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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT 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.
(Exact name of Registrant 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 1100
Seattle, Washington 98101-1838
(Address of principal
executive offices)
Issuer's Telephone Number, Including Area Code
(206) 292-8255
(Issuer's telephone number, including area code)
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Securities registered pursuant to 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
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days.
Yes _____ No ___X___
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
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 December 31, 1998
was 619 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
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PART I
ITEM 1 BUSINESS 4
ITEM 2 PROPERTIES 10
ITEM 3 LEGAL PROCEEDINGS 10
ITEM 4 SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS 10
PART II
ITEM 5 MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS 10
ITEM 6 SELECTED FINANCIAL DATA 10
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 11
ITEM 8 FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA 16
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE 34
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF
FIRST CHOICE HEALTH NETWORK, INC. 35
ITEM 11 EXECUTIVE COMPENSATION 39
ITEM 12 SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT 41
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS 43
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K 44
SIGNATURES 47
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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, 1998, First Choice had arrangements with third party
administrators and health plans representing approximately 850,000
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, 1998.
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 619 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.
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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 Plan merged with Health First Partners,
Inc. and Health Washington L.L.C. which added approximately 18,000
fully insured members.
Effective December 1, 1998 First Choice Health Network, Inc. acquired
Providence Plan Partners Preferred-Washington preferred provider
organization, or PPO Business. The acquired business consists of
approximately 1,000 physicians, which serves about 125,000 subscribers
with an annual revenue stream of approximately $4.0 million. Under the
terms of the purchase First Choice Health Network, Inc. purchased
substantially all of the assets for Providence Plan Partners PPO
Business for a minimum price of $2.8 million to be paid with interest
of six percent over 18 months. There is a potential contingent payment
of up to $700,000 to be determined based on the revenues received by
First Choice Health Network from the PPO Business during the twelve
months after the closing date. This transaction was accounted for
using the purchase method.
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.
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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.
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.
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.
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At December 31, 1998, The Network had contractual arrangements through
which Health Plans in both the public and private sectors representing
approximately 850,000 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 health care coverage to individual groups, Association
Plans as well as a Medicare Supplement product:
Association Plan
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.
The Plan offers three basic types of health care plans to prospective
employer groups: Managed Plans, Triple Option Plans and Point of
Service Plans.
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.
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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.
The Plan employs a staff of telemarketing representatives who sell the
Costco Health Insurance product directly to small groups.
Independent Insurance Agents and Brokers
Independent insurance agents and brokers have been responsible for a
significant portion of The Plan's enrollment growth of the managed care
products.
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.
GOVERNMENTAL REGULATION
State Health Care Legislation
The 1998 legislative session was short; therefore very few bills were
introduced pertaining to health care. Many of the laws that were
passed were procedural in nature. The bills that did become law are
summarized below:
2SHB 1065 - Filing of Corporate Documents by Insurance Companies,
HCSCs, and HMOs
Chapter 23, Laws of 1998
This bill changes some of the mechanisms of how and where insurance
companies, HCSCs, and HMOs file certain corporate documents or apply
for certificates of authority. Many documents currently filed with the
OIC and the Secretary of State will be filed with the OIC solely. Other
documents currently filed with the Secretary of State will be filed
with the OIC instead. This bill reflects procedural changes and has
virtually no business impact on First Choice Health Plan.
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HB 2144 - Insurance Commissioner's Designated Depository
Chapter 25, Laws of 1998
This bill alters what type of trust company or financial institution
the Commissioner may designate to serve as a depository for any deposit
of securities. Previously, only institutions domiciled in the state
could be depositories. Now, if the financial institution has trust
powers in the state it may qualify. This is a procedural change only
and has no impact on First Choice Health Plan.
E2SHB 2342 - International Services
Chapter 313, Laws of 1998
This bill allows for tax credit set-offs against RCW 48.14.020 for the
hiring of qualified persons in newly created positions that are engaged
in various international services, including insurance services. First
Choice Health has no international business; therefore there is no
impact.
HB 3096 - State Preemption of Excise or Privilege Taxes on HMOs and
HCSCs
Chapter 323, Laws of 1998
This bill prohibits any county, city, town or other municipal
subdivision from imposing excise or privilege taxes upon Health Care
Service Contractors or Health Maintenance Organizations. The effective
date is 1/11/2000. It has no effect on First Choice Health Plan's
budgeted finances.
SSB 6302 - Risk-Based Capital of Health Carriers
Chapter 241, Laws of 1998
This bill adopts the risk-based capital formula act, as developed by
the NAIC, and establishes the date of March 1, 1999 as the date that
the first RBC reporting shall occur for First Choice Health Plan. The
amount required to be set aside as statutory capital will increase over
current requirements and continue to increase as long as annualized
premiums increase.
Women's Health and Cancer Rights Act of 1998.
This federal law became effective October 21, 1998 and pertained to all
individual policies and group policies both fully insured and self-
insured. This law mandated benefit administration, outlined
eligibility requirements and notice requirements. First Choice Health
Plan was in compliance with eligibility and benefit requirements
therefore there was no business impact. The notice requirement was
also met with no business impact.
Employees
At December 31, 1998, the Company had 154 employees, 150 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.
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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 20,675 square
feet of space in an office building at 601 Union Street, Suite 1100,
Seattle, Washington expiring March 2003.
Pursuant to the purchase of Providence Plan Partner Preferred_
Washington Preferred Provider Organization described on page 5, The
Company renewed the lease at the office building at 1100 Olive way,
Suite 1480, Seattle, Washington expiring July 2003. This location
consists of 11,209 square feet.
