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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, 2003
[ ] 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, 2003, was 538 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, 2003 and December 31, 2002 3
Condensed Consolidated Statements of Income (Unaudited)
for the Three and Six Months Ended June 30, 2003 and 2002 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Six Months Ended June 30, 2003 and 2002 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 14
Item 4 Controls and Procedures 14
Part II Other Information
Item 1 Legal Proceedings 15
Item 4 Submission of Matters to the Vote of Security Holders 15
Item 6 Exhibits and Reports 16
Signatures 17
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FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
JUNE 30, 2003 AND DECEMBER 31, 2002
June 30, December 31,
ASSETS 2003 2002
CURRENT ASSETS:
Cash and cash equivalents $ 323,619 $ 2,324,382
Investment securities available for sale 6,455,902 4,712,815
Service fees receivable, net of allowance
for doubtful accounts of $142,594 and $131,840 1,312,502 1,400,693
Service fees receivable from related parties 316,407 502,000
Prepaid expenses 456,876 508,900
Deferred tax assets 176,196 181,711
Other current assets 194,391 39,165
Receivable from subsidiary 41,073 102,273
Federal income tax receivable from subsidiary 542,523 -
Current assets of discontinued operations 13,764,023 14,219,465
----------- -----------
Total current assets 23,583,512 23,991,404
FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE:
Furniture and equipment 4,969,396 4,538,941
Computer software 1,380,109 1,277,375
----------- -----------
6,349,505 5,816,316
Less accumulated depreciation and amortization (4,855,662) (4,362,200)
----------- -----------
Furniture, equipment, and computer software, net 1,493,843 1,454,116
DEFERRED TAX ASSETS 985,250 945,214
OTHER ASSETS:
Investment in Assured Health 337,400 337,400
Assets of discontinued operations 2,078,026 2,074,507
----------- -----------
Total other assets 2,415,426 2,411,907
----------- -----------
TOTAL $28,478,031 $28,802,641
=========== ===========
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, 2003 AND DECEMBER 31, 2002
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2003 2002
CURRENT LIABILITIES:
Accounts payable $ 417,450 $ 487,291
Accrued expenses 1,292,367 1,342,978
Federal income tax payable 325,551 110,582
Federal income tax benefit due to subsidiary - 1,607,743
Current liabilities of discontinued operations 8,527,159 10,320,905
----------- -----------
Total current liabilities 10,562,527 13,869,499
MINORITY INTEREST 1,505,946 1,222,530
REDEEMABLE EQUITY PARTICIPATION 2,520,000 2,385,443
SHAREHOLDERS' EQUITY:
Common stock:
Class A, par value $1 - Authorized, 30,000 shares;
issued and outstanding, 538 and 538 shares 538 538
Class B, par value $1 - Authorized, 70,000 shares;
issued and outstanding, 40,600 shares 40,600 40,600
Additional paid-in capital 4,306,221 4,306,221
Paid-in capital from affiliates 1,472,108 1,472,108
Retained earnings 8,014,557 5,452,362
Accumulated other comprehensive income, net of tax 55,534 53,340
----------- -----------
Total shareholders' equity 13,889,558 11,325,169
----------- -----------
TOTAL $28,478,031 $28,802,641
=========== ===========
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, 2003 AND 2002
Three Months Ended Six Months Ended
June 30, June 30,
`
2003 2002 2003 2002
OPERATING REVENUE:
Network access fees $2,508,243 $2,303,410 $4,914,542 $4,345,947
Hospital administrative fees 1,159,794 1,276,551 2,455,773 2,485,096
Hospital administrative fees, related parties 991,955 1,205,289 1,975,922 2,266,145
Third party administration fees 467,914 886,203 - -
Other 129,155 62,563 233,028 100,443
----------- ---------- ---------- -----------
Total operating revenue 5,257,061 4,847,813 10,465,468 9,197,631
----------- ---------- ---------- -----------
OPERATING EXPENSES:
Payroll and related expenses 2,040,929 1,587,873 3,931,884 3,090,309
Selling, general, and administrative expenses 1,499,520 1,226,742 2,928,238 2,252,180
------------ ----------- ---------- -----------
Total operating expenses 3,540,449 2,814,615 6,860,122 5,342,489
------------ ----------- ---------- -----------
Operating income 1,716,612 2,033,198 3,605,346 3,855,142
OTHER INCOME:
Interest 40,615 52,134 95,166 63,877
Other 15,064 68,519 75,108 146,429
------------ ----------- ---------- -----------
Total other income 55,679 120,653 170,274 210,306
------------ ----------- ---------- -----------
Income from continuing operations before
federal income taxes and minority interest 1,772,291 2,153,851 3,775,620 4,065,448
Provision for federal income taxes on
continuing operations 618,024 712,434 1,301,026 1,363,081
