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 March 31, 1999
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 on May 7, 1999, was 50,542,177.
<PAGE>
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at March 31, 1999
and December 31, 1998 ...................... 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at March 31, 1999 and December 31, 1998 4
Consolidated Statements of Operations for the three months
ended March 31, 1999 and 1998 .............. 5
Consolidated Statements of Comprehensive Income for the
three months ended March 31, 1999 and 1998 . 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and 1998 .............. 6-7
Notes to Consolidated Financial Statements ... 8-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ..... 13-18
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ............................. 19
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K .... 20
Signatures.......................................... 21
<PAGE>
<TABLE>
PART 1. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS March 31, 1999 December 31, 1998
----------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents ..... $ 18,735,000 $ 50,264,000
Short-term investments ........ 769,000 961,000
Accounts receivable, less allowances
for doubtful accounts of $11,176,000
and $11,151,000, respectively 69,019,000 63,582,000
Reinsurance recoverable ....... 54,958,000 57,466,000
Deferred income taxes ......... 18,415,000 18,415,000
Other current assets .......... 11,617,000 10,874,000
----------- -----------
Total current assets .......... 173,513,000 201,562,000
Long-Term Investments:
Marketable securities ......... 99,807,000 125,120,000
Other ......................... 23,979,000 23,431,000
----------- -----------
123,786,000 148,551,000
----------- -----------
Property and Equipment:
Land, buildings and improvements 63,074,000 59,228,000
Computer equipment and software 91,182,000 80,944,000
Office furniture and equipment 11,746,000 13,617,000
----------- -----------
166,002,000 153,789,000
Less accumulated depreciation and
amortization.................. (56,189,000) (49,805,000)
----------- -----------
Net property and equipment .... 109,813,000 103,984,000
----------- -----------
Goodwill......................... 93,953,000 100,151,000
Other Assets..................... 3,600,000 3,631,000
----------- -----------
$504,665,000 $557,879,000
=========== ===========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, 1999 December 31, 1998
----------- -----------
<S> <C> <C>
Current Liabilities:
Accounts payable .............. $ 52,825,000 $ 52,408,000
Treasury stock purchase payable 232,000 25,000,000
Accrued expenses .............. 25,381,000 33,545,000
Income taxes payable .......... 10,371,000 2,611,000
Claims reserves ............... 67,985,000 72,589,000
----------- -----------
Total current liabilities ..... 156,794,000 186,153,000
Long-Term Debt................... 225,000,000 225,000,000
Other Non-Current Liabilities.... 8,382,000 8,599,000
----------- -----------
Total liabilities ............. 390,176,000 419,752,000
----------- -----------
Commitments and Contingencies.... -- --
Stockholders' Equity:
Common stock .................. 766,000 765,000
Additional paid-in capital .... 180,318,000 182,842,000
Retained earnings.............. 401,723,000 384,143,000
Accumulated comprehensive income (3,472,000) (3,099,000)
Treasury stock, at cost ....... (464,846,000) (426,524,000)
----------- -----------
Total stockholders' equity .... 114,489,000 138,127,000
----------- -----------
$504,665,000 $557,879,000
=========== ===========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Revenues............................ $117,361,000 $127,758,000
----------- -----------
Operating expenses:
Cost of services ................. 55,696,000 56,813,000
Selling and marketing ............ 11,742,000 12,837,000
General and administrative ....... 9,520,000 11,120,000
Healthcare benefits .............. 2,249,000 4,093,000
Depreciation and amortization .... 7,046,000 5,926,000
----------- -----------
86,253,000 90,789,000
Income from operations.............. 31,108,000 36,969,000
Other (income) expense:
Interest expense ................. 3,411,000 3,184,000
Interest income .................. (1,607,000) (5,261,000)
----------- -----------
Income before income taxes.......... 29,304,000 39,046,000
Income taxes........................ (11,724,000) (15,943,000)
----------- -----------
Net income.......................... $ 17,580,000 $ 23,103,000
=========== ===========
Weighted average shares
outstanding - basic 52,752,000 63,710,000
=========== ===========
Net income per common share - basic. $ .33 $ .36
=========== ===========
Weighted average shares
outstanding - diluted 53,108,000 64,884,000
=========== ===========
Net income per common share - diluted $ .33 $ .36
=========== ===========
