<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
[ ] 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) 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 June 30, 1999, was 607 shares and 40,600 shares,
respectively.
1
<PAGE> 2
FIRST CHOICE HEALTH NETWORK, INC.
INDEX TO FORM 10-Q
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets
at June 30, 1999 and
December 31, 1998 . . . . . . . . . . . . . . . . . . . 3
Consolidated Statements of Operations
for the Six Months Ended
June 30, 1999 and 1998 . . . . . . . . . . . . . . . . 5
Consolidated Statements of Cash Flows
for the Six Months Ended
June 30, 1999 and December 31, 1998. . . . . . . . . . . . . . 6
Notes to Consolidated
Financial Statements . . . . . . . . . . . . . . . . . . 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations. . . . 16
Part II Other Information
Item 1 Legal Proceedings. . . . . . . . . . . . . . . . . . . . 18
Item 2 Changes in Securities . . . . . . . . . . . . . . . . . 18
Item 3 Defaults Upon Senior Securities . . . . . . . . . . . . 18
Item 4 Submission of Matters to a
Vote of Security Holders . . . . . . . . . . . . . . . . 18
Item 5 Other Information . . . . . . . . . . . . . . . . . . . 19
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . 20
Signatures . . . . . . . . . . . . . . . . . . . . . . . 20
2
<PAGE> 3
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
June 30, 1999 and December 31, 1998
<TABLE>
<CAPTION>
June 30, December 31,
Assets 1999 1998
(Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 7,300,137 $ 5,759,751
Service fees receivable, net of allowance
for doubtful accounts of $156,000 as of June 30, 1999 2,720,200 2,234,969
and $146,000 as of December 31, 1998
Service fees and premiums receivable from related parties 1,316,477 1,504,537
Premiums receivable, net of allowance for doubtful accounts
$297,749 for June 30, 1999 and for $215,014 for
December 31, 1998 2,391,903 1,997,926
Due from unrelated provider organizations 56,542 1,586,381
Due from related provider organizations 12,702 972,785
Prepaid expenses 296,407 390,748
Deferred tax assets (Note 3) 70,612 152,318
Other current assets 99,291 81,178
----------- -----------
Total current assets 14,264,272 14,680,593
Furniture, Equipment, and Computer software:
Furniture and equipment 2,881,194 2,601,718
Computer equipment/software 453,958 306,522
------------- -------------
3,335,152 2,908,240
Less accumulated depreciation and amortization 1,748,731 1,488,358
------------- --------------
Furniture, equipment, and computer software, net 1,586,421 1,419,882
Other Assets:
Restricted indemnity cash 1,747,626 1,705,956
Goodwill, net of accumulated amortization of
$157,592 and $113,616 216,668 307,310
Other intangible assets, net of accumulated
amortization of $653,023 and $91,743 2,427,046 2,598,657
------------ ------------
Total other assets 4,391,340 4,611,923
------------- -------------
Total assets $20,242,033 $20,712,398
========== ===========
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
3
<PAGE> 4
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Balance Sheets
(Unaudited)
June 30, 1999 and December 31, 1998
<TABLE>
<CAPTION>
June 30, December 31,
Liabilities and Shareholders' Equity 1999 1998
(Unaudited)
<S> <C> <C>
Current Liabilities:
Accounts payable $ 401,041 $ 377,850
Accrued expenses 1,372,863 1,609,202
Reserve for unpaid claims and claims adjustment expenses 2,870,034 2,102,364
Due to unrelated provider organizations 179,822 1,229,331
Due to related provider organizations 34,038 247,355
Federal income tax payable 121,428 28,417
Unearned premiums 518,684 137,280
Deferred income taxes 116,502 136,715
Current portion of note payable 1,888,040 1,887,996
----------- ----------
Total current liabilities 7,502,453 7,756,510
Note payable (Note 9) 389,631 999,671
Deferred income taxes (Note 3) 76,525 112,624
Minority interest 1,264,202 1,320,085
Commitments (Note 4)
Shareholders' Equity:
Class A, par value $1-Authorized, 30,000 shares;
issued and outstanding, 607 and 619 shares 607 619
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 4,372,715 4,385,102
Paid-in capital from affiliates 1,472,108 1,472,108
Retained Earnings 5,123,192 4,625,080
------------ -----------
Total shareholders' equity 11,009,222 10,523,508
--------------------------------
Total liabilities and shareholders' equity $20,242,033 $20,712,398
