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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2004
[ ] 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.
(Exact name of Registrant as specified in its charter)
Washington 91-1272766
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
600 University Street
Suite 1400
Seattle, Washington 98101
(Address of principal
executive offices)
(206) 292-8255
(Registrant's telephone number, including area code)
Indicate by checkmark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes __X___ No ______
Indicate by checkmark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes ______ No __X___
The aggregate number of Registrant's shares of Class A Common Stock and
Class B Common Stock outstanding on June 30, 2004, was 537 shares and
40,600 shares, respectively.
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FIRST CHOICE HEALTH NETWORK, INC.
INDEX TO FORM 10-Q
Page
Part I Financial Information
Item 1 Financial Statements
Condensed Consolidated Balance Sheets (Unaudited)
at June 30, 2004 and December 31, 2003 3
Condensed Consolidated Statements of Income (Unaudited)
for the Three Months and Six Months Ended June 30, 2004 and 2003 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Six Months Ended June 30, 2004 and 2003 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Item 3 Quantitative and Qualitative Disclosures About Market Risk 15
Item 4 Controls and Procedures 15
Part II Other Information
Item 1 Legal Proceedings 16
Item 6 Exhibits and Reports on Form 8-K 16
Signatures 17
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2004 and DECEMBER 31, 2003
June 30, December 31,
ASSETS 2004 2003
CURRENT ASSETS:
Cash and cash equivalents $ 1,981,368 $ 1,459,881
Investment securities available-for-sale, at fair value 8,672,292 7,132,880
Service fees receivable, net of allowance for doubtful
accounts of $124,927 and $77,194 1,097,251 950,498
Service fees receivable from related parties 205,197 354,114
Prepaid expenses 370,442 442,072
Deferred tax assets 194,065 164,066
Other current assets 94,669 340,025
Receivable from subsidiary 5,213,882 51,650
Federal income tax receivable from subsidiary 3,238 6,677
Current assets of discontinued operations 9,721,178 11,715,163
----------- -----------
Total current assets 27,553,582 22,617,026
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 5,473,950 5,303,600
Computer software 1,503,514 1,386,784
----------- -----------
6,977,464 6,690,384
Less accumulated depreciation (5,833,017) (5,392,963)
----------- -----------
Furniture, equipment, and computer software, net 1,144,447 1,297,421
DEFERRED TAX ASSETS 1,237,416 1,140,249
OTHER ASSETS:
Investment in One Health Port 201,184 141,984
Other assets 166,563 114,135
Assets of discontinued operations 384,628 384,224
----------- -----------
Total other assets 752,375 640,343
----------- -----------
TOTAL ASSETS $30,687,820 $25,695,039
=========== ===========
See notes to condensed consolidated financial statements.
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2004 and DECEMBER 31, 2003
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2004 2003
CURRENT LIABILITIES:
Accounts payable $ 545,750 $ 627,631
Accrued expenses 1,890,068 1,986,532
Federal income tax payable 34,533 70,703
Dividends payable 5,165,952 -
Current liabilities of discontinued operations 7,053,407 3,823,788
----------- -----------
Total current liabilities 14,689,710 6,508,654
MINORITY INTEREST 633,877 1,922,306
REDEEMABLE EQUITY PARTICIPATION 2,520,000 2,520,000
SHAREHOLDERS' EQUITY:
Common stock:
Class A, par value $1 - Authorized, 30,000 shares;
issued and outstanding, 537 shares 537 537
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 shares 40,600 40,600
Additional paid-in capital 4,305,356 4,305,356
Additional capital from affiliates 1,472,108 1,472,108
Retained earnings 7,164,481 8,943,283
Accumulated other comprehensive loss, net of tax (138,849) (17,805)
----------- -----------
Total shareholders' equity 12,844,233 14,744,079
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $30,687,820 $25,695,039
=========== ===========
See notes to condensed consolidated financial statements.
