<PAGE> 1
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 March 31, 1998
[ ] 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)
601 Union Street
Suite 700
Seattle, Washington 98101
(Address of principal
executive offices)
(206) 667-8050
(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 March 31, 1998, was 648 shares and 40,600 shares,
respectively.
Transitional Small Business Disclosure Format ( check one ):
Yes ______ No __X__
1
<PAGE> 2
FIRST CHOICE HEALTH NETWORK, INC.
INDEX TO FORM 10-QSB
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets
at March 31, 1998 and
December 31, 1997 . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations
for the Three Months Ended
March 31, 1998 and 1997 . . . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Three Months Ended
March 31, 1997 and 1996. . . . . . . . . . . . . . . . . 7
Notes to Consolidated
Financial Statements . . . . . . . . . . . . . . . . . . 8
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . 20
Part II Other Information
Item 1 Legal Proceedings. . . . . . . . . . . . . . . . . . . . 22
Item 2 Changes in Securities . . . . . . . . . . . . . . . . . 22
Item 3 Defaults Upon Senior Securities . . . . . . . . . . . . 22
Item 4 Submission of Matters to a
Vote of Security Holders . . . . . . . . . . . . . . . . 22
Item 5 Other Information . . . . . . . . . . . . . . . . . . . 22
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . 22
Signatures . . . . . . . . . . . . . . . . . . . . . . . 23
2
<PAGE> 3
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
MARCH 31, 1998 AND DECEMBER 31, 1997
<TABLE>
<CAPTION>
March 31, December 31,
ASSETS 1998 1997
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $9,003,633 $ 11,356,346
Service fees receivable, net of allowance
for doubtful accounts of $96,187 for 1997 and 1996 1,240,806 1,180,421
Service fees and premiums
receivable from related parties 660,716 1,109,269
Premiums receivable, net of allowance
for doubtful accounts of $83,864 2,038,895 1,849,145
Investment securities available for sale -
Federal income tax receivable 205,380 383,101
Prepaid expenses 433,802 292,112
Other current assets 15,982 15,000
----------- -----------
Total current assets 13,599,214 16,185,394
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 1,776,052 1,667,240
Computer software 304,264 304,264
----------- -----------
2,080,316 1,971,504
Less accumulated depreciation and amortization 1,190,490 1,103,738
----------- -----------
Furniture, equipment and computer software, net 889,826 867,766
OTHER ASSETS:
Restricted indemnity cash 1,713,082 309,368
Goodwill, net of accumulated amortization of
$60,286 and $45,026 304,974 320,577
----------- -----------
Total other assets 2,018,056 629,945
----------- -----------
TOTAL $16,507,096 $17,683,105
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
MARCH 31, 1998 AND DECEMBER 31, 1997
<TABLE>
<CAPTION>
March 31, December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable $ 168,387 206,202
Accrued expenses 1,476,211 1,802,574
Reserve for unpaid claims and claims
adjustment expenses 1,837,231 1,394,107
Due to unrelated provider organizations 814,232 1,376,088
Due to related provider organizations 731,962 1,289,690
Unearned premiums 201,650 335,629
Deferred income taxes 112,624 112,624
----------- ----------
Total current liabilities 5,342,298 6,516,914
DEFERRED INCOME TAXES 217,490 252,986
MINORITY INTEREST 1,401,811 1,312,231
COMMITMENTS AND CONTINGENCIES (Notes 5 and 13)
SHAREHOLDERS' EQUITY:
Common Stock:
Class A, par value $1 - Authorized, 30,000 shares;
issued and outstanding, 648 and 656 shares 648 648
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 and 40,600 shares 40,600 40,600
Additional paid-in capital 4,255,646 4,416,090
Shareholder receivable (250,000) (250,000)
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 4,026,496 3,921,528
----------- ------------
Total shareholders' equity 9,545,498 9,600,974
----------- ------------
TOTAL $16,507,097 $17,683,105
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997
OPERATING REVENUE:
<S> <C> <C>
Premium revenue $9,188,304 $ 64,294
Premium revenue, related parties 1,250,173 822,061
Network access fees 1,346,467 1,040,926
Hospital administrative fees 617,513 477,386
Other - 212
----------- ----------
Total operating revenue 12,402,457 2,404,879
<PAGE>
OPERATING EXPENSES:
Medical expenses 5,585,075 454,601
Medical expenses, related parties 3,723,384 303,068
Payroll and related expenses 1,544,710 898,638
Selling, general, and administrative expenses 1,534,841 698,062
----------- ----------
Total operating expenses 12,388,010 2,354,369
----------- ----------
Operating income 14,447 50,510
OTHER INCOME (EXPENSE):
Interest and dividends 140,880 110,176
