<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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 (IRS 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
November 9, 1998 was 60,824,407.
<PAGE> 2
First Health Group Corp. and Subsidiaries
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page Number
-----------
Item 1. Financial Statements
-----------------------------
<S> <C>
Consolidated Balance Sheets - Assets at September 30, 1998
and December 31, 1997 ...................................... 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at September 30, 1998 and December 31, 1997 ......... 4
Consolidated Statements of Operations for the three months
ended September 30, 1998 and 1997 .......................... 5
Consolidated Statements of Operations for the nine months
ended September 30, 1998 and 1997 .......................... 6
Consolidated Statements of Cash Flows for the nine months
ended September 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 ................ 13-23
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ........................................ 23
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K ................ 24
Signatures ......................................................... 25
Exhibit 11 ......................................................... 26-27
</TABLE>
<PAGE> 3
PART 1. FINANCIAL INFORMATION
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents............. $ 50,272,000 $ 77,836,000
Short-term investments................ 3,486,000 5,999,000
Accounts receivable, less allowances
for doubtful accounts of
$9,853,000 and $10,064,000,
respectively...................... 64,774,000 65,979,000
Reinsurance recoverable............... 59,577,000 142,553,000
Deferred income taxes................. 21,700,000 21,700,000
Other current assets.................. 18,336,000 11,790,000
------------ ------------
Total current assets.................. 218,145,000 325,857,000
Long-Term Investments:
Marketable securities................. 183,694,000 175,938,000
Other................................. 35,182,000 26,394,000
------------ ------------
218,876,000 202,332,000
Property and Equipment:
Buildings and improvements............ 57,295,000 51,914,000
Computer equipment and software....... 88,971,000 61,542,000
Office furniture and equipment........ 27,316,000 23,131,000
------------ ------------
173,582,000 136,587,000
Less accumulated depreciation and
amortization...................... (77,907,000) (63,567,000)
------------ ------------
Net property and equipment............ 95,675,000 73,020,000
Goodwill ................................ 99,612,000 104,729,000
Other Assets............................. 6,628,000 1,940,000
------------ ------------
$638,936,000 $707,878,000
============ ============
</TABLE>
3
<PAGE> 4
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Current Liabilities:
Accounts payable...................... $ 49,403,000 $ 49,342,000
Treasury stock purchase payable....... 22,146,000 --
Accrued expenses...................... 35,943,000 45,474,000
Income taxes payable.................. 11,431,000 --
Claims reserves....................... 73,855,000 150,517,000
------------ ------------
Total current liabilities............. 192,778,000 245,333,000
Long-Term Debt........................... 200,000,000 200,000,000
Other Non-Current Liabilities............ 3,411,000 2,938,000
------------ ------------
Total liabilities..................... 396,189,000 448,271,000
Commitments and Contingencies............ -- --
Stockholders' Equity:
Common stock.......................... 765,000 376,000
Additional paid-in capital............ 183,056,000 157,173,000
Retained earnings..................... 364,815,000 296,140,000
Unrealized holding gain (loss)
on marketable
securities........................ (2,030,000) 3,223,000
Treasury stock, at cost............... (303,859,000) (197,305,000)
------------ ------------
Total stockholders' equity............ 242,747,000 259,607,000
------------ ------------
$638,936,000 $707,878,000
============ ============
</TABLE>
4
<PAGE> 5
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
------------- -------------
<S> <C> <C>
Revenues ..................................... $125,962,000 $126,194,000
------------ ------------
Operating expenses:
Cost of services........................... 57,730,000 57,823,000
Selling and marketing...................... 12,228,000 13,766,000
General and administrative................. 10,751,000 10,287,000
Healthcare benefits........................ 5,233,000 1,900,000
In-process research and development........ -- 80,000,000
Depreciation and amortization.............. 6,027,000 5,370,000
------------ ------------
91,969,000 169,146,000
------------ ------------
Income (loss) from operations................. 33,993,000 (42,952,000)
Other (income) expense:
Interest expense........................... 3,122,000 3,013,000
Interest income............................ (5,721,000) (3,893,000)
------------ ------------
Income (loss) before income taxes............. 36,592,000 (42,072,000)
Income taxes.................................. (14,342,000) (15,816,000)
------------ ------------
Net income (loss)............................. $ 22,250,000 $(57,888,000)
============ ============
Weighted average shares outstanding - basic... 62,468,000 63,556,000
============ ============
Net income (loss) per common share - basic.... $ .36 $ (.91)
============ ============
Weighted average shares outstanding - diluted. 63,573,000 63,556,000
============ ============
Net income (loss) per common share - diluted.. $ .35 $ (.91)
============ ============
</TABLE>
5
<PAGE> 6
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
------------- ------------
<S> <C> <C>
Revenues ...................................... $380,462,000 $259,949,000
------------ ------------
Operating expenses:
Cost of services............................ 170,436,000 96,918,000