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
4
<PAGE> 5
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Income
(Unaudited)
June 30, 1999 and 1998
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Operating Revenue:
Premium revenue $ 15,399,785 $10,119,631 $30,482,734 $19,307,935
Premium revenue, related parties 1,562,665 1,186,196 3,138,031 2,436,369
Medicare revenue 1,286,121 2,075,794
Network access fee 2,063,693 1,255,516 3,983,688 2,601,983
Hospital administrative fees 1,021,173 538,027 1,994,933 870,908
Hospital administrative fees, related party 381,000 440,204 747,000 724,835
------------ ---------- ------------ -----------
Total Operating Revenue 21,714,437 13,539,573 42,422,180 25,942,030
-------------- ------------- -------------- -------------
Operating Expenses:
Medical expenses 9,717,891 6,198,074 18,954,701 11,783,149
Medical expenses, related parties 6,478,594 4,132,049 12,636,468 7,855,433
Payroll and related 2,450,204 1,597,035 4,794,652 3,141,745
Selling, general and
administrative costs 2,626,971 1,786,121 5,283,308 3,320,962
------------ ---------- ----------- ------------
Total Operating Expenses 21,273,660 13,713,279 41,669,129 26,101,289
-------------- ------------- ------------- ------------
Operating income 440,777 (173,706) 753,051 (159,259)
Other Income (Expense):
Interest and dividends 5,254 116,682 107,585 257,562
Other 52,760 (46,892) (62,134)
------------ ---------- ----------- ----------
Total Other Income 58,014 69,790 107,585 195,428
------------- ---------- ----------- ------------
Income before taxes federal taxes
and minority interest 498,791 (103,917) 860,635 36,168
Federal income taxes 198,462 121 418,405 140,448
------------ ---------- ----------- ----------
300,329 (104,038) 442,230 (104,280)
Minority interest 24,041 151,806 55,883 257,018
------------- ------------ ------------ ----------
Net Income $324,370 $47,768 $498,113 $152,738
========== =========== ========== =========
Net Income per common share $ 5.53 $ 0.81 $ 8.50 $ 2.60
============ ========== =========== ==========
Weighted average shares outstanding 58,608 58,646 58,612 58,647
============ =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
5
<PAGE> 6
FIRST CHOICE HEALTH NETWORK, INC.
AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Unaudited)
June 30, 1999 and December 31, 1998
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Operating Activities:
Net income 498,113 152,738
Adjustments to reconcile net income to net cash
cash provided (used) by operating activities:
Depreciation 260,373 175,698
Amortization 596,256 30,522
Deferred Income Taxes, net 25,394 (63,838)
Provision for bad debts 142,736 59,395
Realized (gains) losses on sale of securities 390
Minority interest (55,883) (194,494)
Cash provided (used) by changed in operating assets and liabilities:
Service fees receivable (295,392) 505,497
Premium receivable (393,977) (394,306)
Federal income tax receivable 206,183
Prepaid expenses (94,341) (261,229)
Other current assests (18,113) (316,438)
Accounts payable 23,191 (37,327)
Accrued expenses (248,726) (618,607)
Reserve for unpaid claims and claims adjustment expense 767,670 (160,417)
Due to related provider organizations 536,872 (982,714)
Due to unrelated provider organizations 746,766 (655,142)
Federal income tax payable 93,011
Unearned premiums 381,404 (167,085)
------------ ----------
Net cash provided (used) by operating activities 2,965,354 (2,721,174)
Investing Activities:
Purchase of furniture, equipment, and computer software (426,912) (270,061)
Increase in restricted indemnity cash (41,671) (1,404,569)
------------ ------------
Net cash provided (used) by investing activities (468,583) (1,674,630)
Financing Activities:
Payment on note payable (943,998)
Repurchase of Class A common stock and membership rights
from physicians (12,387) (7,664)
------------ ------------
Net cash provided (used) by financing activities (956,385) (7,664)
------------ ------------
Net increase (decrease) in cash and cash equivalents 1,540,386 (4,403,468)
Cash and cash equivalents at beginning of period 5,759,751 11,356,346
--------------- ----------------
Cash and cash equivalents at end of period $7,300,137 $6,952,878
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for federal income taxes $270,000 $250,000
</TABLE>
See accompanying notes to consolidated financial statements (unaudited).