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 1998.
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, 1999, there were 498 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. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
Net Operating revenue $ 703,551 $ 380,868 $ 1,037,714 $ 1,020,050 $873,080
Net Income per common share 12.00 6.49 20.57 21.66 18.53
Total Assets 20,712,398 19,262,806 10,473,153 7,403,850 6,110,452
Total Liabilities 8,868,805 8,096,615 902,543 787,114 692,105
</TABLE>
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ITEM 7. 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 program. During 1998, the Company
continued to expand its PPO network. In 1998, 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 offering of health insurance products. However, this is
supplemented by the Plan's rental of the PPO network beginning January
1, 1998. 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 for 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. The medicare application was approved in the third
quarter of 1998 with the first sales of the product occurring on
January 1, 1999. 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.
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 for additional restricted
deposits related to the medicare business.
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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Operating revenue for the year ended December 31, 1998 increased
113.98% to approximately $57.0 million in 1998 from approximately $26.5
million in 1997 and $6.2 million in 1996. The majority of the increase
was due to the increase in Plan health insurance membership resulting
from increased growth in 1998 as well as the acquisition of Health
First Partners and Health Washington in the middle of 1997. The Plan's
membership increased from 166,297 member months in 1997 to 395,659
member months in 1998. The Company's network access fees increased
34.37% from $3.6 million in 1996, $4.1 million in 1997 to $5.6 million
in 1998. The increase was a result of growth in the Company's rental
of the PPO network as well as the purchase of the Sound Health network
and related membership in December 1998. Hospital administrative fees
also increased 89.9% from $2.6 million in 1996, $2.5 million in 1997 to
$4.8 million in 1998. The growth in this line item was primarily due
to a large contract beginning in January 1998 which was part of the
merger with Health First Partners. Network access fees and hospital
administrative fees will continue to show growth over the previous year
with the expansion of the PPO network arising from the acquisition of
the Providence Plan Partner-Washington Preferred Provider Organization.
Total operating expenses increased 114.27% to approximately $56.6
million in 1998 versus approximately $26.4 million in 1997 and $4.9
million in 1996. Medical expenses drove the majority of the increase
as a direct result of the increase in Plan health insurance membership.
Selling, general and administrative costs increased to approximately
$7.5 million in 1998 from approximately $4.6 million in 1997 and $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 business. Payroll and
related expenses increased 54.66% from approximately $2.2 million in
1996, $4.3 million in 1997 compared to approximately $6.6 million in
1998. The Company increased the number of employees as a result of the
increased Plan membership and also absorbed 25 employees from the
acquisition of the Providence Plan Partner-Washington Preferred
Provider Organization.
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 mitigate its
risk 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 not directly impacted by
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 shareholder 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. The final payment of $250,000 was received
by the Company in December 1998. This equity investment increased the
number of Class B shareholders to seven.
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At December 31, 1998, the Company had cash, cash equivalents and
investment securities at fair market value of approximately $5.7
million as compared to approximately $11.4 million at December 31,
1997.
The Company had a $300,000 unsecured line of credit form Seafirst Bank.
At December 31, 1996, there were no borrowing outstanding under the
line. Due to the large amount of cash and short-term investments held
by the Network and it's subsidiary, First Choice Health Plan, Inc. (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 $5 million of additional cash
and investments to it's subsidiary. Of the total cash held by The
Plan, $1.4 million was transferred to restricted deposits to increase
the statutory deposits in the first quarter of 1998 to satisfy
regulatory requirements.
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 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, 1998 there were 426 policies
inforce and collected premiums of $281,176. 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.
13
<PAGE> 14
First, The Plan purchased substantially all of the assets of Health WA
in exchange for 34,523 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, was 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 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 Plan gains or losses in the filing of consolidated
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 1,000,000 shares
of preferred stock. This stock has a par value of $29.10 and is
nonvoting and noncumulative, but has a dividend preference rate of
8.75% of the par value per share.
Effective February 1, 1998, the Network and Plan entered into a tax
sharing agreement which provides for the sharing of Federal income tax
liabilities and benefits in the filing of consolidated tax returns.
In July, 1998, the Plan amended the Articles of Incorporation to
increase the authorization of preferred shares to one million
(1,000,000). The Network then increased its investment in the Plan by
purchasing three million (3,000,000) dollars in the Plan's preferred
stock.
Effective December 1, 1998, the Company executed a purchase agreement
to acquire Providence Plan Partners Preferred-Washington PPO Business.
The acquired business consists of approximately 125,000 subscribers
with an annual revenue stream of approximately $4.0 million. The
Company purchased substantially all of the assets of Providence Plan
Partners PPO Business for a minimum price of $2.8 million to be paid
with interest at a rate of six percent over 18 months. There is a
potential contingent payment of up to $700,000 to be determined based
on the revenues received by First Choice Health Network from the PPO
Business during the twelve months after the closing date.
14
<PAGE> 15
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
1999.
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 with 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 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . 17
Consolidated Balance Sheets as of December 31, 1998 and 1997 . . 18
Consolidated Statements of Income
for the years ended December 31, 1998, 1997, and 1996 . . . . .. 20
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1998, 1997, and 1996 . . . . .. 21
Consolidated Statements of Cash Flows
for the years ended December 31, 1998, 1997, and 1996 . . . . . 22
Notes to Consolidated Financial Statements . . . . . . . . . . . . 24
16
<PAGE 17>
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
First Choice Health Network, Inc.