Selling and marketing....................... 37,481,000 28,404,000
General and administrative.................. 32,439,000 17,659,000
Healthcare benefits......................... 13,804,000 6,027,000
In-process research and development......... -- 80,000,000
Depreciation and amortization............... 18,365,000 11,762,000
------------ ------------
272,525,000 240,770,000
------------ ------------
Income from operations......................... 107,937,000 19,179,000
Other (income) expense:
Interest expense............................ 9,467,000 3,013,000
Interest income............................. (16,563,000) (10,594,000)
------------ ------------
Income before income taxes..................... 115,033,000 26,760,000
Income taxes................................... (46,358,000) (42,370,000)
------------ ------------
Net income (loss).............................. $ 68,675,000 $(15,610,000)
============ ============
Weighted average shares outstanding - basic.... 63,022,000 65,400,000
============ ============
Net income (loss) per common share - basic..... $ 1.09 $ (.24)
============ ============
Weighted average shares outstanding - diluted.. 64,225,000 65,400,000
============ ============
Net income (loss) per common share - diluted... $ 1.07 $ (.24)
============ ============
</TABLE>
6
<PAGE> 7
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Cash received from customers.................. $386,470,000 $252,472,000
Cash paid to suppliers and employees.......... (257,083,000) (145,765,000)
Healthcare benefits paid...................... (7,160,000) (4,636,000)
Interest income received...................... 11,816,000 12,330,000
Interest expense paid......................... (7,372,000) (1,533,000)
Income taxes paid, net........................ (33,200,000) (45,764,000)
------------ ------------
Net cash provided by operating activities..... 93,471,000 67,104,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments...................... (246,661,000) (172,576,000)
Sales of investments.......................... 227,800,000 194,314,000
Acquisition of businesses, net
of cash acquired............................ (173,000) (202,802,000)
Purchase of property and equipment............ (38,165,000) (24,722,000)
------------ ------------
Net cash used in investing activities......... (57,199,000) (205,786,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt...... -- 200,000,000
Purchase of treasury stock.................... (84,408,000) (100,802,000)
Proceeds from issuance of common stock........ 20,572,000 7,539,000
Proceeds from sale of put options
on common stock............................. -- 12,300,000
------------ ------------
Net cash provided by (used in)
financing activities........................ (63,836,000) 119,037,000
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS........ (27,564,000) (19,645,000)
CASH AND CASH EQUIVALENTS, BEGINNING
OF PERIOD...................................... 77,836,000 77,439,000
------------ ------------
CASH AND CASH EQUIVALENTS,
END OF PERIOD.................................. $ 50,272,000 $ 57,794,000
============ ============
SUPPLEMENTAL CASH FLOW DATA:
Acquisition of businesses:
Fair value of assets acquired.............. $ -- $367,438,000
Cost in excess of net assets acquired...... 173,000 92,109,000
Fair value of liabilities assumed.......... -- (327,315,000)
Research and development expenses.......... -- 80,000,000
Future payments on acquisition............. -- (9,430,000)
------------ ------------
Net cash paid.............................. $ 173,000 $202,802,000
============ ============
Non-cash financing activity:
Treasury stock purchase payable............ $ 22,146,000 $ --
============ ============
</TABLE>
7
<PAGE> 8
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1997
-------------- ---------------
<S> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
NET INCOME (LOSS)................................. $68,675,000 $(15,610,000)
----------- ------------
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
In-process research and development......... -- 80,000,000
Depreciation and amortization............... 18,365,000 11,762,000
Change in provision for uncollectible
receivables............................... (211,000) 706,000
Amortization of bond premiums............... 255,000 850,000
Tax benefit from stock options exercised.... 5,700,000 3,363,000
Unrealized holding (gain) loss on
marketable securities..................... 3,655,000 (1,019,000)
Other, net.................................. (4,495,000) (1,362,000)
Changes in Assets and Liabilities
Net of Effects of Acquired Businesses:
Accounts receivable......................... 1,416,000 (1,657,000)
Other current assets........................ (6,546,000) 20,150,000
Reinsurance recoverable..................... 82,976,000 (12,909,000)
Accounts payable and accrued expenses....... (9,470,000) (15,775,000)
Claims reserves............................. (76,662,000) 11,482,000
Income taxes payable........................ 11,431,000 578,000
Goodwill, net of amortization............... 2,597,000 --
Non-current assets and liabilities.......... (4,215,000) (13,455,000)
----------- ------------
TOTAL ADJUSTMENTS............................... 24,796,000 82,714,000
----------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES $93,471,000 $ 67,104,000
=========== ============
</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:
<TABLE>
<S> <C>
Purchase price $196,430,000
Transaction costs 3,000,000
------------
Total purchase price $199,430,000
============
Purchase price was allocated as follows:
Fair value of assets acquired $ 87,214,000
</TABLE>
9
<PAGE> 10
<TABLE>
<S> <C>
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
</TABLE>
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 from the date of acquisition, with a
substantial portion of the expenditures being incurred by mid-1999.
