10-K 1 fchn10k1202.txt FCHN 2002 FORM 10-K 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, 2002 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) (206) 292-8255 (Registrant telephone number, including area code) 1 2 Securities registered pursuant to Section 12 (b) of the Act: None Securities registered under Section 12 (g) of the Act: Class A Common Stock, par value $1.00 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 whether the registrant is an accelerated filer (as Defined in Rule 12-b of the Act). Yes _____ No __X___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] There is no trading market for the Registrants common equity (Class A Common Stock, $1.00 par value and Class B Common Stock, $1.00 par value) and, accordingly, the market value of the 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, 2002 was 539 shares of Class A Common Stock, and 40,600 shares of Class B Common Stock, $1.00 par value, respectively. Documents incorporated by reference: None 2 3 PART I ITEM 1 BUSINESS 4 ITEM 2 PROPERTIES 6 ITEM 3 LEGAL PROCEEDINGS 7 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 7 PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 7 ITEM 6 SELECTED FINANCIAL DATA 7 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 8 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 11 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 12 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 33 PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 33 ITEM 11 EXECUTIVE COMPENSATION 41 ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 42 ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 44 ITEM 14 CONTROLS AND PROCEDURES 45 PART IV ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 46 SIGNATURES 47 3 4 PART I ITEM 1. BUSINESS Company Overview First Choice Health Network, Incorporated ("the Company") is a physician and hospital owned company offering preferred provider organization ("PPO") and insured health plan products through a subsidiary, First Choice Health Plan, Incorporated ("the Plan"). See Note 6 to the Company's financial statements appearing elsewhere in this report for revenue and other financial data regarding the Company's two business segments. The Company was organized under the laws of the State of Washington in 1984 and is owned by 538 physicians all of whom own Class A common stock, seven hospital systems who own Class B common stock and four additional hospital participants. The Company's web address is www.fchn.com. PPO Business Segment The Company's principal business since inception has been the development and operation of a preferred provider network ("PPO") of hospitals, physicians and ancillary service providers. Currently, the PPO has approximately 18,500 professional providers and 110 hospitals serving over 1.1 million employees and dependents through contracts with 125 payors including insurers, third party administrators ("TPAs"), union trusts and employers. PPO product offerings include medical and utilization management services for certain PPO clients and various specialty network services including a complementary and alternative medicine PPO and Employee Assistance Program (EAP) product and network services, both of which were new PPO product offerings in 2002. The geographic focus of the Company's PPO offerings is Washington State but includes healthcare providers in Alaska, Montana and Idaho to serve employees and dependents in these areas. Revenue from PPO network services including utilization management services takes the form of monthly access fees from participating payors and fees from payers based on a percentage of the savings generated by PPO provider contracts. In addition participating hospitals pay fees based on PPO claims volumes in those hospitals. Insured Health Plan Business Segment In 1995 the Company formed a wholly owned subsidiary, First Choice Health Plan, Incorporated ("the Plan") to operate as a licensed Health Care Services Contractor under Washington State Law, to offer insured managed care, point-of-service and PPO products to Washington customers. In 1997, the Plan was merged with two other Washington insurance programs, Health First Partners, and Health Washington growing to a total of over 70,000 insured members in 2000. See Note 2 to the Company's financial statements appearing elsewhere in this report for discussion of how the Company arrived at its current 80% ownership interest in the Plan. In late 1998 the U.S. Health Care Financing Administration (now the Centers for Medicare and Medicaid Services "CMS") approved the Plan's application to offer a Medicare Plus Choice product called SeniorsFirst. The product was offered in 1999 and through calendar year 2000, growing to 2,973 members by year end 2000 at which time the Plan ceased offering this product, withdrawing completely from its contractual arrangement with HCFA. The Company still offers a Medicare Select product to seniors that has approximately 800 members. In the spring of 2002, the Plan announced that it would undertake an orderly exit from its commercial insurance product offerings. Its decision was based on three factors: First, ongoing operating losses; second, a decrease in global capitation contract (contracts in which providers assume risk for claims) relationships with providers that resulted in higher capital requirements under risk-based capital standards; and three, rapid increases in claims costs that led to associated increases in risk-based capital requirements. 4 5 As a result of the Plan's actions, its membership has decreased to 27,927 members as of December 31,2002 down from 47,956 as of December 31, 2001. This exit will be complete by December 31, 2003 based on the non-renewal of all remaining commercial business during 2003. As the Plan ceases to offer its commercial insurance products, a new business strategy of offering benefits administration services to self-funded employers is being implemented. This strategy allows the Plan to take advantage of its extensive technological and staff capabilities for health benefits administration that were developed for the commercial insurance business. Development of this TPA business will help to mitigate some of the administrative costs of exiting the commercial insurance business by utilizing current infrastructure. With certain well defined exceptions, these self-funded benefits administration services will not be offered to potential clients that currently obtain such services from benefit administrators that access the Company's PPO products. PPO Business Segment Products Products currently offered within the PPO business segment include: (1) Access to the PPO or to subsets of the PPO (e.g. Hospital Only access) (2) Medical management services including utilization management services (pre- certification, concurrent review, gap analysis, etc.), catastrophic case management, disease management, consumer decision support tools, etc. (3) Employee Assistance Program provider network and services. (4) Complementary and alternative medicine provider network. Plan Business Segment Products Products currently provided within the Plan business segment include: (1) Managed care, point-of-service and PPO insurance products for commercial clients. (2) Such products offered to large cases (50 and over lives). (3) Such products offered to small cases (under 50 lives). (4) Products designed for Associations including the Costco Executive Business Member Health Plan and a product offering to the Employees Health Purchasing Cooperative. (5) A Medicare Select supplement product for seniors. Marketing and Sales PPO products are marketed to payers including insurers, third party administrators, union trusts, and employers through an internal sales force that also works closely with the broker and consultant community. Plan products were also marketed through an internal sales force. In addition, a telemarketing team marketed the Costco Executive Business Member programs. Independent insurance agents and brokers working with the Plan are compensated pursuant to commission arrangements. All new sales activities have ceased. TPA products will be marketed through an internal sales force. Major Customers The Plan's largest remaining customer is the Boeing Company accounting for approximately 38% of premium revenue in 2002 and 24% of premium revenue in 2001. Boeing will cease being a customer in 2003 with approximately two-thirds of this membership ending coverage on June 30, 2003 and the balance ending coverage as of December 31, 2003. 5 6 Competition The PPO and Plan operate in a highly competitive market. The PPO network competes with other managed health care companies primarily in terms of provider contract reimbursement competitiveness, credentialing quality, accuracy and timeliness of provider maintenance, claim repricing, utilization management and other services provided to payer clients as well as the price of accessing the PPO. Plan products compete on price, plan design and service. The PPO offers excellent provider contract and service value to payer clients compared to other independent PPO networks in Washington and the Northwest as shown by the Company's market position as the largest independent PPO in Washington. The PPO product also competes well against the PPO networks of the two dominant regional insurers in the Northwest. The Plan has competed against a shrinking number of insurers offering insured products in Washington. The TPA will compete with numerous other insurance carriers and TPAs operating in Washington, many of which are significantly larger and have greater financial resources than the Company. Competition for TPA clients is based primarily on price and operational performance. Government Regulation The PPO and the Plan are subject to significant regulation. The Plan is regulated by the Washington Office of the Insurance Commissioner (OIC) and must meet stringent standards of market conduct, capital sufficiency, provider network adequacy and patient rights among other matters. The Plan and the PPO are subject to standards regarding privacy and maintenance and transmission of health information established under the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). The planned offerings to self-funded clients and other current offerings are subject to ERISA and Department of Labor standards and requirements. The Plan's Medicare Select product is subject to OIC standards and to the requirements of the CMS. The Company has spent significant funds to assure compliance with these numerous standards and requirements and believes that it is well prepared to meet all HIPAA and other regulatory compliance requirements. The Sarbanes-Oxley Act of 2002 and related rulemaking by the SEC, which effect sweeping corporate disclosure and financial reporting reform, generally require public companies to focus on their disclosure controls and procedures. As a result, public companies such as FCHN now must have disclosure controls and procedures in place and make certain disclosures about them in their periodic SEC reports (i.e., Forms 10-K and 10-Q) and their chief executive and chief financial officers must certify in these filings that they are responsible for developing and evaluating disclosure controls and procedures and disclose the results of an evaluation conducted by them within the 90-day period preceding the filing of the relevant report, among other things. Employees As of December 31, 2002, the company had 146 employees. None of the Company's employees are unionized or subject to collective bargaining agreement. Company management believes that its relationship with its employees is good. Item 2. PROPERTIES The Company leases and occupies two offices in Seattle, Washington. Both leases expire in the Summer of 2003. The Company has entered into a new five- year office lease agreement effective June 2003 that will allow the Company to consolidate its operations at one office at a substantial reduction in lease costs compared to current costs. The new facility is also located in Seattle, Washington. 