<PAGE>   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 YEAR ENDED DECEMBER 31, 1997

                                       OR

[ ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
              --------------------------------------------------------
                         SECURITIES EXCHANGE ACT OF 1934
                         -------------------------------
FOR THE TRANSITION PERIOD FROM _____________________ TO ________________________

                         Commission File Number 0-11488

                         HEALTHFIRST MEDICAL GROUP, P.C.
                 FORMERLY "PHYSICIAN PARTNERS HEALTHFIRST, P.C."

--------------------------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

            Oregon                                        93-1221389
-------------------------------                     -----------------------
(State or other jurisdiction of                     (I.R.S. Employer
 incorporation or organization)                     Identification No.)

1200 NW Front Street
Portland, Oregon                                            97209
---------------------------------------             -----------------------
(Address of Principal Executive Offices)            (Zip Code)

Registrant's telephone number, including area code:

                                 (503) 243-3525

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None
--------------------------------------------------------------------------------
(Title of Class)

None
--------------------------------------------------------------------------------
(Title of Class)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                                    YES [X]   NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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. []

The number of shares of the Registrant's Common Stock outstanding as of March
30, 1998 was 95.


                       DOCUMENTS INCORPORATED BY REFERENCE

None.


<PAGE>   2

<TABLE>
<CAPTION>
                                 TABLE OF CONTENTS




                                       PART I
<S>      <C>
Item 1:  Business
Item 2:  Properties
Item 3:  Legal Proceedings
Item 4:  Submission of Matters to a Vote of Security Holders

                                      PART II

Item 5:  Market for Registrant's Common Equity and Related Stockholder Matters
Item 6:  Selected Financial Data
Item 7:  Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 8:  Financial Statements and Supplementary Data
Item 9:  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

                                      PART III

Item 10: Directors and Executive Officers of the Registrant
Item 11: Executive Compensation
Item 12: Security Ownership of Certain Beneficial Owners and Management
Item 13: Certain Relationships and Related Transactions

                                      PART IV

Item 14: Exhibits, Financial Statement Schedules, and Reports on Form 8-K
</TABLE>


<PAGE>   3


                                       PART I

ITEM 1: BUSINESS

OVERVIEW

HealthFirst, an Oregon professional corporation, is a multi-specialty medical
clinic. HealthFirst was founded in 1997 pursuant to certain reorganization and
merger transactions (the "Transactions") contemplated by the Amended and
Restated Agreement and Plan of Reorganization and Merger (the "Reorganization
and Merger Agreement") among Medford Clinic, P.C. ("Old Medford"), HealthFirst
Medical Group, P.C. ("Old HealthFirst"), The Corvallis Clinic, P.C. ("Old
Corvallis"), and, together with Old Medford and Old Corvallis, referred to
herein, collectively as "Old PCs", and Physician Partners, Inc. ("PPI"). Old
HealthFirst was formed in February 1996 in a merger between the Metropolitan
Clinic, P.C., formed in 1906, and Suburban Medical Clinic, P.C., formed in 1956.

The Transactions, which were consummated on February 1, 1997, resulted in a
separation of operations of Old PCs between medical professional services
activities (i.e., providers of medical services) and the physician practice
management activities of the business. The professional services activities were
spun off into newly formed professional corporations (New PCs). HealthFirst is
one of the New PCs. The physician practice management business, along with
substantially all of the assets and liabilities of the Old PCs, i.e., cash,
receivables, inventories, prepaids, property, plant and equipment, other assets,
payables, accruals, debt, and certain contractual commitments were transferred
to PPI. The New PCs are responsible for providing medical services and the
related costs for provider compensation and benefits. The assets transferred to
the New PCs, which had zero carrying value, include the employment agreements
between each Company and its providers, certain provider contracts under which
the New PCs will be receiving fee-for-service compensation and patient medical
records.

An integral part of the reorganization is a 40-year management agreement
("Management Agreement") whereby PPI provides physician practice management
services to the New PCs. Services to be provided include management and
administrative services, capital resources, facilities, equipment and supplies.
Other benefits of the Merger include a greater access to capital, economies of
scale provided by the consolidated operations of the Old PCs, and shared
strengths of management expertise. As consideration, PPI is entitled to (a)
reimbursement of all managerial costs and expenses (Manager's Expenses) incurred
by PPI and (b) a management fee equal to 16% of (i) net revenues relating to
services provided by the New PCs less (ii) Manager's Expenses.

The management structure between PPI and HealthFirst enables HealthFirst to
retain significant control over its own operation and strategic direction.
Specifically, HealthFirst retains its own physician board of directors. The
function of the physician board includes:

      (i)   determining and managing physician compensation methodologies;

      (ii)  employing and reviewing (with the assistance of PPI's Chief Medical
            Officer) the performance of its Medical Director and compensation
            for and appointment of physician managers;

      (iii) dealing with individual physician quality and behavioral issues;

      (iv)  approving all growth and acquisitions by being the only body which
            can approve employment of physicians of the Company; and

      (v)   appointing three members to the Joint Management Board of Directors
            and designating its Medical Director as an ex officio member.

Subject to the rights of the Company's physician board, the business of
HealthFirst is governed by the Joint Management Board. The Joint Management
Board is designed to represent equally the clinical and physician perspective
and the management and business perspective. The Joint Management Board consists
of six members, with three members appointed by HealthFirst (physician members
of the HealthFirst Board) and three members appointed by PPI (one of whom must
be a local PPI group practice administrator). The Medical Director of
HealthFirst serves as a seventh ex officio, non-voting member of the Joint
Management Board. The Joint Management Board provides local expertise and
develops and approves all submissions to PPI regarding HealthFirst's growth,
annual budgets, payor relations, local strategic initiatives and capital
improvements.


<PAGE>   4

GENERAL

HealthFirst is a multi-specialty group providing professional health care
services on both a prepaid and fee-for-service basis. PPI contracts directly
with health plans and preferred provider organizations ("PPOs") to provide
medical services to enrollees who have selected HealthFirst physicians as their
primary care provider on behalf of HealthFirst. Through contracts with various
health plans, HealthFirst physicians were responsible for the health care of
approximately 69,000 health plan members as of December 31, 1997.

Since its formation, HealthFirst has been the successor to a number of
individual physician practices and medical groups. The direct predecessor of
HealthFirst is Metropolitan Clinic, P.C. ("Metropolitan"). HealthFirst changed
its name from Metropolitan Clinic, P.C. in February 1996 as a result of a
business combination of Metropolitan and Suburban Medical Clinic, Inc.
("Suburban"). HealthFirst's growth is the result of acquisitions, mergers and
alliances over the past five years with medical groups that compliment its
market strategies.

Under capitated contracts, HealthFirst is paid a fixed fee per covered life on a
monthly basis throughout the contract period. Under such agreements, the Company
is responsible for providing or arranging for the provision of covered benefits
to the applicable health maintenance organization ("HMO") member. HealthFirst
provides services on a prepaid basis to patients of HMO Oregon, PacificCare,
Providence Health Plans and others. Enrollment is categorized as "commercial"
for enrollees under the age of 65 whose health coverage is generally sponsored
by employers or "senior" for retired patients. Higher capitation rates are
generally received from senior patients because their medical needs are
generally greater and consequently the cost of covered care is higher. In the
years ending 1995, 1996 and 1997, $14.8 million, $27.8 million and $30.1
million, respectively, of net patient revenues came from prepaid or capitated
patients.

While HealthFirst obtains a significant and growing portion of its revenues from
managed care programs, the other main source of income is the result of a more
traditional form of business. HealthFirst is a Medicare provider and receives
fee-for-service payments from a significant percentage of patients and
traditional indemnity insurers. In the years ending 1995, 1996 and 1997, $22.8
million, $32.3 million and $35.5 million, respectively, of net patient revenues
came from PPOs, other contractual relationships, individuals or private
insurance carriers (fee-for-service).

The following table indicates the percentage of payor mix of the Company's
aggregate net clinic revenue earned by HealthFirst:

<TABLE>
<CAPTION>
PAYOR                                                 1995       1996       1997
-----                                                 ----       ----       ----
<S>                                                   <C>        <C>         <C>
Fee-For-Service:
    Commercial and Private                            52%        47%         47%
    Medicare                                           8%         6%          6%
    Medicaid                                           1%         1%          1%
Prepaid (1)                                           39%        46%         46%
</TABLE>

(1) Includes enrollees under Commercial, Medicare and Medicaid programs


SERVICES

HealthFirst offers a wide range of primary and specialty physician care and
ancillary services through an organized physician group. Approximately 73% of
the Company's providers are primary care providers and


<PAGE>   5

approximately 27% practice various medical and surgical specialties. The primary
care physicians are those concentrating in family practice, internal medicine,
and pediatrics.

The following professional services are offered by HealthFirst:

       Allergy and Immunology           Infectious Disease
       Critical Care                    Internal Medicine
       Dermatology                      Obstetrics
       Dietician                        Oncology
       Family Practice                  Otolaryngology, Head and Neck Surgery
       Gastroenterology                 Pediatrics
       General Surgery                  Podiatry
       Gynecology                       Rheumatology
       Hematology                       Urgent Care
       Immediate Care

Furthermore, HealthFirst has numerous provider arrangements in the community so
that it can offer additional services to patients covered under capitated
contracts.

BUSINESS STRATEGY

HealthFirst believes that group practice offers the best means of promoting and
maintaining the highest standard of medical care. HealthFirst's strategy is to
position itself in a competitive network as the healthcare industry develops.
HealthFirst's relationship with PPI enhances its capacity to provide a high
quality of clinical care and to compete economically in both managed care and
fee-for-service markets.

To increase revenue, HealthFirst has been working with PPI to recruit additional
physicians and merge other physician groups in the area into their clinic. PPI
is working with HealthFirst on initiatives to reduce the Manager's Expenses of
HealthFirst (which are paid by PPI and reimbursed by HealthFirst) through
regional purchasing and insurance contracts, and through the consolidation of
various services.

GOVERNMENT REGULATION

HealthFirst is subject to federal and state laws regulating the relationships
among providers of health care services, physicians and other clinicians. These
laws include the fraud and abuse provisions of the Medicare and Medicaid
statutes, which prohibit the solicitation, payment, receipt or offering of any
direct or indirect remuneration for the referral of Medicare or Medicaid
patients or for the recommending, leasing, arranging, ordering or purchasing of
Medicare or Medicaid covered services. Other laws impose significant penalties
for false or improper billings for physician services and impose restrictions on
physician referrals for designated health services to entities with which they
have financial relationships. Violations of those laws may result in substantial
civil or criminal penalties for individuals or entities, including large civil
money penalties and exclusion from participation in the Medicare and Medicaid
programs. Significant laws applicable to the health care industry generally are
described in more detail below.

