SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - QSB/A
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 1100
Seattle, Washington 98101
(Address of principal
executive offices)
(206) 268-2413
(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 September 30, 1998, was 632 shares and 40,600
shares, respectively.
Transitional Small Business Disclosure Format ( check one ):
Yes ______ No __X__
FIRST CHOICE HEALTH NETWORK, INC.
INDEX TO FORM 10-Q
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets
at September 30, 1998 and
December 31, 1997 . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations
for the Nine Months Ended
September 30, 1998 and 1997 . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Nine Months Ended
September 30, 1998 and 1997. . . . . . . . . . . . . . 6
Notes to Consolidated
Financial Statements . . . . . . . . . . . . . . . . . 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . 15
Part II Other Information
Item 1 Legal Proceedings. . . . . . . . . . . . . . . . . . . . 16
Item 2 Changes in Securities . . . . . . . . . . . . . . . . . 16
Item 3 Defaults Upon Senior Securities . . . . . . . . . . . . 16
Item 4 Submission of Matters to a
Vote of Security Holders . . . . . . . . . . . . . . . . 16
Item 5 Other Information . . . . . . . . . . . . . . . . . . . 16
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . 16
Signatures . . . . . . . . . . . . . . . . . . . . . . . 17
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
September 30, December 31,
Assets 1998 1997
(Unaudited)
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 6,554,456 $ 11,356,346
Service fees receivable, net of allowance
for doubtful accounts of $96,187 for 1998 and 1997 1,981,755 1,180,421
Service fees and premiums receivable
from related parties 1,177,087 1,109,269
Premiums receivable, net of allowance for doubtful accounts
of $235,182 for September 30, 1998 and for $57,796 for
December 31, 1997 2,367,211 1,849,145
Investment securities available for sale
Federal income tax receivable 383,101
Prepaid expenses 331,455 292,112
Accounts Receivable
Other Current Assets 68,547 15,000
----------- -----------
Total Current Assets 12,480,511 16,185,394
----------- -----------
Other Assets
Furniture and equipment 2,274,000 1,667,240
Computer equipment/software 304,964 304,264
Capitalized merger costs -
Goodwill, net of accumulated amortization
of $45,026 and $11,500 271,451 320,577
Intangible asset -
Investment securities available for sale
Restricted indemnity cash 1,741,836 309,368
Other assets
Less accumulated depreciation (1,379,744) (1,103,738)
------------ ------------
15,693,018 17,683,105
============ ============
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
September 30, 1998 and December 31, 1997
<TABLE>
<CAPTION>
September 30, December 31,
Liabilities and Shareholders' Equity 1998 1997
(Unaudited)
<S> <C> <C>
Current Liabilities
Accounts payable 434,460 206,202
Accrued expenses 1,303,883 1,802,574
Reserve for unpaid claims and
claims adjustment expenses 1,617,369 1,394,107
Due to unrelated provider organizations 352,462 1,376,088
Due to related provider organizations 325,349 1,289,690
Unearned premiums 150,611 335,629
Deferred income taxes 112,624 112,624
Other liabilities
----------- ----------
Total Current Liabilities 4,296,759 6,516,914
Deferred Income Taxes - Non-Current 160,992 252,986
Minority Interest 1,358,359 1,312,231
------------ -----------
Total Liabilities 5,816,111 8,082,131
------------ -----------
Shareholders' Equity
Common Stock, Class A 632 648
Common Stock, Class B 40,600 40,600
Additional Paid-in Capital 4,350,068 4,416,090
Retained Earnings 4,263,499 3,921,528
Paid-in capital from affiliates 1,472,108 1,472,108
Shareholder receivable (250,000) (250,000)
------------ -----------
Total Shareholders' Equity 9,876,907 9,600,974
Total Liabilities and Shareholders' Equity 15,693,018 17,683,105
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Income
(Unaudited)
September 30, 1998 and 1997
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Operating Revenue
Premium Revenue $ 10,770,217 $7,235,467 $30,078,151 $7,945,801
Premium Revenue, related parties 1,284,369 1,103,353 3,720,738 2,762,456
Network Access Fee 1,456,730 907,096 4,058,713 3,025,982
Hospital Admin 1,379,855 837,320 2,975,598 1,771,154
Other - - 212
------------ ---------- ------------ -----------