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Three Months Ended Six Months Ended
June 30, June 30,
2004 2003 2004 2003
OPERATING REVENUE:
Network access fees $ 3,014,383 $ 2,808,243 $ 6,039,012 $ 5,514,542
Hospital administrative fees 931,069 859,794 1,853,711 1,855,773
Hospital administrative fees, related parties 1,015,859 991,955 1,998,096 1,975,922
Health benefit management fees 793,709 467,914 1,598,006 886,203
Other 214,597 129,155 430,619 233,028
----------- ----------- ----------- -----------
Total operating revenue 5,969,617 5,257,061 11,919,444 10,465,468
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Payroll and related expenses 2,529,361 2,040,929 5,063,322 3,931,884
Selling, general, and administrative expenses 1,580,346 1,499,520 3,141,493 2,928,238
----------- ----------- ----------- -----------
Total operating expenses 4,109,707 3,540,449 8,204,815 6,860,122
----------- ----------- ----------- -----------
Operating income 1,859,910 1,716,612 3,714,629 3,605,346
----------- ----------- ----------- -----------
OTHER INCOME:
Interest 87,783 40,615 165,044 95,166
Other (36,593) 15,064 (27,368) 75,108
----------- ----------- ----------- -----------
Total other income 51,190 55,679 137,676 170,274
----------- ----------- ----------- -----------
Income from continuing operations before
federal income taxes and minority interest 1,911,100 1,772,291 3,852,305 3,775,620
Provision for federal income taxes on
continuing operations 633,539 618,024 1,272,961 1,301,026
----------- ----------- ----------- -----------
Income from continuing operations before
minority interest 1,277,561 1,154,267 2,579,344 2,474,594
MINORITY INTEREST, net of tax ( 37,808) (181,275) (187,569) (240,815)
----------- ----------- ----------- -----------
Income from continuing operations after
minority interest 1,239,753 972,992 2,391,775 2,233,779
Discontinued operations:
Income from discontinuation of First
Choice Health Plan Insurance operations
(net of applicable income tax expense
of $146,737, $265,486, $532,131 and $169,184) 288,149 513,713 1,037,138 328,416
---------- ----------- ----------- -----------
NET INCOME $ 1,527,902 $ 1,486,705 $ 3,428,913 $ 2,562,195
=========== =========== =========== ===========
NET INCOME FROM CONTINUING OPERATIONS
AFTER MINORITY INTEREST PER COMMON SHARE $ 21.18 $ 16.62 $ 40.86 $ 38.16
=========== ========== =========== ===========
NET INCOME PER COMMON SHARE $ 26.10 $ 25.40 $ 58.58 $ 43.76
=========== ========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,537 58,538 58,537 58,538
=========== ========== =========== ===========
See notes to condensed consolidated financial statements.
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
Six Months Ended
June 30,
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 2,391,775 $ 2,233,779
Adjustments to reconcile net income to net cash
provided by continuing operating activities:
Depreciation 440,054 493,462
Deferred income taxes, net (127,166) (34,521)
Provision for doubtful accounts 47,733 10,754
Minority interest 187,569 283,416
Interest in earnings of One Health Port 40,800 -
Changes in operating assets and liabilities:
Service fees receivable (45,569) 263,030
Due from subsidiary including tax accrual 5,658 (2,089,066)
Prepaid expenses 71,630 52,024
Other current assets 245,356 (155,226)
Other assets (52,428) -
Accounts payable (81,881) (69,841)
Accrued expenses (94,963) (50,611)
Federal income tax payable (36,170) 214,969
------------ -----------
Net cash provided by continuing operating activities 2,992,398 1,152,169
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture, equipment, and computer software (287,080) (533,189)
Purchase of investments available for sale (2,390,945) (2,944,977)
Principal paydowns and sales of investments available for sale 776,093 1,206,748
Investment in One Health Port (100,000) -
------------ -----------
Net cash used by investing activities (2,001,932) (2,271,418)
CASH FLOWS FROM FINANCING ACTIVITIES:
Redeemable equity participation - 134,557
Payments to minority interest (440,450) -
------------ -----------
Net cash provided (used) by financing activities (440,450) 134,557
CASH FLOWS FROM DISCONTINUED OPERATIONS (28,529) (1,016,071)
------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 521,487 (2,000,763)
CASH AND CASH EQUIVALENTS:
Beginning of year 1,459,881 2,324,382
------------ -----------
End of period $ 1,981,368 $ 323,619
============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Federal income taxes $ 1,936,408 $ 1,212,000
See notes to condensed consolidated financial statements.
