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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, 1998
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 (I.R.S. employer identification number)
of 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
----- -----
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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 26, 1999 was approximately $30 million, based on the
closing price of $12.50 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 26, 1999: 3,727,025
Documents Incorporated by Reference:
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 1999 (the "Proxy Statement"), as indicated herein.
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First Commonwealth, Inc.
Form 10-K
For the year ended December 31, 1998
INDEX
ITEM No. Page
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PART I
1 Business......................................................... 2
2 Properties....................................................... 19
3 Legal Proceedings................................................ 19
4 Submission of Matters to a Vote of Security Holders.............. 19
PART II
5 Market for the Registrant's Common Equity and Related
Shareholder Matters.............................................. 20
6 Selected Financial Data.......................................... 21
7 Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 23
7A Quantitative and Qualitative Disclosures About Market Risk....... 29
8 Financial Statements and Supplementary Data...................... 30
9 Accounting and Financial Disclosure.............................. 51
PART III
10 Directors and Executive Officers of the Registrant............... 51
11 Executive Compensation........................................... 51
12 Security Ownership of Certain Beneficial Owners
and Management................................................... 51
13 Certain Relationships and Related Transactions................... 51
PART IV
14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 52
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
Certain statements included or incorporated by reference in this Form
10-K under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and elsewhere in this Form 10-K constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance, or achievements of the Company to be materially different
from any future results, performance, or achievements expressed or implied by
such forward-looking statements. Such factors include, among other things,
increased competition in the markets in which the Company operates; changes in
regulation affecting the Company; changes in the utilization of services;
changes in arrangements relating to payments to providers; the level of the
Company's Indemnity/PPO enrollment and the related Indemnity/PPO risk of
Indemnity/PPO plans; the ability to integrate and successfully operate acquired
businesses and the risks associated with such businesses; the possible need for,
and ability to obtain if needed, financing on acceptable terms to finance the
Company's growth strategy; the ability of the Company to operate within the
limitations imposed by any such financing arrangements; and other factors
referenced or incorporated by reference in this Form 10-K.
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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, 1998, the
Company provided managed care and indemnity/PPO products to approximately
644,900 employees and dependents ("members") through more than 4,000 employer
groups ("groups"). 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 2,425
general dentists and specialists ("providers"). 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, City of Milwaukee 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 ChoiceSM products"). The
Company has integrated its PPO network with the indemnity plan component of its
Managed ChoiceSM product to offer a point-of-service option to members, called
"'Managed ChoiceSM Triple Option." The Company also provides a "network rental"
product primarily to large Taft-Hartley funds and medical HMOs. Under the terms
of this product offering, the Company provides access to the network of reduced
fee arrangements with providers, but does not handle the claims administration.
The Company charges an access fee for these arrangements. The Company also
receives fee income for administrative services only ("ASO") arrangements
whereby the Company pays claims for self funded employers but does not assume
the underwriting risk of these claims.
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.
Effective December 31, 1996, the Company completed the acquisition of
Champion Dental Services, Inc. ("Champion"), a St. Louis, Missouri based prepaid
dental plan which provides services to approximately 60,000
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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
$22.1 million in 1994 to $64.2 million in 1998. Over the same period, the
Company's operating income grew from $2.3 million to $5.9 million. For the year
ended December 31, 1998, the Company's revenues increased 13% to $64.2 million
from $56.6 million in the prior year period and operating income increased 16%
to $5.9 million from $5.1 million. From December 31, 1994 to December 31, 1998,
the number of fully insured members covered by the Company's managed care and
indemnity/PPO products increased from 227,300 to 557,800.
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 ChoiceSM 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 ChoiceSM products
in 1992 and its introduction of Managed ChoiceSM 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., First
Commonwealth Insurance Company, First Commonwealth Reinsurance Company, First
Commonwealth Limited Health Service Corporation, Smileage Dental Services, Inc.
and First Commonwealth of Missouri, Inc.
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<PAGE>
(formerly Champion), 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 $48 billion in 1996. The U.S. Health Care
Financing Administration reports that expenditures for dental services account
for approximately 4% 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 1987 to 1997, the Consumer Price Index for all
Urban Consumers for dental services increased 5.39% annually whereas this index
for all items increased only 3.22% annually. 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 147 million persons, representing approximately 55% of the
total United States population, were covered by some form of dental benefit
coverage at the end of 1997. Historically, a substantial majority of dental
coverage has been through traditional indemnity plans. In recent years, however,
managed dental HMO care has achieved increasing market acceptance. National
managed dental HMO enrollment has grown at an annual rate of approximately 13%
between 1994 and 1997, from approximately 18.3 million covered lives in 1994 to
approximately 26.5 million in 1997. The estimated rate of growth in dental HMOs
for 1998 was approximately 9% 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 HMO benefit
plans represent approximately 19% of the population with dental care coverage
and approximately 9% 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, 1997,
the NADP estimated that there were over 140 managed dental companies in the
United States, with no dominant market leader.
According to the American Dental Association ("ADA"), the number of
practicing dentists in the United States per 100,000 population increased from
53 in 1980 to 60 in 1991. Recently, however, the supply of new dentists has
slowed due to the closing of some dental schools and smaller graduating classes.
In addition, the dental marketplace is highly fragmented with approximately 90%
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 the ADA in 1996,
the median of staff and other costs that are part of total overhead expenses was
approximately 60-65% of the gross revenues of solo and group dental practices.
The increase in the number of dentists as a proportion of the population, the
fragmented dental marketplace, the high proportion of overhead costs for
dentists and an improved level of overall
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dental health has created a competitive environment among dentists, particularly
in metropolitan areas. The Company believes that these factors have contributed
to the 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
1997 article in the Illinois Dental News, over 90% 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 dental HMO plan the pre-determined
payments, typically capitated 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 beginning of
1997, the Company had expanded into Milwaukee and St. Louis, and had initiated
de novo activity in Detroit and Indianapolis.
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 fourth
largest state in terms of enrollment in managed dental care plans and had
approximately 1.4 million persons enrolled in managed dental care plans in 1997
which represented 11.5% 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 321,100 of the Company's 482,200 managed care members
were located in
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Illinois and northwest Indiana as of December 31, 1998. 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 metropolitan markets of Milwaukee, St. Louis, Detroit and
Indianapolis have a combined population of approximately 10.1 million. According
to the NADP, the combined states from these metropolitan areas had approximately
1.4 million people enrolled in dental HMO plans in 1997. Approximately 161,100
of the Company's 482,200 managed care members were primarily located in the
greater metropolitan area of the cities listed above. The Company believes that
these expansion markets continue to offer opportunities for continued growth in
sales of managed dental care and indemnity/PPO products. The Company presently
has limited marketing activity in Indianapolis and does not expect to generate
significant enrollment growth from this market in 1999.
Since the Company's operations are located primarily in the Chicago,
Milwaukee, St. Louis, Detroit, and Indianapolis 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 employers based in its service
areas in order to compete with national dental plans. As of December 31, 1998,
approximately 7,900 members were enrolled with other dental care plans through
such arrangements. The Company also provides its Managed ChoiceSM 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 continue to represent an attractive market
segment for managed care products in all markets. The Company intends to
continue to build upon its current market position in Chicago, as well as in the
other regional markets, and increase its sales staff and telemarketing efforts
towards brokers which sell to medium and smaller-sized employers.
Continue to Expand Product Line. The Company believes that it must
continue to offer its clients and prospective clients a range of new products
that vary in cost, coverage and network access to remain competitive. The
Company believes it can expand the marketing of its Managed ChoiceSM Triple
Option product by expanding its PPO provider network, reducing benefits for
non-network utilization, and reducing the overall cost of the product to reflect
the lower non-network benefit levels. Managed care products that vary in cost
relative to the size of the managed care network also represent areas of growth
for the Company.
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Pursue Acquisition/Market Expansion Opportunities. Management believes
there are significant opportunities to expand the Company's operations into new
markets either through acquisitions or de novo start-ups. The Company has an
extremely strong balance sheet with substantial leverage capacity to support
attractive acquisition opportunities as well as the management experience in
successfully integrating the operations into the Company's business model. The
Company believes that there are several attractive markets for expansion that
can successfully be developed on a start-up basis if acquisition opportunities
are not available.
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 increase
its provider recruitment staff to add new, quality providers to its dental HMO
and PPO networks. 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. 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 improve service levels and achieve additional staffing economies.
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 ChoiceSM products). The following
table shows the enrollment growth in the Company's managed care and
indemnity/PPO plans.