We have audited the accompanying consolidated balance sheets of First
Choice Health Network, Inc. and subsidiary (the Company) as of
December 31, 1998 and 1997, and the related consolidated statements of
income, shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 1998. 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 audits. The
consolidated statements income and cash flows, and shareholders equity
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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
As described in Note 8, the Company acquired a business in 1998, for
which information was not available that is necessary to provide pro
forma disclosures of results of operations information for 1998 and
1997 as if the business had been acquired by the Company at the
beginning of each year. In our opinion, disclosure of such information
is required by generally accepted accounting principles.
In our opinion, except for the omission from the 1998 financial
statements of the disclosures described in the preceding paragraph, the
consolidated financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of
December 31, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31,
1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
May 4, 1999
17
<PAGE> 18
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $5,759,751 $ 11,356,346
Service fees receivable, net of allowance for doubtful
accounts of $146,000 and $96,187 for 1998 and 1997 2,234,969 1,180,421
Service fees and premiums
receivable from related parties 1,504,537 1,088,801
Premiums receivable, net of allowance for doubtful
accounts of $215,014 and $57,796 1,997,926 1,849,145
Due from unrelated provider organizations 1,586,381 52,177
Due from related provider organizations 972,785 1,527,524
Federal income tax receivable 383,101
Prepaid expenses 390,748 292,112
Deferred tax assets (Note 3) 152,318 20,458
Other current assets 81,178 15,000
----------- -----------
Total current assets 14,680,593 17,765,085
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 2,601,718 1,667,240
Computer software 306,522 304,264
----------- -----------
2,908,240 1,971,504
Less accumulated depreciation and amortization 1,488,358 1,103,738
----------- -----------
Furniture, equipment and computer software, net 1,419,882 867,766
OTHER ASSETS:
Restricted indemnity cash 1,705,956 309,368
Goodwill, net of accumulated amortization of $113,616
and $45,026 307,310 320,577
Other intangible assets, net of accumulated amortization
of $91,743 2,598,657
----------- -----------
Total other assets 4,611,923 629,945
----------- -----------
TOTAL $20,712,398 $19,262,806
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE> 19
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
CURRENT LIABILITIES:
<S> <C> <C> <C>
Accounts payable $ 377,850 $ 206,202
Accrued expenses 1,609,202 1,802,574
Reserve for unpaid claims and claims adjustment expenses 2102,364 1,394,107
Due to unrelated provider organizations 1,229,331 2,909,393
Due to related provider organizations 247,355 1,336,086
Federal income tax payable 28,417
Unearned premiums 137,280 335,629
Deferred income taxes 136,715 112,624
Current portion of note payable 1,887,996
----------- ----------
Total current liabilities 7,756,510 8,096,615
NOTE PAYABLE (Note 9) 999,671
DEFERRED INCOME TAXES (Note 3) 112,624 252,986
MINORITY INTEREST 1,320,085 1,312,231
COMMITMENTS AND CONTINGENCIES (Notes 4 and 12)
SHAREHOLDERS' EQUITY:
Common Stock:
Class A, par value $1 - Authorized, 30,000 shares;
issued and outstanding, 619 and 648 shares 619 648
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 shares 40,600 40,600
Additional paid-in capital 4,385,102 4,416,090
Shareholder receivable (250,000)
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 4,625,079 3,921,528
----------- ------------
Total shareholders' equity 10,523,508 9,600,974
----------- ------------
TOTAL $20,712,398 $19,262,806
=========== ============
</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, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
OPERATING REVENUE:
<S> <C> <C> <C>
Premium revenue $42,634,121 $15,711,616 $ -
Premium revenue, related parties 3,720,738 4,050,286 -
Network access fees 5,607,173 4,172,888 3,589,593
Hospital administrative fees 2,956,822 1,283,982
Hospital administrative fees,
primarily related parties 1,841,789 1,243,123 2,599,738
Other 117,627 119,227 10,175
------------ --------------- ----------
Total operating revenue 56,878,270 26,581,122 6,199,506
OPERATING EXPENSES:
Medical expenses 25,149,892 10,472,784 -
Medical expenses, related parties 17,125,490 7,074,205 -
Payroll and related expenses 6,659,224 4,305,685 2,715,630
Selling, general, and administrative
expenses 7,517,177 4,533,543 2,228,786
Amortization expense 160,333 34,151
------------- ------------ ----------
Total operating expenses 56,612,116 26,420,368 4,944,416
------------- -------------- ----------
Operating income 266,154 160,754 1,255,090
OTHER INCOME (EXPENSE):
Interest and dividends 504,415 511,257 292,439
Other (155,928) 97,366 40,462
------------- ------------- ----------
Total other income, net 348,487 608,623 332,901
------------- -------------- ----------
Income before federal income taxes
and minority interest 614,641 769,377 1,587,991
FEDERAL INCOME TAXES 429,348 504,006 550,277
------------ --------------- ----------
185,293 265,371 1,037,714
MINORITY INTEREST 518,258 115,497 -
------------- ------------- ----------
NET INCOME $ 703,551 $ 380,868 $1,037,714
========== =========== ===========
NET INCOME PER COMMON SHARE $ 12.00 $ 6.49 $ 20.57
========= ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,619 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, 1998, 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
Cash received from shareholder receivable 250,000 250,000
Repurchase of Class A common stock
and membership rights from physicians (29) (29) (30,988) (31,017)
Net income
----- ----- ------- ------- ---------- --------- ----------
BALANCE, DECEMBER 31, 1998 619 $619 40,600 $40,600 $4,385,102 $ - $4,426,321
==== ===== ====== ======= ========== ========== ==========
</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, 1998, 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
Cash received from shareholder receivable 250,000 250,0000
Repurchase of Class A common stock
and membership rights from physicians (31,017) (31,017)
Net income 703,551 703,551
---------- ----------- ---------- --------- ----------
BALANCE, December 31, 1998 $4,426,321 $1,472,108 $4,625,079 $ - $10,523,508
========== =========== ========== ========= ============
</TABLE>
22
<PAGE> 23
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
OPERATING ACTIVITIES:
<S> <C> <C> <C> <C>
Net income $ 703,551 $ 380,868 $ 1,037,714
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation 384,620 283,945 169,161
Amortization 160,333 34,151 6,000
Deferred income taxes, net (268,589) (78,604) 123,870
Provision for doubtful accounts 307,000 57,796 -
Minority interest (518,258) (115,497) -
Cash provided (used) by changes in operating
assets and liabilities:
Service fees receivable (1,520,090) (848,307) (337,219)
Premiums receivable (405,968) (1,672,363) -
Federal income tax receivable 383,101 (374,247) 81,275
Prepaid expenses (98,636) (59,791) (24,605)
Other current assets (66,178) 625 -
Accounts payable 171,648 48,279 (117,970)
Accrued expenses (193,372) 761,129 159,906
Reserve for unpaid claims and claims
adjustment expenses 708,257 (737) -
Due to (from) unrelated provider organizations (3,057,956) 1,279,573 -
Due to (from) related provider organizations (533,992) 1,386,205
Federal income tax payable 28,417
Unearned premiums (198,349) 321,261 -
Other 353,497 58,942 (42,304)
--------------------------- ----------
Net cash provided (used) by operating
activities (3,660,964) 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 (810,032) (508,715) (231,342)
Acquisition of license fees - (1,936)
Increase in restricted indemnity cash (1,344,582) - (150,000)
--------------------------- -----------
Net cash provided (used) by investing
activities (2,154,614) 7,237,499 (2,618,070)
--------- ----------- ----------------
BALANCE, carried forward (5,815,578) 8,700,727 (1,604,380)
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 23
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLDIATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
BALANCE, brought forward $(5,815,578) $ 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 (31,017) (1,736) (3,755)
Issuance of Class B common stock and membership
rights from physicians - 1,931,484
Receipt of shareholder receivable 250,000 250,000 -
---------------------------- ----------
Net cash provided by financing activities 218,983 248,264 1,882,729
---------------------------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (5,596,595) 8,948,991 278,349
CASH AND CASH EQUIVALENTS:
Beginning of year 11,356,346 2,407,355 2,129,006
--------------------------- ----------
End of year $ 5,759,751 $11,356,346 $2,407,355
========== =========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for federal
income taxes $ 250,000 $ 955,000 $ 360,000
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
ACTIVITIES:
Shareholder receivable for common stock issuance (500,000)
Net assets for common stock (Note 8) 525,303
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 24
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998 AND 1997
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: In June 1997, Statement of Financial
Accounting Standards (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. The Company currently has no items of
comprehensive income.
On June 16, 1998 the Financial Accounting Standards Board (FASB)
issued SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, which is effective for fiscal years beginning
after June 15, 1999. SFAS No. 113 establishes accounting and
reporting standards for derivative instruments and hedging
activities. Under this statement, certain derivatives are
recognized at fair value and changes in fair market value are
recognized as gains or losses. Management is currently studying
this pronouncement to determine its effect, if any, on the Company's
financial statements.
Cash equivalents: The Company considers all investments purchased
with an original maturity of three months or less to be cash
equivalents. At December 31, 1998 and 1997, cash and cash
equivalents consist of cash management funds of $5,759,751 and
$11,356,346, 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.
24
<PAGE> 25
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
Allowance for doubtful accounts: The Company performs periodic
credit evaluations of its customers and maintains an allowance for
potential credit losses related to service fees receivable.
Premiums receivable: Premiums receivable represents monthly group
health insurance premiums billed and outstanding.
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.
Other intangible assets: Intangible assets assumed in the
Providence Plan Partners PPO network acquisition were trademarks,
contracts, and a noncompetition agreement. Intangible assets are
amortized using the straight-line method over three years.
Goodwill: Goodwill is determined as the difference between the
purchase price and fair value of identifiable net assets purchased.
Goodwill is amortized using the straight-line method over three to
five years. Events or changes in circumstances have not occurred
that indicate the value of goodwill has been impaired as of
December 31, 1998 and 1997.
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 using prior experience and the nature of current health
insurance contracts and volume. Included in the liability is an
estimate of the future expenses necessary to settle 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.
Due to (from) related (unrelated) provider organizations: This
liability or asset is the amount due to (from) health care providers
in conjunction with capitation arrangements, which is computed by
subtracting the claims payments 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 the contract year end. The Company believes
the amounts recorded appropriately reflect the ultimate settlement
amounts.
Unearned premiums: Unearned premiums consists of insurance premiums
received prior to fiscal year end for health insurance coverage
subsequent to year end.
25
<PAGE> 26
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 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, 1998 and 1997 43% and 48%,
respectively, of the premium revenue related to one subscriber
group.
Advertising expense: The Company incurred advertising expenses of
$1,349,729, $787,567 and $4,195 in 1998 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 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.
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, 1998 and 1997,
no write downs were required.
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 41,219 and 41,248 common shares and 17,400 and 17,402
shares applicable to affiliate common share equivalents (Note 2) in
1998 and 1997, respectively. 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.
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.
Reclassifications: Certain 1997 amounts recorded in the financial
statements have been reclassified to conform to the 1998
presentation.
