1
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 SEPTEMBER 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 September 30, 2004, was 453 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 September 30, 2004 and December 31, 2003 3
Condensed Consolidated Statements of Income (Unaudited)
for the Three Months and Nine Months Ended September 30, 2004
and 2003 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Nine Months Ended September 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 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk 16
Item 4 Controls and Procedures 17
Part II Other Information
Item 1 Legal Proceedings 17
Item 2 Unregistered Sales of Equity Securities and Use of
Proceeds 18
Item 4 Submission of Matters to a Vote of Security Holders 18
Item 6 Exhibits 18
Signatures 19
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3
FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
September 30, December 31,
ASSETS 2004 2003
CURRENT ASSETS:
Cash and cash equivalents $ 1,581,992 $ 1,459,881
Investment securities available-for-sale, at fair value 10,002,524 7,132,880
Service fees receivable, net of allowance
for doubtful accounts of $119,871 and $77,194 1,169,886 950,498
Service fees receivable from related parties 295,790 354,114
Prepaid expenses 532,788 442,072
Deferred tax assets 197,445 164,066
Other current assets 111,581 340,025
Receivable from subsidiary - 51,650
Federal income tax receivable 76,791 -
Federal income tax receivable from subsidiary - 6,677
Current assets of discontinued operations 3,097,283 11,715,163
----------- -----------
Total current assets 17,066,080 22,617,026
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 5,504,944 5,303,600
Computer software 1,572,105 1,386,784
----------- -----------
7,077,049 6,690,384
Less accumulated depreciation and amortization (6,008,868) (5,392,963)
----------- -----------
Furniture, equipment, and computer software, net 1,068,181 1,297,421
DEFERRED TAX ASSETS 1,275,856 1,140,249
OTHER ASSETS:
Investment in One Health Port 201,184 141,984
Other assets 192,427 114,135
Assets of discontinued operations 387,223 384,224
----------- -----------
Total other assets 780,834 640,343
----------- -----------
TOTAL $20,190,951 $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)
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2004 2003
CURRENT LIABILITIES:
Accounts payable $ 654,718 $ 627,631
Accrued expenses 1,948,014 1,986,532
Federal income tax payable - 70,703
Federal income tax payable from subsidiary 16,427 -
Dividends payable 1,501 -
Current liabilities of discontinued operations 418,781 3,823,788
----------- -----------
Total current liabilities 3,039,441 6,508,654
MINORITY INTEREST 656,949 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, 453 and 537 shares 453 537
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 shares 40,600 40,600
Additional paid-in capital 4,080,404 4,305,356
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 8,425,516 8,943,283
Accumulated other comprehensive losses, net of tax (44,520) (17,805)
----------- -----------
Total shareholders' equity 13,974,561 14,744,079
----------- -----------
TOTAL $20,190,951 $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 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Three Months Ended Nine Months Ended
September 30, September 30,
`
2004 2003 2004 2003
OPERATING REVENUE:
Network access fees $2,959,444 $2,827,073 $8,998,456 $8,341,615
Hospital administrative fees 898,565 935,692 2,752,276 2,791,465
Hospital administrative fees, related parties 1,048,376 980,097 3,046,472 2,956,019
Health benefit management fees 805,094 503,313 2,403,100 1,389,516
Other 236,627 163,917 667,246 396,945
---------- ---------- ---------- ----------
Total operating revenue 5,948,106 5,410,092 17,867,550 15,875,560
---------- ---------- ---------- ----------
OPERATING EXPENSES:
Payroll and related expenses 2,602,731 2,113,680 7,666,053 6,045,564
Selling, general, and administrative expenses 1,564,199 1,633,585 4,705,692 4,561,823
---------- ---------- ---------- ----------
Total operating expenses 4,166,930 3,747,265 12,371,745 10,607,387
---------- ---------- ---------- ----------
Operating income 1,781,176 1,662,827 5,495,805 5,268,173
OTHER INCOME (EXPENSE):
Interest 96,709 39,380 261,753 134,546
Other (12,575) 42,179 (39,943) 117,287
---------- ---------- ---------- ----------
Total other income (expense) 84,134 81,559 221,810 251,833
---------- ---------- ---------- ----------
Income from continuing operations before
