<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from ________ to ________
Commission file number 0-15846
First Health Group Corp.
(formerly HealthCare COMPARE Corp.)
(Exact name of registrant as specified in its charter)
Delaware 36-3307583
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
3200 Highland Avenue, Downers Grove, Illinois 60515
(Address of principal executive offices, Zip Code)
(630) 241-7900
(Registrant's phone number, including area code)
--------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
The number of shares of Common Stock, par value $.01 per share, outstanding
August 10, 1998 was 63,138,448.
<PAGE> 2
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information Page Number
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at June 30, 1998
and December 31, 1997................................ 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at June 30, 1998 and December 31, 1997.......... 4
Consolidated Statements of Operations for the three months
ended June 30, 1998 and 1997........................... 5
Consolidated Statements of Operations for the six months
ended June 30, 1998 and 1997........................... 6
Consolidated Statements of Cash Flows for the six months
ended June 30, 1998 and 1997........................... 7-8
Notes to Consolidated Financial Statements............... 9-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............. 13-19
Item 3. Quantitative and Qualitative Disclosures About
Market Risk..................................... 19
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security
Holders......................................... 20
Item 6. Exhibits and Reports on Form 8-K................ 20
Signatures....................................................... 21
Exhibit 11....................................................... 22-23
<PAGE> 3
PART 1. FINANCIAL INFORMATION
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- -------------------------------------------------------------------------------
ASSETS June 30, 1998 December 31, 1997
------------- -----------------
Current Assets:
Cash and cash equivalents............. $ 73,047,000 $ 77,836,000
Short-term investments................ 2,869,000 5,999,000
Accounts receivable, less allowances for
doubtful accounts of $9,934,000
and $10,064,000, respectively...... 62,806,000 65,979,000
Reinsurance recoverable............... 66,886,000 142,553,000
Deferred income taxes................. 21,700,000 21,700,000
Other current assets.................. 18,166,000 11,790,000
----------- -----------
Total current assets.................. 245,474,000 325,857,000
Long-Term Investments:
Marketable securities................. 176,944,000 175,938,000
Other................................. 32,872,000 26,394,000
----------- -----------
209,816,000 202,332,000
Property and Equipment:
Buildings and improvements............ 55,466,000 51,914,000
Computer equipment and software....... 77,253,000 61,542,000
Office furniture and equipment........ 26,786,000 23,131,000
----------- -----------
159,505,000 136,587,000
Less accumulated depreciation and
amortization....................... (72,758,000) (63,567,000)
----------- -----------
Net property and equipment............ 86,747,000 73,020,000
Goodwill................................. 100,496,000 104,729,000
Other Assets............................. 4,244,000 1,940,000
----------- -----------
$646,777,000 $707,878,000
============ ============
3
<PAGE> 4
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- -------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, 1998 December 31, 1997
------------- -----------------
Current Liabilities:
Accounts payable...................... $ 50,603,000 $ 49,342,000
Accrued expenses...................... 37,273,000 45,474,000
Claims reserves....................... 78,650,000 150,517,000
----------- -----------
Total current liabilities............. 166,526,000 245,333,000
Long-Term Debt........................... 200,000,000 200,000,000
Other Non-Current Liabilities............ 2,729,000 2,938,000
----------- ------------
Total liabilities..................... 369,255,000 448,271,000
Commitments and Contingencies............ -- --
Stockholders' Equity:
Common stock.......................... 764,000 376,000
Additional paid-in capital............ 180,977,000 157,173,000
Retained earnings..................... 342,565,000 296,140,000
Unrealized holding gain on marketable
securities......................... 897,000 3,223,000
Treasury stock, at cost............... (247,681,000) (197,305,000)
------------ -----------
Total stockholders' equity............ 277,522,000 259,607,000
------------ -----------
$646,777,000 $707,878,000
=========== ===========
4
<PAGE> 5
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- -------------------------------------------------------------------------------
Three Months Ended June 30,
---------------------------
1998 1997
------- -------
Revenues.................................... $126,742,000 $ 68,834,000
----------- -----------
Operating expenses:
Cost of services......................... 55,893,000 20,552,000
Selling and marketing.................... 12,416,000 7,429,000
General and administrative............... 10,568,000 3,714,000
Healthcare benefits...................... 4,478,000 2,035,000
Depreciation and amortization............ 6,412,000 3,304,000
----------- -----------
89,767,000 37,034,000
Income from operations...................... 36,975,000 31,800,000
Other (income) expense:
Interest expense......................... 3,161,000 --
Interest income.......................... (5,581,000) (3,210,000)
----------- -----------
Income before income taxes.................. 39,395,000 35,010,000
Income taxes................................ (16,073,000) (13,566,000)
------------ -----------
Net income.................................. $ 23,322,000 $ 21,444,000
=========== ===========
Weighted average shares
outstanding - basic......................... 63,095,000 65,228,000
========== ===========
Net income per common share - basic......... $ .37 $ .33
========== ===========
Weighted average shares
outstanding - diluted........................ 64,195,000 66,614,000
========== ===========