Fraud and Abuse Laws
Certain provisions of the Social Security Act, commonly referred to as the
"Anti-Kickback Statute," prohibit the offer, payment, solicitation, or receipt
of any form of remuneration in return for the recommendation, arrangement,
purchase, lease or order of items or services that are covered by Medicare or
state health programs. In recent years, there has been increasing scrutiny by
law enforcement authorities, the United States Department of Health and Human
Services, various state agencies, the federal and state courts and Congress, of
financial arrangements between health care providers and potential sources of
patient referrals to ensure that such arrangements are not disguised mechanisms
to pay for patient referrals. The Anti-Kickback Statute is broad in scope and
interpretations by various courts have been ambiguous or conflicting in certain
respects. To the extent PPI is deemed to be either a referral source or a
separate provider under the New PC Management


<PAGE>   6

Agreement that is in a position to influence referrals to or from physicians,
the financial arrangements under these agreements could be subject to scrutiny
and prosecution under the Anti-Kickback Statute.

Physician Self-Referral Law
Significant prohibitions against physician "self-referrals" apply to a variety
of physician-owned or physician-interested entities. The Stark statute (42
U.S.C. **1395nn) generally prohibits referrals by physicians for designated
health services reimbursable under the Medicare and Medicaid programs to
entities in which the referring physician or an immediate family member has an
ownership interest or compensation arrangement, unless an exception provided
under the statute applies. The Stark statute is broad and ambiguous in some
respects, and regulations clarifying the provisions have been issued only with
respect to clinical laboratory services (which was the subject of the "Stark I"
legislation). On January 8, 1998, Health Care Financing Administration published
proposed regulations (the "Proposed Legislation") implementing Stark II, the
legislation that expanded the federal self-referral legislation to cover ten
additional ancillary services (i.e., health care services other than clinical
laboratory services). The Proposed Regulations provide, in the case of
designated health care services provided by a group practice, that the overhead
expenses of and the income from the practice must be distributed according to
methods that indicate that the practice is a unified business and not based on
each satellite office operating as if it were a separate enterprise. A
determination that the sharing of overhead expenses and income of New PCs did
not comply with Stark would preclude referrals to certain designated health
services operated by PPI and could have a material adverse effect on PPI. While
management believes that the overhead expenses of and the income from each New
PC are distributed according to methods that indicate that such New PC is a
unified business, there can be no assurance that the distribution methodology
will not be challenged or scrutinized by governmental authorities. Future
clarification of existing Stark regulations could require PPI, HealthFirst and
related physicians to modify the form of their relationships.

Medicare/Medicaid Reimbursement
State and federal civil and criminal statutes impose substantial penalties,
including civil and criminal fines and imprisonment, upon health care providers
who fraudulently or wrongfully bill governmental or other third-party payors for
health care services. The federal law prohibiting false billings allows a
private person to bring a civil action in the name of the United States
government for violations of its provisions. While management of HealthFirst has
attempted to comply with billing requirements, there is no assurance that the
Company will not be challenged or scrutinized by governmental authorities.
Moreover, Medicare and other reimbursement rules impact the fee structure of
medical billing. To the extent HealthFirst's billing arrangements may need to be
modified to comply with existing or modified regulations, there could be a
material adverse financial effect on the Company.

Oregon Insurance Law
The Oregon Department of Consumer and Business Affairs, Insurance Division (the
"Insurance Division"), regulates the transaction of insurance pursuant to the
Oregon Insurance Code. Pursuant to Insurance Division Bulletin 96-2 (the
"Bulletin") issued in April 1996 by the Oregon Insurance Commissioner, health
care providers that are compensated on a capitated basis by a health insurer or
health care service contractor ("HCSC") are not required to obtain a certificate
of authority to transact insurance if the capitation is internal to a policy of
insurance that is delivered by an authorized insurer of HCSC. The Bulletin also
states that discounted fee-for-service arrangements with reasonable limits on
discounts (i.e., not open-ended discounts) also do not require a certificate of
authority. HealthFirst arrangements should fall into these categories and
therefore are exempt from regulation as an insurance company. There is no
assurance, however, that the position of the Insurance Division will not change
in the future.

Proposed Legislation
In addition to current federal regulations, the Clinton Administration and
several members of Congress have proposed legislation for comprehensive reforms
affecting the payment for and availability of health care services. Aspects of
certain such health care proposals, such as reductions in Medicare and Medicaid
payments and additional prohibitions on direct or indirect physician ownership
of facilities to which they refer patients, if adopted, could have a significant
impact on the health care industry. There can be no assurance as to the ultimate
content, timing or effect of any health care reform legislation, nor is it
possible at this time to estimate the impact of potential legislation on the
industry.


<PAGE>   7

COMPETITION

The health care industry is highly competitive. The industry is also subject to
continuing changes in the services that are provided and how providers are
selected and paid.

HealthFirst operates in the Portland, Oregon area. Primary competitors of
HealthFirst include integrated medical groups such as MedPartners, Cascade
Medical Group, Providence Medical Group, The Portland Clinic, Portland Adventist
Medical Group and others. Competitors also include hospital systems which employ
primary care physicians, independent practice associations ("IPAs"), staff model
HMOs (such as Kaiser) and academic medical centers. In light of its size,
however, HealthFirst is a significant health care provider in its relevant
market. HealthFirst competes for contracts with certain national provider
entities (such as MedPartners) and many regional and local providers of
physician management services. Although the basis of competition may vary,
competition is generally based on cost and quality of care.

In terms of physician practice management ("PPM") companies, only three,
MedPartners, AORI and PhyCor, have a presence in HealthFirst's service area. All
of these publicly traded PPMs have holdings in the Portland, Oregon market.
MedPartners operates a multi-specialty group practice of approximately 70
physicians in the Portland market. MedPartners has been an aggressive suitor of
groups of physicians in the Portland area. AORI has oncology providers in the
Portland market. These practices are in direct competition with HealthFirst's
oncology practice. Further, PhyCor, another publicly traded PPM, has as indirect
presence in the Portland market at The Vancouver Clinic in Vancouver,
Washington.

There can be no assurance that the Company will be able to compete effectively,
that additional competitors will not enter the market, or that such competition
will not make it more difficult for the Company to maintain its current
financial condition.

EMPLOYEES

Provider Employees
As of December 31, 1997, the Company had 110 full-time and 37 part-time
providers. HealthFirst physicians initially serve one-year associate employment
contracts. These contracts offer a signing bonus, a specified guaranteed salary
and eligibility for an incentive bonus. After two years of service at the
associate level, the shareholder physicians vote on whether to offer shares to
the associate physician. A rigorous peer review is completed prior to the
offering of shareholder status.

In addition, the Company employs 12 nurse practitioners. Shareholder contracts
with eligible non-physician employees generally are similar to the associate
version except for compensation and certain other provisions.

Non-Provider Employees
According to the terms of the Reorganization and Merger Agreement, all
non-provider staff is employed by PPI.

The Company considers its relations with its employees to be excellent.

INSURANCE

The business of the Company entails an inherent risk of claims of provider
professional liability. To protect its overall operations from such potential
liabilities, PPI maintains professional liability insurance and general
liability insurance on a claims-made basis. Management does not believe
professional liability exposure is significant; however, there can be no
assurance that a future claim will not exceed the limits of available insurance
coverage or that such coverage will continue to be available. PPI carries
worker's compensation


<PAGE>   8

insurance and maintains multiperil liability, fiduciary liability, employee
dishonesty, professional liability, general liability and directors and
officers' insurance. The Company believes these types of insurance to be
customary and reasonable for a business of its kind.

ITEM 2: PROPERTIES

All assets and liabilities of Old HealthFirst (other than physician-related
assets) were transferred to PPI pursuant to the Reorganization and Merger
Agreement. PPI is, therefore, responsible for all lease payments on real
properties that HealthFirst occupies. HealthFirst then reimburses PPI for all
manager's expenses incurred on its behalf.

The Company's executive offices, which are leased, are located at Suite 310,
1200 NW Front Street, Portland, Oregon 97209. The Company believes these
arrangements and the clinic locations are adequate for its current uses
and anticipated growth.

Currently, the Company occupies clinics in eleven locations in the Portland,
Oregon area.

ITEM 3: LEGAL PROCEEDINGS

HealthFirst is engaged in the defense of lawsuits arising in the ordinary course
and conduct of its business. The Company believes that such actions will not
have a material effect on its business.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On November 20, 1997, a meeting of shareholders of HealthFirst was held. Two new
directors, John Zelko, M.D. and Robert Bailey, M.D. were elected to the Board of
Directors of HealthFirst at such meeting. The term of the new directors
commences on January 1, 1998. Pete Perry, M.D., Resa Bradeen, M.D., James
Ritzenthaler, M.D., David Shute, M.D. and John Teller, M.D. continued as
directors after the November 20 meeting of shareholders. The following chart
tabulates the number of votes cast for and against each director nominated for
election at such annual meeting; there were no abstentions.


                                                For               Against
                                           -----------------    ----------------
John Zelko, M.D.                                66                   7
Robert Bailey, M.D.                             73                   0


                                     PART II

ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

There is no public trading market for the Company's common stock.


<PAGE>   9

ITEM 6: SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
                                               For the Twelve Months Ended December 31,

(Thousands of dollars,
except earnings per share)
                                         1993         1994         1995          1996          1997
                                      --------     --------     --------      --------       --------
<S>                                   <C>          <C>          <C>           <C>            <C>
STATEMENT OF OPERATIONS
DATA:
REVENUES:
Fee-For-Service, Net                $   13,505   $   18,813    $  22,834    $    32,315      $  35,575
Prepaid Health Care                     10,893       13,463       14,818         27,800         30,055
                                    ----------   ----------    ---------    -----------      ---------
Total Net Revenues                      24,398       32,276       37,652         60,115         65,630
Less Provider Compensation
  and Benefits                          (6,278)      (8,375)      (9,530)       (21,610)(1)    (14,369)
                                    ----------   ----------    ---------    -----------      ---------
Net Revenue less Provider
  Compensation and Benefits             18,120       23,901       28,122         38,505         51,261

OPERATING EXPENSES:
Total Operating Expenses                15,963       20,648       27,593         44,416         50,430
Total Operating Income (Loss)            2,157        3,253          529         (5,911)           831
Other Non-Operating Income
 (Expenses)                                 46          101          (29)          (103)          (573)
                                    ----------   ----------    ---------    -----------      ---------
Income (Loss) Before Taxes               2,203        3,354          500         (6,014)           258
                                    ----------   ----------    ---------    -----------      ---------
Income Tax Expense (Benefit)               889        1,416          208         (1,899)            --
                                    ----------   ----------    ---------    -----------      ---------
Net Income (Loss)                   $    1,314   $    1,938    $     292    $    (4,115)     $     258
                                    ==========   ==========    =========    ===========      =========
Earnings Per Share                  $26,816.33   $39,551.02    $5,509.43    $(50,802.47)     $2,866.67
                                    ==========   ==========    =========    ===========      =========
BALANCE SHEET DATA:
Working Capital (Deficit)           $    1,882   $    1,961    $  (1,507)   $    (4,871)     $   3,176
Total Assets                            11,742       16,848       21,075         30,910          3,176
Long Term Debt, Net                      2,223        1,731        3,711          5,066             --
Capital and Direct Financing Lease
  Obligation                                --           --           --          4,663             --
Shareholders' Equity                     5,344        7,253        7,597          2,364              1
</TABLE>

-------------
(1) Includes $3.9 million of deferred compensation.

