SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - QSB
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-23998
FIRST CHOICE HEALTH NETWORK, INC.
(Name of small business issuer as specified in its charter)
Washington 91-1272766
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
1100 Olive Way
Suite 1480
Seattle, Washington 98101
(Address of principal
executive offices)
(206)292-8255
(Issuer's telephone number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15 (d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes __X___ No ______
The aggregate number of Registrant's shares of Class A Common Stock and Class B
Common Stock outstanding on November 10, 1996 was 656 shares and 34,800 shares,
respectively.
Transitional Small Business Disclosure Format ( check one ):
Yes ______ No __X__
Page 1 of 25 Pages
FIRST CHOICE HEALTH NETWORK, INC.
INDEX TO FORM 10-Q
Page
Part I Financial Information
Item I Financial Statements
Consolidated Balance Sheets
at September 30, 1996 and
December 31, 1995 . . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations
for the Three and Nine Months Ended
September 30, 1996 and 1995 . . . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Nine Months Ended
September 30, 1996 and 1995. . . . . . . . . . . . . . . . 6
Notes to Consolidated
Financial Statements . . . . . . . . . . . . . . . . . . . 8
Item 2 Management's Discussion and Analysis
or Plan of Operation . . . . . . . . . . . . . . . 19
Part II Other Information
Item 1 Legal Proceedings . . . . . . . . . . . . . . . 23
Item 2 Changes in Securities . . . . . . . . . . . . . 23
Item 3 Defaults Upon Senior Securities . . . . . . . . 23
Item 4 Submission of Matters to a
Vote of Security Holders . . . . . . . . . . . 23
Item 5 Other Information . . . . . . . . . . . . . . . 24
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . 24
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
September 30, 1996 and December 31, 1995
September 30, December 31,
Assets 1996 1995
(Unaudited)
Current assets:
Cash and cash equivalents $2,465,937 2,129,006
Service fees receivable, net of allowance for
doubtful accounts of $96,187 in 1996 and 1995 939,430 1,104,164
Investment securities
available for sale (note 4) 2,111,135 1,276,783
Federal income tax receivable 29,495 90,129
Prepaid expenses 202,397 182,469
Other assets 15,000 15,625
Total current assets 5,763,394 4,798,176
Furniture, equipment and computer software:
Furniture and equipment 902,154 813,663
Computer software 149,558 149,558
License fees (note 6) 193,812 191,876
1,245,524 1,155,097
Less accumulated depreciation and amortization 668,724 574,377
Net furniture, equipment and
computer software 576,800 580,720
Investment securities available for sale
(note 4) 2,430,265 1,940,454
Deferred Federal income taxes, net (note 5) 27,664 -
Goodwill, net of accumulated amortization of
$10,000 (1996) and $5,500 (1995) (note 1) 80,000 84,500
$8,878,123 7,403,850
See accompanying notes to consolidated financial statements (unaudited).
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
September 30, 1996 and December 31, 1995
September 30, December 31
Liabilities and Shareholders' Equity 1996 1995
(unaudited)
Current liabilities:
Note payable $ - 45,000
Accounts payable 210,122 206,606
Accrued expenses 201,990 212,420
Claim expenses, net of reserves of
$282 (1996) and $0 (1995) 5,986 -
Unearned premiums 7,515 -
Deferred Federal income taxes, net (note 5) 270,199 286,451
Other liabilities 13,600 11,575
Total current liabilities 709,412 762,052
Deferred Federal income taxes, net (note 5) - 25,062
Total liabilities 709,412 787,114
Shareholders' equity (note 2):
Common stock:
Class A, par value $1. Authorized 30,000
shares; issued and outstanding 656 shares
in 1996 and 676 shares in 1995 656 676
Class B, par value $1. Authorized 70,000
shares; issued and outstanding 34,800 shares
in 1996 and 29,000 in 1995 34,800 29,000
Additional paid-in capital 3,552,217 2,630,268
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 3,168,510 2,502,946
Net unrealized loss on investment securities
available for sale, net of deferred taxes
of $30,693 in 1996 and $9,407 in 1995
(notes 4 and 5 ) ( 59,580) ( 18,262)
Total shareholders' equity 8,168,711 6,616,736
Commitments and subsequent events (notes 3, 6, and 8)
$8,878,123 7,403,850
See accompanying notes to consolidated financial statements (unaudited).
