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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-27064
First Commonwealth, Inc.
(Exact name of registrant as specified in its charter)
Delaware 75 - 2154228
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)
444 N. Wells St., Suite 600, Chicago, IL 60610
(Address of principal executive offices, including zip code)
(312) 644-1800
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share, including
associated Preferred Stock Purchase Rights
(Title of Class)
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
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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]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 1997 was approximately $43 million, based on the
closing price of $15.00 of the registrant's common stock on the Nasdaq National
Market. This calculation does not reflect a determination that persons are
affiliates for any other purposes.
Number of shares of common stock outstanding as of February 28, 1997: 3,613,189
Documents Incorporated by Reference:
Part II - Portions of the registrant's 1996 Annual Report to Stockholders, as
indicated herein.
Part III - Portions of the registrant's definitive proxy statement to be
distributed in conjunction with registrant's annual stockholders' meeting to be
held in 1997 (the "Proxy Statement"), as indicated herein.
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PART I
Item 1. Business
First Commonwealth, Inc. is a leading provider of managed dental benefits
in the upper Midwest, including the metropolitan areas of Chicago, Milwaukee,
Detroit, Indianapolis and St. Louis. As of December 31, 1996, the Company
provided managed care and indemnity/PPO products to approximately 397,800
employees and dependents ("members") through more than 4,000 employer groups
("groups"), excluding the acquisition of Champion Dental Services, Inc.
("Champion"), which was completed December 31, 1996. Champion, which serves the
greater St. Louis metropolitan area, adds approximately 60,000 members to the
above figure. The Company markets a broad range of innovative dental benefit
plans which are designed to meet the needs of large, medium and smaller-sized
groups. The managed care and PPO plans offer dental benefits primarily through
the Company's managed care and PPO network of approximately 2,175 general
dentists and specialists ("providers"), excluding the providers associated with
the Champion acquisition. The Company distributes its products through a network
of over 1,400 independent insurance brokers which target medium and smaller-
sized groups, and a direct sales unit which targets larger groups. Significant
client groups served by the Company include Advocate Health Care, Fort Howard
Paper Company, First Chicago/NBD and Inland Steel Industries, Inc. ("Inland").
The Company's managed care plans are provided on a stand-alone basis
("managed care products") and also in conjunction with the Company's indemnity
and indemnity/PPO plans (collectively "indemnity/PPO plans") which provide
benefits outside the Company's managed care network (the combined managed
care/indemnity/PPO plans are referred to as "Managed Choice/SM /products"). The
Company has integrated its PPO network with the indemnity plan component of its
Managed Choice/SM/ product to offer a point-of-service option to members as of
January 1, 1996. Under this new product, "Managed Choice/SM/ Triple Option,"
members have a point-of-enrollment choice between the Company's managed care
plan and an indemnity/PPO plan (which may be the Company's insured indemnity/PPO
plan or the group's self-insured plan administered by the Company). Another new
product introduced in 1996 was the Company's PPO network "rental" option. This
product was developed to meet the needs of a large coalition of labor unions
seeking to offer a network option through their Taft-Hartley funds, while
maintaining their own self-administration. The Company also receives fee income
for administrative services only ("ASO") arrangements and for providing access
to its Preferred Provider Organization ("PPO") network.
The Company receives a monthly premium for each employee who enrolls
in its managed care or indemnity plans. If covered by a managed care plan,
a member selects a provider (general dentist) from the Company's managed
care network. The Company then pays a monthly fee ("capitation payment")
to the provider selected by the member. Certain preventative and diagnostic
services (e.g., cleanings and x-rays) are provided to members at no
additional fee. The dentist provides other dental services for a reduced
fee ("co-payment") paid by the member. If covered by an indemnity plan,
the member pays fees set by the dentist for services rendered and submits
claims for reimbursement.
The Company was founded in 1986 by Christopher C. Multhauf, Chairman of the
Board of Directors and Chief Executive Officer of the Company, David W.
Mulligan, President and Chief Operating Officer of the Company, Richard M.
Burdge, a Director of the Company and Philip N. Bredesen, a former Director of
the Company. Mr. Bredesen was previously the founder and Chairman of the Board
of HealthAmerica Corporation, which grew to operate HMOs in 17 states before
being acquired by Maxicare Health Plans, Inc. in 1986. The Company commenced
operations in 1988 with the goal of building a leading managed dental care
market position in the Chicago metropolitan area.
Since beginning operations in 1988, the Company has grown to become one of
the upper Midwest's leading dental benefit organizations. During 1996, the
Company completed acquisitions in Milwaukee and St. Louis, and began de novo
start-ups in Detroit and Indianapolis. Effective July 18, 1996, the Company
completed the acquisition of Smileage Dental Services, Inc. ("Smileage"), a
Milwaukee, Wisconsin based dental HMO administrator which provides services to
approximately 50,000 members, and an associated reinsurance transaction, for an
aggregate purchase price (including transaction costs) of $5.6 million. The
acquisition was financed through the issuance of the Company's common stock.
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Effective December 31, 1996, the Company completed the acquisition of
Champion, a St. Louis, Missouri based prepaid dental plan which provides
services to approximately 60,000 members, for an aggregate purchase price
(including transaction costs) of $5.6 million. The acquisition was financed
through proceeds from the Company's initial public offering and was paid in cash
on January 2, 1997.
As of January 1, 1997, the Company had increased the available market
population for the markets it serves from the Chicago metropolitan area, which
is the country's third most populous metropolitan market, with a population of
approximately 8.3 million, to include the metropolitan areas of Milwaukee,
Detroit, Indianapolis and St. Louis, as well as Chicago, which have a combined
population of approximately 18.4 million. The Company's revenues increased from
$11.3 million in 1992 to $44.1 million in 1996. Over the same period, the
Company's operating income grew from $1.2 million to $4.0 million. For the year
ended December 31, 1996, the Company's revenues increased 32% to $44.1 million
from $33.3 million in the prior year period and operating income increased 29%
to $4.0 million from $3.1 million. From December 31, 1992 to December 31, 1996,
the number of members covered by the Company's managed care and indemnity/PPO
products increased from 132,000 to 397,800 (excluding approximately 60,000
members with Champion).
Several key operating strategies, including the Company's regional focus,
have contributed to the Company's growth. First, the Company has built the
largest prepaid managed dental care provider network in the Chicago metropolitan
area and maintains the quality of this network through credentialing, ongoing
peer review and Company-sponsored continuing education seminars. Second, the
Company has developed a wide range of innovative dental benefit products that it
believes have contributed to its success in attracting and retaining large
groups. For example, the Company's Managed Choice/SM /products provide it with
the capability to completely replace a group's existing indemnity plan with the
Company's combined managed care and indemnity/PPO plan. Furthermore, the
Company's national account administration program provides its Chicago-based
employers with managed care plan options outside the Company's managed care
network service area through its relationships with independent provider
networks. Third, the Company has built an efficient business development process
that combines an extensive proprietary database with targeted direct mail and
telemarketing to contact employers, independent insurance brokers and providers.
Utilizing this process, the Company markets its products directly to large
employers, distributes its products through brokers to medium and smaller-sized
employers and continuously recruits new providers into its managed care network.
Fourth, the Company has expanded its geographic service area and is implementing
its operating strategy in other major metropolitan areas in contiguous states.
This is intended to enable the Company to continue to achieve administrative
operating efficiencies as it expands.
The Company believes there are significant opportunities for the continued
growth of its business both in the Chicago metropolitan area and through the
expansion of its geographic service area. First, the Company intends to continue
to seek to increase sales from medium and smaller-sized groups by increasing its
sales staff, telemarketing and direct mail efforts towards brokers which sell to
these market segments. The Company believes that these market segments are
currently under penetrated for managed care products. Second, the Company
intends to continue to develop innovative products in response to group needs.
With the introduction of its Managed Choice/SM /products in 1992 and its
introduction of Managed Choice/SM /Triple Option and PPO network rental option
products in 1996, the Company believes that it is well positioned to continue to
expand its presence among large employers and to increase its sales to medium
and smaller-sized employers. Third, the Company has expanded its managed care
provider network in the markets it serves to service existing groups, and it
intends to increase its marketing efforts in these areas and continue to expand
to contiguous or proximate areas. Fourth, the Company is committed to building
and maintaining large, quality provider networks in any major markets it serves.
Fifth, the Company intends to continue to focus on achieving administrative
operating efficiencies through increased use of voice and data technologies and
by emphasizing efficient provider arrangements.
First Commonwealth, Inc. was incorporated in Delaware in 1986. Its
principal place of business is located at 444 North Wells Street, Suite 600,
Chicago, Illinois 60610, and its telephone number is (312) 644-1800. Unless the
context otherwise requires, all references to the "Company" shall mean First
Commonwealth, Inc., together with its subsidiaries, First Commonwealth Limited
Health Services Corporation, First Commonwealth of Illinois, Inc.,
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First Commonwealth Reinsurance Company, First Commonwealth Limited Health
Service Corporation, Smileage Dental Services, Inc. and Champion Dental
Services, Inc. and its affiliate, First Commonwealth Health Services
Corporation. See "Business - Company's Corporate Structure."
The Dental Benefit Marketplace
According to the U.S. Office of National Health Statistics, total
expenditures for dental care in the United States grew from approximately $14
billion in 1980 to an estimated $46 billion in 1995. The U.S. Health Care
Financing Administration reports that expenditures for dental services account
for approximately 5% of total national health care expenditures. According to
the U.S. Department of Labor, the cost of dental services has been rising at a
higher rate than that for consumer goods. The U.S. Department of Labor
Statistics reported that, from 1982 to 1994, the Consumer Price Index for all
Urban Consumers for dental services increased 112% whereas this index for all
items increased 54%. As a result, the Company believes that there has been
increased interest by employers in managing dental care costs.
Employer-sponsored dental benefits are one of the most common employee
welfare benefits. The National Association of Dental Plans ("NADP") estimates
that approximately 117 million persons, representing approximately 46% of the
total United States population, were covered by some form of dental benefit
coverage at the end of 1995. Historically, a substantial majority of dental
coverage has been through traditional indemnity plans. In recent years, however,
managed dental care has achieved increasing market acceptance. National managed
care enrollment has grown at an annual rate of approximately 20% between 1990
and 1995, from approximately 7.8 million covered lives in 1990 to approximately
20.6 million in 1995. The estimated rate of growth in dental HMOs for 1996 was
approximately 15% in terms of enrollment. This compares to over 50 million
Americans who were enrolled in medical HMOs in 1994 according to the Group
Health Association of America. The Company believes the relatively high growth
rate for managed dental care plans is attributable to (i) the greater acceptance
of managed care by employers and employees; (ii) the significant price advantage
relative to indemnity plans; (iii) the cost effectiveness to employers of
managed dental care plans as an employee benefit; and (iv) the growing
acceptance of prepaid dental plans by dentists, resulting in improved
accessibility and convenience for members. Members of managed dental benefit
plans represent approximately 18% of the population with dental care coverage
and approximately 8% of the total U.S. population. The Company believes that
there will continue to be significant growth opportunities in the managed dental
benefits industry.
Historically, larger employers have been more likely to offer dental
benefit coverage to their employees. According to the 1993 Foster Higgins Survey
of Employer Sponsored Health Plans (the "Foster Higgins Survey"), nationally
approximately 87% of employers with more than 200 employees offer some type of
dental benefit to some or all employees and approximately 64% of these employers
have a stand-alone dental plan, separate and distinct from other health and
welfare benefits offered to employees. By comparison, this survey reported that
only 47% of employers with less than 200 employees offer dental benefits. It has
been the Company's experience that many employers that do not offer dental
benefits are willing to consider offering a plan in which the employee pays the
full cost of such benefits through payroll deductions.
The managed dental care industry as a whole is currently fragmented and
characterized by the participation of several large, national insurance
companies and many smaller independent plan sponsors. As of December 31, 1994,
the NADP estimated that there were over 150 managed dental companies in the
United States, with no dominant market leader.
The increase in the number of dentists nationally during the last two
decades has exceeded the rate of population growth. According to the American
Dental Association ("ADA"), the number of practicing dentists in the United
States per 100,000 population has increased from 53 in 1980 to 60 in 1991. In
addition, the dental marketplace is highly fragmented with approximately 88% of
all dentists working in a one or two-dentist office, according to the ADA. Also,
according to a survey of dental practices published by Dental Economics in 1994,
the median of staff and other costs that are part of total overhead expenses was
approximately 60% of the gross revenues of solo and group dental practices. The
increase in the number of dentists as a proportion of the population, the
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fragmented dental marketplace, the high proportion of overhead costs for
dentists and an improved level of overall dental health has created a highly
competitive environment among dentists, particularly in metropolitan areas. The
Company believes that these factors have contributed to the increased
willingness of qualified dentists to participate in managed care and PPO
networks as dentists seek to increase practice revenues.
As in the case of medical coverage, the substantial majority of dental
coverage is provided through traditional fee-for-service indemnity dental plans.
Under a traditional fee-for-service indemnity plan, coverage is provided based
on a reimbursement formula of the usual and customary charges submitted by the
dentist. Compared to medical coverage, the average cost of dental services is
lower and the utilization of services is more predictable. Unlike medical
coverage, dental coverage generally does not cover catastrophic risks. Dental
care is provided almost exclusively on an outpatient basis and, according to a
1990 ADA survey, over 80% of all dental services are performed by general
dentists. Also, dental plans generally do not include coverage for
hospitalization, typically the most expensive component of medical services.
Common features of dental indemnity plans include deductibles, maximum annual
benefits of less than $2,000 per person and significant patient cost-sharing.
Patient cost-sharing typically varies by type of dental procedure ranging from
no cost sharing for preventive procedures to 50% cost-sharing for crowns and
even greater cost-sharing for orthodontic care. This high patient cost-sharing
and the relatively predictable nature of dental expenditures substantially
limits the underwriting risk of a dental plan when compared to the underwriting
risk of a medical plan which covers catastrophic illness and injuries.
Furthermore, since most dental problems are neither life threatening nor
represent serious impairments to overall health, there is a higher degree of
patient cost sensitivity and discretion associated with obtaining dental
services. Many dental conditions also have a range of appropriate courses of
treatment, each of which has a different out-of-pocket cost for patients. For
example, a deteriorated amalgam filling may be replaced with another amalgam
filling (a low-cost alternative), a pin-retained crown build-up (a more costly
alternative) or a gold crown with associated periodontal treatment (the most
costly alternative). The level of coverage provided to the patient and the
dental plan's reimbursement methodology may influence the type of services
selected by the patient or rendered by the dentist.
Under a traditional indemnity insurance plan or fee-for-service
arrangement, the insurer and the patient each pays a percentage of the fee
charged by the dentist, subject to cost-sharing, maximum benefit allowances
and usual and customary limits. Under such an indemnity plan, dentists have
little incentive to reduce total charges because they are compensated on a
fee-for-service basis. By contrast, under a managed dental care plan
capitation payments are fixed and co-payments for additional services are
pre-negotiated by the Company. The co-payments generally are designed to
exceed the dentist's variable costs, but are typically less than the
dentist's usual and customary fee. Fixed capitation payments that do not
vary with the frequency of services provided create an incentive for
dentists to emphasize preventive care, control costs and maintain a long-
term patient relationship that generates consistent capitation revenue.
Fixed capitation payments also substantially reduce the underwriting risk
to the Company associated with the high utilization of services.
Markets Served by the Company
Until July 1996, the Company had focused its efforts primarily on the
Chicago metropolitan market and has grown to become one of the Chicago's leading
managed dental care organizations. The Company began providing managed care
products to employers in the Chicago area in 1988. From 1988 to July 1996, the
Company had expanded into northwest Indiana and certain other areas in Illinois,
initially to serve employees of Chicago-based employers. By the end of 1996, the
Company had expanded into Milwaukee and had initiated expansion activity in
Detroit, Indianapolis and St. Louis.
The Chicago area is the country's third most populous metropolitan market
with a population of approximately 7.5 million. In addition, northwest Indiana
has a population of approximately 750,000 and the other areas of Illinois into
which the Company has expanded have an aggregate population of approximately 1.9
million. According to the NADP, Illinois is the fifth largest state in terms of
enrollment in managed dental care plans and had approximately 1.1 million
persons enrolled in managed dental care plans in 1995 which represented 8.2% of
the state's population. As of December 31, 1994, virtually all of the Company's
216,000 managed care members were located in Illinois. Approximately 282,000 of
the Company's 341,600 managed care members (excluding Champion) were
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located in Illinois as of December 31, 1996. The Company believes that Illinois,
and particularly the Chicago metropolitan area, offers significant opportunities
for continued growth in sales of managed dental care products, especially to
medium and smaller-sized employers who have historically been less likely to
offer managed dental coverage.
The Company believes that, in the Chicago metropolitan area, there are
approximately 500 employers with 500 or more employees (employing an aggregate
of approximately 1.3 million persons), and approximately 50,000 employers with
10 - 499 employees (employing an aggregate of approximately 1.5 million
persons). Based on its database of contacts with employers in the Chicago
metropolitan area, the Company believes that a higher percentage of larger
employers have implemented managed care plans as compared to medium and smaller-
sized employers. The Company believes that medium and smaller-sized employers
have become increasingly receptive to managed dental care products in part
because of their increasing satisfaction with managed care in their medical
benefit plans.
The Milwaukee metropolitan market has a population of approximately 1.6
million. According to the NADP, Wisconsin is the fourteenth largest state in
terms of enrollment in managed dental care plans and had approximately 306,000
people enrolled in managed dental care plans in 1995, which represents 5.5% of
the state's population. Approximately 55,600 of the Company's 341,600 managed
care members (excluding Champion) were primarily located in the greater
Milwaukee, Wisconsin area as of December 31, 1996. The Company believes that its
enrollment in Milwaukee positions it as the second largest managed dental care
provider in Wisconsin and that there are significant opportunities for continued
growth in sales of managed dental care and indemnity/PPO products.
The Detroit metropolitan market has a population of approximately 4.4
million. According to the NADP, Michigan is the twelveth largest state in terms
of enrollment in managed dental care plans and had approximately 442,000 people
enrolled in managed dental care plans in 1995, which represents 4.3% of the
state's population. As of December 31, 1996, the Company had no managed care
members in Michigan. The Company believes that Michigan, and particularly the
non-labor commercial market in the Detroit metropolitan area, offers significant
opportunities for continued growth in sales of managed dental care and
indemnity/PPO products.
The Indianapolis metropolitan market has a population of approximately 1.3
million. According to the NADP, Indiana is the twenty-second largest state in
terms of enrollment in managed dental care plans and had approximately 185,000
people enrolled in managed dental care plans in 1995, which represents 2.0% of
the state's population. As of December 31, 1996, the Company had no managed care
members in the Indianapolis metropolitan market. The Company will be focusing
its efforts in 1997 on establishing a stronger network presence in the
Indianapolis market to take advantage of the longer term opportunities presented
in this under penetrated market.
The St. Louis metropolitan market has a population of approximately 2.8
million. According to the NADP, Missouri is the sixteenth largest state in terms
of enrollment in managed dental care plans and had approximately 278,000 people
enrolled in managed dental care plans in 1995, which represents 4.6% of the
state's population. Champion has approximately 60,000 managed care members that
are located in Missouri as of December 31, 1996 that are not included in the
Company's year end managed care membership figures. The Company believes that
Champion has the largest managed dental care enrollment in the metropolitan St.
Louis area and the second largest provider network, creating significant growth
opportunities in the future.
Since the Company's operations are located primarily in the Chicago,
Milwaukee, Detroit, Indianapolis and St. Louis metropolitan areas, its
operations may be more adversely affected by localized economic, regulatory or
competitive conditions than more geographically diverse companies.
The Company also markets its products to employers based in its service
areas who have employees outside the Company's managed care network service area
("out-of-area employees"). If an employer wishes to offer a managed care product
to its out-of-area employees, the Company has arrangements to provide this
option through its relationships with independent provider networks in over 40
states. The Company collects the revenue for these plans, retains a small
processing fee, and remits the premium to the out-of-area independent dental
plan carrier. Consequently, this product provides negligible gross margin to the
Company. The Company markets this product to
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employers based in its service areas in order to compete with national dental
plans. As of December 31, 1996, approximately 10,400 members were enrolled with
other dental care plans through such arrangements. The Company also provides its
Managed Choice/SM/ product to employers who have some out-of-area employees,
which permits such employees to select the local managed dental care plan or
indemnity coverage through the Company.
Growth Strategy
The Company plans to further expand its business through the following
strategies:
Emphasize Medium and Smaller-sized Employers. The Company believes that
employers with 10-499 employees, which account for approximately 1.5 million
employees in the Chicago metropolitan area, continue to represent an attractive
market segment for managed care products. The Company intends to continue to
build upon its current market position and increase its sales staff,
telemarketing and direct mail efforts towards brokers which sell to medium and
smaller-sized employers.
Continue to Expand Product Line. The Company believes its Managed
Choice/SM/ products, which can replace an employer's existing dental indemnity
plan with a combined managed care and indemnity/PPO product, will continue to be
particularly attractive to medium and smaller-sized employers. Additionally, the
Company plans to increase cross-selling its Managed Choice/SM/ products to its
existing managed care group clients. In response to group interest, the Company
has introduced its Managed Choice/SM/ Triple Option product as of January 1,
1996. This new product includes a point-of-service benefit option through the
Company's PPO. In addition, the Company began offering a PPO network rental
program to large labor unions. The Company also expects to introduce new managed
care plans designed to encourage greater employee participation in its managed
care products.
Expand Geographic Service Area. The Company has expanded its managed care
provider network in Illinois and into northwest Indiana to meet the needs of its
large client groups. In addition, during 1996, the Company expanded into four
new markets by completing two acquisitions and initiating two de novo start-ups.
The Company intends to initiate marketing to groups in these new geographic
areas over the next 12 months and may continue to expand into other contiguous
or proximate markets.
Increase Size of Quality Provider Network. A key factor in the past success
of the Company has been the size, accessibility and quality of the Company's
managed dental care provider network. The Company plans to add new, quality
providers to its networks, as well as to continue to expand the number of
qualified providers who participate in its reduced fee-for-service PPO network.
The Company believes a large, accessible network of quality providers is an
important component in attracting new enrollment into its managed care and PPO
products, both in existing markets and in any new markets developed by the
Company.
Achieve Additional Cost Efficiencies. The Company believes that its
strategy of focusing operations on a regional basis provides certain SG&A cost
savings. Additionally, the Company has experienced a decline in its SG&A
expenses as a percentage of revenues in recent years. The Company continues to
enhance its management information systems and plans to introduce new voice and
data technologies in the areas of billing and enrollment to achieve additional
staffing economies. The Company also regards its large regional enrollment as an
effective cost-containment strategy in its provider contracting efforts. The
Company believes the combination of its volume purchasing arrangements with
providers and its administrative cost efficiencies can contribute to the future
growth of the business.
Products
The Company offers a comprehensive range of flexible and innovative dental
benefit products that are designed to offer flexibility to an employer, its
eligible employees and their dependents. Each product is positioned to meet the
needs of key market segments that the Company has identified. The Company
primarily markets two categories of products: (i) stand-alone managed care
products and (ii) managed care plans offered in combination with indemnity/PPO
plans (marketed by the Company as Managed Choice/SM/ products). The following
table shows the enrollment growth in the Company's managed care and
indemnity/PPO plans.
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<TABLE>
<CAPTION>
As of December 31,
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1994 1995 1996
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<S> <C> <C> <C>
Members
Managed Care(1).. 215,700 265,800 341,600
Indemnity/PPO.... 11,600 36,700 56,200
------- ------- -------
Total........ 227,300 302,500 397,800
======= ======= =======
</TABLE>
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(1) Includes members who have selected the managed care option under the
Company's Managed Choice/SM/ products and excludes Champion members as of
December 31, 1996.
From 1988 to 1992, the Company primarily marketed its managed care plans on
a stand-alone basis. Beginning in 1992, the Company combined its managed care
plans with indemnity plans and began marketing this combination as its Managed
Choice/SM/ products. Since the introduction of Managed Choice/SM/ products in
1992 and the addition of a PPO option in 1996, the Company has experienced
significant enrollment growth in its indemnity products, particularly among
large employers.
The Company also receives fee income for providing access to its PPO
network and for ASO services. As of December 31, 1996, approximately 34,000
participants were eligible to access the Company's PPO network and were covered
under its ASO arrangements. See "Fee Income Products" below.
Managed Care Products. The Company offers a range of managed care plans
which are designed to meet the needs of target markets. These plans vary in
coverage levels and cost, which allows the Company to tailor an appropriate
managed care product to an employer's current overall benefit program. The
Company offers its managed care products on a stand-alone basis and as an
alternative to traditional indemnity dental insurance. Managed care products
generally are more cost effective to groups and members than traditional
indemnity coverage. For example, the Company typically charges 20 to 40% less in
monthly premiums for managed care plans than for its indemnity plans which
provide comparable coverage. In addition, the Company's managed dental care
products offer more comprehensive benefits than traditional dental indemnity
plans. The following table compares certain features of the Company's managed
care plans with the features of a typical indemnity dental plan.
