-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VzDa5mHHf6a3sY0XmICVCMIulS5Thf2d7jZhwZd3umFEQf8b8ir3sYY0c2iMvC1f QKdNy63G7H6PVK4oFB4Nfg== 0000922622-00-000003.txt : 20000418 0000922622-00-000003.hdr.sgml : 20000418 ACCESSION NUMBER: 0000922622-00-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000417 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST CHOICE HEALTH NETWORK INC CENTRAL INDEX KEY: 0000922622 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-HEALTH SERVICES [8000] IRS NUMBER: 911272766 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23998 FILM NUMBER: 602652 BUSINESS ADDRESS: STREET 1: 601 UNION STREET STREET 2: SUITE 1100 CITY: SEATTLE STATE: WA ZIP: 98101 BUSINESS PHONE: 206-292-8255 MAIL ADDRESS: STREET 1: 601 UNION STREET STREET 2: SUITE 1100 CITY: SEATTLE STATE: WA ZIP: 98101 10-K 1 1 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, 1999 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) 1 2 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 ___X__ No ______ 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 shares outstanding on December 31, 1999 was 585 shares of Class A Common Stock, and 40,600 shares of Class B Common Stock, $1.00 par value, respectively. Transitional Small Business Disclosure Format ( check one ): Yes ______ No __X__ Documents incorporated by reference: None 2 3 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 11 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 15 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 15 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 35 PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF FIRST CHOICE HEALTH NETWORK, INC. 36 ITEM 11 EXECUTIVE COMPENSATION 42 ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 43 ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 45 PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 46 SIGNATURES 49 3 4 PART I ITEM 1. DESCRIPTION OF BUSINESS AND PRODUCTS 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, 1999, First Choice had arrangements with third party administrators and health plans representing approximately 1,022,000 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, 1999. 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 467 physicians, all of whom own Class A Common Stock; seven hospitals who own Class B Common Stock, and four 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. 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 4 5 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. Risked Based Capital (RBC) requirements were adopted by the state of Washington and the NAIC effective for 1998 and 1999, which established that certain required amounts of capital be maintained. As of December 31, 1998 and 1999, the Company's RBC exceeded the required amount in connection with its statutory filing. 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 $668,000 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. As of the date of this filing, the contingent payment of $668,000 has been paid. The Plan has filed an application with the Federal Health Care Financing Administration (_HCFA_) for a license to offer a Medicare risk product called SeniorsFirst. The medicare application was approved in the third quarter of 1998 with the first sales of the product occurred on January 1, 1999. As of December 31, 1999, there were 15,934 members and collected premiums of $5,990,985. Redeemable Equity Participation On December 20, 1999, First Choice Health Network, Inc. executed an agreement with University of Washington Academic Medical Center (UWMC) to become a participant in the administration, operations and any incentives bestowed upon any shareholders in First Choice Health Network effective January 1, 2000. First Choice offers and operates a preferred provider organization and a managed care delivery system for cost-effective, quality health care benefits, and for comprehensive health care claims processing and administration. University of Washington Academic Medical Center has agreed to pay the affiliation fee of $2,520,000, payable $1,260,000 upon execution of the Agreement and the remaining $1,260,000 will be paid in three equal payments of $420,000 due annually for three years plus interest at five percent (5%). UWMC does not become a shareholder or member of the Network. UWMC shall participate in any incentive or reward program established by the Network as if UWMC owned 5,800 shares of class B common stock. Dividends, distributions, and liquidation of the Network are also determined as if UWMC owned 5,800 shares of class B stock. If the Network performs certain actions that substantially change the organization, the Network discontinues the health care facility services contract with UWMC, or if total managed care enrollment falls below 500,000 member months, then UWMC can withdraw from the agreement, but no refunds are given. If the Network merges, is sold, or if the Network takes a material action that proves detrimental to UWMC, then UWMC may redeem their interest for the equivalent of the fair value of 5,800 class B common shares of FC stock, less any amounts still owed by UWMC. PRODUCTS First Choice Health Network's PPO 5 6 The Network's PPO is comprised of physicians, hospitals and other health care providers in the states of Washington, Alaska, Idaho and Montana who are required to sign preferred physician contracts, health care facility service contracts and provider contracts, respectively, under which the health care provider agrees to accept, as payment in full, the discounted fee schedule negotiated by The Network for each covered service; such agreements are terminable on 90 days' notice. Subscribers (or members) also have access to a network of providers (marketed as a separate PPO) in the state of Oregon. Physicians In the primary care physician "gatekeeper" system of health care delivery, a Covered Person receives care from a participating primary care physician who, in turn, refers the Covered Person to specialists and hospitals, as required. Primary care physicians, consisting of family practitioners, pediatricians, general practitioners and internists, are important to the Company's health care cost containment as they control utilization of hospitals, specialists and other health care providers. The Network seeks to include within its PPO high-quality, cost-effective physicians who have admitting privileges at a participating PPO hospital. In addition, physicians are recruited in geographic areas in which the Company's PPO does not have a physician presence if a prospective Health Plan has a large number of Covered Persons in such area. Upon receipt of an application by a physician to participate in the PPO, The Network conducts its own credentialing process (separate and distinct from those performed by participating hospitals with respect to physicians with admitting privileges), evaluating relevant information such as malpractice insurance, claims activity and the physician's standing with licensing regulatory authorities. 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. 6 7 At December 31, 1999, The Network had contractual arrangements through which Health Plans in both the public and private sectors representing approximately 1,022,000 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 Risk and 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 Risk The Plan offers a medicare risk product called SeniorsFirst for persons eligible to receive Medicare (parts A and B) at no or minimal cost to the member. SeniorsFirst is a medicare managed care plan combines health insurance and health services in one organization, a Medicare + Choice HMO. SeniorsFirst offer the same benefits that original medicare offers and additional benefits, which may change from year to year. Under this program, the Health Care Financing Administration of the United States Department of Health and Human Services (HCFA) pays a fixed premium for coverage of each member based on a formula of the projected medical expense of each Medicare member. 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. 7 8 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. MARKETING AND SALES The Network markets its PPO and utilization management services through an internal marketing staff to TPAs 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 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. They are compensated pursuant to commission arrangements that vary depending on the particular company products and services sold. MAJOR CUSTOMER The Company's largest customer, the Boeing Company, accounted for approximately 34% of the Company's premium revenue in fiscal 1999 and approximately 43% in fiscal 1998. Boeing accounted for approximately $24,500,000 and $19,800,000 of the Company's consolidated revenues for 1999 an 1998, respectively. The Company believes that it relationship with Boeing is excellent. 