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Income
(Unaudited)
For the Three Months and For the Nine Months Ended September 30, 1996 and 1995
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
Operating revenue (Note 7) $1,555,107 1,299,430 $4,309,355 3,775,564
Less: incurred claims ( 7,084) - (7,084) -
Gross profit 1,548,023 1,299,430 4,302,271 3,775,564
Operating expenses:
Payroll and related 608,667 536,136 1,922,925 1,629,669
Selling, general and 590,667 519,486 1,584,646 1,741,032
administrative costs
Total operating expenses 1,199,334 1,055,622 3,507,571 3,370,701
Operating income 348,689 243,808 794,700 404,863
Other income:
Interest and dividends 74,573 59,857 218,839 186,557
Other income (loss) ( 3,004) 775 10,060 ( 3,094)
71,569 60,632 228,899 183,463
Income before Federal 420,258 304,440 1,023,599 588,326
income taxes
Federal income taxes (Note 5) 170,217 98,598 358,035 197,728
Net income $ 250,041 205,842 $ 665,564 390,598
Net income per common share $ 5.10 $ 4.37 $ 13.58 8.29
See accompanying notes to consolidated financial statements (unaudited).
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended September 30, 1996 and 1995
1996 1995
Cash flows from operating activities:
Net income $ 665,564 390,598
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 73,842 93,643
Deferred Federal income taxes, net ( 47,692) ( 184,929)
(Gains) losses realized on sales of
investment securities ( 11,901) 3,094
Losses realized on sale of
equipment and furnishings 1,841 804
Change in certain assets and liabilities:
Decrease in service fees receivable 164,734 520,575
(Increase) decrease in prepaid expenses ( 19,928) 9,831
Increase (decrease) in prepaid Federal
income tax 60,634 ( 31,184)
Increase (decrease) in accounts payable ( 10,068) 37,690
Decrease in accrued expenses ( 10,594) ( 45,136)
Increase in claim expenses 5,986
Increase in unearned premiums 7,515
Decrease in Federal income taxes payable - ( 21,578)
Total adjustments 214,369 382,810
Net cash provided by operating activities 879,933 773,408
Cash flows from investing activities:
Purchase of investment securities available
for sale ( 5,025,409) ( 758,222)
Sales of investment securities available
for sale 1,002,018 71,475
Maturities of investment securities 2,600,000
Purchase of furniture, equipment and computer
software ( 91,301 ) ( 193,684)
Sale of equipment and furnishings 595
Principal received, bonds 89,121 48,616
Note receivable 18,500
Acquisition of goodwill ( 45,000)
Assignment of call option ( 60)
Net cash used in investing activities ( 1,425,631) ( 857,720)
Cash flows from financing activities:
Payment of note payable ( 45,000)
Issuance of Class A common stock and membership
rights to physicians 3,934
Issuance of Class B common stock and membership
rights to hospitals 931,484
Repurchase of Class A common stock and membership
rights from physicians ( 3,855) ( 2,500)
Net cash provided by financing activities 882,629 1,434
Increase (decrease) in cash and cash equivalents 336,931 ( 82,878)
Cash and cash equivalents at beginning of period 2,129,006 1,934,776
Cash and cash equivalents at end of period $ 2,465,937 1,851,898
(Continued)
See accompanying notes to consolidated financial statements (unaudited).
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended September 30, 1996 and 1995
1996 1995
(Continued)
Supplemental disclosures of cash flow information:
Cash paid during the period for Federal income taxes,
net of refunds $ 345,093 435,204
Supplemental disclosure of noncash investing activities:
Note payable incurred for acquisition of goodwill $ - 45,000
Unrealized gains (losses) on securities available for sale:
Current $ 56,607 30,567
Noncurrent ( 139,955) ( 90,546)
$( 83,348) ( 59,979)
Unrealized losses on securities sold under agreements
to repurchase: $( 6,925) -
Deferred income taxes on unrealized gains (losses) on securities
available for sale and securities sold under agreements to repurchase:
Current $( 16,892) ( 10,393)
Noncurrent 47,585 30,786
$ 30,693 20,393
See accompanying notes to consolidated financial statements (unaudited).
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(1) Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
First Choice Health Network, Inc. (Company) was incorporated under the laws
of the State of Washington on September 28, 1984. The Company was formed to
organize a network of independent participating physicians and hospitals to
provide a comprehensive, managed health care delivery system for group plans
established by employers and benefit groups. The Company's business is
conducted primarily in Washington, Oregon and Alaska.