6 7 ITEM 3. LEGAL PROCEEDINGS In the normal course of business, the Company may encounter claims, assessments, and litigation brought against the Company. If and when these situations arise, the Company assesses the situation and accrues for financial exposure, if appropriate. As of December 31, 2002, the Company is not aware of any such material situations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS In June 2002, the Company held its annual meeting at which shareholders were asked to elect directors for those director positions whose terms were expiring in 2002 and as provided in the Company's bylaws. The following directors were elected at the meeting: Gerald A. Cufley, M.D., Paul M. Elliott, Phillip J. Hass, Scott F. Knonlund, M.D., and Greg Van Pelt In addition, the following directors continued in office following the meeting: Kenneth D. Graham, William F. Johnston, M.D., Garman E. Lutz, William J. MacDonald, M.D., Barbara L. Mitchell, Richard A. McGee, M.D., Richard H. Peterson, Paul G. Ramsey, M.D., Richard E. Rust, M.D., Clyde D. Walker, William R. Stubbs, M.D., M.B.A and Diane E. Cecchettini, R.N. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS There is no public trading market for any of the Company's equity securities. As of December 31, 2002, there were 538 holders of the Company's Class A Common Stock, seven holders of the Company's Class B Common Stock, three Hospital Participants and a hospital holder of a redeemable equity participation. 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. Pursuant to the Company's contracts with the Hospital Participants, if the Company pays any dividends or other distributions with respect to the Class B Common Stock, it 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 2002 2001 2000 1999 1998 ------------ ------------ ----------- ----------- ----------- Operating revenue $ 93,034,185 $122,652,504 $139,144,059 $92,097,975 $56,878,270 Net income(loss) 1,924,891 (1,407,987) (1,349,859) 1,660,238 703,551 Net income(loss) per common share 32.88 (24.04) (23.04) 28.33 12.00 Total assets 27,092,625 30,415,699 30,412,795 30,667,873 20,712,398 Total liabilities 12,159,483 17,847,673 17,837,813 16,394,980 8,868,805 Redeemable equity participation 2,385,443 1,991,850 1,617,000 1,260,000 - Total Equity 11,325,169 9,338,690 10,784,920 12,148,644 10,523,508
7 8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company's PPO product segment saw significant improvements in financial performance in 2002 with a 2002 segment profit of $3,563,492 versus a $1,124,794 segment profit in 2001. This improvement was the result of continuing pricing actions and technologically driven operational efficiency gains among other factors. The financial performance of the Plan product segment improved somewhat in 2002 moving from a loss in 2001 of ($2,705,843) to a loss in 2002 of ($2,042,728). The key factor in these Plan losses was a continuing underwriting loss associated with catastrophic cases below reinsurance attachment points as the Plan pursued an orderly exit from its commercial insurance business lines. Administrative expenses for the Plan have been well controlled as premium revenues have rapidly declined. Consolidated net income was $1,924,890 in 2002 versus consolidated net losses of ($1,407,987) in 2001 and ($1,349,859) in 2000. Financial results for 2002 showed a significant improvement in the Company's financial condition. Shareholders' equity increased by $1,986,479 from $9,338,690 in 2001 to $11,325,169 in 2002. The Company's current ratio improved from 1.40 in 2001 to 1.84 at year end 2002. The Plan's provider settlement receivables were reduced from $658,699 in 2001 to zero at year-end 2002. The Company has no debt and management believes that the Plan's claims liabilities have been conservatively stated at year end 2002. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEARS ENDED DECEMBER 31, 2001 AND 2000 Operating revenue decreased $29.6 million (24.1%) from 2001 to 2002 and decreased $16.5 million (11.9%) from 2000 to 2001. The decrease in 2002 primarily resulted from the Company's orderly exit from the Plan's commercial insurance business and the resultant $31.9 million decrease in premium revenue. The decrease in 2001 was primarily due to the discontinuance of the SeniorsFirst Medicare Risk product (approximately $19.1 million). Network Access fees increased $.4 million (5.2%) from 2001 to 2002 and $.8 million (10.3%) from 2000 to 2001. The increases are primarily due to higher contractual rates. Hospital administrative fees increased $1.8 million (24.2%) from 2001 to 2002 and $1.0 million (14.7%) from 2000 to 2001. The increases are primarily due to a higher volume of services provided by the hospitals and billed charge inflation at hospitals with administrative fees based on charges. Operating expenses decreased $33.0 million (26.7%) from 2001 to 2002 and $19.5 million (13.6%)from 2000 to 2001. The decrease in 2002 primarily resulted from reduced medical expenses ($29.1 million) attributable to the Company's planned exit from the health insurance market. The decrease in 2001 was primarily due to reduced medical expenses as a result of the discontinuance of the SeniorsFirst Medicare Risk product(approximately $16.8 million). Payroll and related expenses decreased $2.0 million (16.2%) from 2001 to 2002 and remained constant in 2001 compared to 2000. The decrease resulted from a planned reduction in the workforce (18.9%) during 2002 that coincided with the implementation of the Company's orderly exit from the health insurance market. Selling, general and administrative costs decreased $0.8 million (7.2%) from 2001 to 2002 and $0.7 million (5.9%) from 2000 to 2001. The decreases noted in 2002 and 2001 resulted from a reduction in Plan membership and the discontinuance of the SeniorsFirst program and the ongoing exit from the health insurance market. Write-down of investment and other expense in both 2002 and 2001 represent the Company's write-down of its investment in the Plan to the Plan's estimated net realizable value. The write-down in 2002 was triggered by an additional $1,918,000 capital infusion from the Company to the Plan. The 2002 write-down 8 9 represents 20% of this investment, representing the ownership interest of the Plan's minority interest shareholders. Amortization Amortization expense decreased $1.08 million (100%) from 2001 to 2002 and $93,000 (7.9%) from 2000 to 2001. The decrease was due to the intangible asset related to the 1998 Sound Health acquisition becoming fully amortized in November 2001. Therefore, there was no such amortization in 2002. Related Party Transactions The Company's related party transactions consist of three components. One component is the premium revenue that is received from the Company's owner hospitals for their employee groups that are members of the Plan. The second component is the Company's payment to the owner hospitals in the form of claims payments for medical services rendered to any member of the Plan. These two components are independent of each other and have no relationship for analytical purposes. A third component, hospital administrative fees from owner hospitals, is unrelated to the other components. 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's operating results have not been significantly affected by general 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 does directly impact the Plan's operation as most commercial groups have only annual rate adjustments. The Plan attempts to mitigate this through a premium rating trend that exceeds the healthcare trend. Due largely to unexpected high cost trends, the Plan has been significantly unsuccessful in improving its underwriting results. Costs are managed through discounted contractual arrangements and medical management activities. The Plan is winding down its commercial insurance business and will have exited this business by December 31, 2003. Market Risk The Company offers its PPO and Plan products in a highly competitive environment. The Company has numerous competitors, including for-profit and not-for-profit HMOs, TPAs, preferred provider organizations ("PPOs"), and indemnity insurance carriers, some of which have substantially larger enrollments and greater financial resources than the Company. The Company's ability to retain existing PPO clients and attract new clients is largely dependent on its ability to offer competitive provider contract value and maintain a network of high quality, efficient, fully credentialed providers who agree to accept competitive reimbursement rates. As the Plan's business model shifted from capitated contracts to fee for service contract arrangements over the past 3 years, management and the Board of Directors have reevaluated the strategic importance of the Plan. As a result, the Plan's existing commercial insured business will be wound down in an orderly manner with a complete exit of the commercial insured business by December 2003. The resulting reduction in membership may subject the Plan to various risks including adverse selection, claim volatility and administrative costs that may result in losses. This decision to exit the insured business required the Company to evaluate the carrying value of its investment in the Plan and resulted in the write-down noted under Results of Operations. 9 10 LIQUIDITY AND CAPITAL RESOURCES Since inception in 1984, 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. The Company's cash flow consists of operating, investing and financing cash flows. Operating cash flow is generated by operating income, depreciation and fluctuations in various balance sheet accounts. The Company anticipates the negative operating cash flow resulting from the Plan wind-down and resultant reduction in the reserve for unpaid claims and claim adjustment expense will be offset by operating income and depreciation. In the event of ongoing negative operating cash flow, the Company's investment portfolio of marketable securities is available to meet liquidity needs. The Company does not anticipate significant financing activities in 2003. At December 31, 2002, the Company had cash and cash equivalents of approximately $2.8 million as compared to approximately $3.0 million at December 31, 2001. This decrease in cash is offset by a $.5 million increase in investment securities available for sale. Investment securities consist of U.S. Government Agency asset-backed and mortgage-backed adjustable rate securities that are marketable in the event additional cash is needed. Following are explanations of significant balance sheet account fluctuations: The 100% reduction in Provider settlements receivable is due to completion of negotiated settlements of these receivables. There were no such contracts in 2002. The decrease in Other current assets of 84%, or $1.3 million is primarily due to the receipt of the Company's expected tax refund and a $.7 million reduction of healthcare receivables as a result of the decrease in Plan membership and collection of outstanding receivables. The reserve for unpaid claims and claims adjustment expenses (IBNR) decreased 27%, or $3.2 million during 2002. Unearned premiums decreased 53%, or $.9 million from 2001 to 2002. Provider settlements payable decreased 84%, or $1.2 million during the current year due to the settlement of those liabilities. The decrease noted in IBNR and unearned premiums is primarily attributed to a 42% decline in Plan membership. On December 20, 1999, the Company 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 paid $1,260,000 of the affiliation fee upon execution of the Agreement with the remaining $1,260,000 to be paid in three equal payments of $420,000 due annually for three years plus interest at five percent(5%). UWMC is not a shareholder or member of the Company. UWMC will 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 its interest for the equivalent of the fair value of 5,800 shares of class B stock, less any amounts still owed by UWMC. The UWMC ownership interest is classified as redeemable equity participation. 