-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Pb2lTxfecGG2LxwXGiGLRTI3E7vCpQSyzatfm92uFoTWGqL+kMr5NO46phLgxvj8 HaXa2w3QJ/wRW7JklfT28g== 0000950131-98-002153.txt : 19980331 0000950131-98-002153.hdr.sgml : 19980331 ACCESSION NUMBER: 0000950131-98-002153 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST COMMONWEALTH INC CENTRAL INDEX KEY: 0001001493 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 752154228 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27064 FILM NUMBER: 98578505 BUSINESS ADDRESS: STREET 1: 444 NORTH WELLS ST STREET 2: STE 600 CITY: CHICAGO STATE: IL ZIP: 60610 BUSINESS PHONE: 3126441800 MAIL ADDRESS: STREET 1: 444 NORTH WELLS ST STREET 2: STE 600 CITY: CHICAGO STATE: IL ZIP: 60610 10-K 1 FORM 10K ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-27064 First Commonwealth, Inc. (Exact name of registrant as specified in its charter) Delaware 75 - 2154228 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 444 N. Wells St., Suite 600, Chicago, IL 60610 (Address of principal executive offices, including zip code) (312) 644-1800 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.001 per share, including associated Preferred Stock Purchase Rights (Title of Class) 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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 27, 1998 was approximately $42 million, based on the closing price of $14.625 of the registrant's common stock on the Nasdaq National Market. This calculation does not reflect a determination that persons are affiliates for any other purposes. Number of shares of common stock outstanding as of February 27, 1998: 3,639,500 Documents Incorporated by Reference: Part II - Portions of the registrant's 1997 Annual Report to Stockholders, as indicated herein. Part III - Portions of the registrant's definitive proxy statement to be distributed in conjunction with registrant's annual stockholders' meeting to be held in 1998 (the "Proxy Statement"), as indicated herein. ================================================================================ 1 PART I Item 1. Business First Commonwealth, Inc. is a leading provider of managed dental benefits in the upper Midwest, including the metropolitan areas of Chicago, Milwaukee, Detroit, Indianapolis and St. Louis. As of December 31, 1997, the Company provided managed care and indemnity/PPO products to approximately 592,300 employees and dependents ("members") through more than 4,500 employer groups ("groups"). The Company markets a broad range of innovative dental benefit plans which are designed to meet the needs of large, medium and smaller-sized groups. The managed care and PPO plans offer dental benefits primarily through the Company's managed care and PPO network of approximately 2,250 general dentists and specialists ("providers"). The Company distributes its products through a network of over 1,400 independent insurance brokers which target medium and smaller-sized groups, and a direct sales unit which targets larger groups. The Company's managed care plans are provided on a stand-alone basis ("managed care products") and also in conjunction with the Company's indemnity and indemnity/PPO plans (collectively "indemnity/PPO plans") which provide benefits outside the Company's managed care network (the combined managed care/indemnity/PPO plans are referred to as "Managed Choice/SM/products"). The Company has integrated its PPO network with the indemnity plan component of its Managed Choice/SM/ product to offer a point-of-service option to members, called "Managed Choice/SM/ Triple Option." The Company also provides a "network rental" product primarily to large Taft-Hartley funds and medical HMOs. Under the terms of this product offering, the Company provides access to the network of reduced fee arrangements with providers, but does not handle the claims administration. The Company charges an access fee for these arrangements. The Company also receives fee income for administrative services only ("ASO") arrangements whereby the Company pays claims for self funded employers but does not assume the underwriting risk of these claims. The Company receives a monthly premium for each employee who enrolls in its managed care or indemnity plans. If covered by a managed care plan, a member selects a provider (general dentist) from the Company's managed care network. The Company then pays a pre-arranged fee, typically a capitation payment, to the provider selected by the member. Certain preventative and diagnostic services (e.g., cleanings and x-rays) are provided to members at no additional fee. The dentist provides other dental services for a reduced fee ("co-payment") paid by the member. If covered by an indemnity plan, the member pays fees set by the dentist for services rendered and submits claims for reimbursement. The Company was founded in 1986 by Christopher C. Multhauf, Chairman of the Board of Directors and Chief Executive Officer of the Company, David W. Mulligan, President and Chief Operating Officer of the Company, Richard M. Burdge, a Director of the Company and Philip N. Bredesen, a former Director of the Company. Mr. Bredesen was previously the founder and Chairman of the Board of HealthAmerica Corporation, which grew to operate HMOs in 17 states before being acquired by Maxicare Health Plans, Inc. in 1986. The Company commenced operations in 1988 with the goal of building a leading managed dental care market position in the Chicago metropolitan area. Since beginning operations in 1988, the Company has grown to become one of the upper Midwest's leading dental benefit organizations. During 1996, the Company completed acquisitions in Milwaukee and St. Louis, and began de novo start-ups in Detroit and Indianapolis. Effective July 18, 1996, the Company completed the acquisition of Smileage Dental Services, Inc. ("Smileage"), a Milwaukee, Wisconsin based dental HMO administrator which provides services to approximately 50,000 members, and an associated reinsurance transaction, for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through the issuance of the Company's common stock. Effective December 31, 1996, the Company completed the acquisition of Champion Dental Services, Inc. ("Champion"), a St. Louis, Missouri based prepaid dental plan which provides services to approximately 60,000 -2- members, for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through proceeds from the Company's initial public offering and was paid in cash on January 2, 1997. As of January 1, 1997, the Company had increased the available market population for the markets it serves from the Chicago metropolitan area, which is the country's third most populous metropolitan market, with a population of approximately 8.3 million, to include the metropolitan areas of Milwaukee, Detroit, Indianapolis and St. Louis. These metropolitan areas have a combined population of approximately 18.4 million. The Company's revenues increased from $17.3 million in 1993 to $56.6 million in 1997. Over the same period, the Company's operating income grew from $1.6 million to $5.1 million. For the year ended December 31, 1997, the Company's revenues increased 28% to $56.6 million from $44.1 million in the prior year period and operating income increased 29% to $5.1 million from $4.0 million. From December 31, 1993 to December 31, 1997, the number of fully insured members covered by the Company's managed care and indemnity/PPO products increased from 193,100 to 515,700. Several key operating strategies, including the Company's regional focus, have contributed to the Company's growth. First, the Company has built the largest prepaid managed dental care provider network in the Chicago metropolitan area and maintains the quality of this network through credentialing, ongoing peer review and Company-sponsored continuing education seminars. Second, the Company has developed a wide range of innovative dental benefit products that it believes have contributed to its success in attracting and retaining large groups. For example, the Company's Managed Choice/SM/ products provide it with the capability to completely replace a group's existing indemnity plan with the Company's combined managed care and indemnity/PPO plan. Furthermore, the Company's national account administration program provides its Chicago-based employers with managed care plan options outside the Company's managed care network service area through its relationships with independent provider networks. Third, the Company has built an efficient business development process that combines an extensive proprietary database with targeted direct mail and telemarketing to contact employers, independent insurance brokers and providers. Utilizing this process, the Company markets its products directly to large employers, distributes its products through brokers to medium and smaller-sized employers and continuously recruits new providers into its managed care network. Fourth, the Company has expanded its geographic service area and is implementing its operating strategy in other major metropolitan areas in contiguous states. This is intended to enable the Company to continue to achieve administrative operating efficiencies as it expands. The Company believes there are significant opportunities for the continued growth of its business in its regional service area. First, the Company intends to continue to seek to increase sales from medium and smaller-sized groups by increasing its sales staff, telemarketing and direct mail efforts towards brokers which sell to these market segments. The Company believes that these market segments are currently under penetrated for managed care products. Second, the Company intends to continue to develop innovative products in response to group needs. Third, the Company has expanded its managed care provider network in the markets it serves. Fourth, the Company intends to continue to focus on achieving administrative operating efficiencies through increased use of voice and data technologies and by emphasizing efficient provider arrangements. First Commonwealth, Inc. was incorporated in Delaware in 1986. Its principal place of business is located at 444 North Wells Street, Suite 600, Chicago, Illinois 60610, and its telephone number is (312) 644-1800. Unless the context otherwise requires, all references to the "Company" shall mean First Commonwealth, Inc., together with its subsidiaries, First Commonwealth Limited Health Services Corporation, First Commonwealth of Illinois, Inc., First Commonwealth Insurance Company, First Commonwealth Reinsurance Company, First Commonwealth Limited Health Service Corporation, Smileage Dental Services, Inc. and First Commonwealth of Missouri, Inc. (formerly Champion), and its affiliate, First Commonwealth Health Services Corporation. See "Business - Company's Corporate Structure." Certain statements included or incorporated by reference in this Annual Report on Form 10-K under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in the Annual Report on Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance, or achievements of the Company to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, increased competition in the markets in which the Company operates; changes in regulation affecting the Company; changes in utilization of services; changes in arrangements relating to payments to providers; the level of the Company's indemnity/PPO enrollment and the related indemnity/PPO risk of indemnity/PPO plans; the ability to integrate and successfully operate acquired businesses and the risks associated with such businesses; the possible need for, and ability to obtain if needed, financing on acceptable terms to finance the Company's growth strategy; the ability of the Company to operate within the limitations imposed by any such financing arrangements; and other factors referenced or incorporated by reference in the Annual Report on Form 10-K. -3- The Dental Benefit Marketplace According to the U.S. Office of National Health Statistics, total expenditures for dental care in the United States grew from approximately $14 billion in 1980 to an estimated $48 billion in 1996. The U.S. Health Care Financing Administration reports that expenditures for dental services account for approximately 4% of total national health care expenditures. According to the U.S. Department of Labor, the cost of dental services has been rising at a higher rate than that for consumer goods. The U.S. Department of Labor Statistics reported that, from 1987 to 1997, the Consumer Price Index for all Urban Consumers for dental services increased 5.39% annually whereas this index for all items increased only 3.22% annually. As a result, the Company believes that there has been increased interest by employers in managing dental care costs. Employer-sponsored dental benefits are one of the most common employee welfare benefits. The National Association of Dental Plans ("NADP") estimates that approximately 124 million persons, representing approximately 47% of the total United States population, were covered by some form of dental benefit coverage at the end of 1996. Historically, a substantial majority of dental coverage has been through traditional indemnity plans. In recent years, however, managed dental care has achieved increasing market acceptance. National dental HMO enrollment has grown at an annual rate of approximately 18% between 1993 and 1996, from approximately 14.4 million covered lives in 1993 to approximately 23.8 million in 1996. The estimated rate of growth in dental HMOs for 1997 was approximately 6-10% in terms of enrollment. This compares to over 77 million Americans who were enrolled in medical HMOs in 1996 according to the Managed Care Digest Services. The Company believes the relatively high growth rate for managed dental care plans is attributable to (i) the greater acceptance of managed care by employers and employees; (ii) the significant price advantage relative to indemnity plans; (iii) the cost effectiveness to employers of managed dental care plans as an employee benefit; and (iv) the acceptance of prepaid dental plans by dentists, resulting in improved accessibility and convenience for members. Members of dental HMO benefit plans represent approximately 19% of the population with dental care coverage and approximately 9% of the total U.S. population. The Company believes that there will continue to be significant growth opportunities in the managed dental benefits industry. Historically, larger employers have been more likely to offer dental benefit coverage to their employees. According