Other - 21,798
---------- ----------
140,880 131,974
---------- ----------
Income before federal income taxes
and minority interest 155,327 182,484
FEDERAL INCOME TAXES 140,327 48,245
---------- ----------
15,000 134,239
MINORITY INTEREST 89,970 -
---------- ----------
NET INCOME $ 104,970 $ 134,239
========== ==========
NET INCOME PER COMMON SHARE $ 1.79 $ 2.29
========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,650 58,656
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 104,969 $ 134,239
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 85,251 43,879
Amortization 15,261
Deferred income taxes, net (35,496) (31,930)
Write-off bad debts 26,068
Realized loss (gain) on sales of securities
available for sale - (21,798)
Minority interest (89,580) -
Cash provided (used) by changes in operating
assets and liabilities:
Service fees receivable 388,168 49,892
Premiums receivable (189,750)
Federal income tax receivable 177,721 8,854
Prepaid expenses (149,044) 83,854
Other current assets (982)
Accounts payable (37,815) 29,803
Accrued expenses (836,939) 351,502
Reserve for unpaid claims and claims
adjustment expenses 443,124
Due to provider organizations (609,007)
Unearned premiums (133,979)
Federal income tax payable 71,255
---------- ----------
Net cash provided by operating activities (842,030) 585,311
INVESTING ACTIVITIES:
Purchase of investment securities available for sale (2,742,162)
Sales and maturities of investment securities
available for sale 2,056,316
Purchase of furniture, equipment, and
computer software (107,313) (92,519)
Increase in restricted indemnity cash (1,403,371) (610)
---------- -----------
Net cash provided (used) by investing activities (1,510,684) (778,975)
--------- -----------
BALANCE, carried forward (2,352,714) (193,664)
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONSOLDIATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
BALANCE, brought forward $ (2,352,714) $ (193,664)
FINANCING ACTIVITIES:
Repurchase of Class A common stock and membership
rights from physicians - (1,736)
----------- ----------
Net cash provided by financing activities - (1,736)
----------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS (2,352,714) (61,161)
CASH AND CASH EQUIVALENTS:
Beginning of year 11,356,346 2,407,355
----------- ----------
End of year $9,003,632 $2,346,194
=========== ==========
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
Shareholder receivable for common stock issuance (250,000) (500,000)
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: DESCRIPTION OF BUSINESS AND SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: First Choice Health Network, Inc. (the Company)
was incorporated under the laws of the state of Washington on September 28,
1984. The Company was formed to organize a network of independent
participating physicians and hospitals to provide a comprehensive, managed
health care delivery system for group plans established by employers and
benefit groups. The Company's business is conducted primarily in
Washington, Oregon, and Alaska.
The Company's wholly owned subsidiary, First Choice Health Plan, Inc., (the
Plan) is a health care services contractor which was formed on January 31,
1995, to offer fully insured health care services to an enrolled population
in Washington state.
Principles of consolidation: The consolidated financial statements include
the accounts of the Company and the Plan. All significant intercompany
accounts have been eliminated in consolidation.
New accounting pronouncements: Effective December 31, 1997, the Company
adopted the provisions of Statement of Financial Accounting Standards
(SFAS) No. 131, Disclosures about Segments of an Enterprise and Related
Information. This statement requires that certain business enterprises
report certain information about operating segments in complete sets of
financial statements of the enterprise. It also requires that certain
business enterprises report selected information about their products and
services, the geographic areas in which they operate, and their major
customers. The notes to the financial statements (see Note 7) include the
required disclosures for the periods ended March 31, 1998 and December 31,
1997.
In 1997, the Company adopted SFAS No. 128, Earnings Per Share. The
statement requires certain calculations and disclosures surrounding
earnings per share that differ from the method previously required by
generally accepted accounting principles (GAAP). Adoption of this standard
has no effect on previously reported earnings per share.
In 1997, the Company has also adopted SFAS No. 129, Disclosure of
Information About Capital Structure. This statement establishes standards
for disclosing information about an entity's capital structure.
