<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - KSB
[ X ] ANNUAL REPORT UNDER TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-23998
FIRST CHOICE HEALTH NETWORK, INC.
(Name of Small Business Issuer as specified in its Charter)
Washington 91-1272766
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
601 Union Street
Suite 700
Seattle, Washington 98101-1838
(Address of principal
executive offices)
Issuer's Telephone Number, Including Area Code
(206) 667-8050
(Issuer's telephone number, including area code)
1
<PAGE> 2
Securities to be registered under Section 12 (b) of the Act: None
Securities to be registered under Section 12 (g) of the Act:
Class A Common Stock, par value $1.00 par value per share
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 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 Form 10-KSB.
[ ]
State issuer's revenues for its most recent fiscal year.: $27,189,745
There is no trading market for the Registrants voting stock (Class A Common
Stock, $1.00 par value and Class B Common Stock, $1.00 par value) and,
accordingly, the market value of the voting stock held by non-affiliates of
the Registrant based on bid and asked prices cannot be determined.
The aggregate number of Registrant's outstanding on March 1, 1998 was 648
shares of Class A Common Stock, and 40,600 shares of Class B Common Stock,
$1.00 par value, respectively.
Transitional Small Business Disclosure Format ( check one ):
Yes ______ No __X__
Documents incorporated by reference:
None
2
<PAGE> 3
Part I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
First Choice Health Network, Inc., ("The Network") is a provider-owned,
managed health care company which has established a network of physicians,
hospitals and other health care providers (a "Preferred Provider Organization"
or "PPO") located almost exclusively in the State of Washington for the
provision of health care services; a small portion of the PPO is located in
each of Alaska, Idaho and Montana. Subscribers (or members) in Oregon can
also access a network of health care providers (marketed as a separate PPO).
The Network contracts with the health care providers in its PPO for the
provision of health care services on a discounted fee basis and contracts with
self-insured employers, indemnity insurers, health maintenance organizations
and union trusts (collectively, "Health Plans") and third party administrators
("TPAs"), to provide their subscribers (or members) access to the PPO, for
which it receives a fee from the Health Plan or the TPA, as applicable,
typically on a per subscriber (or member) per month basis; an additional per
subscriber (or member) monthly fee is received in the event the Health Plan or
TPA elects to receive utilization management services. In addition, the
hospitals participating in the PPO pay First Choice an administrative fee
under their respective participating health care facility service contracts.
At December 31, 1997, First Choice had arrangements with third party
administrators and health plans representing approximately 550,000
subscribers (or members) and their dependents (collectively "Covered
Persons"). Practically all of the Company's revenues were derived from
services performed in the state of Washington during the year ended December
31, 1997.
The Network's success depends to a significant degree on its ability to
control health care costs for the Health Plans utilizing its PPO. In addition
to its discounted fee arrangements with the health care providers
participating in its PPO, The Network controls health care costs with respect
to a portion of the subscribers to its PPO through a primary care physician
"gatekeeper" system of health care delivery and utilization management
programs (third-party review of the utilization of health care services), the
latter of which is available to the Health Plan for an additional per
subscriber (or member) monthly fee.
An integral part of The Network's PPO is its comprehensive quality assurance
program, which is designed to maintain and improve proper medical care and
includes, among other things, verification of physicians' credentials and
hospital accreditation, medical care evaluations, outcome studies which
evaluate hospital admissions and referral patterns and the processing of
Covered Persons' grievances. In excess of 73% of the PPO physicians are board
certified or board eligible in one or more specialties.
First Choice Health Network, a corporation organized under the laws of the
state of Washington in 1984, is owned by 648 physicians, all of whom own Class
A Common Stock; seven hospitals who own Class B Common Stock, and three
hospital participants.
During 1995, The Network formed a wholly-owned subsidiary, First Choice Health
Plan, Inc.("The Plan"), to operate as a health care service contractor
("HCSC") that permits the Company to assume risk for healthcare services in
its operations.
3
<PAGE> 4
An HCSC is an organization that arranges for the provision and delivery of
health care services to a voluntarily enrolled population, either directly or
indirectly as a subcontractor through a Health Plan, for a fixed periodic
premium through a network of providers who generally receive either a
capitation fee (a fixed periodic fee per covered member) or a negotiated fee
for the health care services rendered. HCSCs, like health maintenance
organizations ("HMOs"), may utilize a "gatekeeper" system of health care
delivery whereby each member is serviced by a primary care physician
(generally, a family practitioner, pediatrician or internist) who provides
medical care related to the general health of the HMO member and refers
members to specialists and other health care providers, as appropriate. HCSCs
differ from PPOs in that they are permitted to assume the financial risk of
the cost of health care services exceeding the premiums received from members,
subscribers or Health Plans. HCSCs are required to register with the state of
Washington Department of Insurance which requires, among other items, filing
copies of organizational documents, financial disclosure, forms of agreements
to be issued to members, a schedule of proposed rates of reimbursement to
providers, solicitation materials and a description of grievance procedures
and a quality assurance program. HCSCs are required to have an initial net
worth of $1,500,000 and must thereafter maintain a minimum net worth of
$1,000,000. The Commissioner may waive compliance with the minimum net worth
requirements if satisfied with the entity's financial stability; however, net
worth cannot fall below $500,000. The Plan began marketing and selling it's
health insurance products on January 1, 1997.
Effective July 1, 1997, The Company merged with Health First Partners, Inc.
and Health Washington L.L.C. which added approximately 18,000 fully insured
members. Further details of this transaction are discussed in Item 6 under
"Liquidity and Capital Resources".
PRODUCTS
First Choice Health Network's PPO
The Network's PPO is comprised of physicians, hospitals and other health care
providers in the states of Washington, Alaska, Idaho and Montana who are
required to sign preferred physician contracts, health care facility service
contracts and provider contracts, respectively, under which the health care
provider agrees to accept, as payment in full, the discounted fee schedule
negotiated by The Network for each covered service; such agreements are
terminable on 90 days' notice. Subscribers (or members) also have access to a
network of providers (marketed as a separate PPO) in the state of Oregon.
Physicians
In the primary care physician "gatekeeper" system of health care delivery, a
Covered Person receives care from a participating primary care physician who,
in turn, refers the Covered Person to specialists and hospitals, as required.
Primary care physicians, consisting of family practitioners, pediatricians,
general practitioners and internists, are important to the Company's health
care cost containment as they control utilization of hospitals, specialists
and other health care providers.
The Network seeks to include within its PPO high-quality, cost-effective
physicians who have admitting privileges at a participating PPO hospital. In
addition, physicians are recruited in geographic areas in which the Company's
PPO does not have a physician presence if a prospective Health Plan has a
large number of Covered Persons in such area. Upon receipt of an application
by a physician to participate in the PPO, The Network conducts its own
credentialing process (separate and distinct from those performed by
participating hospitals with respect to physicians with admitting privileges),
evaluating relevant information such as malpractice insurance, claims activity
and the physician's standing with licensing regulatory authorities.
4
<PAGE> 5
Hospitals
The Network has contracts with hospitals in most counties in the State of
Washington and in each county in which it conducts business in other states.
The PPO offers Covered Persons a full range of hospital services, including
tertiary care.
The Network seeks to attract hospitals rendering high-quality, cost-effective
care. Prior to contracting with a hospital, the Company reviews the
hospital's accreditation, federal and state certifications, and internal and
external claims data and reports, including data available from regulatory
agencies.
Other Health Care Providers
The Network has contracts with many health care providers (other than
physicians and hospitals) which, among other services, provide mental health
care, diagnostic services, chiropractic services, physical therapy, out-
patient surgery, laboratory services and home health care.
The Network has also developed a pharmacy network in the state of Washington
which provides data with respect to utilization of prescribed drugs by
physicians participating in the PPO, which the Company intends to incorporate
into its utilization management program.
On January 31, 1995, First Choice Health Network purchased all of the issued
and outstanding stock of Pacific Health Systems, Inc. (subsequently renamed
First Choice Dental Systems, Inc.), a PPO network consisting of in excess of
200 dentists, for $90,000, $45,000 of which was paid on such date and the
balance was paid on February 1, 1996. Under the related purchase agreement,
First Choice is required to make additional contingent purchase price payments
equal to 50 percent of the dental PPO's net income in excess of $295,000 for
each of the calendar years 1995 and 1996, with aggregate additional purchase
price payments not to exceed $260,000.
Utilization Management Services
In addition to providing Health Plans with access to its PPO, The Network
offers a utilization management program for an additional per subscriber (or
member) monthly fee to the Health Plan. The goal of the utilization
management program is to ensure that high quality health care is consistently
delivered to Covered Persons in an efficient and cost-effective manner. The
program includes individual case reviews of hospital admissions, outpatient
surgery, primary care physician referrals to specialists, management of
catastrophic, psychiatric and substance abuse cases, profiling practice
patterns of individual physicians and evaluation of hospital utilization
patterns. The Company hired additional staff experienced in health care
provider risk management and a full time medical director in late 1995.
At December 31, 1997, The Network had contractual arrangements through which
Health Plans in both the public and private sectors representing approximately
550,000 Covered Persons, utilized the Company's PPO. The Network receives a
fee for providing access to its PPO, typically on a per subscriber (or member)
per month basis, from the Health Plan, either directly or indirectly through a
TPA. The per subscriber (or member) monthly fee is generally fixed for a
twelve-month period under contracts with each Health Plan or TPA, and is based
upon the extent of the network utilized (hospitals and/or physicians), whether
utilization management services are requested and the number of Covered
Persons.
First Choice Health Plan Products
The Plan offers three basic types of health care plans to prospective employer
groups: Managed Plans, Triple Option Plans and Point of Service Plans.
5
<PAGE> 6
Managed Plans
All health care, except emergency services, under this plan is provided or
arranged by a primary care physician (PCP) which is chosen by the member
during enrollment. The PCP will refer the member to specialists, as well as
arrange hospital and other services with a Community Network of providers.
Point of Service Plan
This plan offers the same coverage as the Managed Plan but provides another
level of benefit coverage. The member is required to choose a PCP during
enrollment. The member may choose to have his/her services coordinated
through the PCP in order to have the highest level of benefit coverage
available. The member also has the choice to self-refer to an Extended PPO
Network Provider which is paid at a lower level.
Triple Option Health Plan
This plan offers three different levels of benefit coverage: the Community
Network benefit level, the Extended PPO Network benefit level and an out-of-
network benefit level. The member is required to choose a PCP during
enrollment. The member may choose to have his/her services coordinated
through the PCP in order to receive the highest level of benefit coverage
available. However, the member may choose to self-refer to an Extended PPO
Network Provider or a non-participating provider which is covered at a lower
reimbursement.
Association Plans
These plans include a plan offered through Costco Wholesale, a plan offered
through the Employers Health Purchasing Cooperative, a plan offered through
the Bellevue Chamber of Commerce, and a plan offered through the Association
of Washington Businesses which are tailor made to a targeted population of
employees.
Medicare Supplement
Under the HCSC license, The Plan contracted with Olympic Health Management
Systems, Inc., to develop and implement a Medicare Supplement product. The
rate schedules for the first phase of this proposed offering were filed and
approved by the state Office of Insurance Commissioner in the spring of 1996.
Upon acceptance of the proposed rates, the Company and Olympic Health
Management representatives marketed this product to the general public. Rate
schedules for a second phase, a non-agent plan, of this Medicare supplement as
of this time have not been submitted to the OIC.
MARKETING AND SALES
The Network markets its PPO and utilization management services through an
internal marketing staff to third party administrators (TPA) and, in
conjunction with the TPAs and independent brokers and agents, to the Health
Plans. The Network generally does not market directly to subscribers or their
dependents, although it does engage in limited direct mailings relating to
product development.
The Plan distributes its products through it's direct sales force and
telemarketing representatives and through independent insurance agents and
brokers.
Direct Sales Force and Telemarketing
The Plan maintains a direct sales staff of account executives. The account
executives sell the managed care and point of service to employer groups. In
addition, they are the principal administrative contact for employers and
their benefit managers by conducting on-site employee meetings and various
other requests.
6
<PAGE> 7
The Plan employs a staff of telemarketing representatives who sell the Costco
Health Insurance product directly to small groups.