to the 1993 Foster Higgins Survey of Employer Sponsored Health Plans (the "Foster Higgins Survey"), nationally approximately 87% of employers with more than 200 employees offer some type of dental benefit to some or all employees and approximately 64% of these employers have a stand-alone dental plan, separate and distinct from other health and welfare benefits offered to employees. By comparison, this survey reported that only 47% of employers with less than 200 employees offer dental benefits. It has been the Company's experience that many employers that do not offer dental benefits are willing to consider offering a plan in which the employee pays the full cost of such benefits through payroll deductions. The managed dental care industry as a whole is currently fragmented and characterized by the participation of several large, national insurance companies and many smaller independent plan sponsors. As of December 31, 1995, the NADP estimated that there were over 140 managed dental companies in the United States, with no dominant market leader. The increase in the number of dentists nationally during the last two decades has exceeded the rate of population growth. According to the American Dental Association ("ADA"), the number of practicing dentists in the United States has increased from approximately 127,000 in 1982 to approximately 153,000 in 1995. In addition, the dental marketplace is highly fragmented with approximately 90% of all dentists working in a one or two-dentist office, according to the ADA. Also, according to a survey of dental practices published by the ADA in 1996, the median of staff and other costs that are part of total overhead expenses was approximately 60-65% of the gross revenues of solo and group dental practices. The increase in the number of dentists as a proportion of the population, the fragmented dental marketplace, the high proportion of overhead costs for dentists and an improved level of overall dental health has created a highly competitive environment among dentists, particularly in metropolitan areas. The Company -4- believes that these factors have contributed to the willingness of qualified dentists to participate in managed care and PPO networks as dentists seek to increase practice revenues. As in the case of medical coverage, the substantial majority of dental coverage is provided through traditional fee-for-service indemnity dental plans. Under a traditional fee-for-service indemnity plan, coverage is provided based on a reimbursement formula of the usual and customary charges submitted by the dentist. Compared to medical coverage, the average cost of dental services is lower and the utilization of services is more predictable. Unlike medical coverage, dental coverage generally does not cover catastrophic risks. Dental care is provided almost exclusively on an outpatient basis and, according to a 1997 article in the Illinois Dental News, over 90% of all dental services are performed by general dentists. Also, dental plans generally do not include coverage for hospitalization, typically the most expensive component of medical services. Common features of dental indemnity plans include deductibles, maximum annual benefits of less than $2,000 per person and significant patient cost- sharing. Patient cost-sharing typically varies by type of dental procedure ranging from no cost sharing for preventive procedures to 50% cost-sharing for crowns and even greater cost-sharing for orthodontic care. This high patient cost-sharing and the relatively predictable nature of dental expenditures substantially limits the underwriting risk of a dental plan when compared to the underwriting risk of a medical plan which covers catastrophic illness and injuries. Furthermore, since most dental problems are neither life threatening nor represent serious impairments to overall health, there is a higher degree of patient cost sensitivity and discretion associated with obtaining dental services. Many dental conditions also have a range of appropriate courses of treatment, each of which has a different out-of-pocket cost for patients. For example, a deteriorated amalgam filling may be replaced with another amalgam filling (a low-cost alternative), a pin-retained crown build-up (a more costly alternative) or a gold crown with associated periodontal treatment (the most costly alternative). The level of coverage provided to the patient and the dental plan's reimbursement methodology may influence the type of services selected by the patient or rendered by the dentist. Under a traditional indemnity insurance plan or fee-for-service arrangement, the insurer and the patient each pays a percentage of the fee charged by the dentist, subject to cost-sharing, maximum benefit allowances and usual and customary limits. Under such an indemnity plan, dentists have little incentive to reduce total charges because they are compensated on a fee-for- service basis. By contrast, under a dental HMO plan the pre-determined payments, typically capitated payments, are fixed and co-payments for additional services are pre-negotiated by the Company. The co-payments generally are designed to exceed the dentist's variable costs, but are typically less than the dentist's usual and customary fee. Fixed capitation payments that do not vary with the frequency of services provided create an incentive for dentists to emphasize preventive care, control costs and maintain a long-term patient relationship that generates consistent capitation revenue. Fixed capitation payments also substantially reduce the underwriting risk to the Company associated with the high utilization of services. Markets Served by the Company Until July 1996, the Company had focused its efforts primarily on the Chicago metropolitan market, including Northwest Indiana, and has grown to become one of Chicago's leading managed dental care organizations. By the beginning of 1997, the Company had expanded into Milwaukee and St. Louis, and had initiated de novo activity in Detroit and Indianapolis. The Chicago area is the country's third most populous metropolitan market with a population of approximately 7.5 million. In addition, northwest Indiana has a population of approximately 750,000. According to the NADP, Illinois is the fifth largest state in terms of enrollment in managed dental care plans and had approximately 1.1 million persons enrolled in managed dental care plans in 1995 which represented 8.2% of the state's population. As of December 31, 1994, virtually all of the Company's 216,000 managed care members were located in Illinois. Approximately 300,600 of the Company's 450,400 managed care members were located in Illinois and northwest Indiana as of December 31, 1997. The Company believes that Illinois, and particularly the Chicago metropolitan area, offers significant opportunities for continued growth in sales of managed dental care products, -5- especially to medium and smaller-sized employers who have historically been less likely to offer managed dental coverage. The Company believes that, in the Chicago metropolitan area, there are approximately 500 employers with 500 or more employees (employing an aggregate of approximately 1.3 million persons), and approximately 50,000 employers with 10 - 499 employees (employing an aggregate of approximately 1.5 million persons). Based on its database of contacts with employers in the Chicago metropolitan area, the Company believes that a higher percentage of larger employers have implemented managed care plans as compared to medium and smaller- sized employers. The Company believes that medium and smaller-sized employers have become increasingly receptive to managed dental care products in part because of their increasing satisfaction with managed care in their medical benefit plans. The metropolitan markets of Milwaukee, St. Louis, Detroit and Indianapolis have a combined population of approximately 10.1 million. According to the NADP, the combined states from these metropolitan areas had approximately 1.2 million people enrolled in dental HMO plans in 1995. Approximately 139,700 of the Company's 450,400 managed care members were primarily located in the greater metropolitan area of the cities listed above. The Company believes that these expansion markets continue to offer opportunities for continued growth in sales of managed dental care and indemnity/PPO products. The Company presently has limited marketing activity in Indianapolis and does not expect to generate significant enrollment growth from this market in 1998. Since the Company's operations are located primarily in the Chicago, Milwaukee, St. Louis, Detroit, and Indianapolis metropolitan areas, its operations may be more adversely affected by localized economic, regulatory or competitive conditions than more geographically diverse companies. The Company also markets its products to employers based in its service areas who have employees outside the Company's managed care network service area ("out-of-area employees"). If an employer wishes to offer a managed care product to its out-of-area employees, the Company has arrangements to provide this option through its relationships with independent provider networks in over 40 states. The Company collects the revenue for these plans, retains a small processing fee, and remits the premium to the out-of-area independent dental plan carrier. Consequently, this product provides negligible gross margin to the Company. The Company markets this product to employers based in its service areas in order to compete with national dental plans. As of December 31, 1997, approximately 10,100 members were enrolled with other dental care plans through such arrangements. The Company also provides its Managed Choice/SM/ product to employers who have some out-of-area employees, which permits such employees to select the local managed dental care plan or indemnity coverage through the Company. -6- Growth Strategy The Company plans to further expand its business through the following strategies: Emphasize Medium and Smaller-sized Employers. The Company believes that employers with 10-499 employees, which account for approximately 1.5 million employees in the Chicago metropolitan area, continue to represent an attractive market segment for managed care products. The Company intends to continue to build upon its current market position and increase its sales staff, telemarketing and direct mail efforts towards brokers which sell to medium and smaller-sized employers. Continue to Expand Product Line. The Company believes that it must continue to offer its clients and prospective clients a range of new products that vary in cost, coverage and network access to remain competitive. The Company believes it can expand the marketing of its Managed Choice/SM/ Triple Option product by expanding its PPO provider network, reducing benefits for non-network utilization, and reducing the overall cost of the product to reflect the lower non-network benefit levels. Managed care products that vary in cost relative to the size of the managed care network also represent areas of growth for the Company. Expand Geographic Service Area. The Company has expanded its managed care provider network in Illinois and into northwest Indiana to meet the needs of its large client groups. In addition, during 1996, the Company expanded into four new markets by completing two acquisitions and initiating two de novo start-ups. The Company intends to continue marketing to groups in these new geographic areas over the next 12 months and may continue to expand into other contiguous or proximate markets. Increase Size of Quality Provider Network. A key factor in the past success of the Company has been the size, accessibility and quality of the Company's managed dental care provider network. The Company plans to add new, quality providers to its networks, as well as to continue to expand the number of qualified providers who participate in its reduced fee-for-service PPO network. The Company believes a large, accessible network of quality providers is an important component in attracting new enrollment into its managed care and PPO products, both in existing markets and in any new markets developed by the Company. Achieve Cost Efficiencies. The Company believes that its strategy of focusing operations on a regional basis provides certain SG&A cost efficiencies. Additionally, the Company has experienced a decline in its SG&A expenses as a percentage of revenues in recent years to a level that it believes is generally sustainable. The Company continues to enhance its management information systems and plans to introduce new voice and data technologies in the areas of billing and enrollment to achieve staffing economies. The Company also regards its large regional enrollment as an effective cost-containment strategy in its provider contracting efforts. The Company believes the combination of its volume purchasing arrangements with providers and its administrative cost efficiencies can contribute to the future growth of the business. Products The Company offers a comprehensive range of flexible and innovative dental benefit products that are designed to offer flexibility to an employer, its eligible employees and their dependents. Each product is positioned to meet the needs of key market segments that the Company has identified. The Company primarily markets two categories of products: (i) stand-alone managed care products and (ii) managed care plans offered in combination with indemnity/PPO plans (marketed by the Company as Managed Choice/SM/ products). The following table shows the enrollment growth in the Company's managed care and indemnity/PPO plans. -7-
As of December 31, ------------------------- 1995 1996 1997 ---- ---- ---- Members Managed Care(1).. 265,800 341,600 450,400 Indemnity/PPO.... 36,700 56,200 65,300 ------- ------- ------- Total........ 302,500 397,800 515,700 ======= ======= =======