10 11 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 continued to pay the Plan for claims paid on its behalf. In March of 2000, Cascade management dissolved the organization. The dissolution of Cascade did not affect the Company's financial position or results of operations in 1999 because the Plan had a payable to Cascade as of December 31, 1999. The ultimate financial impact of this event approximated $970,000, which was recorded as medical expenses during 2000. During 2001 and 2000 several other provider organizations experienced financial difficulties. As a result of this, the Plan recorded additional medical expense of approximately $2.0 million and $4.4 million in 2001 and 2000, respectively. These amounts represent write-offs of provider settlement receivables and reserves for unpaid claims for estimated claim run out liabilities. As a result of these additional medical expenses, the Plan received approximately $4.2 million in capital infusions from the Company in 2000 and an additional $775,000 in 2001. Due to higher healthcare costs than expected in 2002, the Company made a capital contribution of $1,918,000 into the Plan. This amount represents an estimate of the contractually required capital contribution for 2002. CRITICAL ACCOUNTING POLICIES AND ESTIMATES As a result of the decision to exit the insured health care business by December 31, 2003, the Company's 80% ownership in the Plan was written down at December 31, 2001 to the expected net realizable value, which is the Plan's book value. Management believes this measurement of the expected net realizable value is still valid as of December 31, 2002. The reserve for unpaid claims and claims adjustment expenses represents reported and unreported claims which have been incurred but have not been paid at the date of the financial statements. The reserve for unreported claims is determined actuarially using prior experience and the nature of current health insurance contracts and volume. Included in the liability is an estimate of the future expenses necessary to settle claims. Due to the uncertainties inherent in the estimation process, actual costs may differ from the estimated amounts in the near term, and these differences may be significant. As a result of the decreasing membership in the Plan, management has increased the level of conservatism in the estimate due to increased risk associated with potential claim volatility resulting from a lower membership base. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable as of December 31, 2002. 11 12 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . 13 Consolidated Balance Sheets as of December 31, 2002 and 2001 . . . . . . 15 Consolidated Statements of Income for the years ended December 31, 2002, 2001, and 2000. . . . . . . 17 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2002, 2001, and 2000. . . . . . . 18 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000. . . . . . . 19 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 21 12 13 INDEPENDENT AUDITORS' REPORT Shareholders and Board of Directors First Choice Health Network, Inc. We have audited the accompanying consolidated balance sheet of First Choice Health Network, Inc., as of December 31, 2002 and 2001, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the First Choice Health Network, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. The Financial Statements of First Choice Health Network, Inc. for the year ended December 31, 2000 were audited by other auditors, whose report dated March 30, 2001 expressed an unqualified opinion on those statements. 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Choice Health Network, Inc., as of December 31, 2002 and 2001, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Moss Adams LLP January 29, 2003 Everett, Washington 13 14 INDEPENDENT AUDITORS' REPORT Shareholders and Board of Directors First Choice Health Network, Inc. We have audited the consolidated balance sheet of First Choice Health Network Inc. and subsidiary (the Company) as of December 31, 2000 (not presented herein) and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2000, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP March 30, 2001 Seattle, Washington 14 15 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 and 2001
ASSETS 2002 2001 CURRENT ASSETS: Cash and cash equivalents $ 2,825,460 $ 2,987,101 Investment securities available for sale 13,807,155 13,348,948 Service fees receivable, net of allowance for doubtful accounts of $131,840 and $420,497 1,400,693 1,730,763 Service fees and premiums receivable from related parties 506,340 384,274 Premiums receivable, net of allowance for doubtful accounts of $77,778 and $130,505 2,637,797 2,806,117 Provider settlements receivable - unrelated parties - 476,929 Provider settlements receivable - related parties - 181,770 Prepaid expenses 518,900 777,401 Deferred tax assets (Note 4) 340,467 572,571 Other current assets 244,576 1,506,701 ------------ ----------- Total current assets 22,281,388 24,772,575 FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE: Furniture and equipment 4,698,123 4,466,461 Computer software 1,290,729 1,187,970 ------------ ----------- 5,988,852 5,654,431 Less accumulated depreciation and amortization (4,534,736) (3,451,422) ------------ ----------- Furniture, equipment, and computer software, net 1,454,116 2,203,009 DEFERRED TAX ASSETS (Note 4) 945,214 1,363,347 OTHER ASSETS: Restricted indemnity investments 2,074,507 2,049,242 Investment in Assured Health 337,400 - Goodwill, net of accumulated amortization of $247,734 - 27,526 in 2001 (Note 1) ------------ ----------- Total other assets 2,411,907 2,076,768 ------------ ----------- TOTAL $27,092,625 $30,415,699 ============ ===========
See notes to consolidated financial statements. 15 16 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 and 2001
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001 CURRENT LIABILITIES: Accounts payable $ 487,291 $ 451,771 Accrued expenses 2,046,049 1,833,074 Reserve for unpaid claims and claims adjustment expenses 8,637,313 11,815,058 Provider settlements payable - unrelated parties 225,630 1,416,068 Unearned premiums 763,200 1,633,532 Current portion of note payable - 331,791 ----------- ----------- Total current liabilities 12,159,483 17,481,294 NOTE PAYABLE (Note 10) - 366,379 MINORITY INTEREST 1,222,530 1,237,486 REDEEMABLE EQUITY PARTICIPATION 2,385,443 1,991,850 COMMITMENTS (Note 5) SHAREHOLDERS' EQUITY: Common stock: Class A, par value $1 - Authorized, 30,000 shares; issued and outstanding, 538 and 539 shares 538 539 Class B, par value $1 - Authorized, 70,000 shares; issued and outstanding, 40,600 shares 40,600 40,600 Additional paid-in capital 4,306,221 4,306,581 Paid-in capital from affiliates 1,472,108 1,472,108 Retained earnings 5,452,362 3,527,471 Accumulated other comprehensive income (loss), net of tax 53,340 (8,609) ----------- ----------- Total shareholders' equity 11,325,169 9,338,690 ----------- ----------- TOTAL $27,092,625 $30,415,699 =========== ===========
See notes to consolidated financial statements. 16 17 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 OPERATING REVENUE: Premium revenue $ 72,756,358 $ 95,551,521 $ 90,054,697 Premium revenue, related parties 1,403,361 10,532,868 15,162,019 Medicare revenue - - 19,060,419 Network access fees 9,092,039 8,636,915 7,832,119 Hospital administrative fees 5,067,915 4,628,533 4,532,068 Hospital administrative fees, related parties 4,523,692 3,094,633 2,201,602 Other 190,820 208,034 301,135 ------------ ------------ ------------ Total operating revenue 93,034,185 122,652,504 139,144,059 OPERATING EXPENSES: Medical expenses 51,381,444 66,416,394 70,544,946 Medical expenses, related parties 18,434,620 32,534,341 47,089,964 Payroll and related expenses 10,288,719 12,281,740 12,244,679 Selling, general, and administrative expenses 10,669,098 11,466,664 12,190,024 Amortization expense - 1,081,251 1,174,512 ------------ ------------ ------------ Total operating expenses 90,773,881 123,780,390 143,244,125 ------------ ------------ ------------ Operating income(loss) 2,260,304 (1,127,886) (4,100,066) OTHER INCOME (EXPENSE): Interest and dividends 655,153 826,822 780,904 Write-down of investment and other (380,166) (1,237,486) - ------------ ------------ ------------ Total other income (expense), net 274,987 (410,664) 780,904 ------------ ------------ ------------ Income (loss) before federal income taxes and minority interest 2,535,291 (1,538,550) (3,319,162) FEDERAL INCOME TAX EXPENSE (BENEFIT) 1,014,526 42,499 (1,278,116) ------------ ------------ ------------ 1,520,765 ( 1,581,049) (2,041,046) MINORITY INTEREST, net of tax 404,126 173,062 691,187 ------------ ------------ ------------ NET INCOME (LOSS) $ 1,924,891 $ (1,407,987) $ (1,349,859) ============ ============ ============ NET INCOME (LOSS) PER COMMON SHARE $ 32.88 $ (24.04) $ (23.04) ============ ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING 58,538 58,565 58,579 ============ ============ ============
See notes to consolidated financial statements. 17 18 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Common stock Accumulated Class A Class B Additional Paid-in Other Total paid-in capital from Retained Comprehensive Shareholders' Shares Amt Shares Amt capital affiliates Earnings Income (Loss) Equity BALANCE, January 1, 2000 585 $585 40,600 $40,600 $4,350,034 $1,472,108 $6,285,317 $12,148,644 Repurchase of Class A common stock and membership rights (13) (13) (13,852) (13,865) Net loss (1,349,859) (1,349,859) ---- ---- ------ ------ --------- ---------- ---------- ---------- ----------- BALANCE, December 31, 2000 572 572 40,600 40,600 4,336,182 1,472,108 4,935,458 -0- 10,784,920 Repurchase of Class A common stock and membership rights (33) (33) (29,601) (29,634) Unrealized loss on investments, net of tax (8,609) (8,609) Net loss (1,407,987) (1,407,987) ---- ---- ------ ------ --------- ---------- ---------- ---------- ----------- BALANCE, December 31, 2001 539 539 40,600 40,600 4,306,581 1,472,108 3,527,471 (8,609) 9,338,690 Repurchase of Class A common stock and membership rights (1) (1) (360) (361) Unrealized gain on investments, net of tax 61,949 61,949 Net Income 1,924,891 1,924,891 ---- ---- ------ ------ --------- ---------- ---------- ---------- ----------- 538 $538 40,600 $40,600 $4,306,221 $1,472,108 $5,452,362 $ 53,340 $11,325,169 Balance, December 31, 2002 ==== ==== ====== ====== ========= ========== ========== ========== ===========
See notes to consolidated financial statements. 18 19 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 1,924,891 $(1,407,987) $(1,349,859) Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation 1,083,314 818,428 621,264 Amortization 27,526 1,081,251 1,174,512 Deferred income taxes, net 650,237 42,501 (1,262,279) Provision for doubtful accounts (341,383) (298,778) 253,914 Minority interest (20,526) 1,064,424 (691,187) Changes in operating assets and liabilities: Service fees receivable 496,661 1,196,033 (1,565,527) Premiums receivable 221,046 377,861 (309,916) Prepaid expenses 258,501 62,404 (266,870) Other current assets 1,262,125 (789,742) (546,377) Accounts payable 35,520 (226,283) 158,008 Accrued expenses 212,975 (1,463,715) 1,021,784 Reserve for unpaid claims and claims adjustment expenses (3,177,745) 1,633,463 6,970,982 Provider settlements receivable (payable)- related organizations 181,770 850,848 (769,723) Provider settlements receivable (payable)- unrelated organizations (713,509) 257,488 (2,530,799) Unearned Premiums (870,332) 569,142 (2,040,131) ----------- ----------- ------------- Net cash from operating activities 1,231,071 3,767,338 1,998,850 CASH FLOWS FROM INVESTING ACTIVITIES: (Purchase) of investment in Assured Health (337,400) - - Maturities/(Purchase) of short-term investment 499,995 (499,995) (Purchase) of investments available for sale (8,676,276) (16,524,646) - Maturities/sale of investments available for sale 8,285,056 3,167,089 - (Purchase) of furniture, equipment, and computer software (334,421) (412,808) (1,563,753) (Increase)in restricted indemnity cash (24,733) (250,543) (51,073) ----------- ------------ ------------- Net cash from investing activities (1,087,774) (13,520,913) (2,114,821) ----------- ------------ ------------- BALANCE, carried forward 143,297 (9,753,575) (115,971)
See notes to consolidated financial statements. 19 20 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLDIATED STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 BALANCE, brought forward $ 143,297 $ (9,753,575) $ (115,971) CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of Class A common stock and membership rights from physicians (361) (29,634) (13,865) Redeemable equity participation 393,593 374,850 357,000 Proceeds of note issued - - 1,000,000 (Payment) of note payable (698,170) (301,830) (1,612,004) ----------- ----------- ------------ Net cash from financing activities (304,938) 43,386 (268,869) ----------- ----------- ------------ NET (DECREASE) IN CASH AND CASH EQUIVALENTS (161,641) (9,710,189) (384,840) CASH AND CASH EQUIVALENTS: Beginning of year 2,987,101 12,697,290 13,082,130 ----------- ----------- ------------ End of year $ 2,825,460 $ 2,987,101 $ 12,697,290 =========== =========== ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash received (paid) during the year for: Federal income taxes $ 303,633 $ - $ (430,000) Interest $ (32,294) $ (84,540) $ (11,800) =========== =========== ===========