<TABLE>
<CAPTION>
As of December 31,
------------------
1996 1997 1998
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<S> <C> <C> <C>
Members
Managed Care(1).................. 341,600 450,400 482,200
Indemnity/PPO.................... 56,200 65,300 75,600
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Total................... 397,800 515,700 557,800
======= ======= =======
</TABLE>
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(1) Includes members who have selected the managed care option under the
Company's Managed ChoiceSM 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, 1998, approximately 87,100
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
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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>
(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 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
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<PAGE>
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 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
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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 ChoiceSM
Products. The Company has combined its managed care plans with indemnity dental
coverage in its Managed ChoiceSM products which offer coverage from the dental
HMO network and non-network dentists. Managed ChoiceSM 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 ChoiceSM 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 ChoiceSM
products.
The Company has experienced considerable demand for its Managed
ChoiceSM products since their introduction in 1992. As of December 31, 1998,
Managed ChoiceSM products accounted for approximately 176,500 (approximately
32%) of the Company's approximately 557,800 members. Of the 176,500 Managed
ChoiceSM enrollees, approximately 118,100 are enrolled in the Company's managed
care plans and approximately 58,400 are enrolled in the Company's indemnity
plans.
Managed Care Plans Combined with Indemnity/PPO Plans--Managed ChoiceSM
"Triple Option" Products. The Company has integrated a PPO network with the
indemnity plan component of the Managed ChoiceSM product to offer a
point-of-service option to members. Called the Managed ChoiceSM 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 ChoiceSM 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, 1998, the
Company's PPO network of providers had approximately 600 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 ChoiceSM Triple
Option products since their introduction in 1996. As of December 31, 1998,
Managed ChoiceSM Triple products accounted for approximately 44,300
(approximately 8%) of the Company's approximately 557,800 members. Of the 44,300
Managed ChoiceSM Triple Option enrollees, approximately 27,100 are enrolled in
the Company's managed care plans and approximately 17,200 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
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<PAGE>
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 Choicesm Triple
Option product, as discussed above. As of December 31, 1998, the Company had
approximately 37,800 members in these two categories.
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. As of December 31, 1998, the Company had approximately 49,300 members
in these two categories.
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 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
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<PAGE>
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 14% of the Company's payments to providers
in 1998.
The Company believes that the large number of practicing dentists and
the high proportion of solo practitioners make the Chicago metropolitan markets
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.
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 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. In 1998, the Company's managed care provider annual retention rate
was approximately 92%.
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
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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, 1998, the Company's PPO network had approximately 600
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, 1998:
<TABLE>
<CAPTION>
Subscribers(2)
Number of ----------------------
Size of Group by Number of Subscribers(1) Groups Total % of Total
----------------------------------------- ------ ----- ----------
<S> <C> <C>
Individuals.......................................... N/A 6,600 2.6%
2-10 ............................................ 2,105 10,600 4.2%
11-50 ............................................ 1,661 39,100 15.5%
51-100 ............................................ 380 27,000 10.7%
101-500 ............................................ 340 67,400 26.8%
500+ ............................................ 55 101,400 40.2%
------ -------- ------
Total....................................... 4,541 252,100 100.0%
====== ======== ======
</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, PPO network rental programs and fully insured Medicare
members.
The Company's 10 largest groups accounted for approximately 23% of the
Company's revenues for the year ended December 31, 1998 and accounted for
approximately 14% of total members for such period. None of the Company's groups
accounted for more than 10% of the Company's revenues in 1998.
The Company has been successful in obtaining dental benefit business
from some of the largest employers in the metropolitan areas it serves,
including Advocate Health Care, First Chicago Corporation/NBD, City of
Milwaukee, Milwaukee Public Schools and Washington University (St. Louis). 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 16
employees. This dual distribution system is designed to reach large
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<PAGE>
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 ChoiceSM 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 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, St. Louis and
Detroit 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
metropolitan markets it serves. 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.
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.
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<PAGE>
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 increase
the use of electronic methods for billing, enrollment and ongoing eligibility
maintenance between employer groups and network dentists. The Company believes
that these upgrades 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 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, Detroit, 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. 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.
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<PAGE>
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, Indiana and in Michigan as a Third Party
Administrator and in Illinois 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 Insurance Company, is
licensed in Illinois as a domestic life, accident and health insurer with the
intent to underwrite indemnity dental business and also licensed as a Limited
Health Service Organization; another subsidiary, First Commonwealth Limited
Health Service Corporation, is licensed in Wisconsin as a Limited Service Health
Organization; another subsidiary, First Commonwealth of Missouri, Inc. (formerly
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, enterprise liability statutes, which may increase the Company's
liability for the negligent acts of its providers, 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 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
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<PAGE>
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 through First Commonwealth Limited Health Services
Corporation ("FC-Limited"), a wholly-owned subsidiary, and First Commonwealth
Insurance Company ("FC-Insurance"); in Indiana through FC-Limited; in Wisconsin
through First Commonwealth Limited Health Service Corporation ("FC-Wisconsin"),
a wholly-owned subsidiary; in Missouri through First Commonwealth of Missouri,
Inc. ("FC-Missouri), a wholly-owned subsidiary; and in Michigan through a
fronting arrangement described below. The Company provides administrative and
marketing services for FC-Limited, FC-Wisconsin, and FC-Missouri. 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
FC-Missouri provides dental benefits. Smileage, a wholly-owned subsidiary, is a
Wisconsin based dental HMO administrator.
As the Company has increased its indemnity business, it has entered
into a reinsurance agreement with North American Insurance Company ("North
American"), an Illinois licensed reinsurer, covering a portion of its indemnity
business. North American, in turn, has entered into an agreement with another
third party insurer, Capitol Indemnity ("Capitol"). Capitol 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 Capitol and onto 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
- 17 -
<PAGE>
products. In 1998, FC-Limited entered into an assumptive reinsurance transaction
with FC-Insurance to reinsurance over all of this business rather than reinsure
this business through North American and Capitol.
In addition, in 1997, the Company, acting as agent for North American
and according to a fronting arrangement, began selling managed care and
indemnity dental insurance policies in the state of Michigan. According to the
reinsurance agreement above, North American ceded all policies in Michigan to
Capitol who ceded these policies to FC-RE. Effective July 1998, Capitol replaced
North American in this fronting arrangement.
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 number of managed care providers covered under other
compensation requirements materially increase, or the cost of such arrangements
becomes significantly higher than projected, including utilization of specialty
care benefits, the Company's profitability could be materially and adversely
affected. Total payments to specialists represented approximately 14% of the
Company's payments to managed care providers in 1998.
In addition, an increasing portion of the Company's business is the
sale of indemnity/PPO plans as part of its Managed ChoiceSM 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 ChoiceSM 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
- 18 -
<PAGE>
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.
Employees
The Company had approximately 153 employees as of December 31, 1998.
None of the Company's employees is covered by a collective bargaining agreement.
The Company believes its relations with its employees are good.
Officers and Directors of the Registrant
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 Chairman, Novaeon, Inc.; President-Retired,
Value Health, Inc., a managed
healthcare company
Jackson W. Smart, Jr. Chairman and Chief Executive
Officer-Retired, MSP Communications,
Inc., a radio broadcasting company
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; 1,700 feet of office space in St. Louis with a term
expiring in 2002; and 500 feet of office space in Detroit on a month to month
lease.
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
Stock Trading and Common Stock Prices
The Company's Common Stock trades on The Nasdaq Stock MarketSM under the symbol
FCWI. At February 27, 1999, there were 175 registered shareholders and the
Company believes there are at least 400 round lot shareholders of beneficial
interest.
The following table sets forth the high and low closing prices by quarter for
1998, 1997 and 1996.
<TABLE>
<CAPTION>
Quarter
--------------------------------------------------------------------
First Second Third Fourth
----- ------ ----- ------
<S> <C> <C> <C> <C>
Year ending December 31, 1998
High $15.375 $16.00 $16.125 $13.25
Low $9.625 $13.75 $11.375 $9.75
Year ending December 31, 1997
High $21.25 $19.50 $20.50 $15.25
Low $14.75 $11.25 $14.75 $11.25
Year ending December 31, 1996
High $27.00 $29.00 $29.00 $24.50
Low $24.00 $24.25 $20.75 $16.50
</TABLE>
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.