Total Operating Revenue 14,891,170 10,083,236 40,833,200 15,505,605
------------ ---------- ------------ -----------
Operating Expenses
Medical expenses 6,464,727 4,438,025 18,247,876 5,653,193
Medical expenses, related parties 4,309,818 2,958,684 12,165,251 3,768,796
Payroll and related 1,602,592 1,069,216 4,744,337 2,921,535
Selling, general and
administrative costs 2,097,424 1,410,955 5,418,386 3,063,196
------------ ---------- ----------- ----------
Total Operating Expenses 14,474,562 9,876,880 40,575,851 15,406,720
------------ ---------- ----------- -----------
Other Income (Expense)
Interest and dividends 165,674 116,110 423,235 382,222
Minority Interest (Net of Income Taxes) 108,759 43,222 365,777 43,222
Other (46,893) (109,027) (58,824)
------------ ---------- ----------- ----------
Total Other Income 227,540 159,332 679,985 366,620
------------- ---------- ----------- ----------
Income Before Taxes 644,148 365,688 937,335 465,505
Federal Income Taxes 220,197 125,514 360,645 144,935
------------ ---------- ----------- ----------
Net Income 423,951 240,174 576,690 320,570
============ ========== =========== ==========
Net Income per common share $ 7.23 $ 4.10 $ 9.83 $ 5.47
============ ========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
September 30, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Cash Flows From (To) Operating Activities
Net income $ 576,690 $ 320,570
---------- ----------
Adjustments to reconcile net income to net cash
cash provided by (used for) operating activities:
Depreciation and amortization 324,789 242,274
Deferred Income Taxes, net (91,994) (133,485)
Write off bad debts 177,386
Realized (gains) losses on sale of securities 390 58,824
Minority interest (256,358)
Noncash Donation 245
Changes in certain assets and liabilities:
(Increase) decrease in service fees receivable (869,152) (2,181,755)
(Increase) decrease in premium receivable (518,066)
(Increase) decrease in prepaid expenses (39,343) (426,397)
Other current assests (54,547)
Federal income tax receivable 383,101
(Increase) decrease in accounts payable 228,258 (861)
Increase (decrease) in accrued expenses (498,691) 2,808,517
Reserve for unpaid claims 223,262
Due to related provider organizations (964,341)
Due to unrelated provider organizations (1,023,626)
Unearned premiums (185,018)
------------ ------------
Total Adjustments
Cash provided by operating activities (2,587,260) 628,112
------------ ------------
Cash Flows From Investing Activities
Purchase of equipment and furnishings (607,460) (351,815)
Purchase of securities available for sale (13,259,113)
Sales and maturities of securities available for sale 7,102,513
Maturities of investment securities 11,650,000
Acquisition of Health First Partners, net of cash acquired 27,424
Principal received - bonds
Assignment of call option
Refund of license fees 60,900
Refund of merger development costs 50,000
Payment of merger development costs (333,128)
Increase in restricted indemnity deposit (1,597,850) 4,008
Investment in Health First Partners 2,645,873
------------ ------------
Cash provided (used) by investing activities (2,205,310) 7,596,662
------------ ------------
Cash Flows From Financing Activities
Repurchase of Class A common stock and membership
rights from physicians (9,320) (1,736)
------------ ------------
Cash used for financing activities (9,320) (1,736)
------------ ------------
Net increase (decrease) in cash and cash equivalents (4,801,890) 8,223,038
------------ ------------
Cash and cash equivalents at beginning of period 11,356,346 2,407,355
Cash and cash equivalents at end of period 6,554,456 10,630,393
============ ============
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1:DESCRIPTION OF BUSINESS AND SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Presentation of interim information: In the opinion of the management of
First Choice Health Network, Inc. and Subsidiary The Plan, the accompanying
unaudited consolidated financial statements include all normal adjustments
considered necessary to present fairly the financial position as of
September 30, 1998, and the results of operations for the three months and
nine months ended September 30, 1998 and 1997, and cash flows for nine
months ended September 30, 1998 and 1997. Interim results are not
necessarily indicative of results for a full year.