See notes to consolidated financial statements. 20 21 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 and 2001 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 initially to organize a network of participating physicians and hospitals to serve insurers, third party administrators, union trusts and employers. Subsequently the Company created additional related PPO services including utilization management services. The Company's business is conducted primarily in Washington, with some additional business located in Alaska, Montana and Idaho. 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 products in Washington state. In 2002, the Plan's Board of Directors authorized management to proceed with an orderly exit of the insured health care business by no later than December 31, 2003. Principles of consolidation: The consolidated financial statements include the accounts of the Company and the Plan. All significant inter-company amounts have been eliminated in consolidation. New accounting pronouncements: In June 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred and be measured at fair value and adjusted for changes in estimated cash flows. Existing generally accepted accounting principles provide for the recognition of such costs at the date of management's commitment to an exit plan. Under Statement No. 146, management's commitment to an exit plan would not be sufficient, by itself, to recognize a liability. The Statement is effective for exit or disposal activities initiated after December 31, 2002 and is not expected to have a material impact on the results Of operations or financial condition of the Company. In October 2001,FASB issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, which is effective for business combinations initiated after June 30, 2001. This statement establishes the purchase method as the only acceptable method of accounting for business combinations and eliminates the pooling-of-interest method. The Company did not participate in a business combination in 2001. Also, in October 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 establishes new accounting and reporting standards for goodwill and other intangible assets. Under this statement, goodwill will no longer be amortized, but will be recognized and measured based on its fair value. Pursuant to this statement, the Plan wrote off its remaining goodwill of $27,526 in 2002. Cash equivalents: The Company considers all investments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2002 and 2001, cash and cash equivalents consisted of cash management funds of $2,825,460 and $2,987,101, respectively. 21 22 Investment securities: The Company owns U.S. Government Agency mortgage-backed adjustable rate securities that are classified as available for sale. Investment securities categorized as available for sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available for sale securities are recorded at fair value, with the net unrealized gain or loss included in comprehensive income, net of the related tax effect. Realized gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Service fees receivable: Service fees receivable consists primarily of outstanding invoices and estimates for administrative fees receivable related to claims incurred on or before the balance sheet date but not reported. The Company evaluates the reasonableness of 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 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. 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 investments: Restricted indemnity investments consists of amounts required to be restricted for potential claims from enrollees as required by the Office of the Insurance Commissioner of the State of Washington. The balance consists of short-term treasury funds recorded at fair market value. These Securities are recorded at amortized cost, which approximates fair value. Goodwill: Goodwill is determined as the difference between the purchase price and fair value of identifiable net assets purchased. Pursuant to SFAS No. 142, the Company wrote off its remaining goodwill of $27,526 in 2002. Other intangible assets: Intangible assets assumed in the Sound Health PPO network acquisition were trademarks, contracts, and a noncompetition agreement. Intangible assets are amortized using the straight-line method over three years and became fully amortized in 2001. Reserve for unpaid claims and claims adjustment expenses: This liability represents reported and unreported claims which have been incurred but have not been paid at the date of the financial statements. The reserve for unreported claims is determined actuarially using prior experience and the nature of current health insurance contracts and volume. Included in the liability is an estimate of the future expenses necessary to settle claims. Due to the uncertainties inherent in the estimation process, actual costs may differ from the estimated amounts in the near term, and these differences may be significant. Provider settlement receivable (payable): This liability or asset is the amount due from (to) 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 settlement amounts. 22 23 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 consists 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 Centers for Medicare and Medicaid Services (CMS) based on the the projected medical cost for each Medicare member and is recognized as revenue over the coverage period. The Plan ceased offering the Medicare plan effective January 1, 2001. 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 years ended December 31, 2002, 2001 and 2000, 38%, 24% and 22% respectively, of the premium revenue is related to one subscriber group. Premiums receivables, as of December 31, 2002, 2001 and 2000 from that group represented 88%, 74% and 53%, respectively. Income taxes: Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent that it is more likely than not that deferred tax assets will not be realized. Valuation of long-lived assets: Using its best estimates, based on reasonable and supportable assumptions and projections, the Company reviews its long- lived assets for impairment whenever events or changes in circumstances have indicated that the carrying amounts of its assets might not be recoverable. At December 31, 2002 and 2001, no write-downs were required. Write-down of investment in Plan: As a result of the decision to exit the insured health care business by December 2003, the Company's 80% ownership interest in the Plan was written down to the expected net realizable value which is the Plan's book value at December 31, 2001. The write-down of $1,237,486 is included in Other Expense. A further write-down of $383,600 was recorded in 2002 representing 20% of the 2002 capital contribution to the Plan. 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 41,138, 41,139 and 41,172 common shares and 17,400 shares applicable to affiliate common share equivalents (Note 2) in 2002, 2001 and 2000, 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 accounting principles generally accepted in the United States of America (GAAP) 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 amounts in the 2001 financial statements have been reclassified to conform with the 2002 presentation. 23 24 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 $752, $898 and $1,067 per share during 2002, 2001 and 2000, respectively. Dividends: The Board of Directors may declare and pay dividends on one or more classes of common stock at such times and in such amounts as it designates, but in no event may dividends be paid while there is an outstanding obligation to repurchase shares. Dividends are allocated among shareholders of each class of stock according to the number of shares outstanding to each Class A or Class B shareholder. Any dividends paid to the Class B shareholders must be shared with the non-shareholders that have rights equivalent to those 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 non-shareholder district hospitals that have rights equivalent to those 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 non-shareholder hospitals that have rights equivalent to those 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 non-shareholders 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, the Company executed a participation agreement with the 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. 24 25 UWMC agreed to pay a fee of $2,520,000, $1,260,000 payable upon execution of the agreement and the remaining $1,260,000 payable in three equal annual payments of $420,000 consisting of principal and interest at 5%. The final payment will be adjusted for any outstanding principal and interest. UWMC did not become a shareholder or a member of the Company. UWMC will 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 common stock. If the Company performs certain activities 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 will be given. If the Company merges, is sold, or if the Company takes a material action that proves detrimental to UWMC, then UWMC may redeem its interest for the equivalent of the fair value of 5,800 Class B common shares of Company 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. NOTE 4: FEDERAL INCOME TAXES Federal income taxes consist of the following components:
2002 2001 2000 Current $ 364,289 $ (2) $ (15,837) Deferred 650,237 42,501 (1,262,279) ------------ ------------ ----------- $ 1,014,526 $ 42,499 $(1,278,116) ============ ============ ===========
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: 2002 2001 2000 Amount Percent Amount Percent Amount Percent Computed expected tax rate $ 861,999 34.0 $(523,107) (34.0) $(1,128,515) (34.0) Tax effect of permanent differences: Write-down of investment in subsidiary 130,424 5.1 420,745 27.4 Change in valuation allowance (16,727) (0.5) Adjustment to return filed (26,119) (0.8) Other 22,103 .9 144,861 9.4 (106,755) (3.2) ----------- ----- ---------- ---- ----------- ----- $1,014,526 40.0 $ 42,499 2.8 $(1,278,116) (38.5) =========== ===== ========== ==== =========== =====
25 26 The deferred tax assets and liabilities resulting from the tax effects of temporary differences at December 31 are presented below:
2002 2001 Deferred tax assets: Net operating losses $2,216,807 $2,679,716 Reduction of shareholders' equity 213,724 213,724 Allowance for doubtful accounts 80,441 187,341 Unearned premium 51,898 111,080 Amortization 731,490 686,714 Vacation 127,714 123,959 Other 80,414 150,191 ---------- ---------- Gross deferred tax assets 3,502,488 4,152,725 Valuation allowance (2,216,807) (2,216,807) ---------- ---------- Net deferred tax assets $1,285,681 $1,935,918 ========== ========== Current portion of deferred tax assets $ 340,467 $ 522,571 Long-term portion of deferred tax assets 945,214 1,363,347 ---------- ---------- $1,285,681 $1,935,918 ========== ==========
The valuation allowance was established in 1997 for the tax benefit of the 1997 net operating losses (NOL's) 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 NOL's acquired in acquisition of a business in 1997. The following schedule represents the amounts of the Plan's NOL's 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 2018 280,723 ---------- Total Net Operating Losses 6,520,022 Valuation Allowance (6,520,022) ========== $ -
NOTE 5: COMMITMENTS Leases: The Company leases its office facilities and some office equipment under operating leases expiring through 2005. The leases provide for monthly minimum rent payments, and some include renewal options for an additional five years. 26 2003 958,741 2004 759,128 2005 744,582 ---------- $2,462,451 ========== In connection with the acquisition of a business in 1997, the Company is required to contribute to the capital of the Plan based on a percentage of the Company's administrative fee revenue for the 10 years following July 1, 1997, if any. No minimum amounts of contributions are required. The following contributions were made pursuant to this agreement in 2002 and 2001.