In June 1997, SFAS No. 130, Reporting Comprehensive Income, was issued.
This statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and
losses) in a full set of general-purpose financial statements. This
statement requires that all items that are required to be recognized under
generally accepted accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. This presentation differs from
8
<PAGE> 9
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
the method previously required by GAAP. The Company will be required to
adopt the new method of presentation in 1998. Adoption of this standard is
not expected to have a material effect on the financial statements.
Cash equivalents: The Company considers all highly liquid investments
purchased with an original maturity of three months or less to be cash
equivalents. At March 31, 1998 and December 31, 1997, cash equivalents
consist of cash management funds of $9,003,633 and $11,356,346,
respectively.
Service fees receivable: Service fees receivable consist primarily of
estimates for hospital administrative fees receivable related to claims
incurred on or before the balance sheet date but not reported. The Company
evaluates the reasonableness of hospital administrative fees receivable
based on claims reported in subsequent periods. These estimates are
subject to the effects of trends in claims. Although considerable
variability is inherent in such estimates, management believes that the
hospital administrative fees receivable are reasonable. The estimates are
continually reviewed and adjusted as necessary in the period new
information becomes known.
Allowance for doubtful accounts: The Company performs periodic credit
evaluations of its customers and maintains an allowance for potential
credit losses.
Furniture, equipment, and computer software: Furniture, equipment, and
computer software are recorded at cost. Depreciation and amortization are
computed using the straight-line method over the lesser of the estimated
useful lives of the assets or lease term ranging from three to five years.
Restricted indemnity cash: Restricted indemnity cash consists of amounts
required to be restricted for potential claims from enrollees as required
by the Office of Insurance Commissioner.
Valuation of long-lived assets: Using its best estimates, based on
reasonable and supportable assumptions and projections, the Company reviews
its long-lived assets for impairment whenever events or changes in
circumstances have indicated that the carrying amounts of its assets might
not be recoverable. At March 31, 1998 and December 31, 1997, no write
downs were required.
9
<PAGE> 10
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 five years. Events or changes in
circumstances have not occurred that indicate the value of goodwill has
been impaired as of March 31, 1998 and December 31, 1997.
Reserve for unpaid claims and claims adjustment expenses: This liability
represents reported and unreported claims which have been incurred but have
not been paid at the date of the financial statements. The reserve for
unreported claims is determined actuarially by prior experience and the
nature of current business and volume. Included in the liability is an
estimate of the future expenses necessary to settle claims included in the
reserve for unreported claims. Due to the uncertainties inherent in the
estimation process, actual costs may differ from the estimated amounts in
the near term, and these differences may be significant.
Earnings per share: Net income per common share is computed by dividing
income available to common shareholders by the weighted average number of
common shares outstanding during the period, including 40,600 common shares
and 18,050 shares applicable to affiliate common share equivalents at March
31, 1998 and December 31, 1997, respectively. Shares issued during the
period and shares reacquired during the period were weighted for the
portion of the period that they were outstanding. There are no dilutive
securities.
Due to provider organizations: This liability is the net amount due to
health care providers in conjunction with capitation arrangements, which is
computed by subtracting the claims payment made on behalf of the provider
from the capitated amounts contractually allocated to them. The ultimate
payout or receipt of these amounts is subject to a settlement process
subsequent to March 31, 1998.
Operating revenue: Operating revenue consists primarily of premium
revenue, network access fees, and hospital administrative fees. Premium
revenue represents amounts charged for health care services and is
recognized as revenue in the period for which enrollees are entitled to
medical care. Network access fees are recognized as earned during the
period of coverage and are recorded at contractual rates. Hospital
administrative fees are recognized as earned in the period hospital claims
are incurred by a subscriber and are recorded at a contractual percentage
of the claims.
One subscriber group provided 48% of the premium revenue for the three
months ended March 31, 1998.
Income taxes: Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to reverse. The effect on
10
<PAGE> 11
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
the deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A
valuation allowance is established to the extent that it is more likely
than not that deferred tax assets will not be realized.
Use of estimates: Preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
NOTE 2: SHAREHOLDERS' EQUITY
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.
Voting rights: Holders of each outstanding share of Class A or Class B
common stock are entitled to one vote on each matter submitted to a vote at
meetings of shareholders, and each class of common stock votes as a
separate class.