federal income taxes and minority interest 1,865,310 1,744,386 5,717,615 5,520,006
Provision for federal income taxes on
continuing operations 598,092 594,864 1,871,053 1,895,890
---------- ---------- ---------- ----------
Income on continuing operations before
minority interest 1,267,218 1,149,522 3,846,562 3,624,116
MINORITY INTEREST (23,072) (122,728) (210,641) (363,543)
---------- ---------- ---------- ----------
Income from continuing operations after
minority interest 1,244,146 1,026,794 3,635,921 3,260,573
Discontinued operations:
Income (loss) from discontinuation of First Choice
Health Plan Insurance operations (net of applicable
Income tax expense (benefit) of $8,124, 82,657,
$540,255 and 251,841) 16,889 160,453 1,054,027 488,869
---------- ---------- ---------- ----------
NET INCOME $1,261,035 $1,187,247 $4,689,948 $3,749,442
========== ========== ========== ==========
NET INCOME PER COMMON SHARE $21.56 $20.28 $80.14 $64.05
========== ========== ========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,495 58,538 58,523 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 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Nine Months Ended
September 30,
2004 2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 3,635,921 $ 3,260,573
Adjustments to reconcile net income to net cash
provided by continuing operating activities:
Depreciation 615,905 763,173
Deferred income taxes, net (168,986) (49,476)
Provision for doubtful accounts 42,677 (74,617)
Minority interest 210,641 406,145
Write-down of investment in One Health Port 40,800
Changes in operating assets and liabilities:
Service fees receivable (203,741) 694,156
Amount due from (to) subsidiary, including tax accrual 74,754 (1,546,216)
Prepaid expenses (90,716) (19,042)
Other current assets 228,444 (244,263)
Other assets (78,292) (78,468)
Accounts payable 27,087 98,361
Accrued expenses (38,518) 850,612
Federal income tax payable (147,494) (107,563)
------------ ------------
Net cash provided by continuing operating activities 4,148,482 3,953,375
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment in One Health Port (100,000) -
Purchase of furniture, equipment, and computer software (386,665) (795,898)
Purchase of investments available for sale (4,295,235) (4,876,600)
Principal paydowns and sales of investments available for sale 1,398,876 2,495,731
------------ ------------
Net cash used by investing activities (3,383,024) (3,176,767)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments to minority interest (440,450) -
Repurchase of Class A common stock (225,036) -
Dividends paid (5,162,950) -
Redeemable equity participation - 134,557
------------ ------------
Net cash provided (used) by financing activities (5,828,436) 134,557
CASH FLOWS FROM (TO) DISCONTINUED OPERATIONS 5,185,089 (1,191,433)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 122,111 (280,268)
CASH AND CASH EQUIVALENTS:
Beginning of year 1,459,881 2,324,382
------------ ------------
End of period $ 1,581,992 $ 2,044,114
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Federal income taxes $ 2,693,775 $ 2,194,540
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 NINE MONTHS ENDED SEPTEMBER 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 September 30, 2004, and the results of operations for the three
months and nine months ended September 30, 2004 and 2003, and cash flows for
the nine months ended September 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 nine months ended September 30, 2004, the Company purchased $4.3
million and sold $1.2 million of investments available for sale. Principal
paydowns on investments in debt securities during the first nine months of 2004
were $.2 million. The amortized cost, unrealized gains or losses and fair
values of investments in debt securities as of September 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
---------------------------------------------------------------
September 30, 2004
Mortgage-backed
adjustable rate securities $ 1,617,874 $ 6,052 $ (723) $ (236) $ 1,622,967
Municipal bonds 8,417,335 21,730 (59,508) - 8,379,557
----------- -------- --------- ------- -----------
$ 10,035,209 $ 27,782 $ (60,231) $ (236) $10,002,524
============ ======== ========= ======= ===========
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
============ ======== ========= ======= ===========
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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.
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 and savings 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.
