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 June 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 August 10, 1999, was 49,891,473.
<PAGE>
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at June 30, 1999
and December 31, 1998 ...................... 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at June 30, 1999 and December 31, 1998 4
Consolidated Statements of Operations for the three months
ended June 30, 1999 and 1998 ............... 5
Consolidated Statements of Operations for the six months
ended June 30, 1999 and 1998 ............... 6
Consolidated Statements of Comprehensive Income for the
three months ended June 30, 1999 and 1998 .. 7
Consolidated Statements of Comprehensive Income for the
six months ended June 30, 1999 and 1998 .... 7
Consolidated Statements of Cash Flows for the six months
ended June 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 ..... 13-22
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ............................. 23
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 6. Exhibits and Reports on Form 8-K .... 24
Signatures.......................................... 25
<PAGE>
<TABLE>
PART 1. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS June 30, 1999 December 31, 1998
----------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents ..... $ 24,292,000 $ 50,264,000
Short-term investments ........ 120,000 961,000
Accounts receivable, less allowances for
doubtful accounts of $11,060,000
and $11,151,000, respectively 69,154,000 63,582,000
Reinsurance recoverable ....... 55,901,000 57,466,000
Deferred income taxes ......... 18,415,000 18,415,000
Other current assets .......... 9,364,000 10,874,000
----------- -----------
Total current assets .......... 177,246,000 201,562,000
Long-Term Investments:
Marketable securities ......... 77,229,000 125,120,000
Other ......................... 28,724,000 23,431,000
----------- -----------
105,953,000 148,551,000
----------- -----------
Property and Equipment:
Land, buildings and improvements 64,313,000 59,228,000
Computer equipment and software 101,997,000 80,944,000
Office furniture and equipment 12,548,000 13,617,000
----------- -----------
178,858,000 153,789,000
Less accumulated depreciation and
amortization................ (62,469,000) (49,805,000)
----------- -----------
Net property and equipment .... 116,389,000 103,984,000
----------- -----------
Goodwill......................... 93,104,000 100,151,000
Other Assets..................... 4,871,000 3,631,000
----------- -----------
$497,563,000 $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
June 30, 1999 December 31, 1998
----------- ------------
<S> <C> <C>
Current Liabilities:
Accounts payable .............. $ 48,087,000 $ 52,408,000
Treasury stock purchase payable -- 25,000,000
Accrued expenses .............. 28,067,000 33,545,000
Income taxes payable .......... 2,947,000 2,611,000
Claims reserves ............... 67,952,000 72,589,000
----------- ------------
Total current liabilities ..... 147,053,000 186,153,000
Long-Term Debt................... 235,000,000 225,000,000
Other Non-Current Liabilities.... 7,962,000 8,599,000
----------- ------------
Total liabilities ............. 390,015,000 419,752,000
----------- ------------
Commitments and Contingencies.... -- --
Stockholders' Equity:
Common stock .................. 767,000 765,000
Additional paid-in capital .... 183,271,000 182,842,000
Retained earnings ............. 418,673,000 384,143,000
Accumulated comprehensive income (3,540,000) (3,099,000)
Treasury stock, at cost ....... (491,623,000) (426,524,000)
----------- ------------
Total stockholders' equity .... 107,548,000 138,127,000
----------- ------------
$ 497,563,000 $ 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 June 30,
1999 1998
----------- -----------
<S> <C> <C>
Revenues............................ $115,430,000 $126,742,000
----------- -----------
Operating expenses:
Cost of services ................. 54,532,000 55,893,000
Selling and marketing ............ 11,450,000 12,416,000
General and administrative ....... 9,352,000 10,568,000
Healthcare benefits .............. 2,746,000 4,478,000
Depreciation and amortization .... 7,302,000 6,412,000
----------- -----------
85,382,000 89,767,000
----------- -----------
Income from operations.............. 30,048,000 36,975,000
Other (income) expense:
Interest expense ................. 3,584,000 3,161,000
Interest income .................. (1,809,000) (5,581,000)
----------- -----------
Income before income taxes.......... 28,273,000 39,395,000
Income taxes........................ (11,323,000) (16,073,000)
----------- -----------
Net income.......................... $ 16,950,000 $ 23,322,000
=========== ===========
Weighted average shares outstanding-basic 50,426,000 63,095,000
=========== ===========
Net income per common share-basic. $ .34 $ .37
=========== ===========
Weighted average shares outstanding-diluted 50,787,000 64,195,000
=========== ===========
Net income per common share-diluted $ .33 $ .36
=========== ===========
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Six Months Ended June 30,
1999 1998
----------- -----------
<S> <C> <C>
Revenues............................ $232,791,000 $254,500,000
----------- -----------
Operating expenses:
Cost of services ................. 110,228,000 112,706,000
Selling and marketing ............ 23,192,000 25,253,000
General and administrative ....... 18,872,000 21,688,000
Healthcare benefits .............. 4,995,000 8,571,000
Depreciation and amortization .... 14,348,000 12,338,000