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.
<TABLE>
<CAPTION>
Nine Months Ended
September 30, 1997
------------------
<S> <C>
Pro forma:
Revenue $379,391,000
Net income 64,577,000
Net income per common share - basic .99
Net income per common share - diluted .96
</TABLE>
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.
10
<PAGE> 11
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
distribution was made on June 23, 1998 to stockholders of 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 $5,253,000, net of deferred income taxes, for the nine
months ended September 30, 1998. The net unrealized loss as of
September 30, 1998, included as a component of stockholders' equity,
was $2,030,000 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 September 30, 1998, as reported by the partnership, was $14,618,000.
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 of $8.3 million 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 $433,000 and
$414,000 for the nine months ended September 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 nine months
ended September 30, 1998 and 1997 was $257,000 and $70,000,
respectively, and is included in interest income. 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. The Company's proportionate share of the partnership's
income for the nine months ended September 30, 1998 was $104,000.
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 nine months of
1998, the Company repurchased 3,408,000 shares on the open market for a
total cost of approximately $81 million or an average price of $23.78
per share. Such shares are recorded as treasury shares, at cost,
and can be used for general corporate purposes. The Company has
approximately 5,686,000 shares available for repurchase under its
repurchase authorizations as of September 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 has
outstanding put options which obligate the Company, at the election of
the option holders, to repurchase up to 2,000,000 shares of common stock
at prices ranging from $23.50 to $24.00 per share. The outstanding put
options expire on various dates between December 16, 1998 and March 17,
1999. During the nine months ended September 30, 1998, 500,000 shares
were put to the Company at a total cost of $11,875,000. These shares
were recorded as treasury shares, at cost, in the Company's financial
statements.
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
11
<PAGE> 12
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 1,105,000 and 1,203,000 for the three and nine months ended
September 30, 1998 due to the effect of the grant of stock options.
Net income per common share decreased by $.01 and $.02 for the three
and nine months ended September 30, 1998. There was no dilutive
effect on shares during the three and nine months ended September 30,
1997 since the Company had a net loss for these periods.
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
$5,253,000 and a gain $1,308,000 for the nine months ended September 30,
1998 and 1997, respectively, net of related taxes. Total comprehensive
income amounted to $63,422,000 and $(14,302,000) for the nine months
ended September 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, successfully implement new contracts
and programs, and control healthcare benefit expenses, the Company may not
achieve its planned 1999 financial results (discussed below).
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
13
<PAGE> 14
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 from the date of acquisition, with a substantial
portion of the expenditures being incurred by mid-1999.
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 1999 but there can be no assurance that such
approvals will be obtained.
RESULTS OF OPERATIONS
- ---------------------
Revenues for the three months ended September 30, 1998 were nearly flat at
$125,962,000 compared to $126,194,000 during the same period last year. Revenues
for the nine months ended September 30, 1998 increased 46% to $380,462,000 from
$259,949,000 during the same period in 1997. The Company's revenues consist
primarily of fees for cost management and administrative services provided under
contracts on a percentage of savings basis (PPO and fee schedule services) or on
a predetermined contractual basis. The Company also derives revenues based on a
fixed monthly charge for each participant, excluding covered dependents, in a
client-sponsored health care plan or on a per-transaction basis. As a result of
the Company's insurance company acquisitions, revenues also include an
immaterial amount of premium revenue which is reported in the following table
under the caption "Risk".