Transfer of stock: Shareholders may only transfer their stock in the
Company to the Company for repurchase. The repurchase price is established
by the Board of Directors each fiscal year as set forth in the bylaws.
Class A shares were repurchased at $217 per share during 1997.
Dividends: The Board of Directors may declare and pay dividends on one or
more classes of common stock at such times and in such amounts as it
designates, but in no event may dividends be paid while there is an
outstanding obligation to repurchase shares. Dividends are allocated among
shareholders of each class of stock according to the number of shares
outstanding to each Class A or B shareholder. Any dividends paid to the
Class B shareholders must be shared with the nonshareholder district
hospitals that have rights equivalent to that of the Class B shareholders.
Liquidation rights: Upon liquidation or dissolution, the Board of
Directors, at its discretion, will allocate the value of assets among the
classes of its outstanding stock in proportion to the capital contributions
of shareholders of each class. For these purposes, the contributions by
the nonshareholder district hospitals that have rights equivalent to that
of the Class B shareholders and the membership fees paid by Class A
shareholders are considered capital contributions. The allocation to Class
A shareholders will be shared among all Class A shareholders in accordance
with the number of shares outstanding to each
11
<PAGE> 12
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Class A shareholder. The allocation of the Class B shareholders must be
shared with the nonshareholder hospitals that have rights equivalent to
that Class B shareholders.
Paid-in capital from affiliates: District hospitals are not shareholders
of the Company, but have contractual agreements with the Company that
provide for certain rights and obligations equivalent, but not identical,
to those of Class B shareholders, including liquidation and dividend
rights. The capital contributions of the nonshareholders are recorded as
paid-in capital from affiliates. These contractual agreements are
considered to be common share equivalents for purposes of calculating net
income per common share.
In January 1998, the owners of the Plan entered into an agreement which
increased the Company's ownership in the common stock of the Plan from
75.1% to 80%. The purpose of the increase in common stock ownership was to
allow for the consolidation of tax returns between the Company and the
Plan. This transaction by Health Washington included exchanging of common
stock held by the minority owners for the same number of preferred shares.
This preferred stock is nonvoting and noncumulative and has a dividend
rate of 10.5%.
NOTE 3: FEDERAL INCOME TAXES
Federal income taxes consist of the following components:
Three months ended
March 31, March 31,
1998 1997
---- ----
Current $171,715 $ 80,175
Deferred (31,388) (31,930)
-------- --------
$140,327 $48,245
======== ========
12
<PAGE> 13
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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
three months ended March 31 as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------- --------------------
Amount Percent Amount Percent
<S> <C> <C> <C> <C>
Computed expected rate $83,400 34.0% $ 62,045 34.0%
Tax effect of permanent differences:
Other 21,570 23.2 - -
Tax effect on timing differences (13,946) (7.6)
-------- ------ -------- ------
$104,970 57.2% $ 48,245 26.4%
======== ====== ======== ======
</TABLE>
The deferred tax assets and liabilities resulting from the tax effects of
temporary differences at March 31, 1998 and December 31, 1997 are presented
below:
March 31, December 31,
1998 1997
---- ----
Deferred tax assets:
Net operating losses $1,531,379 $1,531,379
Reduction of shareholders' equity - 628,599
Other 15,605 20,458
--------- --------
Gross deferred tax assets 1,546,984 2,180,436
Valuation allowance 1,531,379 2,159,978
---------- --------
Net deferred tax assets 15,605 20,458
Deferred tax liabilities:
Cash to accrual adjustment 309,720 337,876
Furniture, equipment and computer software 4,789 7,276
---------- --------
Total deferred tax liabilities 314,509 345,152
---------- --------
Deferred federal income taxes, net $ 330,114 $ 365,610
========== =========
Current portion of cash to
accrual adjustment $ 112,624 $ 112,624
Other - -
--------- ---------
Current deferred tax liability 112,624 112,624
Deferred federal income taxes long term 217,490 252,986
--------- ---------
Deferred federal income taxes $ 330,114 $ 365,610
========= =========
13
<PAGE> 14
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The valuation allowance was established in 1997 against the tax benefit of the
1997 net operating losses (NOLs) of the Plan since the Plan will file a
separate federal income tax return for the final six months of 1997 and the
realization of the tax benefit is unlikely. The allowance is also provided
for NOLs acquired in the Health First Partners merger, and the reduction of
shareholders equity as described in Note 10. The following schedule
represents the amounts of the Plan NOLs and their expiration date:
2003 $ 138,000
2007 328,438
2008 53,781
2009 20,754
2010 1,584,667
2011 1,850,561
2012 527,885
----------
$4,504,085
==========
NOTE 3: COMMITMENTS
Leases: The Company leases its office facilities under terms of two
operating leases expiring in September 1999 and January 2002. The leases
provide for monthly minimum rent payments and include renewal options for
an additional five years.