- 20 -
<PAGE>
Item 6. Selected Financial Data
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, 1998, 1997 and 1996 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 herein. The selected consolidated statement of
income data and balance sheet data as of, and for, the years ended December 31,
1995 and 1994 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 herein. 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,
-----------------------
1998 1997 1996(3) 1995 1994
---- ---- ------- ---- ----
(in thousands, except for per share and operating data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Income Data:
Subscriber revenue.......................... $ 64,170 $ 56,594 $ 44,099 $ 33,315 $ 22,077
Benefit coverage expenses................... 42,731 37,932 27,873 20,286 12,321
---------- ---------- ---------- ---------- ----------
Gross margin................................ 21,439 18,662 16,226 13,029 9,756
Selling, general and administrative expense 15,496 13,550 12,273 9,883 7,458
---------- ---------- ---------- ---------- ----------
Operating income............................ 5,943 5,112 3,953 3,146 2,298
Interest income, net........................ 693 495 642 194 59
---------- ---------- ---------- ---------- ----------
Income before income taxes.................. 6,636 5,607 4,595 3,340 2,357
Provision for income taxes.................. 2,645 2,284 1,864 1,336 1,009
---------- ---------- ---------- ---------- ----------
Net income.................................. $ 3,991 $ 3,323 $ 2,731 $ 2,004 $ 1,348
========== ========== ========== ========== ==========
Basic earnings per share (1)................ $ 1.10 $ 0.92 $ 0.79 $ 0.69 $ 0.48
========== ========== ========== ========== ==========
Diluted earnings per share (1).............. $ 1.07 $ 0.89 $ 0.76 $ 0.67 $ 0.47
========== ========== ========== ========== ==========
Selected Operating Data:
Members at end of period:
Managed Care.............................. 482,200 450,400 341,600 265,800 215,700
Indemnity/PPO............................. 75,600 65,300 56,200 36,700 11,600
Fee Income (2)............................ 87,100 76,600 34,000 6,100 NC
---------- ---------- ---------- ---------- ----------
Total Members........................... 644,900 592,300 397,800 308,600 227,300
Consolidated Balance Sheet Data (at end of period):
Total current assets........................ $ 20,252 $ 16,554 $ 21,023 $ 16,889 $ 5,716
Total assets................................ 38,076 31,895 34,454 19,111 7,217
Total current liabilities................... 10,181 8,325 14,331 7,280 3,977
Total liabilities........................... 10,357 8,573 14,498 7,405 4,077
Preferred stock............................. -- -- -- -- 892
Stockholders' equity........................ 27,719 23,323 19,956 11,706 2,248
</TABLE>
- 21 -
<PAGE>
(1) 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.
(2) 1994 members are not comparable.
(3) 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.
- 22 -
<PAGE>
Item 7. Managements's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 Form 10-K.
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, St. Louis, Detroit and
Indianapolis. As of December 31, 1998, the Company had 482,200 members in its
managed care plans, 75,600 members in its fully insured indemnity/PPO plans, and
87,100 members eligible to access the Company's PPO network and covered under
its administrative services only ("ASO") arrangements. In 1992, the Company
began marketing indemnity plans as part of its Managed ChoiceSM products. 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 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 23% of the Company's Indemnity/PPO members as of December
31, 1998. 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 provided 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 provided 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 what the Company has experienced in the past.
Revenues
The Company's annual revenues have increased from $44.1 million in 1996
to $64.2 million in 1998. Revenues increased to $64.2 million for 1998 from
$56.6 million for 1997. Revenue growth for 1998 has been strong both in dollar
and percentage terms, primarily as the result of the addition of new managed
care and indemnity/PPO members. The Company expects that subscriber revenue will
continue to increase at a slower rate than in previous years throughout 1999.
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.
- 23 -
<PAGE>
The largest source of Company revenue is derived from members enrolled
in managed care plans. From 1996 to 1998, the Company's revenue from its managed
care products grew from $32.8 million to $47.9 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 and Champion in 1996. In 1996,
1997 and 1998, managed care revenue accounted for approximately 74%, 77%, and
75%, respectively, of total revenue.
The second largest source of Company revenue is generated from
indemnity/PPO plan premiums. From 1996 to 1998, the Company's revenue from its
indemnity/PPO products grew from $10.6 million to $15.2 million. For 1998 and
1996, revenue from indemnity/PPO enrollment accounted for approximately 24% of
total revenue. 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 and ASO arrangements. Under the
network rental 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 member eligible to access such reduced fee
arrangements. The Company does not make any payments to its PPO network
providers on behalf of the eligible members access such reduced fee
arrangements. Under the Company's ASO arrangements, the Company provides claims
payments and related services for self-insured employers' indemnity plans. Under
these arrangements the Company does not assume any of the underwriting risk for
the indemnity claims.
Benefit Coverage Expenses
From 1996 to 1998, total benefit coverage expenses increased from $27.9
million to $42.7 million. Between 1996 and 1998, total benefit coverage expenses
as a percentage of revenues increased from 63.2% to 66.6% of total revenue. This
increase is largely the result of increases in the benefit coverage expenses of
the Company's managed care products (primarily associated with the Company's
acquisitions) and increases in benefit coverage expenses associated with
indemnity/PPO plans.
Gross Margin
From 1996 to 1998, gross margin increased from $16.2 million to $21.4
million. Between 1996 and 1998, gross margin as a percentage of total revenue
decreased from 36.8% to 33.4% of total revenue. This change is due to 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 acquired in the Wisconsin and
Missouri marketplaces and the decrease in the gross margin on the Company's
indemnity/PPO products in 1998. During 1998, the Company successfully
transitioned portions of its lower gross margin business acquired in Wisconsin
and Missouri to its higher gross margin standard products. In addition, the
Company transitioned substantially all of its Illinois managed care membership
to its new "template plan" line of products which has improved the managed care
gross margin. The Company expects the managed care gross margin to continue to
improve in 1999 as a result of the full year effect of the rollout of the new
template plan design as well as the price increases that went into effect during
1998. The Company also expects the indemnity/PPO gross margin percentage to
remain fairly consistent with the 1998 level throughout 1999. Overall gross
margin percentages will vary if the mix of the Company's indemnity/PPO and
managed care business changes from current levels.
Selling, general and administrative
Selling, general and administrative ("SG&A") expenses as a percent of
revenues declined from 27.8% in 1996 to 24.2% in 1998. 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, 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 1996 through 1998 to a large degree offsets the decreases in the gross
margin percentage during that period. The Company expects SG&A as a percent of
revenue to remain relatively constant in 1999 and management expects it to
decline thereafter, as the Company continues to achieve economies of scale and
operating efficiencies.
- 24 -
<PAGE>
Year 2000 Disclosure
Many existing computer systems and applications abbreviate dates using
only two digits ("98") rather than four digits ("1998"). If not corrected, this
shortcut may cause problems when the century date "2000" occurs. On that date,
some computer operating systems and applications and embedded technology may
recognize the date as January 1, 1900 instead of January 1, 2000. If the Company
fails to correct any critical Year 2000 processing problems prior to January 1,
2000, the affected systems may either cease to function or produce erroneous
data, which could have material adverse operational and financial consequences.
Currently, the Company believes that the major risks associated with the
inability of systems and software to process Year 2000 data correctly include a
disruption in the operation of its core enterprise systems, telephony systems,
accounting and financial systems, and desktop and support systems. A failure of
such systems could materially and adversely affect the Company's results of
operations, financial position and cash flows.
Throughout 1998 the Company has been actively working on its plan to
address year 2000 compliance. The plan consists of three phases. Phase 1
involves an assessment of the Company's internal systems. Phase 1 is completed.
The Company has found as a result of the assessment process that its core
enterprise systems have always contained the ability to store and process the
full four-digit year. Although this capability exists, several functional points
of the system have not fully utilized the capability. Phase 2, scheduled for
completion by July 1999, is the development and execution of specific action
plans to resolve known potential year 2000 issues. Phase 3, scheduled for the
second and third quarters of 1999, is the final testing of each major area
determined as critical to ongoing business operations.
Phase 1 included the identification of core business areas and
processes, analysis of systems and hardware supporting the core business areas
and the prioritization of renovation or replacement of systems and hardware that
are not Year 2000 compliant. Included in the assessment phase is an analysis of
risk management factors such as contingency plans and legal matters. The
internal systems assessment process of Phase 1 categorized internal systems into
4 functional areas: (1) Core Enterprise System, (2) Telephony Systems, (3)
Accounting and Financial Systems, and (4) Desktop and Support Systems. The Core
Enterprise System includes computer systems that support key business functions
such as billing, finance, customer service, and network provider payments.
Within each of these areas it has been determined that the main suppliers of the
systems utilized by the Company are able to provide year 2000 compliant
releases. The acquisition of the available releases will be accomplished either
through existing support arrangements or through the purchase of upgraded
products. A fifth area requiring additional investigation is the assessment of
the Company's major third party relationships outside of the information
technology arena. This process has been completed.
Phase 2 will consist of the conversion or replacement of selected
platforms, applications, databases and utilities. Phase 3 will include the
testing, verifying and validating the renovated or replaced platforms,
applications, databases and utilities.