2002 2001 Remaining 2001 Contribution 775,000 2002 Contribution Advance 1,918,000 ---------- -------- Total Contributions $1,918,000 $775,000 ========== ========
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. 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 PPO and other network products while hospital administrative fees arise from charges to the network hospitals based on claims incurred by members or fixed monthly contractual payments. The other reportable segment, the Plan, offers a variety of fully insured health insurance plans. 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. 27 28 Information about profit or loss and assets of reportable segments:
First Choice First Choice Health Network Health Plan Total 2002: Revenues from external customers $ 16,086,796 $ 76,947,388 $ 93,034,185 Revenue from inter-company 286,463 28,125 314,588 Interest revenue 142,324 512,829 655,153 Depreciation/amortization expense 626,397 456,917 1,083,314 Income tax expense (benefit) 2,045,661 (1,031,135) 1,014,526 Expenditures on furniture, equipment, and computer software 334,421 - 334,421 Segment profit (loss) 3,563,493 (2,042,728) 1,520,765 Assets 17,259,204 16,433,555 33,692,759 Liabilities 3,548,593 10,320,905 13,869,498 2001: Revenues from external customers $ 13,826,171 $108,826,333 $122,652,504 Revenue from inter-company 383,050 - 383,050 Interest revenue 99,142 807,220 906,362 Depreciation/amortization expense 1,485,580 414,099 1,899,679 Income tax expense (benefit) 1,196,097 (1,153,598) 42,499 Expenditures on furniture, equipment, and computer software 412,808 - 412,808 Segment profit (loss) 1,124,794 (2,705,843) (1,581,049) Assets 14,306,068 21,861,357 36,167,425 Liabilities 2,975,528 15,673,925 18,649,453 2000: Revenues from external customers $ 12,077,869 $127,066,190 $139,144,059 Revenue from inter-company 403,860 - 403,860 Interest revenue 95,602 685,302 780,904 Depreciation/amortization expense 1,616,473 179,303 1,795,776 Income tax expense (benefit) 562,064 (1,840,180) (1,278,116) Expenditures on furniture, equipment, and computer software 1,563,753 - 1,563,753 Segment profit (loss) 1,376,066 (3,417,112) (2,041,046) Assets 25,011,867 23,404,879 48,416,746 Liabilities 4,892,138 15,278,104 20,170,242 2002 2001 2000 Revenues: Total revenues for reportable segments and consolidated revenues $ 93,034,185 $122,652,504 $139,144,059 ============ ============ ============ Profit or loss: Total profit or loss for reportable segments $ 1,520,765 $ (1,581,049) $(2,041,046) Adjustment for minority interest in consolidated statements 404,126 173,062 691,187 ------------ ------------ ------------ Consolidated net income (loss) $ 1,924,891 $ (1,407,987) $(1,349,859) ============ ============= =============
28 29
2002 2001 2000 Assets: Total assets for reportable segments $ 33,692,759 $ 36,167,425 $ 48,416,746 Elimination of inter-company investments (4,890,118) (4,949,946) (15,671,522) Elimination of inter-company balances (1,710,016) (801,780) (2,332,429) ------------ ------------ ------------ Consolidated total assets $ 27,092,625 $ 30,415,699 $ 30,412,795 ============ ============ ============ Liabilities: Total liabilities for reportable segments $ 13,869,499 $ 18,649,453 $ 20,170,242 Elimination of inter-company balances (1,710,016) (801,780) (2,332,429) ------------ ------------ ------------ Consolidated total liabilities $ 12,159,483 $ 17,847,673 $ 17,837,813 ============ ============ ============
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 $28.1 million, $25.8 million and $22.7 million of the Company's consolidated revenues for 2002, 2001 and 2000, respectively. NOTE 7: FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents, short-term investments, service fees and premiums receivable, restricted indemnity investments, accounts payable, notes payable, and due to provider organizations approximates fair value because of the short maturity of these instruments. NOTE 8: INVESTMENT SECURITIES AVAILABLE FOR SALE Investment securities available for sale consist of the following:
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Market Value ---------------------------------------------------------- December 31, 2002 Government-backed adjustable rate securities $ 1,886,141 $ 7,112 $ - $ 1,893,253 Mortgage-backed adjustable rate securities 11,862,642 66,025 (14,765) 11,913,902 ---------------------------------------------------------- $ 13,748,783 $ 73,137 $(14,765) $ 13,807,155 ===========================================================
29 30
Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Market Value ---------------------------------------------------------- December 31, 2001 Government-backed adjustable rate securities $ 2,096,826 $ 3,651 $ - $ 2,100,477 Mortgage-backed adjustable rate securities 11,260,732 - (12,261) 11,248,471 ---------------------------------------------------------- $ 13,357,558 $ 3,651 $(12,261) $ 13,348,948 ===========================================================
Contractual maturities of investment securities as of December 31, 2002 are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties.
Available for Sale Amortized Fair Maturity Costs Value ----------------- ----------- ----------- Five to ten years $ 246,355 $ 249,743 Over ten years 13,502,428 13,557,412 ----------- ----------- $13,748,783 $13,807,155 =========== ===========
The amortized cost and estimated fair value of debt securities at December 31, 2002 and 2001 based on contractual maturity dates, excluding principal reductions, are all due after nine and ten years respectively. Proceeds from sales and maturities of investments in debt securities in 2002 and 2001 were $8,285,055 and $3,167,089, respectively. NOTE 9: RETIREMENT PLAN The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan covering all full-time employees. Under the Plan, employees can defer up to the maximum established by the Internal Revenue Service. The Company matches 50% of each employee's contribution, up to 6% of the employee's eligible salary. Employees become fully vested in employee contributions and vest over two years for employer contributions. 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, 2002 and 2001, amounted to $139,691 and $180,300, respectively. NOTE 10: NOTE PAYABLE The Company had a note payable at December 31, 2001 in the amount of $698,170 bearing interest at 9.86%. The note was paid in full in 2002. 30 31 NOTE 11: RESERVE FOR UNPAID CLAIMS AND ADJUSTMENT EXPENSES Activity in the reserve for unpaid claims and unpaid claims processing expenses is summarized as follows for the years ended December 31:
2002 2001 Balance, beginning of year $11,815,058 $10,181,595 Incurred related to: Current year 70,521,415 66,860,450 Prior year (705,351) (359,407) ----------- ----------- Total incurred 69,816,064 66,501,043 Paid related to: Current year 61,901,253 55,266,141 Prior year 11,092,556 9,601,439 ----------- ----------- Total paid 72,993,809 64,867,580 ----------- ----------- Balance, end of year $ 8,637,313 $11,815,058 =========== ===========
During 2002 and 2001, the Company had reinsurance stop loss agreements in place for claims for which the Company is at risk. NOTE 12: REGULATORY MATTERS The Plan is subject to regulation by the Office of the 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 OIC of the state of Washington adopted a risk-based capital (RBC) calculation for determining statutory capital requirements, effective for the year ended December 31, 1998 As of December 31, 2002, the Plan's RBC was $1,946,110 more than the required amount. The primary differences in reporting between SAP and GAAP through December 31, 2002 result from various receivables and excess deferred tax assets beyond calculated admitted portions. The Plan's statutory basis shareholders' equity as filed in the OIC statements was $5,864,930 and $5,754,080 as of December 31, 2002 and 2001, respectively. Statutory basis net loss as filed in the OIC statements was $1,452,534 and $2,949,651 for the years ended December 31, 2002 and 2001, respectively. The Plan is subject to regulations that limit dividend payments and regulate other inter-company transactions. At December 31, 2002 and 2001, the Plan had negative statutory basis earned surplus and therefore must seek regulatory approval prior to any such payment. No dividends were paid by the Plan during 2002 or 2001. 31 32 NOTE 13: UNAUDITED QUARTERLY FINANCIAL DATA - CONDENSED CONSLOLIDATED STATEMENT OF INCOME
Quarter Quarter Quarter Quarter 12/31/2002 09/30/2002 06/30/2002 03/31/2002 ------------ ------------ ------------ ------------ OPERATING REVENUE Premium revenue $ 16,293,484 $17,883,264 $18,647,724 $19,931,886 Premium revenue, related parties 357,172 346,715 345,304 354,170 Medicare revenue - - - - Network access fees 2,385,084 2,361,009 2,303,409 2,042,537 Hospital administrative fees 1,309,631 1,273,188 1,276,551 1,208,545 Hospital administrative fees, related parties 1,127,049 1,130,497 1,205,290 1,060,856 Other 47,575 41,556 63,535 38,154 ------------ ------------ ------------ ------------ Total operating revenue 21,519,995 23,036,229 23,841,813 24,636,148 ------------ ------------ ------------ ------------ OPERATING EXPENSES Medical expenses 11,563,548 10,003,603 14,733,219 15,081,074 Medical expenses, related Parties 3,190,485 6,669,068 5,274,718 3,300,349 Payroll and related expenses 2,345,780 2,525,222 2,680,327 2,737,390 Selling, general and administrative expenses 2,647,568 2,557,436 2,770,040 2,694,054 Amortization expense (27,526) - - 27,576 ------------ ------------ ------------ ------------ Total operating expenses 19,719,855 21,755,329 25,458,304 23,840,393 Operating income (loss) 1,800,140 1,280,900 (1,616,491) 795,755 OTHER INCOME (EXPENSE) Interest and dividends, net 126,001 194,137 180,284 154,731 Write-down of investment and other 26,013 (406,179) - - ------------ ------------ ------------ ------------ Total other income (expense), net 152,014 (212,042) 180,284 154,731 ------------ ------------ ------------ ------------ Income (loss) before federal income taxes and minority interest 1,924,154 1,068,858 (1,436,207) 950,486 FEDERAL INOCME TAX EXPENSE (BENEFIT) 666,494 500,879 (486,075) 333,228 ------------ ------------ ------------ ------------ 1,258,660 567,979 (950,132) 617,258 MINORITY INTEREST, net of tax (33,347) 12,568 389,802 35,103 ------------ ------------ ------------ ------------ NET INOCME (LOSS) $ 1,252,313 $ 580,547 $ (560,330) $ 652,361 ============ ============ ============ ============ NET INCOME (LOSS) PER COMMON SHARE $ 21.39 $ 9.91 $ (9.57) $ 11.14 ============ ============ ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING $ 58,538 $ 58,572 $ 58,540 $ 58,540 ============ ============ ============ =============
