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, 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 November 8, 1999, was 49,065,208.
<PAGE>
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial
Information Page Number
----------- -----------
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at September 30, 1999
and December 31, 1998 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at September 30, 1999 and December 31, 1998 4
Consolidated Statements of Operations for the three months
ended September 30, 1999 and 1998 5
Consolidated Statements of Operations for the nine months
ended September 30, 1999 and 1998 6
Consolidated Statements of Comprehensive Income for the
three months ended September 30, 1999 and 1998 7
Consolidated Statements of Comprehensive Income for the
nine months ended September 30, 1999 and 1998 7
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and 1998 8-9
Notes to Consolidated Financial Statements 10-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-20
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
<PAGE>
PART 1. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
ASSETS September 30, 1999 December 31, 1998
------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents ..... $ 26,434,000 $ 50,264,000
Short-term investments ........ 1,094,000 961,000
Accounts receivable, less allowances
for doubtful accounts of $11,067,000
and $11,151,000, respectively 60,909,000 63,582,000
Reinsurance recoverable ....... 52,195,000 57,466,000
Deferred income taxes ......... 18,415,000 18,415,000
Other current assets .......... 11,158,000 10,874,000
------------ ------------
Total current assets .......... 170,205,000 201,562,000
Long-Term Investments:
Marketable securities ......... 74,779,000 125,120,000
Other ......................... 31,319,000 23,431,000
------------ ------------
106,098,000 148,551,000
------------ ------------
Property and Equipment:
Land, buildings and improvements 65,056,000 59,228,000
Computer equipment and software 111,938,000 80,944,000
Office furniture and equipment 13,221,000 13,617,000
------------ ------------
190,215,000 153,789,000
Less accumulated depreciation and
amortization................ (68,910,000) (49,805,000)
------------ ------------
Net property and equipment .... 121,305,000 103,984,000
------------ ------------
Goodwill......................... 92,256,000 100,151,000
Other Assets..................... 2,417,000 3,631,000
------------ ------------
$ 492,281,000 $ 557,879,000
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, 1999 December 31, 1998
------------ ------------
<S> <C> <C>
Current Liabilities:
Accounts payable .............. $ 44,906,000 $ 52,408,000
Treasury stock purchase payable 22,575,000 25,000,000
Accrued expenses .............. 30,108,000 33,545,000
Income taxes payable .......... 9,125,000 2,611,000
Claims reserves ............... 63,617,000 72,589,000
------------ ------------
Total current liabilities ..... 170,331,000 186,153,000
Long-Term Debt................... 220,000,000 225,000,000
Other Non-Current Liabilities.... 8,584,000 8,599,000
------------ ------------
Total liabilities ............. 398,915,000 419,752,000
------------ ------------
Commitments and Contingencies.... -- --
Stockholders' Equity:
Common stock .................. 768,000 765,000
Additional paid-in capital .... 187,103,000 182,842,000
Retained earnings ............. 432,963,000 384,143,000
Accumulated comprehensive income (3,596,000) (3,099,000)
Treasury stock, at cost ....... (523,872,000) (426,524,000)
------------ ------------
Total stockholders' equity .... 93,366,000 138,127,000
------------ ------------
$ 492,281,000 $ 557,879,000
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30,
--------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenues............................ $ 113,421,000 $ 125,962,000
------------ ------------
Operating expenses:
Cost of services ................. 53,173,000 57,730,000
Selling and marketing ............ 11,252,000 12,228,000
General and administrative ....... 8,959,000 10,751,000
Healthcare benefits .............. 1,087,000 5,233,000
Depreciation and amortization .... 7,395,000 6,027,000
------------ ------------
81,866,000 91,969,000
------------ ------------
Income from operations.............. 31,555,000 33,993,000
Other (income) expense:
Interest expense ................. 3,944,000 3,122,000