- -------------- (1) Includes members who have selected the managed care option under the Company's Managed Choice/SM/ products and excludes Champion members as of December 31, 1996. From 1988 to 1992, the Company primarily marketed its managed care plans on a stand-alone basis. Beginning in 1992, the Company combined its managed care plans with indemnity plans and began marketing this combination as its Managed Choice/SM/ products. Since the introduction of Managed Choice/SM/ products in 1992 and the addition of a PPO option in 1996, the Company has experienced significant enrollment growth in its indemnity products, particularly among large employers. The Company also receives fee income for providing access to its PPO network and for ASO services. As of December 31, 1997, approximately 76,600 participants were eligible to access the Company's PPO network and were covered under its ASO arrangements. See "Fee Income Products" below. Managed Care Products. The Company offers a range of managed care plans which are designed to meet the needs of target markets. These plans vary in coverage levels and cost, which allows the Company to tailor an appropriate managed care product to an employer's current overall benefit program. The Company offers its managed care products on a stand-alone basis and as an alternative to traditional indemnity dental insurance. Managed care products generally are more cost effective to groups and members than traditional indemnity coverage. For example, the Company typically charges 30 to 60% less in monthly premiums for managed care plans than for its indemnity plans which provide comparable coverage. In addition, the Company's managed dental care products offer more comprehensive benefits than traditional dental indemnity plans. The following table compares certain features of the Company's managed care plans with the features of a typical indemnity dental plan. COMPARISON OF FIRST COMMONWEALTH'S MANAGED CARE PLANS WITH A TYPICAL DENTAL INDEMNITY PLAN
First Commonwealth Typical Dental Feature Managed Care Plans Indemnity Plan(1) ===================================================================================== Deductible None $50 per person ===================================================================================== Annual dollar limitation None $1,000 per year on coverage - ------------------------------------------------------------------------------------- Claim forms for Not required; member Required; member or dentist reimbursement makes co-payment directly may incur delays in to dentist obtaining reimbursement - ------------------------------------------------------------------------------------- Member's Member co-payment fixed Member pays any excess charges out-of-pocket costs in advance of service above customary fee levels - -------------------------------------------------------------------------------------
- -------------- (1) These features are also representative of indemnity plans offered by the Company. -8- The Company receives a monthly premium for each employee and eligible dependent enrolled in its managed care plans. The Company remits a predetermined portion of the premium, typically as a capitation payment, to the participating network dentist selected by the member to "pre-pay" for dental care to be rendered to that member. The capitation payment is a fixed, per-member payment which is made by the Company to the provider for each member who chooses that dentist, regardless of the frequency or nature of services rendered. Members covered under the Company's managed care plans obtain certain basic dental procedures such as exams, x-rays, cleanings and fluoride treatments at no additional charge other than, in some cases, a small office visit co-payment. The Company's managed care plans also establish co-payments for other services provided by the network dentist such as fillings, root canals and crowns. The amount of the co-payment varies in accordance with the complexity of the covered procedure but is designed to exceed the provider's variable cost related to the procedure. The network general dentist provides all dental care services except those specialized services that are more appropriately delivered by dental specialists. When a managed care network general dentist identifies the need for a specialist, the general dentist completes a referral request form and forwards it to the Company for review. Examples of dental services provided by a specialist include oral surgery, periodontics, endodontics, pedodontics and orthodontics. The Company's independent contractor dentist consultants review the referral request to determine the appropriateness of the requested treatment. If the dental consultant approves the referral request, the patient is then referred by the network general dentist to a network specialist. The specialist dentist receives a co-payment from the member, negotiated in advance by the Company, for the specialty services rendered. In addition, the Company makes monthly payments to the specialist dentists on a capitated or other basis negotiated by the Company and the specialist. When an employer first introduces the Company's managed care product to its employees, the employer offers an open enrollment period in which employees may join the managed care plan. Employees enroll for a one year period. Each year thereafter the employer offers an open enrollment period in which employees may join the managed care plan and existing enrollees may terminate their coverage under the plan. When employees enroll in the managed care plan, they select a participating dentist from the Company's managed care network for each family member. Unlike many competing plans, the Company's managed care plans permit each member of an employee's family to choose a different dentist. This choice allows an employee to select a dentist closer to work while other family members may choose a dentist closer to home. The Company has designed a range of products to market to employers that currently do not offer a dental plan and to employers that currently offer only a traditional dental indemnity plan. A description of these products and the manner in which they are offered to employer groups follows. Managed Care Plans Offered on a Voluntary Basis. The Company's managed care plans can be offered on a voluntary (employee-pays-all) basis, in which only those employees who wish to receive and pay for coverage do so. This product is attractive to many employers who do not presently offer dental benefits to their employees, because it does not require the employer to contribute toward the cost of the dental plan. The Company believes that the primary reasons many employers do not offer a dental plan are cost and the restrictive underwriting requirements of dental indemnity plans. These underwriting restrictions often include minimum financial contributions from the employer, a guaranteed minimum number of employees participating in the dental plans and significant coverage -9- exclusions. Under the Company's managed care products offered on a voluntary basis, the employee pays for the cost of the plan through a payroll deduction, which may be made on a pre-tax basis if the employer has adopted a flexible spending plan under Section 125 of the Internal Revenue Code. Furthermore, unlike many traditional indemnity carriers, the Company does not require any minimum number of employees to enroll in order for this employee-pay-all dental plan to be implemented. The Company's managed care products also do not have the extensive coverage exclusions of dental indemnity plans. Managed Care Plans Offered as an Alternative to an Existing Indemnity Dental Plan. The Company also offers its managed care plans as an alternative to an employer's existing dental indemnity program. Employees have the choice of enrolling in the Company's managed care plan or remaining in the employer's existing indemnity dental plan. In offering the Company's managed care plan as an alternative, the employer does not have to change existing indemnity dental benefits or its existing dental claims processor. Unlike traditional indemnity plan designs, the Company's managed care plans have no deductible to satisfy, no annual limitation on benefits, no claim forms to file and are easier for many employees to understand because of the relatively simple co-payment structure. The managed care plans offered by the Company to employers as an alternative to existing indemnity plans typically offer more comprehensive coverage than the managed care plans offered to employees on a voluntary basis. The more comprehensive coverage of the managed care alternative is designed to encourage employees to move from the existing dental indemnity plan because the managed care product provides the employer with lower cost per employee. Employers hold an annual open enrollment period in which employees may transfer between the traditional dental indemnity alternative and the managed care alternative. The Company has generally experienced net growth at annual renewals in its managed care plan when offered on such a basis. Managed Care Plans Offered as a Replacement for an Existing Dental Indemnity Plan. In evaluating the Company's managed care plans, some employers have elected to implement the managed care plan as a replacement for an existing dental indemnity plan. The Company believes that, typically, this decision is based on three considerations: (i) the lower cost to the employer of the Company's managed dental care plan compared with the traditional dental indemnity plan, (ii) the improved coverage to employees available through the Company's managed care plans as compared with a typical indemnity dental plan and (iii) the Company's large and accessible network of credentialed dentists. In addition to the Company's stand-alone managed care products, the Company also markets its managed care plans in combination with indemnity coverage. A discussion of these products follows. Managed Care Plans Combined with Indemnity Plans--Managed Choice/SM/ Products. The Company has combined its managed care plans with indemnity dental coverage in its Managed Choice/SM/ products which offer coverage from the dental HMO network and non-network dentists. Managed Choice/SM/ products enable the Company to replace an employer's existing traditional dental indemnity plan offered by a third party insurance company. Upon enrollment or for a limited number of clients, at point of service, members select the managed care product or the indemnity plan provided by the Company. The Company provides the out-of- network coverage on a traditional dental indemnity basis and administers the claims for the out-of-network coverage. In marketing its Managed Choice/SM/ products, the Company consults with prospective groups to identify potential areas of cost containment for the out- of-network coverage. Because the Company controls the design of both the managed care and indemnity plans, it can encourage greater participation levels in the less expensive managed care plan. Through a combination of plan design and claims administration, the Company has helped contain the aggregate cost of its groups' indemnity dental benefit programs through its Managed Choice/SM/ products. The Company has experienced considerable demand for its Managed Choice/SM/ products since their introduction in 1992. As of December 31, 1997, Managed Choice/SM/ products accounted for approximately 142,600 (approximately 28%) of the Company's approximately 515,700 members. Of the 142,600 Managed Choice/SM/ enrollees, approximately 84,000 are enrolled in the Company's managed care plans and approximately 58,600 are enrolled in the Company's indemnity plans. -10- Managed Care Plans Combined with Indemnity/PPO Plans--Managed Choice/SM/ "Triple Option" Products. The Company has integrated a PPO network with the indemnity plan component of the Managed Choice/SM/ product to offer a point-of- service option to members. Called the Managed Choice/SM/ Triple Option, members have a point-of-enrollment choice between the managed care and the indemnity/ PPO plans. If a member selects the indemnity/PPO plan, the member then has a point-of-service option to choose a participating PPO dentist or a non- participating dentist. The member's out-of-pocket cost is reduced by selecting a participating managed care or dental PPO provider over a non-participating provider. Under the Company's Managed Choice/SM/ Triple Option product, members who select the indemnity/PPO plan will have a benefit incentive to select the participating PPO dentist. The reduced fee arrangements of the PPO are expected to assist groups in containing dental costs. As of December 31, 1997, the Company's PPO network of providers had approximately 500 more dentists than its network of managed care providers. The Company is actively recruiting other dentists to participate in its PPO network and intends to add more dentists to its PPO plan to support this triple option product. The Company has had limited success with its Managed Choice/SM/ Triple Option products since their introduction in 1996. As of December 31, 1997, Managed Choice/SM/ Triple products accounted for approximately 14,700 (approximately 2.9%) of the Company's approximately 515,700 members. Of the 14,700 Managed Choice/SM/ Triple Option enrollees, approximately 8,000 are enrolled in the Company's managed care plans and approximately 6,700 are enrolled in the Company's indemnity/PPO plans. See "Fee Income Products" below for members covered under this product on a self-insured basis. Fee Income Products. For self-insured employers, the Company provides claims administration under an administrative services only ("ASO") arrangement whereby the Company does not assume the underwriting risk for the indemnity claims. The Company receives an administrative fee to process the claims and the underwriting risk is retained by the employer sponsoring the self-insured plan. Also under self-insured plans, the Company has offered the integration of the PPO network into employer sponsored plans and can receive a PPO access fee for each member who selects the indemnity/PPO self-insured plan as well as an ASO fee for providing third party administration services. As of December 31, 1997, the Company had approximately 31,900 members in these two categories. In 1996, the Company introduced a new product called a PPO network "rental" option. Under the terms of this new product offering, the Company provides access to its reduced fee arrangements with providers, but does not handle the third party administration services. This product capability was developed in response to the opportunity to market to large union Taft-Hartley funds, many of which handle their own claims processing. The Company has been selected by a coalition of unions representing more than 50,000 members as the endorsed PPO vendor and enrolled the first union group on January 1, 1997. Although this PPO network "rental" option generates modest fee income, it enhances the Company's purchasing power in the dental community and opens up the organized labor market as a new opportunity for the Company's other managed care products. As of December 31, 1997, the