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
NOTE 1 PRESENTATION OF INTERIM INFORMATION
The accompanying unaudited interim condensed consolidated financial statements
and related notes have been prepared pursuant to the rules and regulations of
the Securities and Exchange Commission and in accordance with accounting
principles generally accepted in the United States of America. In the opinion
of the management of First Choice Health Network, Inc.(the "Company") and its
subsidiary, First Choice Health Plan, Inc. (the "Plan"), the accompanying
unaudited interim condensed consolidated financial statements include all
normal adjustments considered necessary to present fairly the financial
position as of June 30, 2004, and the results of operations for the three
months and six months ended June 30, 2004 and 2003, and cash flows for the six
months ended June 30, 2004 and 2003. The interim condensed consolidated
financial statements include the segregation of the discontinued operations
of the insured health plan business. (See Note 4.) The results of
interim operations are not necessarily indicative of operating results for the
entire year.
Certain amounts in the prior period financial statements have been reclassified
to conform with the current period presentation.
NOTE 2 INVESTMENTS
During the six months ended June 30, 2004, the Company purchased $2.4 million
and sold $.7 million of investments available for sale. Principal paydowns on
investments in debt securities during the first six months of 2004 were
$.1 million. The amortized cost, unrealized gains or losses and fair values of
investments in debt securities as of June 30, 2004 and December 31, 2003 are
as follows:
Gross Gross Gross
Amortized Unrealized Unrealized Unrealized
Cost Gains Losses Losses
Less Than More Than
12 Months 12 Months Fair Value
---------------------------------------------------------------
June 30, 2004
Mortgage-backed
adjustable rate securities $ 770,353 $ 52 $( 4,749) $(2,897) $ 762,759
Municipal bonds 7,986,463 22,105 (99,035) - 7,909,533
----------- -------- --------- ------- -----------
$ 8,756,816 $ 22,157 $(103,784) $(2,897) $ 8,672,292
============ ======== ========= ======= ===========
December 31, 2003
Mortgage-backed
adjustable rate securities $ 1,098,214 $ 4,262 $( 4,365) $ (782) $ 1,097,329
Municipal bonds 6,043,750 2,260 (10,459) - 6,035,551
----------- -------- --------- ------- -----------
$ 7,141,964 $ 6,522 $(14,824) $ (782) $ 7,132,880
============ ======== ========= ======= ===========
In determining fair value, management obtains quotations from independent
sources who make markets in similar securities, generally broker dealers.
These quotes are generally estimates of fair value based on an evaluation of
appropriate facts such as trading in similar securities, yields, credit
quality, coupon rate, maturity, type of issue, and other market data.
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Declines in the fair value of individual available-for-sale securities below
their cost that are other than temporary are recognized by write-downs of the
individual securities to their fair value. Such write-downs would be included
in earnings as realized losses. Premiums and discounts are recognized in
interest income using the interest method over the period to call or maturity.
NOTE 3 REPORTABLE OPERATING SEGMENTS
Factors management used to identify the enterprise's reportable segments: The
Company has two reportable segments representing 100% of its revenue. Each
segment requires distinct tracking capabilities in the areas of revenues and
expenses.
As a result of exiting the commercial insurance market, the Plan segment
that offered a variety of fully insured health insurance plans to employer
groups is being reported as a discontinued operation and is not included as
an operating segment (see Note 4).