Interest income .................. (1,546,000) (5,721,000)
------------ ------------
Income before income taxes.......... 29,157,000 36,592,000
Income taxes........................ (12,008,000) (14,342,000)
------------ ------------
Net income.......................... $ 17,149,000 $ 22,250,000
============ ============
Weighted average shares
outstanding - basic 49,599,000 62,468,000
============ ============
Net income per common share - basic. $ .35 $ .36
============ ============
Weighted average shares
outstanding - diluted 50,388,000 63,573,000
============ ============
Net income per common share - diluted $ .34 $ .35
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenues............................ $ 346,212,000 $ 380,462,000
------------ ------------
Operating expenses:
Cost of services ................. 163,401,000 170,436,000
Selling and marketing ............ 34,444,000 37,481,000
General and administrative ....... 27,831,000 32,439,000
Healthcare benefits .............. 6,082,000 13,804,000
Depreciation and amortization .... 21,743,000 18,365,000
------------ ------------
253,501,000 272,525,000
------------ ------------
Income from operations.............. 92,711,000 107,937,000
Other (income) expense:
Interest expense ................. 10,939,000 9,467,000
Interest income .................. (4,962,000) (16,563,000)
------------ ------------
Income before income taxes.......... 86,734,000 115,033,000
Income taxes........................ (35,055,000) (46,358,000)
------------ ------------
Net income.......................... $ 51,679,000 $ 68,675,000
============ ============
Weighted average shares
outstanding - basic 50,995,000 63,022,000
============ ============
Net income per common share - basic. $ 1.01 $ 1.09
============ ============
Weighted average shares
outstanding - diluted 51,529,000 64,225,000
============ ============
Net income per common share - diluted $ 1.00 $ 1.07
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended September 30,
1999 1998
------------ ------------
<S> <C> <C>
Net income.......................... $ 17,149,000 $ 22,250,000
------------ ------------
Unrealized losses on securities,
before tax........................ (95,000) (4,856,000)
Income tax benefit related to items
of other comprehensive income..... 39,000 1,929,000
------------ ------------
Other comprehensive loss............ (56,000) (2,927,000)
------------ ------------
Comprehensive income................ $ 17,093,000 $ 19,323,000
============ ============
Nine Months Ended September 30,
1999 1998
------------ ------------
Net income.......................... $ 51,679,000 $ 68,675,000
------------ ------------
Unrealized losses on securities,
before tax........................ (834,000) (8,799,000)
Income tax benefit related to items
of other comprehensive income..... 337,000 3,546,000
------------ ------------
Other comprehensive loss............ (497,000) (5,253,000)
------------ ------------
Comprehensive income................ $ 51,182,000 $ 63,422,000
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Cash received from customers ......... $ 351,732,000 $ 386,470,000
Cash paid to suppliers and employees . (233,675,000) (257,083,000)
Healthcare benefits paid ............. (8,498,000) (7,160,000)
Interest income received ............. 5,449,000 11,816,000
Interest expense paid ................ (10,733,000) (7,372,000)
Income taxes paid, net ............... (27,866,000) (33,200,000)
------------ ------------
Net cash provided by operating activities 76,409,000 93,471,000
------------ ------------
Cash flows from investing activities:
Purchases of investments ............. (60,522,000) (246,661,000)
Sales of investments ................. 102,053,000 227,800,000
Acquisition of businesses, net
of cash acquired ................... -- (173,000)
Purchase of property and equipment ... (37,182,000) (38,165,000)
------------ ------------
Net cash provided by (used in)
investing activities................... 4,349,000 (57,199,000)
------------ ------------
Cash flows from financing activities:
Exercises of put options on common stock (4,429,000) --
Purchase of treasury stock ........... (99,773,000) (84,408,000)
Extinguishment of long-term debt ..... (15,000,000) --
Stock option loans to employees ...... (2,859,000) --
Proceeds from issuance of common stock 4,217,000 20,572,000
Proceeds from sale of put options
on common stock .................... 3,256,000 --