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. 8 9 GOVERNMENTAL REGULATION State Health Care Legislation The 1999 legislative session did not pass any health care related legislation. There were, however a number of Rule Making Orders issued by the Office of the Insurance Commissioner related to Health Care. These Rule Making Orders are summarized below: R 98-17 (Filed 11/29/99) Standards for Expedited Review of Health Care Service Denials by Health Carriers The effective date is December 30, 1999. The effected WAC Chapters are 284- 43-610, 284-43-620, 284-44-043, 284-46-507, 284-50-377, 284-96-015 The purpose is to set standards for expedited review of health care service denials by health carriers when an enrollee's life and health would be jeopardized by the timelines and procedures for more routine enrollee grievances. These standards shorten the time frames in which Health Carriers may respond to member appeals. There is a business impact on First Choice as this requirement results in increased costs associated with staffing increases, and significant costs associated with contracting with outside review organizations in order to meet standards set forth in this regulation. R 98-21 (Filed 10/11/99) Health Care Provider Contracts The effective date is November 11, 1999. The effected WAC Chapter is 284-43. The following is a summary of what is contained in this Rule Making Order: Provisions requiring carriers to provide 60 days advance notice of changes in procedures must be given only for those changes that affect compensation or health care service delivery. 60 day notice is not required where changes in law prevent the carriers from giving 60 day notice. No change to the contract can be made retroactive without express consent of the provider. Prompt payment standards were modified to reflect standards required by the Health Care Financing Administration for Medicare. Carriers must clearly report the reasons for a claim denial and must have a process for answering health care provider questions about claims. Audit standards were substantially removed in favor of a new cooperative process to establish uniform standards for claims procedures later. Instead, basic standards related to carrier access to records is addressed. Dispute resolution provisions were simplified. Different disputes may be settled through different methods appropriate to the type of dispute. Carriers may require the provider to use the dispute resolution process before resorting to judicial means. Carriers must resolve standard disputes within a reasonable time frame and billing disputes within 60 days. The audit standards have been replaced with a few general standards relating to carrier access to records. Carriers are permitted to use contract forms upon filing with the Office if the contract changes do not affect regulatory requirements. The above changes require procedural and documentation revisions. This has a business impact on First Choice in that there are costs associated with increased staffing and overtime required to meet the time frames, potential interest costs, and costs associated with system modifications to calculate the interest. There are also operational costs such as legal review costs associated with the development of new contracting language as well as costs associated with issuing new contract materials to providers. R 98-7 (Filed 9/8/99) Advertisement of Mental Health Benefits The effective date is October 9, 1999. The effected WAC Chapters are 284-43- 130, 284-43-810. Improve uniformity in the terminology used in the advertising of mental health benefits and increase the understanding of consumers who read, hear, or view the advertisement. There is no business impact on First Choice. R 99-4 (Filed 8/25/99) Washington State Health Insurance Pool The effective date is September 25, 1999. The effected WAC Chapter is 284-91- 060. Many state residents are unable to purchase health insurance in some counties of the state. These rules require the Washington State Health Insurance Pool to provide coverage in Washington counties where no individual health plans are commercially available from health carriers. There is a business impact on First Choice as per member per month assessments on a Plan by Plan basis have substantially increased. 9 10 R 98-20 (Filed 7/28/99) Every Category of Health Care Provider The effective date is August 28, 1999. The effected WAC Chapters are 284-43- 205. The rules are intended to implement RCW 48.43.045 by identifying health carrier practices that would violate the statute. The rules supersede an earlier declaratory order (G 96-13) filed on May 21, 1996. There is a business impact on First Choice as this rule has a premium rating increase associated with it to accommodate in part the expected higher utilization costs. There are also operational costs associated with system modifications and cost increases associated with additional network contracting. R 99-3 (Filed 7/28/99) Filing of Annual Reports The effective date is August 28, 1999. The effected WAC Chapter is 284-07- 050. Reduce the amount of copies of the annual reports that must be filed with the Commissioner. There is no business impact on First Choice. R 97-8 (Filed 12/18/97) Standards for Coverage of Chemical Dependency The effective date is August 22, 1999. The effected WAC Chapter is 284-53. The rule was identified in the Commissioner's Regulatory Improvement process as one that was out of date and should be reviewed and updated. References in the existing rule are outdated and benefit minimums established in 1987 have become ceilings and are no longer considered adequate to pay for increasingly effective but expensive treatment. The lifetime dollar maximum has been deleted and the 24 month dollar maximum has been raised to $10,000. There is a business impact on First Choice as this benefit change has resulted in an increase in premium rates to lessen the impact of the higher benefit maximum, and also increased costs associated with system changes required to accommodate the benefit modifications. Employees At December 31, 1999, the Company had 193 employees, 190 of which were full- time. None of the Company's employees are unionized or subject to collective bargaining agreements with the Company, and the Company believes its relationships with its employees to be good. 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 1999. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 10 11 There is no public trading market for any of the Company's equity securities. As of December 31, 1999, there were 467 holders of the Company's Class A Common Stock, seven holders of the Company's Class B Common Stock, and four 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
1999 1998 1997 1996 1995 -------- ---------- -------- -------- -------- C> Operating revenue $92,097,975 $56,878,270 $25,581,122 $6,199,506 $5,383,522 Net income $ 1,660,238 $ 703,551 $ 380,868 $1,037,714 1,020,050 Net income per common share 28.33 12.00 6.49 20.57 21.66 Total assets 30,667,873 20,712,398 19,262,806 10,473,153 7,403,850 Total liabilities 16,394,980 8,868,805 8,349,601 902,543 787,114 Redeemable equity participation 1,260,000