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Information about profit or loss of reportable segments:
First Choice Health Benefits
Health Network Management Total
-------------- -------------- -----------
Three months ended September 30, 2004:
Revenues from external customers $ 5,143,012 $ 805,094 $ 5,948,106
Intersegment revenue 16,919 (16,919) -
Net income (loss) 1,454,335 (187,117) 1,267,218
Minority interest (23,072)
Income from discontinued operations 16,889
Consolidated net income 1,261,035
Three months ended September 30, 2003:
Revenues from external customers $ 4,906,779 $ 503,313 $ 5,410,092
Intersegment revenue 18,400 (18,400) -
Net income (loss) 1,341,576 (192,054) 1,149,522
Minority interest (122,728)
Income from discontinued operations 160,453
Consolidated net income 1,187,247
First Choice Health Benefits
Health Network Management Total
-------------- -------------- -----------
Nine months ended September 30, 2004:
Revenues from external customers $15,464,450 $ 2,403,100 $17,867,550
Intersegment revenue 48,547 (48,547) -
Net income (loss) 4,333,314 (486,752) 3,846,562
Minority interest (210,641)
Income from discontinued operations 1,054,027
Consolidated net income 4,689,948
Nine months ended September 30, 2003:
Revenues from external customers $14,486,044 $ 1,389,516 $15,875,560
Intersegment revenue 58,864 (58,864) -
Net income (loss) 3,979,772 (355,656) 3,624,116
Minority interest (363,543)
Income from discontinued operations 488,869
Consolidated net income 3,749,442
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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 September 30, 2004 December 31, 2003
Cash and cash equivalents $ 791,229 $ 2,687,652
Investment securities available for sale 2,285,020 8,020,730
Premiums receivable - 898,489
Prepaid expenses and other receivables 4,607 72,026
Federal income tax receivable from parent 16,427 -
Deferred tax asset 2,255 36,266
Restricted indemnity cash and investments 384,968 384,224
----------- -----------
Total assets $ 3,484,506 $ 12,099,387
=========== ===========
Liabilities September 30, 2004 December 31, 2003
Accrued expenses $ 168,901 $ 595,351
Reserve for unpaid loss and loss adjustment expenses 248,150 3,069,224
Provider settlements payable - 83,787
Unearned premiums 1,730 17,099
Federal income tax expense payable to parent - 6,677
Amount due to parent - 51,650
----------- -----------
Total liabilities $ 418,781 $ 3,823,788
=========== ===========
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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 nine months ended September 30, 2004 and
2003:
Operations
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
Operating revenue $ - $ 4,511,603 $ 69,288 $26,398,877
Income from discontinued operations
before federal income tax 25,013 243,110 1,594,282 740,710
Income from discontinued operations
after federal income tax 16,889 160,453 1,054,027 488,869
Net income from discontinued
operations per common share .29 2.74 18.01 8.35
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 41,095 shares for the three
months ended September 30, 2004, 41,123 shares for the nine months ended
September 30, 2004 and 41,138 shares for the three months and nine months
ended September 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.
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.
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The HBM segment offers benefits management and administration services to
self-funded employers and insurance carriers. The HBM membership was 21,351
at September 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 and savings 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 and the prospects for
the Company's entry into the HBM business. 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 SEPTEMBER 30, 2004 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2003
The following table summarizes operating revenues for the three months ended
September 30, 2004 and 2003:
(in millions) Three Months Ended
September 30,
2004 2003
---- ----
Network access fees $3.0 $2.8
Hospital administrative fees 1.9 1.9
Health benefit management fees .8 .5
Other .2 .2
---- ----
Total operating revenues $5.9 $5.4
Operating revenue, net of discontinued operations, increased $.5 million
(9.3%) 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
September 30, 2004 and 2003:
(in millions) Three Months Ended
September 30,
2004 2003
---- ----
Payroll and related expenses $2.6 $2.1
Selling, general and administrative 1.6 1.6
---- ----
Total operating expenses $4.2 $3.7
Payroll and related expenses of the ongoing business segments increased $.5
million (23.8%) 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 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
September 30, 2004 and 2003 is $16,889 and $160,453, respectively. The decrease
in net income in 2004 of $143,564 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.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2003
The following table summarizes operating revenues for the nine months ended
September 30, 2004 and 2003:
(in millions) Nine Months Ended
September 30,
2004 2003
---- ----
Network access fees $ 9.0 $ 8.3
Hospital administrative fees 5.8 5.8
Health benefit management fees 2.4 1.4
Other .7 .4
---- ----
Total operating revenues $17.9 $15.9
Operating revenue, net of discontinued operations, increased $2.0 million
(12.6%) from 2003 to 2004. The increase in 2004 resulted principally from
an increase of $1.0 million from revenue of the Company's HBM business segment
and the impact of increasing rates for network access fees of $.7 million.
