10-K/A 1 fchn10ka22004.txt 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10 - K/A Amendment No. 2 [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 OR [ ] TRANSITION REPORT PURSUANT 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 No.) 600 University Street Suite 1400 Seattle, Washington 98101 (Address of principal executive offices) (206) 292-8255 (Registrant telephone number, including area code) 1 2 Securities registered pursuant to Section 12 (b) of the Act: None Securities registered under Section 12 (g) of the Act: Class A Common Stock, par value $1.00 per share Indicate by check mark 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 check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as Defined in Rule 12-b of the Act). Yes _____ No __X___ There is no trading market for the Registrant's common equity (Class A Common Stock, $1.00 par value and Class B Common Stock, $1.00 par value) and, accordingly, the market value of the stock held by non-affiliates of the Registrant based on bid and asked prices cannot be determined. The aggregate number of Registrant's shares outstanding on December 31, 2004 was 447 shares of Class A Common Stock, and 40,600 shares of Class B Common Stock, $1.00 par value, respectively. Documents incorporated by reference: Portions of the definitive Proxy Statement for the 2005 Annual Meeting of Shareholders are hereby incorporated by reference into Part III of Form 10-K. 2 3 Explanation of Amendment This Amendment No. 2 to Form 10-K/A is being filed with respect to Amendment No. 1 to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on December 1, 2005 ("Amendment No. 1"). The Company hereby amends Amendment No. 1 to include the certifications required under 18 U.S.C. Section 1350, amends the financial statements to include a footnote describing the changes incorporated in Amendment No. 1 and amends the Report of Independent Registered Accounting Firm to include a dual-date so as to reference the additional footnote. No other changes were made to Amendment No. 1, which is set forth in its entirety below. 3 4 FIRST CHOICE HEALTH NETWORK, INC. 2004 FORM 10-K/A ANNUAL REPORT TABLE OF CONTENTS PART I ITEM 1 BUSINESS * ITEM 2 PROPERTIES * ITEM 3 LEGAL PROCEEDINGS * ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS * PART II ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES * ITEM 6 SELECTED FINANCIAL DATA 5 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 5 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 10 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 11 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE * ITEM 9A CONTROLS AND PROCEDURES * ITEM 9B OTHER INFORMATION * PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT * ITEM 11 EXECUTIVE COMPENSATION * ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS * ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS * ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES * PART IV ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 32 SIGNATURES 34 * Not included in this Form 10-K/A. Item is contained in the Original 10-K filed on March 24, 2005. 4 5 PART II ITEM 6. SELECTED FINANCIAL DATA
2004 2003 2002 2001 2000 ------------ ------------ ----------- ----------- ---------- Operating revenue, continuing operations $ 23,860,634 $ 21,412,689 $ 18,872,786 $ 16,563,336 $ 14,866,924 Net income from continuing operations after minority interest 4,803,673 3,936,138 5,776,678 3,067,942 3,758,220 Net income(loss) 5,948,516 4,690,921 1,924,891 (1,407,987) (1,349,859) Total assets 20,609,297 25,636,712 28,802,641 31,217,479 32,658,089 Total liabilities 3,377,975 6,450,327 13,869,499 18,649,453 20,083,110 Total Equity 16,560,687 17,264,079 13,710,612 11,330,540 12,401,920 Net income from continuing operations after minority interest per Class A common share 784.91 609.69 894.78 452.50 540.91 Net income from continuing operations after minority interest per Class B common share 69.02 56.55 83.00 44.08 54.00 Net income(loss) per Class A common share 971.98 726.60 298.16 (207.67) (194.28) Net income(loss) per Class B common share 85.47 67.40 27.66 (20.23) (19.39) Dividends declared per common share, Class A 1,184.36 187.62 - - - Dividends declared on Class B shareholders and non-shareholder hospitals with equivalent rights, per entity 530,370.90 100,000 - - -
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following table summarizes income from continuing operations, discontinued operations and net income for 2002-2004: (In millions) 2004 2003 2002 ---- ---- ---- Income from continuing operations $4.8 3.9 5.8 Income (loss) from discontinued operations 1.1 .8 (3.9) Net income 5.9 4.7 1.9 The Company's income from continuing operations increased by $.9 million from 2003 to 2004 primarily due to the impact of increasing rates for network access fees. The Company's income from continuing operations decreased by $1.9 million from 2002 to 2003 due to the following: 5 6 (1) The change in business focus from the insured health plan to the new HBM business segment. The start-up HBM business experienced a net loss of $.6 million in 2003 compared to no activity in 2002. (2) As a result of the profitability of the discontinued insured health plan, minority interest expense increased by $.9 million from income of $.5 million in 2002 to expense of $.4 million in 2003 (this represents 20% of the health plan legal entity's net income). Consolidated net income has increased by $1.2 million from 2003 to 2004. The increase in 2004 is primarily due to the increased rates for network access fees as mentioned above. Consolidated net income significantly increased by $2.8 million from 2002 to 2003. The increase in 2003 was primarily due to the increased income from discontinued operations of $4.6 million offset by the decrease in income from continuing operations previously noted. Financial results for 2004 continue to show improvement in the Company's financial condition. The Company's current ratio (current assets/current liabilities)improved from 3.5 at year end 2003 to 5.1 at year end 2004. Generally, a higher current ratio indicates increased financial strength. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEARS ENDED DECEMBER 31, 2003 AND 2002 The following table summarizes operating revenues for 2002-2004: (in millions) 2004 2003 2002 ---- ---- ---- Network access fees $12.0 11.1 9.1 Hospital administrative fees 7.7 7.8 9.6 Health benefit management fees 3.2 1.9 - Other 1.0 .6 .2 ---- ---- ---- Total Operating Revenues 23.9 21.4 18.9 Operating revenue of continuing operations increased $2.5 million (11.7%) from 2003 to 2004 and increased $2.5 million (13.5%) from 2002 to 2003. The increase from 2003 to 2004 resulted principally from an increase of $1.3 million from revenue of the Company's HBM business segment and the impact of increasing rates for PPO network access fees of $.9 million. The increase in other revenue primarily results from EAP services. The increase from 2002 to 2003 was primarily attributable to income from the new HBM business segment with operating revenue of $1.9 million, and income from additional services offered through the PPO business segment including EAP and case management services of $.4 million. The following table summarizes operating expenses for 2002-2004: (in millions) 2004 2003 2002 ----- ---- ---- Payroll and related expenses $10.4 8.2 5.9 Selling, general and administrative 6.3 6.3 4.6 ----- ---- ---- Total Operating Expenses 16.7 14.5 10.5 Payroll and related expenses increased $2.2 million (26.8%) from 2003 to 2004 while selling, general and administrative expenses remained constant from 2003 to 2004. The increase in payroll and related expenses resulted primarily from the redirection of costs from the insured health plan business to the new HBM business. Payroll and related expenses increased $2.3 million (39%) from 2002 to 2003 while selling, general and administrative expenses increased $1.7 million (37%) from 2002 to 2003. These increases were primarily due to a shift of $2.9 million in expenses from the discontinued operations of the Plan to the HBM operations as the Plan exits the insurance business. The remaining increase was due to higher operating expenses for the PPO segment resulting from various initiatives including obtaining Utilization Review Accreditation Commission (URAC) accreditation for credentialing, implementation of a new proprietary PPO information system and various provider initiatives. 