6
<PAGE> 7
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: The unaudited consolidated financial
statements and related notes have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of
the management of First Choice Health Network, Inc. and Subsidiary, the
accompanying unaudited consolidated financial statements include all normal
adjustments considered necessary to present fairly the financial position
as of June 30, 1999, and the results of operations for the three months and
six months ended June 30, 1999 and 1998, and cash flows for six months
ended June 30, 1999 and 1998. The consolidated results of operations
presented are not necessarily indicative of the consolidated 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: On June 16, 1998 the Financial Accounting
Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, which is effective for fiscal years
beginning after June 15, 2000. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and hedging activities.
Under this statement, certain derivatives are recognized at fair value and
changes in fair market value are recognized as gains or losses. Management
is currently studying this pronouncement to determine its effect, if any,
on the Company's 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 June 30, 1999 and December 31, 1998, cash equivalents
consist of cash management funds of $7,300,137 and $5,759,751,
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 related to service fees receivable.
Premiums receivable: Premiums receivable represents monthly group health
insurance premiums billed and outstanding.
Furniture, equipment, and computer software: Furniture, equipment, and
computer software are recorded at cost. Depreciation and amortization are
computed using the straight-line method over the lesser of the estimated
useful lives of the assets or lease term ranging from three to five years.
7
<PAGE> 8
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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.
Other intangible assets: Intangible assets assumed in the Sound Health PPO
network acquisition were trademarks, contracts, and a noncompetition
agreement. Intangible assets are amortized using the straight-line method
over three years.
Goodwill: Goodwill is determined as the difference between the purchase
price and fair value of identifiable net assets purchased. Goodwill is
amortized using the straight-line method over three to five years. Events
or changes in circumstances have not occurred that indicate the value of
goodwill has been impaired as of June 30, 1999 and 1998.
Reserve for unpaid claims and claims adjustment expenses: This liability
represents reported and unreported claims which have been incurred but have
not been paid at the date of the financial statements. The reserve for
unreported claims is determined actuarially using prior experience and the
nature of current health insurance contracts and volume. Included in the
liability is an estimate of the future expenses necessary to settle claims.
Due to the uncertainties inherent in the estimation process, actual costs
may differ from the estimated amounts in the near term, and these
differences may be significant.
Due to (from) related (unrelated) provider organizations: This liability
or asset is the amount due to (from) health care providers in conjunction
with capitation arrangements, which is computed by subtracting the claims
payments made on behalf of the provider from the capitated amounts
contractually allocated to them. The ultimate payout or receipt of these
amounts is subject to a settlement process subsequent to the contract year
end. The Company believes the amounts recorded appropriately reflect the
ultimate settlement amounts.
Unearned premiums: Unearned premiums consists of insurance premiums
received prior to fiscal year end for health insurance coverage subsequent
to year end.
Operating revenue: Operating revenue consists primarily of premium
revenue, 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 36.78% of the premium revenue for the six
months ended June 30, 1999.
Income taxes: Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective
tax bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to reverse. The effect on the deferred
tax assets and liabilities of a change in tax rates is recognized in income
in the period that includes the enactment date. A valuation allowance is
established to the extent that it is more likely than not that deferred tax
assets will not be realized.
Valuation of long-lived assets: Using its best estimates, based on
reasonable and supportable assumptions and projections, the Company reviews
its long-lived assets for impairment whenever events or changes in
circumstances have indicated that the carrying amounts of its assets might
not be recoverable. At June 30, 1999 and 1998, no write downs were
required.
8
<PAGE> 9
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
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 41,207 and 41,241
common shares and 17,400 and 17,400 shares applicable to affiliate common
share equivalents for period ended June 30, 1999 and 1998, 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.
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 voting common stock may be held solely by
physicians licensed in the state of Washington who contract with the
Company to provide health care services and who hold active, associate, or
provisional medical staff privileges at one or more of the hospitals that
contract with the Company to provide health care services.
Class B voting common stock may be held by hospitals in the state of
Washington that contract with the Company to provide health care services.
Voting rights: Holders of each outstanding share of Class A or Class B
common stock are entitled to one vote on each matter submitted to a vote at
meetings of shareholders, and each class of common stock votes as a
separate class.
Transfer of stock: Shareholders may only transfer their stock in the
Company to the Company for repurchase. The repurchase price is established
by the Board of Directors each fiscal year as set forth in the bylaws.
Class A shares were repurchased at $1,031.95 and $1,108.15 per share for
period ended June 30, 1999 and 1998, respectively.