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS


The following discussion includes some forward-looking statements that involve a
number of risks and uncertainties. Actual results may differ materially from
historical results or from the results discussed in such forward-looking
statements or outcomes otherwise currently expected or sought by HealthFirst.


OVERVIEW


<PAGE>   10

HealthFirst, an Oregon professional corporation, is a multi-specialty medical
clinic. HealthFirst was founded in 1997 pursuant to certain reorganization and
merger transactions (the "Transactions") contemplated by the Amended and
Restated Agreement and Plan of Reorganization and Merger (the "Reorganization
and Merger Agreement") among Medford Clinic, P.C. ("Old Medford"), Old
HealthFirst, The Corvallis Clinic, P.C. ("Old Corvallis"), and, together with
Old Medford and Old Corvallis, referred to herein, collectively as ("Old PCs"),
and Physician Partners, Inc. ("PPI"). Old HealthFirst was formed in February
1996 in a merger between the Metropolitan Clinic, P.C., formed in 1906, and
Suburban Medical Clinic, P.C., formed in 1956. Pursuant to the terms of the
Reorganization and Merger Agreement, each Old PC affected (a) a reorganization
(the "New PC Reorganization) of its corporate structure by (i) incorporating a
wholly-owned professional corporation subsidiary (a "New PC"), (ii) transferring
to the New PC certain assets and liabilities (including physician employment
agreements) relating to the provider professional services business, (iii)
making a pro rata distribution to its shareholders of all of the capital stock
of the New PC, (iv) converting such Old PC from a professional corporation to a
business corporation and (v) entering into a 40-year management agreement (the
"Management Agreement") with PPI and (b) a merger with and into PPI, resulting
in consolidation of the operations (other than the provider professional
services businesses) of the Old PCs.

HealthFirst currently consists of 159 professional providers who offer a wide
range of primary and specialty care services including allergy, dermatology,
gastroenterology, hematology/oncology, infectious disease, pediatrics,
geriatrics, obstetrics/gynecology, podiatry, rheumatology, and surgery.
HealthFirst's operations are located in and around Portland, Oregon.

HealthFirst believes that group practice offers the best means of promoting and
maintaining the highest standard of medical care. HealthFirst's strategy is to
position itself in a competitive network as the healthcare industry develops.
HealthFirst's relationship with PPI enhances its capacity to provide a high
quality of clinical care and to compete economically in both managed care and
fee-for-service markets.

To increase revenue, HealthFirst is working with PPI to recruit additional
physicians and merge other physician groups in the area into their clinic. PPI
is working on initiatives to reduce the Manager's Expenses of HealthFirst (which
are paid by PPI and reimbursed by HealthFirst) through regional purchasing and
insurance contracts, and through the consolidation of various services.

In 1997, PPI began modifying the computer system programming at HealthFirst to
process transactions in the year 2000. Anticipated spending for this
modification will be expensed as incurred and is not expected to have a
significant impact on HealthFirst's ongoing results of operations.

RESULTS OF OPERATIONS

The following table shows the percentage of Net Revenue less Provider
Compensation represented by various expense categories reflected in the
Company's Statement of Operations. The following table represents twelve months
ended December 31, 1995, 1996 and 1997.

<TABLE>
<CAPTION>
                                                December 31,
                                     --------------------------------
                                      1995         1996         1997
                                     ------       ------       ------
<S>                                   <C>          <C>          <C>
Net Revenues, less Provider           100.0%       100.0%       100.0%
   Compensation

Operating Expenses:
   Clinic salaries, wages and          41.7%        47.1%        36.1%
    benefits
   Purchased medical services          15.1%        25.5%        20.6%
   Medical and office supplies         15.6%        16.3%        12.8%
   General and administrative          16.0%        13.3%        12.2%
    expenses
   Lease and rent expense               3.0%         4.1%         4.1%
   Provision for uncollectible          4.1%         4.9%         4.0%
    accounts
   Depreciation and amortization        2.6%         4.1%         4.0%
   Management fee                        --           --          4.6%
                                     ------       ------       ------
     Total operating expenses          98.1%       115.3%        98.4%
                                     ------       ------       ------
     Operating income (loss)            1.9%       (15.3%)        1.6%
Other Income (Expense)
   Interest income                      0.2%         0.3%         0.8%
   Interest expense                    (0.7%)       (3.7%)       (3.1%)
</TABLE>


<PAGE>   11

<TABLE>
<S>                                    <C>          <C>          <C>
   Other income                         0.4%         3.1%         1.2%
                                     ------       ------       ------
     Net income (loss) before
      income taxes                      1.8%       (15.6%)        0.5%
                                     ------       ------       ------
   Income tax expense (benefit)         0.7%        (4.9%)         --
                                     ------       ------       ------
Net income (loss)                       1.1%       (10.7%)        0.5%
                                     ======       ======       ======
</TABLE>


Twelve Months ended December 31, 1997 Compared to Twelve Months Ended
December 31, 1996

Net Revenues less Provider Compensation increased $12.8 million or 33.2% to
$51.3 million in the twelve months ended December 31, 1997 from $38.5 million in
the twelve months ended December 31, 1996. Net Revenues less Provider
Compensation consists of both Fee-For-Service revenue net of contractual
discounts and Prepaid Healthcare revenues less Provider Compensation and
Benefits. Net Fee-For-Service revenues increased $3.3 million or 10.2% to $35.6
million in the twelve months ended December 31, 1997 compared to $32.3 million
in the twelve months ended December 31, 1996. Prepaid Healthcare revenues
increased $2.3 million or 8.3% to $30.1 million in the twelve months ended
December 31, 1997 compared to $27.8 million in 1996. The increase in Net
Fee-For-Service revenues in 1997 compared to 1996 is due to the addition of
several providers in late 1996 who became fully productive in 1997 and an
increase in the office hours beginning December 1996. The increase in Prepaid
Healthcare revenue is due to increased capitation rates which were offset by
increased hospital costs which led to lower risk pool returns. Management has
negotiated additional capitation rate increases in the 1998 managed care
contracts.

Provider Compensation and Benefits
Provider Compensation and Benefits decreased $7.2 million or 33.3% to $14.4
million in the twelve months ended December 31, 1997 from $21.6 million in 1996.
A significant portion of the decrease is due to a $5.3 million bonus
compensation plan of which $3.9 million of expense was recognized in May 1996.
The remaining difference is due to the decrease in the amount available for
provider compensation.

Operating Expenses
The operating expenses of HealthFirst represent the costs incurred by PPI and
reimbursed by the Company per the terms of the Management Agreement. As a
percentage of Net Revenues less Provider Compensation, most operating expenses
decreased in the year ended December 31, 1997 compared to 1996. The decreases
were the result of operating expenses remaining relatively stable while revenues
increased.

A management fee of $2.4 million for the twelve months ended December 31, 1997
was paid to PPI in accordance with the Management Agreement. As HealthFirst's
results improve, the management fee will increase in direct relation. There
was no such management fee in 1996 as the Management Agreement was not
effective until February 1, 1997.

Other Income and Expenses
In 1997, other income included a one-time transition payment of $.6 million
from PPI. In 1996, other income mainly consisted of rental income from
subleasing office space and other income from Blue Cross/Blue Shield.

Twelve Months Ended December 31, 1996 Compared to Twelve Months Ended
December 31, 1995

Net Revenues less Provider Compensation increased $10.4 million or 37.0% to
$38.5 million in the twelve months ended December 31, 1996 from $28.1 million in
the twelve months ended December 31, 1995. Net Revenues less Provider
Compensation consists of both Fee-For-Service revenue net of contractual
discounts and Prepaid Healthcare revenues less Provider Compensation and
Benefits. Net Fee-For-Service revenues increased $9.5 million or 41.7% to $32.3
million in the twelve months ended December 31, 1996 compared to $22.8 million
in twelve months ended December 31, 1995. Prepaid Healthcare revenues increased
$13.0 million or 87.8% to $27.8 million in the twelve months ended December 31,
1996 compared to $14.8 million in 1995. The increase in Net Fee-For-Service
income is attributable to the purchase of Suburban in February 1996 and the
addition of new providers. The increase in Prepaid Healthcare revenue correlates
with an increase in the number of capitated lives, offset in part by reduced
risk sharing revenues.

Provider Compensation and Benefits


<PAGE>   12

Provider Compensation and Benefits increased $12.1 million or 127.4% to $21.6
million in the twelve months ended December 31, 1996 from $9.5 million in 1995.
A significant portion of the increase was due to the purchase of Suburban in
February 1996. The remaining increase is due to a $5.5 million bonus
compensation plan of which $3.9 million of expense was recognized in May 1996.

Operating Expenses
Total operating expenses increased in the year ended December 31, 1996 compared
to 1995 due to the purchase of Suburban in February 1996. Significant
fluctuations not related to Suburban are discussed below. As a percentage of Net
Revenue less Provider Compensation, Clinic Salaries, Wages and Benefits
increased to 47.1% in 1996 from 41.7% in 1995. The increase was attributable to
the addition of staff required to support new providers added due to the
purchase of Suburban as well as the opening of the Tigard Clinic. As a
percentage of Net Revenue less Provider Compensation and Benefits, Purchased
Medical Services increased to 25.5% from 15.1% for 1996 and 1995, respectively.
This growth is due to Suburban having a high number of managed care contracts.
Depreciation and Amortization increased $0.9 million or 128.6% to $1.6 million
in the twelve months ended December 31,1996 from $0.7 million in 1995. The
increase relates to the purchase of Suburban, the completion of a new clinic
building and equipment to support the addition of new providers.

LIQUIDITY AND CAPITAL RESOURCES

As a result of the Transactions, PPI succeeded to the ownership of substantially
all assets and liabilities and PPI assumed all financing activities relating to
the working capital needs of HealthFirst. Per the Management Agreement, PPI will
purchase the necessary capital equipment to support HealthFirst's operations.


<PAGE>   13
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



                       HEALTHFIRST MEDICAL GROUP, P.C.

                       FINANCIAL STATEMENTS
                       AS OF DECEMBER 31, 1996 AND 1997
                       TOGETHER WITH AUDITORS' REPORT



<PAGE>   14

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors of
HealthFirst Medical Group, P.C.:

We have audited the accompanying balance sheets of HealthFirst Medical Group,
P.C. (an Oregon professional corporation) as of December 31, 1996 and 1997, and
the related statements of operations, stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1997. These
financial statements are the responsibility of HealthFirst's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of HealthFirst Medical Group, P.C.
as of December 31, 1996 and 1997, and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 1997 in
conformity with generally accepted accounting principles.