The following table summarizes operating expenses for the nine months ended
September 30, 2004 and 2003:
(in millions) Nine Months Ended
September 30,
2004 2003
---- ----
Payroll and related expenses $7.7 $6.0
Selling, general and administrative 4.7 4.6
---- ----
Total operating expenses $12.4 $10.6
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Payroll and related expenses of the ongoing business segments increased $1.7
million (28.3%) 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 $.1 million (2.2%) 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 nine months ended
September 30, 2004 and 2003 is $1,054,027 and $488,869, 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 nine 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
September 30, 2004, the Company had cash and cash equivalents of approximately
$1.6 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 September 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 $3.1 million at September 30, 2004.
Following are explanations of significant balance sheet account fluctuations:
Investments in securities available for sale increased $2.9 million from $7.1
million at December 31, 2003, to $10.0 million at September 30, 2004, due to
the re-investment of operating cash flow.
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The following table summarizes the $1.3 million decrease in minority interest
For the nine months ended September 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)
--------
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 $8.6 million from $11.7
million at December 31, 2003 to $3.1 million at September 30, 2004. Of this
decrease, $6.2 million resulted from the redemption of 100% of the Plan's
outstanding preferred stock of $3.5 million and a common stock dividend of $2.7
million. The orderly exit from the health insurance business and the resulting
payment of claims run out accounts for the remaining decrease of $2.4 million.
Current liabilities of discontinued operations decreased by $3.4 million. This
is due primarily to the $2.8 million reduction in the Reserve for unpaid loss
and loss adjustment expense which resulted from payment of claims run-out of
$.9 million, release of loss adjustment expense as run-out costs are incurred of
$.5 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. The
remaining decrease in current liabilities is due to payment of outstanding
expenses as the Plan's run-out business is processed.
Discussion of Non-recurring Items in the Cash Flow Statement for the Nine Months
Ended September 30, 2004:
The Cash Flow Statement for the Nine Months Ended September 30, 2004, reflects
non-recurring cash flow of $5.2 million from the Plan to the Company, from a
July 26, 2004 dividend and redemption of preferred stock described below (shown
as cash flow from discontinued operations) and the subsequent dividend payment
of the same amount to the Company's shareholders (shown as a financing
activity). As a result of the exit from the insured healthcare business, the
Company has determined that any proceeds from the wind down and ultimate
liquidation of the Plan will result in excess capital for the Company's current
needs. As a result, such proceeds were distributed to the Company's
shareholders in the form of a $5.2 million special dividend. Subject to
regulatory approval, the final liquidation of the Plan in 2005 will result in
another special dividend of a significantly smaller amount. Such dividends are
non-recurring.
As a result of these activities, the Plan also paid additional amounts to
Minority interest shareholders of $600,000 in common stock dividends and
$500,000 in preferred stock redemption that reduced the Company's minority
interest balance during 2004.
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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
$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 September 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.
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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
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 quarter
ended September 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 September 30, 2004, the
Company is not aware of any such material situations.
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Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
Maximum Number
(or
Total Number Approximate
of Shares Dollar Value)
Purchased as of Shares that
Part of May Yet Be
Publicly- Purchased
Total Number Announced Under the
Of Shares Average Price Plans or Plans or
Period Purchased Paid Per Share Programs Programs
August 3, 2004 84 $ 2,679 (1) N/A
through August
31, 2004
(1) Shares of Class A Common Stock were repurchased from shareholders no longer
meeting eligibility standards for ownership of such shares. These
shareholders were advised by the Company of their ineligibility and the
terms of repurchase of their shares individually.
Item 4 Submission of Matters to a Vote of Securities Holders
The Company held its 2004 annual meeting of shareholders on
June 24, 2004. The following directors were elected at the annual
meeting:
For Withheld
William F. Johnston 40,789 1
Diane E. Cecchettini 40,781 9
Richard D. Roodman 40,781 9
Thomas W. Wilbur 40,788 2
Clyde D. Walker 40,789 1
Item 6 Exhibits
The following exhibits are filed or 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.
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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 10th day of November, 2004.
FIRST CHOICE HEALTH NETWORK, INC.
By: /s/
--------------------------------------
KENNETH A. HAMM
Executive Vice President of Finance
(Principal Financial and Accounting Officer and Duly Authorized Officer)
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