Independent Insurance Agents and Brokers
During the first year of offering the managed care product, independent
insurance agents and brokers have been responsible for a significant portion
of The Plan's enrollment growth. The Plan will continue to use the services
of independent brokers for additional growth.
COMPETITION
The managed health care industry is highly competitive, primarily on the basis
of price, the size, quality and geographic location of the network of
physicians, hospitals and other health care providers, benefits provided and
quality of service. The Network competes with other managed health care
companies, such as health maintenance organizations and indemnity health
insurance companies, and approximately twelve other PPOs in the state of
Washington and believes, that through its licensure as a HCSC, it can maintain
its PPO base and expand into additional areas of the marketplace.
GOVERNMENT REGULATION
State Health Care Legislation
A number of new bills affecting health care were introduced during the 1997
state legislative session. Only a handful made it out of their respective
committees and were passed into law. The bills that did become law are
summarized below:
SHB 1191 - Mandated benefits review (sunrise provision)
Any person or organization seeking to establish a mandated benefit must
submit the proposed bill to the appropriate committee of the Legislature
at least 90 days prior to the Legislative session. The Legislative
Committee may then send the proposed bill to the Department of Health for
a review and follow-up report on the social and financial impact of the
bill as well as its impact on health care efficacy. This procedure is
commonly referred to as _sun rising_ a bill.
ESHB 2018 - Health Insurance Reform
This bill proposed a number of broad changes including network adequacy
and access plans, grievance and appeals procedures, utilization review
procedures, guidelines for the coverage of emergency services, the
reestablishment of medical loss ratios as a benchmark for rate setting
and individual market stabilization provisions. The sections include:
Tenure discounts - health plans may offer discounts of up to 10% to
community-rated groups which have had continuous enrollment with the
plan for a period of 2 years or more.
Guidelines for coverage of emergency services - includes a `prudent
layperson' definition of an emergency and defines the limits of
differential cost-sharing for emergency services provided by non-network
providers or hospitals.
Wickline clauses - authorizes a study to review the implications and
impacts of language in provider contracts which limits the liability
of a health plan when the health plan refuses to pay for services
recommended by a provider. The specific instances under review are
those cases when, as a result of the health plan's refusal to pay for a
service, the patient does not receive the recommended care and the health
of the patient is harmed.
7
<PAGE> 8
Although Governor Locke praised the efforts of the bill, he vetoed major
portions in opposition to the 'deeming' language contained in the bill
which allowed NCQA-certified plans to be 'deemed' in compliance.
Governor Locke also opposed all sections of the bill relative to
individual market reforms as being counter-productive to the health care
reform measures passed in 1995.
Following the veto, the Office of Insurance Commissioner (OIC)
reintroduced the vetoed portions of the bill, with the exception of the
individual market reform language, under its rule-making authority.
These new `managed care rules' are expected to be adopted in early 1998.
SSB 5178 - Diabetes Cost Reduction
Health plans are required to cover the cost of virtually all diabetes-
related services and supplies. This bill becomes effective January 1,
1998 and sunsets on June 30, 2001. Since First Choice already covers
most diabetic services and supplies, this bill will have only minimal
impact.
Risk-based Capital
The National Association of Insurance Commissioners (NAIC) continues to
work on its model plan for determining reserving requirements for risk-
based plans. This model has been endorsed by the Washington State
Insurance Commissioner and by the majority of Washington's health plans,
including First Choice. It is expected that this model will be
introduced as legislation during the 1998 Legislative session as an
acceptable alternative to the current 14.2% reserving requirement
currently enforced by the OIC.
Other Activities of Note
I-673 Campaign
A coalition consisting of the major health plans, Washington businesses,
the Washington State Hospital Association and the Washington State
Medical Association waged a $1.7 million dollar campaign to successfully
defeat Initiative 673 on the November 1997 ballot. This initiative,
billed as the `patient choice' initiative, would have effectively
destroyed managed care and managed care networks, and reduced access to
health care by increasing the overall costs of health care in general.
First Choice played an active part in, and made significant financial
contribution to, this campaign effort.
Every Category of Provider
In 1996, eight of the major health plans in Washington state filed suit
against the OIC to block impending rules developed by the OIC regarding
their interpretation of the `every category of provider' statute. In
May, 1997, the US District Court (Tacoma) granted the plaintiff's motion
for summary judgment and enjoined the OIC from enforcing their all-
inclusive rules. As a result, health plans in Washington are only
required to recognize the services of alternative providers in their
basic health plan (BHP) look-alike plans as opposed to all plans, as was
the intention of the OIC.
8
<PAGE> 9
Federal Health Care Legislation
HIPAA (Health Insurance Portability and Accountability Act)
There are several components of HIPAA which affect health plans. These
include:
Certificates of Creditable Coverage
Pre existing condition requirements
Non-discriminatory waiting periods
Special enrollment periods
Mental health parity
'Prudent layperson' definition for emergency services
Maternity length of stay requirements
Most provisions went into effect for new and renewing group and
individual health plans beginning July 1, 1997. Mental health parity and
maternity length of stay provisions will take effect for new and renewing
group and individual health plans on January 1, 1998. First Choice
successfully implemented all of the 1997 provisions and is prepared to
implement the 1998 provisions. With regard to the pre-existing
condition, non-discriminatory waiting periods, emergency services and
maternity length of stay provisions, relevant Washington state law is
already more favorable to the consumer so the impact of these provisions
on health plans in Washington is negligible.
The implementation of the mental health parity provisions most probably
represents a step backward for consumers. While the new law prohibits a
health plan from imposing more stringent dollar maximums on this benefit
than it does for medical/surgical benefits, the law does not prevent
plans from imposing day/visit limits. Consequently, most plans,
including First Choice, have simply converted mental health benefits from
a flexible dollar maximum (which could be used as best suits the patient)
to the more rigid old-style inpatient/outpatient day/visit maximums.
Consumer Bill of Rights and Responsibilities; PARCA
There are two patient advocacy bills currently being discussed at the
federal level. They are: The Consumer Bill of Rights and
Responsibilities, supported by the President, and the Patient Access to
Responsible Care Act (PARCA) sponsored by Rep. Norwood and Sen. D'Amato.
Both bills focus on patient access to providers, especially specialty
providers, and disclosure of information. Of the two, PARCA is the more
onerous and is not expected to garner sufficient bipartisan support to
become law. On the other hand, the Consumer Bill of Rights is being
lobbied heavily by the President and is expected to be signed into law in
1998.
Dependence on one or a few major customers
Revenues from one customer of The Plan for the year 1997 represents
approximately $9.5 million of the company's consolidated revenues.
Employees
At December 31, 1997, the Company had 95 employees, 91 of which were full-
time. None of the Company's employees are covered by labor unions, and the
Company believes its relationships with their employees to be good.
9
<PAGE> 10
ITEM 2. DESCRIPTION OF PROPERTY
First Choice leases and occupies two offices in separate buildings in downtown
Seattle. The administrative, finance and marketing departments occupy an
office consisting of approximately 7,135 square feet of space in an office
building at 601 Union Street, Seattle, Washington expiring January 2002. The
claims, medical services and provider relations departments occupy an office
consisting of 11,209 square feet of space in an office building at 1100 Olive
Way, Suite 1480, Seattle, Washington expiring September 1999.
On March 11, 1998, The Network signed a lease to consolidate both current
locations to one central location at 601 Union Street, Suite 1100, Seattle
Washington. This lease expires March 11, 2003 or five years. There is 20,675
square feet at the new location.
Item 3. LEGAL PROCEEDINGS
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted in the fourth quarter of 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no public trading market for any of the Company's equity securities.
On March 1, 1998, there were 648 holders of the Company's Class A Common
Stock, seven holders of the Company's Class B Common Stock, and three Hospital
Participants.
Holders of each class of Common Stock are entitled to share ratably on a
share-for-share basis with respect to any dividends on such class of Common
Stock, when, as and if declared by the Board of Directors out of funds
legally available. Therefore, such dividends may not be paid while an
obligation to repurchase shares remains outstanding. Pursuant to the
Company's contracts with the Hospital Participants, if First Choice pays any
dividends or other distributions with respect to the Class B Common Stock,
First Choice must make an equivalent distribution to the Hospital
Participants. The Company does not currently anticipate paying cash
dividends on its capital stock.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Network's ability to retain existing clients and attract new clients is
largely dependent on its ability to control health care costs by creating and
maintaining a network of high quality, efficient, fully credentialed providers
who agree to accept competitive reimbursement rates and on its ability to
control excess utilization through its utilization management
10
<PAGE> 11
program. During 1997, the Company continued to expand its PPO network.
In 1997, The Network continued its system of physician reimbursement which had
commenced in July 1993, referred to as the Resource Based Relative Value
System, whereby fees to physicians are weighted more toward cognitive services
(i.e., overall patient care) as opposed to procedural services (e.g., surgery
and diagnostic tests). This system is consistent with the Company's belief in
the importance of managing the full scope of patient care to provide the most
appropriate level of service for each patient and its focus on the primary
care "gatekeeper" model for its PPO, whereby a Covered Person must obtain a
referral from a primary care physician prior to obtaining health care services
from specialists and other health care providers.
Since its inception, the Company has negotiated reimbursement to its principal
hospitals under a Diagnostic Related Group (DRG) system under which payments
are based on the diagnosis of the patient's condition, generally
notwithstanding the length of hospitalization. In 1997, The Network
negotiated with additional hospitals to change the basis upon which DRGs are
determined from an "All Medicare Grouper" to an "All Patient Grouper" and
concurrently introduced Washington State-specific hospital weights to more
closely match reimbursement payments to actual resource consumption.
In anticipation of the proposed Washington State health care reform and to
enhance its competitive position in the health care industry, The Plan
obtained, on January 13, 1995, a Certificate of Registration to operate as a
health care service contractor ("HCSC"), in the state of Washington, which
permits The Plan to assume financial risk in its operations.
The Plan's revenues consist primarily of commercial premiums resulting from
the initial offering of health insurance products during 1997. See the "First
Choice Health Plan Products" under "Description of Business" for further
explanation of products currently being offered by The Plan.
Medical expenses are largely comprised of capitation arrangements with the
physician organizations (PO) in which the risk for health insurance coverage
has been passed to the PO. The Plan passes much of the premium to the POs and
keeps a certain percentage for administrative fees which covers services that
the Plan provides on behalf of the PO. In addition, as a result of the merger
with Health First Partners, The Plan assumes the full risk of a small amount
of membership. For the membership that The Plan is at risk for, the medical
expenses are comprised of payments to physicians, hospitals and other health
care providers which includes an estimated amount for incurred but not
reported claims ("IBNR").
The Plan has filed an application with the Federal Health Care Financing
Administration ("HCFA") for a license to offer a Medicare risk product. It is
expected that the application will be approved in the middle of 1998 and the
product offered shortly thereafter. Upon sale of this product, the Plan will
be paid a fixed per member per month capitation amount by the HCFA based on a
formula of the projected medical expense of each Medicare member. Medicare
risk contracts provide revenues which are higher per member than those for
non-Medicare members which provide an opportunity for increased profits and
cash flow. However, these contracts also carry certain risks such as higher
comparative medical costs, government regulatory and reporting requirements
and the possibility of reduced government reimbursement in the future.
11
<PAGE> 12
The Plan transferred an additional $1 million on February 19, 1998 and
$400,000 on March 31, 1998 to it's restricted depository account in order to
satisfy statutory requirements.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Operating revenue for the year ended December 31, 1997 increased 328.8% to
approximately $26.6 million in from approximately $6.2 million in 1996. The
majority of the increase was the result of The Plan's initial offering of
health insurance in the state of Washington in January 1997, as well as the
merger with Health First Partners and Health Washington in July 1997. The
Network showed an increase in administrative and access fee revenues of 10.2%
from approximately $6.2 million in 1996 to approximately $6.8 million in 1997.
Offsetting the increase in premium revenues in 1997 were medical expenses in
the amount of $17.5 million.