10 11 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 credentials providers who agree to accept competitive reimbursement rates and on its ability to control excess utilization through its utilization management program. During 1999, the Company continued to expand its PPO network. In 1999, 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 11 12 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 a license with the Federal Health Care Financing Administration (_HCFA_) 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 restricted depository account in order to satisfy statutory requirements for additional restricted deposits related to the Medicare business. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEARS ENDED DECEMBER 31, 1998 AND 1997 Operating revenue for the year ended December 31, 1999 increased 61.92% to approximately $92.1 million in 1999 from approximately $57.0 million in 1998 and $26.5 million in 1997. The majority of the increase was due to the increase in Plan health insurance membership resulting from increased growth in 1999 . The Plan's membership increased from 166,297 member months in 1997, 395,659 member months in 1998 to 602,856 member months in 1999. The Company's network access fees increased 39.80% from $4.1 million in 1997, $5.6 million in 1998 to $7.8 million in 1999. 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 1999. Hospital administrative fees also increased 32.44% from $2.5 million in 1997, $4.8 million in 1998 to $5.9 million in 1999. 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 60.09% to approximately $90.6 million in 1999 versus approximately $56.6 million in 1998 and $26.4 million in 1997. 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 12 13 approximately $9.7 million in 1999 from approximately $7.5 million in 1998 and $4.6 million in 1997 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 50.35% from approximately $4.3 million in 1997, $6.6 million in 1998 compared to approximately $10.0 million in 1999. 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 Health care costs in the United States have increased more rapidly than the national consumer price index in recent years, and that trend is expected to continue. The Company operating results have not significantly been affected by inflation, and the Company does not anticipate that inflation will have a significant impact on its operating results in the near term. However, inflation in healthcare costs could affect operations if the Company were 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. Market Risk HMOs and health insurance companies operate in a highly competitive environment. The Company has numerous competitors, including for-profit and not-for-profit HMOs, preferred provider organizations ("PPOs"), and indemnity insurance carriers, some of which have substantially larger enrollments and greater financial resources than the Company. 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 credentials providers who agree to accept competitive reimbursement rates and on its ability to control excess utilization through its utilization management program. 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 four additional hospitals pursuant to their respective participation agreements, and funds from operations. In July 1996, First Choice issued 5,800 shares of its Class B common Stock to Swedish Medical Center in exchange for $931,484. This equity investment increased the number of Class B shareholders to six. In December, 1996, First Choice issued 5,800 shares of its Class B Common Stock to Overlake Hospital Medical Center in exchange for $1,000,000 in cash and two additional payments of $250,000 each due in December of 1997 and 1998. 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. At December 31, 1999, the Company had cash and cash equivalents of approximately $13.1 million as compared to approximately $5.7 million at December 31, 1998. 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 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. 13 14 In May 1996 the Company's subsidiary, First Choice Health Plan, Inc., introduced into the marketplace a Medicare Supplement program in conjunction with two of its owner hospitals, Northwest Hospital and Valley Medical Center. At December 31, 1999 there were 473 policies in force and collected premiums of $347,455. The Company has contracted with Olympic Health Management Systems to act as the plan administrator. Its primary responsibilities are maintenance of an adequate sales force legally licensed in Washington state, and to perform premium billing and collection, claims processing and payment, and financial reporting to all applicable parties including the appropriate reports necessary for compliance with the Office of Insurance Commissioner of the State of Washington. On July 1, 1997, First Choice Health Network, Inc. (The Network), First Choice Health Plan, Inc. (The Plan), Health First Partners, Inc. (Health First) and Health Washington, L.L.C. (Health WA) entered into a merger and asset purchase agreement. The agreement between the four companies consisted of three transactions as described in the paragraphs below. First, The Plan purchased substantially all of the assets of Health WA in exchange for 34,523 shares of The Plan's Common 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 in FC Health Plan. Secondly, Health First merged with and into The Plan with Health First ceasing operations and The Plan as the surviving corporation. FC Health 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 Health 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%. 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 consolidation of Plan income or losses in the Company's filing of consolidated tax return which includes 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 1,000,000. The Network then increased its investment in the Plan by purchasing 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 14 15 stream of approximately $4.0 million. The purchase was $2.8 million to be paid with interest at a rate of six percent over 18 months, and a contingent payment of $668,000 based on revenue received by the Company in the twelve months after the closing date. The revenue was received and the $668,000 paid before February 15, 2000. On December 20, 1999, First Choice Health Network, Inc. executed an agreement with University of Washington Academic Medical Center to become a participant in the administration, operations and any incentives bestowed upon any shareholders in First Choice Health Network effective January 1, 2000. University of Washington Academic Medical Center shall pay the affiliation fee of $2,520,000, payable $1,260,000 upon execution of this Agreement and the remaining $1,260,000 will be paid in three equal payments of $420,000 due annually for three years plus interest at five percent (5%). UWMC does not become a shareholder or member of the Network. UWMC shall participate in any incentive or reward program established by the Network as if UWMC owned 5,800 shares of class B common stock. Dividends, distributions, and liquidation of the Network are also determined as if UWMC owned 5,800 shares of class B stock. If the Network performs certain actions that substantially change the organization, the Network discontinues the health care facility services contract with UWMC, or if total managed care enrollment falls below 500,000 member months, then UWMC can withdraw from the agreement, but no refunds are given. If the Network merges, is sold, or if the Network takes a material action that proves detrimental to UWMC, then UWMC may redeem their interest for the equivalent of the fair value of 5,800 class B common shares of FC stock, less any amounts still owed by UWMC. The Company anticipates that the revenues generated by operations cash and cash equivalents as of December 31, 1999 will be sufficient to meet its cash requirements throughout 2000. Throughout 1999 and early 2000, the Plan contracted with Cascade Medical Group (Cascade) for capitated health care services. The Plan did not have insurance risk for the covered individuals to the extent that Cascade could continue to pay the Plan for claims paid on their behalf. In March of 2000, Cascade management dissolved the organization. The dissolution of Cascade does not affect the financial position or results of operations in 1999 because the Plan had a payable to Cascade as of December 31, 1999. However, management believes a loss of between $500,000 and $700,000 will be incurred in 2000 for claims paid in 2000 for which the Plan does not expect to be reimbursed. Management is evaluating the financial impact of this event. The ultimate financial impact of this event will be determined, and the expense recorded, during 2000. Year 2000 Update The Company has assessed its computer systems and facilities regarding the Year 2000 problem. The Year 2000 problem is defined as storing the year as two digits rather than storing the year with four digits to include the century. Date sensitive calculations or reports may treat the year 00 as 1900 rather than 2000 resulting in erroneous results or calculations. As of January 1, 2000, the Company has evaluated its systems and applications to determine whether or not those systems were impacted by Year 2000. Based upon its testing and review, the core business systems operated effectively and there was no impact of Year 2000. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable as of December 31, 1999. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA 15 16 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . 16 Consolidated Balance Sheets as of December 31, 1999 and 1998 . . . . . . 17 Consolidated Statements of Income for the years ended December 31, 1999, 1998, and 1997 . . . . . . . . 19 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998, and 1997 . . . . . . . . 20 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998, and 1997 . . . . . . . . 21 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 23 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, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. 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. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP Seattle, Washington March 24, 2000 16 17 17 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998