------------ ----------- ----------- ----------
Income on continuing operations before
minority interest 1,154,267 1,441,417 2,474,594 2,702,367
MINORITY INTEREST (181,275) 389,801 (240,815) 424,904
------------ ----------- ----------- ---------
Income from continuing operations after
minority interest 972,992 1,831,218 2,233,779 3,127,271
Discontinued operations:
Income (loss) from discontinuation of First Choice
Health Plan Insurance operations (net of applicable
Income tax expense (benefit) of $265,486, ($1,198,509),
$169,184 and ($1,515,928)) 513,713 (2,391,547) 328,416 (3,035,239)
------------ ------------ ----------- ---------
NET INCOME (LOSS) $1,486,705 ($560,329) $2,562,195 $ 92,032
============ =========== =========== ==========
NET INCOME (LOSS) PER COMMON SHARE $25.40 ($9.57) $43.76 $1.57
============ ========== =========== ==========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,538 58,540 58,538 58,540
============ ========== =========== ==========
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, 2003 AND 2002
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 2,233,779 $ 3,127,271
Adjustments to reconcile net income to net cash
provided/(used) by continuing operating activities:
Depreciation 493,462 522,902
Deferred income taxes, net (34,521) (239,414)
Provision for doubtful accounts 10,754 (6,969)
Minority interest 283,416 (424,904)
Changes in operating assets and liabilities:
Service fees receivable 263,030 (297,967)
Amount due to subsidiary (2,089,066) 288,021
Provider settlements receivable - 404,518
Prepaid expenses 52,024 158,197
Other current assets (155,226) 272,335
Accounts payable (69,841) 11,409
Accrued expenses (50,611) (54,806)
Federal income tax payable 214,969 -
------------ ------------
Net cash provided by continuing operating activities 1,152,169 3,760,593
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investment in Assured Health (179,133)
Purchase of furniture, equipment, and computer software (533,189) (148,162)
Purchase of investments available for sale (2,944,977) (2,289,692)
Principal paydowns of investments available for sale 1,206,748 253,136
Other (213,009) -
--------------- ------------
Net cash used by investing activities (2,484,427) (2,363,851)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of Class A common stock membership
rights from physicians - (2,488)
Payment of note payable - (698,170)
Redeemable equity participation 134,557 -
------------ -----------
Net cash provided (used) by financing activities 134,557 (700,658)
CASH FLOWS TO DISCONTINUED OPERATIONS (803,062) (1,117,032)
------------ -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (2,000,763) (420,948)
CASH AND CASH EQUIVALENTS:
Beginning of year 2,324,382 1,620,733
------------ -----------
End of period $ 323,619 $ 1,199,785
============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the period for:
Federal income taxes $1,212,000 -
Interest - $ 32,294
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, 2003 AND 2002
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. and Subsidiary, the
accompanying unaudited interim condensed consolidated financial statements
include all normal adjustments considered necessary to present fairly the
financial position as of June 30, 2003, and the results of operations for
the three and six months ended June 30, 2003 and 2002, and cash flows for
the six months ended June 30, 2003 and 2002. The condensed consolidated
financial statements include the segregation of the discontinued operations
of the insured health plan business which required a restatement
of the prior year's financial statements to be comparative. (See Note 5.)
The results of interim operations are not necessarily indicative of
operating results for the entire year.
NOTE 2 INVESTMENTS
During the six months ended June 30, 2003, the Company purchased $2.9 million
of bonds available for sale. The amortized cost, unrealized gains or losses
and fair values of investments in debt securities as of June 30, 2003 and
December 31, 2002 are as follows:
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
AS OF June 30, 2003
Mortgage-backed adjustable
rate securities $ 6,433,578 $ 29,352 $ (7,028) $ 6,455,902
----------- -------- --------- ----------
Total Bonds $ 6,423,578 $ 29,352 $ (7,028) $ 6,455,902
=========== ======== ========= ==========
AS OF DECEMBER 31, 2002
Mortgage-backed adjustable
rate securities $ 4,695,347 $ 20,089 $ (2,621) $ 4,712,815
----------- -------- --------- ----------
Total Bonds $ 4,695,347 $ 20,089 $ (2,621) $ 4,712,815
=========== ======== ========= ==========
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.
Principal paydowns on investments in debt securities during the first six
months of 2003 were $1,206,748.