                                        ARTHUR ANDERSEN LLP


Portland, Oregon,
  February 20, 1998



<PAGE>   15

                         HEALTHFIRST MEDICAL GROUP, P.C.


                BALANCE SHEETS - AS OF DECEMBER 31, 1996 AND 1997

                   (All dollar amounts expressed in thousands)



                                     ASSETS

<TABLE>
<CAPTION>
                                                                             1996        1997
                                                                            -------      ------
<S>                                                                         <C>          <C>
CURRENT ASSETS:
  Cash and cash equivalents                                                 $   895      $    1
  Patient accounts receivable, net of allowances for
    contractual discounts and uncollectible accounts of
    $2,465 at December 31, 1996                                               6,497        --
  Healthcare and other receivables                                            2,848        --
  Related party receivable                                                       50        --
  Income taxes receivable                                                        58        --
  Prepaid expenses and deposits                                                 201        --
  Prepaid provider compensation                                                --         3,175
                                                                            -------      ------
          Total current assets                                               10,549       3,176
                                                                            -------      ------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated depreciation of
  $5,769 at December 31, 1996                                                20,361        --

OTHER ASSETS                                                                   --          --
                                                                            -------      ------
          Total assets                                                      $30,910      $3,176
                                                                            =======      ======
</TABLE>



<PAGE>   16

                         HEALTHFIRST MEDICAL GROUP, P.C.


          BALANCE SHEETS - AS OF DECEMBER 31, 1996 AND 1997 (CONTINUED)

                   (All dollar amounts expressed in thousands)



                      LIABILITIES AND STOCKHOLDERS' EQUITY

<TABLE>
                                                                                  1996            1997
                                                                                  ----            ----
<S>                                                                          <C>             <C>
CURRENT LIABILITIES:
  Line of credit                                                               $  1,500        $   --
  Current portion of long-term debt and capital and direct
    financing lease obligations                                                   4,663            --
  Accounts payable                                                                2,123            --
  Accrued expenses                                                                  703            --
  Accrued healthcare costs                                                        2,936            --
  Accrued compensation and related expenses                                       3,313            --
  Deferred revenue                                                                  182            --
                                                                               --------        --------
          Total current liabilities                                              15,420            --
                                                                               --------        --------
PAYABLE TO PPI                                                                     --             3,175
LONG-TERM DEBT, net of current portion                                            5,066
CAPITAL AND DIRECT FINANCING LEASE OBLIGATIONS, net of current
  portion                                                                         4,265            --
DEFERRED COMPENSATION AND OTHER LONG-TERM LIABILITIES                             3,795            --
LONG-TERM DEFERRED TAX LIABILITY                                                   --              --
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
  Common stock-
    No par value; 1,000,000 shares authorized; 0 and 94 shares issued and
      outstanding at December 31, 1996 and 1997,
      respectively                                                                 --                 1
    Series 1 Class A--Voting; no par value; 800,000 shares
        authorized; 7,000 and 0 shares issued and outstanding at
        December 31, 1996 and 1997, respectively                                    700            --
    Series 2 Class A--Voting; no par value; 200,000 shares
      authorized; 2,200 and 0 shares issued and outstanding at
      December 31, 1996 and 1997, respectively                                      330            --
    Series 3, 4 and 5 Class A--Voting; no par value; 200,000,
        100,000 and 100,000 shares authorized, none issued or
        outstanding at December 31, 1996 and 1997                                  --              --
    Class B--Nonvoting; no par value; 300,000 shares authorized;
        0 shares issued and outstanding at December 31, 1996 and 1997              --              --
  Additional paid-in capital                                                      1,879            --
  Retained earnings                                                               1,149            --
  Notes receivable from stockholders for purchase of stock                         (439)           --
  Unamortized value of restricted stock awards                                   (1,255)           --
                                                                               --------        --------
          Total stockholders' equity                                              2,364               1
                                                                               --------        --------
          Total liabilities and stockholders' equity                           $ 30,910        $  3,176
                                                                               ========        ========
</TABLE>


      The accompanying notes are an integral part of these balance sheets.


<PAGE>   17

                         HEALTHFIRST MEDICAL GROUP, P.C.



                            STATEMENTS OF OPERATIONS

              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

 (All dollar amounts expressed in thousands, except earnings (loss) per share)



<TABLE>
<CAPTION>
                                                            1995                 1996               1997
                                                          --------             --------           --------
<S>                                                       <C>                  <C>                <C>
REVENUES:
  Fee-for-service, net                                    $ 22,834             $ 32,315           $ 35,575
  Prepaid healthcare                                        14,818               27,800             30,055
                                                          --------             --------           --------
          Net revenues                                      37,652               60,115             65,630

  Less- Provider compensation and benefits                   9,530               21,610             14,369
                                                          --------             --------           --------
          Net revenue less provider compensation
            and benefits                                    28,122               38,505             51,261
                                                          --------             --------           --------
OPERATING EXPENSES:
  Clinic salaries, wages and benefits                       11,737               18,157             18,496
  Purchased medical services                                 4,253                9,812             10,545
  Medical and office supplies                                4,377                6,281              6,536
  General and administrative expenses                        4,491                5,115              6,248
  Lease and rent expense                                       853                1,573              2,125
  Provision for uncollectible accounts                       1,146                1,911              2,056
  Depreciation and amortization                                736                1,567              2,055
  Management fee                                              --                   --                2,369
                                                          --------             --------           --------
          Total operating expenses                          27,593               44,416             50,430
                                                          --------             --------           --------
          Operating income (loss)                              529               (5,911)               831

OTHER INCOME (EXPENSE):
  Interest income                                               39                  100                428
  Interest expense                                            (189)              (1,414)            (1,625)
  Other                                                        121                1,211                624
                                                          --------           ----------           --------
          Net income (loss) before provision
            (benefit) for income taxes                         500               (6,014)               258
                                                          --------           ----------           --------
PROVISION (BENEFIT) FOR INCOME TAXES                           208               (1,899)              --
                                                          --------           ----------           --------
NET INCOME (LOSS)                                         $    292           $   (4,115)          $    258
                                                          ========           ==========           ========

EARNINGS (LOSS) PER SHARE                                 5,509.43           (50,802.47)          2,866.67
                                                          ========           ==========           ========

WEIGHTED AVERAGE SHARES OUTSTANDING                             53                   81                 90
                                                          ========           ==========           ========
</TABLE>


        The accompanying notes are an integral part of these statements.


<PAGE>   18

                         HEALTHFIRST MEDICAL GROUP, P.C.



                            STATEMENTS OF CASH FLOWS

              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

                   (All dollar amounts expressed in thousands)

<TABLE>
<CAPTION>
                                                                         1995              1996             1997
                                                                       -------           -------           -------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                    <C>               <C>               <C>
  Net income (loss)                                                    $   292           $(4,115)          $   258
  Adjustment to reconcile net income (loss) to net cash
    provided by (used in) operating activities-
      Depreciation and amortization                                        736             1,567               148
      Gain on sale of property, plant and equipment                       --                --                --
      Provision for deferred income taxes                                   71            (1,936)             --
      Compensation expense recognized for provider
        stock awards                                                      --                 502              --
      Changes in operating assets and liabilities
        (excluding assets and liabilities purchased
        from Suburban):
          Patient accounts receivable, net                              (1,020)           (1,380)             (178)
          Healthcare and other receivables                                 568               301               691
          Related party receivable                                        --                 277              --
          Income taxes receivable                                         (168)              147              --
          Inventories of drugs and supplies                                (16)              251              --
          Prepaid expenses and deposits                                    (79)              192               (50)
          Prepaid provider compensation                                   --                --              (3,175)
          Other assets                                                     (50)              225              (169)
          Drafts payable                                                (1,579)             (165)             --
          Accounts payable                                                 461               431              (119)
          Accrued expenses                                                 (39)              430              --
          PPI payable                                                     --                --               3,175
          Income taxes payable                                            (359)             --                --
          Accrued healthcare costs                                          92               984              (748)
          Accrued compensation and related expenses                        108               669               154
          Deferred revenue                                                   3               166                68
          Deferred compensation and other long-term
            liabilities                                                    201             2,787               108
                                                                       -------           -------           -------
          Net cash provided by (used in) operating activities
                                                                          (778)            1,333               163
                                                                       -------           -------           -------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property, plant and equipment                            (6,690)           (3,181)              (92)
  Cash proceeds received from short-term investments                     2,616              --                --
  Cash received in acquisition of Suburban                                --                 231              --
                                                                       -------           -------           -------
          Net cash used in investing activities                         (4,074)           (2,950)              (92)
                                                                       -------           -------           -------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of long-term debt                               4,940             2,763             1,000
  Proceeds from issuance of line of credit                                --               1,500              --
  Principal payments on long-term obligations                              (17)             (998)             (734)
  Proceeds from repayments of notes receivable from
    stockholders                                                            62                64                17
  Payments for redemption of common stock                                  (10)               (9)             --
  Cash received from direct financing lease obligations                   --               1,000              --
  Cash contributed to Physician Partners, Inc. in merger                  --                --              (1,158)
</TABLE>


<PAGE>   19

                         HEALTHFIRST MEDICAL GROUP, P.C.


                      STATEMENTS OF CASH FLOWS (CONTINUED)

              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

                   (All dollar amounts expressed in thousands)

<TABLE>
<CAPTION>
                                                                        1995          1996          1997
                                                                       ------        -------       -------
<S>                                                                    <C>           <C>           <C>
 CASH FLOWS FROM FINANCING ACTIVITIES (Continued):
  Proceeds from issuance of common stock                               $ --          $  --         $     1
  Costs incurred related to Physician Partners, Inc.
    transaction                                                          --           (1,933)          (91)
                                                                       ------        -------       -------
          Net cash provided by (used in) financing activities
                                                                        4,975          2,387          (965)
                                                                       ------        -------       -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                          123            770          (894)

CASH AND CASH EQUIVALENTS, beginning of year                                2            125           895
                                                                       ------        -------       -------
CASH AND CASH EQUIVALENTS, end of year                                 $  125        $   895       $     1
                                                                       ======        =======       =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
    Cash paid for interest                                             $  186        $ 1,356       $ 1,620
    Cash paid for income taxes                                            446            181          --
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
  FINANCING ACTIVITIES:
    Notes receivable issued in exchange for common stock               $   80        $   140       $  --
</TABLE>

In 1996, HealthFirst acquired all of the outstanding stock of Suburban in
exchange for 2,200 shares of HealthFirst Series 2 Class A stock. The acquisition
was recorded under the purchase method of accounting. The fair values of
Suburban's assets, including $231 of cash, and liabilities at the date of
acquisition are presented below:

<TABLE>
<S>                                           <C>
Current assets                                $ 2,284
Property, plant and equipment                   5,325
Other long-term assets                             99
Current liabilities                            (2,833)
Long-term liabilities                          (4,617)
                                              -------
          Net equity acquired                 $   258
                                              =======
Reconciliation to equity accounts:
  Common stock                                $   330
  Additional paid-in capital                      122
  Notes receivable from stockholders             (194)
                                              -------
                                              $   258
                                              =======
</TABLE>

In February 1997, HealthFirst assigned all assets and liabilities to Physician
Partners, Inc. as part of the reorganization and merger transaction. The book
value of HealthFirst's assets and liabilities, including $1,200 of cash at the
date of the transaction are presented below:

<TABLE>
<S>                                    <C>
Current assets                         $10,239
Property, plant and equipment           20,305
Other long-term assets                     277
Current liabilities                     11,112
Long-term liabilities                   17,163
Contributed equity                       2,546
</TABLE>

        The accompanying notes are an integral part of these statements.