----------- -----------
171,635,000 180,556,000
----------- -----------
Income from operations.............. 61,156,000 73,944,000
Other (income) expense:
Interest expense ................. 6,995,000 6,345,000
Interest income .................. (3,416,000) (10,842,000)
----------- -----------
Income before income taxes.......... 57,577,000 78,441,000
Income taxes........................ (23,047,000) (32,016,000)
----------- -----------
Net income.......................... $ 34,530,000 $ 46,425,000
=========== ===========
Weighted average shares outstanding-basic 51,632,000 63,355,000
=========== ===========
Net income per common share-basic. $ .67 $ .73
=========== ===========
Weighted average shares outstanding-diluted 51,999,000 64,603,000
=========== ===========
Net income per common share-diluted $ .66 $ .72
=========== ===========
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended June 30,
1999 1998
---------- ----------
<S> <C> <C>
Net income.......................... $16,950,000 $23,322,000
---------- ----------
Unrealized losses on securities, before tax (113,000) (2,689,000)
Income tax benefit related to items of other
comprehensive income.............. 45,000 1,097,000
---------- ----------
Other comprehensive loss............ (68,000) (1,592,000)
---------- ----------
Comprehensive income................ $16,882,000 $21,730,000
========== ==========
Six Months Ended June 30,
1999 1998
---------- ----------
Net income.......................... $34,530,000 $46,425,000
---------- ----------
Unrealized losses on securities, before tax (735,000) (3,929,000)
Income tax benefit related to items of other
comprehensive income.............. 294,000 1,603,000
---------- ----------
Other comprehensive loss............ (441,000) (2,326,000)
---------- ----------
Comprehensive income................ $34,089,000 $44,099,000
========== ==========
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Cash received from customers ......... $ 229,151,000 $ 260,509,000
Cash paid to suppliers and employees . (159,381,000) (172,223,000)
Healthcare benefits paid ............. (6,984,000) (4,432,000)
Interest income received ............. 4,021,000 8,483,000
Interest expense paid ................ (6,834,000) (4,303,000)
Income taxes paid, net ............... (22,252,000) (31,279,000)
------------ ------------
Net cash provided by operating activities 37,721,000 56,755,000
------------ ------------
Cash flows from investing activities:
Purchases of investments ............. (50,688,000) (187,574,000)
Sales of investments ................. 93,401,000 181,671,000
Acquisition of businesses, net of cash
acquired -- (173,000)
Purchase of property and equipment ... (25,735,000) (24,128,000)
------------ ------------
Net cash provided by (used in) investing
activities 16,978,000 (30,204,000)
------------ ------------
Cash flows from financing activities:
Exercises of put options on common stock (4,429,000) --
Purchase of treasury stock ........... (90,099,000) (50,376,000)
Proceeds from issuance of common stock 2,847,000 19,036,000
Proceeds from sale of put options on
common stock 1,010,000 --
Proceeds from issuance of long-term debt 10,000,000 --
------------ ------------
Net cash used in financing activities (80,671,000) (31,340,000)
------------ ------------
Net decrease in cash and cash equivalents (25,972,000) (4,789,000)
Cash and cash equivalents, beginning of period 50,264,000 77,836,000
------------ ------------
Cash and cash equivalents, end of period $ 24,292,000 $ 73,047,000
============ ============
Supplemental cash flow data:
Acquisition of businesses:
Cost in excess of net assets acquired $ -- $ 173,000
============ ============
See Notes to Consolidated Financial Statements
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
1999 1998
------------ ------------
<S> <C> <C>
Reconciliation of Net Income to Net
Cash Provided by Operating Activities:
Net Income............................... $ 34,530,000 $ 46,425,000
------------ ------------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and amortization ....... 14,348,000 12,338,000
Change in provision for uncollectible
receivables (91,000) (130,000)
Tax benefit from stock options exercised 453,000 5,156,000
Unrealized holding loss on marketable
securities 294,000 1,603,000
(Gain) loss on investment sales ..... 688,000 (2,088,000)
Other, net .......................... 326,000 (420,000)
Changes in Assets and Liabilities:
Accounts receivable ................. (5,481,000) 3,303,000
Other current assets ................ 1,510,000 (6,376,000)
Reinsurance recoverable ............. 1,565,000 75,667,000
Accounts payable and accrued expenses (9,799,000) (6,940,000)
Claims reserves ..................... (4,637,000) (71,867,000)
Income taxes payable ................ 336,000 --
Non-current assets and liabilities .. 3,679,000 84,000
------------ ------------
Total adjustments ..................... 3,191,000 10,330,000
------------ ------------
Net cash provided by operating activities $ 37,721,000 $ 56,755,000
============ ============
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. 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 $441,000, net of deferred income taxes, for the
six months ended June 30, 1999. The net unrealized loss as of
June 30, 1999, included as a component of stockholders' equity,
was $3,540,000, 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 four separate investments in another limited partnership
which invests in equipment which is leased to third parties.