</TABLE>
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Net income.......................... $17,580,000 $23,103,000
---------- ----------
Unrealized losses on securities, before tax (622,000) (1,240,000)
Income tax benefit related to items of other
comprehensive income.............. 249,000 506,000
---------- ----------
Other comprehensive loss............ (373,000) (734,000)
---------- ----------
Comprehensive income................ $17,207,000 $22,369,000
========== ===========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Cash received from customers ......... $113,012,000 $121,307,000
Cash paid to suppliers and employees . (81,819,000) (73,544,000)
Healthcare benefits paid ............. (3,743,000) (1,521,000)
Interest income received ............. 2,638,000 3,637,000
Interest expense paid ................ (3,343,000) (2,287,000)
Income taxes paid, net ............... (3,958,000) (2,927,000)
----------- -----------
Net cash provided by operating activities 22,787,000 44,665,000
----------- -----------
Cash flows from investing activities:
Purchases of investments ............. (32,386,000) (109,366,000)
Sales of investments ................. 56,296,000 85,017,000
Purchase of property and equipment ... (12,213,000) (14,382,000)
----------- -----------
Net cash provided by (used in)
investing activities.................. 11,697,000 (38,731,000)
----------- -----------
Cash flows from financing activities:
Exercises of put options on common stock (4,429,000) --
Purchase of treasury stock ........... (63,090,000) (50,376,000)
Proceeds from issuance of common stock 1,096,000 17,748,000
Proceeds from sale of put options on
common stock 410,000 --
----------- -----------
Net cash used in financing activities (66,013,000) (32,628,000)
Net decrease in cash and cash equivalents (31,529,000) (26,694,000)
Cash and cash equivalents, beginning
of period 50,264,000 77,836,000
----------- -----------
Cash and cash equivalents, end of period $ 18,735,000 $ 51,142,000
=========== ===========
Supplemental cash flow data:
Non-cash financing activity:
Treasury stock purchase payable ... $ 232,000 $ --
=========== ===========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Reconciliation of Net Income to Net Cash
Provided by Operating Activities:
Net Income............................... $ 17,580,000 $ 23,103,000
----------- -----------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and amortization ....... 7,046,000 5,926,000
Change in provision for uncollectible
receivables 25,000 (98,000)
Tax benefit from stock options exercised -- 5,156,000
Unrealized holding loss on marketable
securities 240,000 388,000
(Gain) loss on investment sales ..... 759,000 (1,416,000)
Other, net .......................... 55,000 (21,000)
Changes in Assets and Liabilities:
Accounts receivable ................. (5,462,000) (9,938,000)
Other current assets ................ (743,000) (5,658,000)
Reinsurance recoverable ............. 2,508,000 57,227,000
Accounts payable and accrued expenses (7,747,000) 14,865,000
Claims reserves ..................... (4,604,000) (54,983,000)
Income taxes payable ................ 7,760,000 11,819,000
Non-current assets and liabilities .. 5,370,000 (1,705,000)
----------- -----------
Total adjustments ..................... 5,207,000 21,562,000
----------- -----------
Net cash provided by operating activities $ 22,787,000 $ 44,665,000
=========== ===========
</TABLE>
<PAGE>
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, 1998. Accordingly, footnote
disclosures which would substantially duplicate the disclosures
contained in the December 31, 1998 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 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.
3. The Company's investments in marketable securities which are
classified as available for sale had a net unrealized loss in
market value of $373,000, net of deferred income taxes, for the
three months ended March 31, 1999. The net unrealized loss as of
March 31, 1999, included as a component of stockholders' equity,
was $3,472,000 net of deferred income taxes. The Company
liquidated its $12,561,000 investment in a limited partnership
during 1998. The Company received proceeds of $13,131,000 from
the sale and expects to receive additional funds in 1999 after the
completion of the audit of the partnership. The Company has three
separate investments in another limited partnership which invests
in equipment which is leased to third parties. The total
investment as of March 31, 1999 was $21.1 million and is accounted
for on the equity method since the Company owns between a 20% and
25% interest in each particular tranche of the limited
partnership. The Company's proportionate share of the
partnership's income was $355,000 and $225,000 for the three
months ended March 31, 1999 and 1998, respectively, and is
included in interest income.