Proceeds from issuance of long-term debt 10,000,000 --
------------ ------------
Net cash used in financing activities (104,588,000) (63,836,000)
------------ ------------
Net decrease in cash and cash equivalents (23,830,000) (27,564,000)
Cash and cash equivalents, beginning
of period 50,264,000 77,836,000
------------ ------------
Cash and cash equivalents, end of period $ 26,434,000 $ 50,272,000
============ ============
Supplemental cash flow data:
Acquisition of businesses:
Cost in excess of net assets acquired $ -- $ 173,000
============ ============
Non-cash financing activity:
Treasury stock purchase payable ..... $ 22,575,000 $ 22,146,000
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
1999 1998
----------- -----------
<S> <C> <C>
Reconciliation of Net Income to Net
Cash Provided by Operating Activities:
Net Income............................... $ 51,679,000 $ 68,675,000
----------- -----------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and amortization ....... 21,743,000 18,365,000
Change in provision for uncollectible
receivables ........................ (84,000) (211,000)
Tax benefit from stock options exercised 670,000 5,700,000
Unrealized holding loss on marketable
securities ......................... 235,000 3,655,000
(Gain) loss on investment sales ..... 880,000 (3,571,000)
Other, net .......................... 184,000 (669,000)
Changes in Assets and Liabilities:
Accounts receivable ................. 2,757,000 1,416,000
Other current assets ................ (284,000) (6,546,000)
Reinsurance recoverable ............. 5,271,000 82,976,000
Accounts payable and accrued expenses (10,939,000) (9,470,000)
Claims reserves ..................... (8,972,000) (76,662,000)
Income taxes payable ................ 6,514,000 11,431,000
Non-current assets and liabilities .. 6,755,000 (1,618,000)
----------- -----------
Total adjustments ..................... 24,730,000 24,796,000
----------- -----------
Net cash provided by operating activities $ 76,409,000 $ 93,471,000
=========== ===========
See Notes to Consolidated Financial Statements
</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. The Company's investments in marketable securities which are
classified as available for sale had a net unrealized loss in
market value of $497,000, net of deferred income taxes, for the
nine months ended September 30, 1999. The net unrealized loss
as of September 30, 1999, included as a component of
stockholders' equity, was $3,596,000, net of deferred income
taxes. The Company liquidated its $12,561,000 investment in a
limited partnership during 1998. The Company received proceeds
of $14,798,000 from the sale including $1,667,000 in the third
quarter of 1999. The Company has four separate investments in
another limited partnership which invests in equipment which is
leased to third parties. The total investment as of September
30, 1999 was $27.9 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. This
investment total includes an additional $6.7 million invested in
the second and third quarters of 1999. The Company's
proportionate share of the partnership's income was $1,036,000
and $794,000 for the nine months ended September 30, 1999 and
1998, respectively, and is included in interest income.
3. 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 nine months of 1999, the
Company repurchased 5,186,000 shares for a total cost of
approximately $97.3 million. Such shares are recorded as
treasury shares, at cost, and can be used for general corporate
purposes. As of September 30, 1999, approximately 8.1 million
shares remain available for repurchase under the Company's
current repurchase authorization.
<PAGE>
In connection with its stock repurchase program, the Company has
outstanding put options which obligate the Company, at the
election of the option holders, to repurchase up to 2,250,000
shares of common stock at prices ranging from $14.50 to $21.00
per share. The outstanding put options expire on various dates
between December 20, 1999 and May 17, 2000. During the nine
months ended September 30, 1999, 977,000 (out of the 5,186,000
shares 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.
4 Weighted average shares outstanding increased for diluted
earnings per share by 789,000 and 1,105,000 and by 534,000 and
1,203,000, respectively, for the three and nine months ended
September 30, 1999 and 1998 due to the effect of stock options.