The Company's current schedule is subject to change depending on
developments that may arise through unforeseen circumstances, and through
execution of the Company's compliance efforts. The Company is dependent on its
vendors for compliant hardware, systems and applications and upgrades by
experts, both internal and external, and the availability of critical resources
with the requisite skill sets. The Company's ability to meet its target dates is
dependent upon the timely provision of necessary upgrades and modifications by
its suppliers and internal resources. In addition, the Company cannot guarantee
that third parties on whom it depends for essential services (such as utilities,
telecommunications operators, etc.) will convert their critical systems and
processes in a timely manner. Failure or delay by any of these parties could
significantly disrupt the Company's business. The Company's contingency plans
will address mechanisms for preventing or mitigating interruption caused by such
third parties.
The Company believes that it will spend approximately $100,000 in 1999
to finish upgrading and verifying all critical areas identified. This cost
includes the purchase of required software and hardware as well as outside
contracting services. The Company has already secured the necessary resources
for 1999.
- 25 -
<PAGE>
Based on the Company's current schedule for completion of Year 2000
tasks, the Company believes that its planning is adequate to secure Year 2000
readiness of its critical systems. Nevertheless, management cannot provide
assurance that its plans to achieve Year 2000 compliance will be successful or
that the cost of its efforts will not differ materially from estimates, as each
is subject to various risks and uncertainties, many of which are described
above. Accordingly, the Company's goal is to develop business continuity and
contingency plans in 1999 to address high-risk areas as they are identified.
These plans are expected to assess the potential for business disruption in
various scenarios, and to provide for key operational back-up, recovery and
restoration alternatives. However, if the Company, or third parties with whom it
has significant business relationships, fails to achieve Year 2000 readiness
with respect to critical systems, there could be a material adverse affect on
the Company's results of operations, financial position and cash flows.
The Company's Year 2000 most reasonably likely worst case scenario may
involve interruption of data processing services and telecommunications services
and/or interruption of customer billing, operating and other information
systems. As part of its Year 2000 initiative, the Company is evaluating these
worst-case scenarios and is in the process of developing contingency and
business plans tailored for Year 2000-related occurrences. The contingency and
business contingency plans are expected to assess the potential for business
disruption in various scenarios, and to provide key operational back-up,
recovery and restorational alternatives.
The Company's contingency plan initiatives include the following:
personnel to be on call during the Year 2000 change to monitor critical systems,
telecommunications and other processes and to react promptly to facilitate
repairs; back-up plans in the event of failure or information or
telecommunications systems or other Year 2000 disruptions; identification of
alternate suppliers and implementation of plans to be in place for third-party
products/services that fail to meet Year 2000 compliance commitment schedules;
and data retention and recovery procedures to be in place for customer and
critical business data to provide backups with on-site as well as off-site data
copies. The Company anticipates having these contingency plans in place before
December 31, 1999.
The above information, which contains statements that are
"forward-looking" within the meaning of the Private Securities Litigation Reform
Act of 1995, is based on the Company's current best estimates, which were
derived using numerous assumptions of future events, including the availability
and future costs of certain technological and other resources, third party
modification actions and other factors. Given the complexity of these issues and
the possibility of unidentified risks, actual results may vary materially from
those anticipated and discussed above. Specific factors that might cause such
differences include, among others, the availability and cost of personnel
trained in this area, the ability to locate and correct all affected computer
codes, the timing and success of remedial efforts of third party suppliers and
similar uncertainties.
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.
- 26 -
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Consolidated Statement of Income Data:
Subscriber revenue
Managed care................................. $ 47,901 $ 43,509 $ 32,807
Indemnity/PPO................................ 15,162 12,204 10,629
Fee income................................... 1,107 881 663
---------- --------- ----------
Total subscriber revenue................... 64,170 56,594 44,099
---------- --------- ----------
Benefit coverage expenses
Managed care................................. 29,790 27,468 19,555
Indemnity/PPO................................ 12,941 10,464 8,318
Fee income................................... -- -- --
---------- --------- ----------
Total benefit coverage expenses............ 42,731 37,932 27,873
---------- --------- ----------
Gross margin
Managed care................................. 18,111 16,041 13,252
Indemnity/PPO................................ 2,221 1,740 2,311
Fee income................................... 1,107 881 663
---------- --------- ----------
Total gross margin......................... $ 21,439 $ 18,662 $ 16,226
========== ========= ==========
</TABLE>
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Total subscriber revenue increased by $7.6 million, or 13.4%, to $64.2
million in 1998 from $56.6 million in 1997. The $7.6 million increase was
primarily attributable to increased enrollment in the Company's managed care and
indemnity/PPO dental plans, as well as price increases that went into effect
during 1998. Managed care revenue increased $4.4 million over the same period,
primarily due to an increase in new members and price increases. Indemnity/PPO
revenue increased $3.0 million to $15.2 million in 1998 from $12.2 million in
1997, primarily as a result of adding new indemnity/PPO plan members and price
increases.
Total gross margin increased by $2.8 million, or 14.9%, to $21.4
million in 1998 from $18.7 million in 1997. Total gross margin as a percentage
of revenue was 33.4% in 1998 as compared to 33.0% in 1997. This percentage
increase was the result of improved gross margins on both the managed care and
indemnity/PPO lines of business. Managed care gross margin as a percentage of
revenue was 37.8% in 1998 as compared to 36.9% in 1997. The improved managed
care gross margin was the result of transitioning lower gross margin business
acquired in Wisconsin and Missouri to the Company's higher gross margin standard
products, and transitioning the Company's Illinois membership to the new higher
gross margin "template plan" line of products, as well as price increases which
were implemented throughout 1998. The level of indemnity/PPO gross margin as a
percentage of revenue increased to 14.6% in 1998 from 14.3% in 1997. This
increase in indemnity/PPO gross margin was the result of price increases which
were passed on during 1998.
SG&A expenses increased by $1.9 million, or 14.4%, to $15.5 million for
1998 from $13.6 million in 1997. As a percentage of revenue, SG&A expenses
increased to 24.2% for 1998 from 23.9% for 1997. This increase is attributable
primarily to staffing and salary increases that were deferred in 1997 due to the
Company's cost containment efforts that year. The Company expects SG&A as a
percent of revenue to remain relatively constant in 1999 and management expects
it to decline thereafter, as the Company continues to achieve economies of scale
and operating efficiencies. Included in the SG&A total is $265,000, for 1998 and
1997, for the amortization of goodwill associated with the acquisitions.
- 27 -
<PAGE>
Operating income increased by $830,000, or 16.2%, to $5.9 million for
1998 from $5.1 million in 1997. As a percentage of revenue, operating income was
9.3% in 1998 and 9.0% in 1997. The Company expects its operating income
percentage to continue to improve as a result of its improved managed care gross
margin.
The effective tax rate for 1998 was 39.9% compared to 40.7% for 1997.
The decline in effective tax rate is primarily due to the purchase of federally
tax exempt municipal bonds purchased during the 1998 as well as the purchase of
United States Treasury Notes and Bills which are exempt from state tax. The
Company expects to continue to hold and/or purchase federally tax exempt
municipal bonds throughout 1999.
Net income increased by $668,000, or 20.1%, to $4.0 million for 1998
from $3.3 million for 1997.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Total subscriber revenue increased by $12.5 million, or 28.3%, to $56.6
million in 1997 from $44.1 million in 1996. Of this increase, $3.3 million, or
26.4%, was attributable to the operations added through the acquisition of
Missouri based Champion. The remaining $9.2 million increase was a 20.9%
increase in revenues and was primarily attributable to increased enrollment in
the Company's managed care and indemnity/PPO dental plans, as well as a full
year effect of the Wisconsin based Smileage transaction. Managed care revenue
increased $10.7 million over the same period, primarily due to an increase in
new members and $3.3 million from Champion. Indemnity/PPO revenue increased $1.6
million to $12.2 million in 1997 from $10.6 million in 1996, primarily as a
result of adding new indemnity/PPO plan members.
Total gross margin increased by $2.5 million, or 15.4%, to $18.7
million in 1997 from $16.2 million in 1996. Total gross margin as a percentage
of revenue was 33.0% in 1997 as compared to 36.8% in 1996. This percentage
decline was the result of the lower gross margin from the Champion and Smileage
acquisitions as well as from a decrease in gross margin in the Company's
indemnity/PPO plans. Managed care gross margin as a percentage of revenue was
36.9% in 1997 as compared to 40.4% in 1996. This percentage decline was
primarily the result of revenue acquired through the two acquisitions which had
a combined gross margin percentage of 28.0% as compared with the existing
managed care business which had a gross margin percentage of 40.0%. The level of
indemnity/PPO gross margin as a percentage of revenue decreased to 14.3% in 1997
from 21.7% in 1996. This decline in indemnity/PPO gross margin was the result of
increased expenses in the Company's indemnity/PPO plans, primarily attributable
to higher utilization patterns.