Dividends: The Board of Directors may declare and pay dividends on one or
more classes of common stock at such times and in such amounts as it
designates, but in no event may dividends be paid while there is an
outstanding obligation to repurchase shares. Dividends are allocated among
shareholders of each class of stock according to the number of shares
outstanding to each Class A or 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 contributions. The allocation to Class A
shareholders will be shared among all Class A shareholders in accordance
with the number of shares outstanding to each Class A shareholder. The
allocation of the Class B shareholders must be shared with the 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.
9
<PAGE> 10
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Common stock: In January 1998, the owners of the Plan entered into an
agreement which increased the Company's ownership in the common stock of
the Plan from 75.1% to 80%. The purpose of the increase in common stock
ownership was to allow for the consolidation of tax returns between the
Company and the Plan. This transaction included exchanging of the Plan's
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 10.0%.
NOTE 3: FEDERAL INCOME TAXES
Federal income taxes consist of the following components:
Six months ended
June 30, June 30,
1999 1998
-------- --------
Current $546,632 $ 218,620
Deferred (128,227) (78,172)
-------- --------
$418,405 $140,448
======== ========
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>
1999 1998
--------------------- --------------------
Amount Percent Amount Percent
<S> <C> <C> <C> <C>
Computed expected rate $311,616 34.0% $ 12,297 34.0%
Tax effect of permanent differences:
Valuation on Plan NOL's 89,938 248.6%
Cash to accrual 165,624 18.1 56,312 155.7%
Other (58,835) (6.4) 18,099 (50.0)%
--------- ------ -------- --------
$418,405 45.7% $140,448 388.3%
======== ====== ======== ========
</TABLE>
The deferred tax assets and liabilities resulting from the tax effects of
temporary differences at June 30, 1999 and December 31, 1998 are presented
below:
10
<PAGE> 11
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
June 30, December 31,
1999 1998
------------ ------------
Deferred tax assets:
Net operating losses $1,598,029 $1,598,029
Reduction of shareholders' equity 213,724 213,724
Allowance for doubtful accounts 122,745 122,745
Other 53,664 53,664
---------- ---------
Gross deferred tax assets 1,988,162 1,988,162
Valuation allowance 1,835,844 1,835,844
---------- ---------
Net deferred tax assets 152,318 152,318
Deferred tax liabilities:
Cash to accrual adjustment 168,936 225,248
Furniture, equipment and computer software 34,599 24,091
---------- --------
Total deferred tax liabilities 203,535 249,339
---------- --------
Deferred income tax liability, net $ 51,217 $ 97,021
========== =========
Current portion of deferred tax assets $ 152,318 $ 152,318
========= ===========
Current portion of cash to accrual adjustment 90,911 136,715
Long-term portion of deferred tax liabilities 112,624 112,624
--------- ---------
Deferred income tax liability $ 203,535 $ 249,339
========= =========
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
2013 196,000
----------
$4,700,086
==========
11
<PAGE> 12
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)(UNAUDITED)
NOTE 4:COMMITMENTS
Leases: The Company leases its office facilities and some office equipment
under operating leases expiring through 2003. The leases provide for
monthly minimum rent payments, and some include renewal options for an
additional five years.
Rental expense charged to operations under the operating leases for the six
months June 30, 1999 and 1998, was $354,969 and $168,083, respectively.
Future minimum lease payments under the operating leases for the years
ended December 31 are as follows:
1999 $360,438
2000 817,500
2001 815,204
2002 830,026
2003 431,540
------------
$3,254,708
============
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.