6 7 The following table summarizes interest, net and write-down of investment and other: (in millions) 2004 2003 2002 ---- ---- ---- Interest, net $ .4 .2 .1 Write down of investment and other (.1) (.3) (.1) Interest, net results from interest income earned on investments and fluctuates depending on interest rates and balances invested. Discontinued Operations The financial performance of discontinued operations improved by $.3 million in 2004 from income of $.8 million in 2003 to income of $1.1 million in 2004. This increase in net income results from the favorable development of claims reserves upon the exit of the Plan from the insured health business. The reserve for unreported claims was determined actuarially using prior experience and the nature of the health insurance contracts and volume. As a result of the decreasing membership in the Plan, management had increased the level of conservatism in the estimate as of December 31, 2003 due to increased risk associated with potential claim volatility resulting from a lower membership base. Due to the uncertainties inherent in the estimation process, actual costs differed from the estimated amounts. The financial performance of discontinued operations improved by $4.6 million in 2003 from a loss of $3.9 million in 2002 to income of $.8 million in 2003. This primarily resulted from a 25 percent increase in per member per month premium yields in 2003 vs. 2002, while per member per month health care costs increased by 10 percent. Health care costs were favorably impacted by favorable development of claims reserves of approximately $2 million. This resulted from a reduction in the healthcare cost trend from the first half of 2002 that was not fully evident at year end 2002. Related Party Transactions The Company's related party transactions consist of hospital administrative fees from owner hospitals. Inflation Health care costs in the United States have increased more rapidly than the national consumer price index in recent years, and that trend is expected to continue. The Company's operating results have not been significantly affected by general inflation, and the Company does not anticipate that inflation will have a significant impact on its operating results in the near term. Market Risk 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, 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 1984, the Company has financed its operations from equity investments from over 870 physicians, from the seven hospitals constituting the Company's Class B shareholders, non-equity capital contributions from four additional hospitals pursuant to their respective participation agreements, and funds from operations. 7 8 The Company's cash flow consists of operating, investing and financing cash flows. Operating cash flow is generated by operating income, depreciation and fluctuations in various balance sheet accounts. In the event of ongoing negative operating cash flow, the Company's investment portfolio of marketable securities is available to meet liquidity needs. The Company does not anticipate significant financing activities in 2005 other than as noted below. As a result from the exit from the capital intensive health insurance business, the Company requested and received regulatory approval to distribute as dividends a significant portion of its assets in 2004. As a result, the Plan paid $1.0 million to its minority interest shareholders and the Company paid $6.4 million in dividends to shareholders in 2004. Of the $6.4 million, $5.2 million was the result of a nonrecurring special dividend representing the Company's proceeds from the redemption of the Plan's preferred stock and the Plan's $2.7 million dividend on its common stock. The remaining $1.2 million dividend was paid from the Company's recurring cash flows. The first dividend in the Company's history of $1.2 million was paid to shareholders in 2003. Based on an expectation consistently positive cash flow from continuing operations, the Company expects to pay dividends annually. During 2005 the Plan requested regulatory approval to dissolve the Plan and distribute any remaining assets as dividends. The Company expects to declare a special dividend to distribute its share of these non-recurring cash flows to its shareholders in 2005. At December 31, 2004, the Company had cash and cash equivalents of approximately $4.9 million, as compared to approximately $4.1 million at December 31, 2003, resulting from continuing positive operating cash flow, offset by the payment of dividends discussed above. Investment securities consist of municipal bonds that are marketable in the event additional cash is needed. Following are explanations of significant balance sheet account fluctuations: The decreases in accounts receivable and service fees receivable from related parties of $.7 million (38.9%) and $.3 million (75.0%), respectively, are due to the timing of cash receipts on outstanding receivables. The $2.9 million decrease in the reserve for unpaid claims and claim adjustment expenses is due to final claims activity of the Plan's run-out being nearly complete. The following table summarizes the $1.3 million decrease in minority interest for the year ended December 31, 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. 8 9 On December 20, 1999, the Company executed an agreement with University of Washington Academic Medical Center ("UWMC") to become a participant in the administration, operations and any incentives bestowed upon any shareholders in the Company effective January 1, 2000. UWMC is not a shareholder or member of the Company. UWMC will participate in any incentive or reward program established by the Company as if UWMC owned 5,800 shares of class B common stock. Dividends, distributions, and liquidation of the Company are also calculated as if UWMC owned 5,800 shares of class B stock. If the Company performs certain actions that substantially change the organization, the Company discontinues the health care facility services contract with UWMC, or if total managed care enrollment falls below 500,000 member months, then UWMC can withdraw from the agreement, but no refunds are given. If the Company merges, is sold, or if the Company takes a material action that proves detrimental to UWMC, then UWMC may redeem its interest for the equivalent of the fair value of 5,800 shares of class B stock, less any amounts still owed by UWMC. 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 December 31, 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 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. A valuation allowance was established in 1997 for the tax benefit of net operating losses (NOLs) of the Plan which is being reported as discontinued operations. Because the operation of the Plan is being discontinued, future income will not be available to utilize the NOLs. Upon the ultimate liquidation and dissolution of the Plan, these NOLs may be potentially utilized by the Company. Because timing and ultimate realization of these NOLs is uncertain, they are fully reserved. 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. OFF-BALANCE SHEET ARRANGEMENTS The Company has no off-balance sheet arrangements. CONTRACTUAL OBLIGATIONS Contractual obligations consist of operating lease arrangements and are payable as follows: Less than 1 Year 2 - 3 Years 4 - 5 Years More than 5 Years --------------- ----------- ----------- ----------------- $704,088 $1,382,403 $339,048 0 9 10 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The table below represents the balances of the Company's investment securities that are subject to interest rate risk as of December 31, 2004. The investment securities consist of government backed adjustable rate mortgages and municipal bonds with varying maturity dates. Repayment of these mortgages and bonds can accelerate significantly as interest rates decrease and negatively impact the expected return on the investment. Conversely, as interest rates increase, the bonds will likely not pay until maturity reducing the Company's ability to invest its assets at current market interest rates without taking losses on its current investment portfolio. The expected maturities identified in the table below are based upon the stated maturity date of the bond. In the event of changes in interest rates, prepayments of the bonds could cause significant variations from the maturities presented in the table.