Net income per common share - diluted....... $ .36 $ .32
========== ===========
5
<PAGE> 6
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- -------------------------------------------------------------------------------
Six Months Ended June 30,
--------------------------
1998 1997
------ ------
Revenues.................................... $254,500,000 $133,755,000
----------- -----------
Operating expenses:
Cost of services......................... 112,706,000 39,095,000
Selling and marketing.................... 25,253,000 14,638,000
General and administrative............... 21,688,000 7,372,000
Healthcare benefits...................... 8,571,000 4,127,000
Depreciation and amortization............ 12,338,000 6,392,000
----------- -----------
180,556,000 71,624,000
----------- -----------
Income from operations...................... 73,944,000 62,131,000
Other (income) expense:
Interest expense......................... 6,345,000 --
Interest income.......................... (10,842,000) (6,701,000)
------------ -----------
Income before income taxes.................. 78,441,000 68,832,000
Income taxes................................ (32,016,000) (26,554,000)
----------- -----------
Net income.................................. $ 46,425,000 $ 42,278,000
=========== ===========
Weighted average shares
outstanding - basic......................... 63,355,000 66,174,000
=========== ===========
Net income per common share - basic......... $ .73 $ .64
=========== ===========
Weighted average shares
outstanding - diluted....................... 64,603,000 67,514,000
=========== ===========
Net income per common share - diluted....... $ .72 $ .63
=========== ===========
6
<PAGE> 7
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers................. $260,509,000 $128,535,000
Cash paid to suppliers and employees......... (172,223,000) (59,583,000)
Healthcare benefits paid..................... (4,432,000) (3,148,000)
Interest income received..................... 8,483,000 9,003,000
Interest expense paid........................ (4,303,000) --
Income taxes paid, net....................... (31,279,000) (24,478,000)
----------- -----------
Net cash provided by operating activities.... 56,755,000 50,329,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments..................... (187,574,000) (103,512,000)
Sales of investments......................... 181,671,000 146,585,000
Acquisition of businesses, net of cash
acquired..................................... (173,000) (412,000)
Purchase of property and equipment........... (24,128,000) (20,232,000)
----------- ------------
Net cash provided by (used in) investing
activities................................... (30,204,000) 22,429,000
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock................... (50,376,000) (99,947,000)
Proceeds from issuance of common stock....... 19,036,000 3,476,000
Proceeds from sale of put options on
common stock................................. -- 10,811,000
----------- ------------
Net cash used in financing activities........ (31,340,000) (85,660,000)
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS....... (4,789,000) (12,902,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.. 77,836,000 77,439,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD........ $ 73,047,000 $ 64,537,000
=========== ===========
SUPPLEMENTAL CASH FLOW DATA:
Acquisition of businesses:
Cost in excess of net assets acquired..... $ 173,000 $ 412,000
=========== ===========
Non-cash financing activity:
Treasury stock purchase payable........... $ -- $ 855,000
=========== ===========
</TABLE>
7
<PAGE> 8
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
-------- ---------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
NET INCOME........................................ $46,425,000 $42,278,000
---------- ----------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization............... 12,338,000 6,392,000
Change in provision for uncollectible
receivables................................. (130,000) 14,000
Amortization of bond premiums............... 193,000 761,000
Tax benefit from stock options exercised.... 5,156,000 1,361,000
Unrealized holding loss on marketable
securities.................................. 1,545,000 --
Other, net.................................. (2,643,000) (46,000)
Changes in Assets and Liabilities:
Accounts receivable......................... 3,303,000 (4,850,000)
Other current assets........................ (6,376,000) 4,443,000
Reinsurance recoverable..................... 75,667,000 --
Accounts payable and accrued expenses....... (6,940,000) (25,000)
Claims reserves............................. (71,867,000) (675,000)
Income taxes payable........................ -- 747,000
Goodwill, net of amortization............... 2,597,000 --
Non-current assets and liabilities.......... (2,513,000) (71,000)
----------- ----------
TOTAL ADJUSTMENTS.............................. 10,330,000 8,051,000
----------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES $56,755,000 $50,329,000
=========== ==========
</TABLE>
8
<PAGE> 9
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- -------------------------------------------------------------------------------
1. The unaudited financial statements herein have been prepared by the
Company pursuant to the rules and regulations of the Securities and
Exchange Commission. The accompanying interim financial statements have
been prepared under the presumption that users of the interim financial
information have either read or have access to the audited financial
statements for the latest fiscal year ended December 31, 1997.
Accordingly, footnote disclosures which would substantially duplicate the
disclosures contained in the December 31, 1997 audited financial
statements have been omitted from these interim financial statements.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
rules and regulations. Although the Company believes that the disclosures
are adequate to make the information presented not misleading, it is
suggested that these interim financial statements be read in conjunction
with the financial statements and the notes thereto included in the
Company's latest Annual Report on Form 10-K.