Company had approximately 44,700 members in this category. -11- Network Providers The Company believes that the size, quality and accessibility of its network of managed care dentists has been an essential element in its managed care enrollment growth. The Company maintains a proprietary database of dentist contacts throughout its service area which it utilizes to continuously recruit new providers into its network. The Company also believes that its ability to effectively market its network of managed care dentists to employers through its managed care products makes participation in its provider network attractive to many dentists. The Company regards its managed care network providers as customers and has implemented practices and procedures to attract and retain qualified providers. The Company attempts to compensate managed care providers primarily on a capitated basis because it believes that capitated compensation is the most effective method of containing dental benefit plan costs on an ongoing basis. The Company typically ''prepays'' the capitated amounts on the first business day of each month for those members who have selected that dentist, thereby creating attractive cash flow advantages to dentists who participate in the Company's managed care network. Dentists have relative high fixed costs associated with their practices. Many dentists are willing to negotiate their fees and find capitation an attractive revenue source to help them cover such costs. In addition to capitation, managed care dentists also receive co-payments for services (other than certain preventative/diagnostic procedures) at the time service is rendered. The Company attempts to price its members' co-payments so that they exceed a dentist's variable costs for the procedure, but are less than the dentist's usual and customary fee. The Company's benefit plans require a patient to make co-payments directly to the dentist at the time of service, which eliminates delays in payments and reduces the overhead associated with filing claims and attendant collection efforts. In addition, the Company also may negotiate other payment arrangements with managed care dentists under certain circumstances. This may involve, among other things, contributions by the Company toward costs for infection control, cost- sharing by the Company on a discounted fee-for-service basis, or for new providers, minimum monthly payment arrangements. A significant portion of the specialists with which the Company has managed care provider contracts are compensated by the Company on a discounted and full fee-for-service basis and not on a capitated basis. Accordingly, the Company retains the risk of its share of the cost for services provided through such arrangements. Total payments to specialists represented approximately 12% of the Company's payments to providers in 1997. The Company believes that the large number of practicing dentists and the high proportion of solo practitioners make the Chicago metropolitan markets highly competitive for private practice dentists. It has been the Company's experience within the Chicago metropolitan marketplace that dental providers are willing to participate in its managed care network. The Company believes that providers find participation in its managed care network attractive for several reasons. The Company has established a record of delivering large volumes of new patients to participating providers. The Company regards its network providers as customers and believes that it provides higher levels of service and support than typically provided by its competitors. These factors, coupled with the fact that the Company's capitated payment arrangements provide attractive cash flow advantages to its managed care dentists, have enabled the Company to attract and retain qualified providers for its managed care network. The Company also believes that its managed care network must be of demonstrable quality. The Company has developed a multi-step quality assessment program which begins by initially qualifying interested dentists followed by a personal office visit with the dentists. Further credentialing involves verifying a dentist's license, the existence of professional liability coverage and reviewing any previous claims history. Additionally, the dental office itself is reviewed to determine if the Company's managed care quality assessment program standards, which include proper infection control procedures, are being followed. After dentists are added to the managed care network, they and their practices are periodically recredentialed to ensure Company quality assessment standards are being maintained. This recredentialing also includes a periodic random chart audit of members who have received services from network dentists at that practice. Additionally, a comprehensive membership complaint/inquiry database is maintained by the Company, the contents of which are discussed with network dentists when considered necessary. The Company administers its continuing quality assessment program through its staff and through consulting dentists, under the supervision of its corporate Dental Director. The Company further demonstrates its commitment to maintaining a quality -12- oriented managed care network through routine, on-site field visits and telephone service calls to dentists. Additionally, the Company provides an ongoing series of continuing education seminars covering such topics as infection control. The Company also maintains a working relationship with professional dental organizations in dealing with issues of common interest. The Company believes that its managed care network must be stable in order to offer long-term continuity of care. The Company views its providers as customers rather than vendors of care and, consequently, focuses significant resources upon assessing and addressing provider concerns and sources of dissatisfaction. The Company conducts periodic network dentist satisfaction surveys and also provides an ongoing series of continuing education seminars, at no cost for its managed care network providers. Through these contacts, the Company proactively works to meet network dentists' expectations. As a result, the Company's managed care provider annual retention rate has been on average approximately 95%. Managed care network providers are independent contractors who provide services to members pursuant to contractual arrangements with the Company. The Company's relationships with its managed care network dentists generally are terminable at any time by either party upon short notice. The contracts do not require managed care network dentists to provide services exclusively to members of the Company's plans. The Company may, following any required regulatory approval, change the terms, capitation rates, benefits and conditions of the various plans serviced by its managed care network upon advance notice. The Company's contracts with managed care network dentists require the dentists to maintain their own malpractice insurance. The Company also carries insurance protecting it against liability relating to acts or omissions of managed care network dentists. Although no material malpractice or similar claims have been asserted against the Company in the past, there can be no assurance that the Company will not become involved in such litigation or otherwise become subject to material claims relating to its managed care or PPO network dentists in the future. In the event of litigation or claims against the Company for malpractice by one of the providers or for negligence in credentialing one of the providers in its networks, there is no assurance that the Company's professional liability insurance will be sufficient to cover any liability which might result from such litigation or claims. The Company's policy is to permit dentists to participate in either its managed care network, its PPO network or both. Consistent with the practice of other dental PPOs, if a dentist elects to only participate in the Company's PPO network, the credentialing requirements are less extensive than those for the managed care network and currently there are no ongoing peer review requirements for PPO dentists. Presently, substantially all of the participating dentists in the Company's managed care network participate in the Company's PPO network. In addition, at December 31, 1997, the Company's PPO network had approximately 500 additional dentists that do not participate in the Company's managed care network. The Company is actively recruiting other dentists to participate in its PPO network and intends to add more dentists to its PPO network. Customer Groups The following table shows a breakdown of the Company's groups by size as of December 31, 1997:
Number of Subscribers(2) -------------- Size of Group by Number of Subscribers(1) Groups Total % of Total ----------------------------------------- ------ ----- ---------- Individuals........................... N/A 8,700 3.6% 2-10.................................. 1,418 11,900 5.0% 11-50................................. 2,392 37,300 15.6% 51-100................................ 364 25,700 10.8% 101-500............................... 318 63,700 26.6% 500+.................................. 57 91,800 38.4% ----- ------- ----- Total............................ 4,549 239,100 100.0% ===== ======= =====
- -------------- -13- (1) The number of subscribers represents the number of employees of an employer group who have enrolled in one of the Company's products but does not include dependents of such employees. (2) Amounts do not include subscribers in the Company's ASO, ASO/PPO, PPO network access, PPO network rental programs and fully insured Medicare HMO members. The Company's 10 largest groups accounted for approximately 25% of the Company's revenues for the year ended December 31, 1997 and accounted for approximately 17% of total members for such period. None of the Company's groups accounted for more than 10% of the Company's revenues in 1997. The Company's group contracts generally provide for a defined set of dental benefits to be delivered to members for a period of one year at specified monthly rates. The contracts normally have fixed terms of one year and provide for automatic renewal unless terminated by notice from either party provided a specified period (typically 60 days) prior to the end of the term thereof. Marketing and Sales The Company markets its dental benefit plans through a network of over 1,400 independent insurance brokers and a direct sales force consisting of 16 employees. This dual distribution system is designed to reach large groups as well as smaller groups and individuals in an efficient and cost effective manner. The Company believes that this marketing strategy provides it with a competitive advantage by enabling it to market to a wider range of potential groups more efficiently than companies relying on a single distribution system. The Company's direct sales force targets larger employers and groups which are more likely to contribute towards the cost of dental benefits for their employees. In marketing to large groups, the Company's sales force focuses on stand-alone managed care products as an economical alternative to traditional indemnity coverage as well as Managed Choice/SM/ products. The Company pays its direct sales force through a combination of salary and bonus based upon the number of members enrolled for new groups. As part of its growth strategy, the Company intends to increase its internal sales and marketing staff to recruit and manage its network of brokers and expand telemarketing and direct mail efforts. The Company's independent insurance broker network focuses on offering primarily voluntary (employee-pays-all) managed care products to medium and smaller-sized employers which have not previously contributed toward or offered dental care benefits to their employees. The Company believes that there are significant opportunities for the Company to expand managed care coverage to medium and smaller-sized employers by expanding its network of independent brokers who can efficiently sell dental benefit products to the medium and smaller-sized market. Brokers typically do not market the Company's dental benefit plans on an exclusive basis. Brokers generally receive a flat percentage of the premium collected as commission for the initial sale of the Company's product as well as a commission for each annual renewal thereof. The Company has developed a proprietary business development process which is used in conjunction with the Company's direct and brokered sales efforts. This business development process relies heavily on a computerized prospect tracking system which contains detailed benefit and contact information on approximately 35,000 employers in the Chicago, Milwaukee, St. Louis and Detroit metropolitan areas. Using this database, the Company's business development representatives use direct mail to target employer decision makers and brokers and telemarketing to follow up with these employer decision makers and brokers. It has been the Company's experience that the sales cycle may be a multi-year process, particularly since employers tend to make decisions regarding dental coverage on an annual basis. The Company believes that the continuity of communication which it has established with these decision makers gives the Company a significant advantage over its competitors in the metropolitan markets it serves. This comprehensive database also links brokers with their clients which permits the Company's field staff to contact brokers at the time of their clients' annual renewal periods. -14- Marketing generally is a two-step process in which presentations are made first to employers and then directly to employees. Once selected by an employer, the Company typically solicits potential subscribers from the employee base directly. During periodic "open enrollments," when employees are permitted to change dental benefit programs, the Company uses direct mail, work site presentations and other marketing methods to attract new subscribers. The Company stresses its ability to provide a flexible schedule of benefits, quality dental services oriented toward preventive care at reasonable prices and a large panel of dentists from which to choose in these marketing efforts. The Company also has a member services department which assists members on such matters as schedules of benefits, available network dentists, transfers from one network dentist to another, emergency dental services, billing issues and other administrative and