NOTE 2:SHAREHOLDERS' EQUITY
Ownership of stock: Class A voting 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 voting common stock may be held by hospitals in the state of
Washington that contract with the Company to provide health care
services.
26
<PAGE> 27
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
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 $1014.91 and
$1,108.15 per share during 1998 and 1997, respectively.
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 Class A shareholder. The
allocation of the Class B shareholders must be shared with the
nonshareholder hospitals that have rights equivalent to that of
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.
Common stock: 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 included
exchanging common stock held by the minority owners of the Plan, who
are also stockholders in the company, for the same number of
preferred shares. This preferred stock is nonvoting and
noncumulative and has a dividend rate of 8.75%.
27
<PAGE> 28
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
NOTE 3:FEDERAL INCOME TAXES
Federal income taxes consist of the following components:
1998 1997 1996
---- ---- -----
Current $697,957 $582,610 $426,407
Deferred (268,589) (78,604) 123,870
-------- -------- ---------
$429,348 $504,006 $550,277
======== ======= =======
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>
1998 1997 1996
--------------------- ---------------- --------------
Amount Percent Amount Percent Amount Percent
<S> <C> <C> <C> <C> <C> <C>
Computed expected rate $208,978 34.0% $261,558 34.0% $539,917 34.0 %
Tax effect of permanent differences:
Valuation allowance on Plan NOLs 66,640 10.8% 179,481 23.4 - -
Political contributions 139,328 22.7% 34,026 5.6 - -
Other 14,402 2.3% 28,911 3.8 10,360 0.7
--------- ---------- ------ ------ -------- ------
$429,348 69.8% $504,006 66.8% $550,277 34.7 %
======= ===== ======== ====== ======= =======
</TABLE>
28
<PAGE> 29
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
The deferred tax assets and liabilities resulting from the tax effects
of temporary differences at December 31 are presented below:
1998 1997
---- ----
Deferred tax assets:
Net operating losses $1,598,029 $1,531,379
Reduction of shareholders' equity 213,724 213,724
Allowance for doubtful accounts 122,745 52,354
Other 53,664 (31,896)
---------- --------
Gross deferred tax assets 1,988,162 2,180,436
Valuation allowance 1,835,844 2,159,978
---------- --------
Net deferred tax assets 152,318 20,458
Deferred tax liabilities:
Cash to accrual adjustment 225,248 337,876
Furniture, equipment and computer software 24,091 7,276
---------- --------
Total deferred tax liabilities 249,339 345,152
---------- --------
Deferred income tax liability, net $97,021 $365,610
========== ==========
Current portion of deferred tax assets $152,318 $ 20,458
========= =======
Current portion of cash to accrual adjustment 136,715 112,624
Long-term portion of deferred tax liabilities 112,624 252,986
--------- ---------
Deferred income tax liability $249,339 $ 365,610
======== ========
29
<PAGE> 30
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
The valuation allowance was established against the tax benefit of the
1997 and a portion of 1998 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 first 23 days of 1998 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 8. The following
schedule represents the amounts of the Plan's 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
2013 196,000
----------
$4,700,086
==========
NOTE 4:COMMITMENTS
Leases: The Company leases its office facilities and some office
equipment under operating leases expiring through 2003. The leases
provide for monthly minimum rent payments, and some include renewal
options for an additional five years.
Rental expense charged to operations under the operating leases for
the years ended December 31, 1998 and 1997, was $510,316 and
$254,247, respectively.
Future minimum lease payments under the operating leases for the
years ended December 31 are as follows:
1999 $743,614
2000 817,500
2001 815,204
2002 830,026
2003 431,540
----------
$3,637,884
=========
30
<PAGE> 31
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
NOTE 5: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 insur-
ance 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>
1998:
Revenues from external customers $ 8,711,788 $48,166,482 $56,878,270
Revenue from intercompany 345,184 345,184
Interest revenue 65,587 438,828 504,415
Depreciation/amortization expense 391,902 153,051 544,953
Income tax expense (benefit) 1,639,030 (1,209,682) 429,348
Expenditures on furniture, equipment
and computer software 181,330 628,702 810,032
Segment profit (loss) 2,837,133 (2,651,840) 185,293
Assets $20,522,701 $12,374,475 $32,897,176
Liabilities $5,328,643 $4,267,933 $9,596,576
1997:
Revenues from external customers $ 6,545,852 $20,035,270 $26,581,122
Revenue from intercompany 86,198 86,198
Interest Revenue 131,520 379,737 511,257
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 (2,336,461) 265,371
Assets $15,341,433 $11,298,860 $26,578,862
Liabilities $3,046,275 $5,952,073 $8,998,348
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 $867,597 $35,765 $923,362
</TABLE>
31
<PAGE> 32
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997 1996
--------- ------- -------
<S> <C> <C> <C>
Revenues:
Total revenues for reportable segments
and consolidated revenues $56,878,270 $26,581,122 $ 6,199,506
========== =========== ===========
Profit or loss:
Total profit or loss for
reportable segments $185,293 $ 265,371 $ 1,037,714
Adjustment for minority interest in
consolidated statements 518,258 115,497 -
---------------- ---------- -----------
Consolidated net income $703,551 $ 380,868 $ 1,037,714
============== ========== ===========
Assets:
Total assets for reportable segments $32,897,176 $26,578,862 $12,134,579
Elimination of intercompany investment (11,457,007) (7,316,056) (1,673,585)
Elimination of intercompany balances (727,771)
-------------- ---------------- -------------
Consolidated total assets $20,712,398 $19,262,806 $10,460,994
========== =========== ===========
Liabilities:
Total liabilities for reportable
segments $9,596,576 $ 8,998,348 $ 923,362
Elimination of intercompany balances (727,771) (648,747) (32,978)
------------------ ----------- ---------
Consolidated total liabilities $8,868,805 $ 8,349,601 $ 890,384
========== =========== ===========
</TABLE>
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
$19,800,000 and $9,500,000 of the Company's consolidated revenues for
1998 and 1997, respectively.