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NOTE 3 RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board (FASB) issued Statement
No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
This Statement requires that a liability for costs associated with an exit or
disposal activity be recognized when the liability is incurred and be measured
at fair value and adjusted for changes in estimated cash flows. Previously,
generally accepted accounting principles provided for the recognition of such
costs at the date of management's commitment to an exit plan. Under Statement
No. 146, management's commitment to an exit plan would not be sufficient, by
itself, to recognize a liability. The Statement is effective for exit or
disposal activities initiated after December 31, 2002.
In 2003 the Plan will undertake an orderly exit from its commercial insurance
product offerings. This exit will be complete by December 31, 2003 by the
non-renewal of all remaining commercial business during 2003. Disclosure
regarding the discontinuance of the insurance segment of the business is
included in Note 5.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (VIE). This interpretation will require VIE to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the VIE's activities or entitled to receive a majority of the
entity's residual return. The provisions of Interpretation No. 46 are required
to be applied immediately to VIEs created after January 31, 2003. The Company
does not have any VIEs and accordingly the implementation of the Interpretation
did not result in an impact on its financial position or results of operations.
In May 2003, FASB issued Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. This Statement is
effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatory redeemable financial
instruments of nonpublic entities. Adoption of the Statement did not result in
an impact on the Company's statement of financial position or results of
operations.
NOTE 4 REPORTABLE OPERATING SEGMENTS
Factors management used to identify the enterprise's reportable segments: As
the Company exits the commercial insurance market, the Company will re-direct
these resources to a new line of business that is intended to leverage the
Company's technological and staff capabilities for health benefits
administration. The resulting segments of the Company are defined on the basis
of products and services offered and will require distinct tracking
capabilities in the areas of revenue accumulation, expense reporting, marketing
strategies, and customer service requirements.
As a result of the exit from the commercial insurance market, the segment
reported as of December 31, 2002 as the Plan, which offered a variety of fully
insured health insurance plans to employer groups, is being reported as a
discontinued operation and will no longer be included as an operating segment
for ongoing operations. Disclosures for June 30, 2002 have been restated as
required.
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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 PPO network while hospital administrative fees arise from
charges to the network hospitals based on claims incurred by members. The
other reportable segment, third party administration fees (TPA), is the outcome
of the new business strategy of offering benefits administration services to
employers self-funding their company health insurance plans.
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 following information has been restated for the three
and six months ended June 30, 2002, to exclude the discontinued operations.
Information about profit or loss and assets of reportable segments:
First Choice Third Party
Health Network Administration Total
-------------- ------------ -------------
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
Three months ended June 30, 2002:
Revenues from external customers $ 4,847,813 $ - $ 4,847,813
Net income 1,441,417 - 1,441,417
Minority interest 389,801
Loss from discontinued operations (2,391,547)
Consolidated net (loss) (560,329)
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
Six months ended June 30, 2002:
Revenues from external customers $ 9,197,631 $ - $ 9,197,631
Net income 2,702,367 - 2,702,367
Minority interest 424,904
Loss from discontinued operations (3,035,239)
Consolidated net income 92,032
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NOTE 5 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 a complete exit of the commercial insured
business. This exit will be complete by December 31, 2003 by the non-renewal
of all remaining commercial business during 2003.
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, 2003 December 31, 2002
Cash and cash equivalents $ 5,076,905 $ 501,078
Investment securities available for sale 8,335,670 9,094,340
Premiums receivable 1,114 2,642,137
Prepaid expenses and other receivables 269,340 215,411
Deferred tax asset 80,994 158,756
Federal income tax benefit due from parent - 1,607,743
Restricted indemnity cash and investments 2,078,026 2,074,507
------------ ------------
Total assets $ 15,842,049 $ 16,293,972
============ ============
Liabilities
Accrued expenses $ 1,322,874 $ 592,489
Reserve for unpaid loss and loss adjustment expenses 6,088,770 8,637,313
Provider settlements payable 281,162 225,630
Unearned premiums 250,757 763,200
Amount due to parent 41,073 102,273
Federal income tax payable to parent 542,523 -
------------ ------------
Total liabilities $ 8,527,159 $ 10,320,905
============ ============
The following amounts representing revenue, and income and loss from discontinued operations
are included in the condensed consolidated statement of income for the three and six
months ended June 30, 2003 and 2002:
Operations
Three Months Ended Six Months Ended
June 30, June 30,
`
2003 2002 2003 2002
Operating revenue 9,820,053 18,993,999 21,887,274 39,280,329
Income (loss) on discontinued operations before
federal income tax 779,199 (3,590,056) 497,600 (4,551,167)
Income (loss) on discontinued operations after
Federal income tax 513,713 (2,391,547) 328,416 (3,035,239)
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Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company's operations have historically consisted of two business segments.