group service matters. The member services department also handles complaints about providers and conducts member satisfaction surveys. The Company has a separate account management department that focuses on servicing the needs of benefit managers and groups. The Company believes that this service effort is important to group retention and enrollment growth among group members. The Company manages its groups with a long-term strategic goal to increasing participation in the Company's managed care plans. Management Information Systems The management information systems used by the Company are designed to facilitate subscriber and provider service. The Company depends on these systems for comprehensive group service, premium collection and reconciliation, administration of capitation and commission payments, member eligibility processing, marketing support, corporate accounting and management reporting. The Company's management information systems allow it to offer multiple plans tailored to the needs of its groups and have the capability to interface directly with the systems of its groups, which can facilitate expeditious processing of changes in membership information. The Company periodically upgrades its hardware and software systems to (i) enhance its capability for electronic interchange with its groups, (ii) streamline the systems' ability to support both multi-state accounts and multiple products for the same group, (iii) enhance the integration between the Company's management information systems and its corporate accounting software, (iv) improve statistical and analytical capability with respect to various aspects of the Company's business and (v) make other technological changes to improve the efficiency of the Company's systems. The Company plans to introduce new voice and data technologies in 1999 and to increase the use of electronic methods for billing, enrollment and ongoing eligibility maintenance between employer groups and network dentists. The Company believes that these steps should help it to limit staff increases in the future and to increase the effectiveness and efficiency of its administrative operations. The Company is currently in the process of evaluating its information technology infrastructure for Year 2000 compliance and should be substantially completed by the end of 1998. The Company does not expect the cost to modify its information technology infrastructure to be Year 2000 compliant to be material to its financial condition or results of operations. The Company does not currently have any information concerning the Year 2000 compliance status of its customers. In the event that any of the Company's significant customers do not successfully and timely achieve Year 2000 compliance, the Company does not believe that its business or operations would be adversely affected. Competition The Company operates in a highly competitive environment. Its competitors principally include insurance companies, which often offer both managed dental care and indemnity dental products in the Company's market, and independent companies offering managed dental care products similar to those offered by the Company. The managed dental care industry as a whole is currently fragmented and characterized by the participation of several large, national insurance companies and many smaller independent plan sponsors. The Company also competes with numerous other types of businesses in the health care industry, including health maintenance organizations, limited health services corporations, self- funded plans which are administered by third party administrators, preferred provider organizations and other discount fee-for-service dental plans. The Company has experienced, and expects that it will continue to experience in the future, increased competition from all such sources. Many of the Company's competitors are larger and have substantially greater financial and other resources than the Company. Price considerations have been a -15- significant competitive factor in the past and the Company believes pricing will continue to be a significant competitive factor in the future, especially with respect to large government and labor union contracts awarded on the basis of competitive bidding. Currently such contracts constitute less than 5% of the Company's total revenues. The Company believes that it competes principally on the basis of the pricing of managed care products in comparison to traditional indemnity plan coverage, the size, accessibility and quality of its provider network, its service reputation and the diversity of its products. Of these, the Company has found that provider network size, accessibility and quality, service reputation and cost are generally the factors most critical in employer decision-making. While the managed dental care business does not require substantial amounts of capital, the Company believes that certain factors may limit the number of new competitors that successfully enter its marketplace. These include the need for new competitors to comply with governmental licensing requirements and to establish provider and insurance broker networks in order to enter and compete in the market. The Company believes that it is well positioned to continue to compete in the Chicago, Milwaukee and St. Louis metropolitan areas as a result of its growing network of providers and insurance brokers and the Company's service reputation and client base. The Company also believes that it is well positioned to compete in the Detroit and, on a longer term basis, Indianapolis metropolitan areas as a result of the competitive size of its network of providers and the Company's focused marketing efforts. While the Company believes that it has successfully established one of the leading market positions in the Chicago, Milwaukee and St. Louis metropolitan areas, there can be no assurance that the Company will be able to continue to increase or maintain its market share. Increased competition could adversely affect the Company's results of operations. Government Regulation The business of the Company is subject to extensive regulation, by, as may be applicable, the insurance statutes and regulations of the states in which the Company operates with respect to the prepaid health plan, insurance, reinsurance, and related operations of the Company (''Insurance Regulation''). The Company is registered in Illinois and in Michigan as a Third Party Administrator and in Illinois as an Insurance Firm; its subsidiary, First Commonwealth of Illinois, Inc., is registered in Illinois as a Preferred Provider Administrator; another subsidiary, First Commonwealth Limited Health Services Corporation, is licensed in Illinois as a Limited Health Service Organization and in Indiana as a Limited Service Health Maintenance Organization; another subsidiary, First Commonwealth Insurance Company, is licensed in Illinois as a domestic life, accident and health insurer with the intent to underwrite indemnity dental business and is awaiting additional licensure as a Limited Health Service Organization; another subsidiary, First Commonwealth Limited Health Service Corporation, is licensed in Wisconsin as a Limited Service Health Organization; another subsidiary, First Commonwealth of Missouri, Inc. (formerly Champion Dental Services, Inc.), is licensed in Missouri as a prepaid dental plan corporation; and an affiliate, First Commonwealth Health Services Corporation, is organized under Illinois law as a Voluntary Health Services Plan. Insurance Regulation, which may vary from state to state, establishes extensive operational, financial, reporting, and other requirements applicable to the Company's business in such state. Depending upon the nature and scope of regulatory requirements adopted from time to time in each of the states having jurisdiction over the legal entities or operations of the Company, Insurance Regulation may materially and adversely affect the business, operating results and financial condition of the Company. Insurance Regulation generally requires the Company to be licensed by the state insurance department in order to offer its dental care products, administrative services or preferred provider network in such state and otherwise conduct its operations in such state. In addition, Insurance Regulation generally prescribes minimum levels of net worth and reserves, limits the ability of the Company's subsidiaries to pay dividends to the extent required surplus would be impaired, requires filings for approval of products and services offered by the Company and its subsidiaries and the filing of rate schedules, certain product literature, forms of contracts with subscribers, dentists and others (which may entail substantial delay in implementing changes or introducing new products), establishes minimum benefit levels for the Company's dental products in some cases, provides for periodic examinations, including quality assessment review, establishes standards for the Company's management and other personnel, specifies measures for resolving grievances and requires prior approval if more than a certain percentage of the Company's outstanding voting securities are to be acquired. Changes in Insurance Regulation or the application thereof could involve, among other things, premium taxes, increased capitalization requirements, limitations on the payment of dividends, distributions, or principal or interest on subordinated debt, the -16- imposition of guaranty fund assessments, mandated health benefits and other terms of enrollment contracts, restrictions on the use of "fronting arrangements" and reinsurance agreements, requirements for admission of or licensing as foreign reinsurance companies, limited health service organizations, limited service health organizations, prepaid dental plan corporations, preferred provider administrators and third party administrators, state health insurance reforms for groups and individuals, "any willing provider" requirements limiting the Company's right to restrict the size of its provider network, minimum loss ratio requirements, enterprise liability statutes, which may increase the Company's liability for the negligent acts of its providers, or other matters. There can be no assurance that changes in Insurance Regulation or the application of existing Insurance Regulation, including matters relating to the Company's limited operations outside its service areas, will not materially and adversely affect the business or financial condition of the Company. Failure of the Company to comply with the Insurance Regulation could subject the Company to financial penalties, cease and desist orders or the revocation of one or more licenses required to conduct its business. Any future expansion of the Company's business may subject the Company to additional regulation by the state or federal governments. The insurance statutes and regulations of certain states may limit the ability of the Company to expand its operations in or into such states, or may substantially delay the commencement of operations in such states as a result of the need to comply with the licensing requirements of such states. Expansion of the Company's business by acquisition of control of existing regulated entities may subject the Company to substantial filing and approval requirements. Furthermore, proposals have been made in the past, and may be made again, for national and state health care reform which, if enacted, could materially and adversely affect the business and financial condition of the Company. It has been the Company's policy to maintain regular contact and productive working relationships with regulators in each jurisdiction in which it is licensed to conduct business. In general, Insurance Regulation of the states in which the Company and its subsidiaries operate require a person seeking to acquire control, directly or indirectly, of certain regulated entities or of any person controlling such entity to file with the relevant insurance regulatory authority an application for change of control (commonly known as a "Form A") containing certain information regarding the identity and background of the acquiror and its affiliates, the source and amount of funds to be used to effect the acquisition and certain other matters. For purposes of many of these statutes and regulations promulgated thereunder, a person that owns or controls, directly or indirectly, 10% or more of the outstanding voting securities of any other person is generally presumed to "control" that other person. Accordingly, any purchase of Common Stock that would result in the purchaser having beneficial ownership of Common Stock equal to or in excess of the specified threshold level, which may be lower than 10% in some states or, as a result of future regulatory action, in one or more of those states in which the Company currently operates, pursuant to the offering of Common Stock made hereby or otherwise (including through purchases in the open market), must file for and obtain prior approval from all applicable regulatory authorities. Such prior approval could also apply to the acquisition of proxies to vote specified percentages of the outstanding Common Stock and, therefore, could delay or prevent a stockholder from acquiring such proxies in a proxy contest. No assurance can be given that the Company would not seek to invoke these laws and regulations in a proxy contest or a tender offer or merger situation. Failure to comply with change of control provisions under applicable state insurance codes by an investor acquiring the Company's Common Stock at or above the specified threshold levels could result in a material adverse effect on such investor, including the possible entry of a divestiture order, and could also possibly result in adverse regulatory action against the Company and its subsidiaries. Prospective and current stockholders, and not the Company, are responsible for compliance with Form A and similar filing and prior approval requirements. The Company assumes no obligation with respect to these matters. The Company's business is not currently regulated at the federal level. During 1994, however, Congress considered legislation proposing comprehensive reform of the health care system in the United States. The Company cannot predict whether or when future health care reform initiatives at the federal or state level or other initiatives affecting insurance and/or managed care providers such as the Company may be proposed, enacted or implemented or what impact such initiatives may have on the Company's business, operating