Diluted net income per share was $.01 less than basic net income
per share for the three months ended September 30, 1999 and 1998
and $.01 and $.02 less than basic for the nine months ended
September 30, 1999 and 1998, respectively, also due to the effect
of stock options.
5. 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 $56,000 and $2,927,000
for the three months ended September 30, 1999 and 1998,
respectively, net of related taxes. Other comprehensive income
was a loss of $497,000 and $5,253,000 for the nine months ended
September 30, 1999 and 1998, respectively, net of related taxes.
Total comprehensive income amounted to $17,093,000 and
$19,323,000 and $51,182,000 and $63,422,000 for the three and
nine months ended September 30, 1999 and 1998, respectively.
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 nine months ended September 30, 1999 was not
material.
<PAGE>
6. 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.
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.
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 discovery phase of the
litigation is over and the parties are filing various motions for
full and partial relief on many of the claims and counterclaims.
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 condition 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, achieve
the growth that is anticipated as a result of the Company's strategy
of focusing on larger multi-sited national employers, realize the
anticipated benefits of certain technology enhancements, and control
healthcare benefit expenses, the Company may not achieve its planned
1999 and 2000 results (discussed below).
Recent Developments
On July 20, 1999, the Company announced it had entered into a
contract with CNA to provide PPO services to the Mail Handlers
Benefit Plan, one of the largest federal employee health benefit
plans with over 400,000 members and 1 million participants. When
fully implemented, the contract is expected to be one of the
Company's largest in terms of revenue generated.
<PAGE>
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 needed 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 and nine months ended September 30, 1999
decreased $12,541,000 (10%) and $34,250,000 (9%), respectively, from
the same periods last year. Operating expenses (excluding
depreciation) decreased $11,471,000 (13%) and $22,402,000 (9%) for
the three and nine months ended September 30, 1999 from the
comparable periods in 1998. The Company's revenues consist primarily
of fees for services provided under contracts on a percentage of
savings basis (PPO and fee schedule services) or on a predetermined
contractual basis (claims administration and clinical management
services). The Company also derives revenues based on a fixed
monthly charge for each participant, excluding covered dependents, in
a client-sponsored health care plan or on a per-transaction basis.
As a result of the Company's insurance company acquisitions, revenues
also include premium revenue.
<PAGE>
The following table sets forth information with respect to the
sources of the Company's revenues for the three months and nine
months ended September 30, 1999 and 1998, respectively:
<TABLE>
Sources of Revenue
($ in thousands)
Three Months Ended September 30,
--------------------------------------
1999 % 1998 %
------- ---- ------- ----
<S> <C> <C> <C> <C>
Sources of Revenue:
PPO Services $ 56,723 50% $ 55,035 44%
Claims Administration 37,586 33 47,119 37
Clinical Management
Services 8,623 8 10,477 8
Fee Schedule Services 8,029 7 7,843 6
Premiums, Net 1,787 1 4,666 4
Service 673 1 822 1
------- ---- ------- ----
Total Revenue $113,421 100% $125,962 100%
======= ==== ======= ====
Sources of Revenue
($ in thousands)
Nine Months Ended September 30,
--------------------------------------
1999 % 1998 %
------- ---- ------- ----
<S> <C> <C> <C> <C>
Sources of Revenue:
PPO Services $166,753 48% $167,637 44%
Claims Administration 120,380 35 140,344 37
Clinical Management
Services 26,053 7 33,448 9
Fee Schedule Services 25,204 7 22,897 6
Premiums, Net 5,744 2 13,983 3
Service 2,078 1 2,153 1
------- ---- ------- ----
Total Revenue $346,212 100% $380,462 100%
======= ==== ======= ====
</TABLE>
<PAGE>
Revenue for the three months and nine ended September 30, 1999
decreased 10% and 9%, respectively, from the same periods 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 September 30, 1999 increased $1,688,000 (3%) primarily
as a result of additional revenue from existing clients. PPO revenue
for the nine months ended September 30, 1999 decreased $884,000 (1%)
from the same period in 1998. The decrease year-to-date is primarily
due to a loss of business as discussed under "FHC Acquisition Status"
and "The Company's Traditional Business". Claims administration
revenue decreased $9,533,000 (20%) and $19,964,000 (14%),
respectively, from the same periods last year for the same reasons.