<PAGE>
4. The Company's Board of Directors has approved the repurchase of up
to 15 million shares of the Company's outstanding common stock
under its current authorization. Purchases may be made from time
to time, depending on market conditions and other relevant
factors. During the first three months of 1999, the Company
repurchased 2,256,000 shares for a total cost of approximately
$38.3 million (of which $232,000 was payable at March 31, 1999).
Such shares are recorded as treasury shares, at cost, and can be
used for general corporate purposes. The Company has approximately
11.1 million shares available for repurchase under its repurchase
authorizations as of March 31, 1999.
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 3,250,000
shares of common stock at prices ranging from $14.50 to $15.50 per
share. The outstanding put options expire on various dates
between June 30, 1999 and December 20, 1999. During the three
months ended March 31, 1999, 977,000 (of the 2,256,000 shares
that were repurchased) shares were put to the Company at a total
cost of $22,891,000. These shares were recorded as treasury shares,
at cost, in the Company's financial statements. In addition,
the Company settled 573,000 puts by delivering $4,429,000 in cash
to the option holders.
5. Weighted average shares outstanding increased for diluted earnings
per share by 356,000 and 1,174,000, respectively, for the three
months ended March 31, 1999 and 1998 due to the effect of stock
options. Diluted net income per share was the same as basic net
income per share for each of these periods.
6. 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 $373,000 and $734,000 for the
three months ended March 31, 1999 and 1998, respectively, net of
related taxes. Total comprehensive income amounted to $17,207,000
and $22,369,000 for the three months ended March 31, 1999 and 1998,
respectively.
<PAGE>
In 1998, the Company also adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" ("SFAS No. 131"). The Company has determined
it currently operates in one reportable segment as defined by SFAS
No. 131.
Effective January 1, 1999, the Company adopted Statement of
Position 98-1, ("SOP 98-1"), "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." The Company now
capitalizes certain internal payroll and payroll related costs
during the application development stage of a software project.
The effect of adopting SOP 98-1 on the Company's first quarter
results of operations and financial position for the three months
ended March 31, 1999 was not material.
7. The Company and its subsidiaries are subject to various claims
arising in the ordinary course of business and are parties to
various legal proceedings which constitute litigation incidental to
the business of the Company and its subsidiaries. In the opinion
of the Company's management, only one matter is potentially
material to the business or the financial condition of the Company.
On August 6, 1998, amended counterclaims were asserted against the
Company in a lawsuit pending in the United States District Court
for the Northern District of Illinois. The Company had initiated a
lawsuit against United Payors and United Providers ("UP & UP"), a
network of hospital and other medical providers, on April 26, 1996
asserting claims for trademark infringement and state law claims
for deceptive trade practices, fraud and deceptive business
practices and for intentional interference with contracts.
At this time, the Company alleges that UP & UP has employed and
continues to employ false and misleading statements and practices
concerning the nature of its own services and relationships with
payor clients, as well as the nature of the Company's services and
relationships with its payor clients, among other related subjects.
Specifically, the Company alleges that UP & UP misled hospitals to
believe that the benefits of joining UP & UP's network would
principally include the likelihood of an increased market share of
patient visits by mandatory commitments from UP & UP's payor
clients to implement financial incentives and to otherwise
influence its clients' covered beneficiaries to select a provider
in UP & UP's network. The Company further alleges that UP & UP
representatives made false representations claiming an affiliation
or association with the Company's own proprietary network, The
AFFORDABLE Medical Networks.
<PAGE>
In answering the Company's lawsuit, UP & UP denied the allegations
and asserted defenses. UP & UP also asserted counterclaims seeking
damages for alleged "false advertising" by the Company, unfair
competition and deceptive trade practices, defamation, commercial
disparagement, and seeking equitable cancellation of the Company's
service mark "AFFORDABLE." Among other specific allegations, UP &
UP alleges that various statements made by the Company concerning
the acts of UP & UP, which are the subject of the claims summarized
above, and a mailing by the Company attaching a letter from the
Director of the Office of Personnel Management in which UP & UP is
identified as a "silent or non-directed preferred provider
organization" constitute defamation per se and commercial
disparagement and deceptive trade practices.