results or financial condition. -17- Company's Corporate Structure The Company contracts to provide dental care benefits to groups and members in Illinois and Indiana through First Commonwealth Limited Health Services Corporation ("FC-Limited"), a wholly-owned subsidiary; in Wisconsin through First Commonwealth Limited Health Service Corporation ("FC-Wisconsin"), a wholly-owned subsidiary; in Missouri through First Commonwealth of Missouri, Inc. ("FC-Missouri"), a wholly-owned subsidiary; and in Michigan through a fronting arrangement described below. The Company provides administrative and marketing services for FC-Limited, FC-Wisconsin, and FC-Missouri. Another wholly-owned subsidiary, First Commonwealth of Illinois, Inc. ("FC-Illinois"), contracts with dentists and dental care specialists to provide dental care services to groups and to members for whom FC-Limited, FC-Wisconsin, and FC- Missouri provides dental benefits. Smileage, a wholly-owned subsidiary, is a Wisconsin based dental HMO administrator. As the Company has increased its indemnity business, it has entered into a reinsurance agreement with North American Insurance Company ("North American"), an Illinois licensed reinsurer, covering a portion of its indemnity business. North American, in turn, has entered into an agreement with another third party insurer, Capitol Indemnity Corporation ("Capitol"). Capitol has entered into an agreement with another subsidiary of the Company, First Commonwealth Reinsurance Company ("FC-RE"), whereby North American transfers most of this reinsured risk from FC-Limited to Capitol and onto FC-RE. The Company currently retains virtually all of the underwriting risk of its indemnity plans. FC-RE engages in no reinsurance activity that is not related to the Company's indemnity and managed care products. In addition, in 1997, the Company, acting as agent for North American and according to a fronting arrangement, began selling managed care and indemnity dental insurance policies in the state of Michigan. According to the reinsurance agreement above, North American ceded all policies in Michigan to Capitol who ceded these policies to FC-RE. First Commonwealth Health Services Corporation ("FCHSC") is consolidated with the Company and its subsidiaries for financial reporting purposes. FCHSC is not material to the financial condition or operating results of the Company. FCHSC is licensed under the Voluntary Health Services Plans Act (the "VHSP Act"). In accordance with the VHSP Act, FCHSC is operated and conducted as a not-for-profit and is also governed by the provision of the General Not-for- Profit Corporation Act. FCHSC was initially capitalized by First Commonwealth, Inc. ("FC Inc.") through the purchase of a subordinated note. Certain officers and trustees of FCHSC are common to the officers and directors of FC Inc. Consistent with its authority under the VHSP Act, FCHSC provides reimbursement to its members for covered dental care. The VHSP Act requires, among other provisions, that FCHSC not expend more than 20% of its annual subscriber revenue for administrative costs and 10% for marketing costs. FC Inc. provides administrative and marketing services to FCHSC pursuant to a management agreement. First Commonwealth Insurance Company was incorporated in Illinois during 1997 and is a wholly owned subsidiary. It is currently licensed as a domestic life, accident and health insurer with the intent to underwrite indemnity dental business and is awaiting additional licensure under the LHSO Act. As of December 31, 1997, it had not yet commenced business. Risk Management The Company maintains general and professional liability insurance to cover the risk of operating its managed care dental plans. In addition, each dentist in the provider network is required to maintain malpractice insurance. The Company seeks to enter into capitation arrangements whenever possible as its primary means of managed care dentist compensation. In addition to capitation arrangements, the Company also may negotiate other payment arrangements with dentists and specialists. Such arrangements may involve, among other things, contributions by the Company toward costs for infection control, discounted fee-for-service pricing arrangements, or for new providers, minimum monthly payment arrangements. Certain specialists with which the Company has provider contracts are compensated by the Company on a discounted or full fee- for-service basis and not on a capitated basis. Accordingly, the Company retains the risk of its share of the cost for services provided under these compensation arrangements. If the number of managed care providers covered under other compensation requirements materially increase, or the cost of such arrangements becomes significantly higher than projected, including utilization of specialty care benefits, the Company's profitability could be materially and adversely affected. Total payments to specialists represented approximately 12% of the Company's payments to managed care providers in 1997. -18- In addition, an increasing portion of the Company's business is the sale of indemnity/PPO plans as part of its Managed Choice/SM/ product. The Company retains virtually all of the underwriting risk of its indemnity/PPO products. Although dental indemnity/PPO plans have limitations on coverage (including limits on procedures covered, amounts covered per procedure and annual and lifetime benefits), due to variability in both the utilization of services and the cost per service under an indemnity/PPO plan, increased indemnity/PPO enrollment increases the underwriting risk undertaken by the Company. The dental benefit costs associated with the Company's Managed Choice/SM/ products include an estimate of dental expenses incurred by its members outside of the Company's provided network, but which have not yet been reported to the Company. If the utilization or cost per service incurred outside of the Company's network were to be greater than estimated, the Company's business, operating results or financial condition could be materially and adversely affected. The Company has not experienced any significant adverse variations between such estimated and actual expenses, but there can be no assurance that such variations will not occur in the future. The Company staffs its claims processing operation with individuals experienced in dental terminology and procedures such as hygienists, dental office assistants and dentist consultants, who review claims submitted for appropriateness. The Company also uses specific underwriting criteria as an integral part of its risk management program for its indemnity/PPO plans. Utilizing specific underwriting criteria, the Company attempts to assure that each employer group's profile is consistent with relevant rating assumptions. In addition, high patient cost-sharing in dental plans substantially limits the underwriting risk of a dental plan, particularly when compared to the risk in a medical plan. Furthermore, unlike medical plans, dental plans typically do not cover catastrophic risks. Employees The Company had approximately 135 employees as of December 31, 1997. None of the Company's employees is covered by a collective bargaining agreement. The Company believes its relations with its employees are good. Item 2. Properties The Company does not own any real estate; it leases approximately 24,000 feet of office space in Chicago. The lease has a term expiring in 2000, with an option for the Company to extend the lease through 2003. In addition, the Company leases approximately 1,700 feet of office space in Milwaukee with a term expiring in 1999; 1,700 feet of office space in St. Louis with a term expiring in 2000; 500 feet of office space in Detroit with a term expiring in 1998, and 500 feet of office space in Indianapolis with a term expiring in 1998. Item 3. Legal Proceedings The Company is involved from time to time in routine legal and regulatory proceedings incidental to its business. The Company is not involved in any currently pending lawsuits or proceedings that it believes will have, individually or in the aggregate, a material adverse effect on the Company. Item 4. Submission of Matters to a Vote of Security Holders None. -19- PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters (a) Incorporated herein by reference from section entitled "Related Stockholder Matters and Market for the Company's Common Stock" in the Company's 1997 Annual Report to Stockholders, which is included as Exhibit 13 to this Annual Report on Form 10-K. (b) Use of Proceeds from Registered Securities The following information is reported pursuant to Item 701(f) of Regulation S-K: The Company filed a registration statement on Form S-1 which became effective on November 16, 1995 (Registration No. 33-97426). The offering commenced on November 16, 1995 and terminated after the sale of all securities registered. The managing underwriters for this offering were William Blair & Company and Piper Jaffray Inc. The offering related to the Company's Common Stock, par value $.001 per share, and was for the account of the Company and certain selling shareholders, as follows:
Company Selling Shareholders ---------- -------------------- Number of Shares Registered and Sold 530,000 1,577,200 Aggregate Price of Offering Registered and Sold $7,950,000 $23,658,000
The following amounts of expenses were incurred for the Company's account in connection with the issuance and distribution of the securities registered for each category listed below: Direct or indirect payments to directors, officers, general partners of the issuer or their associates; to persons owning ten percent or more of any class of equity securities of the Direct or indirect issuer; and to affiliates of the issuer payments to others ------------------------------------------------- ------------------ Underwriting discounts and 0 $ 556,500 commissions Finders Fees 0 $ 0 Expenses paid to or for underwriters 0 $ 20,000 Other Expenses $50,000 $ 715,173 Total Expenses $50,000 $1,291,673 Net offering proceeds to the Company after total expenses: $6,608,327 Purchase and installation of machinery and equipment 0 $ 789,877 Acquisition of other businesses $ 0 $5,818,450 Total $6,608,327
The use of proceeds reported herein does not represent a material change from the use of proceeds described in the prospectus. -20- Item 6. Selected Financial Data Incorporated herein by reference from section entitled "Selected Consolidated Financial and Operating Data" in the Company's 1997 Annual Report to Stockholders, which is included as Exhibit 13 to this Annual Report on Form 10-K. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Incorporated herein by reference from section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 1997 Annual Report to Stockholders, which is included as Exhibit 13 to this Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Not Applicable Item 8. Financial Statements and Supplementary Data Incorporated herein by reference from sections entitled "Financial Statements" and "Notes to Consolidated Financial Statements" in the Company's 1997 Annual Report to Stockholders, which is included as Exhibit 13 to this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. -21- PART III Item 10. Directors and Executive Officers of the Registrant The information contained under the headings "Election of Directors" and "Executive Officers" in the Proxy Statement (which Proxy Statement will be filed with the Securities and Exchange Commission on or before May 5, 1998) is incorporated herein by reference. Item 11. Executive Compensation Except for information referred to in Item 402(a)(8) of Regulation S-K, the information contained under the headings "Election of Directors" and "Executive Compensation and Other Information" in the Proxy Statement (which Proxy Statement will be filed with the Securities and Exchange Commission on or before May 5, 1998) is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information contained under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement (which Proxy Statement will be filed with the Securities and Exchange Commission on or before May 5, 1998) is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information contained under the heading "Certain Relationships and Related Transactions" in the Proxy Statement (which Proxy Statement will be filed with the Securities and Exchange Commission on or before May 5, 1998) is incorporated herein by reference. -22- PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements The following financial statements are filed as part of this report: Report of Independent Public Accountants on Consolidated Financial Statements.* Consolidated Balance Sheets of the Company as of December 31, 1997, 1996 and 1995.* Consolidated Statements of Income of the Company for the years ended December 31, 1997, 1996 and 1995.* Consolidated Statements of Changes in Stockholders' Equity of the Company for the years ended December 31, 1997, 1996 and 1995.* Consolidated Statements of Cash Flows of the Company for the years ended December 31, 1997, 1996 and 1995.* Notes to Consolidated Financial Statements.* - ----------------- * Incorporated herein by reference from the Company's 1997 Annual Report to Stockholders. (a)(2) Financial Statement Schedules
Report of Independent Public Accountants on Financial Statement Schedule Page 26 Schedule II -- Valuation and Qualifying Accounts Page 27
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (a)(3) Exhibits -------- The following Exhibits are filed herewith or incorporated herein:
Exhibit No. Description - ----------- ----------- 3.1 -- Second Restated Certificate of Incorporation of the Company, as amended (1) 3.2 -- Restated By-laws of the Company (2) 4.1 -- Stockholders Rights Agreement between the Company and First Chicago Trust Company of New York (1)