Description of the types of products and services from which each reportable
segment derives its revenue: The Network operations have two primary products
which have been aggregated into one reportable segment, network access fees
and hospital administrative fees. Network access fees arise from the rental of
the Company's large preferred provider organization ("PPO") and other network
products while hospital administrative fees arise from charges to the network
hospitals based on claims incurred by members or fixed monthly contractual
payments. The other reportable segment, Health Benefits Management ("HBM"),
offers benefits management and administration services to employers who are
self-funding their company health benefit plans. This segment offers manage-
ment and administration services for health benefit plans, flexible spending
accounts, health reimbursement accounts and COBRA benefits.
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.
Information about profit or loss of reportable segments:
First Choice Health Benefits
Health Network Management Total
-------------- -------------- -----------
Three months ended June 30, 2004:
Revenues from external customers $ 5,175,908 $ 793,709 $ 5,969,617
Intersegment revenue 15,926 (15,926) -
Net income (loss) 1,471,317 (193,756) 1,277,561
Minority interest ( 37,808)
Income from discontinued operations 288,149
Consolidated net income 1,527,902
Three months ended June 30, 2003:
Revenues from external customers $ 4,789,147 $ 467,914 $ 5,257,061
Intersegment revenue 20,196 (20,196) -
Net income (loss) 1,273,369 (119,102) 1,154,267
Minority interest (181,275)
Income from discontinued operations 513,713
Consolidated net income 1,486,705
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First Choice Health Benefits
Health Network Management Total
-------------- -------------- -----------
Six months ended June 30, 2004:
Revenues from external customers $10,321,438 $ 1,598,006 $11,919,444
Intersegment revenue 31,628 (31,628) -
Net income (loss) 2,878,979 (299,635) 2,579,344
Minority interest (187,569)
Income from discontinued operations 1,037,138
Consolidated net income 3,428,913
Six months ended June 30, 2003:
Revenues from external customers $ 9,579,265 $ 886,203 $10,465,468
Intersegment revenue 40,464 (40,464) -
Net income (loss) 2,638,196 (163,602) 2,474,594
Minority interest (240,815)
Income from discontinued operations 328,416
Consolidated net income 2,562,195
NOTE 4 DISCONTINUED OPERATIONS
As the Plan's business model shifted from capitated contracts to fee for
service contract arrangements over the past three (3) years, management
and the Board of Directors have reevaluated the strategic importance of the
Plan. As a result, the Plan's existing commercial insured business is being
wound down in an orderly manner with the non-renewal of all commercial
business during 2003 and the run-out of outstanding claim liabilities through
2004.
The discontinuance of the Plan's operation is accounted for pursuant to
SFAS 60, Accounting and Reporting by Insurance Enterprises. This statement
requires recording a liability for all costs expected to be incurred in
connection with the settlement of unpaid claims to be accrued when the
liability for unpaid claims is incurred.
At the Balance Sheet date the following assets included in the condensed
consolidated balance sheet apply to the discontinued operations of the Plan:
Assets June 30, 2004 December 31, 2003
Cash and cash equivalents $ 1,931,441 $ 2,687,652
Investment securities available for sale 7,754,972 8,020,730
Premiums receivable - 898,489
Prepaid expenses and other receivables 30,518 72,026
Deferred tax asset 4,247 36,266
Restricted indemnity cash and investments 384,628 384,224
----------- -----------
Total assets $ 10,105,806 $ 12,099,387
=========== ===========
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Liabilities June 30, 2004 December 31, 2003
Accrued expenses $ 319,749 $ 595,351
Reserve for unpaid loss and loss adjustment expenses 479,260 3,069,224
Provider settlements payable - 83,787
Dividends payable 541,110 -
Payable on preferred stock redemption 494,438 -
Unearned premiums 1,730 17,099
Federal income tax expense payable to parent 3,238 6,677
Amount due to parent 5,213,882 51,650
----------- -----------
Total liabilities $ 7,053,407 $ 3,823,788
=========== ===========
The following amounts, representing revenue and income and loss from
discontinued operations, are included in the condensed consolidated statement
of income for the three months and six months ended June 30, 2004 and 2003:
Operations
For the Three Months For the Six Months
Ended June 30, Ended June 30,
2004 2003 2004 2003
Operating revenue $ 42,935 $ 9,820,053 $ 69,288 $21,887,274
Income from discontinued operations
before federal income tax 434,886 779,199 1,569,269 497,600
Income from discontinued operations
after federal income tax 288,149 513,713 1,037,138 328,416
Net income from discontinued
operations per common share 4.92 8.78 17.72 5.61
NOTE 5 EARNINGS PER SHARE
Net income per common share (Class A and B) is computed by dividing income
available to common shareholders by the weighted average number of common
shares outstanding during the period, including 41,137 shares for the three
months and six months ended June 30, 2004 and 41,138 shares for the three
months and six months ended June 30, 2003, and 17,400 shares for district
hospitals applicable to affiliate common share equivalents for each period.