COMPARISON OF FIRST COMMONWEALTH'S MANAGED CARE PLANS
WITH A TYPICAL DENTAL INDEMNITY PLAN
<TABLE>
<CAPTION>
============================================================================================
First Commonwealth Typical Dental
Feature Managed Care Plans Indemnity Plan(1)
============================================================================================
<S> <C> <C>
Deductible None $50 per person
- --------------------------------------------------------------------------------------------
Annual dollar limitation None $1,000 per year
on coverage
- --------------------------------------------------------------------------------------------
Claim forms for Not required; member Required; member or dentist
reimbursement makes co-payment directly may incur delays in
to dentist obtaining reimbursement
- --------------------------------------------------------------------------------------------
Member's Member co-payment fixed Member pays any excess charges
out-of-pocket costs in advance of service above customary fee levels
- --------------------------------------------------------------------------------------------
</TABLE>
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(1) These features are also representative of indemnity plans offered by
the Company.
The Company receives a monthly premium for each employee and eligible
dependent enrolled in its managed care plans. The Company remits a portion of
the premium as a capitation payment to the participating network dentist
selected by the member to "pre-pay" for dental care to be rendered to that
member. The capitation payment is a
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fixed, per-member payment which is made by the Company to the provider for each
member who chooses that dentist, regardless of the frequency or nature of
services rendered.
Members covered under the Company's managed care plans obtain certain basic
dental procedures such as exams, x-rays, cleanings and fluoride treatments at no
additional charge other than, in some cases, a small office visit co-payment.
The Company's managed care plans also establish co-payments for other services
provided by the network dentist such as fillings, root canals and crowns. The
amount of the co-payment varies in accordance with the complexity of the covered
procedure but is designed to exceed the provider's variable cost related to the
procedure. The network general dentist provides all dental care services except
those specialized services that are more appropriately delivered by dental
specialists.
When a managed care network general dentist identifies the need for a
specialist, the general dentist completes a referral request form and forwards
it to the Company for review. Examples of dental services provided by a
specialist include oral surgery, periodontics, endodontics, pedodontics and
orthodontics. The Company's independent contractor dentist consultants review
the referral request to determine the appropriateness of the requested
treatment. If the dental consultant approves the referral request, the patient
is then referred by the network general dentist to a network specialist. The
specialist dentist receives a co-payment from the member, negotiated in advance
by the Company, for the specialty services rendered. In addition, the Company
makes monthly payments to the specialist dentists on a capitated or other basis
negotiated by the Company and the specialist.
Members pay the same amount as a co-payment for the same service whether it
is delivered by a managed care network general dentist or a managed care network
specialist. At the time of enrollment, members are provided a list which
itemizes all covered procedures, the applicable co-payment and any limitations
or exclusions. Members' specific out-of-pocket cost for each covered service is
thus known in advance of the service being provided by the managed care network
provider. These features make the Company's managed care plan coverage
relatively simple for the member to understand and for the managed care network
provider to administer, particularly when compared to the features of a typical
indemnity plan. Members directly pay their applicable co-payment to managed care
network providers, typically at the time of service. The Company's managed care
plans do not require the patient or provider to complete a claim form in order
to obtain coverage, reducing administrative requirements for its managed care
network providers. Moreover, the Company's fixed co-payment schedule also
improves the provider's ability to collect the patient portion of the cost of
services during the visit. This, combined with prepaid capitation, reduces
collection costs and improves the managed care network provider's cash flow.
When an employer first introduces the Company's managed care product to its
employees, the employer offers an open enrollment period in which employees may
join the managed care plan. Employees enroll for a one year period. Each year
thereafter the employer offers an open enrollment period in which employees may
join the managed care plan and existing enrollees may terminate their coverage
under the plan. When employees enroll in the managed care plan, they select a
participating dentist from the Company's managed care network for each family
member. Unlike many competing plans, the Company's managed care plans permit
each member of an employee's family to choose a different dentist. This choice
allows an employee to select a dentist closer to work while other family members
may choose a dentist closer to home.
The Company has designed a range of products to market to
employers that currently do not offer a dental plan and to employers that
currently offer only a traditional dental indemnity plan. A description of
these products and the manner in which they are offered to employer groups
follows.
Managed Care Plans Offered on a Voluntary Basis. The Company's managed care
plans can be offered on a voluntary (employee-pays-all) basis, in which only
those employees who wish to receive and pay for coverage do so. This product is
attractive to many employers who do not presently offer dental benefits to their
employees, because it does not require the employer to contribute toward the
cost of the dental plan. The Company believes that the primary reasons many
employers do not offer a dental plan are cost and the restrictive underwriting
requirements of dental indemnity plans. These underwriting restrictions often
include minimum financial contributions from the employer, a guaranteed minimum
number of employees participating in the dental plans and significant coverage
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exclusions. Under the Company's managed care products offered on a voluntary
basis, the employee pays for the cost of the plan through a payroll deduction,
which may be made on a pre-tax basis if the employer has adopted a flexible
spending plan under Section 125 of the Internal Revenue Code. Furthermore,
unlike many traditional indemnity carriers, the Company does not require any
minimum number of employees to enroll in order for this employee-pay-all dental
plan to be implemented. The Company's managed care products also do not have the
extensive coverage exclusions of dental indemnity plans.
Managed Care Plans Offered as an Alternative to an Existing Indemnity
Dental Plan. The Company also offers its managed care plans as an alternative to
an employer's existing dental indemnity program. Employees have the choice of
enrolling in the Company's managed care plan or remaining in the employer's
existing indemnity dental plan. In offering the Company's managed care plan as
an alternative, the employer does not have to change existing indemnity dental
benefits or its existing dental claims processor. Unlike traditional indemnity
plan designs, the Company's managed care plans have no deductible to satisfy, no
annual limitation on benefits, no claim forms to file and are easier for many
employees to understand because of the relatively simple co-payment structure.
The managed care plans offered by the Company to employers as an
alternative to existing indemnity plans typically offer more comprehensive
coverage than the managed care plans offered to employees on a voluntary basis.
The more comprehensive coverage of the managed care alternative is designed to
encourage employees to move from the existing dental indemnity plan because the
managed care product provides the employer with lower cost per employee.
Employers hold an annual open enrollment period in which employees may transfer
between the traditional dental indemnity alternative and the managed care
alternative. The Company has generally experienced net growth at annual renewals
in its managed care plan when offered on such a basis.
Managed Care Plans Offered as a Replacement for an Existing Dental
Indemnity Plan. In evaluating the Company's managed care plans, some employers
have elected to implement the managed care plan as a replacement for an existing
dental indemnity plan. The Company believes that, typically, this decision is
based on three considerations: (1) the lower cost to the employer of the
Company's managed dental care plan compared with the traditional dental
indemnity plan, (2) the improved coverage to employees available through the
Company's managed care plans as compared with a typical indemnity dental plan
and (3) the Company's large and accessible network of credentialed dentists.
In addition to the Company's stand-alone managed care products, the Company
also markets its managed care plans in combination with indemnity coverage. A
discussion of these products follows.
Managed Care Plans Combined with Indemnity Plans--Managed Choice/SM/
Products. The Company has combined its managed care plans with indemnity dental
coverage in its Managed Choice/SM/ products which offer coverage from the dental
HMO network and non-network dentists. Managed Choice/SM/ products enable the
Company to replace an employer's existing traditional dental indemnity plan
offered by a third party insurance company. Upon enrollment, members select the
managed care product or the indemnity plan provided by the Company. The Company
provides the out-of-network coverage on a traditional dental indemnity basis and
administers the claims for the out-of-network coverage.
In marketing its Managed Choice/SM/ products, the Company consults with
prospective groups to identify potential areas of cost containment for the out-
of-network coverage. Because the Company controls the design of both the managed
care and indemnity plans, it can encourage greater participation levels in the
less expensive managed care plan. Through a combination of plan design and
claims administration, the Company has helped contain the aggregate cost of its
groups' indemnity dental benefit programs through its Managed Choice/SM/
products.
The Company has experienced considerable demand for its Managed Choice/SM/
products since their introduction in 1992. As of December 31, 1996, Managed
Choice/SM/ products accounted for approximately 138,100 (approximately 35%) of
the Company's approximately 397,800 members (excluding Champion). Of the 138,100
Managed Choice/SM/ enrollees, approximately 86,300 are enrolled in the Company's
managed care plans and approximately 51,800 are enrolled in the Company's
indemnity plans.
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Managed Care Plans Combined with Indemnity/PPO Plans--Managed Choice/SM/
"Triple Option" Products. The Company has integrated a PPO network with the
indemnity plan component of the Managed Choice/SM/ product to offer a point-of-
service option to members. Called the Managed Choice/SM/ Triple Option, members
have a point-of-enrollment choice between the managed care and the indemnity/
PPO plans. If a member selects the indemnity/PPO plan, the member then has a
point-of-service option to choose a participating PPO dentist or a non-
participating dentist. The member's out-of -pocket cost is reduced by selecting
a participating managed care or dental PPO provider over a non-participating
provider.
Under the Company's Managed Choice/SM/ Triple Option product, members who
select the indemnity/PPO plan will have a benefit incentive to select the
participating PPO dentist. The reduced fee arrangements of the PPO are expected
to assist groups in containing dental costs. As of December 31, 1996, the
Company's PPO network of providers had approximately 400 more dentists than its
network of managed care providers. The Company is actively recruiting other
dentists to participate in its PPO network and intends to add more dentists to
its PPO plan to support this triple option product.
The Company has had limited success with its Managed Choice/SM/ Triple
Option products since their introduction in 1996. As of December 31, 1996,
Managed Choice/SM/ Triple products accounted for approximately 9,000
(approximately 2.3%) of the Company's approximately 397,800 members. Of the
9,000 Managed Choice/SM/ Triple Option enrollees, approximately 4,200 are
enrolled in the Company's managed care plans and approximately 4,800 are
enrolled in the Company's indemnity/PPO plans. See "Fee Income Products" below
for members covered under this product on a self-insured basis.
Fee Income Products. For self-insured employers, the Company provides
claims administration under an administrative services only ("ASO") arrangement
whereby the Company does not assume the underwriting risk for the indemnity
claims. The Company receives an administrative fee to process the claims and the
underwriting risk is retained by the employer sponsoring the self-insured plan.
Also under self-insured plans, the Company has offered the integration of the
PPO network into employer sponsored plans and can receive a PPO access fee for
each member who selects the indemnity/PPO self-insured plan as well as an ASO
fee for providing third party administration services. Pursuant to an agreement
with Inland, effective January 1, 1996, the Company is receiving PPO access fees
as well as ASO fees covering approximately 24,000 Inland employees and
dependents, and the Company is actively marketing combined PPO/ASO arrangements
to other employers as part of its Managed Choice/sm/ Triple Option product, as
discussed above.
The Company also provides access to its PPO network for a fee to clients.
Under this program, PPO network providers offer a reduced fee schedule for
services performed. Eligible participants pay reduced fees when they receive
dental care services from a PPO network provider. The Company charges its PPO
network clients a monthly fee for each participant eligible to access the
Company's reduced fee arrangements. The Company does not make any payments to
its PPO network providers on behalf of the participants eligible to access the
reduced fee arrangements.
In 1996, the Company introduced a new product called a PPO network "rental"
option. Under the terms of this new product offering, the Company provides
access to its reduced fee arrangements with providers, but does not handle the
third party administration services. This product capability was developed in
response to the opportunity to market to large union Taft-Hartley funds, many of
which handle their own claims processing. The Company has been selected by a
coalition of unions representing more than 50,000 members as the endorsed PPO
vendor and enrolled the first union group on January 1, 1997. Although this PPO
network "rental" option generates modest fee income, it enhances the Company's
purchasing power in the dental community and opens up the organized labor market
as a new opportunity for the Company's other managed care products.
Network Providers
The Company believes that the size, quality and accessibility of its
network of managed care dentists has been an essential element in its managed
care enrollment growth. The Company maintains a proprietary database of dentist
contacts throughout its service area which it utilizes to continuously recruit
new providers into its network. The
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Company also believes that its ability to effectively market its network of
managed care dentists to employers through its managed care products makes
participation in its provider network attractive to many dentists. The Company
regards its managed care network providers as customers and has implemented
practices and procedures to attract and retain qualified providers.
The Company attempts to compensate managed care providers primarily on a
capitated basis because it believes that capitated compensation is the most
effective method of containing dental benefit plan costs on an ongoing basis.
The Company typically "prepays" the capitated amounts on the first business day
of each month for those members who have selected that dentist, thereby creating
attractive cash flow advantages to dentists who participate in the Company's
managed care network. Dentists have relative high fixed costs associated with
their practices. Many dentists are willing to negotiate their fees and find
capitation an attractive revenue source to help them cover such costs. In
addition to capitation, managed care dentists also receive co-payments for
services (other than certain preventative/diagnostic procedures) at the time
service is rendered. The Company attempts to price its members' co-payments so
that they exceed a dentist's variable costs for the procedure, but are less than
the dentist's usual and customary fee. The Company's benefit plans require a
patient to make co-payments directly to the dentist at the time of service,
which eliminates delays in payments and reduces the overhead associated with
filing claims and attendant collection efforts.
In addition, the Company also may negotiate other payment arrangements with
managed care dentists under certain circumstances. This may involve, among other
things, contributions by the Company toward costs for infection control or cost-
sharing by the Company on a discounted fee-for-service basis. A significant
portion of the specialists with which the Company has managed care provider
contracts are compensated by the Company on such a discounted fee-for-service
basis and not on a capitated basis. Accordingly, the Company retains the risk of
its share of the cost for services provided through such arrangements. Total
payments to specialists represented approximately 9% of the Company's payments
to providers in 1996.
The Company believes that the large number of practicing dentists and the
high proportion of solo practitioners make the Chicago metropolitan market
highly competitive for private practice dentists. It has been the Company's
experience within the Chicago metropolitan marketplace that dental providers are
willing to participate in its managed care network. The Company believes that
providers find participation in its managed care network attractive for several
reasons. The Company has established a record of delivering large volumes of new
patients to participating providers. The Company regards its network providers
as customers and believes that it provides higher levels of service and support
than typically provided by its competitors. These factors, coupled with the fact
that the Company's capitated payment arrangements provide attractive cash flow
advantages to its managed care dentists, have enabled the Company to attract and
retain qualified providers for its managed care network.
The Company also believes that its managed care network must be of
demonstrable quality. The Company has developed a multi-step quality assessment
program which begins by initially qualifying interested dentists followed by a
personal office visit with the dentists. Further credentialing involves
verifying a dentist's license, the existence of professional liability coverage
and reviewing any previous claims history. Additionally, the dental office
itself is reviewed to determine if Company's managed care quality assessment
program standards, which include proper infection control procedures, are being
followed. After dentists are added to the managed care network, they and their
practices are periodically recredentialed to ensure Company quality assessment
standards are being maintained. This recredentialing also includes a periodic
random chart audit of members who have received services from network dentists
at that practice. Additionally, a comprehensive membership complaint/inquiry
database is maintained by the Company, the contents of which are discussed with
network dentists when considered necessary. The Company administers its
continuing quality assessment program through its staff and through consulting
dentists, under the supervision of a lead consulting dentist. The Company
further demonstrates its commitment to maintaining a quality oriented managed
care network through routine, on-site field visits and telephone service calls
to dentists. Additionally, the Company provides an ongoing series of continuing
education seminars covering such topics as infection control. The Company also
maintains a working relationship with professional dental organizations in
dealing with issues of common interest.
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The Company believes that its managed care network must be stable in order
to offer long-term continuity of care. The Company views its providers as
customers rather than vendors of care and, consequently, focuses significant
resources upon assessing and addressing provider concerns and sources of
dissatisfaction. The Company conducts periodic network dentist satisfaction
surveys and also provides an ongoing series of continuing education seminars, at
no cost for its managed care network providers. Through these contacts, the
Company proactively works to meet network dentists' expectations. As a result,
the Company's managed care provider annual retention rate has been on average
approximately 95%.
Managed care network providers are independent contractors who provide
services to members pursuant to contractual arrangements with the Company. The
Company's relationships with its managed care network dentists generally are
terminable at any time by either party upon short notice. The contracts do not
require managed care network dentists to provide services exclusively to members
of the Company's plans. The Company may, following any required regulatory
approval, change the terms, capitation rates, benefits and conditions of the
various plans serviced by its managed care network upon advance notice. The
Company's contracts with managed care network dentists require the dentists to
maintain their own malpractice insurance. The Company also carries insurance
protecting it against liability relating to acts or omissions of managed care
network dentists. Although no material malpractice or similar claims have been
asserted against the Company in the past, there can be no assurance that the
Company will not become involved in such litigation or otherwise become subject
to material claims relating to its managed care or PPO network dentists in the
future. In the event of litigation or claims against the Company for malpractice
by one of the providers or for negligence in credentialing one of the providers
in its networks, there is no assurance that the Company's professional liability
insurance will be sufficient to cover any liability which might result from such
litigation or claims.
The Company's policy is to permit dentists to participate in either its
managed care network, its PPO network or both. Consistent with the practice of
other dental PPOs, if a dentist elects to only participate in the Company's PPO
network, the credentialing requirements are less extensive than those for the
managed care network and currently there are no ongoing peer review requirements
for PPO dentists. Presently, substantially all of the participating dentists in
the Company's managed care network participate in the Company's PPO network. In
addition, at December 31, 1996, the Company's PPO network had approximately 400
additional dentists that do not participate in the Company's managed care
network. The Company is actively recruiting other dentists to participate in its
PPO network and intends to add more dentists to its PPO network.
Customer Groups
The following table shows a breakdown of the Company's groups by size as of
December 31, 1996:
<TABLE>
<CAPTION>
Subscribers(2)
Number of -------------------
Size of Group by Number of Subscribers(1) Groups Total % of Total
- ----------------------------------------- --------- ------- ----------
<S> <C> <C> <C>
Individuals................................ N/A 4,600 2.5%
2-10....................................... 1,530 8,600 4.6%
11-50...................................... 1,956 37,300 20.1%
51-100..................................... 294 20,600 11.1%
101-500.................................... 205 39,200 21.1%
500+....................................... 46 75,400 40.6%
----- ------- -----
Total............................... 4,031 185,700 100.0%
===== ======= =====
</TABLE>
- -----------------
(1) The number of subscribers represents the number of employees of an employer
group who have enrolled in one of the Company's products but does not
include dependents of such employees.
(2) Amounts do not include subscribers in the Company's ASO, ASO/PPO, PPO
network access and rental programs, and excludes subscribers associated
with the Champion acquisition.
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The Company's 10 largest groups accounted for approximately 34% of the
Company's revenues for the year ended December 31, 1996. The Company's 10
largest groups accounted for approximately 32% of total members for such
period. None of the Company's groups accounted for more than 10% of the
Company's revenues in 1996.
The Company has been successful in obtaining dental benefit business
from some of the largest employers in the Chicago metropolitan area,
including First Chicago Corporation, Inland Steel, Loyola University and
Northwestern University. The Company believes that the size and prominence
of its largest employer groups has been instrumental in attracting and
retaining other employers.
The Company's group contracts generally provide for a defined set of
dental benefits to be delivered to members for a period of one year at
specified monthly rates. The contracts normally have fixed terms of one
year and provide for automatic renewal unless terminated by notice from
either party provided a specified period (typically 60 days) prior to the
end of the term thereof.
Marketing and Sales
The Company markets its dental benefit plans through a network of over
1,400 independent insurance brokers and a direct sales force consisting of
15 employees. This dual distribution system is designed to reach large
groups as well as smaller groups and individuals in an efficient and cost
effective manner. The Company believes that this marketing strategy
provides it with a competitive advantage by enabling it to market to a
wider range of potential groups more efficiently than companies relying on
a single distribution system.
The Company's direct sales force targets larger employers and groups
which are more likely to contribute towards the cost of dental benefits for
their employees. In marketing to large groups, the Company's sales force
focuses on stand-alone managed care products as an economical alternative
to traditional indemnity coverage as well as Managed Choice/SM/ products.
The Company pays its direct sales force through a combination of salary and
bonus based upon the number of members enrolled for new groups. As part of
its growth strategy, the Company intends to increase its internal sales and
marketing staff to recruit and manage its network of brokers and expand
telemarketing and direct mail efforts.
The Company's independent insurance broker network focuses on offering
primarily voluntary (employee-pays-all) managed care products to medium and
smaller-sized employers which have not previously contributed toward or
offered dental care benefits to their employees. The Company believes that
there are significant opportunities for the Company to expand managed care
coverage to medium and smaller-sized employers by expanding its network of
independent brokers who can efficiently sell dental benefit products to the
medium and smaller-sized market. Brokers typically do not market the
Company's dental benefit plans on an exclusive basis. Brokers generally
receive a flat percentage of the premium collected as commission for the
initial sale of the Company's product as well as a commission for each
annual renewal thereof.
The Company has developed a proprietary business development process
which is used in conjunction with the Company's direct and brokered sales
efforts. This business development process relies heavily on a computerized
prospect tracking system which contains detailed benefit and contact
information on approximately 35,000 employers in the Chicago, Milwaukee
and St. Louis metropolitan areas. Using this database, the Company's
business development representatives use direct mail to target employer
decision makers and brokers and telemarketing to follow up with these
employer decision makers and brokers. It has been the Company's experience
that the sales cycle may be a multi-year process, particularly since
employers tend to make decisions regarding dental coverage on an annual
basis. The Company believes that the continuity of communication which it
has established with these decision makers gives the Company a significant
advantage over its competitors in the Chicago metropolitan market. This
comprehensive database also links brokers with their clients which permits
the Company's field staff to contact brokers at the time of their clients'
annual renewal periods.
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<PAGE>
Marketing generally is a two-step process in which presentations are
made first to employers and then directly to employees. Once selected by an
employer, the Company typically solicits potential subscribers from the
employee base directly. During periodic "open enrollments," when
employees are permitted to change dental benefit programs, the Company uses
direct mail, work site presentations and other marketing methods to attract
new subscribers. The Company stresses its ability to provide a flexible
schedule of benefits, quality dental services oriented toward preventive
care at reasonable prices and a large panel of dentists from which to
choose in these marketing efforts.
The Company also has a member services department which assists
members on such matters as schedules of benefits, available network
dentists, transfers from one network dentist to another, emergency dental
services, billing issues and other administrative and group service
matters. The member services department also handles complaints about
providers and conducts member satisfaction surveys.
The Company has a separate account management department that focuses
on servicing the needs of benefit managers and groups. The Company believes
that this service effort is important to group retention and enrollment
growth among group members. The Company manages its groups with a long-term
strategic goal to increasing participation in the Company's managed care
plans.
Management Information Systems
The management information systems used by the Company are designed to
facilitate subscriber and provider service. The Company depends on these
systems for comprehensive group service, premium collection and
reconciliation, administration of capitation and commission payments,
member eligibility processing, marketing support, corporate accounting and
management reporting. The Company's management information systems allow it
to offer multiple plans tailored to the needs of its groups and have the
capability to interface directly with the systems of its groups, which can
facilitate expeditious processing of changes in membership information.
The Company periodically upgrades its hardware and software systems to
(i) enhance its capability for electronic interchange with its groups, (ii)
streamline the systems' ability to support both multi-state accounts and
multiple products for the same group, (iii) enhance the integration between
the Company's management information systems and its corporate accounting
software, (iv) improve statistical and analytical capability with respect
to various aspects of the Company's business and (v) make other
technological changes to improve the efficiency of the Company's systems.
The Company plans to introduce new voice and data technologies and to
increase the use of electronic methods for billing, enrollment and ongoing
eligibility maintenance between employer groups and network dentists. The
Company believes that these steps should help it to limit staff increases
in the future and to increase the effectiveness and efficiency of its
administrative operations.
Competition
The Company operates in a highly competitive environment. Its
competitors principally include insurance companies, which often offer both
managed dental care and indemnity dental products in the Company's market,
and independent companies offering managed dental care products similar to
those offered by the Company. The managed dental care industry as a whole
is currently fragmented and characterized by the participation of several
large, national insurance companies and many smaller independent plan
sponsors. The Company also competes with numerous other types of
businesses in the health care industry, including health maintenance
organizations, limited health services corporations, self-funded plans
which are administered by third party administrators, preferred provider
organizations and other discount fee-for-service dental plans. The Company
has experienced, and expects that it will continue to experience in the
future, increased competition from all such sources. Many of the Company's
competitors are larger and have substantially greater financial and other
resources than the Company. Price considerations have been a significant
competitive factor in the past and the Company believes pricing will
continue to be a significant competitive factor in the future, especially
with respect to large government and labor union contracts awarded on the
basis of competitive bidding. Currently such contracts constitute less than
2% of the Company's total revenues. The Company believes that it competes
principally on the basis of the pricing of managed care products in
comparison to traditional indemnity plan coverage, the size, accessibility
and quality of its provider network, its service reputation and the
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diversity of its products. Of these, the Company has found that provider network
size, accessibility and quality, service reputation and cost are generally the
factors most critical in employer decision-making.