In June, 1996, the Company began receiving insurance premium revenue through
the operations of its wholly owned subsidiary, First Choice Health Plan, Inc.
(b) Principles of Consolidation
The consolidated financial statements include the consolidated accounts of
the Company and its wholly-owned subsidiary, First Choice Health Plan, Inc.,
a health care services contractor which was formed on January 31, 1995. All
significant intercompany balances have been eliminated in consolidation.
(c) Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. At
September 30, 1996 and December 31, 1995, cash equivalents consist of money
market funds amounting to $109,468 and $100,764, and cash management funds
of $2,033,574 and $1,880,210, respectively.
(d) Operating Revenue
Operating revenue consists of network access fees and hospital
administrative fees. Network access fees are recognized as earned during the
month of coverage and are recorded at contractual rates. Hospital
administrative fees are recognized as earned in the month hospital claims are
incurred by a subscriber and are recorded at a contractual percentage of the
claims.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(e) Investment Securities
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investment in Debt and
Equity Securities, (Statement 115). Statement 115 applies to investments in
equity securities that have a readily determinable fair market value and all
debt securities.
Under Statement 115, investments are classified as held-to-maturity, trading
securities, or available-for-sale. The Company classifies all investment
securities as available-for-sale. Statement 115 requires that all securities
classified as available-for-sale be recorded at fair market value on the
balance sheet, with unrealized holding gains and losses excluded from earnings
and recognized as a separate component of shareholders' equity. Declines in
the fair values of investment securities available for sale determined to be
other than temporary are recognized as a component of net income.
The cost used in determining the gain or loss on sales of marketable equity
securities and debt securities is average cost and specific identification,
respectively.
(f) Furniture, Equipment, Computer Software and License Fee
Furniture, equipment, computer software and license fee are recorded at cost.
Depreciation and amortization are computed using the straight-line method
over the lesser of the estimated useful lives of the assets, licensing
agreement or lease term, ranging from three to five years.
(g) Goodwill
Goodwill is determined as the difference between the purchase price and fair
market value of net assets purchased. Goodwill is amortized using the
straight-line method over fifteen years.
(h) Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
the deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(i) Advertising
The Company expenses advertising costs as incurred. Advertising expense
amounted to $1,675 and $27,159 for the nine months ended September 30, 1996
and 1995, respectively.
(j) Accounts Receivable
Accounts receivable consists primarily of an estimate for hospital
administrative fees receivable related to claims incurred on or before the
balance sheet date, but not reported.
The Company evaluates the reasonableness of hospital administrative fees
receivable based upon claims reported in subsequent periods. These estimates
are subject to the effects of trends in claim. Although considerable
variability is inherent in such estimates, management believes that the
hospital administrative fees receivable are reasonable. The estimates are
continually reviewed and adjusted as necessary as new information becomes
known; such adjustments are included in the current year operations.
The Company performs periodic credit evaluations of its customers and
maintains allowance for potential credit losses.
(k) Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(2) Shareholders' Equity
(a) Ownership of Stock
Class A common stock may be held solely by physicians licensed in the State
of Washington who contract with the Company to provide health care services
and who hold active, associate or provisional medical staff privileges at one
or more of the hospitals that contract with the Company to provide health
care services.
Class B common stock may be held by hospitals in the State of Washington
that contract with the Company to provide health care services.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(b) Voting Rights
Holders of each outstanding share of Class A or Class B common stock are
entitled to one vote on each matter submitted to a vote at meetings of
shareholders and each class of common stock votes as a separate class.
(c) Transfer of Stock
Shareholders may only transfer their stock in the Company to the Company for
repurchase. The repurchase price is established by the Board of Directors
each fiscal year as set forth in the Bylaws.
(d) Dividends
The Board of Directors may declare and pay dividends on one or more classes
of common stock at such times and in such amounts as it designates, but in no
event may dividends be paid while there is an outstanding obligation to
repurchase shares. Dividends are allocated among shareholders of each class
of stock according to the number of shares outstanding to each Class A or B
shareholder. Any dividends paid to the Class B shareholders must be shared
with the nonshareholder district hospitals that have rights equivalent to
that of the Class B shareholders.
(e) Liquidation Rights
Upon liquidation or dissolution, the Board of Directors, at its discretion,
will allocate the value of assets among the classes of its outstanding stock
in proportion to the capital contributions of shareholders of each class.