14
<PAGE> 15
The following table sets forth information with respect to the sources of
the Company's revenues for the three months and nine months ended September 30,
1998 and 1997, respectively:
<TABLE>
<CAPTION>
SOURCES OF REVENUE
($ in thousands)
Three Months Ended September 30,
--------------------------------
1998 % 1997 %
---- - ---- -
<S> <C> <C> <C> <C>
Service:
PPO Services $ 55,035 44% $ 57,418 45%
Claims Admin & Related 47,119 37 46,332 37
Clinical Management
Services 10,477 8 12,503 10
Fee Schedule Services 7,843 6 7,201 6
-------- ---- -------- ----
Total Service 120,474 95 123,454 98
-------- ---- -------- ----
Risk:
Premiums, Net 4,666 4 2,437 2
Service 822 1 303 --
-------- ---- -------- ----
Total Risk 5,488 5 2,740 2
-------- ---- -------- ----
Grand Total $125,962 100% $126,194 100%
======== ---- ======== ====
Nine Months Ended September 30,
1998 % 1997 %
---- - ---- -
Service:
PPO Services $167,637 44% 162,609 63%
Claims Admin & Related 140,344 37 46,332 18
Clinical Management
Services 33,448 9 21,957 8
Fee Schedule Services 22,897 6 20,331 8
-------- ---- -------- ----
Total Service 364,326 96 251,229 97
-------- ---- -------- ----
Risk:
Premiums, Net 13,983 3 8,150 3
Service 2,153 1 570 --
-------- ---- -------- ----
Total Risk 16,136 4 8,720 3
-------- ---- -------- ----
Grand Total $380,462 100% $259,949 100%
======== ==== ======== ====
</TABLE>
Revenue for the three months ended September 30, 1998 was approximately
flat compared to the same period of 1997 as the Company has lost a number of
traditional First Health Strategies clients (see "FHC Acquisition Status") and,
to a lesser extent, some traditional HealthCare COMPARE clients. The growth in
revenue during the nine months ended September 30, 1998 from the comparable
period of 1997 is primarily attributable to the acquisition of FHC. PPO revenue
for the three and nine months ended September 30,
15
<PAGE> 16
1998 decreased $2,383,000 (4%) and increased $5,028,000 (3%), respectively, from
the same periods of 1997. The decrease in the third quarter is primarily due to
a loss of business as discussed under "FHC Acquisition Status" and "The
Company's Traditional Business". The increase for the nine months ended
September 30, 1998 is due primarily to the inclusion of FHC revenue for nine
months. Claims administration and related primarily represents FHC revenue
earned from processing claims in client-sponsored health care plans. Revenue
from clinical cost management services decreased $2,026,000 (16%) and increased
$11,491,000 (52%), respectively, for the three months and nine months ended
September 30, 1998 from the comparable periods in 1997. The decrease in the
third quarter is also due to the loss of business mentioned above. The increase
for the nine months ended September 30, 1998 is due primarily to the acquisition
of FHC. Revenue from fee schedule services increased $642,000 (9%) and
$2,566,000 (13%) from the comparable periods in 1997 due primarily to expanded
contract activity with several existing clients. Premium revenue increased
$2,229,000 (91%) and $5,833,000 (72%), respectively for the three months and
nine months ended September 30, 1998 from the comparable periods in 1997 due
primarily to new client additions. On a sequential quarterly basis, revenue
declined from the first to the second quarter of 1998 as well as from the second
quarter to the third quarter of 1998 (see "FHC Acquisition Status" and "The
Company's Traditional Business" for further details).
Cost of services decreased $93,000 (0.2%) and increased $73,518,000 (76%),
respectively, for the three months and nine months ended September 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 on a year-to-date basis due to the nature of FHC's business.
Claims administration is a labor-intensive, high-volume, low-margin business.
The decrease in cost of services for the three months ended September 30, 1998
is due primarily to the cost cutting measures the Company has initiated during
the integration of the FHC business. These costs have increased from the second
quarter of 1998 due primarily to additional expenditures incurred to remediate
software for Year 2000 compliance in the Company's Services business.
Selling and marketing costs for the three months and nine months ended
September 30, 1998 decreased $1,538,000 (11%) and increased $9,077,000 (32%),
respectively, from the comparable periods of 1997. The decrease in the third
quarter is due primarily to the consolidation of FHC sales activities into the
traditional Company sales activities. The increase on a year-to-date basis is
due to the inclusion of nine months of FHC financial results in 1998.
General and administrative costs for the three months and nine months
ended September 30, 1998 increased $464,000 (5%) and $14,780,000 (84%),
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.
Healthcare benefits represent medical losses incurred by insureds of the
Company's insurance entities. The loss ratio (losses as a percent of premiums)
was 112% and 99%, respectively, for the three months and nine months ended
September 30, 1998 compared to 78% and 74% for the comparable periods of 1997.
The increase relates to medical losses incurred for the Company's small group
and stop loss insurance businesses.