NOTE 6:FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, service fees and
premiums receivable, accounts payable, notes payable, and due to
provider organizations approximates fair value because of the short
maturity of these instruments.
NOTE 7: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 an additional profit sharing
32
<PAGE> 33
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
contribution to the plan. Employer contributions to the plan for the
years ended December 31, 1998 and 1997, amounted to $90,768 and $60,191
respectively.
NOTE 8:ACQUISITIONS
Health First Partners and Health Washington contract: Effective July
1, 1997, the Plan acquired 100% of the stock of Health First Partners,
Inc., a health care services contractor operating in the state of
Washington, in which shareholders of the Network have and 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 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
for common stock and additional paid-in capital on a percentage of the
Company's revenues for the year ended December 31, 1997. Prior to
December 31, 1998, the Company contributed $1,159,667 in accordance
with the contract based on expected revenues for the period ended
December 31, 1998. The investment in the Plan is eliminated in
consolidation.
In 1998, three shareholders of the Plan converted a portion of their
common stock to preferred stock that increased to 80% the percentage of
share of the Company in the Plan.
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. The pro forma statement of earnings information
assumes the transactions have taken place at the beginning of the
period presented.
1997
----
Operating revenue $29,526,186
===========
Net loss $ 1,457,803
===========
Loss per share $ (26)
===========
33
<PAGE> 34
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
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.
Providence Plan Partners PPO: On December 1, 1998, the Company
purchased all of the assets of Providence Plan Partners PPO Business
for a minimum purchase price of $2,800,000 in the form of a note
payable to be paid with interest at a rate of 6% over 18 months. The
assets acquired consist of provider contracts ($1,680,000), trade name
($140,000), a noncompetition agreement ($840,000), computer equipment,
and software licenses ($140,000). There is a potential contingent
payment of up to $700,000 to be determined based on the revenues
received by the Company from the acquired business during the 12 months
after the closing date. Approximately $290,000 had been recorded as
goodwill and paid as of the date this report as a result of this
arrangement. This acquisition was accounted for using the purchase
method. Results of operations are included in the financial statements
of the Company from the effective date of the acquisition December 1,
1998. Separate financial information about the business is not
available that is necessary to provide pro forma disclosures of results
of operations information for 1998 and 1997 as if the business had been
acquired by the company at the beginning of each year. Accordingly,
pro forma information is not included in this note as is required by
generally accepted accounting principles.
NOTE 9: NOTES PAYABLE
The Company has a note payable at December 31, 1998, related to the
acquisition of Providence Partners PPO business (note 8) in the amount
of $2,888,000. The note is payable in 18 equal monthly installments
beginning in January 1999, plus interest of 6%.
NOTE 10: CLAIM PAYMENTS
Activity in the reserve for unpaid claims and unpaid claims processing
expenses is summarized as follows for the years ended December 31:
1998 1997
------- ------
Balance, beginning of year $1,394,107 $ 18,599
Assumed in acquisition 1,410,245
Incurred related to:
Current year 8,543,200 907,945
Prior year (339,144)
----------- -----------
Total incurred 8,204,056 2,318,190
Paid related to:
Current year 6,440,836 924,083
Prior year 1,054,963 18,599
------------ -----------
Total paid 7,495,736 942,682
------------ -----------
Balance, end of year $2,102,364 $1,394,107
========= =========
34
<PAGE> 35
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998 AND 1997
As a result of changes in the estimates of insured events in the prior
year, the provision for unpaid claims and unpaid claims processing
expenses decreased because of lower than anticipated losses.
The Company renegotiated contracts with two contracted provider
organizations in 1998 that impacted incurred expenses in 1997. Both
renegotiated contracts related to the complete transfer on medical risk
to the Company from contracts where each provider organization
previously held risk. Claims paid in 1998 that related to 1997 were
$905,107. Claims paid in 1998 that related to 1997 were $1,502,904.
NOTE 11: REGULATORY MATTERS
The Company's 80% 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, 1998,
reserves and unassigned capital, and net loss for the year reported to
the NAIC was $7,121,270 and $2,651,839, respectively. The State of
Washington has adopted a risk-based capital calculation for determining
statutory capital requirements. This methodology becomes effective
December 31, 1999. At December 31, 1998, the Company would have been
in compliance with the new capital requirements.
The primary difference in reporting between the NAIC and GAAP is non-
admitted assets of certain property, plant and equipment, goodwill,
accounts receivables over 90 days past due and prepaid expenses. At
December 31, 1998, statutory-basis shareholders' equity and net loss
for the year were $7,121,270 and $(2,651,839) , respectively, for the
Plan. At December 31, 1997, the same balances were $5,346,787 and
$(2,336,464), respectively.
The NAIC has developed statutory accounting practices (the
codification) which are expected to constitute the only source of
prescribed statutory accounting practices. The NAIC has delayed the
effective date for health-related organizations until January 1, 2001.
NOTE 12: 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.
The Company has determined that the amount of damages, if any, is not
expected to be significant. No amount has been reflected in the
consolidated financial statements as of December 31, 1998 and 1997.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
There were no disagreements with accountants on accounting
and financial disclosure.