Average Expected Maturity Date Yield 2005 2006 2009 Thereafter Total Fair Value Government Obligations 4.0% -0- -0- -0- $ 12,123 $ 12,123 $ 12,125 Municipal bonds 4.4% $300,053 $300,171 $500,981 $8,828,036 $9,929,241 $9,892,050
10 11 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm. . . . . . . . . 12 Consolidated Balance Sheets as of December 31, 2004 and 2003 . . . . . . 13 Consolidated Statements of Income for the years ended December 31, 2004, 2003, and 2002. . . . . . . 15 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2004, 2003, and 2002. . . . . . . 16 Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002. . . . . . . 17 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . 18 11 12 REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM Shareholders and Board of Directors First Choice Health Network, Inc. We have audited the accompanying consolidated balance sheet of First Choice Health Network, Inc., as of December 31, 2004 and 2003 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years ended December 31, 2004. These financial statements are the responsibility of First Choice Health Network, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Choice Health Network, Inc., as of December 31, 2004 and 2003 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Moss Adams LLP Everett, Washington January 28, 2005 except for revisions of classifications disclosed in Note 11, as to which the date is December 6, 2005 12 13 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 and 2003
ASSETS 2004 2003 CURRENT ASSETS: Cash and cash equivalents $ 4,880,156 $ 4,147,533 Investment securities available-for-sale, at fair value 10,526,233 15,153,610 Accounts receivable, net of allowance for doubtful accounts of $86,606 and $95,110 1,134,320 1,848,987 Service fees receivable from related parties 31,310 354,114 Prepaid expenses 478,958 514,098 Deferred tax assets 188,554 200,332 Federal income tax receivable 61,304 - Other current assets 236,874 340,025 ----------- ----------- Total current assets 17,537,709 22,558,699 FURNITURE, EQUIPMENT, AND COMPUTER SOFTWARE: Furniture and equipment 5,537,067 5,303,600 Computer software 1,582,945 1,386,784 ----------- ----------- 7,120,012 6,690,384 Less accumulated depreciation (6,159,001) (5,392,963) ----------- ----------- Furniture, equipment, and computer software, net 961,011 1,297,421 DEFERRED TAX ASSETS 1,287,460 1,140,249 OTHER ASSETS: Investment in One Health Port 201,184 141,984 Other assets 236,175 114,135 Restricted indemnity cash and investments 385,758 384,224 ----------- ----------- Total other assets 823,117 640,343 ----------- ----------- TOTAL ASSETS $20,609,297 $25,636,712 =========== ===========
See notes to consolidated financial statements. 13 14 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 and 2003
LIABILITIES AND SHAREHOLDERS' EQUITY 2004 2003 CURRENT LIABILITIES: Accounts payable $ 693,296 $ 627,631 Accrued expenses 2,496,149 2,581,883 Reserve for unpaid claims and claims adjustment expenses 188,530 3,069,224 Provider settlements payable - 83,787 Unearned premiums - 17,099 Federal income tax payable - 70,703 ----------- ----------- Total current liabilities 3,377,975 6,450,327 MINORITY INTEREST 670,635 1,922,306 COMMITMENTS (Note 5) SHAREHOLDERS' EQUITY: Common stock: Class A, par value $1 - Authorized, 30,000 shares; issued and outstanding, 447 and 537 shares 447 537 Class B, par value $1 - Authorized, 70,000 shares; issued and outstanding, 40,600 shares 40,600 40,600 Additional paid-in capital 4,080,410 4,305,356 Additional capital from affiliates 3,992,108 3,992,108 Retained earnings 8,484,084 8,943,283 Accumulated other comprehensive loss, net of tax (36,962) (17,805) ----------- ----------- Total shareholders' equity 16,560,687 17,264,079 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $20,609,297 $25,636,712 =========== ===========
See notes to consolidated financial statements. 14 15 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002 OPERATING REVENUE: Network access fees $12,021,078 $11,153,530 $10,292,039 Hospital administrative fees 3,660,414 3,736,034 3,867,915 Hospital administrative fees, related parties 4,001,531 4,032,114 4,523,692 Health Benefit Management fees 3,230,119 1,908,246 - Employee Assistance Program and Other 947,492 582,765 189,140 ----------- ----------- ----------- Total operating revenue 23,860,634 21,412,689 18,872,786 OPERATING EXPENSES: Payroll and related expenses 10,343,469 8,222,612 5,944,538 Selling, general, and administrative expenses 6,313,585 6,312,450 4,606,129 ----------- ----------- ----------- Total operating expenses 16,657,054 14,535,062 10,550,667 ----------- ----------- ----------- Operating income 7,203,580 6,877,627 8,322,119 OTHER INCOME (EXPENSE): Interest, net 365,193 193,700 128,737 Write-down of investment and other (78,309) (276,327) (93,703) ----------- ----------- ----------- Total other income (expense), net 286,884 (82,627) 35,034 ----------- ----------- ----------- Income from continuing operations before federal income taxes and minority interest 7,490,464 6,795,000 8,357,153 Provision for federal income taxes on continuing operations 2,462,464 2,410,199 2,984,601 ----------- ----------- ----------- Income from continuing operations before minority interest 5,028,000 4,384,801 5,372,552 MINORITY INTEREST, net of tax (224,327) (448,663) 404,126 ----------- ----------- ----------- Income from continuing operations after minority interest 4,803,673 3,936,138 5,776,678 Discontinued operations Income (loss) from discontinuation of First Choice Health Plan Insurance operations (net of applicable income tax expense (benefit) of $574,367, $388,826, and ($1,970,074)) 1,144,843 754,783 (3,851,787) ------------ ------------ ------------ NET INCOME $ 5,948,516 $ 4,690,921 $ 1,924,891 =========== =========== =========== NET INCOME FROM CONTINUING OPERATIONS AFTER MINORITY INTEREST PER CLASS A COMMON SHARE $ 784.91 $ 609.69 $ 894.78 NET INCOME FROM CONTINUING OPERATIONS AFTER MINORITY INTEREST PER CLASS B COMMON SHARE $ 69.02 $ 56.55 $ 83.00 NET INCOME PER CLASS A COMMON SHARE $ 971.98 $ 726.60 $ 298.16 NET INCOME PER CLASS B COMMON SHARE $ 85.47 $ 67.40 $ 27.66 WEIGHTED AVERAGE CLASS A SHARES OUTSTANDING 510 538 538 WEIGHTED AVERAGE CLASS B SHARES OUTSTANDING 63,800 63,800 63,800 DIVIDENDS PER CLASS A COMMON SHARE $ 1,184.36 $ 187.62 $ -0- DIVIDENDS PER CLASS B COMMON SHARE $ 91.44 $ 17.24 $ -0-
See notes to consolidated financial statements. 15 16 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
Common Stock Accumulated Class A Class B Additional Additional Other Total Comprehensive paid-in capital from Retained Comprehensive Shareholders' Income Shares Amt Shares Amt capital affiliates Earnings Income (Loss) Equity (Loss) BALANCE, December 31, 2001 539 $539 40,600 $40,600 $4,306,581 $3,463,958 $3,527,471 $(8,609) $11,330,540 Repurchase of Class A common stock and membership rights from physicians (1) (1) (360) (361) Additional paid-in capital 393,593 Unrealized gain on investments, net of tax 61,949 61,949 $ 61,949 Net Income 1,924,891 1,924,891 1,924,891 ---- ---- ------ ------ ---------- ---------- ---------- -------- ----------- ----------- Balance, $ 1,986,840 December 31, 2002 538 538 40,600 40,600 4,306,221 3,857,551 5,452,362 53,340 13,710,612 =========== Repurchase of Class A common stock and membership rights from physicians (1) (1) (865) (866) Additional paid-in capital 134,557 Dividends Paid (1,200,000) (1,200,000) Unrealized loss on investments, net of tax (71,145) (71,145) $ (71,145) Net income 4,690,921 4,690,921 4,690,921 ---- ---- ------ ------- ---------- ---------- ---------- -------- ----------- ----------- Balance, $ 4,619,776 December 31, 2003 537 537 40,600 40,600 4,305,356 3,992,108 8,943,283 (17,805) 17,264,079 =========== Repurchase of Class A common stock and membership rights from physicians (90) (90) (224,946) (225,036) Dividends Paid (6,364,451) (6,364,451) Minority interest payment (43,264) (43,264) Unrealized loss on investments, net of tax (19,157) (19,157) $ (19,157) Net income 5,948,516 5,948,516 5,948,516 ---- ---- ------ ------- ---------- ---------- ---------- -------- ----------- ----------- Balance, $ 5,929,359 December 31, 2004 447 $447 40,600 $40,600 $4,080,410 $3,992,108 $8,484,084 $(36,962) $16,560,687 =========== ==== ==== ====== ======= ========== ========== ========== ========= =========== See notes to consolidated financial statements.