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
non-shareholders are recorded as additional capital from affiliates. These
contractual agreements are considered to be common share equivalents for
purposes of calculating net income per common share.
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
First Choice Health Network, Inc. (the "Company"), is a physician and hospital
owned company offering a preferred provider organization ("PPO") and health
benefits management services ("HBM") to large self-funded plan sponsors. Until
year end 2003, the Company also offered insured health plan products through a
subsidiary, First Choice Health Plan, Inc. (the "Plan"). The Plan no longer
provides insurance services as of January 1, 2004 and is reported as
discontinued operations in the financial statements.
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Revenue from PPO network services including utilization management services
takes the form of monthly access fees from participating payers and fees from
payers based on a percentage of the savings generated by PPO provider
contracts. In addition, participating hospitals pay fees based on PPO claims
volumes in those hospitals. Other PPO product offerings include medical and
utilization management services for certain PPO clients and various specialty
network services including a complementary and alternative medicine PPO and
Employee Assistance Program ("EAP") product and network services.
The HBM segment offers benefits management and administration services to
self-funded employers and insurance carriers. The HBM membership was 20,949
at June 30, 2004 compared to 10,470 at December 31, 2003. With certain well
defined exceptions, these self-funded benefits administration services will not
be offered to potential clients that currently obtain such services from
benefit administrators that access the Company's PPO products. The HBM
revenues consist primarily of fees paid to administer health benefit plans,
flexible spending accounts and various forms of consumer directed health plans
such as health reimbursement accounts.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q includes forward-looking statements about
the future operations of the Company, including discussion of the effects of
the Company's exit from the insured health care business, the prospects for the
Company's entry into the HBM business, and the adequacy of the Company's
reserves for claims expenses and unreported claims for the discontinued Plan
operations. These forward-looking statements involve certain risks and
uncertainties that could cause actual results to differ materially from those
in the forward-looking statements. Such factors include the Company's ability
to attract and retain new HBM customers and the cost of maintaining
technological and staff capabilities for health benefits management and
administration. Because of these uncertainties, actual future results,
performance or achievements may be materially different from the results,
performance or achievements expressed or implied by these forward-looking
statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED
JUNE 30, 2003
The following table summarizes operating revenues for the three months ended
June 30, 2004 and 2003:
(in millions) Three Months Ended
June 30,
2004 2003
---- ----
Network access fees $3.0 $2.8
Hospital administrative fees 2.0 1.9
Health benefit management fees .8 .5
Other .2 .1
---- ----
Total operating revenues $6.0 $5.3
Operating revenue, net of discontinued operations, increased $.7 million
(13.2%) from 2003 to 2004. The increase in 2004 resulted principally from
an increase of $.3 million from revenue of the Company's HBM business segment
and the impact of increasing rates for network access fees of $.2 million.