35
<PAGE> 36
PART III
ITEM 10. 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 52 President & Chief Executive Officer
David Peel 38 Sr. Vice President _Chief Financial Officer
Ross D. Heyl 45 Sr. Vice President & Chief Marketing Officer
Julie Keeffe 41 Sr. Vice President-Medical Mgmt & Member Services
Joe Leinonen, M.D. 54 Chief Medical Officer
Paul M. Elliott 58 Director (I)
Andrew Fallat 51 Director (III)
William F. Johnston, M.D. 53 Director (III)
Phillip J. Haas 50 Director (I)
Barbara L. Mauk 53 Director (II)
Richard A. McGee, M.D. 53 Director (II)
Richard H. Peterson 56 Director (II)
Richard E. Rust, M.D. 72 Director (II)
Robert H. Smith 54 Director (III)
Clyde D. Walker 43 Director (III)
Richard Stubbs, M.D., M.B.A.53 Director (I)
Kenneth D. Graham 52 Director (II)
James J. Finley, M.D. 59 Director (I)
John F. Koster, M.D. 49 Director (I)
R. Dean Martz, M.D. 41 Director (I)
_________________
</TABLE>
(I) Term Expires in 1999
(II) Term Expires in 2000
(III) Term Expires in 2001
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.
David Peel, Senior Vice President, Chief Financial Officer, 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.
36
<PAGE> 37
Ross D. Heyl, Senior Vice President, Chief Marketing Officer, 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.
Julie Keeffe, Senior Vice President, Medical Management and Member
Services, joined First Choice in
May 1997. Julie has worked in health care since 1979. Prior to coming
to First Choice Health, she provided health care management consulting
services for Milliman and Robertson, Inc, where she implemented
successful strategies for the medical management systems of health
plans and delivery systems. Earlier, Julie was Director of Utilization
and Quality Management for the Virginia Mason Health Plan for nine
years. Her background includes indemnity, PPO, and HMO utilization
management and analysis. Her clinical experience includes several
years of inpatient, outpatient, and emergency care nursing. Julie's
expertise is in designing medical management that meets the needs of
the provider as well as the payer. Her areas of interest include
utilization and quality management, specialty referral.
Joe Leinonen, M.D., Chief Medical Officer, joined First Choice Health
in April 1998 although he was also one of the original developers of
First Choice Health in 1984. He brings 18 years of managed care
experience as a physician executive in a variety of positions with
national, regional and local responsibilities. Dr. Leinonen was born
and raised in Seattle, obtained his undergraduate degree from Stanford
University and his medical degree from the University of Washington.
He received his hospital training at Virginia Mason and served on the
medical staff of Northwest Hospital for 17 years of which 2 years were
served as Chief of Family Practice. He has also served as General
Manager and Medical Director for Equicor's operations in Washington,
Executive Director and Medical Director for CIGNA's Managed Care
Operations for the Northwest Region and was the First President and CEO
for Health Washington.
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.
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.
William F. Johnston, M.D., was elected to serve a three year term as
director at the July 1997 board meeting.
Dr. Johnston is the Medical Director of Emergency Services at Northwest
Hospital. Besides the supervision of the physicians who deliver
emergency medical care at the hospital, his position provides an
interface between administration, nursing, the medical staff and other
hospital departments to help support the smooth delivery of emergency
medical services at the hospital. He serves on the Executive Committee
of the hospital as Chairman of the Department of Emergency Medicine.
Bill also practices as an emergency physician and helps teach Advanced
Cardiac Life Support and Advanced Trauma Life Support Courses. He
received his M.D., M.B.A. and M.S.E.E. (Bioengineering) degrees from
the University of Washington.
37
<PAGE> 38
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.
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.
38
<PAGE> 39
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.
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.
Kenneth D. Graham has served as President and CEO at Overlake Hospital
Medical Center since 1994, and has overseen significant changes in the
organization. The hospital has: developed a new facilities master
plan; introduced operational controls that have significantly improved
hospital efficiency; established contracts with more than 25 managed
care companies and implemented new programs like an adolescent
psychiatric care program; a Multiple Sclerosis Center; a Level III
Emergency Center and a Women's Hospital. Mr. Graham also currently
serves as the voluntary Executive Director of RotaCare International;
an organization dedicated to providing free clinics in association with
local Rotary clubs. RotaCare serves homeless, migrant workers, new
immigrants and the uninsured or underinsured. Mr. Graham is committed
to community involvement in local, regional and national organizations
including the Bellevue Chamber of Commerce and the Rotary Club of
Bellevue. He previously served as a member or advisor of more than a
dozen hospitals or health care organization boards.
James G. Finley, M.D. joined The Everett Clinic in 1973 as a
gastroenterologist. A native of Tennessee, he received his BS degree
from Rhodes College in Memphis, Tennessee. His medical degree was
received from Vanderbilt in 1966 and internship and first year Internal
Medicine residency were also completed at Vanderbilt. A second year of
Internal Medicine and two years of gastroenterology fellowship were
completed at the University of Washington, followed by two years in San
Diego with the United States Navy Hospitals as a gastroenterologist.
Dr. Finley is a Diplomate of the American Board of Internal Medicine
and the American Board of Gastroenterology since 1972. In addition to
his practice of Gastroenterology, he has served as Medical Director of
The Everett Clinic since 1983. This position now occupies 90% of his
professional time. He serves in board positions with Medical Partners
Northwest and Washington Medical Group Alliance.