32 33
Quarter Quarter Quarter Quarter 12/31/2001 09/30/2001 06/30/2001 03/31/2001 ------------ ------------ ------------ ------------ OPERATING REVENUE Premium revenue $ 22,534,246 $23,756,167 $24,214,449 $25,046,659 Premium revenue, related parties 2,292,393 2,223,846 2,280,097 3,736,532 Medicare revenue - - - - Network access fees 3,430,480 1,890,086 1,602,366 1,713,983 Hospital administrative fees 124,946 1,461,637 1,609,971 1,431,979 Hospital administrative fees, related parties 882,289 894,140 562,191 756,013 Other 39,947 55,131 60,791 52,165 ------------ ------------ ------------ ------------ Total operating revenue 29,304,301 30,281,007 30,329,865 32,737,331 ------------ ------------ ------------ ------------ OPERATING EXPENSES Medical expenses 21,454,031 14,013,264 14,924,244 16,024,855 Medical expenses, related Parties 2,559,433 9,342,176 9,949,495 10,683,237 Payroll and related expenses 2,790,277 3,031,291 3,205,177 3,254,995 Selling, general and administrative expenses 2,719,969 2,818,173 2,957,968 2,970,554 Amortization expense 200,157 293,693 293,700 293,701 ------------ ------------ ------------ ------------ Total operating expenses 29,723,867 29,498,597 31,330,584 33,227,342 ------------ ------------ ------------ ------------ Operating income (loss) (419,566) 782,410 (1,000,719) (490,011) OTHER INCOME (EXPENSE) Interest and dividends, net 153,505 213,264 285,167 174,886 Write-down of investment and other (1,227,661) (10,872) 1,047 - ------------ ------------ ------------ ----------- Total other income (expense), net (1,074,156) 202,392 286,214 174,886 ------------ ------------ ------------ ------------ Income (loss) before federal income taxes and minority interest (1,493,722) 984,802 (714,505) (315,125) FEDERAL INOCME TAX EXPENSE (BENEFIT) 21,321 349,329 (223,009) (107,142) ------------ ------------ ------------ ------------ (1,517,043) 635,473 (491,496) (207,983) MINORITY INTEREST, net of tax - - 37,025 136,036 ------------ ------------ ------------ ------------ NET INOCME (LOSS) $ (1,517,043) $ 635,473 $ (454,471) $ (71,947) ============ ============ ============ ============ NET INCOME (LOSS) PER COMMON SHARE $ (25.90) $ 10.85 $ (7.76) $ (1.23) ============ ============ ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING $ 58,539 $ 58,569 $ 58,572 $ 58,572 ============ ============ ============ =============
33 34 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers and directors of First Choice are as follows:
Name Age Position Gary R. Gannaway 56 President & Chief Executive Officer Kenneth Hamm 44 Executive Vice President-Chief Financial Officer Ross D. Heyl 49 Vice President-Chief Marketing Officer Julie Keeffe 45 Vice President-Medical Mgmt & Member Services Ze'ev Young, M.D. 49 Vice President-Chief Medical Officer Services Greg Van Pelt 51 Director (I) Paul M. Elliott 62 Director (III) Kenneth D. Graham 55 Director (I) Phillip J. Haas 54 Director (III) William F. Johnston, M.D. 57 Director (III) Garman E. Lutz 57 Director (II) William J. MacDonald, M.D. 58 Director (III) Barbara L. Mitchell 57 Director (I) Richard A. McGee, M.D. 57 Director (II) Richard H. Peterson 60 Director (I) Paul G. Ramsey, M.D. 53 Director (I) Richard E. Rust, M.D. 76 Director (II) Clyde D. Walker 47 Director (III) Diane E. Cecchettini, R.N. 55 Director (II) Gerald A. Cufley, M.D. 58 Director (I) Scott F. Kronland, M.D. 45 Director (I) William R. Stubbs, M.D., M.B.A. 58 Director (I) __________________ (I) Term Expires in 2003. (II) Term Expires in 2004. (III) Term Expires in 2005.
Gary Gannaway Mr. Gannaway joined First Choice Health Network as President and CEO in January 1996. He has over 25 years of experience in managing and marketing HMOs, PPO's, and other managed care programs across the country. He has worked as a Health Plan General Manager, and as a Regional Vice President for national carriers, including Aetna and CIGNA, and as CEO and COO for physician and hospital-sponsored managed care programs at the regional and national level. Mr. Gannaway is very active on community boards. Mr. Gannaway earned his Bachelor's degree in both Political Science and German at the University of California at Santa Barbara. As an undergraduate, he also studied at Georg August University in Gottingen, Germany. He earned his master's of Education degree from the State University of New York where he also completed his course work and comprehensive examinations for a Ph.D. in Management. 34 35 Kenneth A. Hamm Mr. Hamm, Executive Vice President and Chief Financial Officer, joined First Choice Health Network in July, 2000. He has spent most of his career in the Managed Care industry. Mr. Hamm was Director of Finance in the Group Market segment at Wellpoint Health Networks in Southern California from 1991-1994. Mr. Hamm served in various roles at Premera Blue Cross and Subsidiaries from 1994 to 1999 including five years as Vice President of Finance and Healthcare Economics, as well as a stint in Network Development. Until starting with the Company in July 2000 Mr. Hamm was the interim Chief Financial Officer at Medica Healthplans in Minnesota, a one million member regional HMO, beginning in 1999. Mr. Hamm earned a Bachelors degree in Finance from California State University at Los Angeles in 1985 and is a CPA. Ross Heyl Mr. Heyl, Vice President and Chief Marketing Officer, joined First Choice Health Network in 1985. Mr. Heyl is a licensed health insurance agent in the state of Washington. From 1980 to 1982, he was with Penn Mutual Life Insurance Company in San Francisco and Seattle. From 1982 to 1985, he was an account executive for Rollins Burdick Hunter of Washington. Julie A. Keeffe Ms. Keeffe, Vice President of Medical Management and Member Services, joined First Choice Health in May 1997. Ms. Keeffe has worked in health care since 1979. Prior to coming to First Choice, she provided health care management consulting services from 1996 to 1997 for Milliman and Robertson, Inc, where she implemented successful strategies for the medical management systems of health plans and delivery systems. Earlier, Ms. Keeffe 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. Ms. Keeffe 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, referral management, medical claims review and medical coverage policy development. Julie received her nursing degree from Yakima Valley School of Nursing in 1979. Dr. Ze'ev Young Dr. Young joined the Company as the Chief Medical Officer and Vice President in January 2001. He is responsible for the oversight of medical management and quality improvement. He also participates actively in strategic planning, network development, and public relations. Dr. Young interfaces with the local practitioner community to ensure that high-quality, cost-effective health care services are available to First Choice Health Network members. Dr. Young brings significant managed care experience to the Company. Just prior to joining First Choice, Dr. Young spent nearly three years as the Northwest Regional Medical Director for United Healthcare. While at United Healthcare, Dr. Young was instrumental in successfully introducing local providers to an innovative, practitioner-friendly, and member-centric approach to health care delivery. Prior to joining United Healthcare, Dr. Young spent five years at Regence Blue Shield serving as the Boeing Division Medical Director, and was also responsible for corporate medical policy. 35 36 Dr. Young's undergraduate degree is from the University of California and he is a graduate of the Albert Einstein College of Medicine in New York. In 1978, he was elected to the Alpha Omega Alpha Honor Medical Society. Dr. Young completed his Family Practice Residency at Providence Medical Center in Seattle and is a Board Certified family physician. He has over 20 years practice experience and continues to maintain a small private practice. Dr. Young is also a Clinical Assistant Professor of Family Medicine at the University of Washington School of Medicine. Diane E. Cecchettini, Director since 1999 Diane E. Cecchettini was designated President and Chief Executive Officer by The Multicare Health System Board effective July 1999. Ms. Cecchettini has been with Multicare Health System since June 1989 in various capacities: Executive Vice President, 1997-1999, Vice President-Patient Services 1989-1997. Ms. Cecchettini's previous experience includes: Assistant Administrator, Sutter General Hospital, Sacramento, California, 1985-1989; Administrative Director of Nursing and other management positions at Sutter Memorial Hospital, Sacramento, California, 1977-1985 and direct clinical experience at UCLA Medical Center in Los Angeles, California. Ms. Cecchettini received a Bachelor's degree in Nursing in 1970 from the University of California, Los Angeles, and a Master of Science degree in Human Resources Management in 1976 from the University of Utah. In 1993, Ms. Cecchettini retired as a Lieutenant Colonel from the Air Force Reserves, having served 21 years as a Flight Nurse in Aeromedical Evacuation - serving in the Vietnam era and as a Troop Commander in Desert Storm. Gerald A. Cufley, M.D., Director since 2001 Gerald A. Cufley, M.D. has been in the private practice of medicine in Kirkland, Washington since 1977. After completing a degree of B.A. in Chemistry at the University of Washington in 1966, Dr. Cufley attended the University of Washington School of Medicine and received his medical degree in 1970. Internship and residency in internal medicine were completed at the University of New Mexico Affiliated Hospitals in 1973. Two years of post graduate training in Gastroenterology was obtained at Letterman Army Medical Center and the University of California at San Francisco. From 1975 to 1977, Dr. Cufley served as a medical officer in the U.S. Army at Madigan Army Medical Center at Fort Lewis, Washington. Paul M. Elliott, CPA, Director since 1989 Mr. Elliott, recently retired, was formerly Senior Vice President of Finance and Operations for the Alpac Corporation from 1981 to 1993. 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. Kenneth D. Graham, FACHE, Director since 1997 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 such as 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 Doctor Goodwell; an Internet based virtual clinic service. 36 37 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, Director since 1995 Mr. Haas has been Administrator-Managed Care of Valley Medical Center, a 304-bed acute care public district hospital, since November 1993, 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 the Company. 