The total investment as of June 30, 1999 was $25.8 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 $4.6 million invested in the second quarter of 1999.
The Company's proportionate share of the partnership's income
was $705,000 and $455,000 for the six months ended June 30,
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 six months of 1999, the
Company repurchased 3,824,000 shares for a total cost of
approximately $65.1 million. Such shares are recorded as
treasury shares, at cost, and can be used for general corporate
purposes. As of June 30, 1999, approximately 9.5 million
shares remain available for repurchase under the Company's
current repurchase authorization.
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 $15.50
per share. The outstanding put options expire on various dates
between September 23, 1999 and December 20, 1999. During the
six months ended June 30, 1999, 977,000 (out of the 3,824,000
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.
5. Weighted average shares outstanding increased for diluted
earnings per share by 361,000 and 1,100,000 and 367,000 and
1,248,000, respectively, for the three and six months ended June
30, 1999 and 1998 due to the effect of stock options. Diluted
net income per share decreased by $.01 for all four of these
periods of 1998 and 1997 due to the effect of stock options.
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 $68,000 and
$1,592,000 for the three months ended June 30, 1999 and 1998,
respectively, net of related taxes. Other comprehensive income
was a loss of $441,000 and $2,326,000 for the six months ended
June 30, 1999 and 1998, respectively, net of related taxes.
Total comprehensive income amounted to $16,882,000 and
$21,730,000 and $34,089,000 and $44,099,000 for the three and
six months ended June 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.
<PAGE>
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 six months ended June 30, 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.
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.
<PAGE>
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.
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 financial results (discussed below).
<PAGE>
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 could represent one of the Company's
largest.
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 six months ended June 30, 1999
decreased $11,312,000 (9%) and $21,709,000 (9%), respectively, from
the same periods last year. The Company's revenues consist
primarily of fees for services provided under contracts on a
percentage of savings basis (PPO and fee schedule services) or on a
predetermined contractual basis (claims administration and clinical
management services). The Company also derives revenues based on a
fixed monthly charge for each participant, excluding covered
dependents, in a client-sponsored health care plan or on a per-
transaction basis. As a result of the Company's insurance company
acquisitions, revenues also include premium revenue.
<PAGE>
The following table sets forth information with respect to the
sources of the Company's revenues for the three months and six
months ended June 30, 1999 and 1998, respectively:
<TABLE>
Sources of Revenue
($ in thousands)
Three Months Ended June 30,
1999 % 1998 %
------- ---- ------- ----
<S> <C> <C> <C> <C>
Sources of Revenue:
PPO Services $ 55,969 48% $ 55,947 44%
Claims Administration 39,790 34 45,981 36
Clinical Management Services 8,693 8 11,771 10
Fee Schedule Services 8,546 7 7,688 6
Premiums, Net 1,760 2 4,757 4
Service 672 1 598 --
------- ---- ------- ----
Total Revenue $115,430 100% $126,742 100%
======= === ======= ===
Sources of Revenue
($ in thousands)
Six Months Ended June 30,
1999 % 1998 %
------- ---- ------- ----
<S> <C> <C> <C> <C>
Sources of Revenue:
PPO Services $110,030 47% $112,602 44%
Claims Administration 82,794 36 93,225 37
Clinical Management Services 17,430 7 22,971 9
Fee Schedule Services 17,175 7 15,054 6
Premiums, Net 3,957 2 9,317 3
Service 1,405 1 1,331 1
------- ---- ------- ----
Total Revenue $232,791 100% $254,500 100%
======= ==== ======= ====
</TABLE>
<PAGE>
Revenue for the three months and six ended June 30, 1999
decreased 9% 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 June 30, 1999 was relatively flat compared to the
same period last year. PPO revenue for the six months ended June
30, 1999 decreased $2,572,000 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
$6,191,000 (13%) and $10,431,000 (11%), respectively, from the same
periods last year for the same reasons. Revenue from clinical cost
management services decreased $3,078,000 (26%) and $5,541,000 (24%),
respectively, for the three months and six months ended June 30,
1999 from the comparable periods in 1998. The decrease in the first
and second quarters is also due to the loss of business mentioned
above. Revenue from fee schedule services increased $858,000 (11%)
and $2,121,000 (14%), respectively, from the comparable periods in
1998 due primarily to new contracts and expanded contract activity
with several existing clients. Premium revenue decreased $2,997,000
(63%) and $5,360,000 (58%), respectively, for the three months and
six months ended June 30, 1999 from the comparable periods in 1998
due primarily to the loss of several clients as a result of price
increases implemented by the Company.