Total operating expenses increased 79.5% to approximately $8.9 million in 1997
versus approximately $4.9 million in 1996. Selling, general and
administrative costs increased to approximately $4.6 million in 1997 from
approximately $2.2 million in 1996 as a result of increased marketing
expenditures related to the new health insurance products as well as the
premium and business taxes associated with The Plan's new business. Payroll
and related expenses increased 58.6% from approximately $4.3 million in 1997
compared to approximately $2.7 million in 1996. The Company nearly doubled
the number of employees during 1997 as a result of the offering of the new
health insurance product and the merger which brought total membership in The
Plan to approximately 27,000.
Inflation
The Company has not been effected by nor does it anticipate that inflation
will have a significant impact on its operating results in the near term.
However, this factor could effect operations if the Company was unable to
submit new rates to the OIC in a timely manner in order to obtain approval of
increased rates necessary to insulated itself from this factor. The Company
obtained licensure as an HCSC in January 1995 and assumes risk for medical
costs. The Company transfers risk to health care providers through capitation
arrangements and risk-sharing provisions and is generally insulated from
significant escalation of health care costs.
LIQUIDITY AND CAPITAL RESOURCES
Since inception in 1986, the Company has financed its operations from equity
investments from over 870 physicians, from the seven hospitals constituting
the Company's Class B shareholders, non-equity capital contributions from
three additional hospitals pursuant to their respective participation
agreements, and funds from operations.
In July 1996, First Choice issued 5,800 shares of its Class B Common Stock to
Swedish Medical Center in exchange for $931,484. This equity investment
increased the number of Class B shareholders to six.
In December, 1996, First Choice issued 5,800 shares of its Class B Common
Stock to Overlake Hospital Medical Center in exchange for $1,000,000 in cash
and two additional payments of $250,000 each due in December of 1997 and 1998.
This equity investment increased the number of Class B shareholders to
12
<PAGE> 13
seven. In conjunction, it is possible that the Company could incur contract
exclusivity damages with another hospital shareholder up to $600,000.
Since the amount of damages, if any, is not reasonably estimable,
the possible contingency amount has not been reflected in the financial
statements as of December 31, 1996 or 1997.
At December 31, 1997, the Company had cash, cash equivalents and investment
securities at fair market value of approximately $11.4 million as compared to
approximately $7.9 million at December 31, 1996.
The Company had a $300,000. unsecured line of credit from Seafirst Bank. At
December 31, 1996, there were no borrowings outstanding under the line. Due to
the large amount of cash and short-term investments held by the Network and
it's subsidiary, The Plan, this line of credit was not renewed as of June 1,
1997.
The Network commenced updating its computer systems when it signed contracts
for software development on March 21, 1994, and commenced implementation
thereafter. The Network has obtained necessary programming assistance and has
purchased additional hardware. A portion of the new system programmed to
handle The Plan's shared risk products was put into production in October,
1996. Additional modules were brought on line in January, 1997 to serve the
product line offered through it's subsidiary 'First Choice Health Plan, Inc.'
under it's licensure as an HCSC in the state of Washington. The Network
expended an additional $587,000 on related consulting services and computer
equipment in 1996. The Network does not anticipate comparable expenses in
1998, but should it experience substantial market gains through its
subsidiary's new products, the Company would expend the necessary funds to
maintain those gains.
In January 1995, the Company transferred cash and investments of $1.5 million
to its subsidiary, "First Choice Health Plan, Inc.," in connection with its
licensure as an HCSC. In the first and second quarters of 1997, the Company
transferred an additional $5 million in cash and investments to it's
subsidiary. The Plan transferred an additional $1 million on February to
increase the statutory deposits to a total of $1.3 million to prepare for the
initiation of the Medicare product.
In February 1995, the Company purchased all of the issued and outstanding
stock of a dental PPO for $90,000, $45,000 of which was paid at the closing
and the $45,000 balance of which was paid on February 1, 1996. Under the
related purchase agreement, First Choice is required to make additional
contingent purchased price payments equal to 50 percent of the dental PPO's
net income in excess of $295,000 for each of the calendar years 1995 and 1996,
with aggregate additional purchase price payments not to exceed $260,000. No
additional aggregate payment was paid in 1995. For the 1996 period, the
income of the dental network did not meet the requisite $295,000 minimum;
therefore, no contingency payment for 1996 is owed.
In October 1995, the Company entered into an agreement with Olympic Health
Management Systems, Inc. (OHMS), to develop and implement a Medicare
supplement product. The planning phase concluded with the submission of
proposed rates to the Office of Insurance Commission (OIC)for approval in the
first quarter of 1996. Upon final determination from the OIC, the Company and
OHMS offered the agent marketed portion of this product to consumers. OHMS
will act as the Third Party Administrator, thereby handling all necessary
management, accounting and reporting functions for which it will receive a
specified percentage of the premiums. Finalized contracts were in place on
April 21, 1996 prior to the first public offering of Medicare supplement in
May . Anticipated overhead to all
13
<PAGE> 14
parties involved is not expected to exceed 28%, inclusive of Washington State
premium taxes.
In May of 1996 the Company's subsidiary, First Choice Health Plan, Inc.,
introduced into the market place a Medicare Supplement program in conjunction
with two of its owner hospitals, Northwest Hospital and Valley Medical Center.
At December 31, 1997 there were 426 policies inforce and collected premiums of
$231,568. The Company has contracted with Olympic Health Management Systems
to act as the plan administrator. Their primary responsibilities are to
maintain a adequate sales force legally licensed in Washington state, premium
billing and collection, claims processing and payment, and financial reporting
to all applicable parties including the appropriate reports necessary for
compliance with the Office of Insurance Commissioner of the State of
Washington.
On July 1, 1997, First Choice Health Network, Inc. (The Network), First Choice
Health Plan, Inc. (The Plan), Health First Partners, Inc. (Health First) and
Health Washington, L.L.C. (Health WA) entered into a merger and asset purchase
agreement. The agreement between the four companies consisted of three
transactions as described in the paragraphs below.
First, The Plan purchased substantially all of the assets of Health WA in
exchange for 34,524 shares of The Plan Stock. These shares were issued to the
former shareholders of Health WA. The assets of Health WA consisted primarily
of Health WA's rights to various provider contracts, a large group contract,
as well as other intangible property including trademarks. Estimated growth in
membership was 12,500 as a result of this merger. These shares represent
approximately 12.6% ownership stake in FC Plan.
Secondly, Health First merged with and into The Plan with Health First ceasing
operations and The Plan as the surviving corporation. FC Plan issued 33,572
shares of stock to the former shareholders of Health First for the net assets
of Health First as well as the rights to various provider and group contracts.
The net assets purchased included those assets and liabilities that existed as
of July 1, 1997 which had a book value of approximately $1.0 million.
Estimated growth in membership was 5,500 as a result of this merger. These
shares represent approximately 12.3% ownership stake in The Plan.
Third, The Network, formerly the sole shareholder of The Plan, became
obligated to contribute cash to The Plan in exchange for 55,436 shares of FC
Plan stock. This is facilitated by a Contribution Agreement that states that
The Network shall contribute a certain percentage of revenues over the next
ten years in exchange for those shares. The Network's ownership in the
subsidiary, The Plan, is now approximately 75.1%.
As a result of the merger between Health First Partners and First Choice
Health Plan effective July 1, 1997, First Choice Health Network assumed the
lease of the office space formerly used by Health First Partners. During
July, 1997 approximately 20 employees in the accounting and marketing
departments moved to the new location allowing for additional growth in the
operations department. The additional future minimum lease payments as a
result of this lease have been included in the notes to the financial
statements.
In conjunction with Overlake Hospital becoming a shareholder on December 19,
1996, it is possible that the Company could incur contract exclusivity damages
with another hospital shareholder up to $600,000. Since the amount
14
<PAGE> 15
of any damages is not reasonably estimable, no amount has been reflected in
the consolidated financial statements as of December 31, 1997.
In January 1998, the owners of the Plan signed an agreement which gave the
Company an 80% ownership in the common stock of the Plan. The purpose of the
increase in common stock ownership was to allow for the consolidation of tax
returns between the Company and the Plan. This transaction by Health
Washington exchanging 8,613 shares of common stock for the same number of
preferred shares. Two other owners made a similar exchange of 4,187 shares
each. In order to facilitate this transaction, the Plan amended their Articles
of Incorporation to authorize 100,000 shares of preferred stock. This stock
is has a par value of $29.10 and is nonvoting and noncumulative, but has a
dividend preference a dividend rate of 10.5% of the par value per share.
The Company anticipates that the revenues generated by operations, investment
and financing, plus the capital it currently has in reserves, will be
sufficient to meet its cash requirements throughout 1998.
YEAR 2000 ISSUE
The Year 2000 issue is the result of potential problems with computer systems
or any equipment with computer chips that uses dates where the date has been
stored as just two digits (e.g. 97 for 1997). On January 1, 2000, any clock
or date recording mechanism including date sensitive software which uses only
two digits to represent the year, may recognize a date using 00 as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruption of operations, including among other
things, a temporary inability to process transactions, send invoices, or
engage in similar activities.
The Company has developed a Year 2000 plan that was adopted by senior
management. The plan's time table is on schedule. The critical components of
the financial, operational and information systems have been identified and
incorporated in to the plan. Management has identified manual processing as a
work-around.
The Company has identified key vendors, service providers, and customers to
initiate formal communications with them to determine the extent to which the
Company is vulnerable to those third parties failure to remediate their own
Year 2000 issues. The Company can give no guarantee that the systems of other
companies on which the Company's systems rely will be converted on time or
that a failure to convert by another company or a conversion that is
incompatible wiht the Company's systems, would not have a material adverse
effect on the Company.
The Company's internally used software is externally manufactured and
supported. The Company is currently and will continue to utilize internal and
external resources to implement, reprogram, or replace and test software and
related assets affected by the Year 2000 issue. The Company expects to
complete the majority of its efforts by December 1998 leaving adequate time to
assess and correct any significant issues that may materialize.
The completion of the Year 2000 project is based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially
from those anticipated.
15
<PAGE> 16
ITEM 7. FINANCIAL STATEMENTS
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors Report . . . . . . . . . . . . . . . . . . . 17
Consolidated Balance Sheets as of December 31, 1997 and 1996 . . 18
Consolidated Statements of Earnings
for the years ended December 31, 1997 and 1996 . . . . . . . . 20
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1997 and 1996 . . . . . . . . 21
Consolidated Statements of Cash Flows
for the years ended December 31, 1997 and 1996 . . . . . . . . 23
Notes to Consolidated Financial Statements . . . . . . . . . . . . 25
16
<PAGE 17>
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
First Choice Health Network, Inc.
We have audited the accompanying consolidated balance sheet of First Choice
Health Network, Inc. and subsidiary (the Company) as of December 31, 1997, and
the related consolidated statements of income, shareholders' equity, and cash
flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit. The financial statements of the Company for the year ended
December 31, 1996, were audited by other auditors whose report, dated
March 11, 1997 (March 28, 1997, as to certain subsequent events), expressed an
unqualified opinion on those statements.