The Company replied to UP & UP's counterclaims denying the
allegations, and asserting defenses. The action at this time is
proceeding through the discovery phase. The Company is prosecuting
and defending its interests vigorously. At this time, the Company
does not believe that the counterclaims will have a probable
material adverse effect on the Company's financial position or
future operating results.
<PAGE>
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 group health, 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).
<PAGE>
Recent Developments
In connection with the acquisition in 1997 of FIRST HEALTH
Strategies, Inc. and FIRST HEALTH Services Corporation (collectively
"FHC"), 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 $15 million, to become commercially viable. Such
modifications include the enhancement of various modules to perform
claims adjudication reporting, imaging and correspondence, and are
expected to be completed by the end of 1999. Use of this technology is
expected to ultimately decrease claims processing costs by up to 20%
per claim.
At the date of acquisition, management estimated the Company would
spend approximately $10 million in additional development expenditures
to make the purchased research and development commercially viable.
The increase in development costs to $15 million is due to enhancements
beyond those originally planned by the Company.
Results of Operations
Revenues for the three months ended March 31, 1999 decreased
$10,397,000 (8%) from the same period last year. The Company's
revenues consist primarily of fees for cost management services
provided under contracts on a percentage of savings basis (PPO and fee
schedule services) or on a predetermined contractual basis. The
Company also derives revenues based on a fixed monthly charge for each
participant, excluding covered dependents, in a client-sponsored health
care plan or on a per-transaction basis. As a result of the Company's
insurance company acquisitions, revenues also include premium revenue.
<PAGE>
The following table sets forth information with respect to the
sources of the Company's revenues for the three months ended March 31,
1999 and 1998, respectively:
<TABLE>
Sources of Revenue
($ in thousands)
Three Months Ended March 31,
----------------------------
1999 % 1998 %
------- ---- ------- ----
<S> <C> <C> <C> <C>
Sources of Revenue:
PPO Services $ 54,061 46% $ 56,655 44%
Claims Administration 43,004 37 47,244 37
Clinical Management Services 8,737 7 11,200 9
Fee Schedule Services 8,629 7 7,366 6
Premiums, Net 2,197 2 4,560 4
Service 733 1 733 --
------- ---- ------- ----
Total Revenue $117,361 100% $127,758 100%
======= ==== ======= ====
</TABLE>
Revenue for the three months ended March 31, 1999 decreased 8% from
the same period of 1998 as the Company has lost a number of traditional
First Health Strategies clients who utilized both claims administration
services and PPO services (see "FHC Acquisition Status") and, to a
lesser extent, some traditional HealthCare COMPARE clients. The
decrease reflects the Company's focus on larger multi-sited national
employers in the group health area which resulted in the planned
reduction in revenue for accounts which did not fit this niche. PPO
revenue for the three months ended March 31, 1999 decreased $2,594,000
(5%) from the same period of 1998. The decrease in the first quarter is
primarily due to a loss of business as discussed under "FHC Acquisition
Status" and "The Company's Traditional Business". Claims
administration revenue decreased $4,240,000 (9%) from the same period
last year due to the same reasons. Revenue from clinical cost
management services decreased $2,463,000 (22%) for the three months
ended March 31, 1999 from the comparable period in 1998. The decrease
in the first quarter is also due to the loss of business mentioned
above. Revenue from fee schedule services increased $1,263,000 (17%)
from the comparable period in 1998 due primarily to new contracts and
expanded contract activity with several existing clients. Premium
revenue decreased $2,363,000 (52%) for the three months ended March 31,
1999 from the comparable period in 1998 due primarily to the expected
loss of several clients due to price increases implemented by the
Company.