<PAGE>   20

                         HEALTHFIRST MEDICAL GROUP, P.C.



                       STATEMENTS OF STOCKHOLDERS' EQUITY

              FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997

                   (All dollar amounts expressed in thousands)

<TABLE>
<CAPTION>
                                                                    Common Stock
                                           ----------------------------------------------------------------------
                                                                       Series 1                    Series 2
                                                 No Par                 Class A                     Class A
                                           -------------------     -------------------        -------------------
                                            Number                 Number                     Number                    Additional
                                              Of                    Of                          Of                       Paid-In
                                            Shares      Amount     Shares       Amount        Shares       Amount        Capital
                                           -------     -------     ------       ------        ------       ------       ----------
<S>                                        <C>         <C>         <C>          <C>           <C>          <C>          <C>
BALANCE, December 31, 1994                    --       $  --        4,950        $ 495          --          $--          $  --

  Issuance of common stock                    --          --          800           80          --           --             --
  Redemption of common stock                  --          --         (100)         (10)         --           --             --
  Repayment of notes receivable from
    stockholders                              --          --         --           --            --           --             --
  Net income                                  --          --         --           --            --           --             --
                                           -------     -------     ------        -----        ------        -----        -------
BALANCE, December 31, 1995                    --          --        5,650          565          --           --             --

  Notes receivable from stockholders
    acquired from Suburban                    --          --         --           --            --           --             --
  Common stock issued to acquire
    Suburban                                  --          --         --           --           2,200          330            122
  Issuance of common stock                    --          --        1,400          140          --           --            1,757
  Redemption of common stock                  --          --          (50)          (5)         --           --             --
  Repayment of notes receivable from
    stockholders                              --          --         --           --            --           --             --
  Costs related to Physician
    Partners, Inc. transaction                --          --         --           --            --           --             --
  Net loss                                    --          --         --           --            --           --             --
                                           -------     -------     ------        -----        ------        -----        -------
BALANCE, December 31, 1996                    --          --        7,000          700         2,200          330          1,879

  Issuance of common stock                      94           1       --           --            --           --             --
  Redemption of common stock                  --          --         --           --            --           --             --
  Repayment of notes receivable from
    stockholders                              --          --         --           --            --           --             --
  Net income                                  --          --         --           --            --           --             --
  Transfer of ownership to Physician
    Partners, Inc. during merger
    (see Note 1)                              --          --       (7,000)        (700)       (2,200)        (330)        (1,879)
                                           -------     -------     ------        -----        ------        -----        -------
BALANCE, December 31, 1997                      94     $     1       --          $--            --          $--          $  --
                                           =======     =======     ======        =====        ======        =====        =======
</TABLE>





<TABLE>
<CAPTION>
                                              Unamortized                     Notes
                                               Value of                     Receivable
                                              Restricted      Retained         From
                                             Stock Awards     Earnings     Stockholders    Total
                                             ------------     --------     ------------   -------
<S>                                          <C>              <C>          <C>            <C>
BALANCE, December 31, 1994                     $  --          $ 6,909        $(151)       $ 7,253

  Issuance of common stock                        --             --            (80)          --
  Redemption of common stock                      --             --           --              (10)
  Repayment of notes receivable from
    stockholders                                  --             --             62             62
  Net income                                      --              292         --              292
                                               -------        -------        -----        -------
BALANCE, December 31, 1995                        --            7,201         (169)         7,597

  Notes receivable from stockholders
    acquired from Suburban                        --             --           (194)          (194)
  Common stock issued to acquire
    Suburban                                      --             --           --              452
  Issuance of common stock                      (1,255)          --           (140)           502
  Redemption of common stock                      --               (4)        --               (9)
  Repayment of notes receivable from
    stockholders                                  --             --             64             64
  Costs related to Physician
    Partners, Inc. transaction                    --           (1,933)        --           (1,933)
  Net loss                                        --           (4,115)        --           (4,115)
                                               -------        -------        -----        -------
BALANCE, December 31, 1996                      (1,255)         1,149         (439)         2,364

  Issuance of common stock                        --             --           --                1
  Redemption of common stock                      --             --           --             --
  Repayment of notes receivable from
    stockholders                                  --             --             17             17
  Net income                                      --              258         --              258
  Transfer of ownership to Physician
    Partners, Inc. during merger
    (see Note 1)                                 1,255         (1,407)         422         (2,639)
                                               -------        -------        -----        -------
BALANCE, December 31, 1997                     $  --          $  --          $  --        $     1
                                               =======        =======        =====        =======
</TABLE>

        The accompanying notes are an integral part of these statements.


<PAGE>   21

                         HEALTHFIRST MEDICAL GROUP, P.C.


                          NOTES TO FINANCIAL STATEMENTS




1.  DESCRIPTION OF BUSINESS:

HealthFirst Medical Group, P.C. (HealthFirst), an Oregon professional
corporation, was incorporated on September 18, 1996 under the name Physician
Partners HealthFirst, PC for the purpose of effecting a reorganization
transaction between Physician Partners, Inc. (PPI) and three Oregon professional
corporations (the Founding Clinics).

This transaction, which was consummated on February 1, 1997, resulted in a
separation of operations of the three Founding Clinics between medical
professional services activities (i.e., providers of medical services) and the
physician practice management activities of the business. The professional
services activities were spun off into newly formed professional corporations
(New PCs). HealthFirst is one of the new PCs. The physician practice management
business, along with substantially all of the assets and liabilities of the
three Founding Clinics, i.e., cash, receivables, inventories, prepaids,
property, plant and equipment, other assets, payables, accruals, debt, and
certain contractual commitments were transferred to PPI. The New PCs are
responsible for providing medical services and the related costs for provider
compensation and benefits. The assets transferred to the New PCs, which had zero
carrying value, include the employment agreements between each Company and its
providers, certain provider contracts under which the New PCs will be receiving
fee-for-service compensation and patient medical records.

An integral part of the reorganization is a 40-year management agreement whereby
PPI provides physician practice management services to the New PCs. Services to
be provided include management and administrative services, capital resources,
facilities, equipment and supplies. As consideration, PPI is entitled to (a)
reimbursement of all managerial costs and expenses (Manager's Expenses) incurred
by PPI and (b) a management fee equal to 16% of (i) net revenues relating to
services provided by the New PCs less (ii) Manager's Expenses.

Essentially all of the cash remaining in the New PC after the payments to PPI
under the management agreement will fund the compensation and benefits of
providers employed by the New PCs.

HealthFirst consists of approximately 159 providers who offer a wide range of
primary and specialty care services including allergy, dermatology,
gastroenterology, hematology/oncology, infectious disease, pediatrics,
geriatrics, obstetrics/gynecology, podiatry, rheumatology and surgery.

HealthFirst operates clinics in eleven locations in and around Portland, Oregon
including: Tualatin, Tigard, Westside, Lake Oswego, Broadway, Northwest
Portland, Wilshire, Gateway, Gresham, Hollywood and Powell Valley. A significant
change in the demographics of this area may have an adverse impact on the
business.



<PAGE>   22

                                      -2-

The accompanying financial statements reflect the assets and liabilities as of
December 31, 1996 and results of operations for the years ended December 31,
1995 and 1996, for the HealthFirst Medical Group, P.C. prior to the
reorganization transaction (Old HealthFirst). The Statements of Operations and
Cash Flows for the year ended December 31, 1997 include the results of
operations for Old HealthFirst from January 1 to January 31, 1997. The
remainder of the period represents the operations of HealthFirst Medical Group,
P.C. (New PC) subsequent to the effective date of the reorganization
transaction, February 1, 1997.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER INFORMATION:

Selected accounting policies are discussed below. Other significant accounting
policies regarding revenues, income taxes, professional liability and deferred
compensation are discussed in specific notes that follow.

Cash Equivalents

Cash equivalents consist of all highly liquid investments with original
maturities of three months or less.

Concentration of Credit Risk

HealthFirst extends credit to patients covered by commercial insurance, Medicare
and Medicaid. HealthFirst manages credit risk with the various public and
private insurance providers, as deemed appropriate by management. Allowances for
contractual discounts and uncollectible accounts have been made for potential
losses, where appropriate.

Prepaid Provider Compensation

Prepaid provider compensation includes the amount paid to providers that is in
excess of the earned amount computed in accordance with the Management Agreement
(Note 1). The balance will be reversed in future years when the amount paid is
less than the earned amount.

Inventories of Drugs and Supplies

Inventories are stated at the lower of cost or market, determined by the
first-in, first-out (FIFO) method. In 1996, HealthFirst began using a
just-in-time method with its major supply vendors.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. Maintenance, repairs and minor
replacements are expensed as incurred. When properties are retired or otherwise
disposed of, the related cost and accumulated depreciation are removed from the
respective accounts and any gain or loss on disposition is recorded as other
income or expense.

Depreciation is computed using the straight-line method over the estimated
useful lives of the respective assets. Equipment under capital lease is
amortized using straight-line methods over the shorter of the period of the
lease term or the estimated useful life of the equipment. Estimated lives are as
follows:

Buildings and leasehold improvements                       7-45 years
Furniture and equipment                                    3-15 years



<PAGE>   23

                                      -3-

Payable to PPI

HealthFirst signed a note payable to PPI, bearing interest at 7.6%. Interest
only monthly payments are due in 1998 and principal and interest monthly
payments are due beginning January 1999 for 36 months.

Accrued Healthcare Costs

Accrued healthcare costs are calculated based on reported claims and an estimate
based on historical data of incurred but not reported claims. These accrued
healthcare cost estimates may vary from actual results and the differences may
be significant.

Fair Value of Financial Instruments

The carrying amounts of cash equivalents, patient accounts receivable, accounts
payable and accrued expenses are a reasonable estimate of their fair value based
on the short maturities of these instruments.

Interest rates that are currently available to HealthFirst for issuance of debt
with similar terms and remaining maturities were used to estimate fair value for
debt issues. The current carrying value of debt approximates fair value.