16 17 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
2004 2003 2002 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,948,516 $ 4,690,921 $ 1,924,891 Adjustments to reconcile net income to net cash from operating activities: Depreciation 766,038 1,030,763 1,083,314 Deferred income (taxes) benefit, net (135,433) (54,900) 650,238 Provision for doubtful accounts 9,412 (54,646) (288,657) Minority interest 224,327 709,456 (20,527) Changes in operating assets and liabilities: Accounts receivable 1,028,059 2,396,375 802,799 Prepaid expenses 35,140 210,213 846,673 Other current assets 103,151 (300,860) 380,455 Other assets (122,040) (114,135) 27,526 Accounts payable 65,665 140,340 35,516 Accrued expenses (2,966,428) (4,921,673) (2,880,168) Provider settlements payable (83,787) (141,843) (1,128,582) Unearned premiums (17,099) (746,101) (870,332) Federal income tax accrual (132,007) (39,879) 667,922 Adjustment in value of investment in One Health Port 40,800 195,416 - ----------- ----------- ----------- Net cash provided by operating activities 4,764,314 2,999,447 1,231,068 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investment in One Health Port (100,000) - (337,400) Purchase of investments available for sale (5,007,423) (8,990,862) (6,364,075) Principal paydowns, maturities and sales of investments available for sale 9,624,589 7,563,581 5,973,389 Purchase of furniture, equipment, and computer software (429,628) (874,068) (334,421) Decrease (increase) in restricted cash and investments (1,534) 1,690,283 (25,265) ----------- ----------- ----------- Net cash provided/(used) by investing activities 4,086,004 (611,066) (1,087,772) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of Class A common stock and membership rights from physicians (225,036) (866) (361) Additional capital from affiliate - 134,558 393,593 Payment of note payable - - (698,170) Payment of preferred stock dividend (43,264) - - Payment to minority interest shareholders (440,450) - - Decrease in unrealized loss (8,945) - - Dividends to shareholders (7,400,000) (1,200,000) - ----------- ----------- ----------- Net cash used by financing activities (8,117,695) (1,066,308) (304,938) ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 732,623 1,322,073 (161,642) CASH AND CASH EQUIVALENTS, Beginning of year 4,147,533 2,825,460 2,987,102 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS, End of year $ 4,880,156 $ 4,147,533 $ 2,825,460 =========== =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash received (paid) during the year for Federal income taxes $(3,189,270) $(2,892,635) $ 303,633 =========== =========== =========== Interest $ - $ - $ (32,294) =========== =========== ===========
See notes to consolidated financial statements. 17 18 FIRST CHOICE HEALTH NETWORK, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2004, 2003 and 2002 NOTE 1: DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of business: First Choice Health Network, Inc. (the Company) was incorporated under the laws of the state of Washington on September 28, 1984. The Company was formed initially to organize a network of independent participating physicians and hospitals to serve insurers, third party administrators, union trusts and employers. Subsequently the Company created additional related preferred provider organization (PPO) services including utilization management services and an Employee Assistance Program (EAP). In 2003 the Company initiated a program for providing health benefit management services ("HBM" business) for self funded employers and insurance carriers. The Company's business is conducted primarily in Washington, with some additional business located in Alaska, Montana and Idaho. The Company's majority owned subsidiary, First Choice Health Plan, Inc. (the Plan), is a health care services contractor, which was formed on January 31, 1995, to offer fully insured health products in Washington state. As a result of the decision by the Plan's Board of Directors authorizing management to exit the insured health care business, the Plan did not renew any business after January 1, 2003 and conducted only claims run-out activities during 2004. The Plan's financial information for the Plan's insured healthcare business is presented as a discontinued operation in the financial statements. All financial statement presentations for prior years have been restated accordingly. Principles of consolidation: The consolidated financial statements include the accounts of the Company and the Plan, with the Plan's insured healthcare business being presented as a discontinued operation. Due to this presentation, certain intercompany accounts are included in the financial statements. New accounting pronouncements: In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 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. The discontinuance of the Plan's operation is accounted for pursuant to SFAS No. 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 related liability for unpaid claims is incurred. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29. SFAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exemption for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange is considered to have commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS No. 153 is not expected to have any impact on the Company's current financial condition or results of operations. 18 19 Cash equivalents: The Company considers all investments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2004 and 2003, cash and cash equivalents consisted of cash management funds of $4,880,156 and $4,147,533, respectively. Investment securities: The Company owns U.S. Government Agency mortgage-backed adjustable rate securities and municipal bonds that are classified as available for sale. Investment securities categorized as available for sale are generally held for investment purposes (to maturity), although unanticipated future events may result in the sale of some securities. Available for sale securities are recorded at fair value, with the net unrealized gain or loss included in comprehensive income, net of the related tax effect. Realized gains or losses on dispositions are based on the net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. 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. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Accounts receivable: Accounts receivable consists primarily of outstanding invoices. Allowance for doubtful accounts: The Company performs periodic credit evaluations of its customers and maintains an allowance for potential credit losses related to receivables. Furniture, equipment and computer software: Furniture, equipment and computer software are recorded at cost. Depreciation is computed using the straight-line method over the lesser of the estimated useful lives of the assets or lease term ranging from three to five years. Operating revenue: Operating revenue consists primarily of network access fees, hospital administrative fees, health benefit management fees and employee assistance program and utilization management fees. Network access fees are recognized as earned during the period of coverage and are recorded at contractual rates. Hospital administrative fees are recognized as earned in the period hospital claims are incurred by a subscriber and are recorded at a contractual amount or percentage of the claims. Health benefit management fees and EAP and utilization management fees are recognized in the month services are provided. Income taxes: Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases using the liability method. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent that it is more likely than not that deferred tax assets will not be realized. 