While the managed dental care business does not require substantial amounts
of capital, the Company believes that certain factors may limit the number of
new competitors that successfully enter its marketplace. These include the need
for new competitors to comply with governmental licensing requirements and to
establish provider and insurance broker networks in order to enter and compete
in the market. The Company believes that it is well positioned to continue to
compete in the Chicago, Milwaukee and St. Louis metropolitan areas as a result
of its growing network of providers and insurance brokers and the Company's
service reputation and client base. The Company also believes that it is well
positioned to compete in the Detroit and Indianapolis metropolitan areas as a
result of the competitive size of its network of providers and the Company's
focused marketing efforst. While the Company believes that it has successfully
established one of the leading market positions in the Chicago, Milwaukee and
St. Louis metropolitan areas, there can be no assurance that the Company will be
able to continue to increase or maintain its market share. Increased competition
could adversely affect the Company's results of operations.
Government Regulation
The business of the Company is subject to extensive regulation, by, as may
be applicable, the insurance statutes and regulations of the states in which the
Company operates with respect to the prepaid health plan, insurance,
reinsurance, and related operations of the Company ("Insurance Regulation"). The
Company is registered in Illinois as a Third Party Administrator and as an
Insurance Firm; its subsidiary, First Commonwealth of Illinois, Inc., is
registered in Illinois as a Preferred Provider Administrator; another
subsidiary, First Commonwealth Limited Health Services Corporation, is licensed
in Illinois as a Limited Health Service Organization and in Indiana as a Limited
Service Health Maintenance Organization; another subsidiary, First Commonwealth
Reinsurance Company, is licensed in Arizona as a life and disability reinsurer;
another subsidiary, First Commonwealth Limited Health Service Corporation, is
licensed in Wisconsin as a Limited Service Health Organization; another
subsidiary, Champion Dental Services, Inc., is licensed in Missouri as a prepaid
dental plan corporation; and an affiliate, First Commonwealth Health Services
Corporation, is organized under Illinois law as a Voluntary Health Services
Plan.
Insurance Regulation, which may vary from state to state, establishes
extensive operational, financial, reporting, and other requirements applicable
to the Company's business in such state. Depending upon the nature and scope of
regulatory requirements adopted from time to time in each of the states having
jurisdiction over the legal entities or operations of the Company, Insurance
Regulation may materially and adversely affect the business, operating results
and financial condition of the Company. Insurance Regulation generally requires
the Company to be licensed by the state insurance department in order to offer
its dental care products, administrative services or preferred provider network
in such state and otherwise conduct its operations in such state. In addition,
Insurance Regulation generally prescribes minimum levels of net worth and
reserves, limits the ability of the Company's subsidiaries to pay dividends to
the extent required surplus would be impaired, requires filings for approval of
products and services offered by the Company and its subsidiaries and the filing
of rate schedules, certain product literature, forms of contracts with
subscribers, dentists and others (which may entail substantial delay in
implementing changes or introducing new products), establishes minimum benefit
levels for the Company's dental products in some cases, provides for periodic
examinations, including quality assessment review, establishes standards for the
Company's management and other personnel, specifies measures for resolving
grievances and requires prior approval if more than a certain percentage of the
Company's outstanding voting securities are to be acquired. Changes in Insurance
Regulation or the application thereof could involve, among other things,
increased capitalization requirements, limitations on the payment of dividends,
distributions, or principal or interest on subordinated debt, the imposition of
guaranty fund assessments, mandated health benefits and other terms of
enrollment contracts, restrictions on the use of "fronting arrangements" and
reinsurance agreements, requirements for admission of or licensing as foreign
reinsurance companies, limited health service organizations, limited service
health organizations, prepaid dental plan corporations, preferred provider
administrators and third party administrators, state health insurance reforms
for groups and individuals, "any willing provider" requirements limiting the
Company's right to restrict the size of its provider network, minimum loss ratio
requirements, or other matters. There can be no assurance that changes in
Insurance Regulation or the application of existing Insurance Regulation,
including matters relating to the
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Company's limited operations outside its service areas, will not materially and
adversely affect the business or financial condition of the Company. Failure of
the Company to comply with the Insurance Regulation could subject the Company to
financial penalties, cease and desist orders or the revocation of one or more
licenses required to conduct its business.
Any future expansion of the Company's business may subject the Company to
additional regulation by the state or federal governments. The insurance
statutes and regulations of certain states may limit the ability of the Company
to expand its operations in or into such states, or may substantially delay the
commencement of operations in such states as a result of the need to comply with
the licensing requirements of such states. Expansion of the Company's business
by acquisition of control of existing regulated entities may subject the Company
to substantial filing and approval requirements. Furthermore, proposals have
been made in the past, and may be made again, for national and state health care
reform which, if enacted, could materially and adversely affect the business and
financial condition of the Company. It has been the Company's policy to maintain
regular contact and productive working relationships with regulators in each
jurisdiction in which it is licensed to conduct business.
In general, Insurance Regulation of the states in which the Company
and its subsidiaries operate require a person seeking to acquire control,
directly or indirectly, of certain regulated entities or of any person
controlling such entity to file with the relevant insurance regulatory
authority an application for change of control (commonly known as a "Form
A") containing certain information regarding the identity and background
of the acquiror and its affiliates, the source and amount of funds to be
used to effect the acquisition and certain other matters. For purposes of
many of these statutes and regulations promulgated thereunder, a person
that owns or controls, directly or indirectly, 10% or more of the
outstanding voting securities of any other person is generally presumed to
"control" that other person. Accordingly, any purchase of Common Stock
that would result in the purchaser having beneficial ownership of Common
Stock equal to or in excess of the specified threshold level, which may be
lower than 10% in some states or, as a result of future regulatory action,
in one or more of those states in which the Company currently operates,
pursuant to the offering of Common Stock made hereby or otherwise
(including through purchases in the open market), must file for and obtain
prior approval from all applicable regulatory authorities. Such prior
approval could also apply to the acquisition of proxies to vote specified
percentages of the outstanding Common Stock and, therefore, could delay or
prevent a stockholder from acquiring such proxies in a proxy contest. No
assurance can be given that the Company would not seek to invoke these laws
and regulations in a proxy contest or a tender offer or merger situation.
Failure to comply with change of control provisions under applicable state
insurance codes by an investor acquiring the Company's Common Stock at or
above the specified threshold levels could result in a material adverse
effect on such investor, including the possible entry of a divestiture
order, and could also possibly result in adverse regulatory action against
the Company and its subsidiaries. Prospective and current stockholders, and
not the Company, are responsible for compliance with Form A and similar
filing and prior approval requirements. The Company assumes no obligation
with respect to these matters.
The Company's business is not currently regulated at the federal level.
During 1994, however, Congress considered legislation proposing comprehensive
reform of the health care system in the United States. The Company cannot
predict whether or when future health care reform initiatives at the federal or
state level or other initiatives affecting insurance and/or managed care
providers such as the Company may be proposed, enacted or implemented or what
impact such initiatives may have on the Company's business, operating results or
financial condition.
Company's Corporate Structure
The Company contracts to provide dental care benefits to groups and members
in Illinois and Indiana through First Commonwealth Limited Health Services
Corporation, a wholly-owned subsidiary ("FC-Limited"), in Wisconsin through
First Commonwealth Limited Health Service Corporation, a wholly-owned subsidiary
("FC-Wisconsin"), and in 1997 in Missouri through Champion, a wholly-owned
subsidiary. The Company provides administrative and marketing services for FC-
Limited, FC-Wisconsin, and Champion. Another wholly-owned subsidiary, First
Commonwealth of Illinois, Inc. ("FC-Illinois"), contracts with dentists and
dental care specialists to provide dental care services to groups and to members
for whom FC-Limited, FC-Wisconsin, and Champion provides dental benefits.
Smileage, a wholly-owned subsidiary, is a Wisconsin based dental HMO
administrator.
-17-
<PAGE>
As the Company has increased its indemnity business, it has entered
into a reinsurance agreement with North American Insurance Company, an
Illinois licensed reinsurer ("North American"), covering a portion of its
indemnity business. North American, in turn, has entered into an agreement
with another subsidiary of the Company, First Commonwealth Reinsurance
Company ("FC-RE"), whereby North American transfers most of this
reinsured risk from FC-Limited to FC-RE. The Company currently retains
virtually all of the underwriting risk of its indemnity plans. FC-RE
engages in no reinsurance activity that is not related to the Company's
indemnity products.
First Commonwealth Health Services Corporation ("FCHSC") is
consolidated with the Company and its subsidiaries for financial reporting
purposes. FCHSC is not material to the financial condition or operating
results of the Company. FCHSC is licensed under the Voluntary Health
Services Plans Act (the "VHSP Act"). In accordance with the VHSP Act,
FCHSC is operated and conducted as a not-for-profit and is also governed by
the provision of the General Not-for-Profit Corporation Act. FCHSC was
initially capitalized by First Commonwealth, Inc. ("FC Inc.") through the
purchase of a subordinated note. Certain officers and trustees of FCHSC are
common to the officers and directors of FC Inc. Consistent with its
authority under the VHSP Act, FCHSC provides reimbursement to its members
for covered dental care. The VHSP Act requires, among other provisions,
that FCHSC not expend more than 20% of its annual subscriber revenue for
administrative costs and 10% for marketing costs. FC Inc. provides
administrative and marketing services to FCHSC pursuant to a management
agreement.
Risk Management
The Company maintains general and professional liability insurance to
cover the risk of operating its managed care dental plans. In addition,
each dentist in the provider network is required to maintain malpractice
insurance.
The Company seeks to enter into capitation arrangements whenever
possible as its primary means of managed care dentist compensation. In
addition to capitation arrangements, the Company also may negotiate other
payment arrangements with dentists and specialists. Such arrangements may
involve, among other things, contributions by the Company toward costs for
infection control or discounted fee-for-service pricing arrangements.
Certain specialists with which the Company has provider contracts are
compensated by the Company on such a discounted fee-for-service basis and
not on a capitated basis. Accordingly, the Company retains the risk of its
share of the cost for services provided by such specialists. If the
utilization of specialty care benefits substantially increase under the
Company's managed care plans, the Company's profitability could be
materially and adversely affected. Total payments to specialists
represented approximately 9% of the Company's payments to managed care
providers in 1996.
In addition, an increasing portion of the Company's business is the
sale of indemnity/PPO plans as part of its Managed Choice/SM/ product. The
Company retains virtually all of the underwriting risk of its indemnity/PPO
products. Although dental indemnity/PPO plans have limitations on coverage
(including limits on procedures covered, amounts covered per procedure and
annual and lifetime benefits), due to variability in both the utilization
of services and the cost per service under an indemnity/PPO plan, increased
indemnity/PPO enrollment increases the underwriting risk undertaken by the
Company. The dental benefit costs associated with the Company's Managed
Choice/SM/ products include an estimate of dental expenses incurred by its
members outside of the Company's provided network, but which have not yet
been reported to the Company. If the utilization or cost per service
incurred outside of the Company's network were to be greater than
estimated, the Company's business, operating results or financial condition
could be materially and adversely affected. The Company has not experienced
any significant adverse variations between such estimated and actual
expenses, but there can be no assurance that such variations will not occur
in the future.
The Company staffs its claims processing operation with individuals
experienced in dental terminology and procedures such as hygienists, dental
office assistants and dentist consultants, who review claims submitted for
appropriateness. The Company also uses specific underwriting criteria as an
integral part of its risk management program for its indemnity/PPO plans.
Utilizing specific underwriting criteria, the Company attempts to assure
that each employer group's profile is consistent with relevant rating
assumptions. In addition, high patient cost-sharing in dental plans
substantially limits the underwriting risk of a dental plan, particularly
when compared to the risk in a medical plan. Furthermore, unlike medical
plans, dental plans typically do not cover catastrophic risks.
-18-
<PAGE>
Employees
The Company had approximately 135 employees as of December 31, 1996.
None of the Company's employees is covered by a collective bargaining
agreement. The Company believes its relations with its employees are good.
Item 2. Properties
The Company does not own any real estate; it leases approximately
24,000 feet of office space in Chicago. The lease has a term expiring in
2000, with an option for the Company to extend the lease through 2003. In
addition, the Company leases approximately 1,700 feet of office space in
Milwaukee with a term expiring in 1999; 500 feet of office space in Detroit
with a term expiring in 1997, and 500 feet of office space in Indianapolis
with a term expiring in 1997.
Item 3. Legal Proceedings
The Company is involved from time to time in routine legal and
regulatory proceedings incidental to its business. The Company is not
involved in any currently pending lawsuits or proceedings that it believes
will have, individually or in the aggregate, a material adverse effect on
the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None.
-19-
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Incorporated herein by reference from section entitled "Related
Stockholder Matters and Market for the Company's Common Stock" in the
Company's 1996 Annual Report to Stockholders, which is included as Exhibit
13 to this Annual Report on Form 10-K.
Item 6. Selected Financial Data
Incorporated herein by reference from section entitled "Selected
Consolidated Financial and Operating Data" in the Company's 1996 Annual
Report to Stockholders, which is included as Exhibit 13 to this Annual
Report on Form 10-K.
Item 7. Managements's Discussion and Analysis of Financial Condition and
Results of Operations
Incorporated herein by reference from section entitled "Management's
Discussion and Analysis of Results of Operations and Financial Condition"
in the Company's 1996 Annual Report to Stockholders, which is included as
Exhibit 13 to this Annual Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data
Incorporated herein by reference from sections entitled "Financial
Statements" and "Notes to Consolidated Financial Statements" in the
Company's 1996 Annual Report to Stockholders, which is included as Exhibit
13 to this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
-20-
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
The information contained under the headings "Election of Directors"
and "Executive Officers" in the Proxy Statement (which Proxy Statement will
be filed with the Securities and Exchange Commission on or before April 30,
1997) is incorporated herein by reference.
Item 11. Executive Compensation
Except for information referred to in Item 402(a)(8) of Regulation S-K,
the information contained under the headings "Election of Directors" and
"Executive Compensation and Other Information" in the Proxy Statement
(which Proxy Statement will be filed with the Securities and Exchange
Commission on or before April 30, 1997) is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information contained under the heading "Security Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement (which
Proxy Statement will be filed with the Securities and Exchange Commission
on or before April 30, 1997) is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
The information contained under the heading "Certain Relationships and
Related Transactions" in the Proxy Statement (which Proxy Statement will be
filed with the Securities and Exchange Commission on or before April 30,
1997) is incorporated herein by reference.
-21-
<PAGE>
PART IV
=======
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Financial Statements
The following financial statements are filed as part of this report:
Report of Independent Public Accountants on Consolidated
Financial Statements.*
Consolidated Balance Sheets of the Company as of December 31, 1996,
1995 and 1994.*
Consolidated Statements of Income of the Company for the years
ended December 31, 1996, 1995 and 1994.*
Consolidated Statements of Stockholders' Equity of the Company
for the years ended December 31, 1995, 1994 and 1993.*
Consolidated Statements of Cash Flows of the Company for the years
ended December 31, 1996, 1995 and 1994.*
Notes to Consolidated Financial Statements.*
- ------------
* Incorporated herein by reference from the Company's 1996 Annual Report
to Stockholders.
(a)(2) Financial Statement Schedules
Report of Independent Public Accountants on Financial Statement Schedule
Page 25
Schedule II -- Valuation and Qualifying Accounts Page 26
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instructions or an inapplicable, and therefore
have been omitted.
(a)(3) Exhibits
The following Exhibits are filed herewith or incorporated herein:
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<C> <S>
3.1 -- Second Restated Certificate of Incorporation of the Company, as amended (1)
3.2 -- Restated By-laws of the Company (2)
4.1 -- Stockholders Rights Agreement between the Company and First Chicago Trust Company of
New York (1)
</TABLE>
-22-
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<C> <S>
10.1 -- Series A and Series B Preferred Stock Purchase Agreement dated September 18, 1987 by and
among the Company and the Purchasers referred to therein (1)
10.2 -- Registration Agreement, dated September 18, 1987, by and among the Company and the
Purchasers referred to therein (1)
10.3 -- Founders' Agreement, dated September 18, 1987, by and among the Company, the Purchasers
referred to therein and each of Christopher C. Multhauf and David W. Mulligan (1)
10.4 -- First Amendment and Agreement, dated as of September 18, 1988, by and among the Company
and the Purchasers referred to therein (1)
10.5 -- First Commonwealth, Inc. Management Bonus Plan (1)(3)
10.6 -- 1987 Statutory-Nonstatutory Stock Option Plan, as amended (1)(3)
10.7 -- 1995 Long-Term Incentive Plan, as amended as of March 14, 1997 (3)
10.8 -- First Commonwealth, Inc. Salary Savings Plan (1)(3)
10.9 -- Employment Agreement between the Company and Christopher C. Multhauf (1)(3)
10.10 -- Employment Agreement between the Company and David W. Mulligan (1)(3)
10.11 -- Employment Agreement between the Company and Gregory D. Stobbe, as amended (1)(3)
10.12 -- Employment Agreement between the Company and Mark R. Lundberg (1)(3)
10.13 -- Employment Agreement between the Company and Scott B. Sanders (1)(3)
10.14 -- Reinsurance Agreement between First Commonwealth Limited Insurance Company and First
Commonwealth Reinsurance Company (1)
10.15 -- Reinsurance Agreement between North American Insurance Company and First Commonwealth
Reinsurance Company (1)
10.16 -- Form of First Commonwealth Limited Health Services Corporation Group Master Contract (1)
10.17 -- Form of First Commonwealth of Illinois, Inc. Dental Provider Agreement (1)
10.18 -- Form of First Commonwealth of Illinois, Inc. Participating PPO Dentist Contract (1)
10.19 -- Lease Agreement between 444 North Wells Limited Partnership as sole beneficiary of American
National Bank & Trust Company of Chicago Trust No. 56647 as Landlord and the Company as
Tenant, as amended (1)
10.20 -- Administrative Master Contract, dated December 12, 1990, between First Commonwealth of
Illinois, Inc. and First Commonwealth Limited Health Services Corporation (1)
10.21 -- Administrative Contract, dated December 12, 1990, between First Commonwealth, Inc. and
First Commonwealth Limited Health Services Corporation (1)
</TABLE>
-23-
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
10.22 -- Management Agreement, dated November 20, 1987, between First Commonwealth, Inc. and
First Commonwealth Health Services Corporation (1)
10.23 -- Administrative Master Contract, dated February 1, 1989, between First Commonwealth of
Illinois, Inc. and First Commonwealth Health Services Corporation, as amended (1)
10.24 -- Public Offering Agreement among the Company, Christopher C. Multhauf, David W. Mulligan
and the Selling Stockholders identified therein (1)
10.25 -- Stock Exchange Agreement, dated July 18, 1996, by and among the Company and the
Shareholders of Smileage Dental Services, Inc., is hereby incorporated by reference to Exhibit
2.1 to the Company's Currrent Report on Form 8-K, dated July 18, 1996
10.26 -- Registration Rights Agreement, dated July 18, 1996, between the Company and the Holders of
Registrable Securities referred to therein, is hereby incoporated by reference to Exhibit 99.1 to
the Company's Current Report on Form 8-K, dated July 18, 1996
10.27 -- Stock Purchase Agreement, dated as of October 2, 1996, among the Company, Group Health
Plan, Inc., Champion Dental Services, Inc. and Coventry Corporation, is hereby incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996
11 -- Statement re: computation of per share earnings
13 -- 1996 Annual Report to Stockholders
21 -- Subsidiaries of the Registrant
23 -- Consent of Arthur Andersen LLP
24 -- Powers of Attorney (included on signature page)
27 -- Financial Data Schedule
</TABLE>
- -----------
(1) Incorporated herein by reference to an exhibit with the same number as
filed with the Company's Registration Statement on Form S-1, as amended
(Registration No. 33-97426).
(2) Incorporated herein by reference to an exhibit with the same number as
filed with the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1996.
(3) Represents management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company filed a Form 8-K, as amended, dated as of December
31, 1996, to report the acquisition of Champion Dental Services,
Inc., and to file required financial information relating
thereto.
-24-
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
To the Stockholders and Board of Directors of
First Commonwealth, Inc.:
We have audited in accordance with generally accepted auditing standards
the consolidated financial statements included in FIRST COMMONWEALTH, INC. AND
SUBSIDIARIES' 1996 Annual Report to Stockholders incorporated by reference in
this Form 10-K, and have issued our report thereon dated February 12, 1997. Our
audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule included on page 26 is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois,
February 12, 1997
-25-
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Period Additions
- ------ -----------------------------
Year Ended Balance at Charged to
December Beginning of Costs and Charged to Other Deductions- Balance at
31, Description of Period Expenses Accounts-Describe Describe End of Period
- --- ----------- --------- -------- ----------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
1994 Claims liability $ 225,962 $1,361,455 -- $1,199,703(1) $ 387,714
Allowance for doubtful
accounts $ 80,782 $ 36,000 -- -- $ 116,782
1995 Claims liability $ 387,714 $5,451,936 -- $4,581,969(1) $1,257,681
Allowance for doubtful
accounts $ 116,782 $ 192,808 -- $ 112,274(2) $ 197,316
1996 Claims liability $1,257,681 $8,341,669 -- $8,019,681(1) $1,579,669
Allowance for doubtful
accounts $ 197,316 $ 104,000 -- $ 31,762(2) $ 289,554
</TABLE>
- --------------------
(1) Payment for claims
(2) Write-off of bad debt
-26-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, this Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 31, 1997 FIRST COMMONWEALTH, INC
By: /s/ Christopher C. Multhauf
---------------------------------------------
Christopher C. Multhauf
Chairman of the Board of Directors and Chief
Executive Officer
POWER OF ATTORNEY AND SIGNATURES
Each of the undersigned officers and directors of First Commonwealth, Inc.
hereby severally constitutes and appoints Christopher C. Multhauf, David W.
Mulligan and Scott B. Sanders, and each of them singly, our true and lawful
attorneys, with full power to them and each of them singly, to sign for us in
our names in the capacities indicated below, all amendments to this Annual
Report on Form 10-K, and generally to do all things in our names and on our
behalf in such capacities to enable First Commonwealth, Inc. to comply with the
provisions of the Securities Act of 1934, as amended, and all requirements of
the Securities and Exchange Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Registration Statement has been signed by the following persons in the
capacities indicated on this 31st day of March, 1997.
<TABLE>
Name Capacity
---- --------
<S> <C>
/s/ Christopher C. Multhauf Chairman of the Board of Directors and Chief Executive Officer
- ------------------------------- (principal executive officer)
Christopher C. Multhauf
/s/ David W. Mulligan Director, President, Secretary and Chief Operating Officer
- -------------------------------
David W. Mulligan
/s/ Scott B. Sanders Chief Financial Officer and Treasurer (principal financial and
- ------------------------------- accounting officer)
Scott B. Sanders
/s/ Richard M. Burdge, Sr. Director
- -------------------------------
Richard M. Burdge, Sr.
/s/ William J. McBride Director
- -------------------------------
William J. McBride
/s/ Jackson W. Smart, Jr. Director
- -------------------------------
Jackson W. Smart, Jr.
</TABLE>
-27-
<PAGE>
Exhibit Index
-------------
<TABLE>
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C> <C>
10.7 - 1995 Long-Term Incentive Plan, as amended as of March 14, 1997
11 - Statement re: computation of per share earnings
13 - 1996 Annual Report to Stockholders
21 - Subsidiaries of the Registrant
23 - Consent of Arthur Andersen LLP
24 - Powers of Attorney (included on signature page)
27 - Financial Data Schedule
</TABLE>
<PAGE>
Exhibit 10.7
FIRST COMMONWEALTH, INC.
1995 LONG-TERM INCENTIVE PLAN
(As Amended as of March 14, 1997)
I. INTRODUCTION
1.1 Purposes. The purposes of the 1995 Long-Term Incentive Plan (the
"Plan") of First Commonwealth, Inc. (the "Company"), and its subsidiaries from
time to time (individually a "Subsidiary" and collectively the Subsidiaries"),
are (a) to align the interests of the Company's stockholders and the recipients
of awards under this Plan by increasing the proprietary interest of such
recipients in the Company's growth and success, (b) to advance the interests of
the Company by attracting and retaining officers and other key employees,
consultants, advisors, agents and other independent contractors of the Company,
and well-qualified persons who are not officers or employees of the Company
("non-employee directors") for service as directors of the Company and (c) to
motivate such employees, independent contractors and non-employee directors to
act in the long-term best interests of the Company's stockholders. For purposes
of this Plan, references to employment by the Company shall also mean employment
by a Subsidiary.