2. On July 1, 1997, the Company acquired all the outstanding shares of
capital stock of First Health Strategies, Inc. ("Strategies") and First
Health Services Corporation ("Services") (collectively, "FHC") excluding
the stock of Viable Information Processing Systems, Inc., a wholly-owned
subsidiary of Services, from First Financial Management Corporation and
First Data Corporation for a purchase price of $202 million in cash
subject to adjustment provisions for the change in net working capital. As
a result of the change in net working capital, the purchase price was
adjusted to approximately $196 million. Strategies, based in Salt Lake
City, Utah, and Services, based in Richmond, Virginia, provide independent
health care administration services such as claims administration and
associated health care management services to the self-insured corporate
and government markets. The acquisition was financed with a $200 million
credit agreement underwritten by the Company's bank group. The acquisition
was effected pursuant to the terms of a stock purchase agreement dated May
22, 1997.
Based on the terms of the acquisition, the transaction was accounted for
as a purchase of FHC by the Company for financial reporting and accounting
purposes. Accordingly, the consolidated statements of operations include
FHC's results since the date of acquisition. The Company revalued the
basis of FHC's acquired assets and assumed liabilities to fair value at
the date of purchase. The purchase price of FHC was calculated as the net
cash paid plus the Company's transaction costs. The difference between the
purchase price and the fair value of the identifiable tangible and
intangible assets acquired, the amount allocated to in-process research
and development, and the liabilities assumed and incurred was recorded as
goodwill and will be amortized over a period of 30 years. The allocation
of the purchase price was as follows:
Purchase price $196,430,000
Transaction costs 3,000,000
------------
Total purchase price $199,430,000
============
9
<PAGE> 10
Purchase price was allocated as follows:
Fair value of assets acquired $ 87,214,000
Goodwill 95,317,000
In-process research and development 80,000,000
Liabilities assumed (40,039,000)
Liability for restructuring and integration
costs (23,062,000)
----------
$199,430,000
===========
In-process research and development represents projects related to the
next generation of FHC's claims processing system. These projects
represented FHC's research and development efforts prior to the
acquisition, which had not yet reached the stage of technological
feasibility and had no alternative future use; therefore, the ultimate
revenue generating capability of these projects was uncertain. The
purchased research and development was valued by an independent appraiser
using a discounted, risk-adjusted future income approach taking into
account risks related to existing and future markets and an assessment of
the life expectancy of the technology. The consolidated statement of
operations for the third quarter of 1997 included a charge for the
purchased research and development which was not deductible for income tax
purposes. The Company will incur approximately $10 million in additional
development expenditures to make the purchased research and development
commercially viable. Such modifications are expected to be completed
within 2 to 3 years, with a substantial portion of the expenditures being
incurred within the next 12 to 24 months.
The following unaudited pro forma information reflects the results of the
Company's operations as if the acquisition had occurred at the beginning
of 1997 adjusted for (i) the effect of recurring charges related to the
acquisition, primarily the amortization of goodwill, recording of interest
expense on the borrowings to finance the acquisition and a reduction of
depreciation expense due to the write-down to fair value of fixed assets,
(ii) the removal of revenues and related cost of services and expenses for
acquired businesses held for sale, and (iii) the exclusion of the effects
of the non-recurring charge of $80 million for purchased in-process
research and development recorded by the Company in fiscal 1997 following
consummation of the acquisition.
Six Months Ended
June 30, 1997
----------------
Pro forma:
Revenue $253,197,000
Net income 43,552,000
Net income per common share - basic .66
Net income per common share - diluted .65
These pro forma results have been prepared for comparative purposes only
and do not purport to be indicative of what operating results would have
been had the acquisition actually taken place at the beginning of 1997,
nor do they purport to represent results of future operations of the
merged companies.
3. On May 19, 1998, the Company's Board of Directors authorized a 2-for-1
Common Stock split in the form of a 100% stock distribution. The split was
payable on June 23, 1998 to stockholders of
10
<PAGE> 11
record on June 2, 1998. Historical common share amounts, per share amounts
and stock option data for all periods presented have been restated to give
effect to this 100% stock distribution.