The parent company, First Choice Health Network (the "Network), operates a PPO
rental network and the subsidiary company, First Choice Health Plan
(the "Plan"), operates as a health care service contractor that accepts
insurance risk.
As a result of the decision by the Plan's Board of Directors authorizing
management to exit the insured health care business by no later than December
2003, the Plan business is presented as a discontinued segment in the financial
statements. The exit is proceeding in an orderly manner and no business will
be renewed beginning in February 2003. As a result of the exit, the Plan's
insured membership has declined from 28,715 at December 31, 2002 to 12,808 at
June 30, 2003.
As the Plan ceases to offer its commercial insurance products, a new business
strategy of offering benefits administration services to self-funded employers
("TPA" business) is being implemented. This strategy allows the Company to
take advantage of its extensive technological and staff capabilities for health
benefits administration that were developed for the commercial insurance
business. Development of this TPA business will help to mitigate some of the
administrative costs of exiting the commercial insurance business by utilizing
current infrastructure. TPA membership is 9,568 at June 30, 2003. As a
result, the TPA business has now replaced the discontinued insurance business
as a business segment for the Company.
The Network's revenues consist primarily of access fees paid to utilize the PPO
network, but also includes fees generated from medical management services,
Employee Assistance Programs and a complementary and alternative medicine
provider network.
The TPA revenues consist primarily of fees paid for administrative services
provided by the TPA.
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 TPA business, and the adequacy of the Company's
reserves for claims expenses and unreported claims. 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 new TPA customers, the
cost of maintaining technological and staff capabilities for health benefits
administration, and the risk associated with potential claim volatility and
adverse selection as a result of the reduced membership in the Plan due to the
Company's decision to exit the insured health care business. 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.
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RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Operating revenue, net of discontinued operations, increased $.4 million (8.4%)
from 2002 to 2003. The increase in 2003 resulted principally from the launch
of the Company's TPA business segment ($.5 million). Hospital administration
fees experienced a decrease of $.3 million while network access fee revenue
increased by $.2 million.
Selling, general and administrative expenses of the ongoing business segments
increased $.3 million (22.2%) from 2002 to 2003. The increase resulted
primarily from the redirection of costs from the insured business to the new
TPA business. Payroll and related expenses of the ongoing business segments
experienced a similar fluctuation with a $.5 million increase (28.5%) from 2002
to 2003 resulting from the same redirection of costs from the insured business
to the TPA business.
The Plan's net income and loss as shown on the discontinued operations line on
the statements of income for the three months ended June 30, 2003 and 2002 is
$513,713 and ($2,391,547), respectively. The swing from a net loss in 2002 to
net income in 2003 results from a combination of the following factors: reduced
exposure as member months decreased by 61.7% to 40,987 in 2003, reduced
operating expenses as a result of the decreasing membership and corresponding
start up of TPA services in the Network, and an improvement in the medical loss
ratio from 97.7% in 2002 to 85.1% in 2003.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
Operating revenue, net of discontinued operations, increased $1.3 million
(13.8%) from 2002 to 2003. The increase in 2003 resulted principally from the
launch of the Company's TPA business segment ($.9 million) and the impact of a
rate increase on PPO rental network fees ($.6 million) offset by a decrease in
hospital administration fees of $.3 million.
Selling and administrative expenses of the ongoing business segments increased
$.7 million (30.0%) from 2002 to 2003. The increase resulted primarily from
the redirection of costs from the insured business to the new TPA business.
Payroll and related expenses of the ongoing business segments experienced a
similar fluctuation with a $.8 million increase (27.2%) from 2002 to 2003
resulting from the same redirection of costs from the insured business to the
TPA business.
The Plan's net income and loss as shown on the discontinued operations line on
the statements of income for the six months ended June 30, 2003 and 2002 is
$328,416 and ($3,035,239), respectively. The swing from a net loss to net
income results from a combination of the following factors: reduced exposure
as member months decreased by 56.7% to 96,378 in 2003, reduced operating
expenses as a result of the decreasing membership and corresponding start up of
TPA services in the Network, and an improvement in the medical loss ratio from
97.7% in 2002 to 85.1% in 2003.
Related Party Transactions
The Company's related party transactions consist of four components. One
component is the premium revenue that is received from the Company's owner
hospitals for their employee groups that are members of the Plan. The second
component is the administrative fee received from the Company's owner hospitals
for TPA services. The third component is the Company's payment to the owner
hospitals in the form of claims payments for medical services rendered to any
member of the Plan. These three components are independent of each other and
have no relationship for analytical purposes. A fourth component, hospital
administrative fees from owner hospitals, is unrelated to the other components.