HealthFirst does not hold or issue financial instruments or derivative financial
instruments for trading purposes.


Other Income

Other income includes a $600 one time payment from PPI. The payment was part of
a transition plan developed by PPI to assist HealthFirst in its transition to
the Management Agreement.

Financial Statement Presentation

The accompanying financial statements reflect the assets and liabilities as of
December 31, 1996 and results of operations for the year ended December 31, 1996
for the HealthFirst Medical Group, P.C. prior to the reorganization transaction
("Old HealthFirst"). The Statement of Operations and Cash Flows for the year
ended December 31,1997 include the results of operations for Old HealthFirst
from January 1 to January 31, 1997. The remainder of the period represents the
operations of HealthFirst Medical Group, P.C. ("New PC") subsequent to the
effective date of the reorganization transaction, February 1, 1997.

Provider Compensation and Benefits

Provider compensation and benefits consists of the direct costs of patient care
providers such as physicians and other allied health professionals. A
substantial portion of these costs are paid to providers who are stockholders.

Use of Estimates

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
These estimates and assumptions affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current
year presentation.

3.  REVENUES:

HealthFirst reports its revenues according to two principal types of payment
methodologies as discussed below:

Prepaid Healthcare

HealthFirst contracts with various Health Maintenance Organizations (HMOs) to
provide care to plan enrollees. These programs provide for a prepaid monthly
fixed capitation payment on a per member basis to HealthFirst by the HMO for
plan enrollees.

The majority of the HMO contracts are delegated professional risk with limited
institutional risk based upon utilization parameters mutually agreed upon by
the hospital health plan and HealthFirst.



<PAGE>   24

                                      -4-


HealthFirst has accrued the claims associated with services provided by outside
providers for which HealthFirst is responsible, and an estimate of incurred but
not reported claims is included in accrued healthcare cost in the accompanying
financial statements.

Fee-For-Service

Patient service revenues are recorded in the period in which services are
provided at established rates. HealthFirst has agreements with third-party
payors that provide payments to HealthFirst at amounts different from its
established rates. The difference between the established rates and the related
payment amounts are reflected as contractual discounts, as shown below:


<TABLE>
<CAPTION>
                                                   Year Ended December 31,
                                                 ---------------------------
                                                  1995       1996      1997
                                                 -------   -------   -------
<S>                                              <C>       <C>       <C>
Fee-for-service, gross                           $29,384   $39,628   $47,415
Contractual discounts                             (6,550)   (7,313)  (11,840)
                                                 -------   -------   -------
Fee-for-service, net                             $22,834   $32,315   $35,575
                                                 =======   =======   =======
</TABLE>

A summary of the most significant fee-for-service arrangements is as follows:

       Medicare

       A significant portion of HealthFirst's services are provided to Medicare
       patients. Payments for Medicare outpatient services which are not covered
       under capitated contracts are based on a prevailing fee schedule.
       Approximately 8%, 6%, and 6% of net patient service revenues were derived
       from services provided to fee-for-service Medicare patients in 1995, 1996
       and 1997, respectively.

       Medicaid

       Payments for Medicaid outpatient services which are not covered under
       capitated contracts are based on a prevailing fee schedule. Approximately
       1% of net patient service revenues were derived from services provided to
       fee-for-service Medicaid patients in 1995, 1996 and 1997.

       Other Payors

       HealthFirst has also entered into payment agreements with certain
       commercial insurance carriers and preferred provider organizations. The
       basis for payment to HealthFirst under these agreements includes
       discounts from established charges.



<PAGE>   25

                                      -5-

Major Customers

The following customers represented individually more than 10% of HealthFirst's
net revenue as follows:

<TABLE>
<CAPTION>
                                                     Year Ended
                                                    December 31,
                                                 ------------------
                                                 1995   1996   1997
                                                 ----   ----   ----
<S>                                              <C>    <C>    <C>
Pacificare - Secure Horizons                      10%    12%   12%
Pacificare - Commercial                           11     10     9
Blue Cross - HMO Oregon                           16     12    12
Good Health Plan                                  --     11    12
Blue Cross - Commercial                           10     --    --
</TABLE>

4.  PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consists of the following at December 31, 1996:

<TABLE>
<S>                                                                            <C>
Land and land improvements                                                     $ 2,012
Buildings and leasehold improvements                                            14,756
Furniture and equipment                                                          9,362
                                                                               -------
                                                                                26,130
Less- Accumulated depreciation                                                  (5,769)
                                                                               -------
                                                                               $20,361
                                                                               =======
</TABLE>

5.  INCOME TAXES:

Income taxes are accounted for in accordance with Statement of Financial
Accounting Standards No. 109 (SFAS 109). SFAS 109 requires that HealthFirst
follow the liability method of accounting for deferred income taxes. Differences
between financial reporting and tax basis is primarily due to the use of the
cash method of accounting for income tax purposes.

Deferred income taxes reflect the net tax effects of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of
HealthFirst's deferred tax assets and liabilities are as follows at December 31,
1996:

<TABLE>
<S>                                                                  <C>
Deferred tax assets:
  Cash to accrual adjustments                                        $ 4,570
  Less- Valuation allowance                                             (327)
                                                                     -------
          Net deferred tax asset                                       4,243

Deferred tax liabilities:
  Cash to accrual adjustments                                         (3,679)
  Excess tax depreciation                                               (564)
                                                                     -------
          Gross deferred tax liabilities                              (4,243)
                                                                     -------
          Net deferred tax asset                                     $  --
                                                                     =======
</TABLE>


<PAGE>   26

                                      -6-

The provision (benefit) for income taxes is as follows:

<TABLE>
<CAPTION>
                                                   Year Ended
                                                  December 31,
                                         ----------------------------
                                         1995      1996        1997
                                         ----     -------     -------
<S>                                      <C>      <C>         <C>
Current:
  Federal                                $119     $  --       $  --
  State                                    17        --          --
                                                                 --
Deferred:                                                        --
  Federal                                  63      (1,614)       --
  State                                     9        (285)       --
                                         ----     -------     -------
                                         $208     $(1,899)    $  --
                                         ====     =======     =======
</TABLE>

The differences between the provision (benefit) for income taxes and the amount
computed by applying the statutory federal income tax rate to income before
taxes were as follows:

<TABLE>
<CAPTION>
                                                                        December 31,
                                                               ---------------------------
                                                               1995      1996       1997
                                                               ----     -------    -------
<S>                                                            <C>      <C>        <C>
Federal tax (benefit) at statutory rate                        $175     $(2,105)   $  --
Add (deduct):
  State income tax (benefit), net of federal benefit             17        (301)      --
  Change in valuation allowance                                 --          328       --
  Other                                                          16         179       --
                                                               ----     -------    -------
Provision (benefit) for income taxes                           $208     $(1,899)   $  --
                                                               ====     =======    =======
</TABLE>

In 1996, HealthFirst recognized a valuation allowance in an amount equal to its
net deferred tax assets of $328 because of uncertainty with respect to the
realization of the related tax benefits in future years.

As of December 31, 1997, the net income before provision for income taxes
represents the results of operations for Old HealthFirst from January 1 to
January 31, 1997. The valuation reserve against the deferred tax assets was
reversed in an amount equal to the current tax expense, resulting in no tax
provision being reflected in the 1997 statement of operations. The operations of
the New PC for the remainder of the period have resulted in no net income and,
accordingly, no current tax expense is necessary.



<PAGE>   27

                                      -7-

6.  LONG-TERM DEBT:

Long-term debt at December 31, 1996 is as follows:

<TABLE>
<S>                                                                                            <C>
Note payable, due in monthly installments of principal and interest of $16
    through July 2000, with a final payment of $1,636, bearing interest at
    9.875%. The note is secured by a first mortgage on land, buildings, and
    improvements.                                                                              $1,714

Note payable, due in monthly installments of principal and interest through
    January 2002, bearing interest at 8.4%. The note is secured by inventory,
    furniture, and equipment.                                                                   1,964

Construction loan payable, final payment of principal and interest due in
    January 1997, bearing interest at prime plus 1% (8.25% at December 31,
    1996). The note is secured by building and land.                                            3,706

Note payable, due in annual principal installments of $115 through August 2011,
    bearing interest at 7.9%.                                                                   1,650

Note payable due in monthly installments of $8 including interest through October
    2000, bearing interest at 8.75%                                                               314

Note payable due in monthly installments of $7 plus interest through January 1999,
    bearing interest at 9.875%                                                                    177

Note payable, related party, due in monthly installments of $1 including interest
    through 1998, bearing interest at 6%                                                            8
                                                                                               ------
          Total long-term debt                                                                  9,533

Less- Current portion                                                                           4,467
                                                                                               ------
          Long-term debt, net of current portion                                               $5,066
                                                                                               ======
</TABLE>

Management converted the construction loan to a mortgage loan in 1997, extending
the maturity of the loan to February 2017.

HealthFirst maintained a revolving line-of-credit agreement with a bank
providing up to $2,500, secured by inventory, accounts receivable and equipment.
The line-of-credit bore interest at the lender's prime rate (8.25% at December
31, 1996) plus .5% and matures April 30, 1997. At February 1, 1997, the
line-of-credit was consolidated into a $7,500 line-of-credit as a result of the
reorganization transaction (Note 1).



<PAGE>   28

                                       -8-

7.  LEASE COMMITMENTS:

Capital Leases

HealthFirst leases certain medical equipment and facilities under agreements
which are classified as capital leases. The equipment leases have original terms
of five years and have either a bargain purchase option or a transfer of title
at the end of the lease. The building lease is with Gateway Properties LLC (Note
12) for a term of 21 years. Leased capital assets included in property, plant
and equipment are as follows at December 31, 1996:

<TABLE>
<S>                                                                                                 <C>
Buildings and leasehold improvements                                                                $3,574
Furniture and equipment                                                                                264
                                                                                                    ------
                                                                                                     3,838
Less- Accumulated amortization                                                                        (682)
                                                                                                     -----
                                                                                                    $3,156
                                                                                                    ======
</TABLE>

Operating Leases

Leases that do not meet the criteria for capitalization are classified as
operating leases. Such lease commitments are primarily for facilities and
equipment, and the related rentals are charged to operations as incurred.

Direct Financing Lease Obligation

In May 1996, HealthFirst sold three facilities to HealthFirst Properties LLC
(Note 12) under a sale/leaseback arrangement. The facilities were sold for
$12,550, of which $11,550 is due in the form of an 8% interest-bearing note
receivable due in monthly installments through April 2016. The remainder was
received in cash. The transaction has been accounted for as a financing, wherein
the property and related debt remains on the books and will continue to be
depreciated. A financing obligation representing the proceeds of $1,000 has been
recorded and will be reduced based on payments under the lease. As sales
proceeds are received from the LLC, they will be credited to a financing
obligation, and amortized as a reduction of operating expenses over the
remaining life of the lease. The amount owed on the financing obligation at
December 31, 1996 was $929 of which $76 is due within one year. The lease has a
term of 20 years and requires minimum annual rental payments of $1,318 in
1998, 1999, 2000, 2001 and 2002 and $17,680 thereafter. The financing
obligation and lease payments were assumed by PPI at February 1, 1997.