ASSETS 1999 1998 CURRENT ASSETS: Cash and cash equivalents $13,082,130 $ 5,759,751 Service fees receivable, net of allowance for doubtful accounts of $252,361 and $146,000 for 1999 and 1998 3,929,493 2,234,969 Service fees and premiums receivable from related parties 1,213,593 1,504,537 Premiums receivable, net of allowance for doubtful accounts of $65,427 and $215,014 for 1999 and 1998 2,562,710 1,997,926 Due from unrelated provider organizations 1,891,651 1,586,381 Due from related provider organizations 684,606 972,785 Prepaid expenses 572,935 390,748 Deferred tax assets (Note 4) 548,735 152,318 Other current assets 170,581 81,178 ----------- ----------- Total current assets 24,656,434 14,680,593 FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE: Furniture and equipment 3,353,485 2,601,718 Computer software 324,385 306,522 ----------- ----------- 3,677,870 2,908,240 Less accumulated depreciation and amortization 2,011,730 1,488,358 ----------- ----------- Furniture, equipment and computer software, net 1,666,140 1,419,882 DEFERRED TAX ASSETS (Note 4) 314,384 OTHER ASSETS: Restricted indemnity cash 1,747,626 1,705,956 Goodwill, net of accumulated amortization of $137,614 and $113,616 137,646 307,310 Other intangible assets, net of accumulated amortization of $1,212,757 and $91,743 2,145,643 2,598,657 ----------- ----------- Total other assets 4,030,915 4,611,923 ----------- ----------- TOTAL $30,667,873 $20,712,398 =========== ============
See accompanying notes to consolidated financial statements. 17 18 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998 CURRENT LIABILITIES: Accounts payable $ 520,046 $ 377,850 Accrued expenses 2,275,005 1,609,202 Reserve for unpaid claims adjustment expenses 3,210,613 2,102,364 Due to unrelated provider organizations 5,104,101 1,229,331 Due to related provider organizations 421,711 247,355 Federal income tax payable 28,417 Unearned premiums 3,104,521 137,280 Deferred income taxes 146,979 136,715 Current portion of note payable 1,612,004 1,887,996 ----------- ---------- Total current liabilities 16,394,980 7,756,510 NOTE PAYABLE (Note 10) 999,671 DEFERRED INCOME TAXES (Note 4) 112,624 MINORITY INTEREST 864,249 1,320,085 REDEEMABLE EQUITY PARTICIPATION 1,260,000 COMMITMENTS (Note 5 and 13) SHAREHOLDERS' EQUITY: Common Stock: Class A, par value $1 - Authorized, 30,000 shares; issued and outstanding, 585 and 619 shares 585 619 Class B, par value $1 - Authorized, 70,000 shares; issued and outstanding, 40,600 and 40,600 shares 40,600 40,600 Additional paid-in capital 4,350,034 4,385,102 Shareholder receivable Paid-in capital from affiliates 1,472,108 1,472,108 Retained earnings 6,285,317 4,625,079 ----------- ------------ Total shareholders' equity 12,148,644 10,523,508 ----------- ------------ TOTAL $30,667,873 $20,712,398 =========== ============
See accompanying notes to consolidated financial statements. 18 19 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 OPERATING REVENUE: Premium revenue $64,496,942 $42,634,121 $15,711,616 Premium revenue, related parties 7,204,129 3,720,738 4,050,286 Medicare revenue 6,338,440 Network access fees 7,838,999 5,607,173 4,172,888 Hospital administrative fees 4,289,828 2,956,822 1,283,982 Hospital administrative fees, related party 1,609,000 1,841,789 1,243,123 Other 320,637 117,627 119,227 --------------------------- ---------- Total operating revenue 92,097,975 56,878,270 26,581,122 OPERATING EXPENSES: Medical expenses 41,812,940 25,149,892 10,472,784 Medical expenses, related parties 27,875,293 17,125,490 7,074,205 Payroll and related expenses 10,012,045 6,659,224 4,305,685 Selling, general, and administrative costs 9,741,831 7,517,177 4,533,543 Amortization expense 1,191,012 160,333 34,151 ------------------------- ---------- Total operating expenses 90,633,121 56,612,116 26,420,368 --------------------------- ---------- Operating income 1,464,854 266,154 160,754 OTHER INCOME (EXPENSE): Interest 361,200 504,415 511,257 Other 46,000 (155,928) 97,366 --------------------------- ---------- Total other income, net 407,200 348,487 608,623 --------------------------- ---------- Income before federal income taxes and minority interest 1,872,054 614,641 769,377 FEDERAL INCOME TAXES 279,143 429,348 504,006 --------------------------- ---------- 1,592,911 185,293 265,371 MINORITY INTEREST 67,327 518,258 115,497 -------------------------- ---------- NET INCOME $1,660,238 $ 703,551 $ 380,868 ========= ========= ========== NET INCOME PER COMMON SHARE $ 28.33 $ 12.00 $ 6.49 ========= ========== ========== WEIGHTED AVERAGE SHARES OUTSTANDING 58,601 58,619 58,650 ========= ========== ==========
See accompanying notes to consolidated financial statements. 19 20 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Common Stock ------------ Class A Class B Additional Balance ------- ------- paid-in Shareholder carried Shares Amount Shares Amount capital receivable forward ------ ------ ------ ------ ------- ---------- ------- C> Balances at January 1, 1997 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) Net income Change in unrealized loss on securities available for sale, net of deferred taxes Net income ----- ----- ------- ------- ---------- --------- ---------- Balances at 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 Repurchase of Class A common stock and (34) (34) Membership rights from physicians (35,068) (35,102) Net income ----- ----- ------- ------- ---------- --------- ---------- BALANCE, December 31, 1999 585 $585 40,600 $40,600 $4,350,034 $4,391,219 ===== ===== ======= ======= ========== ========== ========== 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 ------- ---------- -------- -------------- ------ Balances at January 1, 1997 $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 ---------- ----------- ---------- --------- ---------- BALANCES at December 31, 1997 4,207,338 1,472,108 3,921,528 9,600,974 Cash received from shareholder receivable 250,000 250,000 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 Cash received from shareholder receivable Repurchase of Class A common stock and (35,102) (35,102) membership rights from physicians Net income 1,660,238 1,660,238 ---------- ----------- ---------- --------- ---------- BALANCE, December 31, 1999 $4,391,219 $1,472,108 $6,285,317 $ $12,148,644 ========== =========== ========== ========= ==========
See accompanying notes to consolidated financial statements. 20 21 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 OPERATING ACTIVITIES: Net income $ 1,660,238 $ 703,551 $ 380,868 Adjustments to reconcile net income to net cash provided (used) by operating activities: Gain on sale of Dental Network (44,500) Depreciation 523,372 384,620 283,945 Amortization 1,191,012 160,333 34,151 Deferred income taxes, net (813,161) (268,589) (78,604) Provision for doubtful accounts 207,356 307,000 57,796 Minority interest (67,327) (518,258) (115,497) Cash provided (used) by changes in operating assets and liabilities: Service fees receivable (1,631,435) (1,520,090) (848,307) Premiums receivable (544,285) (405,968) (1,672,363) Prepaid expenses (182,187) (98,636) (59,791) Other current assets (89,403) 316,923 (373,622) Intangibles and other (390,009) 353,497 58,942 Accounts payable 142,196 171,648 48,279 Accrued expenses 665,805 (193,372) 761,129 Reserve for unpaid claims and claims adjustment expenses 1,108,249 708,257 (737) Due to (from) unrelated provider organizations 462,536 (533,992) 1,386,205 Due to (from) related provider organizations 3,569,500 (3,057,956) 1,279,573 Federal income tax payable (28,417) 28,417 Unearned premiums 2,967,241 (198,349) 321,261 --------- -------- --------- Net cash provided (used) by operating activities 8,706,778 (3,660,964) 1,463,228 INVESTING ACTIVITIES: Purchase of investment securities available for sale (7,457,715) Sales and maturities of investment securities available for sale 15,301,865 Acquisition of Health First Partners, net of cash acquired (97,936) Sale of Dental Network 90,000 Purchase of furniture, equipment, and computer software (769,630) (810,032) (508,715) Increase in restricted indemnity cash (41,671) (1,344,582) --------- ----------- ---------- Net cash provided (used) by investing activities (721,301) (2,154,614) 7,237,499 --------- ----------- ---------- BALANCE, carried forward 7,985,477 (5,815,578) 8,700,727 ========= =========== ==========