<PAGE>
Cost of services decreased $1,117,000 (2%) for the three months
ended March 31, 1999 from the comparable period of 1998. 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. The decrease in cost of
services for the three months ended March 31, 1999 is due primarily to
the cost reduction measures the Company has initiated during the
integration of the FHC business. These costs have not decreased as
much as revenue 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 ended March 31,
1999 decreased $1,095,000 (9%) from the comparable period of 1998. The
decrease in the first quarter is due primarily to the consolidation of
FHC sales activities into the traditional Company sales activities.
General and administrative costs for the three months ended March
31, 1999 decreased $1,600,000 (14%) from the comparable period of 1998.
This decrease is primarily attributable to the elimination of duplicate
functions within the Company subsequent to the acquisition of FHC.
Healthcare benefits represent medical losses incurred by insureds of
the Company's insurance entities. The loss ratio (losses as a percent
of premiums) was 102% for the three months ended March 31, 1999
compared to 90% for the comparable period of 1998. The increase
relates to medical losses incurred by the Company's stop loss insurance
business. A portion of these losses, however, related to claims runout
for terminated clients.
Depreciation and amortization expenses increased $1,120,000 (19%)
for the three months ended March 31, 1999 from the comparable period of
1998 due primarily to purchases of computer hardware and software.
Interest income for the three months ended March 31, 1999 decreased
$3,654,000 (69%) from the same period in 1998 due to the 50% decrease
in cash equivalents and investments since March 31, 1998. The cash
equivalents and investments have decreased primarily as a result of
approximately $217 million in repurchases of common stock since March
31, 1998.
Interest expense increased $227,000 (7%) due to a $25 million
increase in the amount of outstanding debt on the revolving credit
agreement. The interest rate, however, has remained between 5% and 6%
since the initial funding under the credit agreement.
Net income for the three months ended March 31, 1999, decreased
$5,523,000 (24%) from the comparable period of 1998. This decrease is
due primarily to the planned reductions in revenue the Company has
experienced as well as expenses not being reduced as quickly as the
revenue declined.
<PAGE>
Diluted net income per common for the three months ended March 31,
1999 decreased 8% to $.33 per share from the comparable period of
1998. The decrease in net income per common share was favorably
impacted by the 2.3 million shares of Company common stock repurchased
and added to treasury during the first three months of 1999. For the
three months ended March 31, 1999, diluted common shares outstanding
decreased 18% from the comparable period of 1998.
Liquidity and Capital Resources
The Company had $16,719,000 in working capital at March 31, 1999
compared with working capital of $15,409,000 at December 31, 1998.
Through the first three months of the year, operating activities
provided $22,787,000 of cash. Investment activities provided
$11,697,000 of cash representing net sales of investments of
$23,910,000 less purchases of fixed assets of $12,213,000. Financing
activities used $66,013,000 of cash representing $63,090,000
($25,000,000 which was payable at December 31, 1998 for transactions
settled in 1999) in purchases of treasury stock (of which $40,431,000
was purchased on the open market with the balance being purchased
through the exercise of put options), and exercises of put options in
cash of $4,429,000 partially offset by $1,096,000 in proceeds from
issuance of common stock and $410,000 in sales of put options.
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 March 31, 1999, $225 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 majority of the integration of the acquisition has been
completed. The Company focused 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 instituted
significant price increases, particularly for clients that have been
paying fees at unacceptable profit levels. These actions have resulted
in the loss of a significant number of clients. Management expects
these actions will result in increased efficiency of its operations.
The Company's Traditional Business
The Company lost some traditional group health business in 1998
particularly in the Federal Employee Health Benefit area. However, the
Company does not anticipate the loss of any meaningful business from
its traditional client base in 1999.
<PAGE>
1999 Outlook
Currently the Company anticipates that its earnings per share (EPS)
in 1999 will be comparable to 1998 with an estimated decline in revenue
between 5% and 10% from 1998. The Company anticipates that its PPO,
Claims Administration, Clinical Management and Risk revenue will all
experience a decline from 1998. The Company's Fee Schedule revenue is
expected to grow approximately 10% in 1999 as the workers' compensation
business continues to grow. These revenue fluctuations reflect the
Company's focus on larger multi-sited national employers in the group
health area. The Company anticipates that this strategy will result in
accelerated growth in group health revenue in the later part of 1999.