In March 1998, the Company signed a five-year office lease to consolidate
their current locations to a central location, commencing on July 1, 1998.
Rental expense charged to operations under the operating leases for the
three months March 31, 1998 and 1997, was $82,271 and $43,791,
respectively.
Future minimum lease payments under the operating leases for the years
ended December 31 are as follows:
1998 $526,745
1999 658,437
2000 516,876
2001 516,876
2002 258,438
----------
$2,477,102
==========
NOTE 4: RELATED PARTY TRANSACTIONS _ OPERATING
REVENUE AND SERVICE FEES RECEIVABLE
Operating revenue includes $1,250,173 and $822,061 for administrative service
fees, premium revenue, and network access fees charged to owner and affiliated
groups for the three months ended March 31, 1998 and 1997, respectively.
14
<PAGE> 15
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5: REPORTABLE OPERATING SEGMENTS
Factors management used to identify the enterprise's reportable segments:
The Company has two reportable segments which correspond to the
organization of the parent Company and its majority-owned subsidiary, the
Plan. Each segment requires distinct tracking capabilities in the areas of
revenues, claims processing, marketing strategies and reporting to
regulatory organizations.
Description of the types of products and services from which each
reportable segment derives its revenue:
The Company has two primary products which have been aggregated into one
reportable segment: network access fees and hospital administration fees.
Network access fees arise from the rental of the Company's large PPO
network while hospital administration fees arise from charges to the
network hospitals based on claims incurred by members. The other
reportable segment, The Plan, offers a variety of fully insured health
insurance plans to employer groups.
Measurement of segment profit or loss and segment assets: The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies. The Company evaluates performance based
on profit and loss from operations before income taxes not including
nonrecurring gains and losses. The Company accounts for intersegment
revenues by assigning a management fee to the Plan that is an estimate of
resources expended on the Plan's behalf.
Information about profit or loss and assets of reportable segments as of
March 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
First Choice First Choice
Health Network Health Plan Total
-------------- ----------- -----
<S> <C> <C> <C>
1998:
Revenues from external customers $ 1,710,695 $10,691,762 $12,402,457
Interest Revenue 25,087 145,792 170,879
Interest Expense 30,000 30,000
Depreciation/amortization expense 72,545 27,967 100,512
Income tax expense (benefit) 140,327 - 140,327
Expenditures on furniture, equipment
and computer software - 107,313 107,313
Segment profit (loss) 657,802 (732,384) (74,582)
Assets 13,948,041 11,918,331 25,866,372
Liabilities 985,259 6,673,897 7,659,156
1997:
Revenues from external customers 1,518,524 886,355 2,404,879
Interest revenue 84,971 25,205 110,176
Depreciation/amortization expense 65,430 - 65,430
Income tax expense (benefit) 48,245 - 48,245
Expenditures on furniture, equipment
and computer software 92,519 - 92,519
Segment profit (loss) 738,681 (604,442) 134,239
Assets 3,826,581 7,186,569 11,013,150
Liabilities 133,669 1,217,485 1,351,154
</TABLE>
15
<PAGE> 16
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Revenues:
Total revenues for reportable segments
and consolidated revenues $12,402,457 $ 2,404,879
=========== ===========
Profit or loss:
Total profit or loss for reportable segments $ (74,582) $ 2,404,879
Adjustment for minority interest in
consolidated statements 89,970 -
---------- -----------
Consolidated net income $ 15,388 $ 2,404,879
========== ===========
Assets:
Total assets for reportable segments $25,866,372 $11,013,150
Elimination of intercompany investment (7,316,056) (6,667,308)
----------- -----------
Consolidated total assets $18,550,316 $4,345,842
=========== ===========
Liabilities:
Total liabilities for reportable segments $ 7,659,156 $ 1,351,154
----------- -----------
Consolidated total liabilities $ 7,659,156 $ 1,351,154
=========== ===========
</TABLE>
Substantially all of the revenues from external customers are derived from
within the state of Washington.