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 6) include the
required disclosures for the periods ended September 30, 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
<PAGE>
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 September 30, 1998 and December 31, 1997, cash equivalents
consist of cash management funds of $6,554,456 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 September 30, 1998 and December 31, 1997, no write
downs were required.
<PAGE>
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 September 30, 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
September 30, 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 September 30, 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 44% and 45% of the premium revenue for the
nine months ended September 30, 1998 and 1997, respectively.
Income taxes: Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to reverse. The effect on
<PAGE>
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 $1014.91 per share during 1998.
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
<PAGE>
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 the minority shareholders included exchanging of
common stock 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 for the nine months
ended September 30:
1998 1997
---- ----
Current $452,639 $ 190,803
Deferred (91,994) (45,868)
-------- --------
$360,645 $144,935
======== ========
<PAGE>
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
nine months ended September as follows:
<TABLE>
<CAPTION>
1998 1997
--------------------- --------------------
Amount Percent Amount Percent
<S> <C> <C> <C> <C>
Computed expected rate $194,330 34.0% $ 143,576 34.0%
Tax effect of permanent differences:
Valuation on Plan NOL's 94,942 16.6%
Cash to Accrual 84,468 14.8%
Other (13,095) -2.3% 1,359 0.3%
---------- ---------- ---------------------
$360,645 63.1% $ 144,935 34.3%
======== =========== ======== =========
</TABLE>
The deferred tax assets and liabilities resulting from the tax effects of
temporary differences at September 30, 1998 and December 31, 1997 are
presented below:
September 30, December 31,
1998 1997
---- ----
Deferred tax assets:
Net operating losses $1,531,379 $1,531,379
Reduction of shareholders' equity - 628,599
Other 24,057
--------- --------
Gross deferred tax assets 1,531,379 2,184,035
Valuation allowance 1,531,379 2,159,978
---------- --------
Net deferred tax assets - 24,057
Deferred tax liabilities:
Cash to accrual adjustment 253,406 366,029
Furniture, equipment and computer software 20,211 5,628
---------- --------
Total deferred tax liabilities 273,617 371,657
---------- --------
Deferred federal income taxes, net $ 273,617 $ 395,714
========== =========
Current portion of cash to
accrual adjustment $ 112,624 $ 371,657
Other - -
--------- ---------
Current deferred tax liability 112,624 371,657
Deferred federal income taxes long term 160,993 24,057
--------- ---------
Deferred federal income taxes $ 273,617 $ 395,714
========= =========
<PAGE>
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 9. 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 4: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
nine months September 30, 1998 and 1997, was $327,975 and $173,394,
respectively.
Future minimum lease payments under the operating leases for the years
ended December 31 are as follows:
1998 $176,406
1999 658,437
2000 516,876
2001 516,876
2002 258,438
----------
$2,127,033
==========
NOTE 5:RELATED PARTY TRANSACTIONS - OPERATING
REVENUE AND SERVICE FEES RECEIVABLE
Operating revenue includes $5,148,137 and $3,627,867 for administrative
service fees, premium revenue, and network access fees charged to owner and
affiliated groups for the nine months ended September 30, 1998 and 1997,
respectively.