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MARKET RISK
The Company offers its PPO, TPA and Plan products in a highly competitive
environment. The Company has numerous competitors, including for-profit
and not-for-profit HMOs, TPAs, preferred provider organizations ("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 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.
The TPA will compete with numerous other insurance carriers and TPAs operating
in Washington, many of which are significantly larger and have greater
financial resources than the Company. Competition for TPA clients is based
primarily on price and operational performance.
As discussed above, the Plan's existing commercial insured business will be
wound down in an orderly manner with a complete exit of the commercial insured
business by December 2003. The resulting reduction in membership may subject
the Plan to various risks including adverse selection, claim volatility and
administrative costs that may result in losses. This decision to exit the
insured business required the Company to evaluate the carrying value of its
investment in the Plan. The contractually required capital contribution of
$213,009 was made into the Plan in the second quarter of 2003. This investment
was written down by 20% ($43,000) to reflect the 20% interest not owned by the
Company.
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, 2003, the Company had cash and cash equivalents of approximately
$.3 million compared to approximately $2.3 million at December 31, 2002. The
decrease in cash resulted from activity as shown in the Condensed Consolidated
Statements of Cash Flows on page six.
The Company anticipates that the revenue generated by operations, cash and cash
equivalents and investment securities available for sale as of June 30, 2003
will be sufficient to meet its cash requirements throughout 2003. The
reduction in the Plan's insured membership is expected to be funded by the
Plan's cash and investments totaling $15.5 million at June 30, 2003.
Following are explanations of significant balance sheet account fluctuations:
Cash and cash equivalents deceased 86.1%, or $2.0 million, while investment
securities available for sale increased 37.0%, or $1.7 million. The decrease
in cash resulted from activity as shown in the Condensed Consolidated
Statements of Cash Flows on page six. Federal income tax payable due to
subsidiary of $1.6 million was repaid in the first quarter. The income tax
receivable from subsidiary of $.5 million as of June 30, 2003 is a result of
current year tax accruals.
The Company has not historically paid cash dividends, but is currently
reevaluating this policy given the reduced capital needs as insurance
operations are exited.
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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 by
$1,237,486 at December 31, 2001 to the expected net realizable value, which is
80% of the Plan's book value. Management believes this measurement of the
expected net realizable value is still valid as of June 30, 2003.
The reserve for unpaid claims and claims adjustment expenses 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 the decreasing membership in the Plan, management has increased the
level of conservatism in the estimate due to increased risk associated with
potential claim volatility resulting from a lower membership base.
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
13(a)-15e 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 June 30, 2003, 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, it's 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 Securities Exchange Act of 1934 (Exchange 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;
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(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.
Limitations on the Effectiveness of Controls. The Registrant's management
does not expect that our disclosure controls or our internal controls will
prevent all errors and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the
design of the control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to
their costs. Because of the inherent limitations in all control systems,
no evaluation of controls can provide absolute assurance that all control
issues and instances of fraud, if any, within the Registrant have been
detected. These inherent limitations include the realities that judgments
in decision-making can be faulty, and that breakdowns can occur because of
simple error or mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the control. The design of any system of controls
also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed
in achieving its stated goals under all potential future conditions; over
time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
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, 2003, the
Company is not aware of any such material situations.
Item 4 Submission of Matters to the Vote of Security Holders
The Company held its 2003 annual meeting of shareholders on
June 26, 2003. The following directors were elected at the annual
meeting:
For Withheld
Kenneth D. Graham 40,926 19
Richard A. McGee 35,126 5,816
Barbara L. Mitchell 35,116 5,815
Richard A. Peterson 40,915 17
Paul G. Ramsey 40,917 16
Richard E. Rust 40,923 18
Mitchell B. Weinberg 40,914 14
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The other matters presented for action at the annual meeting were
approved by the following vote:
For Against Abstain
Amendment of Articles of
Incorporation 40,881 6 41
Amendment of Bylaws 40,882 5 41
Ratification of the appointment
Moss Adams LLP as independent
accountants 40,899 3 11
Item 6 Exhibits and Reports
The following exhibits are filed with this report:
Exhibit 31.1 Certification of Gary Gannaway pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Kenneth A. Hamm pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Sarbanes-Oxley Section 906 Certification for Gary Gannaway,
Chief Executive Officer
Exhibit 32.2 Sarbanes-Oxley Section 906 Certification for Kenneth A.
Hamm, Executive Vice President of Finance
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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 14, 2003
By: / s /Kenneth A. Hamm
Kenneth A. Hamm
Executive Vice President of Finance
(Principal Financial and Accounting Officer
and Duly Authorized Officer)