Cost of services decreased $1,361,000 (2%) and $2,478,000 (2%)
for the three months and six months ended June 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 six months
ended June 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.
Selling and marketing costs for the three months and six months
ended June 30, 1999 decreased $966,000 (8%) and $2,061,000 (8%),
respectively, from the comparable periods of 1998. The decrease in
the first and second quarters is due primarily to the consolidation
of FHC sales activities into the traditional Company sales
activities.
General and administrative costs for the three months and six
months ended June 30, 1999 decreased $1,216,000 (12%) and $2,816,000
(13%), 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.
<PAGE>
Healthcare benefits represent medical losses incurred by insureds
of the Company's insurance entities. The loss ratio (losses as a
percent of premiums) was 156% and 126%, respectively, for the three
months and six months ended June 30, 1999 compared to 94% and 92%,
respectively, for the comparable periods 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 $890,000 (14%)
and $2,010,000 (16%), respectively, for the three months and six
months ended June 30, 1999 from the comparable periods of 1998 due
primarily to purchases of computer hardware and software.
Interest income for the three months and six months ended June
30, 1999 decreased $3,772,000 (68%) and $7,426,000 (68%),
respectively, from the same periods in 1998 due to the 54% decrease
in cash equivalents and investments since June 30, 1998. Cash
equivalents and investments have decreased primarily as a result of
approximately $244 million in repurchases of common stock since June
30, 1998.
Interest expense increased $423,000 (13%) and $650,000 (10%) from
the comparable periods of 1998 due to a $35 million increase in the
amount of debt outstanding under the Company's revolving credit
agreement since June 30, 1998. The interest rate is currently about
6.5% per annum.
Net income for the three months and six months ended June 30,
1999, decreased $6,372,000 (27%) and $11,895,000 (26%),
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.
Diluted net income per common for the three months and six months
ended June 30, 1999 decreased 8% to $.33 and 8% to $.66,
respectively, per share from the comparable periods of 1998. The
decrease in net income per common share was favorably impacted by
the 3.8 million shares of Company common stock repurchased and added
to treasury during the first six months of 1999. For the three
months and six months ended June 30, 1999, diluted common shares
outstanding decreased 21% and 20%, respectively, from the comparable
periods of 1998.
<PAGE>
Liquidity and Capital Resources
The Company had $30,193,000 in working capital at June 30, 1999
compared with working capital of $15,409,000 at December 31, 1998.
Through the first six months of the year, operating activities
provided $37,721,000 of cash. Investment activities provided
$16,978,000 of cash representing net sales of investments of
$42,713,000 less purchases of fixed assets of $25,735,000.
Financing activities used $80,671,000 of cash representing
$90,099,000 ($25,000,000 which was payable at December 31, 1998 for
transactions settled in 1999) in purchases of treasury stock (of
which $67,208,000 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 $2,847,000
in proceeds from issuance of common stock, $10,000,000 in issuance
of long-term debt and $1,010,000 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 June 30, 1999,
$235 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 did not encounter 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 it will experience accelerated growth in revenue in
the latter part of 1999. 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.
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 and Implement-
Phase Phase or Replacement Validation ation
Phase Phase Phase
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
IT 100% 100% 95% 80% 73%
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 be
generally be divided into three categories: 1) database systems, 2)
operational systems, and 3) claims administration systems.
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.
<PAGE>
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 Health[R]
Network. The Company has completed internal testing and validation
and is currently testing data interchanges with external third
parties. The testing, validation and implementation phases are
expected to be completed during the third quarter of 1999.