8.  EMPLOYEE BENEFIT PLANS:

Retirement Plans

HealthFirst has a noncontributory profit sharing plan covering all employees who
are eligible subject to certain requirements. HealthFirst, at the discretion of
the Board of Directors, contributes an annual amount not to exceed the maximum
allowed under the Internal Revenue Code. No contributions to the Plan were made
in 1997, 1996 and 1995. HealthFirst does not foresee making contributions to the
profit sharing plan in the future.



<PAGE>   29

                                      -9-

HealthFirst has a 401(k) plan covering all employees who are eligible subject to
certain requirements. Employees contribute between 2% to 10% of their annual
compensation. HealthFirst matches employee contributions at a rate of 10% plus a
discretionary percentage determined by the Board of Directors. The contributions
to the Plan were $69 and $110 in 1995 and 1996, respectively.

HealthFirst also has a defined contribution money purchase pension plan which is
a plan in which all employees are eligible to participate subject to certain
requirements. HealthFirst contributes 8% of employees' compensation which does
not exceed the Social Security integration level ($62 at December 31, 1996),
plus a higher percentage of the amount in excess of the integration level for
the Plan year. Contributions in 1995 and 1996 were $1,133 and $1,523,
respectively.

Supplemental Pension Plan

In 1987, HealthFirst entered into a supplemental pension plan with eight of its
physicians providing for fixed monthly payments over five years commencing with
the physicians' retirements or terminations. The physicians receive payments
upon retirement or termination if certain vesting requirements have been met.
The liability under this agreement is being accrued over the physicians'
estimated remaining service periods before becoming fully vested. On the vesting
date, the present value of the future benefit payments will have been accrued.
HealthFirst has accrued $176 for the plan at December 31, 1996.

Suburban Profit-Sharing Plan

As part of the 1996 acquisition of Suburban, HealthFirst assumed a
profit-sharing plan in which all former employees of Suburban are eligible to
participate subject to certain requirements. The plan is funded by discretionary
employer contributions as determined by the Board of Directors on an annual
basis. The amount of employer contributions, if any, is allocated to eligible
employees based on employee compensation. HealthFirst's contribution for 1996
was $390.

Bonus Compensation Plan

In February 1996, HealthFirst established a bonus compensation plan for eligible
employees. Employees are vested after five years of employment with credit for
prior service. A substantial portion of the participants were fully vested as of
December 31, 1996. The total payout of approximately $5.25 million will be over
a period of eight years. HealthFirst is accruing for the estimated present value
of the bonus compensation over the estimated period of the employees' active
employment from the date the contract was signed until the date they are fully
vested. Compensation expense recognized during 1996 was approximately $3,900, a
portion of which has been paid. The expense was recorded to provider
compensation and benefits. The amount accrued at December 31, 1996, is $3,502,
of which $502 is included in current liabilities and the remainder is included
in deferred compensation. The liability was assumed by PPI at February 1, 1997.



<PAGE>   30

                                      -10-

9.   PROFESSIONAL LIABILITY:

HealthFirst maintained a claims-made professional liability insurance policy.

At February 1, 1997, HealthFirst's professional liability insurance policy was
consolidated into a Physician Partners, Inc. policy as a result of the
reorganization transaction (Note 1). The consolidated claims-made policy has no
deductible and includes full prior acts coverage. Management believes the
coverage is adequate to cover any potential claims.

10.  COMMITMENTS AND CONTINGENCIES:

Legal proceedings

HealthFirst is subject to various legal proceedings and claims which arise in
the ordinary course of business. In the opinion of management, although the
ultimate dispositions of these proceedings are not determinable, adverse
determinations in any or all of such proceedings would not have a material
adverse effect upon the financial position or results of operations of
HealthFirst.

Compliance with Rules and Regulations

The healthcare industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
healthcare program participation requirements, reimbursement for patient
services and Medicare and Medicaid fraud and abuse. Recently, government
activity has increased with respect to investigations and allegations
concerning possible violations of fraud and abuse statutes and regulations by
healthcare providers. Violations of these laws and regulations could result in
expulsion from government healthcare programs, together with the imposition of
significant fines and penalties, as well as significant repayments for patient
services previously billed. Management believes that HealthFirst is in
compliance with the fraud and abuse regulations as well as other applicable
government laws and regulations. Compliance with such laws and regulations can
be subject to future government review and interpretation as well as regulatory
actions unknown or unasserted at this time.

11.  EARNINGS PER SHARE:

All share and per share data have been retroactively restated to give effect to
the recapitalization resulting from the Transactions.

12.  RELATED PARTY TRANSACTIONS:

Coordinated Health Network, Inc.

In December 1993, HealthFirst became a one-third shareholder in Coordinated
Health Network, Inc. (CHN). CHN was formed to obtain patient contracts under the
Oregon Health Plan and generate purchasing discounts. The investment in CHN was
accounted for under the equity method. In 1995, HealthFirst paid premiums to CHN
of $106 and CHN paid HealthFirst $622 in 1995 for claims. No premiums were paid
or received in 1996 or 1997. CHN was legally dissolved in 1996.

Northwest Physicians Alliance

In 1995, HealthFirst invested $52 for a one-third share in Northwest Physicians
Alliance (the Alliance), which was formed with Blue Cross/Blue Shield of Oregon,
two local hospital systems and several physician groups. The Alliance has been
accounted for under the equity method. The Alliance is intended to be the
primary delivery network for Blue Cross/Blue Shield's HMO Oregon product in the
Portland area. The Alliance was legally dissolved in 1998.

HealthFirst Properties LLC

HealthFirst Properties LLC (HPLLC) was formed by certain shareholders of
HealthFirst in 1996 to acquire three clinic buildings from HealthFirst. HPLLC
purchased these properties from HealthFirst for an aggregate purchase price of
$12,550, to be paid under an installment sale contract with a 20-year term.
HPLLC made a $1,000 down payment to HealthFirst. Simultaneous with the execution
of the installment sale contract, HealthFirst agreed to lease back the three
buildings from HPLLC under a 20-year lease agreement. This transaction has been
recorded as a direct financing lease. Accordingly, the monies received from
HPLLC have been recorded as a direct financing lease obligation and the related
property is included in property, plant and equipment in the accompanying
financial statements.



<PAGE>   31

                                      -11-

Gateway Properties LLC

Gateway Properties LLC (Gateway) is owned by several former shareholders of
Suburban. Throughout 1995, Suburban recorded notes receivable for various
payments made on behalf of Gateway. The note receivable at December 31, 1996 was
$144. The terms of the note include monthly installments of principal and
interest of $5 through August 1999 with interest accruing at 7%. HealthFirst has
signed a capital lease to occupy a new clinic building for a term expiring in
August 2015.

Stock Subscriptions

HealthFirst has notes receivable from certain stockholders for their purchase of
common stock. The notes mature at various stages through the year 2008.

Restricted Stock Awards

During 1996, HealthFirst sold shares of Series 1 Class A common stock to ten
providers at prices below their estimated fair value for accounting
purposes. The terms of the related Restricted Stock Agreements require
forfeiture of the stock unless the grantee remains employed by HealthFirst until
February 1, 2002.

The excess of the estimated fair value of the stock over the amount to be paid
of $1,756 is to be recognized as compensation expense. Of this amount, $502 and
$348 has been recognized as compensation expense in 1996 and 1997, respectively.
The remaining amount will be amortized ratably to income over the next
five years.

13.  BUSINESS ACQUISITION:

On February 1, 1996, HealthFirst acquired all of the outstanding stock of
Suburban in exchange for 2,200 shares of HealthFirst Series 2 Class A stock.
Following the acquisition, the name of Suburban was changed to HealthFirst
Management Services Organization, P.C. Results of operations after the
acquisition date are included in the December 31, 1996 statement of operations.
The following pro forma information has been prepared assuming that this
acquisition had taken place at the beginning of 1995. Because fair values of
purchased assets approximated their carrying values, no material pro forma
adjustment was necessary to adjust historical depreciation and amortization.

The pro forma financial information is not necessarily indicative of the results
of operations as they would have been had the acquisition been consummated on
the assumed dates.

<TABLE>
<CAPTION>
                                                                      Year Ended
                                                                     December 31,
                                                               -----------------------
                                                                1995           1996
                                                               --------       --------
<S>                                                            <C>            <C>
Net revenues less provider compensation and benefits           $ 39,625       $ 39,364
Operating expenses                                              (40,364)       (45,452)
Other expenses, net                                                (215)           (92)
                                                               --------       --------
          Net loss before income taxes                             (954)        (6,180)

Benefit for income taxes                                            403          1,899
                                                               --------       --------
          Net loss                                             $   (551)      $ (4,281)
                                                               ========       ========
</TABLE>



<PAGE>   32

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
        AND FINANCIAL DISCLOSURE

None.


                                    PART III

ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT


<TABLE>
<CAPTION>
Current                   Age  Title                                       Term
-------                   ---  -----                                       ----
<S>                       <C>  <C>                            <C>                  <C> <C>
Pete Perry, M.D.          56   Board President                March 18, 1997       to  Present
Resa Bradeen, M.D.        36   Director                       September 18, 1996   to  Present
James Ritzenthaler, M.D.  47   Director                       September 18, 1996   to  Present
David Shute, M.D.         39   Director and Secretary         March 18, 1997       to  Present
John Teller, M.D.         41   Director                       September 18, 1996   to  Present
John Zelko, M.D.          43   Director                       January 1, 1998      to  Present
Robert Bailey, M.D.       47   Director                       January 1, 1998      to  Present
Malcolm McAninch, M.D.    43   Prior Director and Treasurer   March 18, 1997       to  January 1, 1998
Keith Hansen, M.D.        52   Prior Director                 March 18, 1997       to  January 1, 1998
</TABLE>


PETE PERRY, M.D. is the Board President at HealthFirst. Dr. Perry attended
Princeton University and received his bachelor's degree in Religion and
Literature in 1963 and he earned his medical degree from Stanford University in
1968. An internship followed from 1968 to 1970 at the University of Pennsylvania
Hospital. He also served a residency at Good Samaritan Hospital in Portland,
Oregon. Dr. Perry was Board Certified in Internal Medicine in 1974. Prior to
joining HealthFirst, Dr. Perry was in private practice.