We conducted our audit 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 audit provides 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 the
Company as of December 31, 1997, and the results of its operations and cash
flows for the year then ended in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
March 20, 1998
17
<PAGE> 18
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $11,356,346 $ 2,407,355
Service fees receivable, net of allowance
for doubtful accounts of $96,187 for 1997 and 1996 1,180,421 773,337
Service fees and premiums receivable
from related parties 1,109,269 668,046
Premiums receivable, net of allowance
for doubtful accounts of $57,796 1,849,145 -
Investment securities available for sale - 3,072,445
Federal income tax receivable 383,101 8,854
Prepaid expenses 292,112 207,074
Other current assets 15,000 15,625
----------- -----------
Total current assets 16,185,394 7,152,736
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 1,667,240 1,030,286
Computer software 304,264 343,370
----------- -----------
1,971,504 1,373,656
Less accumulated depreciation and amortization 1,103,738 728,819
----------- -----------
Furniture, equipment and computer software, net 867,766 644,837
OTHER ASSETS:
Investment securities available for sale - 2,434,921
Restricted indemnity cash 309,368 150,000
Goodwill, net of accumulated amortization of
$45,026 and $11,500 320,577 78,500
----------- -----------
Total other assets 629,945 2,663,421
----------- -----------
TOTAL $17,683,105 $10,460,994
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE> 19
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable $ 206,202 $ 88,636
Accrued expenses 1,802,574 339,359
Reserve for unpaid claims and claims
adjustment expenses 1,394,107 18,599
Due to unrelated provider organizations 1,376,088 -
Due to related provider organizations 1,289,690 -
Unearned premiums 335,629 14,368
Deferred income taxes 112,624 429,422
----------- ----------
Total current liabilities 6,516,914 890,384
DEFERRED INCOME TAXES 252,986 -
MINORITY INTEREST 1,312,231 -
COMMITMENTS AND CONTINGENCIES (Notes 5 and 13)
SHAREHOLDERS' EQUITY:
Common Stock:
Class A, par value $1 - Authorized, 30,000 shares;
issued and outstanding, 648 and 656 shares 648 656
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 and 40,600 shares 40,600 40,600
Additional paid-in capital 4,416,090 5,046,417
Shareholder receivable (250,000) (500,000)
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 3,921,528 3,540,660
Net unrealized loss on investment securities available
for sale, net of deferred taxes of $15,368 - (29,831)
----------- ------------
Total shareholders' equity 9,600,974 9,570,610
----------- ------------
TOTAL $17,683,105 $10,460,994
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE> 20
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
OPERATING REVENUE:
<S> <C> <C>
Premium revenue $15,711,616 $ -
Premium revenue, related parties 4,050,286 -
Network access fees 4,172,888 3,589,593
Hospital administrative fees, primarily related parties 2,527,105 2,599,738
Other 119,227 10,175
----------- ----------
Total operating revenue 26,581,122 6,199,506
OPERATING EXPENSES:
Medical expenses 10,472,784 -
Medical expenses, related parties 7,074,205 -
Payroll and related expenses 4,305,685 2,715,630
Selling, general, and administrative expenses 4,567,694 2,228,786
----------- ----------
Total operating expenses 26,420,368 4,944,416
----------- ----------
Operating income 160,754 1,255,090
OTHER INCOME (EXPENSE):
Interest and dividends 511,257 292,439
Other 97,366 40,462
---------- ----------
608,623 332,901
---------- ----------
Income before federal income taxes
and minority interest 769,377 1,587,991
FEDERAL INCOME TAXES 504,006 550,277
---------- ----------
265,371 1,037,714
MINORITY INTEREST 115,497 -
---------- ----------
NET INCOME $ 380,868 $1,037,714
========== ==========
NET INCOME PER COMMON SHARE $ 6.49 $ 20.57
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,650 50,446
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
20
<PAGE> 21
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
Common Stock
------------
Class A Class B Additional Balance
------- ------- paid-in Shareholder carried
Shares Amount Shares Amount capital receivable forward
------ ------ ------ ------ ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1996 676 $676 29,000 $29,000 $2,630,268 $ - $2,659,944
Issuance of Class B common stock and
membership rights to physicians 11,600 11,600 2,419,884 2,431,484
Shareholder receivable (500,000) (500,000)
Repurchase of Class A common stock
and membership rights from physicians (20) (20) (3,735) (3,755)
----- ----- ------- ------- ---------- --------- -----------
BALANCE, December 31, 1996 656 656 40,600 40,600 5,046,417 (500,000) 4,587,673
Cash received from shareholder receivable 250,000 250,000
Repurchase of Class A common stock
and membership rights from physicians (8) (8) (1,728) (1,736)
Reduction in equity from issuance
of subsidiary's stock (628,599) (628,599)
----- ----- ------- ------- ---------- --------- ----------
BALANCE, December 31, 1997 648 $648 40,600 $40,600 $4,416,090 $(250,000) $4,207,338
===== ===== ======= ======= ========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE> 22
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
Net unrealized
loss on
investment
securities
Balance Paid-in available for Total
brought capital from Retained sale, net of shareholders'
forward affiliates earnings deferred taxes equity
------- ---------- -------- -------------- ------
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1996 $2,659,944 $1,472,108 $2,502,946 $(18,262) $6,616,736
Issuance of Class B common stock and
membership rights to physicians 2,431,484 2,431,484
Shareholder receivable (500,000) (500,000)
Repurchase of Class A common stock
and membership rights from physicians (3,755) (3,755)
Net income - 1,037,714 1,037,714
Change in unrealized loss on securities
available for sale, net of deferred taxes - (11,569) (11,569)
---------- ----------- ---------- --------- ----------
BALANCE, December 31, 1996 4,587,673 1,472,108 3,540,660 (29,831) 9,570,610
Cash received from shareholder receivable 250,000 250,000
Repurchase of Class A common stock
and membership rights from physicians (1,736) (1,736)
Reduction in equity from issuance
of subsidiary's stock (628,599) (628,599)
Net income - 380,868 380,868
Change in unrealized loss on securities
available for sale, net of deferred taxes - 29,831 29,831
---------- ----------- ---------- --------- ----------
BALANCE, December 31, 1997 $4,207,338 $1,472,108 $3,921,528 $ - $9,600,974
========== =========== ========== ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE> 23
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 380,868 $ 1,037,714
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 283,945 169,161
Amortization 34,151 6,000
Amortization of premium on debt securities
available for sale - (42,138)
Deferred income taxes, net (78,604) 123,870
Write-off bad debts 57,796 -
Realized loss (gain) on sales of securities
available for sale 58,942 (42,304)
Minority interest (115,497) -
Cash provided (used) by changes in operating
assets and liabilities:
Service fees receivable (848,307) (337,219)
Premiums receivable (1,672,363) -
Federal income tax receivable (374,247) 81,275
Prepaid expenses (59,791) (24,605)
Other current assets 625 -
Accounts payable 48,279 (117,970)
Accrued expenses 761,129 159,906
Reserve for unpaid claims and claims
adjustment expenses (737) -
Due to provider organizations 2,665,778 -
Unearned premiums 321,261 -
---------- ----------
Net cash provided by operating activities 1,463,228 1,013,690
INVESTING ACTIVITIES:
Purchase of investment securities available for sale (7,457,715) (6,863,747)
Sales and maturities of investment securities
available for sale 15,301,865 4,628,955
Acquisition of Health First Partners, net of
cash acquired (97,936) -
Purchase of furniture, equipment, and
computer software (508,715) (231,342)
Acquisition of license fees - (1,936)
Increase in restricted indemnity cash - (150,000)
---------- -----------
Net cash provided (used) by investing activities 7,237,499 (2,618,070)
--------- -----------
BALANCE, carried forward 8,700,727 (1,604,380)
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 24
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLDIATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
BALANCE, brought forward $ 8,700,727 $(1,604,380)
FINANCING ACTIVITIES:
Payment of note payable - (45,000)
Repurchase of Class A common stock and membership
rights from physicians (1,736) (3,755)
Issuance of Class B common stock and membership
rights from physicians - 1,931,484
Payment of shareholder receivable 250,000 -
----------- ----------
Net cash provided by financing activities 248,264 1,882,729
----------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 8,948,991 278,349
CASH AND CASH EQUIVALENTS:
Beginning of year 2,407,355 2,129,006
----------- ----------
End of year $11,356,346 $2,407,355
=========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for federal income taxes $ 955,000 $ 360,000
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Shareholder receivable for common stock issuance - (500,000)
Net assets acquired for common stock (Note 10) 525,303 -
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 25
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1996
NOTE 1:DESCRIPTION OF BUSINESS AND SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: First Choice Health Network, Inc. (the Company)
was incorporated under the laws of the state of Washington on September 28,
1984. The Company was formed to organize a network of independent
participating physicians and hospitals to provide a comprehensive, managed
health care delivery system for group plans established by employers and
benefit groups. The Company's business is conducted primarily in
Washington, Oregon, and Alaska.
The Company's wholly owned subsidiary, First Choice Health Plan, Inc., (the
Plan) is a health care services contractor which was formed on January 31,
1995, to offer fully insured health care services to an enrolled population
in Washington state.
Principles of consolidation: The consolidated financial statements include
the accounts of the Company and the Plan. All significant intercompany
accounts have been eliminated in consolidation.
New accounting pronouncements: Effective December 31, 1997, the Company
adopted the provisions of Statement of Financial Accounting Standards
(SFAS) No. 131, Disclosures about Segments of an Enterprise and Related
Information. This statement requires that certain business enterprises
report certain information about operating segments in complete sets of
financial statements of the enterprise. It also requires that certain
business enterprises report selected information about their products and
services, the geographic areas in which they operate, and their major
customers. The notes to the financial statements (see Note 7) include the
required disclosures for the years ended December 31, 1997 and 1996.
In 1997, the Company adopted SFAS No. 128, Earnings Per Share. The
statement requires certain calculations and disclosures surrounding
earnings per share that differ from the method previously required by
generally accepted accounting principles (GAAP). Adoption of this standard
has no effect on previously reported earnings per share.
In 1997, the Company has also adopted SFAS No. 129, Disclosure of
Information About Capital Structure. This statement establishes standards
for disclosing information about an entity's capital structure.
In June 1997, SFAS No. 130, Reporting Comprehensive Income, was issued.
This statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and
losses) in a full set of general-purpose financial statements. This
statement requires that all items that are required to be recognized under
generally accepted accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. This presentation differs from
25
<PAGE> 26
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
the method previously required by GAAP. The Company will be required to
adopt the new method of presentation in 1998. Adoption of this standard is
not expected to have a material effect on the financial statements.
Cash equivalents: The Company considers all highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents. At December 31, 1997 and 1996, cash equivalents consist of
money market funds amounting to $-0- and $232,152, and cash management
funds of $11,356,346 and $2,175,204, respectively.
Investment securities: The Company's investment securities at December 31,
1996, are classified as available-for-sale and are recorded at fair market
value, with unrealized holding gains and losses recognized as a separate
component of shareholders' equity, net of taxes. Declines in the fair
value of investment securities available for sale determined to be other
than temporary are recognized as a component of net income.
The cost used in determining the gain or loss on sales of marketable equity
securities and debt securities is average cost and specific identification,
respectively.
Service fees receivable: Service fees receivable consist primarily of
estimates for hospital administrative fees receivable related to claims
incurred on or before the balance sheet date but not reported. The Company
evaluates the reasonableness of hospital administrative fees receivable
based on claims reported in subsequent periods. These estimates are
subject to the effects of trends in claims. Although considerable
variability is inherent in such estimates, management believes that the
hospital administrative fees receivable are reasonable. The estimates are
continually reviewed and adjusted as necessary in the period new
information becomes known.
Allowance for doubtful accounts: The Company performs periodic credit
evaluations of its customers and maintains an allowance for potential
credit losses.
Furniture, equipment, and computer software: Furniture, equipment, and
computer software are recorded at cost. Depreciation and amortization are
computed using the straight-line method over the lesser of the estimated
useful lives of the assets or lease term ranging from three to five years.
Restricted indemnity cash: Restricted indemnity cash consists of amounts
required to be restricted for potential claims from enrollees as required
by the Office of Insurance Commissioner.
Valuation of long-lived assets: Using its best estimates, based on
reasonable and supportable assumptions and projections, the Company reviews
its long-lived assets for impairment whenever events or changes in
circumstances have indicated that the carrying amounts of its assets might
not be recoverable. At December 31, 1997 and 1996, no write downs were
required.
26
<PAGE> 27
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
Goodwill: Goodwill is determined as the difference between the purchase
price and fair market value of net assets purchased. Goodwill is amortized
using the straight-line method over five years. Events or changes in
circumstances have not occurred that indicate the value of goodwill has
been impaired as of December 31, 1997 and 1996.
Reserve for unpaid claims and claims adjustment expenses: This liability
represents reported and unreported claims which have been incurred but have
not been paid at the date of the financial statements. The reserve for
unreported claims is determined actuarially by prior experience and the
nature of current business and volume. Included in the liability is an
estimate of the future expenses necessary to settle claims included in the
reserve for unreported claims. Due to the uncertainties inherent in the
estimation process, actual costs may differ from the estimated amounts in
the near term, and these differences may be significant.