For these purposes, the contributions by the nonshareholder district
hospitals that have rights equivalent to that of the Class B shareholders and
the membership fees paid by Class A shareholders are considered capital
contributions. The allocation to Class A shareholders will be shared among
all Class A shareholders in accordance with the number of shares outstanding
to each Class A shareholder. The allocation to the Class B shareholders must
be shared with the nonshareholder hospitals that have rights equivalent to
that of Class B shareholders.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(f) Paid-in Capital from Affiliates
District hospitals are not shareholders of the Company, but have contractual
agreements with the Company that provide for certain rights and obligations
equivalent, but not identical, to those of Class B shareholders, including
liquidation and dividend rights. The capital contributions of the
nonshareholders are recorded as paid-in-capital from affiliates. These
contractual agreements are considered to be common share equivalents for
purposes of calculating net income per common share.
(g) Net Income Per Common Share
The weighted average number of common share and common share equivalents
used in computing net income per common share amounted to 48,998 and 47,090
for the nine months ended September 30, 1996 and 1995, respectively.
(3) Line of Credit
At September 30, 1996 and December 31, 1995, the Company had a $300,000 line
of credit, expiring on June 3, 1997. Borrowings under the line bear interest
at the prime rate plus 1%. There were no borrowings outstanding under the
line of credit at September 30, 1996 or December 31, 1995.
(4) Investment Securities
The amortized cost, gross unrealized gains, gross unrealized losses and fair
values of investment securities at September 30, 1996 are as follows:
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
Marketable equity securities $ 576,905 88,360 23,502 641,763
Mortgage and asset-backed
securities 1,907,603 623 146,213 1,762,013
Corporate debt securities 2,140,24 539 3,155 2,137,624
Securities sold under
agreements to repurchase ( 6,675) 1,925 8,850 ( 13,600)
$4,618,073 91,447 181,720 4,527,800
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
The amortized cost, gross unrealized gains, gross unrealized losses and fair
values of investment securities available for sale at December 31, 1995 are
as follows:
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
Marketable equity securities $ 545,101 59,911 31,134 573,878
Mortgage and asset-backed
securities 1,997,823 7,063 64,432 1,940,454
Corporate debt securities 701,982 923 - 702,905
$ 3,244,906 67,897 95,566 3,217,237
The amortized cost and fair values of mortgage and asset-backed securities
and corporate debt securities at September 30, 1996, based on contractual
maturity, are shown below. Actual maturities may differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Amortized cost Fair value
Due in one year or less $1,477,623 1,469,372
Due after one year and through five years 702,147 701,599
Due after five years and through ten years 71,945 72,568
Due after ten years 1,796,128 1,656,098
$4,047,843 3,899,637
During the nine months ended September 30, 1996 and 1995, the Company
realized gains and losses on investment securities available for sale, as
follows:
Nine Months Ended
September 30, 1996 September 30, 1995
Gross proceeds $ 3,602,018 $ 71,475
Gross realized gains 43,070 8,205
Gross realized losses ( 31,170) (11,299)
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(5) Income Taxes
Federal income taxes consist of the following components:
Nine months ended
Sept. 30, Sept. 30,
1996 1995
Current $ 405,727 382,657
Deferred ( 47,692) (184,929)
$ 358,035 197,728
In 1995, the Company filed amended corporate tax returns to recharacterize
certain equity payments, and received tax refunds of $16,868, including
interest of $1,622 in 1996, and $233,634, including interest of $18,920
in 1995, related to these filings.
Federal income taxes differ from the amount computed by applying the
"expected" U.S. corporate income tax rate to income before Federal income
taxes for the nine months ended September 30, as follows:
1996 1995
Amount Percent Amount Percent
Computed "expected" rate $ 348,024 34.0% $ 200,031 34.0%
Tax effect of permanent differences:
Dividend income received from
domestic corporations ( 4,112) ( .4)
Adjustment to prior year tax
returns ( 15,246) ( 1.5)
Other 5,072 . 5 2,675 .4
Tax effect of timing differences 24,297 2.4 ( 4,978) ( .8)
$ 358,035 35.0% 197,728 33.6%
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
The tax effects of temporary differences and carryforwards that give rise to
significant portions of the deferred tax asset and deferred tax liabilities
at September 30, 1996 and December 31, 1995 are presented below:
September 30, December 31,
1996 1995
Deferred tax assets:
Accounts payable and accrued expenses $ 134,914 $ 141,810
Unrealized loss on investment securities 30,693 9,407
Total deferred tax assets 165,607 151,217
Deferred tax liabilities:
Service fees receivable 319,406 375,416
Prepaid expenses 19,921 62,039
Furniture, equipment and accumulated
depreciation 68,815 25,059
Other - 216
Total gross deferred tax liabilities 408,142 462,730
Deferred Federal income taxes, net $ 242,535 $ 311,513
There was no valuation allowance for deferred tax assets as of
September 30, 1996 and December 31, 1995. However, deferred tax assets as of
September 30, 1996 and December 31, 1995 include $30,693 and $9,407,
respectively, of potential tax benefit if securities were to be disposed of
at their current market value. The Federal tax law limits the deductibility
of capital losses (permitted only to the extent of recognized gains), with a
limited carryback of three years to offset prior recognized gains, and a
limited carryforward of five years to offset future recognized gains.