4. The Company's investments in marketable securities which are classified as
available for sale had a net unrealized loss in market value of
$2,326,000, net of deferred income taxes, for the six months ended June
30, 1998. The net unrealized gain at June 30, 1998, included as a
component of stockholders' equity, was $897,000 net of deferred income
taxes. The Company's $12,561,000 investment in a limited partnership is
carried at cost. The current value of the Company's interest in the
limited partnership at June 30, 1998, as reported by the partnership, was
$16,175,000. In the third quarter of 1995, the Company invested in another
limited partnership which invests in equipment which is leased to third
parties. This investment is accounted for on the equity method since the
Company owns a 20% interest in a particular tranche of the limited
partnership. The Company's proportionate share of the partnership's income
was $270,000 and $264,000 for the six months ended June 30, 1998 and 1997,
respectively, and is included in interest income. In the second quarter of
1997, the Company made an additional investment of $4.2 million in this
limited partnership for a 25% interest in a particular tranche of new
equipment. The additional investment is also accounted for on the equity
method. The Company's proportionate share of the partnership's income
attributable to this tranche for the six months ended June 30, 1998 was
$185,000 and is included in interest income. No income was reported on
this investment as of June 30, 1997. In the second quarter of 1998, the
Company invested an additional $5.7 million for a 25% interest in a
particular tranche of new equipment. This additional investment will also
be accounted for on the equity method. No income has been reported for
this investment as of June 30, 1998.
5. The Company's Board of Directors has approved the repurchase of up to
15 million shares of the Company's outstanding common stock. Purchases may
be made from time to time, depending on market conditions and other
relevant factors. During the first six months of 1998, the Company
repurchased 1,490,000 shares on the open market for a total cost of
approximately $37 million or an average price of $24.67 per share. Such
shares are recorded as treasury shares, at cost, and can be used for
general corporate purposes. The Company has approximately 8,104,000 shares
available for repurchase under its repurchase authorizations as of June
30, 1998. In connection with the exercise of options to purchase 850,000
shares of common stock during the first quarter of 1998, an employee paid
the exercise price by delivering to the Company approximately 494,000 of
previously owned common stock. These shares were also recorded as treasury
shares at cost.
In connection with its stock repurchase authorizations, the Company sold
put options which obligate the Company, at the election of the option
holders, to repurchase up to 3,000,000 shares of common stock at prices
ranging from $23.25 to $24.00 per share. The outstanding put options
expire on various dates between August 7, 1998 and March 17, 1999. As of
August 10, 1998, no shares have been put to the Company pursuant to these
options.
6. The Company adopted Statement of Financial Accounting Standards No. 128
(SFAS No. 128), "Earnings Per Share" in 1997. SFAS No. 128 specifies the
computation, presentation and disclosure requirements for earnings per
share and requires retroactive application to all prior periods presented.
In calculating net income per common share, shares increased for diluted
net income per common share by 1,100,000 and 1,386,000 for the three
months ended June 30, 1998 and 1997, respectively, and by 1,248,000 and
1,340,000 for the six months ended June 30, 1998 and 1997, respectively,
due
11
<PAGE> 12
to the effect of stock options. Net income per common share decreased by
$.01 for all four of these periods of 1998 and 1997 due to the effect of
stock options.
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income."
Comprehensive income is a measurement of all changes in stockholders'
equity that result from transactions and other economic events other than
transactions with stockholders. For the Company, these changes consist of
changes in unrealized gains and losses from its investment portfolio. This
amount, net of related taxes, is presented as other comprehensive income
and is added to net income resulting in total comprehensive income. Other
comprehensive income was a loss of $2,326,000 and $5,000 for the six
months ended June 30, 1998 and 1997, respectively, net of related taxes.
Total comprehensive income amounted to $44,099,000 and $42,273,000 for the
six months ended June 30, 1998 and 1997, respectively.
7. On January 1, 1998, the Company changed its name from HealthCare
COMPARE Corp. to First Health Group Corp. The name change is expected to
enhance the Company's marketing efforts by integrating its various
operations and service offerings under one name that communicates the full
depth and range of the Company's health care services.
12
<PAGE> 13
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(UNAUDITED)
- -------------------------------------------------------------------------------
FORWARD-LOOKING INFORMATION
This Management's Discussion and Analysis of Financial Condition and Results
of Operations may include certain forward-looking statements, within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, including (without limitation)
statements with respect to anticipated future operating and financial
performance, growth and acquisition opportunities and other similar forecasts
and statements of expectation. Words such as "expects", "anticipates",
"intends", "plans", "believes", "seeks", "estimates" and "should" and variations
of these words and similar expressions, are intended to identify these
forward-looking statements. Forward-looking statements made by the Company and
its management are based on estimates, projections, beliefs and assumptions of
management at the time of such statements and are not guarantees of future
performance. The Company disclaims any obligations to update or revise any
forward-looking statement based on the occurrence of future events, the receipt
of new information or otherwise.
Actual future performance, outcomes and results may differ materially from
those expressed in forward-looking statements made by the Company and its
management as a result of a number of risks, uncertainties and assumptions.
Representative examples of these factors include (without limitation) general
industry and economic conditions; interest rate trends; cost of capital and
capital requirements; competition from other managed care companies; the ability
to expand the Company's workers' compensation and risk businesses; shifts in
customer demands; the timely completion of modifications to ensure that the
Company's systems are Year 2000 compliant; changes in operating expenses,
including employee wages, benefits and medical inflation; governmental and
public policy changes and the continued availability of financing in the amounts
and at the terms necessary to support the Company's future business. In
addition, if the Company does not continue to successfully integrate FHC (as
defined below) into its existing business, the Company may not realize the
intended benefits of the acquisition.