SG&A expenses increased by $1.3 million, or 10.6%, to $13.6 million for
1997 from $12.3 million in 1996. As a percentage of revenue, SG&A expenses
dropped to 23.9% for 1997 from 27.8% for 1996. 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, higher
revenues relative to the SG&A expenses associated with indemnity/PPO plans, and
cost containment moves by the Company in 1997 to offset the decline in gross
margin. Included in the SG&A total is $265,000 and $64,000, respectively, for
1997 and 1996, for the amortization of goodwill associated with the
acquisitions.
Operating income increased by $1.2 million, or 29.3%, to $5.1 million
for 1997 from $3.9 million in 1996. As a percentage of revenue, operating income
was 9.0% in 1997 and 1996.
The effective tax rate for 1997 was 40.7% compared to 40.6% for 1996.
Net income increased by $592,000, or 21.9%, to $3.3 million for 1997
from $2.7 million for 1996.
- 28 -
<PAGE>
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 provided by (used in) operations was $5.7 million, ($0.6)
million and $3.7 million for the years ended December 31, 1998, 1997 and 1996,
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. In 1997, $2.0 million was transferred
to restricted cash for the formation of an insurance company.
Capital expenditures were $748,000 for 1998 and $682,000 for 1997
mainly for computer system enhancements, furniture, and leasehold improvements.
Capital expenditures were $745,000 for the year ended December 31, 1996,
primarily for office furniture and new computer systems.
Cash provided by (used in) financing activities was $99,000, $43,000,
and ($45,000) for the years ended December 31, 1998, 1997 and 1996, primarily
from issuance of common stock in 1998 and 1997.
As of December 31, 1998, the Company had cash and cash equivalents of
$6.2 million, short-term investments of $4.8 million, long term investments of
$3.1 million, restricted cash of $3.0 million, and no long term debt
outstanding, except as of December 31, 1996, 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 committed unsecured line of credit (the
"Credit Agreement") available which expires June 30, 1999, and to date has not
been executed and utilized. Upon execution of this Credit Agreement, the Company
may borrow up to $5 million at the rate of LIBOR plus one-half percent. 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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company has determined that its market risk exposures, which arise
primarily from exposures to fluctuations in interest rates, are not material to
its future earnings, fair value and cash flows.
- 29 -
<PAGE>
Item 8. Financial Statements and Supplementary Data
Page
Financial Statements ----
Report of Independent Public Accountants............................ 31
Consolidated Balance Sheets as of December 31, 1998, 1997 and 1996.. 32
Consolidated Statements of Income and Comprehensive Income for
the years ended December 31, 1998, 1997 and 1996.................... 34
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 1998, 1997 and 1996.................... 35
Consolidated Statements of Cash Flows for the years
ended December 31, 1998, 1997 and 1996.............................. 37
Reconciliations of Net Income to Net Cash Provided by Operating
Activities for the years ended December 31, 1998, 1997 and 1996..... 38
Notes to Consolidated Financial Statements.......................... 39
- 30 -
<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,
1998, 1997 and 1996, and the related consolidated statements of income and
comprehensive 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, 1998, 1997 and 1996, 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 10, 1999
- 31 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS
- ------ 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 6,188,672 $ 9,047,214 $15,817,498
Short-term investments 4,824,629 - -
Accounts receivable, net of allowances of
$410,224, $334,012 and $289,554 at
December 31, 1998, 1997 and 1996,
respectively 4,941,894 3,443,661 3,010,585
Other receivables 579,015 163,329 220,819
Deposit under reinsurance agreement 2,098 752,284 696,564
Prepaid expenses 2,733,817 2,288,559 408,447
Deferred tax asset 982,000 859,000 869,000
------------ ------------ ------------
Total current assets 20,252,125 16,554,047 21,022,913
------------ ------------ ------------
PROPERTY AND EQUIPMENT, at cost 4,778,118 4,029,771 3,347,829
Less- Accumulated depreciation (3,034,010) (2,319,790) (1,725,450)
------------ ------------ ------------
Property and equipment, net 1,744,108 1,709,981 1,622,379
------------ ------------ ------------
OTHER ASSETS:
Investments 3,075,616 - -
Restricted cash equivalents and government
securities on deposit, at market 2,966,676 3,263,820 1,222,022
Goodwill and other intangibles, net of
accumulated amortization of $593,273,
$328,442 and $63,814 at December 31, 1998,
1997 and 1996, respectively 9,999,467 10,264,298 10,482,110
Deposits and other 38,476 103,495 104,554
------------ ------------ ------------
Total other assets 16,080,235 13,631,613 11,808,686
------------ ------------ ------------
Total assets $38,076,468 $31,895,641 $34,453,978
============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
- 32 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS-continued
As of December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 1996
- ------------------------------------ ---- ---- ----
<S> <C> <C> <C>
CURRENT LIABILITIES:
Accounts payable--trade $ 154,866 $ 88,399 $ 338,000
Accounts payable--dental service providers 1,130,521 394,946 347,529
Claims liability 1,669,388 1,604,329 1,579,669
Accrued payroll and related costs 1,128,745 485,166 739,292
Other accrued expenses 812,390 355,429 648,000
Deferred subscriber revenue 5,088,757 4,444,468 4,448,953
Payable under reinsurance agreement 87,146 752,427 627,789
Income taxes payable 109,541 200,327 101,472
Other current liabilities (Note 2) - - 5,500,000
--------------- -------------- --------------
Total current liabilities 10,181,354 8,325,491 14,330,704
DEFERRED TAX LIABILITY 176,000 247,300 167,157
--------------- -------------- --------------
Total liabilities 10,357,354 8,572,791 14,497,861
--------------- -------------- --------------
STOCKHOLDERS' EQUITY:
Common stock ($.001 par value; 15,000,000
shares authorized, 3,684,525 shares in 1998,
3,636,951 shares in 1997 and 3,600,996 shares
in 1996 issued and outstanding) 3,685 3,637 3,601
Capital in excess of par value 13,353,604 13,251,815 13,206,633
Retained earnings 14,071,846 10,080,858 6,757,451
Less- 735 shares, 495 shares and 425 shares of
common stock held in treasury at December 31,
1998, 1997 and 1996, respectively, at cost (15,942) (13,460) (11,568)
Accumulated other comprehensive income 305,921 - -
--------------- -------------- --------------
Total stockholders' equity 27,719,114 23,322,850 19,956,117
--------------- -------------- --------------
Total liabilities and stockholders' equity $38,076,468 $31,895,641 $34,453,978
=============== ============== ==============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
- 33 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
SUBSCRIBER REVENUE $64,170,121 $56,594,410 $44,098,529
BENEFIT COVERAGE EXPENSES 42,731,042 37,932,044 27,872,976
------------- ------------- -------------
Gross margin 21,439,079 18,662,366 16,225,553
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 15,496,424 13,549,645 12,272,835
------------- ------------- -------------
Operating income 5,942,655 5,112,721 3,952,718
INTEREST INCOME, net 693,333 494,686 642,828
------------- ------------- -------------
Income before income taxes 6,635,988 5,607,407 4,595,546
PROVISION FOR INCOME TAXES 2,645,000 2,284,000 1,864,000
------------- ------------- -------------
NET INCOME $ 3,990,988 $ 3,323,407 $ 2,731,546
------------- ------------- -------------
COMPREHENSIVE INCOME, net of tax:
UNREALIZED GAINS ON SECURITIES:
Unrealized holding gains arising during period,
net of taxes of $16,614 24,921 -- --
STOCK OPTION EXPENSE, recognized only for tax
purposes 281,000 -- --
------------- ------------- -------------
Other comprehensive income 305,921 -- --
------------- ------------- -------------
COMPREHENSIVE INCOME $ 4,296,909 $ 3,323,407 $ 2,731,546
============= ============= =============
BASIC EARNINGS PER SHARE $1.10 $0.92 $0.79
============= ============= =============
DILUTED EARNINGS PER SHARE $1.07 $0.89 $0.76
============= ============= =============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 34 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common Stock Capital
---------------------- in Excess Retained
Shares Dollars of Par Earnings
------ ------- --------- --------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995 3,365,375 $3,365 $7,676,536 $4,025,905
COMPREHENSIVE INCOME
Net income -- -- -- 2,731,546
Other comprehensive income, net of tax:
Comprehensive income -- -- -- --
Stock issued 235,621 236 5,530,097 --
Treasury stock purchased -- -- -- --
---------- --------- ---------- ----------
BALANCE, December 31, 1996 3,600,996 3,601 13,206,633 6,757,451
COMPREHENSIVE INCOME
Net income -- -- -- 3,323,407
Other comprehensive income, net of tax:
Comprehensive income -- -- -- --
Stock issued 35,955 36 45,182 --
Treasury stock purchased -- -- -- --
---------- --------- ---------- ----------