Although management does not currently intend to dispose of these assets,
the Company's ability to obtain tax benefit from a disposition of this type
is uncertain.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(6) Commitments
(a) License Fees
(i) HSD Software License
On March 21, 1994, the Company entered into a software license and beta
site agreement with Health Services Design Corporation (HSD) for the use
of the software application developed and owned by HSD. The agreement
calls for an initial one-time license fee of $145,000.
(ii) VHS Software License
On May 31, 1995, the Company entered into a software licensing
agreement with Value Health Science, Inc. (VHS). The initial license term
begins on the day VHS successfully installs the related software, and ends
three years later. The license term will automatically renew for one more
year at the third anniversary of the commencement date and each anniversary
thereafter. The agreement calls for a $30,000 one-time customization fee and
a $30,000 start-up fee. On an ongoing basis, the agreement calls for minimum
monthly fees plus claim processing fees and out-of-pocket costs with respect
to storage and processing. The current monthly fee, as of September 30, 1996,
was $4,167. The maximum annual license fee shall not exceed $300,000. The
total amount paid for the nine months ended September 30, 1996 and 1995
related to this agreement was $31,253 and $8,334, respectively.
(iii) HPR Software License
On June 26, 1996, the Company entered into a software license agreement
with HPR, Inc., for the use of the software application developed and
owned by HPR, Inc. The agreement calls for an implementation fee of
$7,500 and an initial license fee of $66,000, which expires on January 31,
1996, with an option to renew for an additional seventeen months for a fee
of $46,750. The agreement also provides the Company options to license
other products prior to August 1, 1997, with payment of specified license
fees.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(b) Agreements
On October 20, 1995, the company entered into a consulting agreement with
Olympic Health Management System, Inc. to develop and implement a Medicare
supplement product. The agreement may be terminated without cause at any time
by the Company. The agreement calls for a minimum monthly fee of $11,000
through the sooner of the completion of certain phases or for the first six
months this agreement is in effect. Total fees related to this agreement
amounted to $45,736 for the nine months ended September 30, 1996.
On April 22, 1996, the Company entered into a product line management
agreement with Olympic Health Management, Inc. to implement a Medicare
Supplement product. The agreement may be terminated, without cause, by either
party with written notice of not less than ninety days. The agreement calls
for a monthly fee of $2,500, plus reimbursed expenses. Total fees related to
this agreement amounted to $13,358 for the nine months ended
September 30, 1996.
On April 22, 1996, the Company's subsidiary entered into an administrative
agreement with Olympic Health Management, Inc. to utilize their services as
a third party administrator. The initial term is for twelve months and shall
continue from year-to-year unless terminated. The agreement calls for a
monthly fee equal to 12% of earned premiums. Total fees related to this
agreement for the nine months ended September 30, 1996 amounted to $1,211.
On May 7, 1996, the Company's subsidiary entered into an independent agent
agreement with Olympic Health Management, Inc. The agreement may be
terminated without cause, at any time, by either party. The agreement calls
for a monthly fee equal to 8% of premiums paid. Total fees related to this
agreement for the nine months ended September 30, 1996 amounted to $750.
(c) Leases
The Company leases its office facilities under terms of an operating lease
expiring in September, 1999. The lease provides for monthly minimum rent
payments and includes a renewal option for an additional five years.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(c) Leases (Continued)
Rental expense charged to operations under the operating lease for the nine
months ended September 30, 1996 and 1995 was $107,594 and $104,583,
respectively.