Revenues from one customer of the Plan for the three months ended March 31,
1998 and 1997 represent approximately $5,061,000 and $-0-, respectively, of
the Company's consolidated revenues.
NOTE 6: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, service fees and premiums
receivable, accounts payable and due to provider organizations approximates
fair value because of the short maturity of these instruments.
NOTE 7: RETIREMENT PLAN
The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan
covering all full time employees. Under the plan, employees can defer up to
12% of eligible compensation. The Company matches 50% of the employee
contribution, up to 6% of the employee's eligible salary. Employees become
fully vested in employee and employer contributions when the contributions are
made. The Company also has the option to make an additional profit sharing
16
<PAGE> 17
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
contribution to the plan. Employer contributions to the plan for the three
months ended March 31, 1998 and 1997, amounted to $20,084 and $14,186,
respectively.
NOTE 8: ACQUISITIONS
Effective July 1, 1997, the Plan acquired 100% of the stock of Health First
Partners, Inc., a health care services contractor (HCSC) operating in the
state of Washington, by issuing 33,572 shares of stock. The acquisition has
been accounted for as a purchase with a cost of the net assets acquired of
approximately $936,000. The purchase price was allocated based on the fair
value of assets and liabilities at the date of acquisition as follows:
$660,740 working capital and $275,260 goodwill. The results of operations of
Health First Partners, Inc. have been included in the Company's consolidated
financial statements from the date of acquisition. At the same time, the Plan
acquired a large contract from Health Washington, L.L.C., a limited liability
company licensed under the laws of the state of Washington, by issuing 34,523
shares of common stock. The primary asset acquired through this acquisition
was an employer group health insurance contract and supporting health care
network of providers for which fair value has been determined to be minimal,
accordingly, no amounts have been attributed to this contract in the
accompanying financial statements. The acquisition has been accounted for as
a purchase. The results of operations attributable to the contract have been
included in the Company's consolidated financial statements from the date of
acquisition. As a result of the above transactions, there was a reduction in
the Company's equity as the carrying value of the stock issued exceeded the
fair value of the contract. Health First Partners, Inc. and Health
Washington, L.L.C. are related parties.
The Company retained 75.1% interest in the voting common stock of the Plan as
a result of these acquisitions. In addition, the Company is required to
contribute to the capital of the Plan, a percentage of the Company's
administrative fee revenue for the ten years following July 1, 1997, if any.
No minimum amounts of contributions are required. Subsequent to December 31,
1997, $630,031 was contributed as additional paid-in capital for the
percentage of the Company's revenues from July 1, 1997, through December 31,
1997. The investment in the Plan is eliminated in consolidation.
Pro forma financial information (unaudited): The following pro forma
information sets forth historical information which has been adjusted to
reflect the acquisition of Health First Partners, Inc. as discussed above.
The pro forma information is presented for the years ended December 31, 1997
and 1996. The pro forma statement of earnings information assumes the
transactions have taken place at the beginning of the period presented.
17
<PAGE> 18
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1997 1996
---- ----
Operating revenue $29,526,186 $10,305,374
=========== ===========
Net loss $ 1,457,803 $(1,126,663)
=========== ===========
Loss per share $ (26) $ (23)
=========== ===========
The pro forma results are not necessarily indicative of what actually would
have occurred if the acquisition of Health First Partners, Inc. had been in
effect for the periods presented, are not intended to be a projection of
future results, and do not reflect any synergies that might be achieved from
combined operations.
NOTE 9: CLAIM PAYMENTS
Activity in the provision for unpaid claims and unpaid claims processing
expenses is summarized as follows for the three months ended March 31, 1998:
Balance, beginning of year $1,394,107
Incurred related to:
Current year 1,029,886
Prior year -
----------
Total incurred 1,029,886
Paid related to:
Current year 930,860
Prior year 176,193
----------
Total paid 1,107,053
----------
Balance, end of year $1,316,940
==========
NOTE 10: REGULATORY MATTERS
The Company's 80% owned subsidiary, the Plan, is subject to regulation by the
Office of Insurance Commissioner in the state of Washington including the
requirement to follow statutory (NAIC) accounting principles, which differ
from generally accepted accounting principles. As such, certain levels of
capital are required. At March 31, 1998, reserves and unassigned capital,
and net loss for the year reported to the NAIC was $7,505,350 and $(834,254),
18
<PAGE> 19
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
respectively. The primary difference in reporting between the NAIC and GAAP
is nonadmitted assets of certain property, plant and equipment, goodwill,
accounts receivables over 90 days and prepaid expenses. At March 31, 1998,
the shareholders' equity and net loss for the year were $5,244,434 and
$(732,384) for the Plan, respectively.