1.2 Certain Definitions.
"Affiliate" and "Associate" shall have the respective meanings ascribed to
such terms in Rule 12b-2, as in effect on the effective date of this Plan, under
the Exchange Act; provided, however, that no director or officer of the Company
shall be deemed an Affiliate or Associate of any other director or officer of
the Company solely as a result of his or her being a director or officer of the
Company.
"Agreement" shall mean the written agreement evidencing an award hereunder
between the Company and the recipient of such award.
"Beneficial Owner" (including the terms "Beneficially Own" and "Beneficial
Ownership"), when used with respect to any Person, shall be deemed to include
any securities which:
(a) such Person or any of such Person's Affiliates or Associates
beneficially owns, directly or indirectly (determined as provided in Rule 13d-3,
as in effect on the effective date of this Plan, under the Exchange Act);
(b) such Person or any of such Person's Affiliates or Associates, directly
or indirectly, has:
(i) the right to acquire (whether such right is exercisable immediately
or only after the passage of time or upon the satisfaction of any conditions, or
both) pursuant to any written or oral agreement, arrangement or understanding
(other than customary agreements with and among underwriters and selling group
members with respect to a bona fide public offering of securities), upon the
exercise of any options, warrants, rights or conversion or exchange privileges
or otherwise; provided, however, that a Person shall not be deemed the
Beneficial Owner of, or to Beneficially Own securities tendered pursuant to a
tender or exchange offer made by or on behalf of such Person or any of such
Person's Affiliates or Associates until such tendered securities are accepted
for purchase or exchange; or
(ii) the right to vote pursuant to any written or oral agreement,
arrangement or understanding; provided, however, that a Person shall not be
deemed the Beneficial Owner of, or to Beneficially Own, any security otherwise
subject to this item (ii) if such agreement, arrangement or understanding to
vote (1) arises solely from a revocable proxy or consent given to such Person or
any of such Person's Affiliates or Associates in response to a public proxy or
consent solicitation made pursuant to, and in accordance with, the applicable
rules and regulations under the Exchange Act and (2) is not also then
<PAGE>
reportable by such Person on Schedule 13D (or any comparable or successor
report then in effect) under the Exchange Act; or
(iii) the right to dispose of pursuant to any written or oral agreement,
arrangement or understanding (other than customary agreements with and among
underwriters and selling group members with respect to a bona fide public
offering of securities); or
(c) are beneficially owned, directly or indirectly, by any other
Person with which such Person or any of such Person's Affiliates or Associates
has any written or oral agreement, arrangement or understanding (other than
customary agreements with and among underwriters and selling group members with
respect to a bona fide public offering of securities) for the purpose of
acquiring, holding, voting (except to the extent contemplated by the proviso to
item (ii) of subparagraph (b) of the first paragraph of this definition) or
disposing of any securities of the Company.
Notwithstanding the first paragraph of this definition, no director or
officer of the Company shall be deemed to be the "Beneficial Owner" of, or to
"Beneficially Own," shares of Common Stock or other securities of the Company
beneficially owned by any other director or officer of the Company solely as a
result of his or her being a director or officer of the Company.
"Board" shall mean the Board of Directors of the Company.
"Bonus Stock" shall mean shares of Common Stock which are not subject
to a Restriction Period or Performance Measures.
"Bonus Stock Award" shall mean an award of Bonus Stock under this
Plan.
"Cause" shall mean any act of dishonesty, commission of a felony,
significant activities harmful to the reputation of the Company, refusal to
perform or substantial disregard of duties properly assigned or significant
violation of any statutory or common law duty of loyalty to the Company.
"Change in Control" shall have the meaning set forth in Section
6.8(b).
"Code" shall mean the Internal Revenue Code of 1986, as amended.
"Committee" shall mean the Committee designated by the Board,
consisting of two or more members of the Board, each of whom shall be (a) a
"Non-Employee Director" within the meaning of Rule 16b-3 under the Exchange
Act and (b) an "outside director" within the meaning of Section 162(m) of
the Code, subject to any transition rules applicable to the definition of
outside director.
"Common Stock" shall mean the common stock, $.001 par value, of the
Company.
"Company" has the meaning specified in Section 1.1.
"Directors Options" shall have the meaning set forth in Section 5.1.
"Directors Restricted Stock" shall have the meaning set forth in
Section 5.1.
"Disability" shall mean the inability of the holder of an award to
perform substantially such holder's duties and responsibilities for a continuous
period of at least six months, as determined solely by the Committee.
"ERISA" shall mean the Employee Retirement Income Security Act of
1974, as amended.
<PAGE>
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
"Exempt Person" shall mean each of Christopher C. Multhauf and David
W. Mulligan and each Affiliate thereof.
"Fair Market Value" shall mean the average of the high and low
transaction prices of a share of Common Stock as reported in the National
Association of Securities Dealers Automated Quotation National Market System on
the date as of which such value is being determined, or, if the Common Stock is
listed on a national securities exchange, the average of the high and low
transaction prices of a share of Common Stock on the principal national stock
exchange on which the Common Stock is traded on the date as of which such value
is being determined, or, if there shall be no reported transactions for such
date, on the next preceding date for which transactions were reported; provided,
however, that if Fair Market Value for any date cannot be so determined, Fair
Market Value shall be determined by the Committee by whatever means or method as
the Committee, in the good faith exercise of its discretion, shall at such time
deem appropriate.
"Free-Standing SAR" shall mean an SAR which is not issued in tandem
with, or by reference to, an option, which entitles the holder thereof to
receive, upon exercise, shares of Common Stock (which may be Restricted Stock),
cash or a combination thereof with an aggregate value equal to the excess of the
Fair Market Value of one share of Common Stock on the date of exercise over the
base price of such SAR, multiplied by the number of such SARs which are
exercised.
"Incentive Stock Option" shall mean an option to purchase shares of
Common Stock that meets the requirements of Section 422 of the Code, or any
successor provision, which is intended by the Committee to constitute an
Incentive Stock Option.
"Incumbent Board" shall have the meaning set forth in Section
6.8(b)(2) hereof.
"Independent Contractor" shall mean a consultant, advisor, agent or
other independent contractor which performs services for the Company or its
Subsidiaries, including, but not limited to, dentist consultants, dentist
advisors, dentist providers and insurance agents.
"Mature Shares" shall mean shares of Common Stock for which the holder
thereof has good title, free and clear of all liens and encumbrances and which
such holder either (a) has held for at least six months or (b) has purchased on
the open market.
"Non-Employee Director" shall mean any director of the Company who is
not an officer or employee of the Company or any Subsidiary (except in the
definition of Committee, in which case "Non-Employee Director" shall have the
meaning set forth in Rule 16b-3 under the Exchange Act).
"Non-Statutory Stock Option" shall mean a stock option which is not an
Incentive Stock Option.
"Performance Measures" shall mean the criteria and objectives,
established by the Committee, which shall be satisfied or met (a) as a condition
to the exercisability of all or a portion of an option or SAR or (b) during the
applicable Restriction Period or Performance Period as a condition to the
holder's receipt, in the case of a Restricted Stock Award, of the shares of
Common Stock subject to such award, or, in the case of a Performance Share
Award, of payment with respect to such award. Such criteria and objectives may
include, but are not limited to, the attainment by a share of Common Stock of a
specified Fair Market Value for a specified period of time, earnings per share,
return on equity, earnings of the Company, revenues, market share, cash flows or
cost reduction goals, or any combination of the foregoing and any other criteria
and objectives established by the Committee.
<PAGE>
"Performance Period" shall mean any period designated by the Committee
during which the Performance Measures applicable to a Performance Share Award
shall be measured.
"Performance Share" shall mean a right, contingent upon the attainment
of specified Performance Measures within a specified Performance Period, to
receive one share of Common Stock, which may be Restricted Stock, or in lieu
thereof, the Fair Market Value of such Performance Share in cash.
"Performance Share Award" shall mean an award of Performance Shares
under this Plan.
"Permanent and Total Disability" shall have the meaning set forth in
Section 22(e)(3) of the Code or any successor thereto.
"Person" shall mean any individual, firm, corporation, partnership or
other entity, and shall include any successor (by merger or otherwise) of any of
the forgoing.
"Restricted Stock" shall mean shares of Common Stock which are subject
to a Restriction Period.
"Restricted Stock Award" shall mean an award of Restricted Stock under
this Plan.
"Restriction Period" shall mean any period designated by the Committee
during which the Common Stock subject to a Restricted Stock Award may not be
sold, transferred, assigned, pledged, hypothecated or otherwise encumbered or
disposed of, except as provided in this Plan or the Agreement relating to such
award.
"SAR" shall mean a stock appreciation right which may be a Free-
Standing SAR or a Tandem SAR.
"Stock Award" shall mean a Restricted Stock Award or a Bonus Stock
Award.
"Tandem SAR" shall mean an SAR which is granted in tandem with, or by
reference to, an option (including a Non-Statutory Stock Option granted prior to
the date of grant of the SAR), which entitles the holder thereof to receive,
upon exercise of such SAR and surrender for cancellation of all or a portion of
such option, shares of Common Stock (which may be Restricted Stock), cash or a
combination thereof with an aggregate value equal to the excess of the Fair
Market Value of one share of Common Stock on the date of exercise over the base
price of such SAR, multiplied by the number of shares of Common Stock subject to
such option, or portion thereof, which is surrendered.
"Tax Date" shall have the meaning set forth in Section 6.5.
"Ten Percent Holder" shall have the meaning set forth in Section
2.1(a).
1.3 Administration. This Plan shall be administered by the
Committee. Any one or a combination of the following awards may be made under
this Plan to eligible persons: (a) options to purchase shares of Common Stock in
the form of Incentive Stock Options or Non-Statutory Stock Options, (b) SARs in
the form of Tandem SARs or Free-Standing SARs, (c) Stock Awards in the form of
Restricted Stock or Bonus Stock and (d) Performance Shares. The Committee shall,
subject to the terms of this Plan, select eligible persons for participation in
this Plan and determine the form, amount and timing of each award to such
persons and, if applicable, the number of shares of Common Stock, the number of
SARs and the number of Performance Shares subject to such an award, the exercise
price or base price associated with the award, the time and conditions of
exercise or settlement of the award and all other terms and conditions of the
award, including, without limitation, the form of the Agreement evidencing the
award. The Committee shall, subject to the terms of this Plan, interpret this
Plan and the application thereof, establish rules and regulations it deems
necessary or desirable for the administration of this Plan and may impose,
incidental to the grant of an award, conditions with respect to the
<PAGE>
award, such as limiting competitive employment or other activities. All such
interpretations, rules, regulations and conditions shall be conclusive and
binding on all parties.
The Committee may delegate some or all of its power and authority
hereunder to the Chairman of the Board and Chief Executive Officer or other
executive officer of the Company as the Committee deems appropriate; provided,
however, that the Committee may not delegate its power and authority with regard
to (a) the grant of an award under this Plan to any person who is a "covered
employee" within the meaning of Section 162(m) of the Code or who, in the
Committee's judgment, is likely to be a covered employee at any time during the
period an award hereunder to such employee would be outstanding or (b) the
selection for participation in this Plan of an officer or other person subject
to Section 16 of the Exchange Act or decisions concerning the timing, pricing or
amount of an award to such an officer or other person.
No member of the Board of Directors or Committee, and neither the
Chairman of the Board and Chief Executive Officer nor any other executive
officer to whom the Committee delegates any of its power and authority
hereunder, shall be liable for any act, omission, interpretation, construction
or determination made in connection with this Plan in good faith, and the
members of the Board of Directors and the Committee and the President and Chief
Executive Officer or other executive officer shall be entitled to
indemnification and reimbursement by the Company in respect of any claim, loss,
damage or expense (including attorneys' fees) arising therefrom to the full
extent permitted by law, except as otherwise may be provided in the Company's
Certificate of Incorporation and/or By-laws, as the same may be amended or
restated from time to time, and under any directors' and officers' liability
insurance that may be in effect from time to time.
A majority of the Committee shall constitute a quorum. The acts of the
Committee shall be either (a) acts of a majority of the members of the Committee
present at any meeting at which a quorum is present or (b) acts approved in
writing by a majority of the members of the Committee without a meeting.
Notwithstanding anything to the contrary herein, any grants of awards
to a Non-Employee Director (not including awards under Article V) shall be null
and void unless such awards and all terms thereof are approved in advance by the
Board.
1.4 Eligibility. Participants in this Plan shall consist of such
directors, officers or other key employees of the Company and its Subsidiaries,
and such Independent Contractors, as the Committee, in its sole discretion, may
select from time to time. The Committee's selection of a person to participate
in this Plan at any time shall not require the Committee to select such person
to participate in this Plan at any other time. Non-Employee Directors shall also
be eligible to participate in this Plan in accordance with Article V.
1.5 Shares Available. Subject to adjustment as provided in Sections
6.7 and 6.8, 200,000 shares of Common Stock shall be available under this Plan,
reduced by the sum of the aggregate number of shares of Common Stock (a) that
are issued upon the grant of a Stock Award and (b) which become subject to
outstanding options, including Directors' Options, outstanding Free-Standing
SARs and outstanding Performance Shares. To the extent that shares of Common
Stock subject to an outstanding option (other than in connection with the
exercise of a Tandem SAR), Free-Standing SAR or Performance Share are not issued
or delivered by reason of the expiration, termination, cancellation or
forfeiture of such award or by reason of the delivery or withholding of shares
of Common Stock to pay all or a portion of the exercise price of an award, if
any, or to satisfy all or a portion of the tax withholding obligations relating
to an award, then such shares of Common Stock shall again be available under
this Plan.
Shares of Common Stock to be delivered under this Plan shall be made
available from authorized and unissued shares of Common Stock, or authorized and
issued shares of Common Stock reacquired and held as treasury shares or
otherwise or a combination thereof.
II. STOCK OPTIONS AND STOCK APPRECIATION RIGHTS
<PAGE>
2.1 Stock Options. The Committee may, in its discretion, grant
options to purchase shares of Common Stock to such eligible persons as may be
selected by the Committee. Each option, or portion thereof, that is not an
Incentive Stock Option, shall be a Non-Statutory Stock Option. Each Incentive
Stock Option shall be granted within ten years of the effective date of this
Plan. To the extent that the aggregate Fair Market Value (determined as of the
date of grant) of shares of Common Stock with respect to which options
designated as Incentive Stock Options are exercisable for the first time by a
participant during any calendar year (under this Plan or any other plan of the
Company, or any parent or Subsidiary) exceeds the amount (currently $100,000)
established by the Code, such options shall constitute Non-Statutory Stock
Options. The Committee may not grant an Incentive Stock Option to an Independent
Contractor or a Non-Employee Director.
Options shall be subject to the following terms and conditions and
shall contain such additional terms and conditions, not inconsistent with the
terms of this Plan, as the Committee shall deem advisable:
(a) Number of Shares and Purchase Price. The number of shares of
Common Stock subject to an option shall be determined by the Committee, except
that the Committee shall not grant an option or SAR (or any combination of
options and SARs) in any calendar year to any eligible person which, in the
aggregate, gives such person an option or SAR (or any combination of options and
SARs) to purchase more than 62,500 shares of Common Stock (as may be adjusted
pursuant to Section 6.7). The purchase price per share of Common Stock
purchasable upon exercise of the option shall be determined by the Committee;
provided, however, that the purchase price per share of Common Stock purchasable
upon exercise of an Option shall not be less than 100% of the Fair Market Value
of a share of Common Stock on the date of grant of such option; provided
further, that if an Incentive Stock Option shall be granted to any person who,
at the time such option is granted, owns capital stock possessing more than ten
percent of the total combined voting power of all classes of capital stock of
the Company (or of any parent or Subsidiary) (a "Ten Percent Holder"), the
purchase price per share of Common Stock shall be the price (currently 110% of
Fair Market Value) required by the Code in order to constitute an Incentive
Stock Option.
(b) Option Period and Exercisability. The period during which an
option may be exercised shall be determined by the Committee; provided, however,
that no Incentive Stock Option shall be exercised later than ten years after its
date of grant; provided further, that if an Incentive Stock Option shall be
granted to a Ten Percent Holder, such option shall not be exercised later than
five years after its date of grant. The Committee may, in its discretion,
establish Performance Measures which shall be satisfied or met as a condition to
the grant of an option or to the exercisability of all or a portion of an
option. The Committee shall determine whether an option shall become exercisable
in cumulative or non-cumulative installments and in part or in full at any time.
An exercisable option, or portion thereof, may be exercised only with respect to
whole shares of Common Stock.
(c) Method of Exercise. An option may be exercised (i) by giving
written notice to the Company specifying the number of whole shares of Common
Stock to be purchased and accompanied by payment therefor in full (or
arrangement made for such payment to the Company's satisfaction) either (1) in
cash, (2) by delivery of Mature Shares having a Fair Market Value, determined as
of the date of exercise, equal to the aggregate purchase price payable by reason
of such exercise, (3) by authorizing the Company to withhold whole shares of
Common Stock which would otherwise be delivered upon exercise of the option
having a Fair Market Value, determined as of the date of exercise, equal to the
aggregate purchase price payable by reason of such exercise, (4) in cash by a
broker-dealer acceptable to the Company to whom the optionee has submitted an
irrevocable notice of exercise or (5) a combination of (1), (2) and (3), in each
case to the extent set forth in the Agreement relating to the option, (ii) if
applicable, by surrendering to the Company any Tandem SARs which are cancelled
by reason of the exercise of the option and (iii) by executing such documents as
the Company may reasonably request. The Committee shall have sole discretion to
disapprove of an election pursuant to any of clauses (2)-(5) and in the case of
an optionee who is subject to Section 16 of the Exchange Act, the Company may
require that the method of making such payment be in compliance with Section 16
and the rules and regulations thereunder. Any fraction of a share of Common
Stock which would be required to pay such purchase price shall be disregarded
and the remaining amount due shall be paid in cash by the optionee. No
certificate representing Common Stock shall be delivered until the full purchase
price therefor has been paid.
<PAGE>
(d) Additional Options. The Committee shall have the authority to
include in any Agreement relating to an option a provision entitling the
optionee to an additional option in the event such optionee exercises the option
represented by such option agreement, in whole or in part, by delivering
previously owned whole shares of Common Stock in payment of the purchase price
in accordance with this Plan and such Agreement. Any such additional option
shall be for a number of shares of Common Stock equal to the number of delivered
shares, shall have a purchase price determined by the Committee in accordance
with this Plan, shall be exercisable on the terms and subject to the conditions
set forth in the Agreement relating to such additional option.
2.2 Stock Appreciation Rights. The Committee may, in its discretion,
grant SARs to such eligible persons as may be selected by the Committee. The
Agreement relating to an SAR shall specify whether the SAR is a Tandem SAR or a
Free-Standing SAR.
SARs shall be subject to the following terms and conditions and shall
contain such additional terms and conditions, not inconsistent with the terms of
this Plan, as the Committee shall deem advisable:
(a) Number of SARs and Base Price. The number of SARs subject to an
award shall be determined by the Committee, except that the Committee shall not
grant an option or SAR (or any combination of options and SARs) in any calendar
year to any eligible person which, in the aggregate, gives such person an option
or SAR (or any combination of options and SARs) to purchase more than 62,500
shares of Common Stock (as may be adjusted pursuant to Section 6.7). Any Tandem
SAR related to an Incentive Stock Option shall be granted at the same time that
such Incentive Stock Option is granted. The base price of a Tandem SAR shall be
the purchase price per share of Common Stock of the related option. The base
price of a Free-Standing SAR shall be determined by the Committee; provided,
however, that such base price shall not be less than 100% of the Fair Market
Value of a share of Common Stock on the date of grant of such SAR.
(b) Exercise Period and Exercisability. The Agreement relating to an
award of SARs shall specify whether such award may be settled in shares of
Common Stock (including shares of Restricted Stock) or cash or a combination
thereof. The period for the exercise of an SAR shall be determined by the
Committee; provided, however, that no Tandem SAR shall be exercised later than
the expiration, cancellation, forfeiture or other termination of the related
option. The Committee may, in its discretion, establish Performance Measures
which shall be satisfied or met as a condition to the exercisability of an SAR.
The Committee shall determine whether an SAR may be exercised in cumulative or
non-cumulative installments and in part or in full at any time. An exercisable
SAR, or portion thereof, may be exercised, in the case of a Tandem SAR, only
with respect to whole shares of Common Stock and, in the case of a Free-Standing
SAR, only with respect to a whole number of SARs. If an SAR is exercised for
shares of Restricted Stock, a certificate or certificates representing such
Restricted Stock shall be issued in accordance with Section 3.2(c) and the
holder of such Restricted Stock shall have such rights of a stockholder of the
Company as determined pursuant to Section 3.2(d). Prior to the exercise of an
SAR for shares of Common Stock, including Restricted Stock, the holder of such
SAR shall have no rights as a stockholder of the Company with respect to the
shares of Common Stock subject to such SAR and shall have rights as a
stockholder of the Company in accordance with Section 6.10.
(c) Method of Exercise. A Tandem SAR may be exercised (i) by giving
written notice to the Company specifying the number of whole SARs which are
being exercised, (ii) by surrendering to the Company any options which are
cancelled by reason of the exercise of the Tandem SAR and (iii) by executing
such documents as the Company may reasonably request. A Free-Standing SAR may be
exercised (i) by giving written notice to the Company specifying the whole
number of SARs which are being exercised and (ii) by executing such documents as
the Company may reasonably request.
2.3 Termination of Employment or Service with the Company.
(a) Disability. Subject to paragraph (f) below and Section 6.8, and
unless otherwise specified in the Agreement relating to an option or SAR, as the
case may be, if the employment or service with the Company of the holder of an
option or SAR terminates by reason of Disability, each option and SAR held by
<PAGE>
such holder shall be exercisable only to the extent that such option or SAR, as
the case may be, is exercisable on the effective date of such holder's
termination of employment or service and may thereafter be exercised by such
holder (or such holder's legal representative or similar person) until and
including the earliest to occur of (i) the date which is three months (or such
other period as set forth in the Agreement relating to such option or SAR) after
the effective date of such holder's termination of employment or service and
(ii) the expiration date of the term of such option or SAR.
(b) Retirement. Subject to paragraph (f) below and Section 6.8, and
unless otherwise specified in the Agreement relating to an option or SAR, as the
case may be, if the employment or service with the Company of the holder of an
option or SAR terminates by reason of retirement on or after age 65 with the
consent of the Company, each option and SAR held by such holder shall be
exercisable only to the extent that such option or SAR, as the case may be, is
exercisable on the effective date of such holder's termination of employment or
service and may thereafter be exercised by such holder (or such holder's legal
representative or similar person) until and including the earliest to occur of
(i) the date which is three months (or such other period as set forth in the
Agreement relating to such option or SAR) after the effective date of such
holder's termination of employment or service and (ii) the expiration date of
the term of such option or SAR.
(c) Death. Subject to paragraph (f) below and Section 6.8, and
unless otherwise specified in the Agreement relating to an option or SAR, as the
case may be, if the employment or service with the Company of the holder of an
option or SAR terminates by reason of death, each option and SAR held by such
holder shall be exercisable only to the extent that such option or SAR, as the
case may be, is exercisable on the date of such holder's death, and may
thereafter be exercised by such holder's executor, administrator, legal
representative, beneficiary or similar person, as the case may be, until and
including the earliest to occur of (i) the date which is one year (or such other
period as set forth in the Agreement relating to such option or SAR) after the
date of death and (ii) the expiration date of the term of such option or SAR.
(d) Other Termination. If the employment or service with the Company
of the holder of an option or SAR is terminated by the Company for Cause, each
option and SAR held by such holder shall terminate automatically on the
effective date of such holder's termination of employment or service.
Subject to paragraph (f) below and Section 6.8, and unless specified
in the Agreement relating to an option or SAR, as the case may be, if the
employment or service with the Company of the holder of an option or SAR
terminates for any reason other than Disability, retirement on or after age 65
with the consent of the Company, death or Cause, each option and SAR held by
such holder shall be exercisable only to the extent that such option or SAR is
exercisable on the effective date of such holder's termination of employment or
service and may thereafter be exercised by such holder (or such holder's legal
representative or similar person) until and including the earliest to occur of
(i) the date which is three months (or such other period as set forth in the
Agreement relating to such option or SAR) after the effective date of such
holder's termination of employment or service and (ii) the expiration date of
the term of such option or SAR.
(e) Death Following Termination of Employment or Service. Subject to
paragraph (f) below and Section 6.8, and unless otherwise specified in the
Agreement relating to an option or SAR, as the case may be, if the holder of an
option or SAR dies during the three-month period following termination of
employment or service by reason of Disability, or if the holder of an option or
SAR dies during the three-month period following termination of employment or
service by reason of retirement on or after age 65 with the consent of the
Company, or if the holder of an option or SAR dies during the three-month period
following termination of employment or service for any reason other than
Disability or retirement on or after age 65 with the consent of the Company (or,
in each case, such other period as set forth in the Agreement relating to such
option or SAR), each option and SAR held by such holder shall be fully
exercisable and may thereafter be exercised by the holder's executor,
administrator, legal representative, beneficiary or similar person, as the case
may be, until and including the earliest to occur of (i) the date which is one
year (or such other period as set forth in the Agreement relating to such option
or SAR) after the date of death and (ii) the expiration date of the term of such
option or SAR.