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 6:REPORTABLE OPERATING SEGMENTS
Factors management used to identify the enterprise's reportable segments:
The Company has two reportable segments which correspond to the
organization of the 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
September 30, 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 $ 6,257,492 $34,575,708 $40,833,200
Interest Revenue 63,668 359,568 423,235
Interest Expense -
Depreciation/amortization expense 217,175 58,831 276,006
Income tax expense (benefit) 1,199,136 (838,491) 360,645
Expenditures on furniture, equipment
and computer software - 535,778 535,778
Segment profit (loss) 2,188,197 (1,867,865) 320,332
Assets 15,892,641 10,260,818 26,153,459
Liabilities 1,506,419 3,392,668 4,899,087
1997:
Revenues from external customers 4,663,306 10,842,299 15,505,605
Interest revenue 115,004 267,218 382,222
Depreciation/amortization expense 188,230 12,656 200,886
Income tax expense (benefit) 780,315 (635,380) 144,935
Expenditures on furniture, equipment
and computer software 351,815 - 351,815
Segment profit (loss) 2,183,186 (1,905,838) 277,348
Assets 13,032,133 11,128,341 24,160,474
Liabilities 1,964,843 5,249,931 7,214,774
</TABLE>
<PAGE>
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 $40,833,200 $ 15,505,605
=========== ===========
Profit or loss:
Total profit or loss for reportable segments $ 320,332 $ 277,348
Adjustment for minority interest in
consolidated statements 256,358 43,222
---------- -----------
Consolidated net income $ 576,690 $ 320,570
========== ===========
Assets:
Total assets for reportable segments $26,153,459 $24,160,474
Elimination of intercompany investment (10,297,340) (6,667,308)
----------- -----------
Consolidated total assets $15,856,119 $17,493,166
=========== ===========
Liabilities:
Total liabilities for reportable segments $ 4,899,087 $ 7,214,774
Elimination of intercompany investment (278,234) (984,848)
----------- -----------
Consolidated total liabilities $ 4,620,853 $ 6,229,926
=========== ===========
</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 nine months ended September 30,
1998 and 1997 represent approximately $14,975,288 and $4,627,703 respectively,
of the Company's consolidated revenues.
NOTE 7: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 8:RETIREMENT PLAN
The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan
covering all full time employees. Under the plan, employees can defer up to
12% of eligible compensation. The Company matches 50% of the employee
contribution, up to 6% of the employee's eligible salary. Employees become
fully vested in employee and employer contributions when the contributions are
made. The Company also has the option to make an additional profit sharing
<PAGE>
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 nine
months ended September 30, 1998 and 1997, amounted to $66,500 and $43,667,
respectively.
NOTE 9: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 year ended December 31,
1997. The pro forma statement of earnings information assumes the
transactions have taken place at the beginning of the period presented.
<PAGE>
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1997
----
Operating revenue $29,526,186
===========
Net loss $ 1,457,803
===========
Loss per share $ (26)
===========
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 10:CLAIM PAYMENTS
Activity in the provision for unpaid claims and unpaid claims processing
expenses is summarized as follows for the month ended September 30, 1998:
Balance, beginning of year $ 1,394,107
Incurred related to:
Current year 3,153,563
Prior year -
----------
Total incurred 3,153,563
Paid related to:
Current year 1,771,365
Prior year 1,158,936
----------
Total paid 2,930,301
----------
Balance, end of year $1,617,369
==========
NOTE 11: 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 December 31, 1997, reserves and unassigned capital,
and net loss for the year reported to the NAIC was $7,607,703 and
$(2,650,761).
<PAGE>
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 September 30,
1998, the shareholders' equity and net loss for the year were $6,372,637 and
$(1,648,247) for the Plan, respectively.
NOTE 12: 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 September 30, 1998. For the year
ended December 31, 1997, there was no liability related to this contingency.
NOTE 13: SUBSEQUENT EVENT
On November 12, 1998, the Company executed a purchase agreement to acquire a
PPO business in the state of Washington with an effective date of December 1,
1998. The acquired business consists of approximately 125,000 subscribers
with an annual revenue stream of $4.0 million. The purchase price is a
minimum of $2.8 million to be paid with interest over 18 months. There is a
potential contingent payment of up to $700,000 to be determined based on the
revenues received by First Choice Health Network from the PPO business during
the twelve months after the closing date. This transaction will be accounted
for using the purchase method.
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 September 30, 1998 Compared to Three Months Ended September
30, 1997
Operating revenue increased 47.7% to approximately $14.9 million in the third
quarter of 1998, from approximately $10.0 million during the same period of
1997.
Total operating expenses increased 46.5% to approximately $14.5 million in the
third quarter of 1998, from approximately $9.9 million in the same quarter of
1997. Medical expenses drove the majority of the increase as the result of
claims and capitation offsetting the premium revenue.