19 20 Valuation of long-lived assets: Using its best estimates, based on reasonable and supportable assumptions and projections, the Company reviews its long- lived assets for impairment whenever events or changes in circumstances have indicated that the carrying amounts of its assets might not be recoverable. At December 31, 2004 and 2003 the investment in One Health Port was written down by $40,800 and $195,416, respectively to reflect current equity ownership. In 2002 no write-downs were required. Write-down of investment in the Plan: As a result of the decision to exit the insured health care business by December 2003, the Company's 80% ownership interest in the Plan was written down to the expected net realizable value. Write-downs of $260,793 and $383,600 were recorded in 2003 and 2002, respectively, representing 20% of the capital contributions to the Plan in those years. Earnings per share: Net income per Class A common share is computed by dividing income available to Class A common shareholders by the weighted average number of Class A common shares outstanding during the period, including 510, 538 and 538 Class A common shares for the years ended December 31, 2004, 2003 and 2002, respectively. Net income per Class B common share is computed by dividing income available to Class B common shareholders by the weighted average number of Class B common shares and Class B common share equivalents outstanding during the period, including 40,600 Class B shares for the years ended December 31, 2004, 2003, and 2002, and 23,200 Class B common share equivalents for the years ended December 31, 2004, 2003, and 2002. Class B common share equivalents are owned by three district hospitals and one public hospital which 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 Class B common share. Shares issued and reacquired during each period were weighted for the portion of the period that they were outstanding. There are no dilutive securities. Use of estimates: Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of unpaid claims, claims adjustment expenses, the write-down of the investment in the Plan, the allowance for accounts receivable and deferred income taxes. Reclassifications: Certain amounts in the 2003 and 2002 financial statements have been reclassified to conform with the 2004 presentation. Discontinued Operations: As a result of the decision by the Plan's Board of Directors authorizing management to exit the insured health care business, the Plan did not renew any business after January 1, 2003. The financial information for the Plan's insured healthcare business is presented as a discontinued operation in the financial statements. All financial statement presentations for the prior years have been restated accordingly. 20 21 NOTE 2: SHAREHOLDERS' EQUITY Ownership of stock: Class A voting common stock may be held solely by physicians licensed in the state of Washington who contract with the Company to provide health care services and who hold active, associate or provisional medical staff privileges at one or more of the hospitals that contract with the Company to provide health care services. Class B voting common stock may be held by hospitals in the state of Washington that contract with the Company to provide health care services. Voting rights: Holders of each outstanding share of Class A or Class B common stock are entitled to one vote on each matter submitted to a vote at meetings of shareholders, and each class of common stock votes as a separate class. Transfer of stock: Shareholders may only transfer their stock in the Company to the Company for repurchase. The repurchase price is established by the Board of Directors each fiscal year as set forth in the bylaws. Class A shares were repurchased at $2,679, $866 and $752 per share during 2004, 2003 and 2002, respectively. Dividends: The Board of Directors may declare and pay dividends on one or more classes of common stock at such times and in such amounts as it designates, but in no event may dividends be paid while there is an outstanding obligation to repurchase shares. Dividends are allocated among shareholders of each class of stock according to the number of shares outstanding to each Class A or Class B shareholder. Any dividends paid to the Class B shareholders must be shared with the non-shareholders that have rights equivalent to those of the other shareholders. In 2004 the Company paid dividends totaling $6,364,451, including $1,184.36 per share to Class A shareholders and $530,370.90 to each Class B shareholder and non-shareholder hospital that have equivalent rights. In 2003 the Company paid a dividend totaling $1.2 million including $187.62 per share to Class A shareholders and $100,000 to each Class B shareholder and non-shareholder hospital that have equivalent rights. Liquidation rights: Upon liquidation or dissolution, the Board of Directors, at its discretion, will allocate the value of assets among the classes of its outstanding stock in proportion to the capital contributions of shareholders of each class. For these purposes, the contributions by the non-shareholder district hospitals that have rights equivalent to those of the Class B shareholders and the membership fees paid by Class A shareholders are considered capital contributions. The allocation to Class A shareholders will be shared among all Class A shareholders in accordance with the number of shares outstanding to each Class A shareholder. The allocation of the Class B shareholders must be shared with the non-shareholder hospitals that have rights equivalent to those of Class B shareholders. Paid-in capital from affiliates: District and public 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 paid-in capital from affiliates. These contractual agreements are considered to be common share equivalents for purposes of calculating net income per common share. On December 20, 1999, the Company executed a participation agreement with the University of Washington Academic Medical Center (UWMC) to become a participant in the administration, operations, and any incentives bestowed upon any shareholders in the Company effective January 1, 2000. UWMC did not become a shareholder or a member of the Company. UWMC will participate in any incentive or reward program established by the Company as if UWMC owned 5,800 shares of Class B common stock. Dividends, distributions and liquidation of the Company are also determined as if UWMC owned 5,800 shares of Class B common stock. 21 22 If the Company performs certain activities that substantially change the organization, the Company discontinues the health care facility services contract with UWMC, or if total managed care enrollment falls below 500,000 member months, then UWMC can withdraw from the agreement, but no refunds will be given. If the Company merges, is sold, or if the Company takes a material action that proves detrimental to UWMC, then UWMC may redeem its interest for the equivalent of the fair value of 5,800 Class B common shares of Company stock. NOTE 3: FEDERAL INCOME TAXES Federal income taxes consist of the following components:
2004 2003 2002 Current $ 2,292,388 $ 2,232,809 $ 3,058,231 Deferred 170,076 177,390 (73,630) ----------- ----------- ----------- $ 2,462,464 $ 2,410,199 $ 2,984,601 =========== =========== ===========
Federal income taxes differ from the amount computed by applying the expected U.S. corporate income tax rate to income before federal income taxes for the years ended December 31 as follows: 2004 2003 2002 Amount Percent Amount Percent Amount Percent Computed expected tax rate $ 2,546,758 34.0 $2,310,300 34.0 $2,841,432 34.0 Tax effect of permanent differences: Write-down of investment in subsidiary - - 88,670 1.3 130,424 1.6 Interest on municipal bonds (97,405) (1.3) Other 13,111 0.2 11,229 .2 12,745 .1 --------- ---- ---------- ---- ---------- ---- $2,462,464 32.9 $2,410,199 35.5 $2,984,601 35.7 ========== ==== ========== ==== ========== ====
The deferred tax assets and liabilities resulting from the tax effects of temporary differences at December 31 are presented below:
2004 2003 Deferred tax assets: Net operating loss $2,216,807 $2,216,807 Reduction of shareholders' equity 213,724 213,724 Allowance for doubtful accounts 29,446 26,246 Depreciation and amortization 755,878 790,086 Vacation 147,728 137,819 Long-term incentive plan 144,160 82,620 Other 183,455 53,820 ---------- ---------- Gross deferred tax assets 3,691,198 3,521,122 Valuation allowance (2,216,807) (2,216,807) ---------- ---------- Net deferred tax assets 1,474,391 1,304,315 ========== ========== Current portion of deferred tax assets $ 186,931 $ 164,066 Long-term portion of deferred tax assets 1,287,460 1,140,249 ---------- ---------- Total deferred tax assets $1,474,391 $1,304,315 ========== ==========
22 23 A valuation allowance was established in 1997 for the tax benefit of the 1997 net operating losses (NOLs) of the Plan which is being reported as a discontinued operation. The Company filed a separate federal income tax return for the final six months of 1997 and the first three weeks of 1998, and the realization of the tax benefit is unlikely. The allowance also provides for NOLs acquired in acquisition of a business in 1997. The following schedule represents the amounts of the Plan's NOLs and their expiration date: 2007 $ 150,754 2008 53,781 2009 20,754 2010 1,584,667 2011 2,075,894 2012 2,353,449 2018 280,723 ----------- Total net operating losses $ 6,520,022 ===========
Because the operation of the Plan is being discontinued, future income will not be available to utilize the NOLs. Upon the ultimate liquidation and dissolution of the Plan, these NOLs may be potentially utilized by the Company. Because the timing and ultimate realization of these NOLs is uncertain, they are fully reserved. NOTE 4: COMMITMENTS Leases: The Company leases its office facilities and some office equipment under operating leases expiring through 2008. The leases provide for monthly minimum rent payments, and some include renewal options for an additional five years. Rental expense charged to operations under the operating leases for the years ended December 31, 2004, 2003 and 2002 were $661,580, $834,564 and $928,093, respectively. Future minimum lease payments under operating leases for the years ending December 31 are as follows: 2005 704,088 2006 698,388 2007 684,015 2008 339,048 ---------- $2,425,539 ==========
23 24 NOTE 5: REPORTABLE OPERATING SEGMENTS Factors management used to identify the enterprise's reportable segments: The Company has two reportable segments representing 100% of it's revenue. Each segment requires distinct tracking capabilities in the areas of revenues and expenses. 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. Disclosures for prior years have been restated accordingly. 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 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), is the outcome of the new business strategy of offering benefits management and administration services to employers who are self-funding their company health benefit plans. This segment offers management and administration services for health benefit plans, flexible spending accounts, health savings 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. 24 25 Information about profit or loss and assets of reportable segments:
First Choice Health Benefits Health Network Management Total 2004: Revenues from external customers $ 20,630,515 $ 3,230,119 $ 23,860,634 Intersegment revenue 66,538 (66,538) - Interest income 365,193 - 365,193 Depreciation expense 689,434 76,604 766,038 Income tax provision (benefit) 2,784,211 (321,747) 2,462,464 Segment profit (loss) 5,652,567 (624,567) 5,028,000 Minority interest (224,327) Income from discontinued operations 1,144,843 Consolidated net income 5,948,516 Expenditures on furniture, equipment and computer software 429,628 - 429,628 Assets of reportable segments 17,150,265 - 17,150,265 Liabilities of reportable segments 3,064,340 - 3,064,340 2003: Revenues from external customers $ 19,504,443 $ 1,908,246 $ 21,412,689 Intersegment revenue 74,413 (74,413) - Interest income 193,700 - 193,700 Depreciation expense 851,670 179,093 1,030,763 Income tax provision (benefit) 2,740,230 (330,031) 2,410,199 Segment profit (loss) 5,025,449 (640,648) 4,384,801 Minority interest (448,663) Income from discontinued operations 754,783 Consolidated net income 4,690,921 Expenditures on furniture, equipment and computer software 874,068 - 874,068 Assets of reportable segments 13,491,308 104,344 13,595,652 Liabilities of reportable segments 2,684,866 - 2,684,866 2002: Revenues from external customers $ 18,872,786 $ - $ 18,872,786 Intersegment revenue 28,125 (28,125) - Interest income 128,737 - 128,737 Depreciation expense 1,083,314 - 1,083,314 Income tax provision (benefit) 2,989,081 ( 4,480) 2,984,601 Segment profit (loss) 5,381,248 ( 8,696) 5,372,552 Minority interest 404,126 Loss from discontinued operations (3,851,787) Consolidated net income 1,924,891 Expenditures on furniture, equipment and computer software 334,421 - 334,421 Assets of reportable segments 12,508,669 - 12,508,669 Liabilities of reportable segments 3,548,594 - 3,548,594 2004 2003 2002 Revenues: Total revenues from reportable segments and discontinued operations $ 23,939,561 $ 51,053,380 $ 93,034,185 ============ ============ ============ Profit or loss: Total profit for reportable segments and discontinued operations $ 6,172,843 $ 5,139,584 $ 1,520,765 Adjustment for minority interest in consolidated statements (224,327) (448,663) 404,126 ------------ ------------ ------------ Consolidated net income $ 5,948,516 $ 4,690,921 $ 1,924,891 ============ ============ ============
25 26
2004 2003 2002 Assets: Total assets for reportable segments $ 17,095,122 $ 13,537,325 $ 12,508,669 Assets of Plan legal entity 3,514,175 12,099,387 16,293,972 ------------ ------------ ------------ Consolidated total assets $ 20,609,297 $ 25,636,712 $ 28,802,641 ============ ============ ============ Liabilities: Total liabilities for reportable segments $ 3,064,340 $ 2,684,866 $ 3,548,594 Liabilities of Plan legal entity 313,635 3,765,461 10,320,905 ------------ ------------ ------------ Consolidated total liabilities $ 3,377,975 $ 6,450,327 $ 13,869,499 ============ ============ ============
Substantially all of the revenues from external customers are derived from within the state of Washington. NOTE 6: FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents, accounts receivable, and accounts payable approximates fair value because of the short maturity of these instruments. NOTE 7: INVESTMENT SECURITIES AVAILABLE FOR SALE Investment securities available for sale consist of the following:
Gross Gross Gross Amortized Unrealized Unrealized Unrealized Cost Gains Losses Losses Less Than More Than 12 Months 12 Months Fair Value --------------------------------------------------------------- December 31, 2004 Mortgage-backed adjustable rate securities $ 12,123 $ 21 $ (19) $ - $ 12,125 Municipal bonds 9,929,241 23,842 (61,033) - 9,892,050 Common stock mutual funds 622,055 3 - - 622,058 ----------- -------- --------- -------- ----------- $ 10,563,419 $ 23,866 $(61,052) $ - $10,526,233 ============ ======== ========= ======== =========== December 31, 2003 Mortgage-backed adjustable rate securities $ 9,139,486 $ 29,590 $(26,197) $(24,820) $ 9,118,059 Municipal bonds 6,043,750 2,260 (10,459) - 6,035,551 ----------- -------- --------- -------- ----------- $ 15,183,236 $ 31,850 $(36,656) $(24,820) $15,153,610 ============ ======== ========= ======== ===========
Certain investment securities shown above currently have fair values less than amortized cost and therefore contain unrealized losses. The Company has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase The decline in value is not related to any company or industry specific event. At December 31, 2004, there are approximately 16 investment securities with unrealized losses. The Company anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. 26 27 Contractual maturities of investment securities as of December 31, 2004 are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties.