BALANCE, December 31, 1997 3,636,951 3,637 13,251,815 10,080,858
COMPREHENSIVE INCOME
Net income -- -- -- 3,990,988
Other comprehensive income, net of tax:
Unrealized holding gains arising during period -- -- -- --
Stock option expense, recognized for tax purposes -- -- -- --
Other comprehensive income -- -- -- --
Comprehensive income -- -- -- --
Stock issued 47,574 48 101,789 --
Treasury stock purchased -- -- -- --
---------- --------- ---------- -----------
BALANCE, December 31, 1998 3,684,525 $3,685 $13,353,604 $14,071,846
========== ========= =========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 35 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY-continued
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Accumulated
Treasury Stock Other Total
------------------------- Comprehensive Comprehensive Stockholders'
Shares Dollars Income Income Equity
------ ------- ------ ------ ------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 $ -- $ -- $ -- $11,705,806
COMPREHENSIVE INCOME
Net income -- -- $ 2,731,546 -- 2,731,546
Other comprehensive income, net of tax:
------------
Comprehensive income -- -- 2,731,546 -- --
============
Stock issued -- -- -- 5,530,333
Treasury stock purchased (425) (11,568) -- (11,568)
----- -------- ------------- -----------
BALANCE, December 31, 1996 (425) (11,568) -- 19,956,117
COMPREHENSIVE INCOME
Net income -- -- 3,323,407 -- 3,323,407
Other comprehensive income, net of tax:
------------
Comprehensive income -- -- 3,323,407 -- --
============
Stock issued -- -- -- 45,218
Treasury stock purchased (70) (1,892) -- (1,892)
---- -------- ------------- -----------
BALANCE, December 31, 1997 (495) (13,460) -- 23,322,850
COMPREHENSIVE INCOME
Net income -- -- 3,990,988 -- 3,990,988
Other comprehensive income, net of tax:
Unrealized holding gains arising during period -- -- 24,921 -- 24,921
Stock option expense, recognized for tax purposes -- -- 281,000 -- 281,000
------------
Other comprehensive income -- -- 305,921 305,921 --
------------
Comprehensive income -- -- $4,296,909 -- --
============
Stock issued -- -- -- 101,837
Treasury stock purchased (240) (2,482) -- (2,482)
----- -------- ------------- -----------
BALANCE, December 31, 1998 (735) ($15,942) $305,921 $27,719,114
===== ======== ============= ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 36 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from subscribers $63,879,276 $55,767,127 $43,124,110
Cash paid to providers of care (28,507,698) (26,593,902) (15,202,299)
Cash paid to employees, brokers and suppliers (14,576,975) (15,887,165) (14,465,535)
Claims paid (13,016,149) (10,300,714) (8,063,681)
Interest paid - - (514)
Interest received 631,198 459,212 624,373
Income taxes paid (2,457,912) (1,993,502) (1,911,500)
Cash transferred to restricted funds (286,561) (2,035,911) (373,158)
----------- ----------- -----------
Net cash provided by (used in) operating activities 5,665,179 (584,855) 3,731,796
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net (748,347) (681,939) (745,509)
Purchase of short-term investments (4,807,612) (517,130) (5,161,968)
Purchase of long-term investments (3,067,117) - -
Proceeds from sale of short-term investments - 517,130 5,097,314
Cash received in acquisition - - 432,326
Cost of acquisitions - (5,546,816) (171,680)
----------- ----------- -----------
Net cash used in investing activities (8,623,076) (6,228,755) (549,517)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 101,837 45,218 7,010
Principal payments on capital leases - - (26,996)
Purchase of treasury stock (2,482) (1,892) (11,568)
Payments of preferred dividends - - (13,380)
----------- ----------- -----------
Net cash provided by (used in) financing activities 99,355 43,326 (44,934)
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (2,858,542) (6,770,284) 3,137,345
CASH AND CASH EQUIVALENTS, beginning of year 9,047,214 15,817,498 12,680,153
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 6,188,672 $ 9,047,214 $15,817,498
=========== =========== ===========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 37 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
RECONCILIATIONS OF NET INCOME TO NET CASH PROVIDED BY OPERATING
ACTIVITIES
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income $3,990,988 $3,323,407 $2,731,546
Adjustments to reconcile net income to net cash provided by
operating activities-
Depreciation and amortization 979,050 858,965 648,247
(Increase) decrease in assets-
Accounts receivable, net (1,498,233) (433,076) (1,109,339)
Other receivables (415,686) 57,490 (149,728)
Deposit under reinsurance agreement 750,186 (55,720) (265,042)
Prepaid expenses (445,258) (1,880,112) 881,526
Deferred tax asset (123,000) 10,000 (154,000)
Restricted cash equivalents and government
securities on deposit 313,164 (2,041,798) (373,158)
Deposits and other 65,019 1,059 (59,854)
Increase (decrease) in current liabilities-
Accounts payable--trade 66,467 (249,601) (26,349)
Accounts payable--dental service providers 735,575 47,417 (67,676)
Claims liability 65,059 24,660 321,988
Accrued payroll and related costs 643,579 (254,126) (78,972)
Other accrued expenses 456,961 (292,571) (91,022)
Deferred subscriber revenue 644,289 (4,485) 1,186,160
Payable under reinsurance agreement (665,281) 124,638 238,535
Income taxes payable (107,400) 98,855 56,934
(Decrease)/Increase in long-term liabilities-
Deferred tax liability 209,700 80,143 42,000
---------- ---------- ----------
Net cash provided by (used in) operating activities $5,665,179 $ (584,855) $3,731,796
========== ========== ==========
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these statements.
- 38 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998, 1997 and 1996
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 Insurance
Company ("FC Insurance"), First Commonwealth Limited Health Service
Corporation ("LHSCWI"), Smileage Dental Services, Inc. ("SDS") and First
Commonwealth of Missouri, Inc. ("FCMO"), formerly 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. SDS's and CDS's balance sheets are also
included in the accompanying consolidated balance sheets beginning
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 and Michigan licensed Third Party
Administrator ("TPA"). As a TPA, FC Inc. provides administrative and
marketing services to certain subsidiaries 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, FCMO 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, 1998, 1997 and 1996.
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.
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.
- 39 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
FC Insurance was incorporated in Illinois during 1997 and is a wholly
owned subsidiary of FC Inc. It is licensed as a domestic life, accident
and health insurer to underwrite indemnity dental business and also
received licensure under the LHSO Act in November 1998, which will allow
it to underwrite managed care dental business. Effective January 1, 1998,
it consummated a reinsurance transaction with LHSC for the business that
was previously reinsured to an independent party (see Reinsurance
Activity) and onto FCRC. For the year ended December 31, 1998, its
business was indemnity dental only.
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
("Statutes") and is registered with the Office of the Commissioner of
Insurance of Wisconsin. The Statutes 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, 1998, 1997 and 1996.
SDS, a wholly owned subsidiary of FC Inc., is a Wisconsin based dental
health maintenance organization administrator.
FCMO is a Missouri corporation and is a wholly owned subsidiary of FC Inc.
FCMO is a St. Louis, Missouri based prepaid dental plan corporation
organized under Section 379.900 RSMo.
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.
Investments
The Company has invested funds in municipal bonds that are federally tax
exempt as well as United States Treasury notes.
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.
- 40 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
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, 1998 and 1997.
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:
<TABLE>
<CAPTION>
December 31
----------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Leasehold improvements $ 433,409 $ 433,409 $ 422,231
Furniture 840,871 830,220 780,967
Office equipment 588,354 567,954 513,566
Computer equipment and software 2,915,484 2,198,188 1,631,065
---------- ---------- ----------
Total property and equipment $4,778,118 $4,029,771 $3,347,829
========== ========== ==========
</TABLE>
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 Liabilities
Other current liabilities at December 31, 1996, represents the Company's
liability relating to its acquisition of CDS. This amount was paid on
January 2, 1997.
- 41 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
Claims Liability
The Company provides indemnity dental coverage for certain customers and
records a liability for 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 the 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 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. In 1997, a separate
independent third party insurer was inserted into the agreement between
Insurer and 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.