16
<PAGE> 17
Depreciation and amortization expenses increased $657,000 (12%) and
$6,603,000 (56%), respectively, for the three months and nine months ended
September 30, 1998 from the comparable periods of 1997 due primarily to
purchases of computer hardware and software as well as the 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 nine months ended September 30,
1998 increased $1,828,000 (47%) and $5,969,000 (56%), respectively, from the
same periods in 1997 although the amount of cash equivalents and investments
have decreased 13% since September 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 $3.7 million
in gains associated with the sale of various investments.
Interest expense consists of interest paid on the revolving credit
agreement entered into on July 1, 1997 to finance the acquisition of FHC. The
interest rate has been approximately 6% since the initial funding under the
credit agreement.
Net income (excluding the effects of the 1997 charge for in-process
research and development) for the three months and nine months ended September
30, 1998, increased $138,000 (1%) and $4,285,000 (7%), 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 (excluding the effects of the 1997
charge for in-process research and development) for the three months and nine
months ended September 30, 1998 increased 3% to $.35 per share and 11% to $1.07
per share, respectively, from the comparable periods of 1997. The increase in
net income per common share was favorably impacted by the total of 4.4 million
shares of Company common stock added to treasury during the first nine months of
1998. For the three months and nine months ended September 30, 1998, diluted
common shares outstanding decreased 3% and 4%, respectively, from the comparable
periods of 1997.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company had $25,367,000 in working capital at September 30, 1998
compared with working capital of $80,524,000 at December 31, 1997. The decrease
is primarily attributable to the repurchase of 3,908,000 shares of Company
common stock for a total cost of $92,929,000 during the first nine months of
1998 ($22,146,000 of which was payable as of September 30, 1998 for trades not
yet settled). Through the first nine months of the year, operating activities
provided $93,471,000 of cash. Investment activities used $57,199,000 of cash
representing net purchases of investments of $18,861,000 and purchases of fixed
assets of $38,165,000. Financing activities used $63,836,000 of cash
representing $84,408,000 in purchases of treasury stock (of which $58,908,000
was purchased on the open market with the balance being purchased through the
exercise of put options and the funding of stock option exercises) partially
offset by $20,572,000 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
17
<PAGE> 18
increase available borrowings to $350 million. As of September 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 and into 1999 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.
The Company is in the final stages of contract renewal with numerous
traditional First Health Strategies clients for January 1, 1999 effective dates.
The Company has decided that such contracts will include significant price
increases, particularly for clients that have been paying fees to the Company at
unacceptable profit levels. These actions have resulted in the loss of a
significant number of clients. Additionally, the Company is negotiating with
current claims administration clients to provide 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. In addition, the Company is offering these clients stop loss insurance
where appropriate. The Company's biggest challenge in the foreseeable future
will be to reduce expenses as quickly as the anticipated 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 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 also anticipates realizing a loss in business
from clients that have not instituted more aggressive managed care programs to
better control escalating health care costs. As the Company prepares for 1999,
it does not anticipate the loss of any meaningful business from its traditional
client base.
1999 OUTLOOK
- ------------
Currently the Company anticipates that its earnings per share (EPS) growth
in 1999 will be approximately 10% and will be driven by:
PPO growth which is targeted in the high single digit area, which is
highly dependent on the receipt of new contracts and implementation of new
business, particularly in the workers' compensation area.
FEE SCHEDULE growth is anticipated to exceed 20% as the workers'
compensation business is the Company's fastest growing area. This growth is
dependent on the addition of new clients with whom the Company is currently
engaged in discussions.
UTILIZATION MANAGEMENT AND CLAIMS ADMINISTRATION revenue are estimated to
decline by more than 10% due to the loss of customers resulting from the
Company's renewal strategy of requiring clients to take all services it offers
and instituting substantial price increases. Management anticipates that
numerous clients that are principally single-sited, such as school districts,
hospitals and municipalities will not renew their contracts. Although contract
renewals by traditional FIRST HEALTH clients has progressed at a satisfactory
rate, certain large clients that the Company had hoped to retain chose not to
renew their contracts. Accordingly, the 1999 contract renewal process has not
been as successful as originally anticipated.
RISK BUSINESS revenue is anticipated to decline approximately 10% in 1999
as a result of the Company's implementation of substantial price increases in
this area. Consequently, the Company anticipates that certain current clients
will not renew their contracts.
Looking at each of the Company's business segments, management foresees
the following:
Overall revenue growth in 1999 versus 1998 will be modest with a decline in
the mid to high single digits in group health revenue driven by a decrease in
the number of clients served. However, solid growth in the workers'
compensation and public sector business is anticipated.
The remaining group health business is expected to be more profitable due
to the various actions that have been undertaken during the last several
months, including implementing an average price increase of approximately 10%
on claims administration, displacing competitive PPO networks, streamlining
operations and improving efficiency.