Available for Sale Amortized Fair Maturity Costs Value ----------------- ----------- ----------- To one year $ 922,112 $ 922,115 One to five years 801,421 810,671 Five to ten years 1,414,567 1,416,280 Over ten years 7,425,319 7,377,167 ----------- ----------- $10,563,419 $10,526,233 =========== ===========
Proceeds from sales and maturities of investment securities in 2004 and 2003 were $9,624,589 and $7,563,581, respectively. Sales of investment securities resulted in gross gains of $62 and gross losses of $128,233 in 2004. Sales of investment securities resulted in gross gains of $8,949 and gross losses of $54,207 in 2003. NOTE 8: RETIREMENT PLAN The Company has a qualified 401(k) Employee Savings and Profit Sharing Plan covering all full-time employees. Under the plan, employees can defer up to the maximum established by the Internal Revenue Service. The Company matches 50% of each employee's contribution, up to 6% of the employee's eligible salary. Employees are fully vested in employee contributions and vest over two years for employer contributions. The Company also has the option to make an additional profit sharing contribution to the plan. Employer contributions to the plan for the years ended December 31, 2004 and 2003, amounted to $156,906 and $151,173, respectively. The Company also has a non-qualified contribution retirement program covering executive management employees. Participants must have been employed by the Company for at least one year and hold a position approved by the President and Board of Directors as having a significant corporate-wide impact on accomplishing the Company's strategic goals and objectives. Under this program, the Company funds the deferred benefits through participant accounts based upon the percentages of the individual participant's base salary approved by the Board of Directors. Deferred benefits of the trust, which have been included in accrued expenses, were $236,175 and $114,135 at December 31, 2004 and 2003, respectively. The expenses in relation to the program were $100,663 and $97,234 for the years ended December 31, 2004 and 2003, respectively. The market value of the trust assets was $236,175 and $114,135 at December 31, 2004 and 2003, respectively. Realized and unrealized gains and losses on the assets accrue to the individual participants. NOTE 9: 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. 27 28 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 consolidated balance sheet will be converted to cash to satisfy obligations of and pay dividends on behalf of the discontinued Plan:
December 31, 2004 2003 Assets Cash and cash equivalents $ 2,503,998 $ 2,687,652 Investment securities available for sale, at fair value 622,058 8,020,730 Premiums receivable, net of allowance for doubtful accounts of $17,916 - 898,489 Prepaid expenses and other receivables 738 72,026 Deferred tax assets 1,623 36,266 Restricted indemnity cash and investments 385,758 384,224 ----------- ----------- Total assets $ 3,514,175 $ 12,099,387 ============ ============ Liabilities Accrued expenses $ 125,105 $ 595,351 Reserve for unpaid loss and loss adjustment expenses 188,530 3,069,224 Provider settlements payable - 83,787 Unearned premiums - 17,099 Federal income tax expense payable to parent 17,053 6,677 Amount due to parent 38,090 51,650 ----------- ----------- Total liabilities $ 368,778 $ 3,823,788 ============ ============
The following amounts representing revenue and income and loss from discontinued operations are included in the consolidated statement of income:
2004 2003 2002 Operating revenue $ 78,927 $ 29,640,691 $ 74,161,399 Income (loss) on discontinued operations before federal income tax 1,719,210 1,143,609 (5,821,861) Income (loss) on discontinued operations after federal income tax 1,144,843 754,783 (3,851,787) Net income (loss) from discontinued operations per Class A common share 187.07 116.91 (596.62) Net income (loss) from discontinued Operations per Class B common share 16.45 10.84 (55.34)
28 29 NOTE 10: UNAUDITED QUARTERLY FINANCIAL DATA - CONDENSED CONSOLIDATED STATEMENT OF INCOME
Quarter Quarter Quarter Quarter 12/31/2004 09/30/2004 06/30/2004 03/31/2004 ---------- ---------- ---------- ---------- OPERATING REVENUE Network access fees $ 3,022,622 $ 2,959,444 $ 3,014,383 $ 3,024,629 Hospital administrative fees 908,138 898,565 931,069 922,642 Hospital administrative fees, related parties 955,059 1,048,376 1,015,859 982,237 Health benefit management fees 827,019 805,094 793,709 804,297 Employee assistance program and other 280,246 236,627 214,597 216,022 ----------- ----------- ----------- ----------- Total operating revenue 5,993,084 5,948,106 5,969,617 5,949,827 ----------- ----------- ----------- ----------- OPERATING EXPENSES Payroll and related expenses 2,677,416 2,602,731 2,529,361 2,533,961 Selling, general and administrative expenses 1,607,893 1,564,199 1,580,346 1,561,147 ----------- ----------- ----------- ----------- Total operating expenses 4,285,309 4,166,930 4,109,707 4,095,108 ----------- ----------- ----------- ----------- Operating income 1,707,775 1,781,176 1,859,910 1,854,719 OTHER INCOME (EXPENSE) Interest, net 103,440 96,709 87,783 77,261 Write-down of investment and other (38,366) (12,575) (36,593) 9,225 ----------- ----------- ----------- ----------- Total other income, net 65,074 84,134 51,190 86,486 ----------- ----------- ----------- ----------- Income from continuing operations before federal income taxes and minority interest 1,772,849 1,865,310 1,911,100 1,941,205 Provision for federal income taxes on continuing operations 591,411 598,092 633,539 639,422 ----------- ----------- ----------- ----------- Income from continuing operations before minority interest 1,181,438 1,267,218 1,277,561 1,301,783 MINORITY INTEREST, net of tax (13,686) (23,072) (37,808) (149,761) ----------- ----------- ----------- ----------- Income from continuing operations after minority interest 1,167,752 1,244,146 1,239,753 1,152,022 DISCONTINUED OPERATIONS Income from discontinuation of First Choice Health Plan operations (net of applicable income tax expense of $34,082, $8,124, $146,767 and $385,394) 90,816 16,889 288,149 748,989 ----------- ----------- ----------- ---------- NET INCOME $ 1,258,568 $ 1,261,035 $ 1,527,902 $ 1,901,011 =========== =========== =========== ========== NET INCOME PER CLASS A COMMON SHARE $ 222.68 $ 212.30 $ 237.10 $ 295.00 NET INCOME PER CLASS B COMMON SHARE $ 18.08 $ 18.12 $ 21.95 $ 27.31 WEIGHTED AVERAGE CLASS A SHARES OUTSTANDING 471 495 537 537 WEIGHTED AVERAGE CLASS B SHARES OUTSTANDING 63,800 63,800 63,800 63,800
29 30