In addition, in 1997, FC Inc., acting as agent for Insurer and according
to a fronting agreement, began selling managed care and indemnity dental
insurance policies in the state of Michigan. According to the same
agreement, Insurer ceded all managed care and indemnity dental insurance
policies in Michigan to the same separate independent third party insurer
who ceded these policies to FCRC.
Effective January 1, 1998, LHSC, rather than reinsure the policies to the
Insurer, assumptively reinsured the same policies to FC Insurance.
Earnings Per Share
In 1997, the Company adopted Financial Accounting Standards Board
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
per Share." Under SFAS No. 128, primary earnings per share is replaced by
"Basic" earnings per share, which excludes dilution and is computed by
dividing income available to common shareholders by the weighted-average
number of common shares outstanding for the period. "Diluted" earnings per
share, which is computed similarly to fully diluted EPS, reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock. All
prior-period EPS information (including interim EPS) has been restated to
conform with the provisions of SFAS No. 128.
The following tables reconcile the numerators (net income) and
denominators (shares) of the basic and diluted earnings per share
computations.
<TABLE>
<CAPTION>
1998 EPS 1997 EPS 1996 EPS
---- --- ---- --- ---- ---
<S> <C> <C> <C> <C> <C> <C>
Net income 3,990,988 $3,323,407 $2,731,456
========== ========== ==========
Basic shares/EPS 3,643,953 $1.10 3,617,994 $0.92 3,470,871 $0.79
===== ===== =====
Effect of dilutive
common stock
options 93,711 109,340 128,694
---------- ---------- ----------
Diluted/EPS 3,737,664 $1.07 3,727,334 $0.89 3,599,565 $0.76
========== ===== ========== ===== ========== =====
</TABLE>
Options to purchase shares of common stock outstanding during 1998, 1997,
and 1996 that were not included in the computation of diluted EPS because
the options' exercise price was greater than the average market price of
the common shares are summarized in the following table.
- 42 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
Weighted average shares under option 62,500 17,875 31,167
Weighted average option price $15.51 $16.78 $23.10
Weighted average contractual life (in years) 7.4 8.6 9.4
Subsequent to December 31, 1998, the Company issued 68,500 options to various
key employees at the option price of $11.94 per share.
Segment Information
The Company considers its managed care and indemnity/PPO products to be
operating segments as defined in SFAS No. 131. However, due to the similar
economic characteristics of these segments, management has aggregated these
segments for purposes of complying with the disclosure requirements of SFAS
No. 131.
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 Illinois
Department of Insurance require LHSC, which is licensed under the LHSO Act,
to maintain a minimum net worth of $500,000. 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. At December 31, 1998, 1997 and 1996, balances of $94,889,
$632,767 and $705,867, 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 $20,050, $19,037 and
$15,674 at December 31, 1998, 1997 and 1996.
The State of Wisconsin insurance statutes require, among other provisions,
that LHSCWI maintain a minimum capital of $100,000, apply a ten percent
compulsory surplus factor to Point of Service/Indemnity ("POS") premium, and
limit POS business to ten percent of total premium volume. LHSCWI has a
certificate of deposit for $111,071 at Wisconsin bank and had POS business of
$735,201 in 1998, $189,788 in 1997 and none in 1996.
The State of Missouri statutes and related regulations of the Missouri
Department of Insurance require FCMO, 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.
- 43 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
The State of Illinois statutes and related regulations of the Illinois
Department of Insurance require FC Insurance to maintain a minimum net worth
of $1.5 million. FC Insurance maintains a deposit with the State of $1.6
million in accordance with State requirements.
It is management's opinion that the Company was in compliance with these
provisions at December 31, 1998, 1997 and 1996.
Interest income earned on restricted funds is included in interest income,
net in the consolidated statements of income.
5. CLAIMS LIABILITY
The Company's claims liability, claims incurred and payments related to
indemnity/PPO policies for the years ended December 31, 1998, 1997 and 1996,
are as follows:
<TABLE>
<CAPTION>
December 31
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Claims liability, beginning of year $ 1,604,329 $ 1,579,669 $ 1,257,681
Add- Claims incurred 13,043,382 10,506,867 8,341,669
Less- Claims payments-
Current year (11,403,233) (9,042,693) (7,274,355)
Prior years (1,575,090) (1,439,514) (745,326)
------------ ----------- -----------
Claims liability, end of year $ 1,669,388 $ 1,604,329 $ 1,579,669
============ =========== ===========
</TABLE>
6. LEASE OBLIGATIONS
The Company leases office space and various office equipment which are
accounted for as operating leases. Rental costs under the operating lease
agreements approximated $617,000, $617,000 and $486,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
Minimum future obligations under operating leases in effect at December 31,
1998, are:
Years ending December 31-
1999 $335,489
2000 93,999
2001 50,156
2002 and thereafter 67,792
--------
Total $547,436
- 44 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
7. INCOME TAXES
The current and deferred components of the provision for taxes are as
follows:
December 31
--------------------------------------
1998 1997 1996
---------- ---------- ----------
Current provision $2,537,000 $2,195,000 $1,962,000
---------- ---------- ----------
Deferred provision (benefit) 108,000 89,000 (98,000)
---------- ---------- ----------
Total tax provision $2,645,000 $2,284,000 $1,864,000
A reconciliation of the effective tax rate from statutory U.S. federal income
tax rate of 34% for 1998, 1997 and 1996, is as follows:
1998 1997 1996
---- ---- ----
Statutory rate 34% 34% 34%
State tax, net of federal benefit 5 5 5
Goodwill and other permanent items 2 2 2
Income from municipal bond investments (1) -- --
---- ---- ----
Effective tax rate 40% 41% 41%
==== ==== ====
As of December 31, 1998, 1997 and 1996, total net current deferred tax assets
were $982,000, $859,000 and $869,000, respectively, and total net noncurrent
deferred tax liabilities were $176,000, $247,300 and $167,157, respectively.
The temporary differences that give rise to deferred tax assets and
liabilities are as follows:
<TABLE>
<CAPTION>
December 31
---------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Claims liability $ 359,000 $ 608,804 $ 616,100
Allowance for doubtful accounts 160,000 130,265 112,900
Vacation accrual 71,000 52,566 54,700
Miscellaneous 392,000 67,365 85,300
--------- --------- ---------
Total current tax asset 982,000 859,000 869,000
--------- --------- ---------
Accumulated amortization (160,000) (80,103) -
--------- --------- ---------
Accumulated depreciation and other (16,000) (167,197) (167,157)
--------- --------- ---------
Total noncurrent tax liability (176,000) (247,300) (167,157)
--------- --------- ---------
Total $ 806,000 $ 611,700 $ 701,843
========= ========= =========
</TABLE>
- 45 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
8. SOURCES OF REVENUE (Unaudited)
The following table shows the percentage of revenue attributable to each
type of product offered:
1998 1997 1996
---- ---- ----
Managed care 75% 77% 74%
Indemnity/PPO 24 22 24
Fee income 1 1 2
--- --- ---
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, 1998, 1997
and 1996.
10. LINE OF CREDIT
The Company has a committed unsecured line of credit (the "Credit
Agreement") available with a Chicago bank that expires June of 1999, which
to date has not been utilized. Pursuant to this Credit Agreement, the
Company may borrow up to $5 million at the rate of LIBOR plus one-half
percent.
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.
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.
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.
- 46 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
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 1998, 1997 and 1996 consistent with the
provisions of SFAS No. 123, the Company's net income (in thousands) and
diluted earnings per share would have been reduced to the pro forma
amounts of $3,789 and $1.01 in 1998, $3,268 and $0.88 in 1997 and $2,645
and $0.73 in 1996.
The weighted average grant-date fair values of options granted in 1998,
1997 and 1996 were $6.00, $6.80 and $12.25, 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 1998, 1997 and 1996, respectively: risk-
free interest rates of 5.4%, 6.8% and 6.5%; expected lives of 7 years;
expected volatility of 41% in 1998 and in 1997 and 42% in 1996; 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 ratably over a period of two to four
years from the date of the grant. The Company had granted 248,125 total
options as of December 31, 1998, 1997 and 1996, to key employees and
directors at option prices ranging from $.50 to $15.00 per share. Of the
total options granted, 109,240, 133,375 and 148,950 had vested and were
exercisable as of December 31, 1998, 1997 and 1996, respectively, and
132,685, 87,925 and 60,675 of the total options, granted and vested had
been exercised as of December 31, 1998, 1997 and 1996, 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 350,000 shares of common stock have been
reserved for issuance under the 1995.