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The following table summarizes operating expenses for the three months ended
June 30, 2004 and 2003:
(in millions) Three Months Ended
June 30,
2004 2003
---- ----
Payroll and related expenses $2.5 $2.0
Selling, general and administrative 1.6 1.5
---- ----
Total operating expenses $4.1 $3.5
Payroll and related expenses of the ongoing business segments increased $.5
million (23.9%) from 2003 to 2004. The increase resulted primarily from the
redirection of costs from the discontinued insured business to the new HBM
business. Selling, general and administrative expenses of the ongoing business
segments remained relatively constant with an increase of $.1 million (5.4%)
from 2003 to 2004.
The Plan's net income as shown on the discontinued operations line on the
condensed consolidated statements of income for the three months ended
June 30, 2004 and 2003 is $288,149 and $513,713, respectively. The decrease
in net income in 2004 of $255,564 results from the discontinuance of the Plan's
membership in 2004. Net income in 2004 is the result of favorable development
of claims reserves upon the exit of the Plan from the insured healthcare
business.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO SIX MONTHS ENDED
JUNE 30, 2003
The following table summarizes operating revenues for the six months ended
June 30, 2004 and 2003:
(in millions) Six Months Ended
June 30,
2004 2003
---- ----
Network access fees $ 6.0 $ 5.5
Hospital administrative fees 3.9 3.9
Health benefit management fees 1.6 .9
Other .4 .2
---- ----
Total operating revenues $11.9 $10.5
Operating revenue, net of discontinued operations, increased $1.4 million
(13.3%) from 2003 to 2004. The increase in 2004 resulted principally from
an increase of $.7 million from revenue of the Company's HBM business segment
and the impact of increasing rates for network access fees of $.5 million.
The following table summarizes operating expenses for the six months ended
June 30, 2004 and 2003:
(in millions) Six Months Ended
June 30,
2004 2003
---- ----
Payroll and related expenses $5.1 $4.0
Selling, general and administrative 3.1 2.9
---- ----
Total operating expenses $8.2 $6.9
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Payroll and related expenses of the ongoing business segments increased $1.1
million (28.5%) from 2003 to 2004. The increase resulted primarily from the
redirection of costs from the insured business to the new HBM business.
Selling, general and administrative expenses of the ongoing business segments
remained relatively constant with an increase of $.2 million (6.9%) from 2003
to 2004.
The Plan's net income and loss as shown on the discontinued operations line on
the condensed consolidated statements of income for the six months ended
June 30, 2004 and 2003 is $1,037,138 and $328,416, respectively. The increase
in net income from 2003 to 2004 results from the favorable development of
claims reserves upon the exit of the Plan from the insured health care
business in 2003. Based upon the six months of claims run out paid in 2004,
the reserve for unpaid loss and loss adjustment expense recorded at December
31, 2003 has restated favorably by approximately $1.4 million. This represents
the bulk of the pre-tax income of discontinued operations in 2004.
RELATED PARTY TRANSACTIONS
The Company's related party transactions consist of two components. One
component is the fees received from the Company's owner hospitals for HBM
services. The other component is hospital administrative fees from owner
hospitals.
MARKET RISK FROM COMPETITORS
The Company offers its PPO and HBM products in a highly competitive
environment. The Company has numerous competitors, including for-profit and
not-for-profit HMOs, third party administrators ("TPAs"), PPOs and indemnity
insurance carriers, some of which have substantially larger enrollments and
greater financial resources than the Company. The Company's ability to retain
existing PPO clients and attract new PPO and HBM clients is largely dependent
on its ability to offer competitive provider contract value and maintain a
network of high quality, efficient, fully credentialed providers who agree to
accept competitive reimbursement rates.
LIQUIDITY AND CAPITAL RESOURCES
Since inception in 1986, the Company has financed its operations from
equity investments from over 870 physicians, from the seven hospitals
comprising the Company's Class B shareholders, non-equity capital
contributions from four additional hospitals pursuant to their respective
participation agreements, and funds from operations.
As indicated on the Company's Condensed Consolidated Balance Sheet at
June 30, 2004, the Company had cash and cash equivalents of approximately
$2.0 million compared to approximately $1.5 million at December 31, 2003.