<PAGE>
(f) Termination of Employment or Service - Incentive Stock Options.
Subject to Section 6.8 and unless otherwise specified in the Agreement relating
to the option, if the employment or service with the Company of a holder of an
incentive stock option terminates by reason of Permanent and Total Disability
(as defined in Section 22(e)(3) of the Code), each incentive stock option held
by such optionee shall be exercisable only to the extent that such option is
exercisable on the effective date of such optionee's termination of employment
or service by reason of Permanent and Total Disability, and may thereafter be
exercised by such optionee (or such optionee's legal representative or similar
person) until and including the earliest to occur of (i) the date which is three
months (or such other period no longer than one year as set forth in the
Agreement relating to such option) after the effective date of such optionee's
termination of employment or service by reason of Permanent and Total Disability
and (ii) the expiration date of the term of such option.
Subject to Section 6.8 and unless otherwise specified in the Agreement
relating to the option, if the employment or service with the Company of a
holder of an incentive stock option terminates by reason of death, each
incentive stock option held by such optionee shall be exercisable only to the
extent that such option is exercisable on the date of such optionee's death and
may thereafter be exercised by such optionee's executor, administrator, legal
representative, beneficiary or similar person until and including the earliest
to occur of (i) the date which is one year (or such shorter period as set forth
in the Agreement relating to such option)after the date of death and (ii) the
expiration date of the term of such option.
If the employment or service with the Company of the optionee of an
Incentive Stock Option is terminated by the Company for Cause, each Incentive
Stock Option held by such optionee shall terminate automatically on the
effective date of such optionee's termination of employment or service.
If the employment or service with the Company of a holder of an
incentive stock option terminates for any reason other than Permanent and Total
Disability, death or Cause, each incentive stock option held by such optionee
shall be exercisable only to the extent such option is exercisable on the
effective date of such optionee's termination of employment or service, and may
thereafter be exercised by such holder (or such holder's legal representative or
similar person) until and including the earliest to occur of (i) the date which
is three months after the effective date of such optionee's termination of
employment or service and (ii) the expiration date of the term of such option.
If the holder of an incentive stock option dies during the three-month
period following termination of employment or service by reason of Permanent and
Total Disability (or such shorter period as set forth in the Agreement relating
to such option), or if the holder of an incentive stock option dies during the
three-month period following termination of employment or service for any reason
other than Permanent and Total Disability, death or Cause, each incentive stock
option held by such optionee shall be exercisable only to the extent such option
is exercisable on the date of the optionee's death and may thereafter be
exercised by the optionee's executor, administrator, legal representative,
beneficiary or similar person until and including the earliest to occur of (i)
the date which is one year (or such shorter period as set forth in the Agreement
relating to such option) after the date of death and (ii) the expiration date of
the term of such option.
2.4 Termination of Independent Contractor. Not-withstanding
anything to the contrary herein, all of the terms relating to the exercise,
cancellation or other disposition of an option or SAR upon a termination of an
Independent Contractor, whether by reason of Disability, retirement, death,
Cause or other termination, shall be determined by the Committee. Such
determination shall be made at the time of the grant of such option or SAR, as
the case may be, and shall be specified in the Agreement relating to such option
or SAR.
III. STOCK AWARDS
==================
3.1 Stock Awards. The Committee may, in its discretion, grant Stock
Awards to such eligible persons as may be selected by the Committee. Subject to
adjustment as provided in Sections 6.7 and 6.8 of this Plan, the aggregate
number of shares of Common Stock available under this Plan pursuant to all Stock
<PAGE>
Awards shall not exceed 50,000 of the aggregate number of shares of Common Stock
available under this Plan. The Agreement relating to a Stock Award shall specify
whether the Stock Award is a Restricted Stock Award or Bonus Stock Award.
3.2 Terms of Stock Awards. Stock Awards shall be subject to the
following terms and conditions and shall contain such additional terms and
conditions, not inconsistent with the terms of this Plan, as the Committee shall
deem advisable.
(a) Number of Shares and Other Terms. The number of shares of Common
Stock subject to a Restricted Stock Award or Bonus Stock Award and the
Performance Measures (if any) and Restriction Period applicable to a Restricted
Stock Award shall be determined by the Committee.
(b) Vesting and Forfeiture. The Agreement relating to a Restricted
Stock Award shall provide, in the manner determined by the Committee, in its
discretion, and subject to the provisions of this Plan, for the vesting of the
shares of Common Stock subject to such award (i) if specified Performance
Measures are satisfied or met during the specified Restriction Period or (ii) if
the holder of such award remains continuously in the employment or service of
the Company during the specified Restricted Period and for the forfeiture of the
shares of Common Stock subject to such award (x) if specified Performance
Measures are not satisfied or met during the specified Restriction Period or (y)
if the holder of such award does not remain continuously in the employment or
service of the Company during the specified Restriction Period.
Bonus Stock Awards shall not be subject to any Performance Measures or
Restriction Periods.
(c) Share Certificates. During the Restriction Period, a certificate
or certificates representing a Restricted Stock Award shall be registered in the
holder's name and may bear a legend, in addition to any legend which may be
required pursuant to Section 6.6, indicating that the ownership of the shares of
Common Stock represented by such certificate is subject to the restrictions,
terms and conditions of this Plan and the Agreement relating to the Restricted
Stock Award. All such certificates shall be deposited with the Company, together
with stock powers or other instruments of assignment (including a power of
attorney), each endorsed in blank with a guarantee of signature if deemed
necessary or appropriate, which would permit transfer to the Company of all or a
portion of the shares of Common Stock subject to the Restricted Stock Award in
the event such award is forfeited in whole or in part. Upon termination of any
applicable Restriction Period (and the satisfaction or attainment of applicable
Performance Measures), or upon the grant of a Bonus Stock Award, in each case
subject to the Company's right to require payment of any taxes in accordance
with Section 6.5, a certificate or certificates evidencing ownership of the
requisite number of shares of Common Stock shall be delivered to the holder of
such award.
(d) Rights with Respect to Restricted Stock Awards. Unless otherwise
set forth in the Agreement relating to a Restricted Stock Award, and subject to
the terms and conditions of a Restricted Stock Award, the holder of such award
shall have all rights as a stockholder of the Company, including, but not
limited to, voting rights, the right to receive dividends and the right to
participate in any capital adjustment applicable to all holders of Common Stock;
provided, however, that a distribution with respect to shares of Common Stock,
other than a distribution in cash, shall be deposited with the Company and shall
be subject to the same restrictions as the shares of Common Stock with respect
to which such distribution was made.
3.3 Termination of Employment or Service.
(a) Disability, Retirement and Death. Subject to Section 6.8 and
unless otherwise set forth in the Agreement relating to a Restricted Stock
Award, if the employment or service with the Company of the holder of such award
terminates by reason of Disability, retirement on or after age 65 with the
consent of the Company or death, the portion of such award which is subject to a
Restriction Period shall terminate as of the effective date of such holder's
termination of employment or service shall be forfeited and such portion shall
be cancelled by the Company.
<PAGE>
(b) Other Termination. Subject to Section 6.8 and unless otherwise
set forth in the Agreement relating to a Restricted Stock Award, if the
employment or service with the Company of the holder of a Restricted Stock Award
terminates for any reason other than Disability, retirement on or after age 65
with the consent of the Company or death, the portion of such award which is
subject to a Restriction Period on the effective date of such holder's
termination of employment or service shall be forfeited and such portion shall
be cancelled by the Company.
3.4 Termination of Independent Contractor. Not-withstanding anything
to the contrary herein, all of the terms relating to the exercise, cancellation
or other disposition of a Restricted Stock Award upon a termination of an
Independent Contractor, whether by reason of Disability, retirement, death,
Cause or other termination, shall be determined by the Committee. Such
determination shall be made at the time of the grant of such Restricted Stock
Award, and shall be specified in the Agreement relating to such Restricted Stock
Award.
IV. PERFORMANCE SHARE AWARDS
4.1 Performance Share Awards. The Committee may, in its discretion,
grant Performance Share Awards to such eligible persons as may be selected by
the Committee.
4.2 Terms of Performance Share Awards. Performance Share Awards
shall be subject to the following terms and conditions and shall contain such
additional terms and conditions, not inconsistent with the terms of this Plan,
as the Committee shall deem advisable.
(a) Number of Performance Shares and Performance Measures. The
number of Performance Shares subject to any award and the Performance Measures
and Performance Period applicable to such award shall be determined by the
Committee.
(b) Vesting and Forfeiture. The Agreement relating to a Performance
Share Award shall provide, in the manner determined by the Committee, in its
discretion, and subject to the provisions of this Plan, for the vesting of such
award, if specified Performance Measures are satisfied or met during the
specified Performance Period, and for the forfeiture of such award, if specified
Performance Measures are not satisfied or met during the specified Performance
Period.
(c) Settlement of Vested Performance Share Awards. The Agreement
relating to a Performance Share Award (i) shall specify whether such award may
be settled in shares of Common Stock (including shares of Restricted Stock) or
cash or a combination thereof and (ii) may specify whether the holder thereof
shall be entitled to receive, on a current or deferred basis, dividend
equivalents, and, if determined by the Committee, interest on any deferred
dividend equivalents, with respect to the number of shares of Common Stock
subject to such award. If a Performance Share Award is settled in shares of
Restricted Stock, a certificate or certificates representing such Restricted
Stock shall be issued in accordance with Section 3.2(c) and the holder of such
Restricted Stock shall have such rights of a stockholder of the Company as
determined pursuant to Section 3.2(d). Prior to the settlement of a Performance
Share Award in shares of Common Stock, including Restricted Stock, the holder of
such award shall have no rights as a stockholder of the Company with respect to
the shares of Common Stock subject to such award.
4.3 Termination of Employment or Service.
(a) Disability, Retirement and Death. Subject to Section 6.8 and
unless otherwise set forth in the Agreement relating to a Performance Share
Award, if the employment or service with the Company of the holder of such award
terminates by reason of Disability, retirement on or after age 65 with the
consent of the Company or death, the portion of such award which is subject to a
Performance Period on the effective date of such holder's termination of
employment or service shall be forfeited and such portion shall be cancelled by
the Company.
<PAGE>
(b) Other Termination. Subject to Section 6.8 and unless otherwise
set forth in the Agreement relating to a Performance Share Award, if the
employment or service with the Company of the holder of a Performance Share
Award terminates for any reason other than Disability, retirement on or after
age 65 with the consent of the Company or death, the portion of such award which
is subject to a Performance Period on the effective date of such holder's
termination of employment or service shall be forfeited and such portion shall
be cancelled by the Company.
4.4 Termination of Independent Contractor. Not-withstanding anything
to the contrary herein, all of the terms relating to the exercise, cancellation
or other disposition of a Performance Share Award upon a termination of an
Independent Contractor, whether by reason of Disability, retirement, death,
Cause or other termination, shall be determined by the Committee. Such
determination shall be made at the time of the grant of such Performance Share
Award, and shall be specified in the Agreement relating to such Performance
Share Award.
V. PROVISIONS RELATING TO NON-EMPLOYEE DIRECTORS
5.1 Eligibility. Each Non-Employee Director shall be granted options
to purchase shares of Common Stock in accordance with this Article V ("Director
Options"). All options granted under this Article V shall constitute Non-
Statutory Stock Options.
5.2 Grants of Stock Options. Each Non-Employee Director shall
be granted Non-Statutory Stock Options as follows:
(a) Initial Public Offering. On the date of the initial public
offering by the Company, each person who is a Non-Employee Director immediately
after such initial public offering or meeting of stockholders (other than any
Non-Employee Director who is expected to resign in connection with the Company's
initial public offering) shall be granted an option to purchase 1,000 shares of
Common Stock at a purchase price per share equal to the Fair Market Value of a
share of Common Stock on the date of grant of such option.
(b) Annual Meeting. On the date of each annual meeting of
stockholders of the Company, each person who is a Non-Employee Director
immediately after such annual meeting of stockholders shall be granted an option
to purchase 1,000 shares of Common Stock at a purchase price per share equal to
the Fair Market Value of a share of Common Stock on the date of grant of such
option.
(c) New Non-Employee Directors. In addition, following the initial
public offering of the Company, on the date on which a person is first elected
or begins to serve as a Non-Employee Director (other than by reason of
termination of employment or service) shall be granted an option to purchase
10,000 shares of Common Stock at a purchase price per share equal to the Fair
Market Value of a share of Common Stock on the date of grant of such option.
(d) Option Period and Exercisability. Except as otherwise provided
herein, each option granted under this Article V shall become exercisable in
full on the first to occur of (i) the day before the Company's annual meeting of
stockholders next following the date of grant or (ii) the first anniversary of
its date of grant. Each option granted under this Article V shall expire ten
years after its date of grant. An exercisable option, or portion thereof, may be
exercised in whole or in part only with respect to whole shares of Common Stock.
Options granted under this Article V shall be exercisable in accordance with
Section 2.1(c).
5.3 Termination of Directorship.
(a) Disability. Subject to Section 6.8, if the holder of an option
granted under this Article V ceases to be a director of the Company by reason of
Disability, each such option held by such holder shall be exercisable only to
the extent that such option is exercisable on the effective date of such
holder's ceasing to be a
<PAGE>
director and may thereafter be exercised by such holder (or such holder's
guardian, legal representative or similar person) until the earliest to occur of
the (i) date which is three months after the effective date of such holder's
ceasing to be a director and (ii) the expiration date of the term of such
option.
(b) Retirement. Subject to Section 6.8, if the holder of an option
granted under this Article V ceases to be a director of the Company on or after
age 65, each such option held by such holder shall be exercisable only to the
extent that such option is exercisable on the effective date of such holder's
ceasing to be a director and may thereafter be exercised by such holder (or such
holder's legal representative or similar person) until the earliest to occur of
the (i) date which is three months after the effective date of such holder's
ceasing to be a director and (ii) the expiration date of the term of such
option.
(c) Death. Subject to Section 6.8, if the holder of an option
granted under this Article V ceases to be a director of the Company by reason of
death, each such option held by such holder shall be fully exercisable and may
thereafter be exercised by such holder's executor, administrator, legal
representative, beneficiary or similar person, as the case may be, until the
earliest to occur of the (i) date which is one year after the date of death and
(ii) the expiration date of the term of such option.
(d) Other Termination. Subject to Section 6.8, if the holder of an
option granted under this Article V ceases to be a director of the Company for
any reason other than Disability, retirement on or after age 65 or death, each
such option held by such holder shall be exercisable only to the extent such
option is exercisable on the effective date of such holder's ceasing to be a
director and may thereafter be exercised by such holder (or such holder's legal
representative or similar person) until the earliest to occur of the (i) date
which is three months after the effective date of such holder's ceasing to be a
director and (ii) the expiration date of the term of such option.
(e) Death Following Termination of Directorship. Subject to Section
6.8, if the holder of an option granted under this Article V dies during the
three-month period following such holder's ceasing to be a director of the
Company by reason of Disability, or if such a holder dies during the three-month
period following such holder's ceasing to be a director of the Company on or
after age 65, or if such a holder dies during the three-month period following
such holder's ceasing to be a director for any reason other than by reason of
Disability or retirement on or after age 65, each such option held by such
holder shall be exercisable only to the extent that such option is exercisable
on the date of the holder's death and may thereafter be exercised by the
holder's executor, administrator, legal representative, beneficiary or similar
person, as the case may be, until the earliest to occur of the (i) date one year
after the date of death and (ii) the expiration date of the term of such option.
VI. GENERAL
6.1 Effective Date and Term of Plan. This Plan shall be submitted to
the stockholders of the Company for approval and, if approved by the affirmative
vote of a majority of the voting power of the shares of capital stock of the
Company entitled to vote thereon, shall become effective as of the commencement
of the initial public offering of the Company. This Plan shall terminate ten
years after its effective date unless terminated earlier by the Board.
Termination of this Plan shall not affect the terms or conditions of any award
granted prior to termination.
Awards hereunder may be made at any time prior to the termination of
this Plan, provided that no award may be made later than ten years after the
effective date of this Plan. In the event that this Plan is not approved by the
stockholders of the Company, this Plan and any awards hereunder shall be void
and of no force or effect.
6.2 Amendments. The Board may amend this Plan as it shall deem
advisable, subject to any requirement of stockholder approval required by
applicable law, rule or regulation including Rule 16b-3 under the Exchange Act
and Section 162(m) of the Code; provided, however, that no amendment shall be
made without
<PAGE>
stockholder approval if such amendment would (a) increase the maximum number of
shares of Common Stock available for issuance under this Plan (subject to
Section 6.7), (b) reduce the minimum purchase price in the case of an option or
the base price in the case of an SAR, (c) effect any change inconsistent with
Section 422 of the Code or (d) extend the term of this Plan. No amendment may
impair the rights of a holder of an outstanding award without the consent of
such holder.
6.3 Agreement. Each award under this Plan shall be evidenced by an
Agreement setting forth the terms and conditions applicable to such award. No
award shall be valid until an Agreement is executed by the Company and the
recipient of such award and, upon execution by each party and delivery of the
Agreement to the Company, such award shall be effective as of the effective date
set forth in the Agreement.
6.4 Non-Transferability of Stock Options, SARs and Performance
Shares. No option, SAR or Performance Share shall be transferable other than (i)
by will, the laws of descent and distribution or pursuant to beneficiary
designation procedures approved by the Company or (ii) as otherwise permitted
under Rule 16b-3 under the Exchange Act as set forth in the Agreement relating
to such award. Each option, SAR or Performance Share may be exercised or settled
during the participant's lifetime only by the holder or the holder's legal
representative or similar person. Except as permitted by the second preceding
sentence, no option, SAR or Performance Share may be sold, transferred,
assigned, pledged, hypothecated, encumbered or otherwise disposed of (whether by
operation of law or otherwise) or be subject to execution, attachment or similar
process. Upon any attempt to so sell, transfer, assign, pledge, hypothecate,
encumber or otherwise dispose of any option, SAR or Performance Share, such
award and all rights thereunder shall immediately become null and void.
6.5 Tax Withholding. The Company shall have the right to require,
prior to the issuance or delivery of any shares of Common Stock or the payment
of any cash pursuant to an award made hereunder, payment by the holder of such
award of any Federal, state, local or other taxes which may be required to be
withheld or paid in connection with such award. An Agreement may provide that
(i) the Company shall withhold whole shares of Common Stock which would
otherwise be delivered to a holder, having an aggregate Fair Market Value
determined as of the date the obligation to withhold or pay taxes arises in
connection with an award (the "Tax Date"), or withhold an amount of cash which
would otherwise be payable to a holder, in the amount necessary to satisfy any
such obligation or (ii) the holder may satisfy any such obligation by any of the
following means: (1) a cash payment to the Company, (2) delivery to the Company
of Mature Shares having an aggregate Fair Market Value, determined as of the Tax
Date, equal to the amount necessary to satisfy any such obligation, (3)
authorizing the Company to withhold whole shares of Common Stock which would
otherwise be delivered having an aggregate Fair Market Value, determined as of
the Tax Date, or withhold an amount of cash which would otherwise be payable to
a holder, equal to the amount necessary to satisfy any such obligation, (4) in
the case of the exercise of an option, a cash payment by a broker-dealer
acceptable to the Company to whom the optionee has submitted an irrevocable
notice of exercise or (5) any combination of (1), (2) and (3), in each case to
the extent set forth in the Agreement relating to the award; provided, however,
that the Committee shall have sole discretion to disapprove of an election
pursuant to any of clauses (2)-(5) and that in the case of a holder who is
subject to Section 16 of the Exchange Act, the Company may require that the
method of satisfying such an obligation be in compliance with Section 16 and the
rules and regulations thereunder. An Agreement may provide for shares of Common
Stock to be delivered or withheld having an aggregate Fair Market Value in
excess of the minimum amount required to be withheld. Any fraction of a share of
Common Stock which would be required to satisfy such an obligation shall be
disregarded and the remaining amount due shall be paid in cash by the holder.
6.6 Restrictions on Shares. Each award made hereunder shall be
subject to the requirement that if at any time the Company determines that the
listing, registration or qualification of the shares of Common Stock subject to
such award upon any securities exchange or under any law, or the consent or
approval of any governmental body, or the taking of any other action is
necessary or desirable as a condition of, or in connection with, the delivery of
shares thereunder, such shares shall not be delivered unless such listing,
registration, qualification, consent, approval or other action shall have been
effected or obtained, free of any conditions not acceptable to the Company. The
Company may require that certificates evidencing shares of Common Stock
delivered pursuant to any award made hereunder bear a legend indicating that the
sale, transfer or
<PAGE>
other disposition thereof by the holder is prohibited except in compliance with
the Securities Act of 1933, as amended, and the rules and regulations
thereunder.
6.7 Adjustment. Except as provided in Section 6.8, in the event of
any stock split, stock dividend, recapitalization, reorganization, merger,
consolidation, combination, exchange of shares, liquidation, spin-off or other
similar change in capitalization or event, or any distribution to holders of
Common Stock other than a regular cash dividend, the number and class of
securities available under this Plan, the number and class of securities subject
to each outstanding option and the purchase price per security, the number of
securities subject to each option to be granted to Non-Employee Directors
pursuant to Article V, the terms of each outstanding SAR, the number and class
of securities subject to each outstanding Stock Award, and the terms of each
outstanding Performance Share shall be appropriately adjusted by the Committee,
such adjustments to be made in the case of outstanding options and SARs without
an increase in the aggregate purchase price or base price. The decision of the
Committee regarding any such adjustment shall be final, binding and conclusive.
If any such adjustment would result in a fractional security being (a) available
under this Plan, such fractional security shall be disregarded, or (b) subject
to an award under this Plan, the Company shall pay the holder of such award, in
connection with the first vesting, exercise or settlement of such award, in
whole or in part, occurring after such adjustment, an amount in cash determined
by multiplying (i) the fraction of such security (rounded to the nearest
hundredth) by (ii) the excess, if any, of (1) the Fair Market Value on the
vesting, exercise or settlement date over (2) the exercise or base price, if
any, of such award.
6.8 Change in Control.
(a) (i) Notwithstanding any provision in this Plan or any
Agreement (other than an Agreement with an Independent Contractor), in the event
of a Change in Control pursuant to Section (b)(iii) or (iv) below, (1) all
outstanding options and SARS shall immediately become exercisable in full, (2)
the Restriction Period applicable to any outstanding Restricted Stock Award
shall lapse, (3) the Performance Period applicable to any outstanding
Performance Share shall lapse and (4) the Performance Measures applicable to any
outstanding Restricted Stock Award (if any) and to any outstanding Performance
Share shall be deemed to be satisfied at the maximum level. If, in connection
with such Change in Control, holders of Common Stock receive solely shares of
common stock that are registered under Section 12 of the Exchange Act, there
shall be substituted for each share of Common Stock available under this Plan,
whether or not then subject to an outstanding award, the number and class of
shares into which each outstanding share of Common Stock shall be converted
pursuant to such Change in Control. If, in connection with such Change in
Control, holders of Common Stock receive solely cash and shares of common stock
that are registered under Section 12 of the Exchange Act, each outstanding award
shall be surrendered to and cancelled by the Company, and the holder shall
receive, within ten days of the occurrence of such Change in Control, a
proportionate amount of cash in the manner provided in Section (a)(ii) below,
and there shall be substituted for the award surrendered a similar award
reflecting a proportionate number of the class of shares into which each
outstanding share of Common Stock shall be converted to such Change in Control.
In the event of any such substitution, the proportion of cash and common stock,
the purchase price per share in the case of an option and the base price in the
case of an SAR, and any other terms of outstanding awards shall be appropriately
adjusted by the Committee, such adjustments to be made in the case of
outstanding options and SARs without an increase in the aggregate purchase price
or base price; provided, that the proportion of cash and common stock
substituted for outstanding awards shall reflect the approximate proportion of
cash and common stock received by holders of Common Stock in such Change in
Control. If, in connection with a Change in Control, holders of Common Stock
receive any portion of the consideration in a form other than cash or shares of
common stock that are registered under Section 12 of the Exchange Act, each
share of Common Stock available under this Plan, whether or not then subject to
an outstanding award, shall be substituted or surrendered for such proportion of
common stock, cash or other consideration as shall be determined by the
Committee pursuant to Section 6.7.