The projected decrease in group health revenue is driven by four factors:
1) anticipated client losses; 2) fewer employers making new managed care
commitments in 1998 and reduced new business opportunities resulting in
increased price competition; 3) lower retention of the traditional FIRST HEALTH
block of business than originally anticipated; 4) delayed start-up and slower
ramp-up of some new business.
On the positive side, the Company expects that the business it has
retained will be stable and more profitable than in 1998. The Company has
succeeded in narrowing the focus of the FIRST HEALTH business to multi-sited
national payers with more standardized requirements than existed at the time of
the acquisition. These changes are expected to enable the Company to lower
overall costs while improving services, which is anticipated to result in
increased profitability.
WORKERS' COMPENSATION is the Company's fastest growing area and revenue
growth in excess of 20% is projected. The Company is negotiating several new
contracts and forecasted revenue growth is dependent on the successful
completion and implementation of these contracts.
PUBLIC SECTOR BUSINESS-MEDICAID revenue growth is expected to increase by
approximately 15% as a result of numerous contracts the Company is actively
pursuing.
18
<PAGE> 19
YEAR 2000 MATTERS
- -----------------
General
-------
The Company has made significant progress on its company-wide Year 2000
(or "Y2K") readiness project, and the project is currently on target to have the
Company's significant information technology ("IT") and non-IT systems Y2K ready
by the end of 1999. The Company defines a significant system as one which, if
not Y2K ready, may have a material adverse impact on its results of operations,
revenues, regulatory compliance or relationships with customers, vendors or
others. The Company is using both internal and external resources to accomplish
its Y2K project objectives. Modification of the source code for the Company's
primary group health medical claims processing system has been completed and
testing of the modified system has begun. Modification of the source
19
<PAGE> 20
code for the Company's pharmacy claims processing system is continuing and is
expected to be completed by the end of 1998. The Company believes that
significant IT systems are either currently Y2K ready, will be replaced with
systems designed to be Y2K ready, or retired by the end of 1999. As a service
provider, the Company's non-IT systems consist primarily of equipment typically
found in commercial office buildings including, electrical, fire alarm and
suppression, security, HVAC and elevator systems, and the Company does not
anticipate any material Y2K problems with the non-IT systems within its control.
As part of its Y2K project, the Company is assessing, and developing contingency
plans to address the most reasonably likely worst case scenarios from the
failure of a significant Company or a material third party system to be Y2K
ready.
Y2K Project
-----------
The Company has instituted a corporate-wide Y2K readiness project to
identify its IT and non-IT systems which will require modification or
replacement and to establish appropriate remediation and contingency plans to
avoid an impact on its ability to continue to provide its services. Current
plans call for any necessary modifications, replacements and testing to support
Year 2000 to be completed before the end of 1999, prior to any anticipated
potential impact on the Company's services and operations. The Company's Y2K
project is divided into three major sections: 1) IT Software Systems, 2) IT
Hardware Systems and, 3) Non-IT Systems. For each major section, the Company has
implemented the following five-phase approach:
1. Inventory Phase. Inventory of significant systems.
2. Assessment Phase. Assessment of the vulnerability of significant
systems to the Y2K problem and development of correction and
contingency plans.
3. Modification/Replacement Phase. Modification of computer source code,
and software, hardware and equipment upgrade, retirement or
replacement.
4. Testing & Validation Phase. Testing (both internally and with third
parties) of all modified, upgraded or replaced components and
interfaces.
5. Implementation Phase. Modified, upgraded or replaced components are put
into operation.
The following chart graphically depicts the approximate current state of
completion for each phase:
<TABLE>
<CAPTION>
===============================================================================================
Inventory Assessment Modification or Testing and Implementation
Phase Phase Replacement Phase Validation Phase Phase
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IT Software 100% 70% 70% 20% 0%
- -----------------------------------------------------------------------------------------------
IT Hardware 100% 85% 70% 0% 0%
- -----------------------------------------------------------------------------------------------
Non-IT Systems 100% 25% 0% 0% 0%
===============================================================================================
</TABLE>
20
<PAGE> 21
IT Software Systems
The Company's IT software systems are comprised of both proprietary and
commercial third party software applications which can be generally be divided
into three categories: 1) database systems, 2) operational systems, and 3)
claims administration systems. The Company has completed the inventory phase
for all its IT software systems.
Database Systems. The assessment phase of the Company's database systems
is also complete. As part of its ongoing efforts to update and enhance its IT
resources, the majority of the Company's database systems currently utilize four
digits to represent the year in date data (i.e., 02/02/1998). Consequently,
nearly all database IT systems presently being used by the Company were created
with the change of millennium in mind and no further modifications are
necessary. The testing and validation phase is expected to be completed by the
end of the second quarter of 1999.