PINS. This application is used to maintain demographic
information on providers in The First Health[R] Network.
Modifications to this application have been completed 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
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.
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.
<PAGE>
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 by the end of
the third quarter of 1999.
Additionally, the Company has an agreement with Electronic Data
Systems ("EDS") for access to certain EDS systems to enable the
Company and EDS to provide certain workers' compensation bill
repricing services to Company clients. The Company has received
assurances from EDS that it is taking appropriate measures to ensure
its systems will not be interrupted by a Y2K problem. The Company
and EDS have completed internal modifications and testing and are
working together to establish testing and validation schedules with
clients. The testing, validation and implementation phases have
been completed with approximately 95% of the Company's clients.
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 third 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 their 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 June 30, 1999, the Company has
incurred approximately $14,000,000 (88%) 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, 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 June 30, 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 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company on May 18,
1999, all directors of the Company were re-elected. The number of
votes cast for and withheld for each director were as follows:
<TABLE>
For Withheld
---------- -----------
<S> <C> <C>
Michael J. Boskin 48,268,857 93,746
Daniel S. Brunner 48,271,765 90,838
Robert S. Colman 48,271,965 90,638
Ronald H. Galowich 48,271,265 91,338
Harold S. Handelsman 48,268,957 93,746
Burton W. Kanter 47,682,223 680,380
Don Logan 48,268,457 94,146
Thomas J. Pritzker 48,271,565 91,038
David E. Simon 45,767,052 2,595,551
James C. Smith 48,271,588 91,015
</TABLE>
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: August 10, 1999 /s/James C. Smith
----------------------
James C. Smith
President and Chief Executive Officer
Dated: August 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 June 30,
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $16,950,000 $23,322,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 51,288,000 63,057,000
Other issuances of common stock ...... 50,000 38,000
Purchases of treasury stock .......... (912,000) --
---------- ----------
Weighted average common and common share
equivalents........................... 50,426,000 63,095,000
========== ==========
Net income per common share............ $ .34 $ .37
========== ==========
Six Months Ended June 30,
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $34,530,000 $46,425,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 53,463,000 63,890,000
Other issuances of common stock ...... 86,000 695,000
Purchases of treasury stock .......... (1,917,000) (1,230,000)
---------- ----------
Weighted average common and common share
equivalents........................... 51,632,000 63,355,000
========== ==========
Net income per common share............ $ .67 $ .73
========== ==========
</TABLE>
<PAGE>
<TABLE>
First Health Group Corp. and Subsidiaries EXHIBIT 11
COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE
(Unaudited)
Three Months Ended June 30,
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $16,950,000 $23,322,000
========== ==========
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 51,288,000 63,057,000
Other issuances of common stock ...... 50,000 38,000
Purchases of treasury stock .......... (912,000) --
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options 361,000 1,100,000
---------- ----------
Weighted average common and common share
equivalents........................... 50,787,000 64,195,000
========== ==========
Net income per common share............. $ .33 $ .36
========== ==========
Six Months Ended June 30,
1999 1998
---------- ----------
<S> <C> <C>
Net income ............................. $34,530,000 $46,425,000
Weighted average number of common shares
outstanding:
Shares outstanding from beginning of period 53,463,000 63,890,000
Other issuances of common stock ...... 86,000 695,000
Purchases of treasury stock .......... (1,917,000) (1,230,000)
Common Stock Equivalents:
Additional equivalent shares issuable from
assumed exercise of common stock options 367,000 1,248,000
---------- ----------
Weighted average common and common share
equivalents........................... 51,999,000 64,603,000
========== ==========
Net income per common share............. $ .66 $ .72
========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
data here
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 24,292
<SECURITIES> 77,349
<RECEIVABLES> 80,214
<ALLOWANCES> 11,060
<INVENTORY> 0
<CURRENT-ASSETS> 177,246
<PP&E> 178,858
<DEPRECIATION> 62,469
<TOTAL-ASSETS> 497,563
<CURRENT-LIABILITIES> 147,053
<BONDS> 0
0
0
<COMMON> 767
<OTHER-SE> 106,781
<TOTAL-LIABILITY-AND-EQUITY> 497,563
<SALES> 0
<TOTAL-REVENUES> 232,791
<CGS> 0
<TOTAL-COSTS> 157,287
<OTHER-EXPENSES> 14,348
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,995
<INCOME-PRETAX> 57,577
<INCOME-TAX> 23,047
<INCOME-CONTINUING> 34,530
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 34,530
<EPS-BASIC> .67
<EPS-DILUTED> .66
</TABLE>