Earnings per share: Net income per common share is computed by dividing
income available to common shareholders by the weighted average number of
common shares outstanding during the period, including 40,600 common shares
and 18,050 shares applicable to affiliate common share equivalents in
both 1997 and 1996. Shares issued during the period and shares
reacquired during the period were weighted for the portion of the period
that they were outstanding. There are no dilutive securities.
Due to provider organizations: This liability is the net amount due to
health care providers in conjunction with capitation arrangements, which is
computed by subtracting the claims payment made on behalf of the provider
from the capitated amounts contractually allocated to them. The ultimate
payout or receipt of these amounts is subject to a settlement process
subsequent to December 31, 1997.
Operating revenue: Operating revenue consists primarily of premium
revenue, network access fees, and hospital administrative fees. Premium
revenue represents amounts charged for health care services and is
recognized as revenue in the period for which enrollees are entitled to
medical care. Network access fees are recognized as earned during the
period of coverage and are recorded at contractual rates. Hospital
administrative fees are recognized as earned in the period hospital claims
are incurred by a subscriber and are recorded at a contractual percentage
of the claims.
For the year ended December 31, 1997, 48% of the premium revenue related to
one subscriber group.
Advertising: The Company expenses advertising costs as incurred.
Advertising expense amounted to $237,292 and $4,195 in 1997 and 1996,
respectively.
Income taxes: Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to reverse. The effect on
27
<PAGE> 28
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
the deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A
valuation allowance is established to the extent that it is more likely
than not that deferred tax assets will not be realized.
Use of estimates: Preparation of consolidated 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 and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
NOTE 2:SHAREHOLDERS' EQUITY
Ownership of stock: Class A common stock may be held solely by physicians
licensed in the state of Washington who contract with the Company to
provide health care services and who hold active, associate, or provisional
medical staff privileges at one or more of the hospitals that contract with
the Company to provide health care services.
Class B common stock may be held by hospitals in the state of Washington
that contract with the Company to provide health care services.
Voting rights: Holders of each outstanding share of Class A or Class B
common stock are entitled to one vote on each matter submitted to a vote at
meetings of shareholders, and each class of common stock votes as a
separate class.
Transfer of stock: Shareholders may only transfer their stock in the
Company to the Company for repurchase. The repurchase price is established
by the Board of Directors each fiscal year as set forth in the bylaws.
Class A shares were repurchased at $217 per share during 1997.
Dividends: The Board of Directors may declare and pay dividends on one or
more classes of common stock at such times and in such amounts as it
designates, but in no event may dividends be paid while there is an
outstanding obligation to repurchase shares. Dividends are allocated among
shareholders of each class of stock according to the number of shares
outstanding to each Class A or B shareholder. Any dividends paid to the
Class B shareholders must be shared with the nonshareholder district
hospitals that have rights equivalent to that of the Class B shareholders.
Liquidation rights: Upon liquidation or dissolution, the Board of
Directors, at its discretion, will allocate the value of assets among the
classes of its outstanding stock in proportion to the capital contributions
of shareholders of each class. For these purposes, the contributions by
the nonshareholder district hospitals that have rights equivalent to that
of the Class B shareholders and the membership fees paid by Class A
shareholders are considered capital contributions. The allocation to Class
A shareholders will be shared among all Class A shareholders in accordance
with the number of shares outstanding to each
28
<PAGE> 29
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
Class A shareholder. The allocation of the Class B shareholders must be
shared with the nonshareholder hospitals that have rights equivalent to
that Class B shareholders.
Paid-in capital from affiliates: District hospitals are not shareholders
of the Company, but have contractual agreements with the Company that
provide for certain rights and obligations equivalent, but not identical,
to those of Class B shareholders, including liquidation and dividend
rights. The capital contributions of the nonshareholders are recorded as
paid-in capital from affiliates. These contractual agreements are
considered to be common share equivalents for purposes of calculating net
income per common share.
NOTE 3:INVESTMENT SECURITIES
The Company had no investment securities at December 31, 1997.
The amortized cost, gross unrealized gains, gross unrealized losses, and fair
values of investment securities available for sale at December 31, 1996, are
as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
---------- -------- -------- ----------
<S> <C> <C> <C> <C>
Marketable equity securities $ 600,336 $ 73,975 $ 11,531 $ 662,780
Mortgage and asset-backed securities 1,876,587 1,791 125,128 1,753,250
Corporate debt securities 3,075,642 15,999 305 3,091,336
---------- -------- --------- ----------
$5,552,565 $ 91,765 $136,964 $5,507,366
========== ======== ========= ==========
</TABLE>
Realized gains (losses) were $(58,942) and $56,564 in 1997 and 1996,
respectively.
NOTE 4:FEDERAL INCOME TAXES
Federal income taxes consist of the following components:
1997 1996
---- ----
Current $582,610 $426,407
Deferred (78,604) 123,870
-------- --------
$504,006 $550,277
======== ========
29
<PAGE> 30
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
Federal income taxes differ from the amount computed by applying the expected
U.S. corporate income tax rate to income before federal income taxes for the
years ended December 31 as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------- --------------------
Amount Percent Amount Percent
<S> <C> <C> <C> <C>
Computed expected rate $261,558 34.0% $539,917 34.0%
Tax effect of permanent differences:
Valuation allowance on Plan NOLs 179,481 23.4 - -
Political contributions 34,026 5.6 - -
Other 28,911 3.8 10,360 .7
-------- ------ -------- ------
$504,006 66.8% $550,277 34.7%
======== ====== ======== ======
</TABLE>
The deferred tax assets and liabilities resulting from the tax effects of
temporary differences at December 31 are presented below:
1997 1996
---- ----
Deferred tax assets:
Net operating losses $1,531,379 $ -
Reduction of shareholders' equity 628,599 -
Other 20,458 15,368
---------- --------
Gross deferred tax assets 2,180,436 15,368
Valuation allowance 2,159,978 -
---------- --------
Net deferred tax assets 20,458 15,368
Deferred tax liabilities:
Cash to accrual adjustment 337,876 418,080
Furniture, equipment and computer software 7,276 26,710
---------- --------
Total deferred tax liabilities 345,152 444,790
---------- --------
Deferred federal income taxes, net $(365,610) $(429,422)
========== =========
Current portion of cash to
accrual adjustment $ 112,624 $ 418,080
Other - 11,342
--------- ---------
Current deferred tax liability 112,624 429,422
Deferred federal income taxes,long term 252,986 -
--------- ---------
Deferred federal income taxes $ 365,610 $ 429,422
========= =========
30
<PAGE> 31
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
The valuation allowance was established in 1997 against the tax benefit of the
1997 net operating losses (NOLs) of the Plan since the Plan will file a
separate federal income tax return for the final six months of 1997 and the
realization of the tax benefit is unlikely. The allowance is also provided
for NOLs acquired in the Health First Partners merger, and the reduction of
shareholders equity as described in Note 10. The following schedule
represents the amounts of the Plan NOLs and their expiration date:
2003 $ 138,000
2007 328,438
2008 53,781
2009 20,754
2010 1,584,667
2011 1,850,561
2012 527,885
----------
$4,504,085
==========
NOTE 5:COMMITMENTS
Leases: The Company leases its office facilities under terms of two
operating leases expiring in September 1999 and January 2002. The leases
provide for monthly minimum rent payments and include renewal options for
an additional five years.
Rental expense charged to operations under the operating leases for the
years ended December 31, 1997 and 1996, was $254,247 and $148,500,
respectively.
Future minimum lease payments under the operating leases for the years
ended December 31 are as follows:
1998 $325,394
1999 279,717
2000 144,468
2001 145,140
2002 12,095
--------
$906,814
========
NOTE 6:RELATED PARTY TRANSACTIONS - OPERATING
REVENUE AND SERVICE FEES RECEIVABLE
Operating revenue includes $5,293,409 and $2,063,365 for administrative
service fees, premium revenue, and network access fees charged to owner and
affiliated groups for the years ended December 31, 1997 and 1996,
respectively.
31
<PAGE> 32
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
NOTE 7:REPORTABLE OPERATING SEGMENTS
Factors management used to identify the enterprise's reportable segments:
The Company has two reportable segments which correspond to the
organization of the parent Company and its majority-owned subsidiary, the
Plan. Each segment requires distinct tracking capabilities in the areas of
revenues, claims processing, marketing strategies and reporting to
regulatory organizations.
Description of the types of products and services from which each
reportable segment derives its revenue:
The Company has two primary products which have been aggregated into one
reportable segment: network access fees and hospital administration fees.
Network access fees arise from the rental of the Company's large PPO
network while hospital administration fees arise from charges to the
network hospitals based on claims incurred by members. The other
reportable segment, the Plan, offers a variety of fully insured health
insurance plans to employer groups.
Measurement of segment profit or loss and segment assets: The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies. The Company evaluates performance based
on profit and loss from operations before income taxes not including
nonrecurring gains and losses. The Company accounts for intersegment
revenues by assigning a management fee to the Plan that is an estimate of
resources expended on the Plan's behalf.
Information about profit or loss and assets of reportable segments:
<TABLE>
<CAPTION>
First Choice First Choice
Health Network Health Plan Total
-------------- ----------- -----
<S> <C> <C> <C>
1997:
Revenues from external customers $ 6,545,852 $20,035,270 $26,581,122
Interest Revenue 131,520 379,737 511,257
Interest Expense 35,000 35,000
Depreciation/amortization expense 265,570 51,926 317,496
Income tax expense (benefit) 537,730 (33,724) 504,006
Expenditures on furniture, equipment
and computer software 508,715 508,715
Segment profit (loss) 2,601,835 (2,336,464) 265,371
Assets 13,761,732 11,298,860 24,999,161
Liabilities 1,466,574 5,952,073 7,418,647
1996:
Revenues from external customers 6,157,878 41,628 6,199,506
Interest revenue 190,671 101,768 292,439
Depreciation/amortization expense 174,820 - 174,820
Income tax expense (benefit) 550,277 - 550,277
Expenditures on furniture, equipment
and computer software 231,342 - 231,342
Segment profit (loss) 997,281 40,433 1,037,714
Assets 10,399,864 1,734,715 12,134,579
Liabilities 887,597 35,765 923,362
</TABLE>
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Revenues:
Total revenues for reportable segments
and consolidated revenues $26,581,122 $ 6,199,506
=========== ===========
Profit or loss:
Total profit or loss for reportable segments $ 265,371 $ 1,037,714
Adjustment for minority interest in
consolidated statements 115,497 -
---------- -----------
Consolidated net income $ 380,868 $ 1,037,714
========== ===========
Assets:
Total assets for reportable segments $24,999,161 $12,134,579
Elimination of intercompany investment (7,316,056) (1,673,585)
----------- -----------
Consolidated total assets $17,683,105 $10,460,994
=========== ===========
Liabilities:
Total liabilities for reportable segments $ 7,418,647 $ 923,362
Elimination of intercompany balance (648,747) (32,978)
----------- -----------
Consolidated total liabilities $ 6,769,900 $ 890,384
=========== ===========
</TABLE>
32
<PAGE> 33
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
Substantially all of the revenues from external customers are derived from
within the state of Washington.
Revenues from one customer of the Plan represent approximately $9,500,000 of
the Company's consolidated revenues for 1997.
NOTE 8:FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, service fees and premiums
receivable, accounts payable and due to provider organizations approximates
fair value because of the short maturity of these instruments.
NOTE 9:RETIREMENT PLAN
The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan
covering all full time employees. Under the plan, employees can defer up to
12% of eligible compensation. The Company matches 50% of the employee
contribution, up to 6% of the employee's eligible salary. Employees become
fully vested in employee and employer contributions when the contributions are
made. The Company also has the option to make additional profit sharing
contributions.
33
<PAGE> 34
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
contribution to the plan. Employer contributions to the plan for the years
ended December 31, 1997 and 1996, amounted to $60,191 and $45,645,
respectively.