12
<PAGE> 13
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Information about profit or loss and assets of reportable segments as of
June 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
First Choice First Choice
Health Network Health Plan Total
-------------- ----------- -----
<S> <C> <C> <C>
1999:
Revenues from external customers $ 5,868,393 $36,553,788 $42,422,180
Interest Revenue (30,612) 138,197 107,585
Interest Expense 37,760 15,000 52,760
Depreciation/amortization expense (388,572) 52,689 (335,883)
Income tax expense (benefit) 539,604 (121,199) 418,405
Expenditures on furniture, equipment
and computer software (426,912) (426,912)
Segment profit (loss) 749,598 (307,368) 442,230
Assets 20,126,461 11,572,579 31,699,040
Liabilities 4,070,110 4,006,792 8,076,902
1998:
Revenues from external customers 3,680,793 22,261,237 25,942,030
Interest revenue 44,359 243,203 287,562
Interest expense 30,000 30,000
Depreciation/amortization expense 147,196 59,024 206,220
Income tax expense (benefit) 140,448 140,448
Expenditures on furniture, equipment
and computer software 270,061 270,061
Segment profit (loss) 1,840,687 (1,882,443) (41,756)
Assets 12,019,156 10,245,954 22,265,110
Liabilities 958,741 6,151,579 7,110,320
</TABLE>
13
<PAGE> 14
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Revenues:
Total revenues for reportable segments
and consolidated revenues $42,422,180 $ 25,942,030
=========== ===========
Profit or loss:
Total profit or loss for reportable segments $ 442,230 $ (41,756)
Adjustment for minority interest in
consolidated statements 55,883 194,494
---------- -----------
Consolidated net income $ 498,113 $ 152,738
========== ===========
Assets:
Total assets for reportable segments $31,699,040 $25,866,372
Elimination of intercompany investment (11,457,007) (7,316,056)
----------- -----------
Consolidated total assets $20,242,033 $14,805,343
=========== ===========
Liabilities:
Total liabilities for reportable segments $8,076,902 $ 7,110,320
Elimination of intercompany balances (108,293) (3,187,478)
----------- -----------
Consolidated total liabilities $ 7,968,609 $ 3,922,842
=========== ===========
</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 six months ended June 30, 1999
and 1998 represent approximately $12,364,631 and $10,087,479 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
contribution to the plan. Employer contributions to the plan for the six
months ended June 30, 1999 and 1998, amounted to $69,560 and $44,585,
respectively.
NOTE 8:ACQUISITIONS
The Company retained 75.1% interest in the voting common stock of the Plan as
a result of Health First Partners, Inc. 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 for common stock and additional
paid-in capital on a percentage of the Company's revenues for the year ended
December 31, 1997. Prior to December 31, 1998, the Company contributed
$1,159,667 in accordance with the contract based on expected revenues for the
period ended December 31, 1998. The investment in the Plan is eliminated in
consolidation.
In 1998, three shareholders of the Plan converted a portion of their common
stock in the Plan to preferred stock of the Plan that increased to 80% the
percentage of share of the Company in the Plan.
14
<PAGE> 15
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
On December 1, 1998, the Company purchased all of the assets of Providence
Plan Partners PPO Business for a minimum purchase price of $2,800,000 in the
form of a note payable to be paid with interest at a rate of 6% over 18
months. The assets acquired consist of provider contracts ($1,680,000), trade
name ($140,000), a noncompetition agreement ($840,000), computer equipment,
and software licenses ($140,000). There is a potential contingent payment of
up to $700,000 to be determined based on the revenues received by the Company
from the acquired business during the 12 months after the closing date.
Approximately $290,000 had been recorded as goodwill and paid as of the date
this report as a result of this arrangement. This acquisition was accounted
for using the purchase method. Results of operations are included in the
financial statements of the Company from the effective date of the acquisition
December 1, 1998. Separate financial information about the business is not
available that is necessary to provide pro forma disclosures of results of
operations information for 1998 and 1997 as if the business had been acquired
by the company at the beginning of each year. Accordingly, pro forma
information is not included in this note as is required by generally accepted
accounting principles.
NOTE 9: NOTES PAYABLE
The Company has a note payable at June 30, 1999 and December 31, 1998, related
to the acquisition of Providence Partners PPO business (note 8) in the amount
of $2,277,671 and $2,888,000, respectively. The note is payable in 18 equal
monthly installments beginning in January 1999, plus interest of 6%.
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 December 31, 1998, reserves and unassigned capital,
and net loss for the year reported to the NAIC was $7,121,270 and $2,651,839,
respectively. The State of Washington has adopted a risk-based capital
calculation for determining statutory capital requirements that is effective
beginning January 1, 1999. At June 30, 1999, the Company is in compliance
with the new capital requirements.
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 past due and prepaid expenses. At June 30, 1999, the
shareholders' equity and net loss for the year were $7,312,891 and $(243,635)
for the Plan, respectively.
The NAIC has developed statutory accounting practices (the codification) which
are expected to constitute the only source of prescribed statutory accounting
practices. The NAIC has delayed the effective date for health-related
organizations until January 1, 2001.
15
<PAGE> 16
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 1998 Annual Statement on Form 10-K.