Operational Systems. Approximately 70% of roughly 350 operational systems
(consisting primarily of third party software applications) have been assessed.
Of those assessed, the Company has received assurances from approximately 85% of
the third party vendors that their systems are currently Y2K ready. For those
systems that may have a Y2K problem, the Company is assessing whether it will
modify, upgrade, replace or retire such systems. The operational systems
assessment phase expected to be completed by the end of 1998.
Claims Administration Systems. The Company utilizes a number of different
systems to process health benefits claims for its clients. The Company's primary
group health and Medicaid medical claims administration system is proprietary to
the Company. Utilizing both internal and external resources, modification of the
source code for the group health system was completed in the third quarter of
1998. Testing of the modified system also began in the third quarter of 1998. As
part of the testing phase, prior to the end of 1998, the Company plans to
communicate with clients and other third parties which interface with this
system and establish time frames to complete necessary testing and validation.
The testing and validation phase is expected to be completed by the end of the
second quarter of 1999.
The Company also licenses a medical claims administration system from a
third party vendor, which is used primarily to process claims for the Company's
risk clients. The Company has received written assurance that this system was
designed and programmed with the Year 2000 in mind, and that all updates and
changes to the system continue to be Year 2000 compliant.
To process pharmacy claims for clients, the Company utilizes a
Company-owned proprietary system. Utilizing both internal and external
resources, modification of the source code for this system is continuing and is
expected to be completed by the end of 1998.
The Company utilizes a proprietary claims processing system for its
government (Medicaid) contracts. Utilizing both internal and external services,
modification of the source code for this system is estimated to be completed in
early 1999. As part of the testing phase, the Company plans to communicate with
clients and other third parties that interface with this system and establish
time frames to complete necessary testing and validation. The testing and
validation phase is expected to be completed by the end of the third quarter of
1999.
Additionally, the Company has an agreement with Electronic Data Systems
("EDS") for access to certain EDS systems to enable the Company and EDS to
provide certain workers' compensation bill repricing services to Company
clients. The Company has received assurances from EDS that it is taking
appropriate measures to ensure its systems will not be interrupted by a Y2K
problem. The Company and EDS are also working together to ensure Company clients
are notified of any EDS
21
<PAGE> 22
system changes and modifications that clients will need to make, and to
establish any necessary testing and validation schedules. The testing and
validation phase is expected to be completed by the end of the second quarter of
1999.
IT Hardware Systems
-------------------
The Company has completed the inventory phase for its IT hardware systems,
and the assessment phase is currently on target to be completed by the end of
1998.
Non-IT Systems
--------------
The Company's non-IT systems are primarily comprised of systems typically
found in commercial office buildings including, electrical, fire alarm and
suppression, security, HVAC and elevator systems. The inventory phase for non-IT
systems at the Company's major facilities in Downers Grove, IL, Salt Lake City,
UT, Scottsdale, AZ and Sacramento, CA is complete. The Company is currently at
the beginning of the assessment phase for its non-IT systems. As part of the
assessment phase, the Company is communicating with the owners/landlords of
office spaces which the Company leases to determine the Year 2000 readiness of
such office space. The Company is also communicating with its significant
vendors and suppliers to determine their Y2K readiness and, when possible,
obtain written assurances that the Y2K problem will not materially adversely
effect their ability to continue to provide supplies or services to the Company.
Costs
-----
The Company estimates the total cost of its Y2K readiness project to be
approximately $15,000,000 which will be funded through operating cash flows. Of
the total project cost, approximately $5,000,000 is attributable to the purchase
of new hardware and software which will be capitalized. The remaining
$10,000,000, which will be expensed as incurred, is not expected to have a
material effect on the results of operations. To date, the Company has incurred
approximately $9,000,000 (60%) of its total estimated Year 2000 costs. 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.
Year 2000 remediation costs represent approximately 15% of the Company's
total IT budget and no material projects have been deferred due to the Company's
Year 2000 efforts.
Contingency Plans
-----------------
The Company's IT systems interface with numerous clients, medical service
providers and regulatory agencies, and failure to correct a material Y2K problem
could interrupt business activities and operations and materially adversely
affect the Company's results of operations, revenues, regulatory compliance or
relationships with customers, vendors or others. Not only must the Company
ensure that its own IT and non-IT systems are Y2K ready, but it also must
ascertain that the systems of third parties with whom the Company interfaces are
both Y2K ready and that their solutions to the Y2K problem are compatible with
those of the Company. As the Company assesses the Y2K readiness of its IT and
non-IT systems' contingency plans are also being developed to address the most
reasonably likely worst case scenarios from the failure of a significant Company
or material third party system to be Y2K ready. Contingency plans will continue
to be modified and developed as the Company progresses in its Y2K readiness
project.