Year 2000 Matters
General
The Company has made significant progress on its company-wide Year
2000 ("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. 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 which may result 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:
<PAGE>
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 and 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>
-----------------------------------------------------------------------
Inventory Assessment Modification Testing Implement-
Phase Phase or and ation
Replacement Validation Phase
Phase Phase
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IT 100% 100% 95% 70% 50%
Software
Systems
-----------------------------------------------------------------------
IT 100% 100% 90% 90% 90%
Hardware
Systems
-----------------------------------------------------------------------
Non-IT 100% 98% 95% 80% 90%
Systems
-----------------------------------------------------------------------
</TABLE>
IT Software Systems
The Company's IT software systems are comprised of both proprietary
and commercial third party software applications which can generally be
divided into three categories: 1) database systems, 2) operational
systems, and 3) claims administration systems.
<PAGE>
Database Systems. 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 phases are expected to be completed by the end
of the third quarter of 1999. Concurrent with the completion of
testing and validation, the remediated database systems will be
implemented.
Operational Systems. The Company has received assurances from
approximately 85% of the third party vendors that their applications
are currently Y2K ready. For those applications that may have a Y2K
problem, The Company is assessing whether it will modify, upgrade,
replace or retire such applications. Also included in this category
are several proprietary Company applications:
MCPS. This application is used to reprice medical bills to the
negotiated PPO contract rates with providers in The First HealthR
Network. MCPS is in the testing and validation phase, and it is
expected to be implemented during the second quarter of 1999.
PINS. This application is used to maintain demographic information on
providers in The First Health [R] Network. Modifications to this
application are expected to be completed during the second quarter of
1999, and the testing, validation and implementation phases are
expected to be completed during the third quarter of 1999.
IMPaCT. This application is used to provide medical review services
to clients. IMPaCT is in the testing and validation phase, and it is
expected to be implemented during the third quarter of 1999.
CHE. The Company is currently assessing the need to modify data feed
formats into and out of its centrally housed eligibility (che)
application. Modification, testing, validation and implementation
phases are expected to be completed during the third quarter of 1999.
Claims Administration Systems. The Company utilizes a number of
different systems to process health benefits claims for its clients.
The Company completed the modification and testing on its primary
group health medical claims processing system - the ACT System - well
ahead of schedule, and the Y2K-ready ACT System was placed in
operation in mid-April. The ACT System uses the 4-digit year,
including the century, for all internal codes. A windowing technique
is used for external interfaces that are not yet Y2K ready. The
Company is also communicating with clients and other third parties
which interface with this system to establish schedules for testing
and validation.
The Company also licenses medical claims administration systems from
third party vendors, which are used primarily to process claims for
specific clients. The Company has received written assurances that
these systems are designed and programmed with the Year 2000 in mind,
and that all updates and changes to the system continue to be Year
2000 compliant. These systems include the Company's FirstClaim system
used to process claims for its ConfidentCare clients, and its ERISCO
system.
<PAGE>
To process pharmacy claims for clients, The Company utilizes Company-
owned proprietary systems. Utilizing both internal and external
resources, modification of the source code for these systems is
continuing and the modifications and testing are expected to be
completed during the third quarter of 1999.
The Company utilizes customized Medicaid claims processing systems for
its government (Medicaid) contracts. Utilizing both internal and
external services, modification of the source code for the majority of
these systems is complete and the remainder are on target to be
completed during the third quarter of 1999. The testing, validation
and implementation phases are being conducted consistent with the time
frames required in Company contracts with the respective states and
are expected to be completed during 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 have completed internal modifications and testing and are working
together to establish testing and validation schedules with clients.
The testing, validation and implementation phases are expected to be
completed during the second quarter of 1999.
IT Hardware Systems
The Company has completed the inventory and assessment phases for its
IT hardware systems. The testing phase is on target to be completed
by the end of the second quarter of 1999. The majority of the effort
in the implementation phase relates to an upgrade of the desktop
environment, a process which is approximately 90% complete and on
target to be completed by the end of the third quarter of 1999.