<PAGE>
(ii) Notwithstanding any provision in this Plan or any Agreement (other
than an Agreement with an Independent Contractor), in the event of a Change in
Control pursuant to Section (b)(i) or (ii) below, or in the event of a Change in
Control pursuant to Section (b)(iii) or (iv) below in connection with which the
holders of Common Stock receive cash, each outstanding award shall be
surrendered to the Company by the holder thereof, and each such award shall
immediately be cancelled by the Company, and the holder shall receive, within
ten days of the occurrence of a Change in Control pursuant to Section (b)(i) or
(ii) below or within ten days of the approval of the stockholders of the Company
contemplated by Section (b)(iii) or (iv) below, a cash payment from the Company
in an amount equal to (1) in the case of an option, the number of shares of
Common Stock then subject to such option, multiplied by the excess, if any, of
the greater of (A) the highest per share price offered to stockholders of the
Company in any transaction whereby the Change in Control takes place or (B) the
Fair Market Value of a share of Common Stock on the date of occurrence of the
Change in Control, over the purchase price per share of Common Stock subject to
the option; (2) in the case of a Free-Standing SAR, the number of shares of
Common Stock then subject to such SAR, multiplied by the excess, if any, of the
greater of (A) the highest per share price offered to stockholders of the
Company in any transaction whereby the Change in Control takes place or (B) the
Fair Market Value of a share of Common Stock on the date of occurrence of the
Change in Control, over the base price of the SAR; and (3) in the case of a
Restricted Stock Award or Performance Share Award, the number of shares of
Common Stock or the number of Performance Shares, as the case may be, then
subject to such award, multiplied by the greater of (A) the highest per share
price offered to stockholders of the Company in any transaction whereby the
Change in Control takes place or (B) the Fair Market Value of a share of Common
Stock on the date of occurrence of the Change in Control. In the event of a
Change in Control, each Tandem SAR shall be surrendered by the holder thereof
and shall be cancelled simultaneously with the cancellation of the related
option. The Company may, but is not required to, cooperate with any person who
is subject to Section 16 of the Exchange Act to assure that any cash payment in
accordance with the foregoing to such person is made in compliance with Section
16 and the rules and regulations thereunder.
(b) "Change in Control" shall mean:
(i) the acquisition by any individual, entity or group (a "Person"),
including any "person" within the meaning of Section 13(d)(3) or 14(d)(2) of the
Exchange Act, of Beneficial Ownership of 50% or more of either (1) the then
outstanding shares of common stock of the Company (the "Outstanding Company
Common Stock") or (2) the combined voting power of the then outstanding
securities of the Company entitled to vote generally in the election of
directors (the "Outstanding Company Voting Securities"); excluding, however, the
following: (A) any acquisition directly from the Company (excluding any
acquisition resulting from the exercise of an exercise, conversion or exchange
privilege unless the security being so exercised, converted or exchanged was
acquired directly from the Company), (B) any acquisition by the Company, (C) any
acquisition by an employee benefit plan (or related trust) sponsored or
maintained by the Company or any corporation controlled by the Company, (D) any
acquisition by an Exempt Person or (E) any acquisition by any corporation
pursuant to a transaction which complies with clauses (1), (2) and (3) of
subsection (iii) of this Section 6.8(b); provided further, that for purposes of
clause (2), if any Person (other than an Exempt Person, the Company or any
employee benefit plan (or related trust) sponsored or maintained by the Company
or any corporation controlled by the Company) shall become the Beneficial Owner
of 50% or more of the Outstanding Company Common Stock or 50% or more of the
Outstanding Company Voting Securities by reason of an acquisition by the
Company, and such Person shall, after such acquisition by the Company, become
the Beneficial Owner of any additional shares of the Outstanding Company Common
Stock or any additional Outstanding Company Voting Securities and such
Beneficial Ownership is publicly announced, such additional Beneficial Ownership
shall constitute a Change in Control;
(ii) individuals who, as of the effective date hereof, constitute the Board
of Directors (the "Incumbent Board") cease for any reason to constitute at least
a majority of such Board; provided that any individual who becomes a director of
the Company subsequent to the effective date hereof whose
<PAGE>
election, or nomination for election by the Company's stockholders, was
approved by the vote of at least a majority of the directors then
comprising the Incumbent Board shall be deemed a member of the Incumbent
Board; and provided further, that any individual who was initially elected
as a director of the Company as a result of an actual or threatened
election contest, as such terms are used in Rule 14a-11 of Regulation 14A
promulgated under the Exchange Act, or any other actual or threatened
solicitation of proxies or consents by or on behalf of any Person other
than the Board shall not be deemed a member of the Incumbent Board;
(iii) approval by the stockholders of the Company of a reorganization,
merger or consolidation or sale or other disposition of all or
substantially all of the assets of the Company (a "Corporate Transaction");
excluding, however, a Corporate Transaction pursuant to which (1) all or
substantially all of the individuals or entities who are the Beneficial
Owners, respectively, of the Outstanding Company Common Stock and the
Outstanding Company Voting Securities immediately prior to such Corporate
Transaction will Beneficially Own, directly or indirectly, more than 50%
of, respectively, the outstanding shares of common stock, and the combined
voting power of the outstanding securities of such corporation entitled to
vote generally in the election of directors, as the case may be, of the
corporation resulting from such Corporate Transaction (including, without
limitation, a corporation which as a result of such transaction owns the
Company or all or substantially all of the Company's assets either directly
or indirectly) in substantially the same proportions relative to each other
as their Beneficial Ownership, immediately prior to such Corporate
Transaction, of the Outstanding Company Common Stock and the Outstanding
Company Voting Securities, as the case may be, (2) no Person (other than an
Exempt Person; the Company; any employee benefit plan (or related trust)
sponsored or maintained by the Company or any corporation controlled by the
Company; the corporation resulting from such Corporate Transaction; and any
Person which Beneficially Owned, immediately prior to such Corporate
Transaction, directly or indirectly, 50% or more of the Outstanding Company
Common Stock or the Outstanding Company Voting Securities, as the case may
be) will Beneficially Own, directly or indirectly, 50% or more of,
respectively, the outstanding shares of common stock of the corporation
resulting from such Corporate Transaction or the combined voting power of
the outstanding securities of such corporation entitled to vote generally
in the election of directors and (3) individuals who were members of the
Incumbent Board will constitute at least a majority of the members of the
board of directors of the corporation resulting from such Corporate
Transaction; or
(iv) approval by the stockholders of the Company of a plan of complete
liquidation or dissolution of the Company.
Notwithstanding anything to the contrary herein, no Change of Control
shall be deemed to have taken place as a result of the issuance of shares of
Common Stock by the Company or the sale of shares of Common Stock by its
stockholders in connection with the Company's initial public offering.
6.9 No Right of Participation or Employment. No person shall have
any right to participate in this Plan. Neither this Plan nor any award made
hereunder shall confer upon any person any right to continued employment by the
Company, any Subsidiary or any affiliate of the Company or affect in any manner
the right of the Company, any Subsidiary or any affiliate of the Company to
terminate the employment of any person at any time without liability hereunder.
6.10 Rights as Stockholder. No person shall have any right as a
stockholder of the Company with respect to any shares of Common Stock or other
equity security of the Company which is subject to an award hereunder unless and
until such person becomes a stockholder of record with respect to such shares of
Common Stock or equity security.
6.11 Governing Law. This Plan, each award hereunder and the related
Agreement, and all determinations made and actions taken pursuant thereto, to
the extent not otherwise governed by the Code or the
<PAGE>
laws of the United States, shall be governed by the laws of the State of
Delaware and construed in accordance therewith without giving effect to
principles of conflicts of laws.
<PAGE>
EXHIBIT 11
FIRST COMMONWEALTH, INC.
COMPUTATION OF PRIMARY AND FULLY DILUTED EARNINGS PER SHARE
<TABLE>
<CAPTION>
Earnings Per Share
----------------------------------
12/31/96 12/31/95 12/31/94
---------- ---------- ----------
<S> <C> <C> <C>
Weighted average common shares outstanding(1) 1,054,870 1,049,396 1,031,010
Common Shares issued upon initial public offering(1)(2) 530,000 64,778 -0-
Common Shares issued to Series B Preferred Stockholders upon
initial public offering (1) 1,784,000 1,784,000 1,784,000
Common Shares issued upon acquisition (1)(3) 106,551 -0- -0-
Additional common share equivalents related to option grants
within one year of initial public offering in accordance with -0- -0- 6,052
SEC Staff Accounting Bulletin Number 83 (1)(4)(5)
Additional common share equivalents related to stock options
assumed to be exercised in accordance with the treasury
stock method (6)(7)(8) 129,047 95,145 20,116
---------- ---------- ----------
Total weighted average common and equivalent shares outstanding 3,604,468 2,993,319 2,841,178
========== ========== ==========
Net Income $2,731,547 $2,003,522 $1,348,067
========== ========== ==========
Earnings per share - Primary $ 0.76 $ 0.67 $ 0.47
========== ========== ==========
Earnings per share - Fully diluted $ 0.76 $ 0.66 $ 0.47
========== ========== ==========
</TABLE>
NOTES
=====
(1) Amount computed for purposes of presenting fully diluted earnings per share
is the same as this amount.
(2) New shares issued in initial public offering of 530,000 shares on November
16, 1995.
(3) New shares issued upon acquisition of Smileage Dental Services, Inc. of
231,399 shares and common share equivalents on July 18, 1996.
(4) Computed based on initial public offering price of $15.00 per share.
(5) No stock options were granted less than or equal to one year prior to the
initial public offering date.
(6) Options with an exercise price less than the fair value of common stock
during the year presented are assumed to have been exercised with the
proceeds from the exercise, including tax benefits assumed to have been
realized, being used to purchase treasury shares. The repurchase of
treasury shares is assumed to be at
<PAGE>
the average market price for purposes of computing primary earnings per
share and the ending market price for purposes of computing fully diluted
earnings per share.
(7) Average and ending fair market values are determined by reference to the
price and date upon which stock options are granted. All such options are
granted at the fair value on the date of the grant. These prices at the end
of each quarter are as follows:
<TABLE>
<CAPTION>
Quarter Ended 1996 1995 1994
------------- ----- ---- ----
<S> <C> <C> <C>
March 31 $25.750 $ 1.70 $1.43
June 30 $27.875 $ 1.70 $1.70
September 30 $22.250 $ 1.70 $1.70
December 31 $19.500 $26.00 $1.70
</TABLE>
(8) The additional share equivalents related to stock options for purposes of
fully diluted earnings per share are 129,047, 118,763, 29,176, at December
31, 1996, 1995 and 1994, respectively.
<PAGE>
EXHIBIT 13
==========
1996 ANNUAL REPORT TO STOCKHOLDERS
Note: Attached hereto are the incorporated pages from the Company's 1996 Annual
Report to Stockholders
<PAGE>
FINANCIAL AND OTHER INFORMATION SECTION
- --------------------------------------------------------------------------------
Selected Consolidated Financial and Operating Data 16
- --------------------------------------------------------------------------------
Management's Discussion and Analysis of Results
of Operations and Financial Condition 18
- --------------------------------------------------------------------------------
Report of Independent Public Accountants 23
- --------------------------------------------------------------------------------
Financial Statements 24
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements 30
- --------------------------------------------------------------------------------
Officers and Directors 38
- --------------------------------------------------------------------------------
Related Stockholder Matters and Market
for the Company's Common Stock Inside Back Cover
- --------------------------------------------------------------------------------
15
<PAGE>
First Commonwealth, Inc.
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
- --------------------------------------------------------------------------------
The selected consolidated statement of income data and balance sheet data as of,
and for, the years ended December 31, 1996, 1995 and 1994 are derived from, and
are qualified by reference to, the consolidated financial statements of the
Company audited by Arthur Andersen LLP, independent public accountants,
appearing elsewhere in this Annual Report. The selected consolidated statement
of income data and balance sheet data as of, and for, the years ended December
31, 1993 and 1992 are derived from audited financial statements of the Company
not included herein. The selected consolidated financial information set forth
below should be read in conjunction with "Management's Discussion and Analysis
of Results of Operations and Financial Condition" and the Company's consolidated
financial statements and related notes appearing elsewhere in this Annual
Report. The selected operating data has been derived from the accounting records
of the Company and has not been audited. <TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996(5) 1995 1994 1993 1992
-------- ------- ------- ------- -------
(in thousands, except for per share and operating data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Income Data:
Subscriber revenue............................. $ 44,099 $ 33,315 $22,077 $17,337 $11,265
Benefit coverage expenses...................... 27,873 20,286 12,321 9,429 5,453
-------- ------- ------- ------- -------
Gross margin................................... 16,226 13,029 9,756 7,908 5,812
Selling, general and administrative expense.... 12,273 9,883 7,458 6,263 4,575
-------- ------- ------- ------- -------
Operating income............................... 3,953 3,146 2,298 1,645 1,237
Interest income, net........................... 642 194 59 32 28
-------- ------- ------- ------- -------
Income before income taxes and
extraordinary item..................... 4,595 3,340 2,357 1,677 1,265
Provision for income taxes..................... 1,864 1,336 1,009 672 498
-------- ------- ------- ------- -------
Income before extraordinary item............... 2,731 2,004 1,348 1,005 767
Extraordinary item (1)......................... - - - - 375
-------- ------- ------- ------- -------
Net income..................................... $ 2,731 $ 2,004 $ 1,348 $ 1,005 $ 1,142
======== ======= ======= ======= =======
Weighted average common and
common equivalent shares outstanding (2) 3,604 2,993 2,841 2,816 2,805
Earnings per share--before
extraordinary item (2)................. $ 0.76 $ 0.67 $ 0.47 $ 0.36 $ 0.27
Earnings per share--
extraordinary item (2)................. - - - - 0.14
-------- ------- ------- ------- -------
Earnings per share (2)......................... $ 0.76 $ 0.67 $ 0.47 $ 0.36 $ 0.41
======== ======= ======= ======= =======
Selected Operating Data:
Members at end of period (3):
Managed Care................................... 341,600 265,800 215,700 181,800 129,500
Indemnity/PPO.................................. 56,200 36,700 11,600 11,300 2,500
-------- ------- ------- ------- -------
Total Members.................................. 397,800 302,500 227,300 193,100 132,000
======== ======= ======= ======= =======
Number of managed care providers (4)........... 2,175 1,375 1,025 900 800
</TABLE>
See notes on following page.
16
<PAGE>
First Commonwealth, Inc.
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA--continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996(5) 1995 1994 1993 1992
------- ------- ------- ------- -------
(in thousands, except for per share and operating data)
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data (at end of period):
Total current assets................................. $21,023 $16,889 $ 5,716 $ 3,941 $ 2,501
Total assets......................................... 34,454 19,111 7,217 5,203 3,149
Total current liabilities............................ 14,331 7,280 3,977 3,276 1,886
Total liabilities.................................... 14,498 7,405 4,077 3,414 1,898
Preferred stock...................................... - - 892 892 1,309
Stockholders' equity................................. 19,956 11,706 2,248 898 (58)
</TABLE>
(1) Represents the utilization of tax loss carryforwards.
(2) Earnings per share reflects the conversion of all outstanding shares of
Series B Preferred Stock upon the consummation of initial public offering
in November 1995. See Note 2 of the Notes to Consolidated Financial
Statements.
(3) Amounts do not include eligible participants in the Company's ASO or PPO
rental programs.
(4) Represents the number of managed care providers for the dental HMO and
PPO in Illinois, Indiana, Michigan and Wisconsin at end of period.
(5) Reflects results of the acquisition of Smileage Dental Services, Inc. from
July 18, 1996. Balance sheet data (but not income or operating data) as of
December 31, 1996 includes amounts relating to Champion Dental Services,
Inc., which was acquired as of December 31, 1996.
17
<PAGE>
First Commonwealth, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------------
The following discussion and analysis of the Company's consolidated results of
operations and consolidated financial condition should be read in conjunction
with the Selected Consolidated Financial and Operating Data and the Company's
consolidated financial statements, including the notes thereto appearing
elsewhere in this Annual Report.
Overview
- --------------------------------------------------------------------------------
The Company began operations in the Chicago area in 1988 and has grown to be
a leading provider of managed dental benefits in the upper Midwest, including
the metropolitan areas of Chicago, Milwaukee, Detroit and Indianapolis. As of
December 31, 1996, the Company had 341,600 members in its managed care plans,
56,200 members in its fully insured indemnity/PPO plans, and 34,100 eligible
participants accessing the Company's PPO network and members covered under its
administrative services only ("ASO") arrangements. In 1992, the Company began
marketing indemnity plans as part of its Managed ChoiceSM products. Since the
introduction of Managed ChoiceSM products in 1992, the Company has experienced
significant enrollment growth in this product line, particularly among large
employers. In January 1996, the Company introduced its new PPO product
(Managed ChoiceSM Triple Option), which integrates a managed component, the PPO
option, into the Company's indemnity plans. The Indemnity/PPO revenue line now
includes revenue from both indemnity business that includes the PPO component
as well as indemnity business that does not include the PPO component. The PPO
component was available to less than 10% of the Company's Indemnity/PPO members
as of December 31, 1996. The Company's Managed ChoiceSM products enable the
Company to completely replace an employer's existing indemnity plan with the
Company's combined managed care and indemnity/PPO plan.
Acquisitions
- --------------------------------------------------------------------------------
Effective July 18, 1996, the Company completed the acquisition of Smileage
Dental Services, Inc. ("Smileage"), a Wisconsin-based dental HMO administrator,
which provides services to approximately 50,000 members, and an associated
reinsurance transaction, for an aggregate purchase price (including transaction
costs) of $5.6 million. The acquisition was financed through the issuance
of the Company's common stock.
Effective December 31, 1996, the Company completed the acquisition of
Champion Dental Services, Inc. ("Champion"), a Missouri-based prepaid dental
plan, which provides services to approximately 60,000 members, for an aggregate
purchase price (including transaction costs) of $5.6 million. The acquisition
was financed through proceeds from the Company's initial public offering and
was paid in cash on January 2, 1997.
Both acquisitions offer managed care products that are typically at a lower
gross margin level than the Company has experienced in the past. For a
discussion of pro forma results and other information, see Note 15-Business
Combinations in Notes to Consolidated Financial Statements.
Revenues
- --------------------------------------------------------------------------------
The Company's annual revenues have increased from $22.1 million in 1994 to
$44.1 million in 1996. Revenues increased to $44.1 million for 1996 from $33.3
million for 1995. Revenue growth for 1996 has been strong both in dollar and
percentage terms, primarily as the result of the addition of new managed care
and indemnity/PPO members as well as the acquisition of Smileage in July. The
Company believes that the rate of revenue growth in its current markets will
decline from historical levels primarily as a result of its higher revenue
base.
The Company's product pricing varies based on the type of plan, the services
provided and the member copayment (or coinsurance). In addition, pricing
varies by marketplace based on employer and employee preference and
competition. Pricing also may vary as a result of different pricing terms of
the plans in effect at companies when acquired by the Company. As a result,
per member pricing can fluctuate based on product mix, shifting marketplace
preferences and acquisition timing. As contracts are renewed, the Company will
seek to improve profitability on lower margin plans by increasing pricing, by
offering plans with additional services at higher prices and margins, and by
offering higher margin plans with fewer services at lower costs.
The largest source of Company revenue comes from members enrolled in managed
care plans. From 1994 to 1996, the Company's revenue from its managed care
products grew from $19.7 million to $32.8 million. This increase is primarily
attributable to managed care enrollment growth and, to a lesser degree, a shift
toward managed care products with higher benefit and premium levels, as well as
the acquisition of Smileage in July 1996. In 1994, managed care enrollment
accounted for approximately 89% of total revenue compared to approximately 74%
of total revenue for 1996.
18
<PAGE>
First Commonwealth, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION--continued
- --------------------------------------------------------------------------------
The second largest source of Company revenue is generated from indemnity/PPO
plan premiums. From 1994 to 1996, the Company's revenue from its indemnity/PPO
products grew from $1.7 million to $10.6 million. For 1996, revenue from
indemnity/PPO enrollment accounted for approximately 24% of total revenue
compared to approximately 8% of total revenue in 1994. The Company believes
that revenue from indemnity/PPO enrollment will continue to increase in the
future.
The third largest source of revenue is fee income which is generated from
the Company's PPO network rental program. Under this program, PPO network
providers offer services according to a reduced fee schedule negotiated by the
Company. The Company charges its PPO groups a monthly fee for each participant
eligible to access such reduced fee arrangements. The Company does not make any
payments to its PPO network providers on behalf of the participants eligible to
access such reduced fee arrangements.
During 1995, one large PPO rental group did not renew its contract which
expired May 31, 1995 and another large group terminated all of its arrangements
with the Company effective at the end of 1995. These contracts have been
terminated as a result of decisions by both such groups to consolidate certain
health and dental insurance coverage based on quotes from several companies.
Collectively, these arrangements accounted for 4.3% of revenues and 9.5% of
gross margin for the year ended December 31, 1994 and 3.0% of revenues and 7.2%
of gross margin for the year ended December 31, 1995. The Company reached an
agreement with a large group pursuant to which, effective January 1, 1996, the
Company has received PPO access fees as well as ASO fees covering approximately
24,000 employees and dependents, and the Company is actively marketing combined
PPO/ASO arrangements to other employers.
Benefit Coverage Expenses
- --------------------------------------------------------------------------------
From 1994 to 1996, total benefit coverage expenses increased from $12.3
million to $27.9 million. Between 1994 and 1996, total benefit coverage
expenses as a percentage of revenues increased from 55.8% to 63.2% of total
revenue. This increase is largely the result of a shift in the Company's
product mix toward a higher percentage of overall revenues represented by the
indemnity/PPO component of the Company's Managed ChoiceSM products (which has
relatively high benefit coverage expenses), a decrease in the percentage of
overall revenues represented by PPO network rental fees (which have no benefit
coverage expenses), and increases in the benefit coverage expenses of the
Company's managed care products (primarily associated with the Company's
acquisition of Smileage in July 1996).
Gross Margin
- --------------------------------------------------------------------------------
From 1994 to 1996, gross margin increased from $9.8 million to $16.2
million. Between 1994 and 1996, gross margin as a percentage of total revenue
decreased from 44.2% to 36.8% of total revenue. This change is largely the
result of a shift in the Company's product mix toward a higher percentage of
overall revenues represented by the indemnity component of the Company's
Managed ChoiceSM products (which has a lower percentage gross margin), a
decrease in the percentage of overall revenues represented by PPO network
rental fees (which have a 100% gross margin), and a decline in the gross margin
of the Company's managed care products, primarily due to the lower gross margin
on the managed care products sold in the Wisconsin marketplace in 1996. The
Company believes that its gross margin percentage may continue to decline for
some period of time primarily as a result of the decreasing proportion of PPO
access fee income and the increasing proportion of indemnity/PPO plan revenues.
The Company also will experience a decline in the managed care gross margin
percentage as a result of the relatively lower percentage gross margin members
acquired through the acquisitions of Smileage and Champion.
Selling, General and Administrative
- --------------------------------------------------------------------------------
Selling, general and administrative ("SG&A") expenses as a percent of revenues
declined from 33.8% in 1994 to 27.8% in 1996. This decrease was largely
attributable to the increase in the percentage of revenue from indemnity/PPO
products in 1996 as compared to 1994. The change is primarily the result of
economies of scale in meeting the administrative needs of increased enrollment
due to the relatively fixed nature of certain SG&A expenses as well as higher
revenues relative to the SG&A expenses associated with indemnity/PPO plans. This
decrease in SG&A expenses as a percentage of revenue from 1994 through 1996 to a
substantial degree offsets the decreases in the gross margin percentage during
that period. The Company would expect to continue to
19
<PAGE>
First Commonwealth, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION--continued
- --------------------------------------------------------------------------------
gain operating leverage on meeting the administrative needs of the business
and foresee that SG&A expenses as a percentage of revenue would continue to
decline.
Results of Operations
- --------------------------------------------------------------------------------
The following tables set forth certain information from the Company's
consolidated statement of income for the periods indicated. In the opinion of
management, these tables have been prepared on the same basis as the audited
consolidated financial statements appearing elsewhere in this Annual Report and
fairly present the results of operations of the Company for the periods covered
thereby.
<TABLE>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Consolidated Statement of Income Data:
Subscriber revenue
Managed care....................... $ 32,807 $ 25,739 $ 19,706
Indemnity/PPO...................... 10,629 6,893 1,663
Fee income......................... 663 683 708
--------- --------- ---------
Total subscriber
revenue.................... 44,099 33,315 22,077
--------- --------- ---------
Benefit coverage expenses
Managed care....................... 19,555 14,835 10,958
Indemnity/PPO...................... 8,318 5,451 1,363
Fee income......................... - - -
--------- --------- ---------
Total benefit
coverage expenses.......... 27,873 20,286 12,321
--------- --------- ---------
Gross margin
Managed care....................... 13,252 10,904 8,748
Indemnity/PPO...................... 2,311 1,442 300
Fee income......................... 663 683 708
--------- --------- ---------
Total gross margin......... $ 16,226 $ 13,029 $ 9,756
========= ========= =========
</TABLE>
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Total subscriber revenue increased by $10.8 million, or 32.4%, to $44.1
million in 1996 from $33.3 million in 1995. Of this increase, $3.6 million, or
33.3%, was attributable to the operations added through the acquisition of
Smileage and the associated reinsurance transaction. The remaining $7.2
million increase was a 21.6% growth in revenues and was primarily attributable
to increased enrollment in the Company's managed care and indemnity/PPO dental
plans. Managed care revenue increased $7.1 million over the same period,
primarily due to the $3.6 million from Smileage and from an increase in new
members. Indemnity/PPO revenue increased $3.7 million to $10.6 million in 1996
from $6.9 million in 1995, primarily as a result of adding new indemnity/PPO
plan members.