NOTE 10: ACQUISITIONS
Effective July 1, 1997, the Plan acquired 100% of the stock of Health First
Partners, Inc., a health care services contractor (HCSC) operating in the
state of Washington, in which shareholders of the Network have an interest,
by issuing 33,572 shares of stock. The acquisition has
been accounted for as a purchase with a cost of the net assets acquired of
approximately $936,000. The purchase price was allocated based on the fair
value of assets and liabilities at the date of acquisition as follows:
$660,740 working capital and $275,260 goodwill. The results of operations of
Health First Partners, Inc. have been included in the Company's consolidated
financial statements from the date of acquisition. At the same time, the Plan
acquired a large contract from Health Washington, L.L.C., a limited liability
company licensed under the laws of the state of Washington, in which the
shareholders of the Network have an interest, by issuing 34,523 shares
of common stock. The primary asset acquired through this acquisition
was an employer group health insurance contract and supporting health care
network of providers for which fair value has been determined to be minimal,
accordingly, no amounts have been attributed to this contract in the
accompanying financial statements. The acquisition has been accounted for as
a purchase. The results of operations attributable to the contract have been
included in the Company's consolidated financial statements from the date of
acquisition. As a result of the above transactions, there was a reduction in
the Company's equity as the carrying value of the stock issued exceeded the
fair value of the contract.
The Company retained 75.1% interest in the voting common stock of the Plan as
a result of these acquisitions. In addition, the Company is required to
contribute to the capital of the Plan, a percentage of the Company's
administrative fee revenue for the ten years following July 1, 1997, if any.
No minimum amounts of contributions are required. Subsequent to December 31,
1997, $630,031 was contributed as additional paid-in capital for the
percentage of the Company's revenues from July 1, 1997, through December 31,
1997. The investment in the Plan is eliminated in consolidation.
Pro forma financial information (unaudited): The following pro forma
information sets forth historical information which has been adjusted to
reflect the acquisition of Health First Partners, Inc. as discussed above.
The pro forma information is presented for the years ended December 31, 1997
and 1996. The pro forma statement of earnings information assumes the
transactions have taken place at the beginning of the period presented.
34
<PAGE> 35
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
1997 1996
---- ----
Operating revenue $29,526,186 $10,305,374
=========== ===========
Net loss $ 1,457,803 $(1,126,663)
=========== ===========
Loss per share $ (26) $ (23)
=========== ===========
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition of Health First Partners, Inc. had been in
effect for the periods presented, are not intended to be a projection of
future results, and do not reflect any synergies that might be achieved from
combined operations.
NOTE 11: CLAIM PAYMENTS
Activity in the provision for unpaid claims and unpaid claims processing
expenses is summarized as follows for the year ended December 31, 1997:
Balance, beginning of year $ 18,599
Assumed in acquisition 1,410,245
Incurred related to:
Current year 907,945
Prior year -
----------
Total incurred 2,318,190
Paid related to:
Current year 924,083
Prior year 18,599
----------
Total paid 942,682
----------
Balance, end of year $1,394,107
==========
NOTE 12: REGULATORY MATTERS
The Company's 75.1% owned subsidiary, the Plan, is subject to regulation by
the Office of Insurance Commissioner in the state of Washington including the
requirement to follow statutory (NAIC) accounting principles, which differ
from generally accepted accounting principles. As such, certain levels of
capital are required. At December 31, 1997, reserves and unassigned capital,
and net for the year reported to the NAIC were $7,607,703 and $(2,650,761),
35
<PAGE> 36
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997 AND 1996
respectively. The primary difference in reporting between the NAIC and GAAP
is nonadmitted assets of certain property, plant and equipment, goodwill,
accounts receivables over 90 days and prepaid expenses. At December 31, 1997,
the shareholders' equity and net loss for the year were $5,346,787 and net
$(2,336,464), respectively, for the Plan.
NOTE 13: CONTINGENCY
In connection with Overlake Hospital becoming a shareholder in December 1996,
the Company incurred a contractual contingent liability for exclusivity
damages to another hospital shareholder of up to $600,000. Since the amount
of any damages is not reasonably estimable, no amount has been reflected in
the consolidated financial statements as of December 31, 1997 and 1996.
NOTE 14: SUBSEQUENT EVENTS
In January 1998, the owners of the Plan entered into an agreement which
increased the Company's ownership in the common stock of the Plan from 75.1%
to 80%. The purpose of the increase in common stock ownership was to allow
for the consolidation of tax returns between the Company and the Plan. This
transaction by Health Washington included exchanging of common stock held by
the minority owners for the same number of preferred shares. This preferred
stock is nonvoting and noncumulative and has a dividend rate of 10.5%.
In March 1998, the Company signed a five year office lease to consolidate
their current locations to a central location, commencing on July 1, 1998 with
annual lease payments of $516,876 for the next five years.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
First Choice Health Network, with the approval of the Company's
Board of Directors, notified KPMG Peat Marwick LLP on August 12,
1997 regarding the Company's decision not to retain KPMG Peat
Marwick LLP as the Company's auditors for the fiscal year ending
December 31, 1997.
KPMG Peat Marwick LLP's report on the Company's financial statements
for each of the two years ending December 31, 1996 contained no
adverse opinion or disclaimer of opinion, and was not qualified or
modified as to uncertainty, audit scope, or accounting principals.
There were no disagreements with KPMG Peat Marwick LLP on any matter
of accounting principals or practices, financial statement
disclosure, or auditing scope or procedure during the two most
recent fiscal years ended December 31, 1996 and 1995 and the
subsequent interim period through August 12, 1997.
There were no disagreements with accountants on accounting and
financial disclosure.
36
<PAGE> 37
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16 (a)OF THE EXCHANGE ACT.
The executive officers and directors of First Choice are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ----------------------------------------------------------------------------
<S> <C> <C>
Gary R. Gannaway 51 Vice President & Chief Executive Officer
Nancy Cortez 49 Vice President-Compliance & Communications
Ross D. Heyl 44 Vice President-Marketing
David Peel 37 Vice President -Finance
Judith A. Sarafin 42 Vice President-Operations
Ricord B. Winstead, M.D. 50 Vice President & Medical Director
Paul M. Elliott 57 Director (II)
Andrew Fallat 50 Director (I)
John L. Fleming, M.D. 54 Director (I)
Phillip J. Haas 49 Director (II)
Barbara L. Mauk 52 Director (III)
Richard A. McGee, M.D. 52 Director (III)
Richard H. Peterson 55 Director (III)
Richard E. Rust, M.D. 71 Director (III)
Robert H. Smith 53 Director (I)
Richard Stubbs, M.D., M.B.A. 52 Director (II)
Clyde D. Walker 42 Director (I)
</TABLE>
(I) Term Expires in 1998
(II) Term Expires in 1999
(III) Term Expires in 2000
Gary R. Gannaway assumed the position of President and Chief Executive Officer
of First Choice in January 1996. Mr. Gannaway has an extensive background in
the development and marketing of managed health care and creating innovative
partnerships between physicians and hospitals. Mr. Gannaway has served as
Principal and President of Dauner, Gannaway and Associates, a managed care
consulting and management company, with offices in Phoenix, Arizona and
Wichita, Kansas, from 1987 to 1995. During the same period he has served as
President and CEO of Premier healthcare of Arizona, a statewide HMO; as
President of the Arizona Healthcare Alliance of Phoenix, which developed and
marketed seven area PHOs; and Vice President for western U.S. managed care
operations at Aetna Health Plans.
Nancy Cortez, Vice President, Compliance, joined First Choice Health in
November, 1992. Ms. Cortez has over 25 years of health care experience
including indemnity, PPO, HMO, Medicare and Medicaid. Prior to joining First
Choice she worked as an independent health care consultant. From 1985 to
1987, Ms. Cortez was a senior consultant with KPMG Peat Marwick, Seattle,
responsible for project management and support, primarily for
37
<PAGE> 38
Medicaid IS design and installation projects. From 1970 to 1985, she was with
Regence Blue Shield (formerly King County Medical Blue Shield) where she was
the Manager, Profile Development Systems and the Manager, Medicare, Technical
Services. Ms. Cortez received her bachelor of arts degree in languages from
Seattle University. She earned a master of business degree from the
University of Washington, specializing in management information systems
design and finance. Ms. Cortez also holds first and second degrees in
language and literature for foreign students from the University of Grenoble,
Grenoble, France.
Ross D. Heyl, Vice President, Marketing, joined First Choice in 1985. From
1982 to 1985, Mr. Heyl was an account executive for Rollins Burdick Hunter of
Washington; and from 1980 to 1982, he was employed by Penn Mutual Life
Insurance Company in San Francisco and Seattle. Mr. Heyl is a licensed health
insurance agent in the state of Washington.
David Peel, Vice President, Finance, and Treasurer joined First Choice Health
Network in July 1996. He served as the Vice President of Product Development
and Underwriting until assuming the position of Chief Financial Officer in
February 1997. Mr. Peel served as Vice President and Chief Financial Officer
for Premier Healthcare of Arizona from 1995 to 1996 and as Associate Director,
Provider Contracting for Samaritan Health Plan in Phoenix, Arizona from 1987
to 1995.
Judith A. Sarafin, Vice President, Operations joined First Choice in November,
1994. Ms. Sarafin served as Information Systems Manager from 1992 to 1994 and
as Manager of the Claims Audit Department from 1988 to 1992 at King County
Medical Blue Shield in Seattle. Ms. Sarafin was a health care consultant with
KPMG Peat Marwick, Seattle, and prior to that worked for Group Health
Cooperative as claims systems implementation project manager, medical
technologist and billing supervisor.
Ricord B. Winstead, M.D., Vice President and Medical Director, joined First
Choice in October 1995 and is responsible for the First Choice's utilization
management program and for relations with First Choice's the physicians
participating in the Company's PPO. Dr. Winstead served as Associate Regional
Chief of Staff for the north district of Group Health Cooperative of Puget
Sound. He has been Medical Director of Puget Sound Division of QualMed Health
Plan and Cigna Health Plan of Washington. Dr. Winstead is a certified member
of the American Board of Family Practice and is a member of the American
College of Physician Executives and of the national, state and county
Academies of Family Physicians. He is the immediate past president of the
King County Academy of Family Physicians. Dr. Winstead was licensed to
practice family medicine in Washington state in 1980 after earning his M.D.
degree from the University of Washington School of Medicine. He received his
Bachelor's degree from John Hopkins University in Baltimore and completed his
residency in family practice at Swedish Hospital in Seattle in 1982.
Paul M. Elliott has been a director of First Choice since September 1989. Mr.
Elliott is President and CFO for Cafe Fonte in Seattle. Mr. Elliott has
served as Director of Plan of Pepsi Cola in Seattle from July 1993 through
1995, and from August 1981 through June 1993, Mr. Elliott served as Senior
Vice President, - Finance Operations, and Treasurer of Al Pac Corporation.
38
<PAGE> 39
Andrew Fallat has been a director of First Choice since July 1995. He has
been the Chief Executive Officer at Evergreen General Hospital for 17 years.
Mr. Fallat is the Chief Executive Officer of Evergreen Community Health Care,
Puget Sound's largest and most comprehensive hospital based hospice and home
health program, mobile paramedic services and a broad range of other community
based health assistance programs. He is a board member on the Foundation for
Health Care Quality, a Fellow in the American College of Healthcare Executives
and is the College's Regent for the state of Washington.
John L. Fleming, M.D., has been a director of First Choice since July 1995.
Dr. Fleming is a practicing physician in Family Medicine at Roosevelt Medical
Center. He has been a member of the American Academy of Family Physicians and
King County Medical Society since 1970. He is the consulting physician at
Seattle Pacific University. He served as the CEO at Roosevelt Medical Center
from 1988 through 1996 and has served on the Northwest Health Partners Board
of Directors, the Board of Directors of Pacific Consolidated Services
Corporation, and Board of Directors of First Choice Health Network (since
1996). At Northwest Hospital, Dr. Fleming has served as the Secretary-
Treasurer and Chief-of-Staff Elect of the Medical Staff and will soon assume
the role of Chief-of-Staff of that institution. He received his undergraduate
degree from Pacific Union College, his medical degree from Loma Linda
University, and a Rotating Internship at Charles Kettering Memorial Hospital.
Phillip J. Haas has been a director of First Choice since July 1995. Mr. Haas
is Administrator Primary and Managed Care of Valley Medical Center. From 1988
through 1993, he was Executive Director of Virginia Mason Health Plan, an HMO
serving over 40,000 members. From 1985 to 1988, Mr. Haas was President of
First Choice Health Network. He has previously served as Senior Vice
President of the Illinois Hospital Association, president of a hospital shared
services organization, and administrative director of a medical school-based
prepaid group practice plan. He is a Fellow of the American College of
Healthcare Executives.