Future minimum lease payments under the operating lease for the years ended
December 31 are as follows:
1996 $ 34,551
1997 138,204
1998 138,204
1999 96,358
$407,317
(7) Related Party Transactions
(a) Note Receivable
At December 31, 1994, the Company had an $18,500 note receivable from an
officer of the Company. The note bore interest at 4.5% and was paid in full
in February, 1995.
(b) Operating Revenue and Service Fees Receivable
Operating revenue includes approximately $767,990 and $798,025 for
administrative service fees charged to owner and affiliated hospitals and
network access fees charged to owner and affiliated hospitals through third-
party administrators for the nine months ended September 30, 1996 and 1995,
respectively.
(8) Acquisition
Effective January 31, 1995, the Company acquired 100% of the stock interest
in Pacific Health Systems, Inc., a dental Preferred Provider Organization
(PPO) operating in the state of Washington, by delivering cash of $45,000 and
a noninterest-bearing note of $45,000 due in full on January 31, 1996. In
addition to the fixed purchase price, the Company shall make contingent
purchase price payments to be calculated as 50% of the dental PPO net income,
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(8) Acquisition (Continued)
as defined in the purchase agreement, in excess of $295,000 for each of the
calendar years 1995 and 1996 with an aggregate amount not to exceed $260,000.
No contingent purchase price payments were due for calendar year 1995. The
entire purchase price was allocated to goodwill. The operation of the PPO was
merged into the Company.
(9) Fair Value of Financial Instruments
On December 31, 1995, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 107, Disclosures About Fair Values of Financial
Instruments, as modified by SFAS No. 119, Disclosure About Derivative
Financial Instruments and Fair Value of Financial Instruments. SFAS No. 107
requires disclosures of fair value for financial instruments, whether or not
they are included in the balance sheet, for which it is practicable to
estimate fair value. SFAS No. 119 requires disclosures about amount, nature
and terms of derivative financial instruments.
The Company's financial instruments, included in the September 30, 1996 and
December 31, 1995 balance sheet, consist of investment securities available
for sale. The fair value of the investment securities is based upon quoted
market prices (Note 4).
The Company has invested in derivative financial instruments held for
nontrading purposes that are subject to off-balance-sheet market risk related
to investment securities available for sale. In 1995, the Company placed
$250,000 with Prudential Securities Incorporated (Prudential) with the
primary investment objective of capital appreciation and secondary objective
of current growth. The risk tolerance in the investment portfolio is moderate.
(10) Retirement Plans
The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan
(Plan) covering substantially all employees that are not already covered by a
collective bargaining agreement. Under the Plan, employees can defer up to
12% of the eligible compensation. The Company matches 50% of the employee
contribution, up to 6% of the participant's eligible salary. The Company also
has the option to make an additional profit sharing contribution to the Plan.
Employer contributions to the Plan for the nine months ended
September 30, 1996 and 1995 amounted to $33,686 and $26,748, respectively.
(Continued)
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Notes to Consolidated Financial Statements
(Unaudited)
(11) Concentration of Credit Risk
The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of cash and cash equivalents and trade accounts
receivable. The Company places its cash and temporary cash investments with
high credit quality institutions. At times, such investments may be in excess
of the FDIC insurance limit. The Company routinely assesses the financial
strength of its customers and, as a consequence, believes that its trade
accounts receivable credit risk exposure is limited.
Item 2
Management's Discussion and Analysis
or Plan of Operation
The following discussion and analysis should be read in conjunction with the
financial statements and notes thereto included in this quarterly report and
with the Company's 1995 Annual Statement on Form 10-KSB.
Three Months Ended September 30, 1996 Compared to Three Months Ended
September 30, 1995
Operating revenue increased 19.7% to approximately $1.6 million in the
third quarter of 1996, from approximately $1.3 million during the same
quarter of 1995, primarily as a result of an increase in the number of
subscribers (or members) and their dependents (collectively, "Covered
Persons") utilizing the Company's network of physicians, hospitals or other
health care providers ("PPO"), and an increase in rates to renewing groups.
Total operating expenses increased 13.6% to approximately $1.2 million in
the third quarter of 1996, from approximately $1.06 million in the same
quarter of 1995, primarily due to expenditures for marketing materials,
contracts and additional staffing necessary to introduce First Choice Health
Plan's (FCHP), the Company's subsidiary, first new commercial product since
it received its HCSC licensure in January 1995. The expenses in these
categories are projected to continue in the fourth quarter. The completion
of certain specialized computer programming projects in connection with the
Company's computer systems upgrade also contributed to the increase.