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Operating revenue increased 60.4% to approximately $21.7 million in the second
quarter of 1999, from approximately $13.5 million during the same period of
1998. The majority of the increase was due to a 52.5% increase in the Plan's
health insurance member months. In addition, The Plan commenced offering a
Medicare Risk product effective January 1, 1999. Network access fees also
increased 64.4% as a result the purchase of the Sound Health PPO network and
related membership in December 1998 as well as growth of the Company's rental
of the PPO network.
Total operating expenses increased 55.1% to approximately $21.2 million in the
second quarter of 1999, from approximately $13.7 million in the same quarter
of 1998. Medical expenses drove the majority of the increase as the result of
the increase in Plan health insurance membership. Payroll and related
expenses increased 53.4% resulting from the Sound Health acquisition and the
hiring of additional employees needed to administrate the increased growth.
Operating expenses also increased as the result of increased marketing
expenditures related to the new Medicare product as well as the premium and
business taxes associated with The Plan's business.
Federal income taxes increased to $198,462 in 1999 from $121 in 1998
resulting from decreased Plan losses to offset the Company's net income in
addition to temporary timing differences in the recognition of the goodwill
related to the Sound Health acquisition.
Minority interest also decreased 84.2% from $151,806 in 1998 to $24,041 in
1999 as a result of decreased net losses on the Company's majority owned
subsidiary.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Operating revenue increased 63.5% to approximately $42.4 million in the first
half of 1999, from approximately $25.9 million during the same period of 1998.
The majority of the increase was due to a 54.1% increase in the Plan's health
insurance member months. In addition, The Plan commenced offering a Medicare
Risk product effective January 1, 1999 resulting in approximately $2.1
million. Network access fees also increased 53.1% as a result the purchase
of the Sound Health PPO network and related membership in December 1998 as
well as growth of the Company's rental of the PPO network.
Total operating expenses increased 59.6% to approximately $41.6 million in the
first half of 1999, from approximately $26.1 million in the same quarter of
1998. Medical expenses drove the majority of the increase as the result of
claims and capitation offsetting the premium revenue. Payroll and related
expenses increased 52.6% resulting from the Sound Health acquisition and the
hiring of additional employees needed to administrate the increased growth.
Operating expenses also increased as the result of increased marketing
expenditures related to the new Medicare products as well as the premium and
business taxes associated with The Plan's business.
Federal income taxes increased to $418,405 in 1999 from $140,405 in 1998
resulting from decreased Plan losses to offset the Company's net income in
addition to temporary timing differences in the recognition of the goodwill
related to the Sound Health acquisition.
Minority interest also decreased 78.3% from $257,018 in 1998 to $55,883 in
1999 as a result of decreased net losses on the Company's majority owned
subsidiary.
16
<PAGE> 17
Liquidity and Capital Resources
At June 30, 1999, the Company had cash, cash equivalents and investment
securities at fair market value of approximately $7.3 million compared to
approximately $5.7 million at December 31, 1998.
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 the minority
shareholders exchanged 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 its 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 10.0% of the par value per share.
Effective February 1, 1998, the Network and Plan entered into a tax sharing
agreement which provides for the sharing of Federal income tax liabilities in
the filing of consolidated tax returns.
In July 1998, the Plan amended the Articles of Incorporation to increase the
authorization of preferred shares to one million (1,000,000). The Network
then increased its investment in the Plan by purchasing 103,092 shares of the
Plan's preferred stock for $3.0 million reducing Network's payable to Plan by
$3.0 million. These shares are cumulative and have a dividend rate of 8.75%.
Effective December 1, 1998, the Company executed a purchase agreement to
acquire Providence Plan Partners Preferred-Washington PPO Business. The
acquired business consists of approximately 125,000 subscribers with an annual
revenue stream of $4.0 million. The Company purchased substantially all of
the assets of Providence Plan Partners PPO Business for a minimum price of
$2.8 million to be paid with interest at a rate of six percent 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.
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 1999.
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 95% complete on its Year 2000
plan. The time frame to finish the Year 2000 plan is by the 3rd quarter of
1999. The Company has contracted with an outside consulting team to verify
the Company's Year 2000 compliance. 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 has been and continues to communicate with key vendors, service
providers, and customers to determine the extent to which the Company is
vulnerable to those parties' failure to resolve their own Year 2000 issues.
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 $150,000. As of June 30,
1999, the company has incurred approximately $135,000 in costs associated with
Year 2000 compliance.