See accompanying notes to consolidated financial statements. 21 22 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLDIATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 BALANCE, brought forward $7,985,477 $(5,815,578) $8,700,727 FINANCING ACTIVITIES: Repurchase of Class A common stock and membership rights from physicians (35,102) (31,017) (1,736) Receipt of shareholder receivable 250,000 250,000 Redeemable equity participation 1,260,000 Payment of note payable (1,887,996) ---------- --------- ---------- Net cash provided by financing activities (663,098) 218,983 248,264 ---------- ----------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,322,379 (5,596,595) 8,948,991 CASH AND CASH EQUIVALENTS: Beginning of period 5,759,751 11,356,346 2,407,355 --------- ---------- ---------- End of year $13,082,130 $5,759,751 $11,356,346 ========== =========== ========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for federal income taxes $1,350,000 $ 250,000 $ 955,000 Cash paid during the year for interest 94,174 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES: Net assets for common stock (Note 8) 525,303 Business acquired for note payable 612,333 837,920
See accompanying notes to consolidated financial statements. 22 23 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1999, 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 majority 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: On June 16, 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Financial Instruments and Hedging Activities, which is effective for quarters of fiscal years beginning after June 15, 2000. SFAS No. 133 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, 1999 and 1998, cash and cash equivalents consist of cash management funds of $13,082,130 and $5,759,751, 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 is reasonable. The estimates are continually reviewed and adjusted as necessary in the period new information becomes known. Allowance for doubtful accounts: The Company performs periodic credit evaluations of its customers and maintains an allowance for potential credit losses related to receivables. Premiums receivable: Premiums receivable represents monthly group health insurance premiums billed and outstanding. 23 24 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 of the State of Washington. 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, 1999 and 1998. 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 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 consist of insurance premiums received prior to fiscal year end for health insurance coverage subsequent to year end. Operating revenue: Operating revenue consist primarily of premium revenue, medicare 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. Medicare revenue is paid at a fixed per member per month capitation amount by the HCFA based on the projected medical cost for each Medicare member and are recognized as revenue over the coverage period. 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, 1999 and 1998, 34% and 43%, respectively, of the premium revenue related to one subscriber group. 24 25 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 1999 and 1998, no write downs were required. Earnings per share: Net income per common share (class A and B) is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period, including 41,201, 41,219 and 41,248 common shares and 17,400, 17,400, and 17,402 shares applicable to affiliate common share equivalents (Note 2) in 1999, 1998 and 1997, respectively. Shares issued and reacquired during each 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 prior year amounts have been reclassified to conform to the current year 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. 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 $1,031.95, $1,014.91 and $1,108.15 per share during 1999, 1998 and 1997, respectively. 25 26 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 nonshareholders that have rights equivalent to that of the other 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%. NOTE 3: REDEEMABLE EQUITY PARTICIPATION On December 20, 1999, First Choice Health Network, Inc. executed an agreement with University of Washington Academic Medical Center (UWMC) to become a participant in the administration, operations and any incentives bestowed upon any shareholders in the Company effective January 1, 2000. UWMC will pay a fee of $2,520,000, payable $1,260,000 upon execution of this Agreement and the remaining $1,260,000 in three equal payments of $420,000 due annually for three years plus interest at five percent (5%). UWMC does not become a shareholder or member of the Company. UWMC shall participate in any incentive or reward program established by the Company as if UWMC owned 5,800 shares of class B common stock. Dividends, distributions, and liquidation of the Company are also determined as if UWMC owned 5,800 shares of class B stock. If the Company performs certain actions that substantially change the organization, the Company discontinues the health care facility services contract with UWMC, or if total managed care enrollment falls below 500,000 member months, then UWMC can withdraw from the agreement, but no refunds are given. If the Company merges, is sold, or if the Company takes a material action that proves detrimental to UWMC, then UWMC may redeem their interest for the equivalent of the fair value of 5,800 class B common shares of FC stock, less any amounts still owed by UWMC. Since redemption, under certain terms, is outside the control of the Company, the amounts received are recorded as a redeemable equity participation. 26 27 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4: FEDERAL INCOME TAXES Federal income taxes consist of the following components: Years Ended December 31, ------------------------ 1999 1998 1997 ------ ------ ------ Current $1,092,304 $697,937 $582,610 Deferred (813,161) (268,589) (78,604) ---------- --------- -------- $279,143 $429,348 $504,006 ========== ========= ======== 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:
1999 1998 1997 ------ ------ ----- Amount Percent Amount Percent Amount Percent ------- ------- ------ ------- ------ ------- Computed expected rate $636,498 34.0% $208,978 34.0% $261,558 34.0% Tax effect of permanent differences: Valuation allowance on Plan NOLs 66,640 10.8 179,481 23.4% Change in valuation allowance (73,608) (3.9)% Provision reconciliation to return filed (283,747) (15.2)% Political contributions 139,328 22.7% 34,026 5.6% Other 14,402 2.3% 28,911 3.8% --------- ----- -------- ------ ------ ----- $279,143 14.9% $429,348 69.8% $504,006 66.8% ======== ===== ======== ===== ======= =====
27 28 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The deferred tax assets and liabilities resulting from the tax effects of temporary differences at December 31 are presented below: 1999 1998 ---- ---- Deferred tax assets: Net operating losses $2,200,080 $1,598,029 Reduction of shareholders' equity 213,724 213,724 Allowance for doubtful accounts 108,048 122,745 Unearned Premium 211,107 Amortization 209,848 Vacation 87,506 Other 32,886 53,664 --------- ---------- Gross deferred tax assets 3,063,199 1,988,162 Valuation allowance (2,200,080) (1,835,844) --------- ---------- Net deferred tax assets 863,119 152,318 Deferred tax liabilities: Cash to accrual adjustment 112,624 225,248 Furniture, equipment and computer software 34,355 24,091 --------- -------- Total deferred tax liabilities 146,979 249,339 --------- -------- Deferred income tax asset (liability), net $716,140 ($97,021) ========= ======== Current portion of deferred tax assets 548,735 152,318 Long-term portion of deferred tax assets 314,384 -------- -------- Deferred income tax assets $863,119 $152,318 ======== ======== Current portion of deferred tax liabilities $146,979 $136,715 Long-term portion of deferred tax liabilities 112,624 --------- -------- Deferred income tax liability $146,979 $ 249,339 ======== ======== 28 29 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The valuation allowance was established in 1997 for the tax benefit of the 1997 NOLs of the Company since the Company filed a separate federal income tax return for the final six months of 1997 and the first three weeks of 1998 and the realization of the tax benefit is unlikely. The allowance also provides for NOLs acquired in the Health First Partners, Inc. acquisition as described in Note 8. The following schedule represents the amounts of the Plan's NOLs and their expiration date: 2007 150,754 2008 53,781 2009 20,754 2010 1,584,667 2011 2,075,894 2012 2,353,449 2013 231,526 ---------- $6,470,825 ========== NOTE 5: 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, 1999, 1998 and 1997, was $749,108, $510,316 and $254,247, respectively. Future minimum lease payments under the operating leases for the years ended December 31 are as follows: 2000 817,500 2001 815,204 2002 830,026 2003 431,540 ---------- $2,894,270 ========== NOTE 6: 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 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. 