RESA BRADEEN, M.D. is a Director of HealthFirst. Dr. Bradeen attended the
University of Tennessee in Chattanooga, where she received a bachelor's degree
in Elementary Education in 1983 and a master of Education degree in Special
Education in 1985. She earned her medical degree from the University of
Louisville School of Medicine, Louisville, Kentucky, in 1990, and completed her
postgraduate training in Pediatrics in 1993 at Oregon Health Sciences University
in Portland, Oregon. She is the co-chair of the Pediatrics Department at
HealthFirst and was the Chair of Suburban Medical Clinic's Pediatrics Department
in 1994. In addition to serving on HealthFirst's Board of Directors, she is the
medical site Director at HealthFirst's Powell Valley Office and a representative
on the Clinical Quality Committee for the Good Health Plan of Oregon.

JAMES RITZENTHALER, M.D. is a Director of HealthFirst. Dr. Ritzenthaler attended
undergraduate and medical school at the University of Colorado, in Boulder,
Colorado. After receiving his medical degree in 1981, he completed a residency
at Good Samaritan Hospital in 1984. Board Certified in Internal Medicine, Dr.
Ritzenthaler previously served as Medical Director for Metropolitan Clinic.

DAVID SHUTE, M.D. is a Director of HealthFirst. He received his bachelor's
degree and his medical degree from the University of Illinois in 1980 and 1984,
respectively. Dr. Schute served a residency at Oregon Health Sciences University
in Portland, Oregon, from 1985 to 1987. He was Board Certified by the American
Board of Internal Medicine in 1987. In addition, Dr. Schute is also a member of
the Multnomah County Medical Society and the Oregon Medical Association.

JOHN TELLER, M.D. is a Director of HealthFirst. Dr. Teller earned a bachelor's
degree from Oregon State University, Corvallis, Oregon, in 1978 and his medical
degree from Oregon Health Sciences University, Portland, Oregon, in 1982. An
internship followed in 1983 at Hennepin County Medical Center in Minneapolis,
Minnesota. He also served a residency at Lutheran Medical Center, Brooklyn, New
York, in 1985, where he was Chief Resident. Prior to joining HealthFirst, Dr.
Teller was a physician with Tualatin Medical Center. Board Certified in Family
Practice, Dr. Teller has been in practice since 1985.


<PAGE>   33

JOHN ZELKO, M.D. is a Director of HealthFirst. Dr. Zelko received his bachelor's
degree from the University of Hawaii in 1974 and earned his medical degree from
the University of Hawaii, John A. Burns School of Medicine in 1978. Dr. Zelko
completed an internship and residency at University of Colorado Health Sciences
Center in General Surgery. He was Board Certified by the American Board of
Surgeons in 1984. Prior to joining HealthFirst, Dr. Zelko was a surgeon at
Metropolitan Clinic, P.C.

ROBERT BAILEY, M.D. is a Director of HealthFirst. He received his undergraduate
degree in Humanities and Chemistry from Eastern Oregon State College. He
received his medical degree from Oregon Health Sciences University in 1985. Dr.
Bailey was Board Certified in Internal Medicine in 1986 and completed an
internship and residency at Good Samaritan Hospital and Medical Center in
Portland, Oregon in 1988.

MALCOLM MCANINCH, M.D. was a Director of HealthFirst. Dr. McAninch earned a
bachelor of science degree in Biology from the University of Puget Sound in 1977
and a doctor of medicine from Jefferson Medical College of Thomas Jefferson
University in 1981. Dr. McAninch completed an internship and residency at Good
Samaritan Hospital and Medical Center in 1985 where he was the Chief Resident in
Internal Medicine. He is Board Certified in Internal Medicine from the American
Board of Internal Medicine. Prior to joining HealthFirst, Dr. McAninch was a
physician with Elma Family Practice Clinic from 1985 to 1987. Dr. McAninch had
been a physician with Metropolitan Clinic, the direct predecessor of
HealthFirst, since 1987 and was on its Board of Directors from 1990 to 1996. Dr.
McAninch's term as Board Director ended on January 1, 1998.

KEITH HANSEN, M.D. was a Director of HealthFirst. Dr. Hansen graduated from the
University of California, Berkeley in 1967 with a degree in Physiology. In 1971,
Dr. Hansen received his medical degree from Bowman Gray School of Medicine, Wake
Forest University. A residency in Internal Medicine followed from 1971 through
1974 at UCLA Hospital and Clinics in Los Angeles, California. He was Board
Certified in Internal Medicine in 1974 and Hematology in 1978. Dr. Hansen is a
Director of the Columbia River Oncology Program's Adult Autologous Bone Marrow
Transplantation Program and has been a physician with the Metropolitan Clinic,
P.C., the predecessor of HealthFirst, since 1978. Dr. Hansen's term as Director
of HealthFirst ended on January 1, 1998.

ITEM 11: EXECUTIVE COMPENSATION

COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS

Currently, HealthFirst Directors are entitled to receive compensation for
serving on the Board of Directors an amount equal to $10,000 per year. An
additional $2,000 per year was paid to Dr. Ritzenthaler and Dr. Teller for
serving on the Joint Management Board. Prior to the Merger, Directors received
compensation of $8,500 per year. Directors are also reimbursed for reasonable
and actual out-of-pocket expenses incurred in connection with duties performed
as Directors.

Since March 1997, Pete Perry, M.D. has served as President, Director, and
Provider of HealthFirst. For those duties, Dr. Perry received an annual salary.
Pete Perry, M.D. equally divides his time between his responsibilities as a
Provider of the Company and Board President. Other then the compensation
provided to Dr. Perry as President, no compensation was provided to any
executive officer of HealthFirst for their duties as officers in the years ended
1995, 1996 and 1997.


<PAGE>   34

The following table summarizes the compensation received by the Company's
Executive Officers:


<TABLE>
<CAPTION>


                                                                Long-Term
                                                           Compensation Awards
                                          Annual         ------------------------
                                       Compensation      Restricted    Securities
Name and Principal                  -------------------    Stock       Underlying       All Other
Position                    Year    Salary(1)     Bonus    Awards       Options      Compensation(2)
------------------          ----    ---------     -----    ------       -------      --------------
<S>                         <C>     <C>           <C>     <C>            <C>            <C>

Pete Perry, M.D.            1997    150,000        --        --           --             950
  President and Director
</TABLE>


(1)   Salary information is disclosed on a calendar year basis. The Officer may
      receive certain perquisites and personal benefits, the dollar amounts of
      which are below current Securities and Exchange Commission thresholds for
      reporting requirements.

(2)   This column includes Company contributions and allocations under the
      Company's 401(k) retirement plan.


The following table summarizes the compensation received by the Company's Board
of Directors:

<TABLE>
<CAPTION>
Name                                   1995          1996           1997
----                                   ----          ----           ----
<S>                                    <C>          <C>            <C>
Resa Bradeen, M.D.                        --        8,500          10,000
James Ritzenthaler, M.D.               8,500        8,500          12,000
David Shute, M.D.                         --           --           8,333
John Teller, M.D.                      8,500        8,500          12,000
Malcolm McAninch, M.D.                 8,500        8,500           8,333
Keith Hansen, M.D.                        --           --           8,333
</TABLE>

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Set forth below is current information concerning beneficial ownership of the
Company Common Stock as of March 30, 1998 by (i) each of the nominees and
current Directors, (ii) each of the named executive officers, (iii) all current
Directors and executive officers of the Company as a group, and (iv) all persons
known by the Company to be the beneficial owners of five percent or more of
Company Common Stock.
<TABLE>
<CAPTION>
                                       Shares of Company Common
HEALTHFIRST                            Stock Beneficially Owned      Percent Outstanding *
-----------                            ------------------------      ---------------------
<S>                                    <C>                           <C>
Pete Perry, M.D.                                  1                          1.1%
John Zelko, M.D.                                  1                          1.1%
Resa Bradeen, M.D.                                1                          1.1%
Robert Bailey, M.D.                               1                          1.1%
James Ritzenthaler, M.D.                          1                          1.1%
David Shute, M.D.                                 1                          1.1%
John Teller, M.D.                                 1                          1.1%
All directors and executive officers
of the Company as a group                         7                          7.4%
</TABLE>

* Rounded to the nearest tenths.

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.


<PAGE>   35

                                     PART IV

ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K


(a) Financial Statements, Financial Statement Schedules and Exhibits
 (1)  Financial Statements
      The following financial statements of HealthFirst Medical Group, PC are
      included in Part II, Item 8 of this report:

<TABLE>
<CAPTION>

      <S>                                                                            <C>
      Report of Independent Public Accountants
      Balance Sheets - December 31, 1996 and 1997
      Statements of Operations - Years ended December 31, 1995, 1996 and 1997
      Statements of Shareholders' Equity - Years ended December 31, 1995, 1996
       and 1997
      Statements of Cash Flows - Years ended December 31, 1995, 1996 and 1997
</TABLE>

 (2)  Financial Statement Schedules
      None required.

 (3)  Exhibits

      2.1*  Amended and Restated Agreement and Plan of Reorganization and
            Merger, dated as of September 19, 1996, as amended on November 4,
            1996, November 29, 1996 and December 31, 1996, among Physician
            Partners, Inc., The Corvallis Clinic, P.C., HealthFirst Medical
            Group, P.C. and Medford Clinic, P.C.

      3.1** Amended and Restated Articles of Incorporation of HealthFirst
            Medical Group, P.C.

      3.2** Bylaws of HealthFirst Medical Group, P.C.

      10.1  Amended and Restated 1997 Stock Option Plan for all Non-Employee
            Providers Affiliated with PPI dated November 12, 1997

      27.1  Financial Data Schedule

----------
      *     Previously filed connection with Registration Statement No.
            333-15595 and hereby incorporated by reference
      **    Previously filed and hereby incorporated by reference
<PAGE>   36
                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                            HealthFirst Medical Group, P.C.
                                            (Registrant)

                                         By /s/ David L. Perry, M.D.
                                            -----------------------------------
                                            David L. Perry, M.D.
                                            President and Director

                                            3/30/98

Pursuant to the requirements of 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.

By  /s/ David L. Perry, M.D.             By /s/ David Shute, M.D.
    ---------------------------------       ------------------------------------
    David L. Perry, M.D.                    David Shute, M.D.
    President and Director                  Secretary and Director

    3/30/98                                     3/30/98

By  /s/ Karen M. Shepard                 By /s/ Resa Bradeen, M.D.
    ---------------------------------       ------------------------------------
    Karen M. Shepard                        Resa Bradeen, M.D.
    Chief Financial Officer and             Director
    Controller

    3/30/98                                 3/30/98

By  /s/ James Ritzenthaler, M.D.         By /s/ John Teller, M.D.
    ---------------------------------       ------------------------------------
    James Ritzenthaler, M.D.                John Teller, M.D.
    Director                                Director

    3/30/98                                 3/30/98

By  /s/ John Zelko, M.D.                 By /s/ Robert Bailey, M.D.
    ---------------------------------       ------------------------------------
    John Zelko, M.D.                        Robert Bailey, M.D.
    Director                                Director

    3/30/98                                 3/30/98