Revenue from clinical cost management services decreased $1,854,000
(18%) and $7,395,000 (22%), respectively, for the three months and
nine months ended September 30, 1999 from the comparable periods in
1998. This decrease is also due to the loss of business mentioned
above. Revenue from fee schedule services increased $186,000 (2%)
and $2,307,000 (10%), respectively, from the comparable periods in
1998 due primarily to new contracts and expanded contract activity
with several existing clients. Premium revenue decreased $2,879,000
(62%) and $8,239,000 (59%), respectively, for the three months and
nine months ended September 30, 1999 from the comparable periods in
1998 due primarily to the planned loss of several clients as a result
of price increases implemented by the Company.
Cost of services decreased $4,557,000 (8%) and $7,035,000 (4%) for
the three months and nine months ended September 30, 1999,
respectively, from the comparable periods 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 and nine months
ended September 30, 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. The
costs for Year 2000 compliance are nearly complete as of the end of
the third quarter in 1999. Fourth quarter costs should be far less
than those experienced in prior quarters.
Selling and marketing costs for the three months and nine months
ended September 30, 1999 decreased $976,000 (8%) and $3,037,000 (8%),
respectively, from the comparable periods of 1998. The decrease is
due primarily to the consolidation of FHC sales activities into the
traditional Company sales activities.
<PAGE>
General and administrative costs for the three months and nine
months ended September 30, 1999 decreased $1,792,000 (17%) and
$4,608,000 (14%), respectively, from the comparable periods 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. Healthcare benefits decreased
$4,146,000 (79%) and $7,722,000 (56%) for the three and nine months
ended September 30, 1999, respectively, from the comparable periods
of 1998. This decrease is due primarily to the termination of the
Company's unprofitable HMO-like business. The loss ratio (losses as
a percent of premiums) was 61% and 106%, respectively, for the three
months and nine months ended September 30, 1999 compared to 112% and
99%, respectively, for the comparable periods of 1998. The
improvement in the loss ratio during the third quarter of 1999 is due
to termination of the Company's unprofitable HMO-like business,
improved experience in the remaining book of business, and the
addition of clients in the more profitable employer stop loss
insurance business.
Depreciation and amortization expenses increased $1,368,000 (23%)
and $3,378,000 (18%), respectively, for the three months and nine
months ended September 30, 1999 from the comparable periods of 1998
due primarily to purchases of computer hardware and software.
Depreciation expense will continue to grow primarily as a result of
continuing investments the Company is making in its information
technology infrastructure.
Interest income for the three months and nine months ended
September 30, 1999 decreased $4,175,000 (73%) and $11,601,000 (70%),
respectively, from the same periods in 1998 due to the 51% decrease
in cash equivalents and investments since September 30, 1998. Cash
equivalents and investments have decreased primarily as a result of
approximately $220 million in repurchases of common stock since
September 30, 1998.
Interest expense increased $822,000 (26%) and $1,472,000 (16%)
from the comparable periods of 1998 due to a $20 million increase in
the amount of debt outstanding under the Company's revolving credit
agreement since September 30, 1998. The interest rate is currently
about 7% per annum.
Net income for the three months and nine months ended September
30, 1999, decreased $5,101,000 (23%) and $16,996,000 (25%),
respectively, from the comparable periods of 1998. This decrease is
due primarily to the planned reductions in revenue the Company has
experienced, lesser amounts of interest income due to share
repurchases, as well as expenses not being reduced as quickly as the
revenue declined.