Payroll and related expenses increased 13.5% to $608,667 in the third
quarter of 1996, from $536,136 in the same quarter of 1995, primarily due to
the addition of staff necessary to the introduction of new products. Payroll
and related expenses decreased to 39.3% of operating revenue for the three-
month period ending September 30, 1996, compared to 41.3% of operating
revenue in the same period of 1995.
Selling, general and administrative costs increased 13.7% to $590,667 in
the third quarter of 1996, from $519,486 in same quarter of 1995, primarily
due to increases in the following: advertising - for marketing materials
needed to introduce new product; consulting - for actuarial studies done on
new product rates and computer programmers working in the final stages of the
Company's systems upgrade; and in supplies. Increases in software licensing
fees, depreciation, and network service fees were all due to increased
business activity.
Other income increased 18% to $71,569 in the third quarter of 1996, from
$60,632 during the same quarter in 1995, primarily due an increase in cash
available for investment.
Income taxes increased 72.6% to $170,217 in the third quarter of 1996, from
$98,598 during the same quarter in 1995, primarily due to the increase in
income before federal income taxes.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended
September 30, 1995
Operating revenue increased 14% to approximately $4.3 million in the first
nine months of 1996, from approximately $3.8 million during the same period
of 1995, primarily as a result of an increase in the number of subscribers
(or members) and their dependents (collectively, "Covered Persons") utilizing
the Company's network of physicians, hospitals or other health care providers
("PPO"), and an increase in rates to renewing groups.
Total operating expenses increased 4% to approximately $3.5 million in the
first nine months of 1996, from approximately $3.4 million in the same period
of 1995, primarily due to an increase in payroll and related expenses verses
decreases in advertising and promotion, legal and accounting, travel and
entertainment, and supplies which account for the slight change between the
two periods. It is anticipated that expenses in the last three months of
1996 will increase due to the introduction of new product(s) through the
licensure of the Company's subsidiary 'First Choice Health Plan, Inc.' The
Company received approval of proposed rates from the Washington state Office
of Insurance Commissioner in late September 1996 and expects to have
commercial business starting in January 1997.
Payroll and related expenses increased 18% to approximately $1.9 million in
the first nine months of 1996, from approximately $1.6 million in the same
period of 1995, primarily due to staffing required for the implementation of
products under the licensure of FCHP; the expansion of technical support for
data systems, placement of a full time medical director not in place in 1995
and increased costs for employee benefits. Payroll and related expenses
increased to 44.7% of operating revenue for the nine-month period ending
September 30, 1996, compared to 43.2% of operating revenue in the same period
of 1995.
Selling, general and administrative costs decreased 9% to approximately
$1.6 million in the first nine months ending September 30, 1996, from
approximately $1.75 million in same period of 1995, primarily due to
decreases in advertising - through a reassessment of marketing strategies; in
travel and entertainment due to a reduction in business trips; and in
supplies. By-law changes made in 1995 but not in 1996 are the primary reason
for the decrease in legal expenses in 1996. Increases in insurance and
depreciation were due to increased business activity.
Other income increased 24.8% to $228,899 in the first nine months ending
September 30, 1996, from $183,463 during the same period in 1995, primarily
due an increase in cash available for investment.
Income taxes increased 81.1% to $358,035 in the first nine months ending
September 30, 1996, from $197,728 during the same period in 1995, primarily
due to the increase in income before federal income taxes.
Liquidity and Capital Resources
The Company has a $300,000 line of credit from Seafirst Bank. On June 1,
1996, this line of credit was renewed for a one-year period ending June 1,
1997. At September 30, 1996, there were no borrowings outstanding under the
line.
At September 30, 1996, the Company had cash, cash equivalents and
investment securities at fair market value of approximately $7 million
compared to approximately $5.9 million at June 30, 1996, approximately $5.5
million at March 31, 1996, and approximately $5.3 million at December 31, 1995.
Net cash provided by operating activities during the first nine months ended
September 30, 1996 was $879,933, compared to $773,408 for the same period in
1995, due primarily to an increase in net income before adjustments, and a
decrease in service fees receivable. A concerted effort to reduce service
fees receivable account for the increase in cash in the first nine months of
1996.
Net cash used in investing activities during the first nine months ended
September 30, 1996, was approximately $1.4 million, compared to approximately
$.9 used during the same period in 1995. The use of cash in the first nine
months of 1996 was due primarily to the purchase of investment securities.