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. 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., Director since 1998 Dr. Johnston had been the Medical Director of Emergency Services at Northwest Hospital since 1977. 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. Dr. Johnston 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. Scott F. Kronlund, M.D., M.S., Director since 2002 Scott F. Kronlund has been the Senior Vice President for Ambulatory Services at Good Samaritan Community Healthcare since 2002. He previously was the Chief Medical Officer at Good Samaritan for four years, responsible for all outpatient physician and clinic services and also serves an internal consultant to several community-based programs. 37 38 Dr. Kronlund is also the Chair of the Community Advisory Board, University of Washington Health Promotions Research Center which focuses on research related to healthy aging. He also serves on the Auxiliary Faculty and is a Guest Lecturer at the University of Washington, Tacoma, Graduate School of Nursing. Dr. Kronlund holds a Bachelor of Science in Chemistry at the Pacific Lutheran University in Tacoma, a medical degree from the University of Washington School of Medicine as well as a Master of Science degree in preventative and Administrative Medicine from the University of Wisconsin. In addition, he is a board-certified family physician, having received his residency training at the University of Iowa. Dr. Kronlund is currently professionally affiliated with the American Academy of Family Physicians, Washington State Medical Association, Medical Society of Pierce County and is a Certified Physician Executive through the American College of Physician Executives. Garman E. Lutz, CPA, Director since 2000 Mr. Lutz has been Senior Vice President of Finance and Chief Financial Officer for Empire Health Services in Spokane, Washington, since 1990. Empire operates Deaconess Medical Center, Valley Hospital and Medical Center, St. Luke's Extended Care Center, Family Home Care and First Care Urgent Care Centers. He also serves in various positions for EHS' joint venture projects including Inland Northwest Health Services, Inland Empire Hospital Shares Services and the Spokane PHCO. Mr. Lutz, prior to his appointment at Empire Health Services, was a partner in a local Spokane CPA firm for over eighteen years. His practice experience concentrated in a management advisory service, audit and financial planning. Mr. Lutz served as Chairman of the Valley Hospital & Medical Center Advisory Board from its inception in 1985 until August of 1990. Prior to his appointment as an officer of EHS, Mr. Lutz served on the EHS Board of Directors from 1988 through 1990. Mr. Lutz is active in many community organizations and currently is a board member of the Spokane Area Chamber of Commerce, Eastern Washington Museum Foundation, Inland Empire Genetics Clinic, Leadership Spokane and the Rockwood Retirement Committee. He is a member of the AICPA, Washington Society of CPA's, and Healthcare Financial Management Association. William J. MacDonald, M.D., Director since 2000 Dr. MacDonald attended Brown University, received his medical degree from the University of Vermont, and completed his residency at the University of Pennsylvania. He earned a Fellowship at the University of California, San Diego, and is board certified in Internal Medicine and Cardiovascular Disease. He joined The Everett Clinic in 1976. Dr. MacDonald has served as Board Chair and President of The Everett Clinic for the last five years. He has a half-time cardiology practice, providing reality testing in both the hospital and office environments. Special interests include learning about the future of American medicine, and effective organizational governance. Richard A. McGee, M.D., F.A.C.P., Director since 1995 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, since June 1997. He was previously Chief of Staff and Chief of Medical Affairs of Stevens Healthcare, a Public Hospital District, from 1987 to 1989 and 1989 to 1996, respectively. In addition, Dr. McGee 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. 38 39 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 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. Barbara L. Mitchell, Director since 1986 Ms. Mitchell has been the Director, Human Resources for Valley Medical Center, Renton, Washington, since November 1999. Previously, she was the Managing Partner of ClearPoint, an employee benefits brokerage and consulting firm from 1997 to 1999. 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 H. Peterson, Director since 1997 Mr. Peterson has been President and Chief Executive Officer of Swedish Health Services, a non-profit organization comprised of a 163-bed community hospital on the Ballard campus, the 436-bed Providence Seattle Medical Center and a 697-bed tertiary care hospital on the First Hill campus, since 1995. Mr. Peterson previously served as President and Chief Executive Officer of Fairview Riverside Medical Center in Minneapolis, Minnesota, from 1982 to 1991. 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. Paul G. Ramsey, M.D., Director since 2000 Dr. Paul G. Ramsey is the Vice President for Medical Affairs and Dean of the School of Medicine at the University of Washington. Dr. Ramsey also practices part-time and maintains his hospital staff privileges. Dr. Ramsey graduated from Harvard College in 1971 with honors in Biochemistry and received his M.D. from Harvard Medical School in 1975. Following completion of residency training in Internal Medicine at Massachusetts General Hospital, he came to the University of Washington as a Senior Fellow in Infectious Disease in 1978. Dr. Ramsey served as Chief Medical Resident at the then University Hospital (now University of Washington Medical Center) in 1980-1981. He joined the faculty in the Department of Medicine in 1980 as an Acting Instructor and was appointed as an Assistant Professor in 1982. Dr. Ramsey was promoted to Associate Professor in 1986 and to Professor of Medicine in 1991. He served as Coordinator of Student Teaching for the Department of Medicine from 1982-1990 and was Associate Chair of the Department from 1988-1990. He was appointed as Chair of the Department of Medicine in 1992 and became the first holder of the Robert G. Petersdorf Endowed Chair in Medicine in 1995. He served as Chair of the Department of Medicine until June 1997 when he was appointed Vice President for Medical Affairs and Dean of the School of Medicine. 39 40 Dr. Ramsey has received the Distinguished Teacher Award from the University of Washington School of Medicine's graduating class three times (in 1984, 1986, and 1987) and the Margaret Anderson Award from the University of Washington graduating class of 1989. The latter Award recognizes exceptional support of medical students. Dr. Ramsey's research has focused on the development of methods to assess physicians' clinical competence. From 1983-1986, he conducted the first large- scale study of the relationship of certification of physicians by the American Board of Internal Medicine to performance in practice. He has been the Principal Investigator on multiple research grants related to assessment of physicians' clinical skills and served as a Henry J. Kaiser Family Foundation Faculty Scholar in General Internal Medicine for five years. Dr. Ramsey received the John P. Hubbard Award from the National Board of Medical Examiners in 1999 in recognition of his research contributions in the field of evaluation. He has served on multiple national committees and is a member of multiple organizations, including the American Association for the Advancement of Science, the American Federation for Medical Research and the Association of American Physicians. Richard E. Rust, M.D., Director since 1985 Dr. Rust is a retired family practitioner. 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. William R. Stubbs, M.D., M.B.A., Director since 1999 Dr. Stubbs is the Vice President, Medical Affairs and the senior physician manager in the Multicare Health System since February 1994, with direct responsibility for medical staff relationships and the departments of Medical Staff Services, Family Practice Residency Education, Quality Management, Pharmacy and Materials Management, Chaplains, Risk and Legal Services, Hospitalists Program, Emergency Planning, 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. He teaches Medical Ethics for the Tulane University Masters of Medical Management program and the University of Washington Certificate program of Medical Management. Greg Van Pelt, Director since 2001 Greg Van Pelt has been the Vice President and Chief Executive of the Providence Health System, Washington Region, since June 2001. The Washington Region of the Providence Health System includes hospital, clinic and long-term care services with more than 9,000 colleagues throughout the state. Mr. Van Pelt has been with Providence Health System for over 25 years. He has served in management roles both as Chief Executive, Providence Health Plan and Chief Executive, Providence-St. Vincent Hospital and Medical Center, both in Portland, Oregon.Providence has been serving the West for over 140 years through its hospitals and health services in Alaska, Washington, Oregon and California. 40 41 Clyde D. Walker, Director since 1995 Mr. Walker has been the Senior Vice President, Human Resources at Continental Mills since December 31, 2002. Mr. Walker was the Vice President, Human Resources of PRIMEX Aerospace and Electronics Division and PRIMEX Aerospace Company in Redmond, WA, from October 1977 to June 2000. 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 both Big Brothers and Big Sisters of King County and led both boards through the combination of the two independent agencies. He remains on the resultant combined Board. Classification of Directors. - The management of the Company is vested in a Board of Directors. The Board of Directors consists of seventeen individuals: Seven (7) directors (the "Class A Directors") are physicians representing Class A shareholders. Seven (7) directors (the "Class B Directors") 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") represent employers other than health care providers and/or are consumers of health care services. The Board is divided into three categories as follows: Category I: Three Class A Directors, two Class B Directors, and one Class C Director. Category II: Two Class A Directors, three Class B Directors, and one Class C Director. Category III: Two Class A Directors, two Class B Directors, and one Class C Director.