RECENT DEVELOPMENTS
On July 1, 1997, the Company acquired all of the outstanding shares of
capital stock of FIRST HEALTH Strategies, Inc. and FIRST HEALTH Services
Corporation (collectively "FHC"), excluding the stock of Viable Information
Processing Systems, Inc., a wholly-owned subsidiary of Services, from First
Financial Management Corporation and First Data Corporation for a purchase price
of $202 million in cash, subject to a working capital adjustment which resulted
in a reduction of the purchase price to approximately $196 million. In
connection with the acquisition, which was accounted for as a purchase, the
Company recorded a charge to earnings of $80 million for purchased in-process
research and development which is not deductible for income tax purposes.
In-process research and development relates to the next generation of FHC's
claims processing system software which had not yet reached the stage of
technological feasibility and had no alternative future use; therefore, the
ultimate revenue generating capability of these projects was uncertain. The
research and development acquired will require additional development efforts,
estimated to cost $10 million, to become commercially viable. Such modifications
are expected to be completed within 2 to 3 years, with a substantial portion of
the expenditures being incurred within the next 12 to 24 months.
13
<PAGE> 14
On August 30, 1997 the Company acquired Loyalty Life Insurance Company
("Loyalty"), which is licensed to conduct health insurance business in 49 states
for a purchase price of approximately $12 million. On October 1, 1996, in
anticipation of the acquisition, Loyalty entered into a reinsurance agreement
with a former affiliate, National Farmers Union Life Insurance Company
("National Farmers"). Under the terms of the reinsurance agreement, all premiums
and deposits received by Loyalty are transferred to National Farmers. Premiums
and policy benefits, which are not material in amount, are ceded to National
Farmers and shown net of such cessions in the consolidated statements of
operations. Reinsurance recoverable and the related claim reserves are reported
separately in the consolidated balance sheets. Loyalty continues to have primary
liability as a direct insurer for risks reinsured. Loyalty is currently seeking
approvals from insurance regulators and policy holders, as necessary, which
would permit the legal replacement of Loyalty by National Farmers. Such
approvals would release Loyalty from future liability under its existing
insurance policies and result in the removal of policy liabilities from the
Company's consolidated balance sheets. The Company anticipates receiving the
remainder of the approvals in 1998, but there can be no assurance that such
approvals will be obtained.
RESULTS OF OPERATIONS
Revenues for the three months and six months ended June 30, 1998 increased
84% and 90% or $57,908,000 and $120,745,000, respectively, from the comparable
periods of 1997. The Company's revenues consist primarily of fees for cost
management and administrative services provided under contracts on a percentage
of savings basis (PPO and fee schedule services) or on a predetermined
contractual basis. The Company also derives revenues based on a fixed monthly
charge for each participant, excluding covered dependents, in a client-sponsored
health care plan or on a per-transaction basis. As a result of the Company's
insurance company acquisitions, revenues also include an immaterial amount of
premium revenue.
The following table sets forth information with respect to the sources of the
Company's revenues for the three months and six months ended June 30, 1998 and
1997, respectively:
<TABLE>
<CAPTION>
SOURCES OF REVENUE
($ in thousands)
Three Months Ended June 30,
-----------------------------
1998 % 1997 %
---- - ---- -
<S> <C> <C> <C> <C>
Service:
PPO Services $ 55,947 44% $54,295 79%
Claims Admin & Related 45,981 36 -- --
Clinical Management
Services 11,771 10 4,674 7
Fee Schedule Services 7,688 6 6,831 10
-------- ---- ------- ----
Total Service 121,387 96 65,800 96
-------- ---- ------- ----
Risk:
Premiums, Net 4,757 4 2,767 4
Service 598 -- 267 --
-------- ---- ------- ----
Total Risk 5,355 4 3,034 4
-------- ---- ------- ----
Grand Total $126,742 100% $68,834 100%
======= ==== ======= ====
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------
1998 % 1997 %
---- - ---- -
<S> <C> <C> <C> <C>
Service:
PPO Services $112,602 44% $105,191 79%
Claims Admin & Related 93,225 37 -- --
Clinical Management
Services 22,971 9 9,454 7
Fee Schedule Services 15,054 6 13,130 10
-------- ---- ------- ---
Total Service 243,852 96 127,775 96
-------- ---- ------- ---
Risk:
Premiums, Net 9,317 3 5,713 4
Service 1,331 1 267 --
-------- ---- ------- ---
Total Risk 10,648 4 5,980 4
-------- ---- ------- ---
Grand Total $254,500 100% $133,755 100%
======== ==== ======= ===
</TABLE>
The growth in revenue during the three months and six months ended June 30,
1998 from the comparable periods of 1997 is primarily attributable to the
acquisition of FHC. PPO revenue increased $1,652,000 (3%) and $7,411,000 (7%),
respectively, from the same periods of 1997. This growth is primarily the result
of additional revenue from FHC clients and increased utilization of the PPO
network by existing clients. Claims administration and related represents the
majority of FHC revenue earned from processing claims in client-sponsored health
care plans. Revenue from clinical cost management services increased $7,097,000
(152%) and $13,517,000 (143%), respectively, for the three months and six months
ended June 30, 1998 from the comparable periods in 1997 due primarily to the
purchase of FHC. Revenue from fee schedule services increased $857,000 (13%) and
$1,924,000 (15%) from the comparable periods in 1997 due primarily to expanded
contract activity with several existing clients. Premium revenue increased
$1,990,000 (72%) and $3,604,000 (63%), respectively for the three months and six
months ended June 30, 1998 from the comparable periods in 1997 due primarily to
new client additions. On a sequential quarterly basis, revenue has declined from
the first to the second quarter of 1998 as well as from the fourth quarter of
1997 (see FHC Acquisition Status and The Company's Traditional Business for
further details). The Company, as well, may be adversely impacted in the third
quarter as a result of the General Motors (GM) strike and work stoppage since GM
is one of the Company's largest clients.