29 30 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Description of the types of products and services from which each reportable segment derives its revenue: The Company has two primary products which have been aggregated into one reportable segment: network access fees and hospital administration fees. Network access fees arise from the rental of the Company's large PPO network while hospital administration fees arise from charges to the network hospitals based on claims incurred by members. The other reportable segment, the Plan, offers a variety of fully insured health insurance plans to employer groups. Measurement of segment profit or loss and segment assets: The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit and loss from operations before income taxes not including nonrecurring gains and losses. The Company accounts for intersegment revenues by assigning a management fee to the Plan that is an estimate of resources expended on the Plan's behalf. Information about profit or loss and assets of reportable segments: NOTE 5 #1
First Choice First Choice Health Network Health Plan Total -------------- ----------- ----- 1999: Revenues from external customers $ 11,850,166 $80,247,809 $92,097,975 Revenue from intercompany 337,226 337,226 Interest revenue (expense) (44,726) 405,926 361,200 Depreciation/amortization expense 1,497,695 216,689 1,714,384 Income tax expense (benefit) 640,470 (361,327) 279,143 Expenditures on furniture, equipment and computer software 769,630 769,630 Segment profit (loss) 1,748,182 (155,271) 1,592,911 Assets $23,515,062 $20,555,995 $44,071,057 Liabilities $6,213,590 $10,413,052 $16,626,642 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 86,918 86,918 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 (2,336,464) 265,371 Assets $13,761,732 $12,817,130 $26,578,862 Liabilities $1,466,574 $7,531,774 $8,998,348
30 31 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 #2
1999 1998 1997 ---- ----- ---- Revenues: Total revenues for reportable segments and consolidated revenues $92,097,975 $56,878,270 $ 26,581,122 =========== =========== =========== Profit or loss: Total profit or loss for reportable segments $1,592,911 $185,293 $ 265,371 Adjustment for minority interest in consolidated statements 67,327 518,258 115,497 ---------- -------- -------- Consolidated net income $1,660,238 $703,551 $380,868 ========== ======== ========= Assets: Total assets for reportable segments $44,071,057 $32,897,176 $26,578,862 Elimination of intercompany investment (13,171,522) (11,457,007) (6,667,309) Elimination of intercompany balances (231,662) (727,771) (648,747) ----------- ----------- ---------- Consolidated total assets $30,667,873 $20,712,398 $19,262,806 ========== =========== =========== Liabilities: Total liabilities for reportable segments $16,626,642 $9,596,576 $8,998,348 Elimination of intercompany balances (231,662) (727,771) (648,747) ----------- --------- ----------- Consolidated total liabilities $16,394,980 $8,868,805 $8,349,601 =========== ========== ==========
31 32 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 $24,500,000 and $19,800,000 of the Company's consolidated revenues for 1999 and 1998, respectively. NOTE 7: 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 8: 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 contribution to the plan. Employer contributions to the plan for the years ended December 31, 1999 and 1998 amounted to $141,117 and $90,768 respectively. NOTE 9: 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 Company 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. The Company contributed $1,714,515 for common stock and additional paid-in-capital on a percentage of the Company's revenues for the year ended December 31, 1999. The investment in the Plan is eliminated in consolidation. 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. 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. 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. 32 33 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Providence Plan Partners PPO: On December 1, 1998, the Company purchased all of the assets of Providence Plan Partners PPO Business for a purchase price of $3,500,000 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 contingent payment of $668,000 to be determined based on the revenues received by the Company from the acquired business during the 12 months after the closing date. This acquisition was accounted for using the purchase method. Results operations are included in the financial statements of the Company from the effective date of the acquisition December 1, 1998. NOTE 10: NOTES PAYABLE The Company has an unsecured note payable at December 31, 1999 and 1998, related to the acquisition of Providence Partners PPO business (note 8) of $1,612,004 and $2,887,667, respectively. The note is payable in 18 equal monthly installments plus interest of 6%, starting December 1998. 33 34 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 11: RESERVE FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSES Activity in the reserve for unpaid claims and claims adjustment expenses is summarized as follows for the years ended December 31: 1999 1998 ------- ------ Balance, beginning of year $2,102,364 $ 1,394,107 Incurred related to: Current year 12,042,521 8,543,200 Prior year (848,750) (339,144) ---------- ----------- Total incurred 11,193,771 8,204,056 Paid related to: Current year 8,831,908 6,440,836 Prior year 1,253,614 1,054,963 ---------- ----------- Total paid 10,085,522 7,495,799 ---------- ----------- Balance, end of year $3,210,613 $2,102,364 ========== ========== As a result of changes in estimates of insured events in the prior year for 1999 and 1998, and recovery of duplicate claims payments of approximately $700,000 in 1999, the provision for unpaid claims and claims adjustment expenses for 1997 and 1998 decreased because of lower than anticipated losses. The Company negotiated contracts with two contracted provider organizations in 1998 that impacted incurred expenses in 1997. Both renegotiated contracts related to the transfer of medical risk to the Company from contracts where each provider organization previously held risk. Claims incurred in 1998 include $1,502,904 for the retention of this risk. Claims paid in 1998 that related to 1997 were $905,107. 34 35 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12: REGULATORY MATTERS The Company is subject to regulation by the Office of Insurance Commissioner (OIC)in the state of Washington including the requirement to follow statutory accounting principles (SAP), which differ from accounting principles generally accepted in the United States of America (GAAP). The OIC also requires that certain levels of capital be maintained. The State of Washington has adopted a risk-based capital (RBC) calculation for determining statutory capital requirements. This methodology became effective for the year ended December 31, 1999. At December 31, 1999, the Company was in compliance with the new capital requirements. The primary differences in reporting between the SAP and GAAP result from goodwill, accounts receivables over 90 days past due, and prepaid expenses being treated as _non-admitted_ assets under SAP. The NAIC has developed statutory accounting practices (the codification) which are expected to constitute the only source of prescribed statutory accounting practices. The NAIC anticipates the effective date for health-related organizations to be January 1, 2001. The codification will have no effect on those financial statements which are in accordance with accounting principles generally accepted in the United States of America. Statutory-basis shareholders' equity as filed in the OIC statement was $6,627,243 and $7,121,270 as of December 31, 1999 and 1998, respectively. Statutory-basis net loss as filed in the OIC statements was $364,612 and $2,651,839 for the year ended December 31, 1999 and 1998, respectively. The Company is subject to regulations which limit dividend payments and regulate other intercompany transactions. At December 31, 1999 and 1998, the Company had negative statutory basis earned surplus and therefore must seek regulatory approval prior to payment. No dividends were paid by the Company during 1999 or 1998. NOTE 13: SUBSEQUENT EVENTS Throughout 1999 and early 2000, the Plan contracted with Cascade Medical Group (Cascade) for capitated health care services. The Plan did not have insurance risk for the covered individuals to the extent that Cascade could continue to pay the Plan for claims paid on their behalf. In March of 2000, Cascade management dissolved the organization. The dissolution of Cascade does not affect the financial position or results of operations in 1999 because the Plan had a payable to Cascade as of December 31, 1999. However, management believes a loss of between $500,000 and $700,000 will be incurred in 2000 for claims paid in 2000 for which the Plan does not expect to be reimbursed. Management is evaluating the financial impact of this event. The ultimate financial impact of this event will be determined, and the expense will be recorded, during 2000. 