The categories have staggered three year terms. 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 nine (9) directors is generally required to transact business at a meeting of the Board, except that a quorum of thirteen (13) 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 healthcare providers, any issues reviewed by the Board regarding the limitation or termination of health care provider contracts, and any merger or sale of the corporation or any subsidiary. No executive officer or director has filed a report of beneficial ownership under Section 16 of the Securities Exchange Act of 1934 relating to his or her ownership of Class A common stock, but such filings will be made in the near future. 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:
Annual Compensation All other Name and Principal Position Year Salary Bonus Compensation(1) Gary Gannaway 2002 $299,091 $ 67,500 $6,000 President and CEO 2001 $270,000 $ - $ 7,735 2000 $268,887 $138,915 $ 8,646 Kenneth Hamm 2002 $211,767 $50,750 $ 1,067 Executive Vice President, Finance 2001 $203,000 $12,019 $ 960 2000 $ 96,154 $ - $15,194 Ross Heyl 2002 $125,135 $30,126 $ 5,000 Vice President 2001 $120,500 $29,243 $ 5,000 2000 $116,970 $25,200 $ 5,000 Julie Keeffe, R.N. 2002 $157,029 $28,125 $ 941 Vice President 2001 $150,000 $18,200 $ 960 2000 $145,600 $33,250 $ 600 Ze'ev Young, M.D. 2002 $193,075 $34,648 $ 2,807 Vice President and Chief Medical Officer 2001 $181,442 $ - $ 960 ____________________ (1) All other compensation includes auto allowances and car fringe benefits with the exception of $15,194 reported for Ken Hamm in year 2000. Mr. Hamm worked as a consultant to the Company before being hired as Chief Financial Officer and the $15,194 represents consulting fees.
Effective June 28, 2001, Class A and C Directors receive $500 per Board meeting and $125 per hour, for committee meetings attended. Class B Hospital Directors are not compensated since their positions typically preclude them from keeping director fee compensation. EMPLOYMENT AGREEMENTS Effective January 1, 2003, Gary R. Gannaway entered into a three year employment agreement as the Company's President and Chief Executive Officer. Under his employment agreement with First Choice, Mr. Gannaway will receive an annual base salary of $302,940 for 2003, subject to a 2% annual increase. Mr. Gannaway will be eligible to receive an annual bonus of up to 50% of base pay according to performance achieved against mutually determined targets. The amount of the annual bonus shall be determined and awarded by the Board of Directors. In addition, Mr. Gannaway is eligible for a long-term incentive award based on performance over the three-year term of the employment agreement and for a Supplemental Executive Retirement program funded at a rate of 7% of base pay. 42 43 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as of December 31, 2002, 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 11 Executive Compensation" in 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
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 % 315 Martin Luther King Jr. Way Tacoma, WA 98415 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 - - - - Kenneth D. Graham - - - - Phillip J. Haas - - - - William F. Johnston, M.D. 1 - * - Garman Lutz - - - - Greg Van Pelt - - - - William J. MacDonald, M.D. 1 - * - Barbara L. Mitchell - - - - Richard A. McGee, M.D. 1 - * - Richard H. Peterson - - - -
43 44
Shares Owned Percent of Name Class A Class B Class A Class B ------- ------- ------- ------- ------- Paul G. Ramsey, M.D. - - - - Richard E. Rust, M.D. 1 - * - William R. Stubbs, M.D., M.B.A. - - - - Clyde D. Walker - - - - Diane E. Cecchettini, R.N. - - - - Gerald A. Cufley, M.D. 1 - * - Scott F. Kronland, M.D. - - - - Gary Gannaway - - - - Kenneth Hamm - - - - Ross Heyl - - - - Julie Keeffe - - - - Ze'Ve Young, M.D. - - - - All directors and executive officers as a group (21 persons) 5 40,600 * 100% _________________ * Less than one percent of outstanding shares of Class A common stock.
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, Note 2, Shareholders Equity." ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On December 20, 1999, the Company 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. 44 45 University of Washington Academic Medical Center has agreed to pay an affiliation fee of $2,520,000, payable $1,260,000 upon execution of the Agreement with the remaining $1,260,000 payable in three equal payments of $420,000 plus interest at five percent (5%). UMWC made the final $420,000 principle payment in 2002, however, they owed $134,557 in interest as of December 2002. UMWC subsequently paid the outstanding interest in February 2003. The following table shows with respect to each participating hospital that owns Class B common stock or participating equity in the Company, the amount of premiums paid to the Company and the amount of medical expense reimbursement paid by the Company during 2002.
Premium Medical Owner Hospital Revenue Expense ---------------------------------- ------------ ---------- Empire Health Centers Group, Inc. $ - $ 203,483 Evergreen Hospital Medical Center 1,404,184 1,527,167 Good Samaritan Hospital - 1,064,071 Multicare Medical Center - 2,441,481 Northwest Hospital - 999,301 Overlake Hospital - 1,076,669 Providence Facilities - 2,231,276 Stevens Hospital - 869,289 Swedish Hospital - 3,969,902 UW Medical Center - 2,649,318 Valley Medical Center - 1,402,663 ------------ ----------- Grand Total $1,404,184 $18,434,620
In addition, the owner hospitals paid a total of $4,523,692 in administrative fees to the Company in 2002. ITEM 14 CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Registrant's disclosure controls and procedures (as defined in rule 13a-14 and 15d-14 adopted under the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Registrant's Chief Executive Officer, and Chief Financial Officer, within the 90-day period preceding the filing date of this annual report. The Registrant's Chief Executive Officer and Chief Financial Officer concluded That the Registrant's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Registrant in the reports it files or submits under the Act is (i) accumulated and communicated to the Registrant's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, Processed, summarized and reported as required by the Act and rules thereunder on a timely basis. (b) Changes in Internal Controls: Since the date of the evaluation of the Registrant's disclosure control and procedures referred to above, the Registrant did not make any significant changes in its internal controls or other factors that could significantly affect those controls, including any corrective action with regard to significant deficiencies and material weaknesses. 45 46 PART IV Item 15. 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.* 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.* 10.3 Form of Agreement between Registrant and Health Care Provider other than Hospitals and Physicians participating in PPO.* 10.4 Form of Agreement between Registrant and Third Party Administrator.* 10.5 Form of Agreement between Registrant and Insurance Company.* 10.6 Copy of Participation Agreement dated March 27, 1985, between Registrant and King County Public Hospital District No.2 (Evergreen General Hospital).* 10.7 Copy of Participation Agreement dated March 26, 1985, between Registrant and Valley Medical Center.* 10.8 Copy of Participation Agreement dated December 19, 1991, between Registrant and Public Hospital District No.2 of Snohomish County (Stevens Memorial Hospital) and related Promissory Note in the aggregate principal amount of $ 566,000.* (b) Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended December 31, 2002. 10.24 Copy of Chief Executive Officer's 2003 Compensation Agreement 10.25 Copy of Chief Executive Officer's Long Term Incentive Contract * Filed as an Exhibit to 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. *** Filed as Exhibit 10.23 to Registrant's Current Report on Form 8-K filed on January 3, 2000. 46 47 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 31st day of March, 2003. FIRST CHOICE HEALTH NETWORK, INC. By: -------------------------------------- KENNETH HAMM Executive Vice President of Finance (Principal Financial and Accounting Officer and Duly Authorized Officer) In accordance with the Securities 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 March 31, 2003.
Signature Title Date --------- ----- ---- /s/ President and Chief Executive Officer March 31, 2003 ---------------------------- (Principal Executive Officer) GARY R. GANNAWAY /s/ Executive Vice President of Finance March 31, 2003 ---------------------------- (Principal Financial and Accounting Officer) KENNETH HAMM /s/ Director March 31, 2003 ---------------------------- DIANE E. CECCHETTINI /s/ Director March 31, 2003 ---------------------------- GERALD A. CUFLEY, M.D. /s/ Chairman of the Board of Directors March 31, 2003 ---------------------------- PAUL M. ELLIOTT /s/ Director March 31, 2003 ---------------------------- KENNETH D. GRAHAM /s/ Director March 31, 2003 ---------------------------- PHILLIP J. HAAS
47 48
Signature Title Date --------- ----- ---- /s/ Director March 31, 2003 ---------------------------- WILLIAM F. JOHNSTON, M.D. /s/ Director March 31, 2003 ---------------------------- SCOTT F. KRONLUND, M.D. /s/ Director March 31, 2003 ---------------------------- GARMAN E. LUTZ /s/ Director March 31, 2003 ---------------------------- WILLIAM J. MACDONALD, M.D. /s/ Director March 31, 2003 ---------------------------- RICHARD A. MCGEE, M.D. /s/ Director March 31, 2003 ---------------------------- BARBARA L. MITCHELL /s/ Director March 31, 2003 ---------------------------- RICHARD H. PETERSON /s/ Director March 31, 2003 ---------------------------- PAUL G. RAMSEY, M.D. /s/ Director March 31, 2003 ---------------------------- RICHARD E. RUST, M.D. /s/ Director March 31, 2003 ---------------------------- GREG VAN PELT /s/ Director March 31, 2003 ---------------------------- CLYDE D. WALKER
48 49 CERTIFICATIONS The undersigned certifies, pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that to my knowledge this Report on Form 10-K for the year ended December 31, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in this Report fairly presents, in all material respects, the financial condition and the results of operations of First Choice Health Network, Inc. and Subsidiary. By: / s /Gary Gannaway ----------------------------- Gary Gannaway, President and Chief Executive Officer March 31, 2003 The undersigned certifies, pursuant to 18.U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that to my knowledge this Report on Form 10-K for the year ended December 31, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in this Report fairly presents, in all material respects, the financial condition and the results of operations of First Choice Health Network, Inc. and Subsidiary. By: / s /Kenneth A. Hamm ----------------------------- Kenneth A. Hamm, Executive Vice President of Finance March 31, 2003 49 50 I, Gary Gannaway, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certify that: (1) I have reviewed this Annual report on Form-10K of First Choice Health Network, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officer, and I are responsible for Establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedure as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the Audit Committee of registrant's Board of Directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weakness. By: / s /Gary Gannaway ----------------------------- Gary Gannaway, President and Chief Executive Officer March 31, 2003 50 51 I, Kenneth A. Hamm, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Certify that: (1) I have reviewed this Annual report on Form-10K of First Choice Health Network, Inc.; (2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; (3) Based on my knowledge, the financial statements, and other financial information included in this annual report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; (4) The registrant's other certifying officer, and I are responsible for Establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedure as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and (c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the Audit Committee of registrant's Board of Directors (or persons performing the equivalent functions): (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and (6) The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weakness. By: / s /Kenneth A. Hamm ----------------------------- Kenneth A. Hamm, Executive Vice President of Finance March 31, 2003 51