Cost of services increased $35,341,000 (172%) and $73,611,000 (188%),
respectively, for the three months and six months ended June 30, 1998 from the
comparable periods of 1997. Cost of services consists primarily of salaries and
related costs for personnel involved in claims administration, PPO
administration, development and expansion, utilization management programs, fee
schedule and other cost management and administrative services offered by the
Company. To a lesser extent, cost of services includes telephone expenses,
facility expenses and information processing costs. These costs have increased
significantly as a percent of revenue due to the nature of FHC's business.
Claims administration is a labor-intensive, high-volume, low-margin business.
Cost of services may continue to increase as the Company integrates the FHC
business with its traditional cost management operations.
15
<PAGE> 16
Selling and marketing costs for the three months and six months ended June
30, 1998 increased $4,987,000 (67%) and $10,615,000 (73%), respectively, from
the comparable periods of 1997 due primarily to salaries and training of sales
personnel primarily associated with the FHC acquisition but these expenses, as a
percentage of revenue, have declined since the third quarter of 1997 as the
Company has consolidated traditional FHC sales activities. To a lesser extent,
the increase related to commissions paid to agents and third-party
administrators by the Company's insurance entities.
General and administrative costs for the three months and six months ended
June 30, 1998 increased $6,854,000 (185%) and $14,316,000 (194%), respectively,
from the comparable periods of 1997. This increase is primarily attributable to
the operations of FHC as well as growth in the Company's insurance subsidiaries.
To a lesser extent, the increase relates to salaries and benefits incurred in
the executive and administrative areas of the Company.
Healthcare benefits represent medical losses incurred by insureds of the
Company's insurance entities. The loss ratio (losses as a percent of premiums)
was 94% and 92%, respectively, for the three months and six months ended June
30, 1998 compared to 74% and 72% for the comparable periods of 1997. The
increase relates to medical losses incurred for the Company's stop loss
insurance. Due to the small size of this business, this expense is expected to
be volatile until the Company can fully integrate its managed care services.
Depreciation and amortization expenses increased $3,108,000 (94%) and
$5,946,000 (93%), respec-tively, for the three months and six months ended June
30, 1998 from the comparable periods of 1997 due primarily to purchases of
computer hardware and software as well as the purchase of the Company's
Scottsdale facility and amortization of goodwill associated with the FHC and
Loyalty acquisitions. Depreciation expense as a percent of revenue remained
between 4% and 5%.
Interest income for the three months and six months ended June 30, 1998
increased $2,371,000 (74%) and $4,141,000 (62%), respectively, for the same
periods in 1997 although the amount of cash equivalents and investments has only
increased 37% since June 30, 1997 due to the repurchases of the Company's common
stock. The increase in interest income is due primarily to the Company investing
in longer term investments with higher yields and gains associated with the sale
of various investments.
Interest expense represents interest paid on the revolving credit agreement
entered into on July 1, 1997. The interest rate has been approximately 6% since
the initial funding under the credit agreement.
Net income for the three months and six months ended June 30, 1998, increased
$1,878,000 (9%) and $4,147,000 (10%), respectively, from the comparable periods
of 1997. This increase is due primarily to the revenue growth achieved through
the FHC acquisition.
Diluted net income per common share for the three months and six months ended
June 30, 1998 increased 13% to $.36 per share and 14% to $.72 per share,
respectively, from the comparable periods of 1997. The increase in net income
per common share was favorably impacted by the repurchase of approximately
1,490,000 shares of Company common stock during the first six months of 1998.
For the three months and six months ended June 30, 1998, there were
approximately 4% fewer weighted average common shares outstanding than during
the comparable periods of 1997.
