <C> <C>
Cash and cash equivalents $2,112,479 $2,112,479 $1,408,901 $1,408,901
Marketable securities 2,808,827 2,808,827 4,840,825 4,840,825
Restricted investments 1,000,000 1,000,000 1,000,000 1,000,000
</TABLE>
6. DEFERRED INCOME
On December 21, 1998, PCI entered into a contract with Advantage Health Plan
("AHP"), a Louisiana-based HMO in the process of a business wind down,
whereby PCI would offer its HMO products to approximately 11,000 existing AHP
commercial members effective February 1, 1999. PCI received $1.75 million
for guaranteeing coverage of these members. PCI assumed no responsibility
for medical services rendered to AHP-covered members prior to February 1,
1999. Additionally, none of the
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<PAGE>
existing AHP contracts were acquired by PCI; rather, PCI entered into new
contracts that were priced according to its own rate structure, subject to
certain maximums and restrictions that were established by the Department of
Insurance ("DOI") for the state of Louisiana.
At December 31, 1998, the Company has reflected the $1.75 million received in
connection with this contract as deferred income as the Company had not yet
offered medical coverage to existing AHP members. This deferred income will
be recognized as revenue over the term, typically one year or less, of the
contracts accepted by former AHP members. As a result, this deferred income
will be substantially recognized as revenue during 1999.
7. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENTS - The Company has entered into employment agreements
with five officers with salaries aggregating $822,500 annually. These
agreements provide for guaranteed bonuses ranging from 10 - 15% of these
officers' base salaries and also provide for severance payments of three to
twelve months base salary in the event of a change in control of the Board of
Directors of the Company.
RESTRICTED DEPOSITS - As an ongoing requirement of the state of Louisiana,
PCI has deposited with the Commissioner of Insurance a safekeeping receipt of
$1,000,000, consisting of certificates of deposit in ten separate banking
corporations doing banking business with the state of Louisiana.
OPERATING LEASE - Beginning July 1, 1997, the Company entered into an
operating lease for the building housing its corporate headquarters. In
January 1999, the Company relocated its corporate headquarters and entered
into an additional operating lease. The Company incurred rental expenses of
$66,537, $57,371 and $5,000 during 1998, 1997 and 1996, respectively. Net
rental commitments over the next five years are as follows:
1999 $152,460
2000 163,350
2001 163,350
2002 163,350
2003 163,350
Thereafter 27,225
--------
$833,085
========
Litigation - In the ordinary course of operations, the Company is subject to
various litigation matters relating to health benefits provided to its
subscribers. Although the outcome of these matters cannot be determined, it
is management's opinion that disposition of these proceedings will not have a
material adverse effect on the Company's consolidated financial statements.
Pursuant to the contract referred to in Note 6, PCI has agreed to indemnify
AHP for any possible monetary damages incurred by certain third parties as a
result of the execution of the contract. Management is presently unable to
determine the magnitude of any possible losses that may be incurred as a
result of this indemnification but does not believe that this indemnification
will have an adverse effect on the Company's consolidated financial
statements.
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<PAGE>
REGULATORY REQUIREMENTS - The state of Louisiana has implemented financial
regulations for HMO's requiring, among other things, minimum net worth
requirements. For each HMO which, by July 1, 1995, had not filed its
application for a certificate of authority with the Commissioner of Insurance
as required by law, the minimum net worth requirement is $2.0 million. PCI
was in compliance with the state statutory net worth requirement at December
31, 1998.
During 1998 and since the inception of operations in the first quarter of
1997, the Company has incurred substantial losses from operations due to the
lack of premium revenue resulting from delays in marketing its managed care
products. Based on current operations and projections, the Company could
fall out of compliance with the minimum capitalization requirements of the
DOI during the fourth quarter of 1999, and would be required prior to such
time to raise additional capital as a condition to remain in compliance.
However, PCI has recently introduced several new products to the marketplace
and has been named as an approved HMO for several large group accounts which
are currently undergoing enrollment. Revenue from these enrollment
activities may reduce the Company's current operating losses sufficiently to
permit it to remain in regulatory compliance through the remainder of 1999.
The Company is exploring on a preliminary basis several alternatives to
substantially increase premium revenue or capitalization, including the
acquisition of existing base of members and/or the sale of additional capital
stock. However, there can be no assurance that the Company will achieve
income in the near term from new enrollees from group or individual products,
or from the acquisition of existing base of members, sufficient to remain in
regulatory compliance during all of 1999, or that, if necessary, the Company
will succeed in increasing its capitalization through the sale of additional
capital stock. PCI's failure to maintain compliance with regulatory capital
requirements could result in one or more actions by the DOI with respect to
PCI that could be materially adverse to shareholders, including the loss of
part or all of their investments in the Company.
8. STOCK-BASED COMPENSATION PLAN
The Company has a stock-based compensation plan through which several of the
Company's officers are entitled to receive restricted stock grants contingent
upon their satisfaction of specific tenure requirements. Restricted stock
grants, which are vested one-third each year after the award date, are
scheduled to be awarded as follows:
NUMBER OF
SHARES
1999 7,350
2000 5,625
2001 15,350
2002 15,350
2003 16,500
------
60,175
======
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." The Company recognizes
compensation cost equal to the fair value of the restricted stock when
awarded. The Company did not recognize any material compensation cost
related to the issuance of stock grants in 1998 and 1997.
16
<PAGE>
9. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations
of risk consist primarily of investments in marketable securities and
commercial premiums receivable. As of December 31, 1998, the Company had no
significant concentrations of credit risk due to the limited amounts which
are invested in any one issuer and the large number of employer groups
comprising the Company's customer base.
10. CLAIMS PAYABLE AND RESERVES FOR INCURRED BUT UNREPORTED CLAIMS
The following is a summary of claims payable and reserves for incurred but
unreported claims:
1998 1997
Balance, January 1 $ 145,131 $ -
Incurred related to:
Current year 3,886,996 331,905
Prior years 40,903 -
---------- --------
Total incurred 3,927,899 331,905
Paid related to:
Current year 2,941,146 186,774
Prior years 93,450 -
---------- --------
Total paid 3,034,686 186,774
---------- --------
Balance, December 31 $1,038,344 $145,131
========== ========
11. INCOME TAXES
Significant components of the Company's deferred tax assets at December 31,
1998 and 1997 are as follows:
1998 1997
Net operating loss carryforwards $2,691,000 $1,120,000
Organizational expenses 273,000 364,000
---------- ----------
Deferred tax asset 2,964,000 1,484,000
Valuation allowance (2,964,000) (1,484,000)
---------- ----------
Deferred tax asset reported $ - $ -
========== ==========
A valuation allowance for the entire deferred tax asset has been recorded as
its realization is not considered more likely than not.
12. MAJOR CUSTOMER
Premium revenue from PCI's largest employer group aggregated approximately
$667,000, representing 18% of total premiums for 1998.
******
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