NOTE 11: CONTINGENCY
In connection with Overlake Hospital becoming a shareholder in December 1996,
the Company incurred a contractual contingent liability for exclusivity
damages to another hospital shareholder of up to $600,000. Since the amount
of any damages is not reasonably estimable, no amount has been reflected in
the consolidated financial statements as of March 31, 1998.
19
<PAGE> 20
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS 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 1997 Annual Statement on Form 10-KSB.
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Operating revenue increased 415.7% to approximately $12.4 million in the first
quarter of 1998, from approximately $2.4 million during the same period of
1997. The majority of the increase was the result of the Company's initial
offering of health insurance in the state of Washington in January, 1997 as
well as the merger with Health First Partners and Health Washington in July,
1997.
Total operating expenses increased 426.2% to approximately $12.4 million in
the first quarter of 1998, from approximately $2.4 million in the same quarter
of 1996. Medical expenses drove the majority of the increase as the result of
claims and capitation offsetting the premium revenue.
Federal income taxes increased 192.2% to $140,327 from $48,245 was the result
of the Company's inability to utilize the Plan's net loss for the month of
January as well as the Company's conversion to the accrual method of tax
reporting.
Liquidity and Capital Resources
At March 31, 1998, the Company had cash and cash equivalents of approximately
$9.0 million compared to approximately $11.4 million. In the first quarter of
1998, The Plan transferred an additional $1.4 million bringing the total
statutory deposits to $1.7 million in order to satisfy state regulatory
requirements and to prepare for the initiation of the Medicare product in the
third or fourth quarter of 1998.
20
<PAGE> 21
In January 1998, the owners of the Plan signed an agreement which gave the
Company an 80% ownership in the common stock of the Plan. The purpose of the
increase in common stock ownership was to allow for the consolidation of tax
returns between the Company and the Plan. This transaction by Health
Washington exchanging 8,613 shares of common stock for the same number of
preferred shares. Two other owners made a similar exchange of 4,187 shares
each. In order to facilitate this transaction, the Plan amended their Articles
of Incorporation to authorize 100,000 shares of preferred stock. This stock
has a par value of $29.10 and is nonvoting and noncumulative, but has a
dividend preference a dividend rate of 10.5% of the par value per share.
The Company anticipates that the revenues generated by operations, investment
and financing, plus the capital it currently has in reserves, will be
sufficient to meet its cash requirements throughout 1998.
21
<PAGE> 22
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:
27 - Financial Data Schedule
22
<PAGE> 23
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: May 14, 1998
By: / s /David Peel
----------------------
David Peel
Vice President of Finance
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
23
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST CHOICE
HEALTH NETWORK, INC. AND SUBSIDIARY FIRST QUARTER 1998 FINANCIAL STATEMENTS
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1998
<CASH> 9,003,633
<SECURITIES> 0
<RECEIVABLES> 3,940,417
<ALLOWANCES> 180,051
<INVENTORY> 0
<CURRENT-ASSETS> 13,599,214
<PP&E> 2,080,316
<DEPRECIATION> 1,190,490
<TOTAL-ASSETS> 16,507,096
<CURRENT-LIABILITIES> 5,342,298
<BONDS> 0
0
0
<COMMON> 41,248
<OTHER-SE> 9,504,850
<TOTAL-LIABILITY-AND-EQUITY> 16,507,097
<SALES> 12,402,457
<TOTAL-REVENUES> 12,543,337
<CGS> 9,308,459
<TOTAL-COSTS> 12,388,010
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 155,327
<INCOME-TAX> 140,327
<INCOME-CONTINUING> 15,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 104,970
<EPS-PRIMARY> 1.79
<EPS-DILUTED> 1.79
<PAGE>
</TABLE>