16
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
The Company had $78,948,000 in working capital at June 30, 1998 compared with
working capital of $80,524,000 at December 31, 1997. The decrease is primarily
attributable to the repurchase of 1,490,000 shares of Company common stock for a
total cost of $36,751,000 during the first six months of 1998. Through the first
six months of the year, operating activities provided $56,755,000 of cash.
Investment activities used $30,204,000 of cash representing net purchases of
investments of $5,903,000 and purchases of fixed assets of $24,128,000.
Financing activities used $31,340,000 of cash representing $50,376,000 in
purchases of treasury stock (of which $36,751,000 was purchased on the open
market) partially offset by $19,036,000 in proceeds from issuance of common
stock.
On July 1, 1997, the Company entered into a $200 million revolving credit
agreement (the "Agreement") to facilitate the acquisition of FHC. In August,
1997, the Agreement was amended to increase available borrowings to $350
million. As of June 30, 1998, $200 million was outstanding under this facility.
The Company believes that its working capital, long-term investments, credit
facility and cash generated from future operations will be sufficient to fund
the Company's anticipated operations and expansion plans.
FHC ACQUISITION STATUS
The Company currently estimates that the majority of the integration of the
acquisition will continue throughout 1998 in order to properly rationalize the
various components of FHC. The Company is focusing First Health Strategies on
the niche of serving multi-sited employers of 1,000 or more employees. As a
result of this focus, the Company has sold several hundred client contracts that
do not fit into this niche which represent approximately $20 million in annual
revenue. The Company did not receive material consideration for this sale.
Additionally, the Company expects to exit certain other service lines that don't
fit into this niche. The Company has closed sales and claims pricing locations
throughout the country to centralize activities and fully integrate duplicate
support and administrative functions.
Numerous traditional First Health Strategies clients are currently in their
contract renewal phase for January 1, 1999 effective dates. The Company has
decided these renewals will occur with significant price increases, particularly
for clients that have been paying fees to the Company at unacceptable profit
levels. The Company currently anticipates that these actions may result in the
potential loss of a significant amount of business. Additionally, the Company is
negotiating with current claims administration clients to sell them its PPO,
clinical management and pharmacy benefit management (PBM) services to replace
the competitive PPO, clinical management and PBM services they may be currently
using and the Company is selling stop loss insurance where appropriate. The
biggest challenge the Company will be facing in the foreseeable future will be
to reduce expenses as quickly as the planned reduction in revenue. The Company's
inability to successfully execute on merger and integration plans may have a
material adverse impact on the Company's business.
THE COMPANY'S TRADITIONAL BUSINESS
Throughout the first two quarters of 1998, the Company will be responding to
the loss of some group health business from current clients, especially in the
Federal Employee Health Benefit (FEHBA) area. The Company anticipates realizing
a loss in business from clients that have not instituted more aggressive managed
care programs to better control escalating health care costs. However, the
Company anticipates its workers' compensation and risk areas will grow in excess
of 20% in 1998.
17
<PAGE> 18
YEAR 2000 MATTERS
The Company believes that it has identified all significant applications that
will require modification to ensure Year 2000 compliance. Internal and external
resources are being used to make the required modifications and test Year 2000
compliance. The Company plans to complete the modifications and testing process
of all significant applications by mid 1999, prior to any anticipated impact on
its operating systems. The total cost of the Year 2000 project is estimated at
$10,000,000 and is being funded through operating cash flows. Of the total
project cost, approximately $3,500,000 is attributable to the purchase of new
hardware and software which will be capitalized. The remaining $6,500,000, which
will be expensed as incurred, is not expected to have a material effect on the
results of operations. The Company expects to receive reimbursement of at least
10% of the costs directly from a number of its clients due to the nature of the
contractual arrangements with these entities.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third-party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes and other similar
uncertainties.
In addition, the Company has communicated with others with whom it does
significant business to determine Year 2000 compliance readiness and the extent
to which the Company is vulnerable to any third-party Year 2000 issues. There
can be no assurance that the systems of other companies on which the Company's
systems rely will be converted in a timely manner, or that a failure to convert
by another company, or a conversion that is incompatible with the Company's
systems, would not have a material adverse effect on the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 establishes
standards for reporting information about operating segments and related
disclosures about products and services, geographic areas and major customers.
This statement is effective for fiscal years beginning after December 15, 1997.
This standard expands or modifies current disclosures and, accordingly, will
have no impact on the Company's reported financial position, results of
operations and cash flows. The Company is assessing the impact of SFAS No. 131
on its future reporting.
In March 1998, the Accounting Standards Executive Committee of the AICPA
issued Statement of Position 98-1, ("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." The SOP provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. Specifically, certain external payroll and payroll related
costs should be capitalized during the application development state of a
project and depreciated over the computer software's useful life. The Company
currently expenses these costs as incurred and is evaluating the effects of this
SOP on its accounting for internally developed software. The SOP is expected to
be adopted in the fourth quarter of 1998.