Total gross margin increased by $3.2 million, or 24.5%, to $16.2 million in
1996 from $13.0 million in 1995. Total gross margin as a percentage of revenue
was 36.8% in 1996 as compared to 39.1% in 1995. This percentage decline was
primarily the result of a shift in the Company's product mix toward a higher
percentage of overall revenues being generated by the Company's indemnity/PPO
products, which have a relatively lower percentage gross margin than the
Company's managed care products. Managed care gross margin as a percentage of
revenue was 40.4% in 1996 as compared to 42.4% in 1995. This percentage decline
was primarily the result of revenue acquired through the Smileage transaction
which has a gross margin percentage of 22.2% as compared with the existing
managed care business which had a gross margin percentage of 42.6%. The level
of indemnity/PPO gross margin as a percentage of revenue increased to 21.7% in
1996 from 20.9% in 1995. This improved indemnity/PPO gross margin
20
<PAGE>
First Commonwealth, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION--continued
- --------------------------------------------------------------------------------
is the result of increased premium rates charged for the Company's indemnity/PPO
plans.
SG&A expenses increased by $2.4 million, or 24.2%, to $12.3 million for 1996
from $9.9 million in 1995. As a percentage of revenue, SG&A expenses dropped to
27.8% for 1996 from 29.7% for 1995. The change is primarily the result of
economies of scale in meeting the administrative needs of increased enrollment
due to the relatively fixed nature of certain SG&A expenses as well as higher
revenues relative to the SG&A expenses associated with indemnity/PPO plans.
Commissions to independent brokers increased 34.1% primarily due to higher
revenue. As a percentage of total revenue, commissions for 1996 declined to
4.3% from 5.3% for 1995 as a result of a higher proportion of direct sales and
lower commissions associated with the Company's growing indemnity/PPO business.
In 1996, included in the SG&A total is $64,000 for the amortization of goodwill
associated with the acquisition of Smileage.
Operating income increased by $807,000, or 25.7%, to $4.0 million for 1996
from $3.1 million in 1995. As a percentage of revenue, operating income was
9.0% in 1996 as compared to 9.4% in 1995. The percentage decline was due
primarily to the decrease in the overall percentage gross margin which was
partially offset by lower SG&A expenses as a percentage of revenue.
The effective tax rate for 1996 was 40.6% compared to 40.0% for 1995. The
tax rate for 1996 was higher primarily as the result of the non-deductibility
of the amortization of goodwill from the Smileage acquisition. Net income
increased by $727,000, or 36.3%, to $2.7 million for 1996 from $2.0 million for
1995.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
- --------------------------------------------------------------------------------
Total subscriber revenue increased by $11.2 million, or 50.9%, to $33.3
million in 1995 from $22.1 million in 1994. This increase is primarily
attributable to increased enrollment in the Company's managed care and
indemnity/PPO dental plans. Managed care revenue increased 30.6% over the same
period, primarily due to a 23.2% increase in new members and, to a lesser
extent, a shift toward managed care products with higher benefit and premium
levels. Indemnity/PPO revenue increased $5.2 million to $6.9 million in 1995
from $1.7 million in 1994, primarily as a result of adding new indemnity/PPO
plan members.
Total gross margin increased by $3.2 million, or 33.5%, to $13.0 million in
1995 from $9.8 million in 1994. Total gross margin as a percentage of revenue
was 39.1% in 1995 as compared to 44.2% in 1994. This percentage decline was
primarily the result of an increasing percentage of revenue being generated by
the Company's indemnity/PPO products, which have a significantly lower gross
margin percentage than the Company's managed care products. Managed care gross
margin as a percentage of revenue was 42.4% in 1995 as compared to 44.4% in
1994. This percentage decline was primarily the result of reduced premium rates
for new large employer groups and an increase in the average monthly dental
specialist expenses per subscriber due to an increase in fee-for-service
payments. The level of indemnity/PPO gross margin as a percentage of revenue
increased to 20.9% in 1995 from 18.0% in 1994. This improved indemnity/PPO gross
margin is the result of favorable claims experience and increased premium rates
charged for the Company's indemnity/PPO plans.
SG&A expenses increased by $2.4 million, or 32.5%, to $9.9 million for 1995
from $7.5 million in 1994. As a percentage of revenue, SG&A expenses dropped
to 29.7% for 1995 from 33.8% for 1994. The change is primarily the result of
economies of scale in meeting the administrative needs of increased enrollment
due to the relatively fixed nature of certain SG&A expenses as well as higher
revenues relative to the SG&A expenses associated with indemnity/PPO plans.
Commissions to independent brokers increased 34.1% primarily due to higher
revenue. As a percentage of total revenue, commissions for 1995 declined to
5.3% from 6.0% for 1994 as a result of a higher proportion of direct sales and
lower commissions associated with the Company's growing indemnity/PPO business.
Operating income increased by $848,000, or 37.0%, to $3.1 million for 1995
from $2.3 million in 1994. As a percentage of revenue, operating income was
9.4% in 1995 as compared to 10.4% in 1994. The decline was due primarily to the
lower gross margin, partially offset by the lower SG&A as a percentage of
revenue.
The effective tax rate for 1995 was 40.0% compared to 42.8% for 1994. The
tax rate in the first nine months of 1994 was higher primarily due to certain
non-recurring charges.
Net income increased by $656,000, or 48.7%, to $2.0 million for 1995 from
$1.3 million for 1994.
21
<PAGE>
First Commonwealth, Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION--continued
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
The Company's historical operating cash requirements have been met
principally through operating cash flows. The primary uses of cash have been
for operating activities and capital investments in the business. The
acquisition of Champion was financed through proceeds from the Company's
initial public offering and was paid in cash on January 2, 1997. The Company
believes that cash generated from operations will be adequate to finance its
anticipated operating needs for the foreseeable future.
Cash flow from operations was $3.7 million, $4.2 million and $1.4 million
for the years ended December 31, 1996, 1995 and 1994, respectively. The Company
primarily receives premium payments in advance of disbursing managed care
dentist capitation payments and indemnity/PPO claims payments. Cash balances in
excess of current needs are invested in interest-bearing accounts or cash
equivalents. Cash flow from operations consist primarily of subscriber premiums
and investment income net of capitation payments to network dentists, claims
paid, brokers' commissions, general and administrative expenses and income
taxes.
Capital expenditures were $745,000 during 1996 mainly for furniture,
leasehold improvements, and equipment resulting primarily from the Company
expanding its leased office space. Capital expenditures were $765,000 and
$422,000 for the years ended December 31, 1995 and 1994 respectively, primarily
for office furniture and new computer systems.
Cash used in financing activities was $45,000, $103,000 (excluding the $6.6
million net proceeds received from the initial public offering), and $66,000
for the years ended December 31, 1996, 1995 and 1994, primarily for payments on
capital leases and dividends on preferred stock.
As of December 31, 1996, the Company had cash and cash equivalents of $15.8
million and no long term debt outstanding, except that included in other
current liabilities is a payable to the parent of Champion for the $5.5 million
purchase price. In addition, the Company has a $500,000 unsecured revolving
line of credit facility which expires June 30, 1997, which has not been drawn
upon during the past three years. Any outstanding indebtedness under the line
of credit will bear interest at a rate equal to the prime rate. To the extent
the Company makes acquisitions, a portion of the purchase price may be financed
through borrowings.
Under applicable insurance laws of the states in which the Company conducts
business, the Company's subsidiaries operating in the particular state are
required to maintain a minimum level of net worth and reserves. The Company may
be required from time to time to invest funds in one or more of its
subsidiaries to meet regulatory requirements, or to expand its operations into
new geographic areas. In addition, applicable laws generally limit the ability
of the Company's subsidiaries to pay dividends to the extent that required
regulatory capital or surplus would be impaired.
Impact of Inflation
- --------------------------------------------------------------------------------
The Company does not believe the impact of inflation has significantly
affected the Company's operations.
22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Stockholders and Board of Directors
of First Commonwealth, Inc.:
We have audited the accompanying consolidated balance sheets of FIRST
COMMONWEALTH, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31,
1996, 1995 and 1994, and the related consolidated statements of income, changes
in stockholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 financial statements referred to above present fairly, in
all material respects, the financial position of First Commonwealth, Inc. and
Subsidiaries as of December 31, 1996, 1995 and 1994, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois,
February 12, 1997
23
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
As of December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
ASSETS 1996 1995 1994
- ------ ---- ---- ----
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $15,817,498 $12,680,153 $ 2,706,412
Accounts receivable, net of allowance of
$289,554, $197,316 and $116,782 at
December 31, 1996, 1995 and 1994,
respectively 3,010,585 1,751,376 1,563,447
Other receivables 220,819 52,091 32,568
Deposit under reinsurance agreement 696,564 431,522 -
Prepaid expenses 408,447 1,289,973 1,102,254
Deferred tax asset 869,000 665,000 218,590
Income taxes receivable - 19,000 92,249
----------- ----------- -----------
Total current assets 21,022,913 16,889,115 5,715,520
----------- ----------- -----------
PROPERTY AND EQUIPMENT, at cost 3,347,829 2,464,782 1,916,618
Less- Accumulated depreciation (1,725,450) (1,086,279) (831,186)
----------- ----------- -----------
Property and equipment, net 1,622,379 1,378,503 1,085,432
----------- ----------- -----------
OTHER ASSETS:
Restricted cash equivalents and government
securities on deposit, at cost which
approximates market 1,222,022 798,744 362,637
Goodwill and other intangibles, net of
accumulated amortization of $63,814 10,482,110 - -
Deposits and other 104,554 44,700 53,471
----------- ----------- -----------
Total other assets 11,808,686 843,444 416,108
----------- ----------- -----------
Total assets $34,453,978 $19,111,062 $ 7,217,060
=========== =========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
24
<PAGE>
<TABLE>
<CAPTION>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS-continued
- --------------------------------------------------------------------------------
As of December 31, 1996, 1995 and 1994
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995 1994
- ------------------------------------ ---- ---- ----
<S> <C> <C> <C>
CURRENT LIABILITIES:
Accounts payable--trade.............................. $ 338,000 $ 364,349 $ 148,747
Accounts payable--dental service providers........... 347,529 399,206 293,203
Claims liability..................................... 1,579,669 1,257,681 387,714
Accrued payroll and related costs.................... 739,292 846,263 591,777
Other accrued expenses............................... 648,000 720,179 228,667
Current portion of capital lease obligations......... -- 26,996 61,425
Deferred subscriber revenue.......................... 4,448,953 3,262,791 2,259,881
Payable under reinsurance agreement.................. 627,789 389,254 --
Accrued preferred dividends and
stock redemption payable......................... -- 13,380 5,860
Income taxes payable................................. 101,472 -- --
Other current liabilites (Note 2).................... 5,500,000 -- --
----------- ----------- ----------
Total current liabilities........................ 14,330,704 7,280,099 3,977,274
CAPITAL LEASE OBLIGATIONS, less current portion......... -- -- 26,996
DEFERRED TAX LIABILITY--long-term....................... 167,157 125,157 72,497
----------- ----------- ----------
Total liabilities................................ 14,497,861 7,405,256 4,076,767
----------- ----------- ----------
REDEEMABLE PREFERRED STOCK 6% Series B
($1,000 par value; no shares authorized or issued
at December 31, 1996 and 1995; 892 shares
authorized, issued and outstanding in 1994.)......... -- -- 892,000
----------- ----------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock ($.001 par value; 1,000,000 shares
authorized, none issued)......................... -- -- --
Common stock ($.001 par value; 15,000,000 shares
authorized, 3,600,996 shares in 1996, 3,365,375
shares in 1995 and 1,049,000 shares in 1994
issued and outstanding)...................... 3,601 3,365 1,049
Capital in excess of par value....................... 13,206,633 7,676,536 175,801
Retained earnings.................................... 6,757,451 4,025,905 2,071,443
Less 425 shares of common stock held in treasury
at December 31, 1996, at cost.................... (11,568) -- --
----------- ----------- ----------
Total stockholders' equity....................... 19,956,117 11,705,806 2,248,293
----------- ----------- ----------
Total liabilities and stockholders' equity....... $34,453,978 $19,111,062 $7,217,060
=========== =========== ==========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
25
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
SUBSCRIBER REVENUE..................................... $44,098,529 $33,315,410 $22,077,668
BENEFIT COVERAGE EXPENSES.............................. 27,872,976 20,286,131 12,321,270
---------- ---------- ----------
Gross margin........................................ 16,225,553 13,029,279 9,756,398
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSE................................. 12,272,835 9,883,288 7,458,146
---------- ---------- ----------
Operating income.................................... 3,952,718 3,145,991 2,298,252
INTEREST INCOME, net................................... 642,828 193,531 58,815
---------- ---------- ----------
Income before income taxes.......................... 4,595,546 3,339,522 2,357,067
PROVISION FOR INCOME TAXES............................. 1,864,000 1,336,000 1,009,000
---------- ---------- ----------
NET INCOME............................................. $ 2,731,546 $ 2,003,522 $ 1,348,067
========== ========== ==========
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING.......................... 3,604,468 2,993,319 2,841,178
========== ========== ==========
EARNINGS PER COMMON AND COMMON
EQUIVALENT SHARE....................................... $ .76 $ .67 $ .47
========== ========== ==========
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements.
26
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Capital Total
------- -----
Common Stock in Excess Retained Treasury Stock Stockholders'
------------ --------- -------- -------------- -------------
Shares Dollars of Par Earnings Shares Dollars Equity
------ ------- ------ -------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993......... 1,016,125 $1,016 $ 119,946 $ 776,896 -- $ -- $ 897,858
Preferred dividends............. -- -- -- (53,520) -- -- (53,520)
Net income...................... -- -- -- 1,348,067 -- -- 1,348,067
Stock issued.................... 32,875 33 55,855 -- -- -- 55,888
--------- ------ ----------- ---------- ---- ---------- -----------
BALANCE, December 31, 1994......... 1,049,000 1,049 175,801 2,071,443 -- -- 2,248,293
Preferred dividends............. -- -- -- (49,060) -- -- (49,060)
Net income...................... -- -- 2,003,522 -- -- 2,003,522
Conversion of preferred shares.. 1,784,000 1,784 890,216 -- -- -- 892,000
Stock issued.................... 532,375 532 6,610,519 -- -- -- 6,611,051
--------- ------ ----------- ---------- ---- ---------- -----------
BALANCE, December 31, 1995......... 3,365,375 3,365 7,676,536 4,025,905 -- -- 11,705,806
Net income...................... -- -- -- 2,731,546 -- -- 2,731,546
Stock issued.................... 235,621 236 5,530,097 -- -- -- 5,530,333
Treasury stock purchased........ -- -- -- -- (425) (11,568) (11,568)
--------- ------ ----------- ---------- ---- ---------- -----------
BALANCE, December 31, 1996......... 3,600,996 $3,601 $13,206,633 $6,757,451 (425) $ (11,568) $19,956,117
========= ====== =========== ========== ==== ========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements.
27
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from subscribers................. $ 43,124,110 $ 34,107,857 $ 22,079,386
Cash paid to providers of care................. (15,202,299) (13,984,854) (10,222,828)
Cash paid to employees, brokers and suppliers.. (14,465,535) (9,385,336) (7,807,407)
Claims paid.................................... (8,063,681) (4,581,969) (1,199,703)
Interest paid.................................. (514) (4,995) (10,205)
Interest received.............................. 624,373 179,154 47,611
Income taxes paid.............................. (1,911,500) (1,662,677) (1,383,728)
Cash transferred to restricted funds........... (373,158) (436,107) (97,087)
------------ ------------ ------------
Net cash provided by operating activities.. 3,731,796 4,231,073 1,406,039
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net........ (745,509) (765,418) (422,431)
Purchase of short-term investment.............. (5,161,968) -- --
Purchase of long-term investment............... -- -- (56,177)
Proceeds from short-term investment............ 5,097,314 -- --
Proceeds from long-term investment............. -- -- 51,768
Cash received in acquisition................... 432,326 -- --
Acquisition related expenses................... (171,680) -- --
Organizational costs........................... -- -- (22,665)
------------ ------------ ------------
Net cash used in investing activities...... (549,517) (765,418) (449,505)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock....................... 7,010 6,611,051 55,888
Principal payments on capital leases........... (26,996) (61,425) (68,364)
Purchase of treasury stock..................... (11,568) -- --
Payments of preferred dividends................ (13,380) (41,540) (53,520)
------------ ------------ ------------
Net cash (used in) provided by
financing activities...................... (44,934) 6,508,086 (65,996)
------------ ------------ ------------
Net increase in cash and cash equivalents.. 3,137,345 9,973,741 890,538
CASH AND CASH EQUIVALENTS,
beginning of year................................. 12,680,153 2,706,412 1,815,874
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
end of year....................................... $ 15,817,498 $ 12,680,153 $ 2,706,412
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Capital lease obligation incurred.............. $ -- $ -- $ 9,209
============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements.
28
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
RECONCILIATIONS OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net income......................................... $ 2,731,546 $2,003,522 $1,348,067
Adjustments to reconcile net income to net cash
provided by operating activities--
Depreciation and amortization................... 648,247 411,927 320,458
Loss on sale of equipment....................... -- 60,420 --
(Increase) decrease in assets--
Accounts receivable, net.................... (1,109,339) (187,929) (432,964)
Other receivables........................... (149,728) (19,523) 31,730
Deposit under reinsurance agreement......... (265,042) (431,522) --
Prepaid expenses............................ 881,526 (187,719) (288,386)
Deferred tax asset.......................... (154,000) (446,410) (101,913)
Income taxes receivable..................... -- 73,249 (92,249)
Restricted cash equivalents and
government securities....................... (373,158) (436,107) (97,087)
Deposits and other.......................... (59,854) 8,771 (4,000)
Increase (decrease) in current liabilities--
Accounts payable--trade..................... (26,349) 215,602 61,011
Accounts payable--dental service providers.. (67,676) 106,003 67,742
Claims liability............................ 321,988 869,967 161,752
Accrued payroll and related costs........... (78,972) 254,486 135,512
Other accrued expenses...................... (91,022) 491,512 82,737
Deferred subscriber revenue................. 1,186,160 1,002,910 400,326
Payable under reinsurance agreement......... 238,535 389,254 --
Income taxes payable........................ 56,934 -- (203,715)
Increase in long-term liabilities--
Long-term deferred tax liability............ 42,000 52,660 17,018
----------- ---------- ----------
Net cash provided by operating
activities......................................... $ 3,731,796 $4,231,073 $1,406,039
=========== ========== ==========
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these statements.
29
<PAGE>
First Commonwealth, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
1. ORGANIZATION
- -------------------------------------
The accompanying consolidated financial statements include the accounts of
First Commonwealth, Inc. ("FC Inc."), First Commonwealth of Illinois, Inc.
("FCI"), First Commonwealth Limited Health Services Corporation ("LHSC"), First
Commonwealth Health Services Corporation ("HSC"), First Commonwealth
Reinsurance Company ("FCRC"), First Commonwealth Limited Health Service
Corporation ("LHSCWI"), Smileage Dental Services, Inc. ("SDS") and Champion
Dental Services, Inc. ("CDS"). These companies are collectively referred to
hereinafter as "the Company."
As discussed in Note 15, FC Inc. completed the acquisitions of SDS on July
18, 1996, and CDS on December 31, 1996. Included in the consolidated statement
of income for the year ended December 31, 1996, are the results of SDS since
its acquisition. CDS's balance sheet is also included in the accompanying
consolidated balance sheet as of December 31, 1996.
The Company is a provider of managed dental benefits in the upper Midwest,
including the metropolitan areas of Chicago, Milwaukee, Detroit and
Indianapolis, and with the acquisition of CDS, St. Louis. The Company provides
dental care coverage and/or arranges for dental care services to be provided to
its subscribers primarily on a prepaid basis. The Company also provides
indemnity/Preferred Provider Organization dental coverage and administrative
claim services.
FC Inc. operates as an Illinois licensed Third Party Administrator ("TPA").
As a TPA, FC Inc. provides administrative and marketing services to FCI, LHSC
and HSC pursuant to management agreements. It also provides claim processing
services for self-funded employers.
FCI is an Illinois corporation and is a wholly owned subsidiary of FC Inc.
FCI operates as a Preferred Provider Administrator which directly contracts
with general dentists and specialists. These provider arrangements are made
available to LHSC, LHSCWI and HSC, as well as health maintenance organizations
and self-funded employers. In making these provider arrangements available,
FCI does not undertake any underwriting risk.
LHSC is an Illinois for-profit corporation and is a wholly owned subsidiary
of FC Inc. LHSC is licensed under the Illinois Limited Health Service
Organization Act ("LHSO Act"). LHSC is also licensed by the Indiana Department
of Insurance as a Limited Service Health Maintenance Organization. LHSC has
entered into a Provider Agreement with FCI whereby FCI arranges for dental care
services to LHSC's subscribers through FCI's network of private practice
dentists. Consistent with its authority under the LHSO Act, LHSC also provides
reimbursement for covered dental care provided outside of this network. In
providing such services, LHSC undertakes underwriting risk. The LHSO Act
requires, among other provisions, that LHSC meet certain net worth and deposit
requirements discussed in Note 4. It is management's opinion that LHSC was in
compliance with these provisions as of December 31, 1996, 1995 and 1994.
HSC is an affiliated Illinois corporation, licensed under the Voluntary
Health Services Plans Act (the "VHSP Act"). In accordance with the VHSP Act,
HSC is operated and conducted not for profit and is also governed by the
provisions of the General Not for Profit Corporation Act. HSC was initially
capitalized by FC Inc. through the purchase of a subordinated note. That note
and accrued interest thereon (both of which are eliminated in consolidation)
may be repaid, in whole or in part, only from HSC's earned surplus, subject to
the written approval of the Director of the Illinois Department of Insurance.
Certain officers and trustees of HSC are common to the officers and directors
of the Company. Consistent with its authority under the VHSP Act, HSC provides
reimbursement to its members for covered dental care. The VHSP Act requires,
among other provisions, that HSC not expend more than 20% of its annual
subscriber revenue for administrative costs and 10% for marketing costs. It is
management's opinion that HSC was in compliance with these provisions as of
December 31, 1996, 1995 and 1994.
FCRC was incorporated in Arizona during 1994 and is a wholly owned
subsidiary of FC Inc. It is licensed by the Arizona Department of Insurance as
a domestic life and disability reinsurer. FCRC began reinsurance activity
during 1995. All of FCRC's reinsurance activity relates to LHSC's indemnity
insurance policies.
LHSCWI was incorporated in Wisconsin in 1996 and is a wholly owned
subsidiary of FC Inc. LHSCWI is licensed to operate as a Limited Service
Health Organization under Chapter 611 of the Wisconsin insurance statutes ("the
Statutes") and is registered with the Office of the Commissioner of Insurance
of Wisconsin. The Wisconsin insurance statutes
30
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
require, among other provisions, that LHSCWI meet certain net worth and deposit
requirements discussed in Note 4. It is management's opinion that LHSCWI was in
compliance with these provisions as of December 31, 1996.
SDS, a wholly owned subsidiary of FC Inc., is a Wisconsin based dental HMO
administrator.
CDS is a Missouri corporation and is a wholly owned subsidiary of FC Inc.
CDS is a St. Louis, Missouri based prepaid dental plan corporation organized
under Section 379.900RSMo.
2. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Principles of Consolidation
The accompanying financial statements include all the accounts of the
Company. All material intercompany transactions and balances have been
eliminated in consolidation.
HSC, a not-for-profit company managed by FC Inc., has been included in the
accompanying consolidated financial statements. HSC's financial position and
results of operations are not material to the Company's financial statements.
Cash and Cash Equivalents
For purposes of these statements, the Company considers all cash and
short-term investments with original maturities of less than 90 days to be cash
and cash equivalents.
Accounts Receivable and Deferred Subscriber Revenue
The Company invoices most of its subscriber groups prior to the month in
which the groups' members will be entitled to service. The Company records
these invoices as accounts receivable on the date the invoices are sent and
also records as deferred subscriber revenue those amounts either invoiced or
received in advance of the period of service.
Revenue Recognition
Subscriber revenue collected for dental care is recognized as revenue in the
period in which the member is entitled to service. Related costs for dental
care are expensed in the period the Company is obligated to provide such
service.
Prepaid Expenses
The Company pays its providers to render covered dental care to eligible
enrolled subscribers and dependents. Payment is typically made during the
month prior to the month in which the subscribers and dependents become
eligible for coverage. This payment is recorded as a prepaid expense at
December 31, 1995 and 1994.