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. For the years ended December 31, 1998, 1997 and 1996,
the Company had granted 64,000, 94,000 and 105,500, respectively, total
options to key employees and directors at option prices ranging from
$11.25 to $28.625 per share. Of the total options granted, 90,863, 38,813
and 11,000 had vested and were exercisable as of December 31, 1998, 1997
and 1996, respectively, and 2,750 of the total options, granted and vested
had been exercised during the year ended December 31, 1998. In addition,
0, 77,238 and 42,000 options were rescinded during the years ended
December 31, 1998, 1997 and 1996.
A summary of the status of the Company's two stock option plans at
December 31, 1998, 1997 and 1996 and changes during the years then ended
is presented in the table below:
- 47 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Option Option Option
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 277,700 $ 7.08 289,950 $ 7.90 235,750 $ 4.15
Granted 64,000 11.41 94,000 12.26 105,500 22.06
Exercised (47,510) 1.98 (29,012) 1.56 (9,300) 0.75
Forfeited - - (16,238) 10.36 (2,000) 21.81
Cancelled - - (61,000) 20.47 (40,000) 24.12
-------- ----- -------- ------- -------- -------
Outstanding at end of year 294,190 $ 8.86 277,700 $ 7.08 289,950 $ 7.90
======== ======= ======== ======= ======== =======
Exercisable at end of year 200,103 $ 7.29 172,188 $ 4.38 159,950 $ 2.43
======== ======= ======== ======= ======== =======
</TABLE>
Of the 294,190 total options outstanding at December 31, 1998, 101,740
have option prices between $.70 and $1.70, with a weighted average option
price of $1.38 and a weighted average remaining contractual life of three
years. 101,740 of these options are exercisable at December 31, 1998, with
a weighted average option price of $1.38.
Of the total options outstanding at December 31, 1998, 129,950 have option
prices between $11.25 and $11.75 with a weighted average option price of
$11.52 and with a weighted average remaining contractual life of nine
years. 54,488 of these options are exercisable at December 31, 1998, with
a weighted average option price of $11.51.
Of the total options outstanding at December 31, 1998, 60,500 have option
prices between $14.56 and $17.00, with a weighted average option price of
$15.08 and a weighted average remaining contractual life of seven years.
41,875 of these options are exercisable at December 31, 1998, with a
weighted average option price of $15.14.
The remaining 2,000 options outstanding at December 31, 1998, have option
prices of $28.625, with a weighted average remaining contractual life of
eight years. These options are exercisable at December 31, 1998.
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.
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.
- 48 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
13. QUARTERLY FINANCIAL DATA (Unaudited) (in thousands, except per share data)
Quarter
------------------------------------
First Second Third Fourth
----- ------ ----- ------
1998-
Subscriber revenue $15,615 $15,961 $16,145 $16,449
Gross margin 5,165 5,292 5,387 5,596
Net income 913 952 1,018 1,107
Basic earnings per common share .25 .26 .28 .30
Diluted earnings per common share .24 .25 .27 .30
1997-
Subscriber revenue $13,463 $13,856 $14,519 $14,756
Gross margin 4,700 4,733 4,573 4,656
Net income 760 798 882 883
Basic earnings per common share .21 .22 .24 .24
Diluted earnings per common share .20 .21 .24 .24
1996-
Subscriber revenue $ 9,773 $10,019 $11,786 $12,521
Gross margin 3,747 3,799 4,220 4,460
Net income 669 698 667 697
Basic earnings per common share .20 .21 .19 .19
Diluted earnings per common
share .19 .20 .18 .19
14. RETIREMENT PLAN
The Company has a 401(k) salary deferral plan in which all employees of
the Company who have completed at least ninety days 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 $84,051, $91,949 and
$58,937 during the years ended December 31, 1998, 1997 and 1996,
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.
- 49 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-continued
December 31, 1998, 1997 and 1996
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
year ended December 31, 1996 for the acquisitions are as follows: Revenues
(in thousands) for the year ended December 31, 1996 would be $50,860; Net
income (in thousands) for the year ended December 31, 1996 would be
$2,856; and diluted Net Income per share for the year ended December 31,
1996 would be $0.77. This pro forma information has been prepared assuming
the acquisitions of SDS and CDS and the Company's initial public offering
had occurred as of January 1, 1995.
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 companies been combined
in prior periods.
- 50 -
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
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,
1999) 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, 1999) 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, 1999) 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, 1999) is incorporated herein by reference.
- 51 -
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K
(a)(1) Financial Statements
Financial statements for First Commonwealth, Inc. listed in
the Index to Financial Statements and Supplementary Data on page 29 are
filed as part of this Annual Report.
(a)(2) Financial Statement Schedules
Financial statements for First Commonwealth, Inc. listed in
the Index to Financial Statements and Supplementary Data on page 29 are
filed as part of this Annual Report.
Consent of Independent Accountants Page 30
Schedule II -- Valuation and Qualifying Accounts Page 54
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:
Exhibit No. Description
- ----------- -----------
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)
4.2 -- First Amendment to Stockholders Rights Agreement dated
December 15, 1998 is hereby incorporated to Form 8-A/A dated
February 5, 1999
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 February 18,
1998 (3)
- 52 -
<PAGE>
Exhibit No. Description
- ----------- -----------
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)
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)
- 53 -
<PAGE>
Exhibit No. Description
- ----------- -----------
11 -- Statement re: computation of per share earnings (included in
Item 8 filed herewith)
21 -- Subsidiaries of the Registrant
23 -- Consent of Arthur Andersen LLP
24 -- Powers of Attorney (included on signature page)
27 -- Financial Data Schedule
- ---------
(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
None
- 54 -
<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' 1998 Annual Report to Stockholders incorporated by reference in
this Form 10-K, and have issued our report thereon dated February 10, 1999. 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 56 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 10, 1999
- 55 -
<PAGE>
FIRST COMMONWEALTH, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
Period -------------------------------
- ------ Balance at Charged to
Year Ended Beginning of Costs and Charged to Other Deductions- Balance at
December 31, Description of Period Expenses Accounts-Describe Describe End of Period
------------ ----------- ------------ --------- ----------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
1996 Claims liability $1,257,681 $8,341,669 -- $8,019,681(1) $1,579,669
Allowance for doubtful
accounts $197,316 $124,000 -- $31,762(2) $289,554
1997 Claims liability $1,579,669 $10,506,867 -- $10,482,207(1) $1,604,329
Allowance for doubtful
accounts $289,554 $204,655 -- $160,197(2) $334,012
1998 Claims liability $1,604,329 $12,941,142 -- $12,876,083(1) $1,669,388
Allowance for doubtful
accounts $334,012 $144,000 -- $67,788(2) $410,224
</TABLE>
- --------
(1) Payment for claims
(2) Write-off of bad debt
- 56 -
<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, 1999 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, 1999.
<TABLE>
<CAPTION>
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>
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
21 -- Subsidiaries of the Registrant
23 -- Consent of Arthur Andersen LLP
24 -- Powers of Attorney (included on signature page)
27 - Financial Data Schedule
<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, Inc.
Services Corporation
First Commonwealth of Illinois, Inc. Illinois First Commonwealth, Inc.
First Commonwealth Insurance Illinois First Commonwealth, Inc.
Company
First Commonwealth Reinsurance Arizona First Commonwealth, Inc.
Company
First Commonwealth Limited Health Wisconsin First Commonwealth, Inc.
Service Corporation
Smileage Dental Services, Inc. Wisconsin First Commonwealth, Inc.
First Commonwealth of Missouri, Missouri First Commonwealth, Inc.
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 10, 1999, on the consolidated financial statements of First
Commonwealth, Inc. and Subsidiaries (the "Company") included in the Company's
1998 Annual Report on Form 10-K, and to the incorporation of our report, dated
February 10, 1999, 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, 1999
<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, 1998 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-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 6,189
<SECURITIES> 4,825
<RECEIVABLES> 5,352
<ALLOWANCES> 410
<INVENTORY> 0
<CURRENT-ASSETS> 20,252
<PP&E> 4,778
<DEPRECIATION> 3,034
<TOTAL-ASSETS> 38,076
<CURRENT-LIABILITIES> 10,181
<BONDS> 0
0
0
<COMMON> 4
<OTHER-SE> 27,715
<TOTAL-LIABILITY-AND-EQUITY> 38,076
<SALES> 0
<TOTAL-REVENUES> 64,170
<CGS> 0
<TOTAL-COSTS> 58,083
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 144
<INTEREST-EXPENSE> 693
<INCOME-PRETAX> 6,636
<INCOME-TAX> 2,645
<INCOME-CONTINUING> 3,991
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,991
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.07
</TABLE>