The Company anticipates that the revenue generated by operations, cash and cash
equivalents and investment securities available for sale as of June 30,
2004, will be sufficient to meet its cash requirements throughout 2004. The
run-out of claims liability reserves during 2004 in the Plan's discontinued
operations is expected to be funded by the Plan's cash and investments
totaling $9.7 million at June 30, 2004.
Following are explanations of significant balance sheet account fluctuations:
Investments in securities available for sale increased $1.6 million from $7.1
million at December 31, 2003, to $8.7 million at June 30, 2004, due to the re-
investment of operating cash flow. The $5.2 million increase in receivable
from subsidiary represents the Company's proceeds from the Plan's preferred
stock retirement and common stock dividend payable July 26, 2004. The $5.2
million increase in dividend payable represents the Company's common stock
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dividend declared June 24, 2004 and payable July 26, 2004. The following table
summarizes the $1.3 million decrease in minority interest for the six months
ended June 30, 2004:
(in millions)
Minority interest in Plan's net income $ .2
Payment to Plan's minority stockholders (.4)
Plan's common stock dividend to minority stockholders (.6)
Plan's minority interest preferred stock redemption (.5)
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Total $(1.3)
The above payment to the Plan's minority stockholders of $.4 million represents
the minority stockholders 20% interest in the contractually required capital
contribution from the Company to the plan for 2003. Because of the wind down of
the Plan's business activities, the Plan's stockholders approved this payment
in lieu of a full capital contribution to the Plan. The effect is that the
minority interest stockholders received the 20% interest that they would have
enjoyed had the full capital contribution been made. Other balance sheet
account fluctuations primarily result from normal payment and collection timing
differences.
Current assets of discontinued operations decreased by $2.0 million from
$11.7 million at December 31, 2003 to $9.7 million at June 30, 2004, due to
the orderly exit from the health insurance business and the resulting payment
of claims run out. The $3.2 million increase in current liabilities of
discontinued operations is due to the following fluctuations:
(in millions)
Accrued expenses $ (.3)
Reserve for unpaid loss and loss adjustment expense (2.6)
Dividends payable .5
Preferred stock redemption payable .5
Amount due to parent 5.2
Other (.1)
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Total $ 3.2
Following are explanations for these fluctuations:
Accrued expenses - Payment of outstanding expenses as the Plan's run-out
business is processed.
Reserve for unpaid loss and loss adjustment expense - Payment of claims run-
out of $.9 million, release of loss adjustment expense as run-out costs are
incurred of $.3 million, and release of claim volatility margin of $1.4
million. As a result of favorable claims run-out, the claim volatility margin
was not needed.
Dividends payable - Common stock dividends payable to the Plan's minority
shareholders.
Preferred stock redemption payable - Preferred stock redemption payable to
the Plan's minority shareholders.
Amount due to parent - The $5.2 million increase in amount due to parent
represents the amount of preferred stock redemption and common stock dividends
payable to the Company.
DIVIDENDS
The balance sheet presents all assets and liabilities of the health plan legal
entity as discontinued. On June 22, 2004, the Plan's Board of Directors
authorized the redemption of 100% of the Plan's outstanding preferred stock of
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$3.5 million and a common stock dividend of $2.7 million. Both transactions
received the appropriate regulatory approval and were paid July 26, 2004. The
Plan generated cash for the dividend by selling marketable securities. At the
same time, the Company's Board of Directors declared a special dividend of $5.2
million that was paid to its shareholders July 26, 2004. This amount represents
all of the Company's proceeds from the Plan transactions. During 2005, the
Company expects to request regulatory approval to dissolve the Plan and
distribute any remaining assets as dividends. The Company plans to declare a
special dividend to distribute its share of these non-recurring cash flows to
its shareholders as they are received.
The Company had not paid any dividends in its history until 2003, when it
declared and paid a $1.2 million dividend to shareholders in connection with
the winding down of the Plan. Based on its expectations of generating positive
cash flow on a consistent basis in the future, the Company plans to pay annual
cash dividends.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
As a result of the decision to exit the insured health care business by
December 31, 2003, the Company's 80% ownership in the Plan was written down at
December 31, 2001 to the expected net realizable value, which is the Plan's
book value. Management believes this measurement of the expected net
realizable value is still valid as of June 30, 2004.