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 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: Name Age Position Gary R. Gannaway 53 President & Chief Executive Officer David Peel 39 Sr. Vice President _Chief Financial Officer Ross D. Heyl 46 Sr. Vice President & Chief Marketing Officer Julie Keeffe 42 Sr. Vice President-Medical Mgmt & Member Services Joe Leinonen, M.D. 55 Chief Medical Officer Paul M. Elliott 59 Director (III) Andrew Fallat 52 Director (II) James J. Finley, M.D. 60 Director (III) Kenneth D. Graham 53 Director (I) Phillip J. Haas 51 Director (III) William F. Johnston, M.D. 54 Director (II) John F. Koster, M.D. 50 Director (III) R. Dean Martz, M.D. 42 Director (III) Barbara L. Mauk 54 Director (I) Richard A. McGee, M.D. 54 Director (I) Richard H. Peterson 57 Director (I) Richard E. Rust, M.D. 73 Director (I) Robert H. Smith,III 55 Director (II) Richard Stubbs, M.D., M.B.A. 54 Director (III) Clyde D. Walker 44 Director (II) (I) Term Expires in 2000 (II) Term Expires in 2001 (III) Term Expires in 2002 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 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, CPA Mr. Elliott, recently retired, was formerly Senior Vice President of Finance and Operations for the Alpac Corporation. From August 1969 to August 1981, he was Vice President-Controller for Airborne Freight Corporation in Seattle. He is a member of the Board of Visitors for Central Washington University, on the Board of the Boys & Girls Clubs of South Snohomish County and a member of Rotary Club International. Andrew Fallat, FACHE Mr. Fallat has served as the Chief Executive Officer of Evergreen Healthcare since 1981. Evergreen Healthcare is a provider of a broad range of services in King and Snohomish Counties including a 149 bed acute care hospital, 17 bed skilled nursing facility, a free standing surgical center, 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 board member on the Foundation for Health Care Quality and is a Fellow in the American College of Healthcare Executives. Mr. Fallat holds a Masters degree in Healthcare Administration from George Washington University and a B.S. in Zoology from Duke University. James G. Finley, M.D. Dr. Finley joined The Everett Clinic in 1973 as a gastroenterologist. A native of Tennessee, he received his B.S. 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 Hospital as a gastroenterologist. Dr. Finley is a Diplomat of the American Board of Internal Medicine and the American Board of Gastroenterology since 1972. In addition to his practice of Gastroenterolgy, he has served as Medical Director of The Everett Clinic since 1983. 37 38 Since January 1998, this position now occupies 100% of his professional time. He serves in board positions with Medical Partners Northwest and Washington Medical Group Alliance. Kenneth D. Graham, FACHE Mr. 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. He serves as Chair of the Overlake Venture Center and also the Chair of Dr. Goodwell.com; an Internet based virtual clinic service. 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. He earned a B.S. degree in Public Health and a Masters degree in Public Health Hospital Administration, both from UCLA. He is a Fellow in the American College of Health Care Executives and is the College's Regent for the State of Washington. Phillip J. Haas Mr. Haas is Administrator-Managed Care of Valley Medical Center, a 304-bed acute care public district hospital, with responsibility for negotiating, implementing, and administering contracts and joint ventures linking payers with the hospital, its clinic network, individual practice associations, and medical staff. Since joining Valley Medical Center in November 1993, he managed the development of a clinic network including seven primary care clinics, a family practice residency clinic, a behavioral health clinic, and two occupational health clinics. From 1988 through 1993, Mr. Haas was Executive Director of Virginia Mason Health Plan, an HMO serving over 40,000 members. From 1985 to 1988, he was President of First Choice Health Network, a preferred provider organization. His prior experiences include serving 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 and a Director of First Choice Health Network, Inc. He received a M.B.A. degree from the University of Chicago and a B.A. degree from Northwestern University in Evanston, Illinois. William F. Johnston, M.D., F.A.C.E.P. 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. 38 39 John Koster, M.D. 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 20 hospitals, 9 freestanding 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. Dr. Koster was senior vice president of Rocky Mountain Healthcare Corporation, which managed BCBS plans of Colorado, New Mexico and Nevada. 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. Dr. Martz 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, American Association 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 neurological surgery at the University of Michigan Hospitals in Ann Arbor. Barbara L. Mauk Ms. Mauk is the Director, Human Resources for Valley Medical Center, Renton, Washington. Previously, she was the Managing Partner of ClearPoint, 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, Society of Human Resource Management, and the Employee Benefits Planning Association. Richard A. McGee, M.D., F.A.C.P. Dr. McGee has a full-time private medical oncology practice and is President of Washington Cancer Centers, the largest medical oncology 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 the specialty Boards of both the American Board of Hematology and the American Board of Medical Oncology. He is President of the Washington State Medical Oncology Society. He 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 is a member of the Clinical Practice Committee of the American Society of Clinical Oncology and Assistant Editor for Clinical Practice on their Web site. In the past, he has served as Chief of the Medical Staff 39 40 and Chairman of several hospital committees. He was 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 was done at the University of Washington Hospital and the National Institutes of Health in Bethesda, Maryland. Richard H. Peterson 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. 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. Dr. Rust is a retired family practitioner. Dr. Rust has served on the First Choice Health Network Board of Directors since 1985. Additional activities have included serving as Trustee of the Washington Academy of Family Physicians; Trustee, King County Medical Society; Trustee and Vice Chairman of King County Medical Blue Shield; and President of King County Academy of Family Physicians. He was Chief of Medical Staff of Northwest Hospital in 1965. Robert H. Smith, III Mr. Smith is Executive Vice President and Chief Financial Officer of Good Samaritan Community Healthcare. Mr. Smith holds an M.B.A. from San Diego State University, 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, Merle West Medical Center in Klamath Falls, Oregon and was a senior accountant with Ernst & Young in San Diego. He has 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 several non-profit organizations. Richard Stubbs, M.D., M.B.A 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 Fellow of the American Board of Family Practice and a Fellow of the American College of Physician Executives where he currently serves on the Council of Fellows. He teaches Medical Ethics for the Tulane University Masters of Medical Management program. 