Potential business risks of the Year 2000 problem include the inability to
enroll and bill groups and members, processing and paying claims and other
core processes. However, based on the testing of the core business systems, it
does not appear that the Company will have difficulties in meeting core
responsibilities internally. In addition, the Company relies on other
companies for receiving payments and other information required to operate
effectively and therefore cannot reasonably estimate the impact of Year 2000
if key third parties are unsuccessful in completing their Year 2000 efforts.
17
<PAGE> 18
The Company is in the process of developing a detailed contingency plan in
order to meet the needs of the various clients which include members,
physicians and provider organizations if Year 2000 issues cause disruption.
The development of the contingency plan includes evaluating various potential
eventualities, identifying key processes and developing alternative temporary
procedures.
Part II Other Information
Item 1 Legal Proceedings
There are no material legal proceedings pending.
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
(a) The Annual Meeting of Stockholders was held on May 24, 1999.
(b)(1) The following individual was elected to the Board of Directors as a
Director for a one-year term expiring at the Company's 2000 Annual
Meeting of Stockholders: Kenneth D. Graham.
(b)(2) The following individual was elected to the Board of Directors as a
Director for two-year terms expiring at the Company's 2001 Annual
Meeting of Stockholders: James J. Finley.
(b)(3) The following individuals were elected to the Board of Directors as
Directors for three-year terms expiring at the Company's 2002 Annual
Meeting of Stockholders: Paul M. Elliott, Phillip J. Haas, John Koster,
R.D. Martz, and Richard Stubbs.
(b)(4) The following individuals' terms continued after the Annual Meeting
as Directors: Barbara L. Mauk, Richard A. McGee, Richard H. Peterson,
and Richard E. Rust. Their terms will expire at the Company's 2000
Annual Meeting of Stockholders.
(b)(5) The following individuals' terms continued after the Annual Meeting
as Directors: Andrew Fallat, William F. Johnston, Robert H. Smith,
and Clyde D. Walker. Their terms will expire at the Company's 2001
Annual Meeting of Stockholders.
(c) The matters submitted for vote at the Annual Meeting were as follows:
(c)(1) Election of Class A Directors for one, two, and three-year terms
expiring at the Company's 2000, 2001,and 2002 Annual Meeting of
Stockholders.
18
<PAGE> 19
The shares were voted as follows:
NOMINEE NUMBER OF SHARES
- ------------------------ ------------------------
Kenneth D. Graham for 40,920
Against 7
Withheld 0
Abstentions 16
James J. Finley for 40,922
Against 4
Withheld 0
Abstentions 17
Paul M. Elliott for 40,914
Against 10
Withheld 0
Abstentions 19
Phillip J. Haas for 40,913
Against 12
Withheld 0
Abstentions 18
John Koster for 40,912
Against 12
Withheld 0
Abstentions 19
R.Dean Martz for 40,922
Against 1
Withheld 0
Abstentions 20
Richard Stubbs for 40,910
Against 13
Withheld 0
Abstentions 20
(c)(2) Approval of amendment to bylaws to increase the Board of Directors
from 11 to 15 individuals, with six directors being physicians
representing Class A shareholders, six directors being participating
hospitals representing class B shareholders, and three directors
representing employers and/or consumers of health care services.
Item 5 Other Information
None
19
<PAGE> 20
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: August 13, 1999
By: / s /David Peel
---------------
David Peel
Vice President of Finance
(Principal Financial and Accounting Officer
and Duly Authorized Officer)
20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FIRST
CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY SECOND QUARTER 1999 FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 7,300,137
<SECURITIES> 0
<RECEIVABLES> 6,428,580
<ALLOWANCES> 453,749
<INVENTORY> 0
<CURRENT-ASSETS> 14,264,272
<PP&E> 3,335,152
<DEPRECIATION> 1,748,731
<TOTAL-ASSETS> 20,242,033
<CURRENT-LIABILITIES> 7,502,453
<BONDS> 0
0
0
<COMMON> 41,207
<OTHER-SE> 11,009,222
<TOTAL-LIABILITY-AND-EQUITY> 20,242,033
<SALES> 42,422,180
<TOTAL-REVENUES> 42,529,765
<CGS> 31,591,169
<TOTAL-COSTS> 41,669,129
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 860,635
<INCOME-TAX> 418,405
<INCOME-CONTINUING> 442,230
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 498,113
<EPS-BASIC> 8.50
<EPS-DILUTED> 8.50
</TABLE>