22
<PAGE> 23
Projected completion dates for Y2K modifications and testing are based on
current best estimates, derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. The Company believes its Y2K project will
reduce the uncertainty about the Y2K readiness of its significant customers,
vendors and suppliers and, therefore, its ability to continue to provide its
services without significant interruptions in its normal business operations.
However, due to the general uncertainty inherent in the Y2K problem, in
particular the uncertainty of the Y2K readiness of customers and third-party
suppliers such as utility and telecommunications companies, the Company is
unable to determine at this time whether actual results will differ materially
from those anticipated, whether third party systems on which the Company's
systems rely will be converted in a timely manner, or that failure by a third
party to convert its systems, 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 internal payroll and payroll related
costs should be capitalized during the application development stage 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.
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.
23
<PAGE> 24
PART II
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
24
<PAGE> 25
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: November 9, 1998 /s/James C. Smith
---------------------------------------
James C. Smith
President and Chief Executive Officer
Dated: November 9, 1998 /s/Joseph E. Whitters
---------------------------------------
Joseph E. Whitters
Chief Financial Officer
(Principal Financial and Accounting Officer)
25
<PAGE> 1
EXHIBIT 11
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
COMPUTATION OF BASIC EARNINGS PER COMMON SHARE
(UNAUDITED)
- ------------------------------------------------
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Net income (loss) .............................. $22,250,000 $(57,888,000)
=========== ============
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period .. 63,138,000 63,436,000
Other issuances of common stock .............. 62,000 120,000
Purchases of treasury stock .................. (732,000) --
---------- -------------
Weighted average common and common share
equivalents .................................... 62,468,000 63,556,000
=========== ============
Net income (loss) per common share ............ $.36 $(.91)
=========== ============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Net income (loss) .............................. $68,675,000 $(15,610,000)
=========== ============
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period .. 63,890,000 67,394,000
Other issuances of common stock .............. 881,000 224,000
Purchases of treasury stock .................. (1,749,000) (2,218,000)
---------- -------------
Weighted average common and common share
equivalents .................................... 63,022,000 65,400,000
=========== ============
Net income (loss) per common share ............. $1.09 $(.24)
=========== ============
</TABLE>
26
<PAGE> 2
EXHIBIT 11
<TABLE>
<CAPTION>
FIRST HEALTH GROUP CORP. AND SUBSIDIARIES
COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE
(UNAUDITED)
- ------------------------------------------------
Three Months Ended September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Net income (loss) .............................. $22,250,000 $(57,888,000)
=========== ============
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period .. 63,138,000 63,436,000
Other issuances of common stock .............. 62,000 120,000
Purchases of treasury stock .................. (732,000) --
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options .... 1,105,000 --
---------- -------------
Weighted average common and common share
equivalents .................................... 63,573,000 63,556,000
=========== ============
Net income (loss) per common share ............. $.35 $(.91)
=========== ============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Net income (loss) .............................. $68,675,000 $(15,610,000)
=========== ============
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period .. 63,890,000 67,394,000
Other issuances of common stock .............. 881,000 224,000
Purchases of treasury stock .................. (1,749,000) (2,218,000)
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options .... 1,203,000 --
---------- -------------
Weighted average common and common share
equivalents .................................... 64,225,000 65,400,000
=========== ============
Net income (loss) per common share ............. $1.07 $(.24)
=========== ============
</TABLE>
27
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 50,272
<SECURITIES> 187,180
<RECEIVABLES> 74,627
<ALLOWANCES> (9,853)
<INVENTORY> 0
<CURRENT-ASSETS> 218,145
<PP&E> 173,582
<DEPRECIATION> (77,907)
<TOTAL-ASSETS> 638,936
<CURRENT-LIABILITIES> 192,778
<BONDS> 0
0
0
<COMMON> 765
<OTHER-SE> 241,982
<TOTAL-LIABILITY-AND-EQUITY> 638,936
<SALES> 0
<TOTAL-REVENUES> 125,962
<CGS> 0
<TOTAL-COSTS> 85,942
<OTHER-EXPENSES> 6,027
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,122
<INCOME-PRETAX> 36,592
<INCOME-TAX> 14,342
<INCOME-CONTINUING> 22,250
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,250
<EPS-PRIMARY> .36
<EPS-DILUTED> .35
</TABLE>