Net cash provided by financing activities during the first nine months ended
September 30, 1996 was $882,629 compared to $1,434 provided in the same period
in 1995. The increase in cash from financing activities is due to the
addition of Swedish Medical Center as an owner of the Company. This was
offset slightly by the payment, in February 1996, of the note held by Pacific
Health Systems, Inc. for the purchase of First Choice Dental System, Inc.
On July 16, 1996 the Company entered into an agreement to sell Fifty-Eight
Hundred (5,800) shares of it's Class B common stock., valued at approximately
$160.60 per share to Swedish Medical Center, a Washington non-profit
corporation, for the sum of $931,484. The Company has received payment in
full. Under the terms of the agreement Swedish acknowledges that full
disclosure has been made and that they are capable of evaluating the merits
and risks of and investment in the Company. This sale has been reported to
the Washington State Department of Financial Institutions, Securities Division.
On February 1, 1995, the Company purchased all of the issued and
outstanding stock of a dental PPO for $90,000, $45,000 of which was paid at
the closing and the $45,000 balance of which is payable on February 1, 1996.
Under the related purchase agreement, First Choice is required to make
additional contingent purchase-price payments equal to 50% of the dental
PPO's net income in excess of $295,000 for each of the calendar years 1995
and 1996, with aggregate additional purchase price payments not to exceed
$260,000. The additional aggregate purchase-price, due in January 1996 for
1995, will not be owed because net income projections were not realized.
On July 25, 1995, First Choice Health Network, Inc. submitted amended
Federal corporate income tax returns for the years 1992 and 1993. KPMG Peat
Marwick had been asked to study payments made by shareholders which were
recorded as additional income for income tax purposes rather than the equity
basis used on our financial statements. It has been determined that, except
for certain physician non-membership contracts, these shareholder payments
should have been recorded as equity for all purposes. The total of these
amended returns is $229,091. As of this filing, the Internal Revenue Service
has refunded all portions inclusive of interest, penalty decrease and
reduction of interest previously charged.
Subsequent to year-end, the Company transferred cash of $150,000 to its
subsidiary, First Choice Health Plan, Inc., in connection with its licensure
as an HCSC. The Company previously transferred $1.5 million in January 1995
to fund the required statutory reserve. Additional funds may be required
when the Company introduces products pursuant to the license. There can be
no assurance the Company will be able to obtain the requisite financing to
expand its operations to introduce such new products. As of this filing
these funds remain on deposit.
The Company signed contracts for software development on March 21, 1994,
commenced implementation thereof, and have obtained necessary programming
assistance and additional hardware. Portions of the new system have been
installed and are currently being utilized in a pilot program. The Company
expects to have a fully operational systems in place by January 1997 for use
in its commercial business. The final stage of implementation will be in the
spring of 1997 for use in the Company's PPO business.
In May of 1996 the Company's subsidiary, First Choice Health Plan, Inc.,
introduced into the market place a Medicare Supplement program in conjunction
with two of its owner hospitals, Northwest Hospital and Valley Medical
Center. By the quarter ending September 30, 1996 there were 162 policies
enforce and collected premiums of $17,605. The Company has contracted with
Olympic Health Management Systems to act as the plan administrator. Their
primary responsibilities are to maintain a adequate sales force legally
licensed in Washington state, premium billing and collection, claims
processing and payment, and financial reporting to all applicable parties
including the appropriate reports necessary for compliance with the Office
of Insurance Commissioner of the State of Washington.
Part II - Other Information
Item 1 Legal Proceedings
There are no material pending legal proceedings.
Item 2 Changes in Securities
No changes in the Company's securities occurred during this
period.
Item 3 Defaults Upon Senior Securities
No senior securities of the Company are outstanding.
Item 4 Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders.
Item 5 Other Information
None
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K
None
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
FIRST CHOICE HEALTH NETWORK, INC.
Date: November 15, 1996
By: / s /Randolph R. Barker
Randolph R. Barker
Vice President of Finance and Treasurer
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
FIRST CHOICE HEALTH NETWORK, INC.
Date: November 15, 1996
By:
Randolph R. Barker
Vice President of Finance and Treasurer
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
<TABLE> <S> <C>
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST CHOICE
HEALTH NETWORK, INC. FINANCIAL STATEMENT DATED SEPTEMBER 30, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY SUCH FINANCIAL STATEMENTS.
</LEGEND>
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