Barbara L. Mauk has been a director of First Choice since May 1986. Ms. Mauk
is the Managing Partner of Great Northwest Benefits, an employee benefits
brokerage and consulting firm. She has previously served as the Chief
Operating Officer of The Reppond Company; Vice President Human Resources for
KIRO Broadcasting, Inc.; and Personnel Director for Northwest Hospital. She
is active with Bellevue Rotary, the American Compensation Association, and the
Employee Benefits Planning Association.
Richard A. McGee, M.D., has been a director of First Choice since July 1995.
Dr. McGee has a full-time medical oncology practice and is the President of
Washington Cancer Centers, the largest oncology medical group in Washington
State. He was previously the Medical Director of Stevens Healthcare, a Public
Hospital District, and is a consultant in Medical Staff affairs to other area
hospitals. He is a diplomat of the American Board of Internal Medicine, as
well as both the American Board of Hematology and the American Board of
Medical Oncology. He is a member of the Board of Directors and President-
Elect of Washington State Medical Oncology Society and is Chairman of the
Quality Assurance Committee of Stevens Health Network, a local PHO. He is a
Clinical Professor of Medicine at the University of Washington and is a Fellow
of the American College of Physicians. He has served in the past as Chief of
the Medical Staff, chairman of several medical staff committees, and as Vice-
Chairman of the Board of Directors of Snohomish County Physicians Corporation,
a Blue Shield company. His undergraduate studies were at John Carroll
University, his graduate studies at Johns Hopkins University Medical School
and his post graduate work at the University of Washington Hospital and the
National Institutes of Health in Bethesda, Maryland.
39
<PAGE> 40
Richard H. Peterson was elected to serve a three year term as director at the
July 1997 board meeting. Mr. Peterson is President and Chief Executive
Officer of Swedish Health Services, a non-profit organization comprised of a
163-bed community hospital on the Ballard campus and a 697-bed tertiary care
hospital on the First Hill campus. Mr. Peterson previously served as
President and Chief Executive Officer of Fairview Riverside Medical Center in
Minneapolis, Minnesota and Executive Vice President and Chief Operating
Officer of North Memorial Medical Center in Robbinsdale, Minnesota. In all,
his career in health system administration has spanned more than 25 years. A
native of Minnesota, Mr. Peterson holds a master's degree in hospital and
health care administration from the University of Minnesota and a B.A. from
Macalester College in St. Paul, Minnesota.
Richard E. Rust, M.D., has been a director of First Choice since May 1986.
Dr. Rust is a retired family physician. His past activities include serving
as Trustee of the Washington Academy of Family Physicians; Trustee, King
County Medical Society; Trustee and Vice Chairman of King County Medical Blue
Shield; and President of King County Academy of Family Physicians. He was
Chief of Medical Staff of Northwest Hospital in 1965.
Robert H. Smith, III, has been a director of First Choice since January 1995.
Mr. Smith has been Executive Vice President and Chief Financial Officer of
Good Samaritan Community Hospital since 1985. Mr. Smith is a certified public
accountant (CPA) and a certified healthcare executive (CHE). Previously, Mr.
Smith served as Chief Financial Officer for Roseville Community Hospital near
Sacramento from 1983 to 1985, and Merle West Medical Center in Klamath Falls,
Oregon from 1974 to 1983. and a senior accountant with Ernst & Young in San
Diego from 1972 to 1974. Mr. Smith served actively with the Healthcare
Financial Management Association in various posts, including chapter
president, and has recently served as treasurer of the Board of Directors of
the Puyallup branch of the YMCA. Mr. Smith is currently on the Washington
State Hospital Association DRG Advisory Board and has served as an advisory
Board member for healthcare reimbursement issues for the State of Washington.
Richard Stubbs was elected to serve a three year term as director at the July
1997 board meeting. Dr. Stubbs is the Vice President, Medical Affairs and the
senior physician manager in the MultiCare Health System with direct
responsibility for medical staff relationships and the departments of Medical
Staff Services, Family Practice Residency Education, Quality Management,
Medical Records, Transcription, Pharmacy, Cancer Services, Perinatal and
Neonatal Services. Dr. Stubbs' position represents the key link between
MultiCare Health Systems and the physician community in the Pierce and South
King County areas. Dr. Stubbs previously served as Medical Director, McKay-
Dee Hospital Center in Ogden, Utah, Medical Director for Blue Cross and Blue
Shield of Virginia, in Richmond, Virginia, and Medical Director, IPA and Group
Plans, FHP in Southern California. Dr. Stubbs received his undergraduate and
medical degrees from the University of Arkansas and his M.B.A. from the
University of Phoenix. He is diplomat of the American Board of Family
Practice and a Fellow of the American College of Physician Executives where he
currently serves on the Council of Fellows. He teaches Medical Ethics for the
Tulane University Masters of Medical Management program.
40
<PAGE> 41
Clyde D. Walker has been director of First Choice since April 1995. Mr.
Walker is Vice President, Human Resources of Olin Aerospace Division and Olin
Aerospace Company in Redmond, Washington, where it has been his responsibility
to design and manage the company's medical benefits plan covering over 700
employees and their dependents. Mr. Walker previously served as Director,
Contracts and Pricing. He is actively involved in community efforts including
the Guiding Light organization which provides positive role models for young
African-American males. Mr. Walker serves on the board of directors of Big
Sisters of King County and mentors athletes at the University of Washington.
He received an M.B.A. degree from City University and a B.A. Degree in
Business from the University of Washington.
The Company's Board of Directors proposed an amendment of the Bylaws to modify
the membership of the Board, and on June 29, 1995, the shareholders approved
the changes unanimously.
Classification of Directors. - The management of this corporation shall be
vested in a Board of Directors. Effective from June 29, 1995, the Board of
Directors shall consist of eleven individuals: Four (4) directors (the "Class
A Directors") shall be physicians representing Class A shareholders. Four (4)
directors (the "Class B Directors") shall represent Class B shareholders and
any public hospitals that have made capital contributions to the corporation
("participating hospitals"). Three (3) directors (the "Class C Directors")
shall represent employers other than health care providers and/or be consumers
of health care services.
The Board shall be divided into three categories as follows:
Category I: One Class A Director, one Class B Director, and one Class C
Director.
Category II: Two Class A Directors, one Class B Director, and one Class
C Director.
Category III: One Class A Director, two Class B Directors, and one Class
C Director.
Directors may be removed, with or without cause, by an affirmative vote of the
holders of at least 75% of the outstanding shares of each class of Common
Stock, and the number, classification, qualifications and terms of directors
may not be altered except by such class voting.
A quorum of six directors is generally required to transact business at a
meeting of the Board, except that a quorum of eight directors is required for
determination of the admission and expulsion of shareholders and "members"
(i.e., PPO physicians), the fees charged for and/or paid to health care
providers, and any issues reviewed by the Board regarding the limitation or
termination of health care provider contracts.
41
<PAGE> 42
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth a summary of the compensation earned by the
Company's President and Chief Executive Officer and each other executive
officer who earned in excess of $100,000 in each of the last three fiscal
years:
<TABLE>
<CAPTION>
Name and Principal Annual Compensation All Other
Position Year Salary Bonus Compensation
- ----------------------- ---- ------ ----- ------------
<S> <C> <C> <C> <C> <C>
Gary Gannaway (1) 97 $221,589 $ 126,000
President and 96 $189,653 $ 100,000 $75,000 (2)
Chief Executive Officer
Randolph Barker 97 $100,948 $ -
Former VP, Finance 96 $115,439 $ 15,000 (3)
95 $124,209 $ 19,500 (3)
David Peel 97 $121,384 $ 22,900
Vice President, Finance
Ross Heyl 97 $ 93,467 $ 18,000
Vice President,Marketing 96 $ 93,467 $ 15,400
Ricord Winstead 97 $148,950 $ -
Vice President, 96 $145,445 $ 15,000
Medical Director
</TABLE>
(1) Mr. Gannaway commenced serving as Chief Executive Officer on January 15,
1996.
(2) Consists of $35,000 relocation expenses and $40,000 sign-on bonus.
(3) Pursuant to Mr. Stumpfel's resignation, Mr. Barker served as interim
Chief Executive Officer from May 1, 1995 through January 14, 1996.
Additional compensation for these duties was approved by the Board
of Directors.
Barbara L. Mauk, the Chairman of the Board, has been compensated $500 per
month (inclusive of attendance at regular Board meeting) and an additional
$150 per hour for committee meetings since July 1, 1994. All other directors
have received $75 per hour for attendance at Board and committee meetings
since February 1, 1995. The Chairman and directors compensation remained the
same through December 31, 1997.
42
<PAGE> 43
EMPLOYMENT AGREEMENTS
On October 19, 1995, Gary R. Gannaway entered into a five year employment
agreement as the Company's President and Chief Executive Officer, filling the
vacancy created by the resignation in April 1995 of James G. Stumpfel. Mr.
Gannaway commenced employment on January 16, 1996. Under his employment
agreement with First Choice, Mr. Gannaway will be employed for a five-year
term expiring January 15, 2001 and will receive an annual base salary of
$200,000 for 1996, subject to a minimum 5% annual increase, and will be
allowed $6,000 per annum for automobile expenses. The Company has also agreed
to provide Mr. Gannaway with group life insurance coverage in a dollar amount
equal to twice his annual base salary as well as comprehensive medical, dental
and disability insurance coverage.
On January 26, 1996, First Choice paid Mr. Gannaway $35,000 to cover expenses
related to relocating to the Seattle, Washington area and to subsidize any
down payment obligation relating to the purchase of a home, and $20,000 of a
$40,000 sign-on bonus. The balance of the sign-on bonus was paid out on March
20, 1996.
In each of the years of the employment agreement subsequent to the initial
year, Mr. Gannaway will be eligible to receive a bonus of up to 60% of his
annual base salary, based on achieving performance criteria established by the
Board of Directors.
At December 31, 1997, the respective employment agreements of Mr. Gannaway,
and Mr. Heyl provided that in the event the Company merges with, acquires or
is sold to another entity or business and it can reasonably be determined that
Mr. Gannaway or Mr. Heyl, as the case may be, is no longer being authorized to
perform substantially the duties of President and Chief Executive Officer
(with respect to Mr. Gannaway), or Vice President, Marketing (with respect to
Mr. Heyl), Mr. Gannaway or Mr. Heyl, as the case may be, may elect to
terminate his respective employment, in which event he shall be entitled to
the same severance pay and benefits that he would otherwise have been entitled
to following a termination without cause, for a period of 12 months (with
respect to Mr. Gannaway) or six months (with respect to Mr. Heyl) or until the
applicable person secures other employment, whichever occurs first.
At December 31, 1997, the respective employment agreements provided that Mr.
Gannaway may terminate his employment on 90 days' prior written notice, and
Mr. Heyl on 30 days' prior written notice, and that Mr. Gannaway, and Mr. Heyl
will keep information about the Company confidential and will not compete
with the Company by accepting employment or otherwise becoming associated with
any other managed care organization owned or operated in any geographic areas
served by the Company, for a period of 12 months ( with respect to Mr.
Gannaway) and nine months (with respect and Mr. Heyl) following their
respective voluntary termination's of employment. Mr. Heyl's employment
agreements at December 31, 1996 also provided that if, at the expiration of
the term of their respective contracts, the Company offers a new contracts Mr.
Heyl the terms of which are no less favorable than the terms of his present
contract, and Mr. Heyl do not accept such offer, then Mr. Heyl will not accept
employment by or be associated with any other managed care organization owned
and operated in geographic areas served by the Company for a period of 12
months following the expiration of his present contract.
43
<PAGE> 44
At December 31, 1997, the respective employment agreements of Mr. Heyl also
provided that the Company will indemnify Mr. Heyl against any liabilities
incurred by either in the conduct of his individual employment other than
those as to which they are adjudged to have been liable for misconduct in the
performance of his respective duties, as such standards of conduct are set
forth in the Company's Restated Articles of Incorporation and Bylaws. The
Company has also agreed to obtain officers' and directors' liability
insurance, subject to its reasonable availability, providing coverage for Mr.