<PAGE>
Diluted net income per common for the three months and nine months
ended September 30, 1999 decreased 3% to $.34 and 7% to $1.00,
respectively, per share from the comparable periods of 1998. The
decrease in net income per common share was favorably impacted by the
12.6 million shares of Company common stock repurchased and added to
treasury since September 30, 1998. For the three months and nine
months ended September 30, 1999, diluted common shares outstanding
decreased 21% and 20% respectively, from the comparable periods of
1998.
Liquidity and Capital Resources
The Company had a $126,000 working capital deficit at September
30, 1999 compared with positive working capital of $15,409,000 at
December 31, 1998. Through the first nine months of the year,
operating activities provided $76,409,000 of cash. Investment
activities provided $4,349,000 of cash representing net sales of
investments of $41,531,000 less purchases of fixed assets of
$37,182,000. Financing activities used $104,588,000 of cash
representing $99,773,000 ($25,000,000 which was payable at December
31, 1998 for transactions settled in 1999) in purchases of treasury
stock (of which $76,882,000 was purchased on the open market with the
balance being purchased through the exercise of put options),
$15,000,000 in extinguishment of long-term debt, $2,859,000 in loans
to employees to finance the exercise of stock options and exercises
of put options in cash of $4,429,000 partially offset by $4,217,000
in proceeds from issuance of common stock, $10,000,000 in issuance of
long-term debt and $3,256,000 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 September 30, 1999, $220
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 integration of the acquisition will be completed by the end of
1999. 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 unreasonably low margins.
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.
<PAGE>
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 did not encounter the loss of any meaningful business
from its traditional client base in 1999.
1999 Outlook
Currently the Company anticipates that its earnings per share
(EPS) in 1999 will be approximately 3% lower than 1998 with an
estimated decline in revenue in the high single digit area from 1998.
The Company anticipates that its Claims Administration, Clinical
Management and Risk revenue will all experience a decline from 1998
levels. The Company's Fee Schedule revenue is expected to grow in
the mid single digit area in 1999 as the workers' compensation
business continues to grow. PPO revenue is expected to be comparable
to 1998. These revenue fluctuations reflect the Company's focus on
larger multi-sited national employers in the group health area. The
Company recently announced a new contract with the Mail Handlers
Benefit Plan that it believes will provide momentum for the Company's
growth into the year 2000.
2000 Outlook
Currently the Company is targeting revenue growth in the 10% area
to more than $500 million in 2000. Earnings per share (EPS)
percentage growth is currently estimated to be in the high teen area
resulting in EPS of approximately $1.60 for the year.
Revenue growth will be lead by the addition of the Mail Handlers
Benefit Plan to our PPO business. Additionally, the Company has
announced several additional new contracts which should allow us to
achieve the forecast we are currently anticipating. Expenses are
currently forecasted not to grow as quickly as the growth in revenue
which, coupled with fewer shares outstanding, allows for EPS growth
in the high teen area.
<PAGE>
Potential Managed Care Litigation
Much has been recently written about the plaintiff's bar attacking
managed care organizations. We believe First Health is very well
positioned to avoid litigation for the following reasons:
* Counsel for class action plaintiffs is sophisticated and
understands the differences between HMOs, which offer little or
no choice to their subscribers regarding provider selection, and
the PPO services the Company provides.
* The Company does not incent or penalize its network physicians
through capitation, risk sharing, cash incentive bonuses or
other methods for denying or limiting care. Its "control" over
physicians is limited to qualifying them for participation in
the network based on objective criteria related only to their
credentials, licensure, malpractice history, insurance, etc..
They are truly independent contractors, solely responsible for
the health care of their patients.
* Consistent with many state law requirements and national
accreditation standards, there is no direct or indirect
financial bonus or remuneration paid to individuals involved in
the recommendation of medical care based on medical necessity.