Property and Equipment
Depreciation is calculated using the straight-line method over the assets'
estimated useful lives which are as follows:
Leasehold improvements 5 years or life of lease
Furniture 10 years
Office equipment 5 years
Computer equipment
and software 3 years
Property and equipment consist of the following:
December 31
-----------
1996 1995 1994
---- ---- ----
Leasehold
improvements $ 422,231 $ 349,658 $ 239,446
Furniture 780,967 562,400 444,551
Office equipment 513,566 442,668 265,061
Computer
equipment
and software 1,631,065 1,110,056 967,560
---------- ---------- ----------
Total property
and equipment $3,347,829 $2,464,782 $1,916,618
========== ========== ==========
Goodwill
The excess of cost over fair value of net assets acquired resulting from the
SDS and CDS acquisitions, accounted for using the purchase method, is being
amortized using the straight-line method over 40 years.
Accounts Payable-Dental Service Providers
The Company records payables to dental service providers for certain
services not included in the monthly prepayment to such providers discussed
above.
Other Current Liabilites
Other current liabilites at December 31, 1996, represents the Company's
liability relating to its acquisition of CDS. This amount was paid on
January 2, 1997.
Claims Liability
The Company provides indemnity dental coverage for certain customers and records
a liability for
31
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
incurred but not reported and unpaid claims related to this coverage. Generally,
this liability is estimated based on the age of existing claims and the
Company's historical lag with respect to the reporting and payment of such
claims. Changes in these estimates are reflected in results of operations in the
period in which such changes occur.
Reinsurance Activity
Effective January 1, 1995, LHSC entered into an agreement with a third party
insurer ("Insurer") whereby LHSC ceded certain losses on indemnity insurance
policies to the Insurer. Concurrent with the execution of this agreement,
Insurer entered into an agreement with FCRC whereby Insurer ceded certain losses
related to LHSC policies to FCRC. The Company has effectively retained all
insurance risk on these LHSC losses ceded to Insurer. Accordingly, LHSC accounts
for net payments to Insurer as deposits and records a claims liability for all
incurred and unpaid losses on such policies. FCRC records a payable to Insurer
for amounts Insurer has deposited with FCRC. The Company does not recognize any
revenue from these reinsurance arrangements.
Earnings Per Share
Earnings per share is calculated by dividing net income by the weighted
average number of shares of common stock outstanding during the period plus (1)
the number of shares of common stock into which the Series B Preferred Stock
were converted upon the occurrence of the initial public offering for periods
solely prior to the initial public offering; (2) the dilutive effect of stock
options; and (3) the dilutive effect of all shares issued and shares subject to
options granted at prices below the public offering price of $15 per share
within one year prior to the initial filing date of the registration statement
for the initial public offering.
3.USE OF ESTIMATES AND ASSUMPTIONS
- ----------------------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
4.REGULATORY REQUIREMENTS AND
RESTRICTED FUNDS
- ----------------------------------------
The State of Illinois statutes and related regulations of the llinois
Department of Insurance require LHSC, which is licensed under the LHSO Act, to
maintain a minimum net worth of $500,000 at December 31, 1996, 1995 and 1994.
LHSC maintains a deposit with the State of $200,000 in accordance with the
State of Illinois requirements.
The State of Indiana statutes and related regulations of the Indiana
Department of Insurance require LHSC, which is licensed as a Limited Service
Health Maintenance Organization, to maintain a $50,000 deposit with the State.
The State of Arizona statutes and related regulations of the Arizona
Department of Insurance require FCRC, which is licensed as a domestic life and
disability reinsurer, to maintain a minimum of $100,000 deposited in trust with
the State and a minimum surplus of $25,000. FCRC is required to maintain a
trust account equal to the amount of claims payable on all insurance ceded.
Prior to January 1, 1995, there was no reinsurance activity. At December 31,
1996 and 1995, balances of $705,867 and $450,374, respectively, were required
in the trust account.
The State of Illinois statutes and related regulations of the Illinois
Department of Insurance require HSC, which is licensed under the VHSP Act, to
maintain a contingency reserve in contributed capital of $15,674 at December
31, 1996, and $11,939 at December 31, 1995 and 1994.
The State of Wisconsin insurance statutes require, among other provisions,
that LHSCWI maintain a minimum capital of $100,000, applies a ten percent
compulsory surplus factor to Point of Service (POS) premium, and limits POS
business to ten percent of total premium volume. LHSCWI has a certificate of
deposit for $102,682 at a Wisconsin bank and did not have any POS business in
1996.
The State of Missouri statutes and related regulations of the Missouri
Department of Insurance require CDS, which is licensed as a Prepaid Dental Plan
Corporation, to maintain a $50,000 deposit with the State and to maintain a
maximum net worth of $150,000.
It is management's opinion that the Company was in compliance with these
provisions at December 31, 1996, 1995 and 1994.
Interest income earned on restricted funds is included in interest income,
net in the consolidated statements of income.
32
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
5. CLAIMS LIABILITY
- --------------------------------------------------------------------------------
The Company's claims liability, claims incurred and payments related to
indemnity policies for the years ended December 31, 1996, 1995 and 1994, are as
follows:
December 31
-----------
1996 1995 1994
---- ---- ----
Claims liability,
beginning of year $ 1,257,681 $ 387,714 $ 225,962
Add--
Claims incurred 8,341,669 5,451,936 1,361,455
Less--
Claims payments-
Current year (7,274,355) (4,421,539) (1,101,082)
Prior years (745,326) (160,430) (98,621)
----------- ----------- -----------
Claims liability,
end of year $ 1,579,669 $ 1,257,681 $ 387,714
=========== =========== ===========
6. Lease Obligations
- --------------------------------------------------------------------------------
The Company leases office space and various office equipment. The office
space lease is accounted for as an operating lease while the leases of the
office equipment are classified and accounted for as capital leases. The
capital lease assets are included in property and equipment in the consolidated
balance sheets. Rental costs under the operating lease agreements approximated
$486,000, $350,000 and $293,000 for the years ended December 31, 1996, 1995 and
1994, respectively.
The Company's capital leases expired in 1996. Minimum future obligations
under operating leases in effect at December 31, 1996 are:
Years ending December 31--
1997 $ 322,013
1998 322,409
1999 310,796
2000 and thereafter 47,138
----------
Total $1,012,356
==========
7. Income Taxes
- --------------------------------------------------------------------------------
The current and deferred components of the provision for taxes are as
follows:
December 31
-----------
1996 1995 1994
---- ---- ----
Current $1,962,000 $1,706,000 $1,093,895
Deferred (98,000) (370,000) (84,895)
---------- ---------- ----------
Total tax provision $1,864,000 $1,336,000 $1,009,000
========== ========== ==========
A reconciliation of the effective tax rate from statutory U.S. federal
income tax rate of 34% for 1996, 1995 and 1994, is as follows:
1996 1995 1994
---- ---- ----
Statutory rate 34% 34% 34%
State tax, net of
federal benefit 5 5 5
Goodwill and other
permanent items 2 1 4
-- -- --
Effective tax rate 41% 40% 43%
== == ==
As of December 31, 1996, 1995 and 1994, total net current deferred tax assets
were $869,000, $665,000 and $218,590, respectively, and total net noncurrent
deferred tax liabilities were $167,157, $125,157 and $72,497, respectively. The
temporary differences that give rise to deferred tax assets and liabilities are
as follows:
December 31
-----------
1995 1994 1994
---- ---- ----
Claims liability $ 616,100 $ 490,500 $154,116
Allowance for
doubtful accounts 112,900 54,400 46,421
Vacation accrual 54,700 39,500 28,583
Miscellaneous 85,300 80,600 (10,530)
--------- --------- --------
Total current
tax asset 869,000 665,000 218,590
--------- --------- --------
Accumulated
depreciation (167,157) (125,157) (72,497)
--------- --------- --------
Total noncurrent
tax liability (167,157) (125,157) (72,497)
--------- --------- --------
Total $ 701,843 $ 539,843 $146,093
========= ========= ========
8. Sources of Revenue (Unaudited)
- --------------------------------------------------------------------------------
The following table shows the percentage of revenue attributable to each
type of product offered:
1996 1995 1994
---- ---- ----
Managed care 74% 77% 89%
Indemnity/PPO 24 21 8
Fee income 2 2 3
--- --- ---
Total 100% 100% 100%
=== === ===
9. Significant Customers
- --------------------------------------------------------------------------------
There are no customers that accounted for a significant amount of the Company's
subscriber revenue in the years ended December 31, 1996 and 1995. In 1994, one
customer accounted for approximately 11% of the Company's subscriber revenue.
33
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
10. Line of Credit
- --------------------------------------------------------------------------------
The Company entered into an unsecured line of credit agreement (the "Credit
Agreement") with a Chicago bank in September of 1991, which to date has not
been utilized. Under this Credit Agreement, the Company may borrow up to
$500,000 at the prime rate of interest. The credit facility is subject to
annual one-year extensions with the consent of the bank.
11. Preferred Stock
- --------------------------------------------------------------------------------
During 1995, the Board of Directors and stockholders of the Company approved
an amendment and restatement of its Restated Certificate of Incorporation to,
among other things, authorize 1,000,000 shares of preferred stock, $.001 par
value, which may be issued from time to time in one or more series with such
rights, preferences and qualifications as the Company's Board of Directors may
determine. The Board of Directors has designated 150,000 shares of the
preferred stock as Series A Junior Participating Preferred Stock. There are no
shares issued or outstanding of the Series A Junior Participating Preferred
Stock.
6% Series B Preferred Stock
Concurrent with the closing of the initial public offering discussed in Note
12, each share of 6% Series B Preferred Stock ("Series B Stock") was converted
into 2,000 shares of common stock in accordance with the conversion features
discussed below. Following the offering, no shares of Series B Stock were
issued or authorized for issuance. While outstanding, the Series B Stock had
voting rights equal to the number of common shares into which such shares could
be converted. The Series B Stockholders were able to elect two of six
directors. Certain rights associated with Series B Stock were as follows:
Dividends Rights
The Series B Stock was entitled to receive a $60 per share annual cumulative
dividend out of funds legally available for payment of dividends, as declared
by the Board. The Company paid cash dividends on Series B Stock of $49,060 and
$53,520 for the years ended December 31, 1995 and 1994, respectively. As of
December 31, 1995 and 1994, accrued cumulative dividends for Series B Stock
totaled $13,380 and $5,860, respectively.
Conversion Features
Each share of Series B Stock was convertible, at the option of the holder,
into 2,000 shares of common stock. Additionally, each share of Series B Stock
was automatically converted into 2,000 shares of common stock upon the closing
of a public offering in which the aggregate offering price exceeds $10,000,000
and the offering price per share equals or exceeds $3.50.
12. Common Stock
- --------------------------------------------------------------------------------
In November, 1995, the Company completed an initial public offering of
530,000 shares of its common stock at $15 per share. As discussed in Note 11,
concurrent with the initial public offering, each share of Series B Stock was
converted into 2,000 shares of common stock.
The holder of each share of common stock is entitled to one vote on each
matter submitted to a vote to the stockholders of the Company.
The Company has two incentive plans, a 1987 Statutory-Nonstatutory Stock
Option Plan ("1987 Plan") and a 1995 Long-Term Incentive Plan ("1995 Plan"),
which were approved by the Board of Directors and stockholders. The Company
has adopted the disclosure-only provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation."
Accordingly, no compensation cost has been recognized for the stock option
plans. Had compensation cost for the Company's two stock option plans been
determined based on the fair value at the grant date for awards in 1996 and
1995 consistent with the provisions of SFAS No. 123, the Company's net earnings
(in thousands) and earnings per share would have been reduced to the pro forma
amounts of $2,645 and $0.73 in 1996 and $1,987 and $0.66 in 1995.
The weighted average grant-date fair values of options granted in 1996 and
1995 were $12.25 and $8.14, respectively. The fair value of each option grant
was estimated on the date of the grant using the Black-Scholes option pricing
model with the following weighted average assumptions for options issued in
1996 and 1995, respectively: risk-free interest rates of 5.8 and 6.5 percent;
expected lives of 7 years; expected volatility of 42 percent; and no expected
dividends.
Under the 1987 Plan, the Company can award up to 250,000 options to key
employees, granted at a price equal to the fair market value at the date of the
grant as determined by the Board of Directors or the Stock Option Compensation
Committee, and vesting
34
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
ratably over a period of two to four years from the date of the grant. The
Company had granted 248,125, 248,125 and 240,250 total options as of December
31, 1996, 1995 and 1994, respectively, to key employees and directors at option
prices ranging from $.50 to $15.00 per share. Of the total options granted,
148,950, 134,959 and 113,896 had vested and were exercisable as of December 31,
1996, 1995 and 1994, respectively, and 60,675, 51,375 and 49,000, of the total
options, granted and vested had been exercised as of December 31, 1996, 1995 and
1994, respectively.
In connection with the initial public offering, the Company adopted the 1995
Long-Term Incentive Plan (the "1995 Plan"). Under the 1995 Plan, the Company may
grant incentive stock options or nonqualified stock options. The 1995 Plan also
provides for the grant of stock appreciation rights, bonus stock awards which
are vested upon grant, stock awards which may be subject to a restriction period
and specified performance measures, and performance shares. A total of 150,000
shares of common stock have been reserved for issuance under the 1995 Plan.
Under the 1995 Plan, options are granted at a price equal to the fair market
value at the date of the grant as determined by the Board of Directors and vest
ratably over a period of one to four years from the date of the grant. As of
December 31, 1996 and 1995, the Company had granted 105,500 and 39,000,
respectively, total options to key employees and directors at option prices
ranging from $15.00 to $28.625 per share. Of the total options granted, 11,000
and none, had vested and were exercisable as of December 31, 1996 and 1995,
respectively. In addition, 42,000 options were rescinded as of December 31,
1996, and in 1995, in connection with the initial public offering, stock bonus
awards totaling 1,865 shares of common stock were granted to non-officer
employees.
A summary of the status of the Company's two stock option plans at December 31,
1996 and 1995 and changes during the years then ended is presented in the table
below.
Of the 289,950 total options outstanding at December 31, 1996, 177,450 have
option prices between $.50 and $1.70, with a weighted average option price of
$1.34 and a weighted average remaining contractual life of 6 years. 146,450 of
these options are exercisable at December 31, 1996, with a weighted average
option price of $1.27.
Of the total options outstanding at December 31, 1996, 90,500 have option prices
between $15.00 and $18.75, with a weighted average option price of $16.76 and a
weighted average remaining contractual life of 9 years. 13,500 of these options
are exercisable at December 31, 1996, with a weighted average option price of
$15.00.
The remaining 22,000 of the options outstanding at December 31, 1996 have option
prices between $23.875 and $28.625, with a weighted average option price of
$24.42 and a weighted average remaining contractual life of 10 years. None of
these options are exercisable at December 31, 1996.
During 1995, the Board of Directors adopted a stockholders rights plan. Under
the stockholders rights plan, each share of common stock will have associated
with it one preferred share purchase right (a "Right"). Under certain
circumstances, each Right would entitle the holders thereof to purchase one one-
hundredth of a share of Series A Junior Participating Preferred Stock for a
price of $40 per one one-hundredth of a share. The Rights are not presently
exercisable and are transferable only with the related shares of common stock.
<TABLE>
<CAPTION>
1996 1995
---- ----
Wtd. Avg. Wtd. Avg.
Shares Opt. Price Shares Opt. Price
------- ---------- ------- ----------
<S> <C> <C> <C> <C>
Outstanding at beg. year......... 235,750 $ 4.15 191,250 $ 1.31
Granted.......................... 105,500 22.06 49,000 15.00
Exercised........................ (9,300) 0.75 (2,375) 1.15
Forfeited........................ (2,000) 21.81 (2,125) 1.49
Cancelled........................ (40,000) 24.12 - -
------- -------
Outstanding at end of year....... 289,950 7.90 235,750 4.15
======= =======
Exercisable at end of year....... 159,950 2.43 134,959 1.19
------- -------
</TABLE>
35
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
The Rights would become exercisable at the specified exercise price upon the
occurrence of certain events, including the acquisition of 15% or more of the
Company's common stock by a person or group, as defined. The Rights may be
redeemed, as a whole, at a redemption price of $.01 per Right, subject to
adjustment, at the direction of the Board of Directors, at any time prior to
the occurrence of certain events. In addition, in certain circumstances, the
Board of Directors may direct the exchange of shares of common stock (or
preferred shares) for all or any part of the Rights at the exchange rate of one
share of common stock (or one one-hundredth of a preferred share) per Right,
subject to adjustment.
13. QUARTERLY FINANCIAL DATA
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(in thousands, except per share data)
Quarter
-------
First Second Third Fourth
----- ------ ----- ------
<S> <C> <C> <C> <C>
1996
- ----
Subscriber revenue $9,728 $10,019 $11,786 $12,521
Gross margin 3,699 3,799 4,220 4,460
Net income 669 698 667 697
Earnings per common share .19 .20 .18 .19
1995
- ----
Subscriber revenue $7,934 $ 8,204 $ 8,528 $ 8,649
Gross margin 3,100 3,197 3,291 3,441
Net income 501 532 513 458
Earnings per common share .18 .19 .18 .14
1994
- ----
Subscriber revenue $5,172 $ 5,385 $ 5,679 $ 5,841
Gross margin 2,307 2,361 2,526 2,562
Net income 347 343 383 275
Earnings per common share .12 .12 .13 .10
</TABLE>
14. RETIREMENT PLAN
- --------------------------------------------------------------------------------
The Company has a 401(k) salary deferral plan in which all employees of the
Company who have completed at least six months of service are eligible to
participate. Under the plan, the Company provides a matching contribution of
$.50 for every dollar an employee invests in the plan up to an annual maximum
of 2% of the employee's compensation for the year. The Company may make
additional discretionary contributions to the plan. The Company incurred
401(k) contributions expense of $58,937, $44,427 and $37,630 during the years
ended December 31, 1996, 1995 and 1994, respectively.
15. BUSINESS COMBINATIONS
- --------------------------------------------------------------------------------
Effective July 18, 1996, the Company completed the acquisition of SDS and an
associated reinsurance transaction, for an aggregate purchase price (including
transaction costs) of $5.6 million. The acquisition was financed through the
issuance of 231,399 shares of the Company's common stock. The acquisition
resulted in the excess of cost over fair value of net assets acquired of
approximately $5.6 million.
Effective December 31, 1996, the Company completed the acquisition of CDS
for an aggregate purchase price (including transaction costs) of $5.6 million.
The acquisition was financed through proceeds from the Company's initial public
offering and was paid in cash on January 2, 1997. The acquisition resulted in
the excess of cost over fair value of net assets acquired of approximately $4.9
million.
The acquisitions of SDS and CDS were accounted for using the purchase method
of accounting with SDS's results of operations included in the accompanying
consolidated statement of income for the year ended December 31, 1996 from the
effective date of the acquisition.
Unaudited pro forma combined results of operations of the Company for the
years ended December 31, 1996 and 1995 for the acquisitions are as follows:
Revenue (in thousands) for the years ended December 31, 1996 and 1995 would be
$50,860 and $42,058, respectively; Net Income (in thousands) for the years
ended December 31, 1996 and 1995 would be $2,856 and $2,444, respectively; and
Net Income per share for the years ended December 31, 1996 and 1995 would be
$0.77 and $0.66, respectively. This pro forma information has been prepared
assuming the acquisition of SDS and CDS and the Company's initial public
offering had occurred as of January 1, 1995.
36
<PAGE>
First Commonwealth, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued
- --------------------------------------------------------------------------------
For the years ended December 31, 1996, 1995 and 1994
The pro forma results include the historical accounts of the Company and the
historical accounts of the acquired businesses and pro forma adjustments
including the amortization of the excess purchase price over the fair value of
the net assets acquired, the reduction of salaries and expenses which will not
be incurred on an ongoing basis, and the applicable income tax effects of these
adjustments. The pro forma results of operations are not necessarily indicative
of actual results which may have occurred had the operations of the acquired
company been combined in prior periods.
37
<PAGE>
OFFICERS AND DIRECTORS
- --------------------------------------------------------------------------------
Officers
Christopher C. Multhauf
Chairman and Chief Executive Officer
David W. Mulligan
President and Chief Operating Officer, Secretary
Gregory D. Stobbe
Senior Vice President, Operations
Mark R. Lundberg
Vice President, Sales
Scott B. Sanders
Chief Financial Officer and Treasurer,
Assistant Secretary
Directors
Christopher C. Multhauf
Chairman and Chief Executive Officer
David W. Mulligan
President and Chief Operating Officer, Secretary
Richard M. Burdge, Sr.
Executive Vice President-Retired,
CIGNA Corporation
William J. McBride
President-Retired
Value Health, Inc.,
a managed healthcare company
Jackson W. Smart, Jr.
Chairman and Chief Executive Officer,
MSP Communications, Inc., a radio
broadcasting company
38
<PAGE>
Related Stockholder Matters and Market for the Company's Common Stock
for the Company's Common Stock
Form 10-K
A copy of the Form 10-K, which is filed with the Securities and Exchange
Commission, will be sent free to any shareholder upon written request. Write to:
Mr. Scott B. Sanders
Chief Financial Officer, Assistant Secretary
444 N. Wells Street, Suite 600
Chicago, IL 60610
Transfer Agent & Registrar
First Chicago Trust Co. of New York
Analyst Contacts
Security analyst inquiries are welcomed. Please call:
Mr. Scott B. Sanders
Chief Financial Officer
(312) 644-1800
Annual Meeting
April 30, 1997
Chicago, Illinois
Dividend Policy
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain earnings to finance the growth and development of
its business and does not anticipate paying cash dividends on its Common Stock
in the foreseeable future. Any payment of cash dividends in the future will
depend upon the financial condition, capital requirements and earnings of the
Company, limitations on dividend payments by subsidiaries of the Company under
applicable state laws requiring the maintenance of specified levels of capital
and surplus and such other factors as the Board of Directors may deem relevant.
Stock Trading and Common Stock Prices
The Company's Common Stock is traded on the NASDAQ National Market under the
symbol FCWI. At February 28, 1997, there were 146 registered shareholders.
The following table sets forth the high and low closing prices by quarter for
1996.
Quarter ending High Low
- -------------- ---- ---
March 31 $27.00 $24.00
June 30 $29.00 $24.25
September 30 $29.00 $20.75
December 31 $24.50 $16.50
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
Jurisdiction
Name of Subsidiary Of Incorporation Doing Business As
- ------------------ ---------------- -----------------
- ------------------------------------------------------------------------------
<S> <C> <C>
First Commonwealth Limited Health Illinois First Commonwealth,
Services Corporation Inc.
- ------------------------------------------------------------------------------
First Commonwealth of Illinois, Inc. Illinois First Commonwealth,
Inc.
- ------------------------------------------------------------------------------
First Commonwealth Reinsurance Arizona First Commonwealth,
Company Inc.
- ------------------------------------------------------------------------------
First Commonwealth Limited Health Wisconsin First Commonwealth,
Service Corporation Inc.
- ------------------------------------------------------------------------------
Smileage Dental Services, Inc. Wisconsin First Commonwealth,
Inc.
- ------------------------------------------------------------------------------
Champion Dental Services, Inc. Missouri First Commonwealth,
Inc.
- -----------------------------------------------------------------------------
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF ARTHUR ANDERSEN LLP
As independent public accountants, we hereby consent to the incorporation
by reference in this Form 10-K of First Commonwealth, Inc., of our report,
dated February 12, 1997, on the consolidated financial statements of First
Commonwealth, Inc. and Subsidiaries (the "Company") included in the Company's
1996 Annual Report to Stockholders, and to the incorporation of our report,
dated February 12, 1997, on the financial statement schedule of the Company, and
included in this Form 10-K, into the Company's previously filed S-3 Registration
Statement, File No. 333-18379, and S-8 Registration Statement, File No.
333-00474.
ARTHUR ANDERSEN LLP
Chicago, Illinois,
March 31, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
the Consolidated Financial Statements of First Commonwealth, Inc. as of
December 31, 1996 and for the twelve months then ended, and is qualified in its
entirety by reference to such financial statements. </LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 15,817
<SECURITIES> 0
<RECEIVABLES> 3,011
<ALLOWANCES> 290
<INVENTORY> 0
<CURRENT-ASSETS> 21,023
<PP&E> 3,348
<DEPRECIATION> 1,725
<TOTAL-ASSETS> 34,454
<CURRENT-LIABILITIES> 14,331
<BONDS> 0
0
0
<COMMON> 4
<OTHER-SE> 19,956
<TOTAL-LIABILITY-AND-EQUITY> 34,454
<SALES> 0
<TOTAL-REVENUES> 44,099
<CGS> 0
<TOTAL-COSTS> 40,146
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,595
<INCOME-TAX> 1,864
<INCOME-CONTINUING> 2,731
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,731
<EPS-PRIMARY> 0.76
<EPS-DILUTED> 0.76
</TABLE>