40 41 Clyde D. Walker Mr. Walker is Vice President, Human Resources of PRIMEX Aerospace and Electronics Division and PRIMEX Aerospace Company in Redmond, WA. Mr. Walker has over ten years experience in the human resources field and over twenty years of business administration and management experience. Since 1977, Mr. Walker has held positions of increasing levels of responsibility in areas including subcontract administration, contract administration, pricing and human resources. He received an M.B.A. degree from City University in Seattle and a B.A. degree in business administration from the University of Washington. Mr. Walker recently served as Chairman of the Board of Directors of Big Brothers/Big Sisters of King County and led both boards through the combination of the two independent agencies. He remains on the resultant combined Board and also serves on the Board of Directors of First Choice Health Network. The Company's Board of Directors proposed an amendment of the Bylaws to modify the membership of the Board, and on June 29, 1999, 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, 1999, the Board of Directors shall consist of fifteen individuals: Six (6) directors (the "Class A Directors") shall be physicians representing Class A shareholders. Six (6) 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: Two Class A Directors, two Class B Directors, and one Class C Director. Category II: Two Class A Directors, two Class B Directors, and one Class C Director. Category III: Two Class A Directors, two Class B Directors, and one Class C Director. Directors may be removed, with or without cause, by an affirmative vote of the holders of at least 75% of the outstanding shares of each class of Common Stock, and the number, classification, qualifications and terms of directors may not be altered except by such class voting. A quorum of six (6) directors is generally required to transact business at a meeting of the Board, except that a quorum of eight (8) directors is required for determination of the admission and expulsion of shareholders and "members" i.e., PPO physicians), the fees charged for and/or paid to health care providers, and any issues reviewed by the Board regarding the limitation or termination of health care provider contracts. 41 42 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: Name and Principal Annual Compensation All Other Position Year Salary Bonus Compensation - ----------------------- ---- ------ ----- ------------ Gary Gannaway (1) 99 $238,218 $100,000 $7,484 President and CEO 98 $226,518 $126,000 97 $221,589 $126,000 Ross Heyl 99 $112,879 $15,930 $5,208 Senior Vice President, Marketing 98 $95,108 $18,000 97 $93,467 $18,000 Julie Keeffe, R.N. 99 $143,205 $11,820 $475 Senior Vice President, Medical 98 $117,500 $5,300 Management & Member Services Joe Leinonen, M.D. 99 $195,539 $12,610 $6,250 Chief Medical Officer 98 $139,500 David Peel 99 $143,637 $22,250 $6,250 Senior Vice President, Finance 98 $122,497 $22,900 97 $121,384 $22,900 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, 1999. 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. 42 43 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. 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. 43 44 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 - - - - 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 - * - 44 45 Shares Owned Percent of Name Class A Class B Class A Class B -------- ------- ------- ------- ------- Richard Stubbs, M.D., M.B.A. - - - - Robert H. Smith - - - - Clyde D. Walker - - - - Kenneth D. Graham - - - - James J. Finley, M.D. - - - - John Koster, M.D. - - - - R. Dean Martz, M.D - - - - All directors and executive officers as a group (3 persons) 3 40,600 * 100% Four additional hospitals in the state of Washington (Evergreen Hospital Medical Center, 12040 Northeast 128th Street, Kirkland, WA 98034, Valley Medical Center, 400 S. 43rd Street, Renton WA 98055, Stevens Memorial Hospital, 21601 76th Avenue, Edmonds, WA 98026, and University of Washington Medical Center, 1959 Northeast Pacific Street, Seattle, WA 98195) are not shareholders of the Company, but have made capital contributions to the Company in consideration of contractual rights substantially similar to the rights to which each holder of Class B Common Stock is entitled, including liquidation and dividend rights, but excluding voting rights. See "Item 8. Description of Securities." ITEM 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. The Company received the final payment in December 1998. Pursuant to their respective health care facility service contracts with The Network, the holders of the Class B Common Stock and the Hospital Participants paid the following aggregate fee to First Choice in 1984: Northwest Hospital: $81,159; Providence-General: $150,174; Good Samaritan Community Healthcare: $136,808; Multicare Medical Center: $207,271; Empire Health Services: $138,525; Evergreen General Hospital: $100,997; Valley Medical Center: $134,144; and Stevens Memorial Hospital: $88,093; Swedish Hospital: $265,861; and Overlake Hospital Medical Center: $ 0. 45 46 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 2.4 Purchase agreement dated as November 12, 1998, among First Choice Health Network, Inc. and Providence Plan Partners. 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.* 46 47 10.5 Form of Agreement between Registrant and Insurance Company .* 10.6 Copy of Participation Agreement dated March 27, 1985, between Registrant and King County Public Hospital District No.2 ( Evergreen General Hospital ).* 10.7 Copy of Participation Agreement dated March 26, 1985, between Registrant and Valley Medical Center.* 10.8 Copy of Participation Agreement dated December 19, 1991, between Registrant and Public Hospital District No.2 of Snohomish County (Stevens Memorial Hospital) and related Promissory Note in the aggregate principal amount of $ 566,000.* 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. 47 48 10.16 Copy of Employment Agreement dated March 1, 1994, between Registrant and Randolph R. Barker.** 10.17 Copy of Employment Agreement dated October 19, 1995 between Registrant and Gary R. Gannaway.** 10.18 Copy of Registrant's Amended By-Laws dated June 29, 1995. 10.19 Copy of Subscription Agreement dated July 16, 1996, between Registrant and Swedish Medical Center. 10.20 Copy of Agreement dated April 22, 1996 between Registrant and Olympic Health Management Systems, Inc. Production Line Management - Medicare Select. 10.20a Copy of Agreement dated April 22, 1996 between Registrant and Olympic Health Management Systems, Inc. for Administrative Agreement. 10.20b Copy of Agreement dated April 22, 1996 between Registrant and Olympic Health Management Systems, Inc. for Independent Agent Agreement. 10.20c Copy of Agreement dated April 22, 1996 between Registrant and Olympic Health Management Systems, Inc. for Supervising Agent Addendum to Independent Agent Agreement. 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.** 10.23 Copy of Participation Agreement dated December 20, 1999, between Registrant and University of Washington Medical Center and related Promissory Note in the aggregate principal amount of $ 1,260,000.* 16 Letter of change in certifying accountant (b) * Filed as same numbered Exhibit in Registrant's Registration Statement on Form 10-SB. ** Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10K-SB. (b) Reports on Form 8-K. 16 Report dated December 30, 1999. Participation Agreement of University of Washington Medical Center. 48 49 SIGNATURES In accordance with Section 13 or 15 (d) of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of April 2000. FIRST CHOICE HEALTH NETWORK, INC. By: /s/DAVID PEEL -------------------------------------- DAVID PEEL Chief Financial Officer In accordance with the Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated on April 14, 2000. 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 49 50 / 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, III Director - ---------------------------- ROBERT H. SMITH, III / 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 KOSTER Director - ---------------------------- JOHN KOSTER, M.D. / s / R. DEAN MARTZ Director - ---------------------------- R. DEAN MARTZ, M.D. 50 EX-27 2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY AUDITED DECEMBER 31, 1999 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1999 DEC-31-1999 13,082,130 0 7,705,796 317,788 0 24,656,434 3,677,870 2,011,730 30,667,873 16,394,980 0 0 0 41,185 12,107,459 30,667,873 92,097,975 92,505,175 69,688,233 90,633,121 0 0 0 1,872,054 279,143 1,592,911 0 0 0 1,660,238 28.33 28.33
-----END PRIVACY-ENHANCED MESSAGE-----