18
<PAGE> 19
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting
and reporting standards for derivative instruments and hedging activities. This
statement is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. The Company is assessing the impact of SFAS No. 133 on its future
accounting and reporting.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
19
<PAGE> 20
PART II
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company on May 19,
1998, all directors of the Company were re-elected. The number of
votes cast for and withheld for each director were as follows:
For Withheld
--------------- --------------
Robert J. Becker, M.D. 26,023,958 722,442
Michael J. Boskin 26,023,958 722,442
Daniel S. Brunner 26,024,158 722,242
Robert S. Colman 26,023,308 723,092
Ronald H. Galowich 26,023,958 722,442
Harold S. Handelsman 26,024,058 722,342
Burton W. Kanter 26,024,058 722,342
Don Logan 26,023,208 723,192
Thomas J. Pritzker 26,023,958 722,442
David E. Simon 25,829,208 917,192
James C. Smith 26,024,158 722,242
A proposal to approve the Company's 1998 Directors' Stock Option
Plan was approved with 24,015,576 shares cast for, 2,653,504 shares
against and 77,320 shares abstaining.
A proposal to approve the Company's 1998 Stock Option Plan was
approved with 22,523,668 shares cast for, 4,068,118 shares against
and 92,373 shares abstaining. In addition, there were 62,241 broker
non-votes.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
(a) Exhibit 11 - Computation of Basic Earnings Per Common Share
(b) Exhibit 11 - Computation of Diluted Earnings Per Common Share
Reports on Form 8-K:
None
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
First Health Group Corp.
Dated: August 10, 1998 /s/James C. Smith
--------------------------
James C. Smith
President and Chief Executive Officer
Dated: August 10, 1998 /s/Joseph E. Whitters
---------------------------
Joseph E. Whitters
Chief Financial Officer
(Principal Financial and Accounting
Officer)
21
<PAGE> 1
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES EXHIBIT 11
COMPUTATION OF BASIC EARNINGS PER COMMON SHARE
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
1998 1997
------- --------
<S> <C> <C>
Net income ..................................... $23,322,000 $21,444,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period.. 63,057,000 65,898,000
Other issuances of common stock.............. 38,000 60,000
Purchases of treasury stock.................. -- (730,000)
----------- ----------
Weighted average common and common share
equivalents................................... 63,095,000 65,228,000
========== ==========
Net income per common share..................... $ .37 $ .33
========== ==========
Six Months Ended June 30,
-------------------------
1998 1997
------ ------
Net income ..................................... $46,425,000 $42,278,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period.. 63,890,000 67,394,000
Other issuances of common stock.............. 695,000 118,000
Purchases of treasury stock.................. (1,230,000) (1,338,000)
----------- -----------
Weighted average common and common share
equivalents................................... 63,355,000 66,174,000
========== ==========
Net income per common share..................... $ .73 $ .64
========== ==========
</TABLE>
22
<PAGE> 2
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES EXHIBIT 11
COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------
1998 1997
-------- -------
<S> <C> <C>
Net income...................................... $23,322,000 $ 21,444,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period.. 63,057,000 65,898,000
Other issuances of common stock.............. 38,000 60,000
Purchases of treasury stock.................. -- (730,000)
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options... 1,000,000 1,386,000
---------- ----------
Weighted average common and common share
equivalents................................... 64,195,000 66,614,000
========== ==========
Net income per common share..................... $ .36 $ .32
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
------ ------
<S> <C> <C>
Net income...................................... $46,425,000 $ 42,278,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period.. 63,890,000 67,394,000
Other issuances of common stock.............. 695,000 118,000
Purchases of treasury stock.................. (1,230,000) (1,338,000)
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options... 1,248,000 1,340,000
---------- ----------
Weighted average common and common share
equivalents................................... 64,603,000 67,514,000
========== ==========
Net income per common share..................... $ .72 $ .63
========== ==========
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> USD
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> APR-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 73,047
<SECURITIES> 179,813
<RECEIVABLES> 72,740
<ALLOWANCES> (9,934)
<INVENTORY> 0
<CURRENT-ASSETS> 245,474
<PP&E> 159,505
<DEPRECIATION> (72,758)
<TOTAL-ASSETS> 646,777
<CURRENT-LIABILITIES> 166,526
<BONDS> 0
0
0
<COMMON> 764
<OTHER-SE> 276,758
<TOTAL-LIABILITY-AND-EQUITY> 646,777
<SALES> 0
<TOTAL-REVENUES> 126,742
<CGS> 0
<TOTAL-COSTS> 83,355
<OTHER-EXPENSES> 6,412
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,161
<INCOME-PRETAX> 39,395
<INCOME-TAX> 16,073
<INCOME-CONTINUING> 23,322
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 23,322
<EPS-PRIMARY> .37
<EPS-DILUTED> .36
</TABLE>