Quarter Quarter Quarter Quarter 12/31/2003 09/30/2003 06/30/2003 03/31/2003 ---------- ---------- ---------- ---------- OPERATING REVENUE Network access fees $ 2,811,915 $ 2,827,073 $ 2,808,243 $ 2,706,299 Hospital administrative fees 944,569 935,692 859,794 995,979 Hospital administrative fees, related parties 1,076,095 980,097 991,955 983,967 Health Benefit Management fees 518,730 503,313 467,914 418,289 Employee assistance program and other 185,820 163,917 129,155 103,873 ----------- ----------- ----------- ----------- Total operating revenue 5,537,129 5,410,092 5,257,061 5,208,407 ----------- ----------- ----------- ----------- OPERATING EXPENSES Payroll and related expenses 2,177,048 2,113,680 2,040,929 1,890,955 Selling, general and administrative expenses 1,750,627 1,633,585 1,499,520 1,428,718 ----------- ----------- ----------- ----------- Total operating expenses 3,927,675 3,747,265 3,540,449 3,319,673 ----------- ----------- ----------- ----------- Operating income 1,609,454 1,662,827 1,716,612 1,888,734 OTHER INCOME (EXPENSE) Interest, net 59,154 39,380 40,615 54,551 Write-down of investment and other (393,614) 42,179 15,064 60,044 ----------- ----------- ----------- ----------- Total other income (expense), net (334,460) 81,559 55,679 114,595 ----------- ----------- ----------- ----------- Income from continuing operations before federal income taxes and minority interest 1,274,994 1,744,386 1,772,291 2,003,329 Provision for federal income taxes on continuing operations 514,309 594,864 618,024 683,002 ----------- ----------- ----------- ----------- Income from continuing operations before minority interest 760,685 1,149,522 1,154,267 1,320,327 MINORITY INTEREST, net of tax (85,120) (122,728) (181,275) (59,540) ----------- ----------- ----------- ----------- Income from continuing operations after minority interest 675,565 1,026,794 972,992 1,260,787 DISCONTINUED OPERATIONS Income (loss) from discontinuation of First Choice Health Plan operations (net of applicable income tax expense (benefit) of $136,985, $82,657, $265,486 and ($ 96,302)) 265,914 160,453 513,713 (185,297) ----------- ----------- ----------- ----------- NET INCOME $ 941,479 $ 1,187,247 $ 1,486,705 $ 1,075,490 =========== =========== =========== =========== NET INCOME PER CLASS A COMMON SHARE $ 146.10 $ 183.90 $ 230.28 $ 166.59 NET INCOME PER CLASS B COMMON SHARE $ 13.53 $ 17.06 $ 21.36 $ 15.45 WEIGHTED AVERAGE CLASS A SHARES OUTSTANDING 537 538 538 538 WEIGHTED AVERAGE CLASS B SHARES OUTSTANDING 63,800 63,800 63,800 63,800
30 31 NOTE 11: REVISIONS OF CLASSIFICATION We made revisions of classification with regard to assets, liabilities and equity during the years ended December 31, 2004 and 2003. Such revisions of classification had no impact on net income as previously reported. These revisions related to the following: o Redeemable Equity Participation. We revised our classification of $2,520,000 relating to the equity payment from the University of Washington, from redeemable equity participation to additional capital from affiliates as we determined that this is a more appropriate classification in accordance with EITF Topic D-98, as the redemption of the interest is within the Company's control. o Earnings Per Share information. We clarified the presentation of our earnings per share information as we determined that it is more appropriate to use the "two-class" method of disclosure for our two classes of common stock, which is in accordance with SFAS 128 and EITF 03-6. o Discontinued Operations. We revised our classification of our discontinued operations in accordance with SFAS 144. The assets and liabilities of our discontinued operations are abandoned, not held for sale, and thus, per SFAS 144, they have been appropriately reclassified to operating assets and liabilities rather than segregated as discontinued operations assets and liabilities. This presentation also impacts the statement of cash flows to reflect these reclassifications. These reclassifications resulted in a decrease to net cash flows from operations of $1,305,747, $2,125,068 and $7,841,811 in 2004, 2003 and 2002, respectively. They resulted in an increase to cash flows from investing activities of $7,406,084, $2,715,494 and $3,641,477 in 2004, 2003 and 2002, respectively. And, they resulted in a decrease to cash flows from financing activities of $1,087,758 in 2004. 31 32 PART IV Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (1) Financial Statements. The financial statements and related documents listed in Item 8 of this report are filed as part of this report. (2) Financial Statement Schedules. All other schedules to the consolidated financial statements are omitted because they are not applicable or not material or because the information is included in the consolidated financial statements or related notes in Item 8 above. (3) Exhibits. 3.1 Copy of Registrant's Articles of Incorporation (1) 3.2 Copy of Registrant's By-Laws as amended June 26, 2003 (2) 10.1 Form of Agreement between Registrant and Physician participating in PPO. (3) 10.2 Form of Health Care Facility Service Contract between Registrant and Hospital participating in PPO. (3) 10.3 Form of Agreement between Registrant and Health Care Provider other than Hospitals and Physicians participating in PPO. (3) 10.4 Form of Agreement between Registrant and Third Party Administrator. (3) 10.5 Form of Agreement between Registrant and Insurance Company.(3) 10.6 Copy of Participation Agreement dated March 27, 1985, between Registrant and King County Public Hospital District No.2 (Evergreen General Hospital).(3) 10.7 Copy of Participation Agreement dated March 26, 1985, between Registrant and Valley Medical Center. (3) 10.8 Copy of Participation Agreement dated December 19, 1991, between Registrant and Public Hospital District No.2 of Snohomish County (Stevens Memorial Hospital) and related Promissory Note in the aggregate principal amount of $566,000. (3) 10.9 Copy of Participation Agreement dated December 20, 1999 between Registrant and University of Washington Academic Medical Center, and related Promissory Note in the aggregate principal amount of $1,260,000. (4) 10.10 Copy of the Chief Executive Officer's 2003 Compensation Agreement. (5) * 10.11 Copy of the Registrant's 2003 - 2005 Long-Term Incentive Program. (6) * 10.12 Copy of the Registrant's Supplemental Executive Retirement Plan. (7) * 10.13 Copy of the Registrant's 2005 - 2007 Long-Term Incentive Program. * 14.1 Code of Conduct for Chief Executive Officer. (8) 14.2 Code of Conduct for Chief Financial Officer. (9) 14.3 Code of Conduct for Vice President, Finance. 32 33 31.1 Certification pursuant to Rule 13(a)-14(a) for Gary R. Gannaway. 31.2 Certification pursuant to Rule 13(a)-14(a) for Stacy A. Kessel. 32.1 Section 1350 Certification for Gary R. Gannaway, Chief Executive Officer. 32.2 Section 1350 Certification for Stacy A. Kessel, Chief Financial Officer. * Denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K. (1) Filed as Exhibit 3.1 to Amendment No.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2003 (the "2003 10-K/A"). (2) Filed as Exhibit 3.2 to the 2003 10-K/A. (3) Filed as an Exhibit to Registrant's Registration Statement on Form 10-SB. (4) Filed as Exhibit 10.23 to Registrant's Current Report on Form 8-K filed on January 3, 2000. (5) Filed as Exhibit 10.24 to Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (the "2002 10-K"). (6) Filed as Exhibit 10.25 to the 2002 10-K. (7) Filed as Exhibit 10.26 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003. (8) Filed as Exhibit 14.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2003 (the "2003 10-K"). (9) Filed as Exhibit 14.2 to the 2003 10-K. 33 34 SIGNATURES In accordance with Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 6th day of December, 2005. FIRST CHOICE HEALTH NETWORK, INC. By: /s/ Stacy A. Kessel -------------------------------------- STACY A. KESSEL Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer) 34