Heyl for any liability incurred by him arising out of his position, whether or
not the Company would otherwise be required to indemnify him.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of March 31, 1998, information with respect
to the beneficial ownership of the Company's Class A Common Stock and Class B
Common Stock by (i) each person known by the Company to own beneficially more
than five percent of either the Class A Common Stock or Class B Common Stock,
(ii) each of the persons named in the Summary Compensation Table set forth in
"Item 10. Executive Compensation" of this Part I of this Annual Report, (iii)
each director, and (iv) all directors and executive officers as a group,
together with their percentage ownership of each such class of Common Stock.
Shares Owned Percent of
Name Class A Class B Class A Class B
---- ------- ------- ------- -------
Northwest Hospital - 5,800 - 14.3%
1550 North 155th
Seattle, WA 98133
Providence-General - 5,800 (1) - 14.3%
14th and Colby
Everett, WA 98201
Good Samaritan - 5,800 - 14.3%
Community Healthcare
407-14th Avenue S.E.
Puyallup, WA 98371
Multicare Medical Center - 5,800 - 14.3%
409 South J
Tacoma, WA 98405
Empire Health Services - 5,800 - 14.3%
80 Fifth Avenue
Spokane, WA 99210
Swedish Medical Center - 5,800 - 14.3%
747 Broadway
Seattle, WA 98114
Overlake Hospital Medical Center - 5,800 - 14.3%
1035 116th Avenue N.E.
Bellevue, WA 98004
Paul M. Elliott - - - -
Andrew Fallat - - - -
John L. Fleming, M.D. 1 - * -
Phillip J. Haas - - - -
Barbara L. Mauk - - - -
Richard A. McGee, M.D. 1 - * -
Richard H. Peterson - - - -
Richard E. Rust, M.D. 1 - * -
Richard Stubbs, M.D., M.B.A. - - - -
Robert H. Smith - - - -
Clyde D. Walker - - - -
All directors and executive
officers as a group (3 persons) 3 40,600 * 100%
44
<PAGE> 45
(1) Pursuant to a settlement agreement with the Attorney General of the State
of Washington, Providence-General (i) is permitted to exercise its voting
rights with respect to such shares only when requested to do so by the Board
of Directors of First Choice, (ii) is prohibited from attempting to direct,
control or influence the business operations of First Choice through its
status as shareholder, (iii) is permitted access as a shareholder only to
documents and information approved by the Board of Directors of First Choice,
and (iv) is required to divest itself of such shares if a commercially
reasonable offer is initiated by First Choice to repurchase such shares at
fair market value.
Three additional hospitals in the state of Washington (Evergreen Hospital
Medical Center, 12040 N.E. 128th Street, Kirkland, WA 98034, Valley Medical
Center, 400 S. 43rd Street, Renton WA 98055, and Stevens Memorial Hospital,
21601 76th Avenue, Edmonds, WA 98026) are not shareholders of the Company,
but have made capital contributions to the Company in consideration of
contractual rights substantially similar to the rights to which each holder of
Class B Common Stock is entitled, including liquidation and dividend rights,
but excluding voting rights. See "Item 8. Description of Securities."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In July 1996, Swedish Medical Center, a Washington non-profit corporation,
purchased 5,800 shares of The Network's Class B Common Stock at a purchase
price of $160.60 per share, or an aggregate of $931,848. On July 16, 1996 the
purchase price was paid in full.
In December 1996, Overlake Hospital Medical Center, a Washington non-profit
corporation, purchased 5,800 shares of the Company's Class B Common Stock at
a purchase price of $258.62 per share, or an aggregate of $1,500,000. On
December 19, 1996, $1,000,000 was received by the Company and accordance with
the terms of the contract $250,000 is to be paid in December 1997 and $250,000
in December 1998.
Pursuant to their respective health care facility service contracts with The
Network, the holders of the Class B Common Stock and the Hospital Participants
paid the following aggregate fee to First Choice in 1984: Northwest Hospital:
$81,159; Providence-General: $150,174; Good Samaritan Community Healthcare:
$136,808; Multicare Medical Center: $207,271; Empire Health Services:
$138,525; Evergreen General Hospital: $100,997; Valley Medical Center:
$134,144; and Stevens Memorial Hospital: $88,093; Swedish Hospital:
$265,861; and Overlake Hospital Medical Center: $ 0.
45
<PAGE> 46
Item 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K.
(a) Exhibits
2.1 Copy of Registrant's Restated Articles of
Incorporation.*
2.2 Copy of Registrant's By-Laws.*
2.3 Copy of Contribution, Merger and Asset Purchase Agreement dated
June 2, 1997
10.1 Form of Agreement between Registrant and
Physician participating in PPO. **
10.2 Form of Health Care Facility Service Contract
between Registrant and Hospital participating in PPO.*
10.2a Copy of Agreements dated May 1, 1985, and May 17, 1993,
respectively, with Northwest Hospital.*
10.2b Copy of Agreement dated May 1, 1985, with Providence-
General (formerly General Hospital of Everett).*
10.2c Copy of Agreement dated May 1, 1985, and amendment dated
July 1, 1993, with Good Samaritan Community Hospital.*
10.2d Copy of Agreement dated March 10, 1986, with Multicare
Medical Center.*
10.2e Copy of Addendum to Agreement dated April 30, 1992, with
Empire Health Services.*
10.2f Copy of Agreement dated September 6, 1985, and addendum
dated June 17, 1992, with Evergreen General Hospital .*
10.2g Copy of Agreement dated November 19, 1993, with General
Hospital of Everett.*
10.2h Copy of Agreement dated December 9, 1991, and addendum dated
November 1, 1992 with Stevens Memorial Hospital .*
10.3 Form of Agreement between Registrant and Health Care
Provider other than Hospitals and Physicians participating in PPO.*
10.4 Form of Agreement between Registrant and Third Party Administrator.*
10.5 Form of Agreement between Registrant and Insurance Company .*
10.6 Copy of Participation Agreement dated March 27, 1985, between
Registrant and King County Public Hospital District No.2 ( Evergreen
General Hospital ).*
10.7 Copy of Participation Agreement dated March 26, 1985, between
Registrant and Valley Medical Center.*
10.8 Copy of Participation Agreement dated December 19, 1991, between
Registrant and Public Hospital District No.2 of Snohomish County
(Stevens Memorial Hospital) and related Promissory Note in the
aggregate principal amount of $ 566,000.*
46
<PAGE> 47
10.9a Copy of Promissory Note dated June 10, 1991, in aggregate principal
amount of $453,000 issued by Empire Health Services.*
10.9b Copy of Subscription Agreement dated July 25, 1991, between
Registrant and Empire Health Services.*
10.9c Copy of Stock Pledge Agreement dated July 25, 1991, between
Registrant and Empire Health Services.*
10.10 Copy of Settlement Agreement effective December 16, 1993, among
the Attorney General of the State of Washington, the Sisters of
Providence in Washington and General Hospital Medical Center .*
10.11 Copy of Employment Agreement dated September 1, 1993, as amended,
between Registrant and Clayton S. Field.*
10.12 Copy of Employment Agreement dated January 17, 1994, between
Registrant and James G. Stumpfel, and related Promissory Note dated
March 18, 1994, in the aggregate principal amount of $18,500.*
10.13a Copy of Lease dated December 5, 1988, between Registrant and
Martin Selig.*
10.13b Copy of Lease Amendments date April 5, 1990, May 29, 1992,
December 2, 1992, and December 20, 1993, respectively, each
between Registrant and Martin Selig.*
10.14 Copy of $300,000 Line of Credit dated June 13, 1991, from
Seafirst Bank.*
10.15 Copy of acquisition agreement dated February 1, 1995, between
Registrant and Pacific Health Systems, Inc.
10.16 Copy of Employment Agreement dated March 1, 1994, between
Registrant and Randolph R. Barker.**
10.17 Copy of Employment Agreement dated October 19, 1995 between
Registrant and Gary R. Gannaway.**
10.18 Copy of Registrant's Amended By-Laws dated June 29, 1995.
10.19 Copy of Subscription Agreement dated July 16, 1996, between
Registrant and Swedish Medical Center.
10.20 Copy of Agreement dated April 22, 1996 between Registrant and
Olympic Health Management Systems, Inc. Production Line
Management - Medicare Select.
10.20a Copy of Agreement dated April 22, 1996 between Registrant and
Olympic Health Management Systems, Inc. for Administrative
Agreement.
10.20b Copy of Agreement dated April 22, 1996 between Registrant and
Olympic Health Management Systems, Inc. for Independent Agent
Agreement.
10.20c Copy of Agreement dated April 22, 1996 between Registrant and
Olympic Health Management Systems, Inc. for Supervising Agent
Addendum to Independent Agent Agreement.
47
<PAGE> 47
10.21 Copy of Subscription Agreement dated July 16,1996, between
Registrant and Overlake Hospital Medical Center.
10.22 Copy of Employment Agreement dated March 1, 1994 between
Registrant and Mr. Ross D. Heyl.**
16 Letter of change in certifying accountant (b)
* Filed as same numbered Exhibit in Registrant's Registration Statement
on Form 10-SB.
** Denotes a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Annual Report on Form 10K-SB.
(b) Reports on Form 8-K.
16 Report dated December 1, 1997 regarding the engagement of Deloitte &
Touche LLP as independent accountants.
48
<PAGE> 49
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, on the 15th day of April, 1998.
FIRST CHOICE HEALTH NETWORK, INC.
By: /s/DAVID PEEL
--------------------------------------
DAVID PEEL
Chief Financial Officer
In accordance with the Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated on April 15, 1998.
SIGNATURE TITLE
--------- -----
/ s / GARY R. GANNAWAY Principal Executive Officer
- ----------------------------
GARY R. GANNAWAY
/ s / DAVID PEEL Principal Financial Officer
- ----------------------------
DAVID PEEL
49
<PAGE> 50
/ s / WILLIAM B. CONNOLEY Director
- ----------------------------
WILLIAM B. CONNOLEY
/ s / PAUL M. ELLIOTT Director
- ----------------------------
PAUL M. ELLIOTT
/ s / ANDREW FALLAT Director
- ----------------------------
ANDREW FALLAT
/ s / JOHN L. FLEMING, M.D. Director
- ----------------------------
JOHN L. FLEMING, M.D.
/ s / PHILLIP J. HAAS Director
- ----------------------------
PHILLIP J. HAAS
/ s / BARBARA L. MAUK Director
- ----------------------------
BARBARA L. MAUK
/ s / RICHARD A. MCGEE, M.D. Director
- ----------------------------
RICHARD A. MCGEE, M.D.
/ s / RICHARD H. PETERSON Director
- ----------------------------
RICHARD H. PETERSON
/ s / RICHARD E. RUST, M.D. Director
- ----------------------------
RICHARD E. RUST, M.D.
/ s / ROBERT H. SMITH Director
- ----------------------------
ROBERT H. SMITH
/ s / CLYDE D. WALKER Director
- ----------------------------
CLYDE D. WALKER
50
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROMFIRST CHOICE
HEALTH NETWORK, INC. AND SUBSIDIARY AUDITED DECEMBER 31, 1997 FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 11,356,346
<SECURITIES> 0
<RECEIVABLES> 4,138,835
<ALLOWANCES> (153,983)
<INVENTORY> 0
<CURRENT-ASSETS> 16,185,394
<PP&E> 1,971,504
<DEPRECIATION> (1,103,738)
<TOTAL-ASSETS> 17,683,105
<CURRENT-LIABILITIES> 6,516,914
<BONDS> 0
0
0
<COMMON> 41,248
<OTHER-SE> 9,559,726
<TOTAL-LIABILITY-AND-EQUITY> 17,683,105
<SALES> 26,581,122
<TOTAL-REVENUES> 27,189,745
<CGS> 17,546,989
<TOTAL-COSTS> 26,420,368
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 769,377
<INCOME-TAX> (504,006)
<INCOME-CONTINUING> 265,371
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 380,868
<EPS-PRIMARY> 6.49
<EPS-DILUTED> 6.49
<PAGE>
</TABLE>