The reserve for unpaid claims and claims adjustment expenses in discontinued
operations of the Plan 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. As a result of decreasing membership in the
Plan during 2003, management increased the level of conservatism in the
estimate due to increased risk associated with potential claim volatility
resulting from a lower membership base. This conservatism is now being
realized as shown by the approximate $1.4 million favorable development of the
reserve for unpaid loss and loss adjustment expense recorded at
December 31, 2003.
The development and selection of "critical" accounting estimates and the
associated disclosures in this discussion have been discussed by management
with the audit committee of the Board of Directors.
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the reported market risks faced by
the Company since the end of its most recent fiscal year.
Item 4 CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the
Registrant's disclosure controls and procedures (as defined in Rule 13a-
15(e) under the Securities Exchange Act of 1934 (the "Act")) was carried
out under the supervision and with the participation of the Registrant's
Chief Executive Officer, Executive Vice President of Finance and several
other members of the registrant's senior management as of the end of the
period covered by this report. Based on that evaluation, the Registrant's
Chief Executive Officer and Executive Vice President of Finance concluded
that the Registrant's disclosure controls and procedures are effective in
ensuring that the information required to be disclosed by the Registrant
in the reports it files or submits under the Act is (i) accumulated and
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communicated to the Registrant's management (including the Chief Executive
Officer and Executive Vice President of Finance) as appropriate to allow
timely decisions regarding required disclosure, and (ii) recorded,
processed, summarized and reported within the time periods specified in
the SEC's rules and forms.
(b) Changes in Internal Control over financial reporting: In the six months
ended June 30, 2004, there has been no change in the Registrant's
internal control over financial reporting that has materially affected,
or is reasonably likely to materially affect, its internal control over
financial reporting.
Disclosure Controls and Internal Controls. Disclosure controls are
procedures that are designed with the objective of ensuring that
information required to be disclosed in the Registrant's reports filed
under the Act is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission's (SEC)
rules and forms. Disclosure controls are also designed with the objective
of ensuring that such information is accumulated and communicated to our
management, as appropriate to allow timely decisions regarding required
disclosure. Internal Controls are procedures which are designed with the
objective of providing reasonable assurance that (1) transactions are
properly authorized; (2) assets are safeguarded against unauthorized or
improper use; and (3) transactions are properly recorded and reported,
all to permit the preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America.
Part II Other Information
Item 1 Legal Proceedings
In the normal course of business, the Company may encounter claims,
assessments, and litigation brought against the Company. If and when
these situations arise, the Company assesses the situation and accrues
for financial exposure, if appropriate. As of June 30, 2004, the
Company is not aware of any such material situations.
Item 6 Exhibits and Reports on Form 8-K
(a) The following exhibits are furnished with this report:
31.1 Certification pursuant to Rule 13a-14(a) for Gary R. Gannaway.
31.2 Certification pursuant to Rule 13a-14(a) for Kenneth A. Hamm.
32.1 Section 1350 Certification for Gary R. Gannaway, Chief Executive
Officer.
32.2 Section 1350 Certification for Kenneth A. Hamm, Executive Vice
President.
(b) The following report on Form 8-K was filed by the registrant during the
quarter ended June 30, 2004:
On June 25, 2004, the Company filed a Current Report on Form 8-K
reporting under Item 2 that the Board of Directors declared a dividend
of $5,164,451 payable, contingent on regulatory approval, to the holders
of the Company's Class A and Class B Common Stock and to participating
hospitals with certain contract rights in connection with liquidation of
the Plan.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on the 11th day of August, 2004.
FIRST CHOICE HEALTH NETWORK, INC.
By: /s/
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KENNETH A. HAMM
Executive Vice President of Finance
(Principal Financial and Accounting Officer and Duly Authorized Officer)
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