* Most importantly, participants in its customers' plans have
choice. Commonly, its customers offer 2 or more plan options,
the PPO option alone inherently provides choice with a
meaningful (but compared to an HMO, modest) benefit
differential. The choice of medical specialists is solely
within the control of the treating physician and the patient.
As a result of all of these factors, the Company believes it is in
a much better and advantageous position concerning potential managed
care litigation.
Year 2000 Matters
General
The Company has substantially completed its Year 2000 ("Y2K")
readiness project. The Company's internal modification, testing and
implementation phases for its information technology ("IT") systems
have been completed except for one which is used to process claims
under a small Medicaid contract. The testing, validation and
implementation phases for this system are being conducted consistent
with the time frames required in the Company's contract and are
expected to be completed prior to the end of 1999. Y2K readiness
efforts related to the Company's IT Hardware systems is also nearly
complete, with only a small number of desktop PCs remaining to be
replaced and/or upgraded. The remainder of the Company's Y2K
readiness efforts will be focused on testing its data exchanges with
clients and third parties to ensure the compatibility of each
party's Y2K readiness preparations.
<PAGE>
The Company has also essentially completed its Y2K readiness
preparations for its non-IT systems. These systems are primarily
comprised of systems typically found in commercial office buildings
including, electrical, fire alarm and suppression, security, HVAC
and elevator systems. The Company has received assurances from its
significant vendors and suppliers that the Y2K problem will not
materially adversely effect their ability to continue to provide
supplies or services. Included in its non-IT systems Y2K readiness
preparations are the Company's telecommunications systems. The
Company utilizes systems from Lucent and Nortel for its primary
telecommunication systems and has received assurances that these
systems are Y2K-ready. 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 also Y2K-ready.
Y2K Project
The Company's Y2K project was divided into three major sections: 1)
IT Software Systems, 2) IT Hardware Systems and, 3) Non-IT Systems.
For each major section, the Company implemented a five-phase
approach: Inventory Phase (Inventory of significant systems);
Assessment Phase (Assessment of the vulnerability of significant
systems to the Y2K problem and development of correction and
contingency plans); Modification/Replacement Phase (Modification of
computer source code, and software, hardware and equipment upgrade,
retirement or replacement); Testing and Validation Phase (Testing,
internally and with third parties, of all modified, upgraded or
replaced components and interfaces); and 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:
The following chart graphically depicts the approximate current
state of completion for each phase:
<TABLE>
Inventory Assessment Modification Testing and Implement-
Phase Phase or Replacement Validation ation
Phase Phase Phase
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
IT
Software 100% 100% 99% 95% 97%
Systems
IT
Hardware 100% 100% 99% 95% 98%
Systems
Non-IT 100% 100% 99% 99% 99%
Systems
</TABLE>
<PAGE>
Costs
The Company estimates the total cost of its Y2K readiness project to
be approximately $16,000,000 which has been 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. As of September 30, the Company had incurred
approximately $15,000,000 (94%) 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 impact of a Y2K interruption on the Company would depend upon
the nature and extent of the interruption. The nature of the
problem could be solely within the Company's systems, or it could be
due to some external problem outside the control of the Company
(i.e., the systems of clients or some other third party). Also,
depending on the nature of the problem, the extent of the
interruption could be limited only to a single client, or encompass
several clients. Depending on the nature and extent of the
interruption, the Company will focus its resources and efforts on
fixing or establishing a workaround to the problem as quickly as
possible. Contingency plans, based upon most reasonably likely Y2K
interruption scenarios, will continue to be developed and modified
as the Company progresses in its Y2K readiness project. The Company
believes, however, that the combination of its own internal Y2K
readiness efforts and those of its clients and third parties with
whom the Company does business, together with the testing of data
interchanges with clients and third parties, significantly reduces
the likelihood that the Year 2000 problem will cause a significant
interruption or materially impact the Company's ability to provide
its services.