John Koster, M.D. joined Sisters of Providence Health System in April
1997 as vice president of Clinical and Physician Services. In May of
1998 he was promoted to senior vice president in the Office of the CEO
and chief executive of the Washington region. The Sisters of
Providence Health System is comprised of hospitals, long-term care
facilities, physician practices, managed care plans and other health
and social services in the states of Alaska, Washington, Oregon and
California. Prior to joining Sisters of Providence, Dr. Koster was
senior vice president of Targeted Member Services at VHA, a nationwide
network of leading community-owned healthcare organizations and
physicians. He focused on business development and educational needs
of specific segments such as physician group practices and HMOs. He
has served as an advisor to physicians and management staff in
healthcare organizations in every part of the country. Dr. Koster also
served as vice president of Presbyterian Healthcare Services in
Albuquerque, New Mexico, an integrated health care financing and
delivery system serving 14 communities in New Mexico and Colorado.
Board certified in Internal medicine, Dr. Koster was in private
practice with a multispecialty group of primary care physicians from
1980 until 1988. Dr. Koster graduated from New Mexico Tech with a
bachelor's degree in biology. He earned his medical degree from the
University of New Mexico. His postgraduate studies include Internship
at Providence Hospital in Portland, Oregon and a residency in Internal
medicine at the University of New Mexico Medical School.
R. Dean Martz, M.D. is a practicing neurosurgeon in Spokane since 1990.
He is an active staff member of both Sacred Heart Medical and Deaconess
Medical Centers in Spokane. He is a member of the American Medical
Association, Congress of Neurological Surgeons, and was certified by
the American Board of Neurological Surgeons in 1993. He received his
medical degree from Case Western Reserve University in Cleveland, Ohio.
He trained in general and neurological surgery at the University of
Michigan Hospitals in Ann Arbor.
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.
39
<PAGE> 40
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.
ITEM 11. 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) 98 $226,518 $126,000
President and CEO 97 $221,589 $126,0
96 $189,653 $100,000 $75,000 (2)
Ross Heyl 98 $95,108 $18,000
Senior Vice President,
Marketing 97 $93,467 $18,000
96 $93,467 $15,400
Julie Keeffe, R.N. 98 117,500 5,300
Senior Vice President, Medical
Management & Member Services
Joe Leinonen, M.D. 98 139,500 -
Chief Medical Officer
David Peel 98 122,497 22,900
Senior Vice President,Finance 97 121,384 22,900
</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.
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.
40
<PAGE> 41
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.
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.
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.
41
<PAGE> 42
ITEM 12. 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 - 14.3%
14th and Colby
Everett, WA 98201
Good Samaritan - 5,800 - 14.3%
Community Healthcare
407-14th Avenue SE
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 NE
Bellevue, WA 98004
Paul M. Elliott - - - -
42
<PAGE> 43
Andrew Fallat - - - -
William F. Johnston, 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 - - - -
Kenneth D. Graham - - - -
James J. Finley, M.D. - - - -
John F. Koster, M. D. - - - -
R. Dean Martz, M. D. - - - -
All directors and executive
officers as a group (3 persons) 3 40,600 * 100%
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."
43
<PAGE> 44
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
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.
44
<PAGE> 45
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, 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 .*
45
<PAGE> 46
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.*
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.**
46
<PAGE> 47
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.
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 November 11, 1998. Purchase agreement of Providence
Plan Partner- Washington Preferred Provider Organization.
47
<PAGE> 48
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 3rd day of August 1999.
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 August 3, 1999.
SIGNATURE TITLE
--------- -----
/ s / GARY R. GANNAWAY Principal Executive Officer
- ----------------------------
GARY R. GANNAWAY
/ s / DAVID PEEL Principal Financial Officer
- ----------------------------
DAVID PEEL
/ s / WILLIAM F. JOHNSTON Director
- ----------------------------
WILLIAM F. JOHNSTON
/ s / PAUL M. ELLIOTT Director
- ----------------------------
PAUL M. ELLIOTT
/ s / ANDREW FALLAT Director
- ----------------------------
ANDREW FALLAT
/ s / RICHARD STUBBS Director
- ----------------------------
RICHARD STUBBS
48
<PAGE> 49
/ 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
/ s / KENNETH D. GRAHAM Director
- ----------------------------
KENNETH D. GRAHAM
/ s / JAMES J. FINLEY Director
- ----------------------------
JAMES J. FINLEY, M.D.
/ s / JOHN F. KOSTER Director
- ----------------------------
JOHN F. KOSTER, M.D.
/ s / R. DEAN MARTZ Director
- ----------------------------
R. DEAN MARTZ
49
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST
CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY AUDITED DECEMBER 31, 1998
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 5,759,751
<SECURITIES> 0
<RECEIVABLES> 5,737,432
<ALLOWANCES> 361,000
<INVENTORY> 0
<CURRENT-ASSETS> 14,680,593
<PP&E> 2,908,240
<DEPRECIATION> 1,488,358
<TOTAL-ASSETS> 20,712,398
<CURRENT-LIABILITIES> 7,756,510
<BONDS> 0
0
0
<COMMON> 41,219
<OTHER-SE> 10,482,289
<TOTAL-LIABILITY-AND-EQUITY> 20,712,398
<SALES> 56,878,270
<TOTAL-REVENUES> 57,226,757
<CGS> 42,275,382
<TOTAL-COSTS> 56,612,116
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 614,641
<INCOME-TAX> 429,348
<INCOME-CONTINUING> 185,293
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 703,551
<EPS-BASIC> 12.00
<EPS-DILUTED> 12.00
</TABLE>