Federal income taxes increased 75.4% to $220,197 from $125,514 was the result
of the increase in income before federal taxes.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September
30, 1997
Operating revenue increased 163.3% to approximately $40.8 million for the
first nine months of 1998, from approximately $15.5 million during the same
period of 1997. The majority of the increase was the result of the merger
with Health First Partners and Health Washington in July, 1997.
<PAGE>
Total operating expenses increased 163.4% to approximately $40.6 million in
the first nine months of 1998, from approximately $15.4 million in the same
quarter of 1997. Medical expenses drove the majority of the increase as the
result of claims and capitation offsetting the premium revenue.
Federal income taxes increased 148.8% to $360,645 from $144,935 was the result
of the Company's conversion to the accrual method of tax reporting as well as
the increase in income before income taxes.
Liquidity and Capital Resources
At September 30, 1998, the Company had cash and cash equivalents of
approximately $6.5 million compared to approximately $11.4 million at December
31, 1997. In the second 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 first quarter of 1999.
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.
Year 2000 Issue
The Company has assessed its computer systems and facilities regarding the
Year 2000 problem. The Year 2000 problem is defined as storing the year as
two digits rather than storing the year with four digits to include the
century. Date sensitive calculations or reports may treat the year 00 as 1900
rather than 2000 resulting in erroneous results or calculations. The Company
is working on the Year 2000 problem to ensure that all computer systems are
Year 2000 compliant. The Company is currently 80% complete on its Year 2000
plan. The time frame to finish the Year 2000 plan is by the 2nd quarter of
1999. The Company intends to bring in an outside audit team to verify the
company's Year 2000 compliance at the end of the 2nd quarter of 1999.
Although The Company believes it will meet these time frames for Year 2000
compliance, there can be no assurance that the company's operations will not
be disrupted or put at risk to some degree.
The Company is in the process of testing its computer systems for Year 2000
compliance. Custom applications have been designed with the Year 2000 in mind
and therefore are already in compliance. Other systems that The Company has
purchased were initially designed to be Year 2000 compliant. The Company
expects to incur expenses related to the testing and verification of the
computer systems in the amount of approximately $100,000. As of September 30,
1998, the company has incurred approximately $50,000 in costs associated with
Year 2000 compliance.
The Company relies on receiving data manually (paper) or electronically from
outside vendors. The Company is requesting that all data received from our
vendors include a four-digit year rather than a two-digit year. The Company
has sent out surveys to its vendors to help determine business risk associated
with the Year 2000 problem. In the event that a vendor is unable to send
electronic data with a four-digit year, The Company will use the century
conversion logic outlined in our contingency plan.
The Company has developed a contingency plan surrounding the transfer of
electronic data from other companies. In the event that the data received
includes a two-digit year rather than the necessary four-digit year, the data
will be converted using a logic that any two-digit year after '30' will have
the 19th century, and any year before '30' will have the century of '20'. The
Company will continue to evaluate and identify possible scenarios which could
impact the company. The contingency plan will be updated accordingly.
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
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 13, 1998
By: / s /David Peel
David Peel
Vice President of Finance
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST
CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY THIRD QUARTER 1998 FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1998
<CASH> 6,554,456
<SECURITIES> 0
<RECEIVABLES> 5,526,053
<ALLOWANCES> 331,369
<INVENTORY> 0
<CURRENT-ASSETS> 12,480,511
<PP&E> 2,578,964
<DEPRECIATION> 1,379,744
<TOTAL-ASSETS> 15,693,108
<CURRENT-LIABILITIES> 4,296,759
<BONDS> 0
0
0
<COMMON> 41,232
<OTHER-SE> 10,028,063
<TOTAL-LIABILITY-AND-EQUITY> 14,805,343
<SALES> 40,833,200
<TOTAL-REVENUES> 40,833,200
<CGS> 30,413,127
<TOTAL-COSTS> 40,575,851
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 571,558
<INCOME-TAX> 360,645
<INCOME-CONTINUING> 576,690
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 576,690
<EPS-PRIMARY> 9.83
<EPS-DILUTED> 9.83
</TABLE>