Notice
Projected completion dates for Y2K modifications, testing and
implementation 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. First Health 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, First
Health is unable to determine at this time whether actual results
will differ materially from those anticipated, whether third party
systems on which First Health'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 First Health's
systems, would not have a material adverse effect on First Health.
<PAGE>
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, 2000. The Company does not
expect SFAS No. 133 to have a material effect on its results of
operations and financial position.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
The Company's market risk exposure at September 30, 1999 is
consistent with the types of market risk and amount of exposure
presented in its 1998 Annual Report on Form 10-K. 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
<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: November 8, 1999 /s/James C. Smith
James C. Smith
President and Chief Executive Officer
Dated: November 8, 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 September 30,
1999 1998
----------- -----------
<S> <C> <C>
Net income ............................. $ 17,149,000 $ 22,250,000
=========== ===========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning
of period ........................... 49,871,000 63,138,000
Other issuances of common stock ...... 69,000 62,000
Purchases of treasury stock .......... (341,000) (732,000)
----------- -----------
Weighted average common and common share
equivalents........................... 49,599,000 62,468,000
=========== ===========
Net income per common share............ $ .35 $ .36
=========== ===========
Nine Months Ended September 30,
1999 1998
----------- -----------
Net income ............................. $ 51,679,000 $ 68,675,000
=========== ===========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning
of period ........................... 53,463,000 63,890,000
Other issuances of common stock ...... 157,000 881,000
Purchases of treasury stock .......... (2,625,000) (1,749,000)
----------- -----------
Weighted average common and common share
equivalents........................... 50,995,000 63,022,000
=========== ===========
Net income per common share............ $ 1.01 $ 1.09
=========== ===========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries EXHIBIT 11
COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE
(Unaudited)
----------------------------------------------------------------------
Three Months Ended September 30,
1999 1998
----------- -----------
<S> <C> <C>
Net income ............................. $ 17,149,000 $ 22,250,000
=========== ===========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning
of period ........................... 49,871,000 63,138,000
Other issuances of common stock ...... 69,000 62,000
Purchases of treasury stock .......... (341,000) (732,000)
Common Stock Equivalents:
Additional equivalent shares issuable
from assumed exercise of common
stock options ....................... 789,000 1,105,000
----------- -----------
Weighted average common and common share
equivalents........................... 50,388,000 63,573,000
=========== ===========
Net income per common share............. $ .34 $ .35
=========== ===========
Nine Months Ended September 30,
1999 1998
----------- -----------
Net income ............................. $ 51,679,000 $ 68,675,000
=========== ===========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning
of period ........................... 53,463,000 63,890,000
Other issuances of common stock ...... 157,000 881,000
Purchases of treasury stock .......... (2,625,000) (1,749,000)
Common Stock Equivalents:
Additional equivalent shares issuable
from assumed exercise of common
stock options ...................... 534,000 1,203,000
----------- -----------
Weighted average common and common share
equivalents........................... 51,529,000 64,225,000
=========== ===========
Net income per common share............. $ 1.00 $ 1.07
=========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 26,434
<SECURITIES> 75,873
<RECEIVABLES> 71,976
<ALLOWANCES> 11,067
<INVENTORY> 0
<CURRENT-ASSETS> 170,205
<PP&E> 190,215
<DEPRECIATION> 68,910
<TOTAL-ASSETS> 492,281
<CURRENT-LIABILITIES> 170,331
<BONDS> 0
0
0
<COMMON> 768
<OTHER-SE> 92,598
<TOTAL-LIABILITY-AND-EQUITY> 492,281
<SALES> 0
<TOTAL-REVENUES> 346,212
<CGS> 0
<TOTAL-COSTS> 231,758
<OTHER-EXPENSES> 21,743
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10,939
<INCOME-PRETAX> 86,734
<INCOME-TAX> 35,055
<INCOME-CONTINUING> 51,679
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 51,679
<EPS-BASIC> 1.01
<EPS-DILUTED> 1.00
</TABLE>