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 and assessment phases for non-IT systems are almost complete
with only a few small office sites remaining. The Company is on target
to complete its modification, replacement and testing phases during the
third quarter of 1999. The Company has also received written
assurances from the vast majority of its significant vendors and
suppliers that the Y2K problem will not materially adversely effect
their ability to continue to provide supplies or services, and
continues to seek written assurances from the remainder. The Company
utilizes systems from Lucent and Nortel for its primary
telecommunication systems and has received assurances that these
systems are Y2K-ready. Additionally, the majority of the Company's
communication traffic is carried by AT&T and Sprint and the Company
has received assurances that their systems are Y2K-ready. The Company
also continues to evaluate responses from owners/landlords of office
spaces which the Company leases and from significant vendors/suppliers
to determine their Year 2000 readiness. To date, no responses have
indicated that any facilities or vendors/suppliers will have a Year
2000 problem which would have a material adverse effect on the
Company.
<PAGE>
Costs
The Company estimates the total cost of its Y2K readiness project to
be approximately $16,000,000 which will be funded through operating
cash flows. Of the total project cost, approximately $6,000,000 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. As of March 31, 1999, the Company has incurred
approximately $12,000,000 (75%) of its total estimated Year 2000
costs. The Company expects to receive reimbursement of at least 40%
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 which may result 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.
New Accounting Pronouncements
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 requires that all derivative instruments be measured at fair
value. This statement also requires changes in the fair value of
derivatives to be recorded each period in current earnings or
comprehensive income depending on the intended use of the derivatives.
This statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company has not yet determined the
impact of SFAS No. 133 on its results of operations and financial
position.
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
The Company's market risk exposure at March 31, 1999 is consistent
with the types of market risk and amount of exposure presented in its
1998 Annual Report on Form 10-K.
<PAGE>
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:
The Company filed a Report on Form 8-K dated March 19, 1999
reporting under Item 5, the adoption of a Shareholder Rights
Agreement.
<PAGE>
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: May 10, 1999 /s/James C. Smith
-----------------
James C. Smith
President and Chief Executive Officer
Dated: May 10, 1999 /s/Joseph E. Whitters
---------------------
Joseph E. Whitters
Chief Financial Officer
(Principal Financial and Accounting Officer)
<TABLE>
First Health Group Corp. and Subsidiaries EXHIBIT 11
COMPUTATION OF BASIC EARNINGS PER COMMON SHARE
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $17,580,000 $23,103,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 53,463,000 63,890,000
Other issuances of common stock ...... 40,000 486,000
Purchases of treasury stock .......... (751,000) (666,000)
---------- ----------
Weighted average common and common share
equivalents........................... 52,752,000 63,710,000
========== ==========
Net income per common share............ $ .33 $ .36
========== ==========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries EXHIBIT 11
COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE
(Unaudited)
Three Months Ended March 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $17,580,000 $23,103,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 53,463,000 63,890,000
Other issuances of common stock ...... 40,000 486,000
Purchases of treasury stock .......... (751,000) (666,000)
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options 356,000 1,174,000
---------- ----------
Weighted average common and common share
equivalents........................... 53,108,000 64,884,000
========== ==========
Net income per common share............. $ .33 $ .36
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 18,735
<SECURITIES> 100,576
<RECEIVABLES> 80,195
<ALLOWANCES> 11,176
<INVENTORY> 0
<CURRENT-ASSETS> 173,513
<PP&E> 166,002
<DEPRECIATION> 56,189
<TOTAL-ASSETS> 504,665
<CURRENT-LIABILITIES> 156,794
<BONDS> 0
0
0
<COMMON> 766
<OTHER-SE> 113,723
<TOTAL-LIABILITY-AND-EQUITY> 504,665
<SALES> 0
<TOTAL-REVENUES> 117,361
<CGS> 0
<TOTAL-COSTS> 79,207
<OTHER-EXPENSES> 7,046
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,411
<INCOME-PRETAX> 29,304
<INCOME-TAX> 11,724
<INCOME-CONTINUING> 17,580
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,580
<EPS-PRIMARY> .33
<EPS-DILUTED> .33
</TABLE>