-23- Exhibit No. Description - ----------- ----------- 10.1 -- First Commonwealth, Inc. Management Bonus Plan (1)(3) 10.2 -- 1987 Statutory-Nonstatutory Stock Option Plan, as amended (1)(3) 10.3 -- 1995 Long-Term Incentive Plan, as amended as of February 18, 1998 (3) 10.4 -- First Commonwealth, Inc. Salary Savings Plan (1)(3) 10.5 -- Employment Agreement between the Company and Christopher C. Multhauf (1)(3) 10.6 -- Employment Agreement between the Company and David W. Mulligan (1)(3) 10.7 -- Employment Agreement between the Company and Gregory D. Stobbe, as amended (1)(3) 10.8 -- Employment Agreement between the Company and Mark R. Lundberg (1)(3) 10.9 -- Employment Agreement between the Company and Scott B. Sanders (1)(3) 10.10 -- Reinsurance Agreement between First Commonwealth Limited Insurance Company and First Commonwealth Reinsurance Company (1) 10.11 -- Reinsurance Agreement between North American Insurance Company and First Commonwealth Reinsurance Company (1) 10.12 -- Form of First Commonwealth Limited Health Services Corporation Group Master Contract (1) 10.13 -- Form of First Commonwealth of Illinois, Inc. Dental Provider Agreement (1) 10.14 -- Form of First Commonwealth of Illinois, Inc. Participating PPO Dentist Contract (1) 10.15 -- Lease Agreement between 444 North Wells Limited Partnership as sole beneficiary of American National Bank & Trust Company of Chicago Trust No. 56647 as Landlord and the Company as Tenant, as amended (1) 10.16 -- Administrative Master Contract, dated December 12, 1990, between First Commonwealth of Illinois, Inc. and First Commonwealth Limited Health Services Corporation (1) 10.17 -- Administrative Contract, dated December 12, 1990, between First Commonwealth, Inc. and First Commonwealth Limited Health Services Corporation (1) -24- Exhibit No. Description - ----------- ----------- 10.18 -- Management Agreement, dated November 20, 1987, between First Commonwealth, Inc. and First Commonwealth Health Services Corporation (1) 10.19 -- Administrative Master Contract, dated February 1, 1989, between First Commonwealth of Illinois, Inc. and First Commonwealth Health Services Corporation, as amended (1) 10.20 -- Public Offering Agreement among the Company, Christopher C. Multhauf, David W. Mulligan and the Selling Stockholders identified therein (1) 10.21 -- Stock Exchange Agreement, dated July 18, 1996, by and among the Company and the Shareholders of Smileage Dental Services, Inc., is hereby incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K, dated July 18, 1996 10.22 -- Registration Rights Agreement, dated July 18, 1996, between the Company and the Holders of Registrable Securities referred to therein, is hereby incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K, dated July 18, 1996 10.23 -- Stock Purchase Agreement, dated as of October 2, 1996, among the Company, Group Health Plan, Inc., Champion Dental Services, Inc. and Coventry Corporation, is hereby incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 11 -- Statement re: computation of per share earnings (included in Exhibit 13 filed herewith) 13 -- 1997 Annual Report to Stockholders 21 -- Subsidiaries of the Registrant 23 -- Consent of Arthur Andersen LLP 24 -- Powers of Attorney (included on signature page) 27 -- Financial Data Schedule - ---------------------- (1) Incorporated herein by reference to an exhibit with the same number as filed with the Company's Registration Statement on Form S-1, as amended (Registration No. 33-97426). (2) Incorporated herein by reference to an exhibit with the same number as filed with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996. (3) Represents management contract or compensatory plan or arrangement. (b) Reports on Form 8-K No reports on Form 8-K were filed in the fourth quarter of 1997. -25- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Stockholders and Board of Directors of First Commonwealth, Inc.: We have audited in accordance with generally accepted auditing standards the consolidated financial statements included in FIRST COMMONWEALTH, INC. AND SUBSIDIARIES' 1997 Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 11, 1998. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule included on page 25 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Chicago, Illinois February 11, 1998 -26- FIRST COMMONWEALTH, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Period Additions ------ ------------------------------- Balance at Charged to Year Ended Beginning of Costs and Charged to Other Balance at December 31, Description Period Expenses Accounts-Describe Deductions-Describe End of Period - ----------- ---------------------- ------------ ----------- ----------------- ------------------- ------------- 1995 Claims liability $ 387,714 $ 5,451,936 -- $ 4,581,969(1) $1,257,681 Allowance for doubtful accounts $ 116,782 $ 192,808 -- $ 112,274(2) $ 197,316 1996 Claims liability $1,257,681 $ 8,341,669 -- $ 8,019,681(1) $1,579,669 Allowance for doubtful accounts $ 197,316 $ 104,000 -- $ 31,762(2) $ 289,554 1997 Claims liability $1,579,669 $10,506,867 -- $10,482,207(1) $1,604,329 Allowance for doubtful accounts $ 289,554 $ 204,655 -- $ 160,197(2) $ 334,012
- ------------------- (1) Payment for claims (2) Write-off of bad debt -27- SIGNATURES Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, this Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 30, 1998 FIRST COMMONWEALTH, INC By: /s/ Christopher C. Multhauf -------------------------------------------- Christopher C. Multhauf Chairman of the Board of Directors and Chief Executive Officer POWER OF ATTORNEY AND SIGNATURES Each of the undersigned officers and directors of First Commonwealth, Inc. hereby severally constitutes and appoints Christopher C. Multhauf, David W. Mulligan and Scott B. Sanders, and each of them singly, our true and lawful attorneys, with full power to them and each of them singly, to sign for us in our names in the capacities indicated below, all amendments to this Annual Report on Form 10-K, and generally to do all things in our names and on our behalf in such capacities to enable First Commonwealth, Inc. to comply with the provisions of the Securities Act of 1934, as amended, and all requirements of the Securities and Exchange Commission. Pursuant to the requirements of the Securities Exchange Act of 1934, this Registration Statement has been signed by the following persons in the capacities indicated on this 30th day of March, 1998.
Name Capacity ---- -------- /s/ Christopher C. Multhauf Chairman of the Board of Directors and - -------------------------------------- Chief Executive Officer Christopher C. Multhauf (principal executive officer) /s/ David W. Mulligan Director, President, Secretary and - -------------------------------------- Chief Operating Officer David W. Mulligan /s/ Scott B. Sanders Chief Financial Officer and Treasurer - -------------------------------------- (principal financial and accounting Scott B. Sanders officer) /s/ Richard M. Burdge, Sr. Director - -------------------------------------- Richard M. Burdge, Sr. /s/ William J. McBride Director - -------------------------------------- William J. McBride /s/ Jackson W. Smart, Jr. Director - -------------------------------------- Jackson W. Smart, Jr.
-28- Exhibit Index -------------
Exhibit No. Description - ----------- ----------- 10.3 -- 1995 Long-Term Incentive Plan, as amended as of February 18, 1998 13 -- 1997 Annual Report to Stockholders 21 -- Subsidiaries of the Registrant 23 -- Consent of Arthur Andersen LLP 24 -- Powers of Attorney (included on signature page) 27 -- Financial Data Schedule
-29- EX-10.3 2 1995 LONG-TERM INCENTIVE PLAN AS AMENDED Exhibit 10.3 FIRST COMMONWEALTH, INC. 1995 LONG-TERM INCENTIVE PLAN (As Amended as of February 18, 1998) I. INTRODUCTION 1.1 Purposes. The purposes of the 1995 Long-Term Incentive Plan (the "Plan") of First Commonwealth, Inc. (the "Company"), and its subsidiaries from time to time (individually a "Subsidiary" and collectively the "Subsidiaries"), are (a) to align the interests of the Company's stockholders and the recipients of awards under this Plan by increasing the proprietary interest of such recipients in the Company's growth and success, (b) to advance the interests of the Company by attracting and retaining officers and other key employees, consultants, advisors, agents and other independent contractors of the Company, and well-qualified persons who are not officers or employees of the Company ("non-employee directors") for service as directors of the Company and (c) to motivate such employees, independent contractors and non-employee directors to act in the long-term best interests of the Company's stockholders. For purposes of this Plan, references to employment by the Company shall also mean employment by a Subsidiary. 1.2 Certain Definitions. "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2, as in effect on the effective date of this Plan, under the Exchange Act; provided, however, that no director or officer of the Company shall be deemed an Affiliate or Associate of any other director or officer of the Company solely as a result of his or her being a director or officer of the Company. "Agreement" shall mean the written agreement evidencing an award hereunder between the Company and the recipient of such award. "Beneficial Owner" (including the terms "Beneficially Own" and "Beneficial Ownership"), when used with respect to any Person, shall be deemed to include any securities which: (a) such Person or any of such Person's Affiliates or Associates beneficially owns, directly or indirectly (determined as provided in Rule 13d-3, as in effect on the effective date of this Plan, under the Exchange Act); (b) such Person or any of such Person's Affiliates or Associates, directly or indirectly, has: (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time or upon the satisfaction of any conditions, or both) pursuant to any written or oral otherwise; provided, however, that a Person shall not be deemed the Beneficial Owner of, or to Beneficially Own securities tendered pursuant to a tender or exchange offer made by or on securities are accepted for purchase or exchange; or agreement, arrangement or understanding (other than customary agreements with and among underwriters and selling group members with respect to a bona fide public offering of securities), upon the exercise of any options, warrants, rights or conversion or exchange privileges or of such Person or any of such Person's Affiliates or Associates until such tendered (ii) the right to vote pursuant to any written or oral agreement, arrangement or understanding; provided, however, that a Person shall not be deemed the Beneficial Owner of, or to Beneficially Own, any security otherwise subject to this item (ii) if such agreement, arrangement or understanding to vote (1) arises solely from a revocable proxy or consent given to such Person or any of such Affiliates or Associates in response to a public proxy or consent solicitation made pursuant to, and in accordance with, the applicable rules and regulations under the Exchange Act and (2) is not also then reportable by such Person on Schedule 13D (or any comparable or successor report then in effect) under the Exchange Act; or (iii) the right to dispose of pursuant to any written or oral agreement, arrangement or understanding (other than customary agreements with and among underwriters and selling group members with respect to a bona fide public offering of securities); or (c) are beneficially owned, directly or indirectly, by any other Person with which such Person or any of such Person's Affiliates or Associates has any written or oral agreement, arrangement or understanding (other than customary agreements with and among underwriters and selling group members with respect to a bona fide public offering of securities) for the purpose of acquiring, holding, voting (except to the extent contemplated by the proviso to item (ii) of subparagraph (b) of the first paragraph of this definition) or disposing of any securities of the Company. Notwithstanding the first paragraph of this definition, no director or officer of the Company shall be deemed to be the "Beneficial Owner" of, or to "Beneficially Own," shares of Common Stock or other securities of the Company beneficially owned by any other director or officer of the Company solely as a result of his or her being a director or officer of the Company. "Board" shall mean the Board of Directors of the Company. "Bonus Stock" shall mean shares of Common Stock which are not subject to a Restriction Period or Performance Measures. "Bonus Stock Award" shall mean an award of Bonus Stock under this Plan. "Cause" shall mean any act of dishonesty, commission of a felony, significant activities harmful to the reputation of the Company, refusal to perform or substantial disregard of duties properly assigned or significant violation of any statutory or common law duty of loyalty to the Company. "Change in Control" shall have the meaning set forth in Section 6.8(b). "Code" shall mean the Internal Revenue Code of 1986, as amended. "Committee" shall mean the Committee designated by the Board, consisting of two or more members of the Board, each of whom shall be (a) a "Non-Employee Director" within the meaning of Rule 16b-3 under the Exchange Act and (b) an "outside director" within the meaning of Section 162(m) of the Code, subject to any transition rules applicable to the definition of outside director. "Common Stock" shall mean the common stock, $.001 par value, of the Company. "Company" has the meaning specified in Section 1.1. "Directors Options" shall have the meaning set forth in Section 5.1. "Directors Restricted Stock" shall have the meaning set forth in Section 5.1. "Disability" shall mean the inability of the holder of an award to perform substantially such holder's duties and responsibilities for a continuous period of at least six months, as determined solely by the Committee. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. -31- "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Exempt Person" shall mean each of Christopher C. Multhauf and David W. Mulligan and each Affiliate thereof. "Fair Market Value" shall mean the average of the high and low transaction prices of a share of Common Stock as reported in the National Association of Securities Dealers Automated Quotation National Market System on the date as of which such value is being determined, or, if the Common Stock is listed on a national securities exchange, the average of the high and low transaction prices of a share of Common Stock on the principal national stock exchange on which the Common Stock is traded on the date as of which such value is being determined, or, if there shall be no reported transactions for such date, on the next preceding date for which transactions were reported; provided, however, that if Fair Market Value for any date cannot be so determined, Fair Market Value shall be determined by the Committee by whatever means or method as the Committee, in the good faith exercise of its discretion, shall at such time deem appropriate. "Free-Standing SAR" shall mean an SAR which is not issued in tandem with, or by reference to, an option, which entitles the holder thereof to receive, upon exercise, shares of Common Stock (which may be Restricted Stock), cash or a combination thereof with an aggregate value equal to the excess of the Fair Market Value of one share of Common Stock on the date of exercise over the base price of such SAR, multiplied by the number of such SARs which are exercised. "Incentive Stock Option" shall mean an option to purchase shares of Common Stock that meets the requirements of Section 422 of the Code, or any successor provision, which is intended by the Committee to constitute an Incentive Stock Option. "Incumbent Board" shall have the meaning set forth in Section 6.8(b)(2) hereof. "Independent Contractor" shall mean a consultant, advisor, agent or other independent contractor which performs services for the Company or its Subsidiaries, including, but not limited to, dentist consultants, dentist advisors, dentist providers and insurance agents. "Mature Shares" shall mean shares of Common Stock for which the holder thereof has good title, free and clear of all liens and encumbrances and which such holder either (a) has held for at least six months or (b) has purchased on the open market. "Non-Employee Director" shall mean any director of the Company who is not an officer or employee of the Company or any Subsidiary (except in the definition of Committee, in which case "Non-Employee Director" shall have the meaning set forth in Rule 16b-3 under the Exchange Act). "Non-Statutory Stock Option" shall mean a stock option which is not an Incentive Stock Option. "Performance Measures" shall mean the criteria and objectives, established by the Committee, which shall be satisfied or met (a) as a condition to the exercisability of all or a portion of an option or SAR or (b) during the applicable Restriction Period or Performance Period as a condition to the holder's receipt, in the case of a Restricted Stock Award, of the shares of Common Stock subject to such award, or, in the case of a Performance Share Award, of payment with respect to such award. Such criteria and objectives may include, but are not limited to, the attainment by a share of Common Stock of a specified Fair Market Value for a specified period of time, earnings per share, return on equity, earnings of the Company, revenues, market share, cash flows or cost reduction goals, or any combination of the foregoing and any other criteria and objectives established by the Committee. "Performance Period" shall mean any period designated by the Committee during which the Performance Measures applicable to a Performance Share Award shall be measured. -32- "Performance Share" shall mean a right, contingent upon the attainment of specified Performance Measures within a specified Performance Period, to receive one share of Common Stock, which may be Restricted Stock, or in lieu thereof, the Fair Market Value of such Performance Share in cash. "Performance Share Award" shall mean an award of Performance Shares under this Plan. "Permanent and Total Disability" shall have the meaning set forth in Section 22(e)(3) of the Code or any successor thereto. "Person" shall mean any individual, firm, corporation, partnership or other entity, and shall include any successor (by merger or otherwise) of any of the forgoing. "Restricted Stock" shall mean shares of Common Stock which are subject to a Restriction Period. "Restricted Stock Award" shall mean an award of Restricted Stock under this Plan. "Restriction Period" shall mean any period designated by the Committee during which the Common Stock subject to a Restricted Stock Award may not be sold, transferred, assigned, pledged, hypothecated or otherwise encumbered or disposed of, except as provided in this Plan or the Agreement relating to such award. "SAR" shall mean a stock appreciation right which may be a Free-Standing SAR or a Tandem SAR. "Stock Award" shall mean a Restricted Stock Award or a Bonus Stock Award. "Tandem SAR" shall mean an SAR which is granted in tandem with, or by reference to, an option (including a Non-Statutory Stock Option granted prior to the date of grant of the SAR), which entitles the holder thereof to receive, upon exercise of such SAR and surrender for cancellation of all or a portion of such option, shares of Common Stock (which may be Restricted Stock), cash or a combination thereof with an aggregate value equal to the excess of the Fair Market Value of one share of Common Stock on the date of exercise over the base price of such SAR, multiplied by the number of shares of Common Stock subject to such option, or portion thereof, which is surrendered. "Tax Date" shall have the meaning set forth in Section 6.5. "Ten Percent Holder" shall have the meaning set forth in Section 2.1(a). 1.3 Administration. This Plan shall be administered by the Committee. Any one or a combination of the following awards may be made under this Plan to eligible persons: (a) options to purchase shares of Common Stock in the form of Incentive Stock Options or Non-Statutory Stock Options, (b) SARs in the form of Tandem SARs or Free-Standing SARs, (C) Stock Awards in the form of Restricted Stock or Bonus Stock and (d) Performance Shares. The Committee shall, subject to the terms of this Plan, select eligible persons for participation in this Plan and determine the form, amount and timing of each award to such persons and, if applicable, the number of shares of Common Stock, the number of SARs and the number of Performance Shares subject to such an award, the exercise price or base price associated with the award, the time and conditions of exercise or settlement of the award and all other terms and conditions of the award, including, without limitation, the form of the Agreement evidencing the award. The Committee shall, subject to the terms of this Plan, interpret this Plan and the application thereof, establish rules and regulations it deems necessary or desirable for the administration of this Plan and may impose, incidental to the grant of an award, conditions with respect to the award, such as limiting competitive employment or other activities. All such interpretations, rules, regulations and conditions shall be conclusive and binding on all parties. The Committee may delegate some or all of its power and authority hereunder to the Chairman of the Board and Chief Executive Officer or other executive officer of the Company as the Committee deems -33- appropriate; provided, however, that the Committee may not delegate its power and authority with regard to (a) the grant of an award under this Plan to any person who is a "covered employee" within the meaning of Section 162(m) of the Code or who, in the Committee's judgment, is likely to be a covered employee at any time during the period an award hereunder to such employee would be outstanding or (b) the selection for participation in this Plan of an officer or other person subject to Section 16 of the Exchange Act or decisions concerning the timing, pricing or amount of an award to such an officer or other person. No member of the Board of Directors or Committee, and neither the Chairman of the Board and Chief Executive Officer nor any other executive officer to whom the Committee delegates any of its power and authority hereunder, shall be liable for any act, omission, interpretation, construction or determination made in connection with this Plan in good faith, and the members of the Board of Directors and the Committee and the President and Chief Executive Officer or other executive officer shall be entitled to indemnification and reimbursement by the Company in respect of any claim, loss, damage or expense (including attorneys' fees) arising therefrom to the full extent permitted by law, except as otherwise may be provided in the Company's Certificate of Incorporation and/or By-laws, as the same may be amended or restated from time to time, and under any directors' and officers' liability insurance that may be in effect from time to time. A majority of the Committee shall constitute a quorum. The acts of the Committee shall be either (a) acts of a majority of the members of the Committee present at any meeting at which a quorum is present or (b) acts approved in writing by a majority of the members of the Committee without a meeting. Notwithstanding anything to the contrary herein, any grants of awards to a Non-Employee Director (not including awards under Article V) shall be null and void unless such awards and all terms thereof are approved in advance by the Board. 1.4 Eligibility. Participants in this Plan shall consist of such directors, officers or other key employees of the Company and its Subsidiaries, and such Independent Contractors, as the Committee, in its sole discretion, may select from time to time. The Committee's selection of a person to participate in this Plan at any time shall not require the Committee to select such person to participate in this Plan at any other time. Non-Employee Directors shall also be eligible to participate in this Plan in accordance with Article V. 1.5 Shares Available. Subject to adjustment as provided in Sections 6.7 and 6.8, 350,000 shares of Common Stock shall be available under this Plan, reduced by the sum of the aggregate number of shares of Common Stock (a) that are issued upon the grant of a Stock Award and (b) which become subject to outstanding options, including Directors' Options, outstanding Free-Standing SARs and outstanding Performance Shares. To the extent that shares of Common Stock subject to an outstanding option (other than in connection with the exercise of a Tandem SAR), Free-Standing SAR or Performance Share are not issued or delivered by reason of the expiration, termination, cancellation or forfeiture of such award or by reason of the delivery or withholding of shares of Common Stock to pay all or a portion of the exercise price of an award, if any, or to satisfy all or a portion of the tax withholding obligations relating to an award, then such shares of Common Stock shall again be available under this Plan. Shares of Common Stock to be delivered under this Plan shall be made available from authorized and unissued shares of Common Stock, or authorized and issued shares of Common Stock reacquired and held as treasury shares or otherwise or a combination thereof. II. STOCK OPTIONS AND STOCK APPRECIATION RIGHTS 2.1 Stock Options. The Committee may, in its discretion, grant options to purchase shares of Common Stock to such eligible persons as may be selected by the Committee. Each option, or portion thereof, that is not an Incentive Stock Option, shall be a Non-Statutory Stock Option. Each Incentive Stock Option shall be granted within ten years of the effective date of this Plan. To the extent that the aggregate Fair Market Value -34- (determined as of the date of grant) of shares of Common Stock with respect to which options designated as Incentive Stock Options are exercisable for the first time by a participant during any calendar year (under this Plan or any other plan of the Company, or any parent or Subsidiary) exceeds the amount (currently $100,000) established by the Code, such options shall constitute Non- Statutory Stock Options. The Committee may not grant an Incentive Stock Option to an Independent Contractor or a Non-Employee Director. Options shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of this Plan, as the Committee shall deem advisable: (a) Number of Shares and Purchase Price. The number of shares of Common Stock subject to an option shall be determined by the Committee, except that the Committee shall not grant an option or SAR (or any combination of options and SARs) in any calendar year to any eligible person which, in the aggregate, gives such person an option or SAR (or any combination of options and SARs) to purchase more than 62,500 shares of Common Stock (as may be adjusted pursuant to Section 6.7). The purchase price per share of Common Stock purchasable upon exercise of the option shall be determined by the Committee; provided, however, that the purchase price per share of Common Stock purchasable upon exercise of an Option shall not be less than 100% of the Fair Market Value of a share of Common Stock on the date of grant of such option; provided further, that if an Incentive Stock Option shall be granted to any person who, at the time such option is granted, owns capital stock possessing more than ten percent of the total combined voting power of all classes of capital stock of the Company (or of any parent or Subsidiary) (a "Ten Percent Holder"), the purchase price per share of Common Stock shall be the price (currently 110% of Fair Market Value) required by the Code in order to constitute an Incentive Stock Option. (b) Option Period and Exercisability. The period during which an option may be exercised shall be determined by the Committee; provided, however, that no Incentive Stock Option shall be exercised later than ten years after its date of grant; provided further, that if an Incentive Stock Option shall be granted to a Ten Percent Holder, such option shall not be exercised later than five years after its date of grant. The Committee may, in its discretion, establish Performance Measures which shall be satisfied or met as a condition to the grant of an option or to the exercisability of all or a portion of an option. The Committee shall determine whether an option shall become exercisable in cumulative or non-cumulative installments and in part or in full at any time. An exercisable option, or portion thereof, may be exercised only with respect to whole shares of Common Stock. (c) Method of Exercise. An option may be exercised (i) by giving written notice to the Company specifying the number of whole shares of Common Stock to be purchased and accompanied by payment therefor in full (or arrangement made for such payment to the Company's satisfaction) either (1) in cash, (2) by delivery of Mature Shares having a Fair Market Value, determined as of the date of exercise, equal to the aggregate purchase price payable by reason of such exercise, (3) by authorizing the Company to withhold whole shares of Common Stock which would otherwise be delivered upon exercise of the option having a Fair Market Value, determined as of the date of exercise, equal to the aggregate purchase price payable by reason of such exercise, (4) in cash by a broker- dealer acceptable to the Company to whom the optionee has submitted an irrevocable notice of exercise or (5) a combination of (1), (2) and (3), in each case to the extent set forth in the Agreement relating to the option, (ii) if applicable, by surrendering to the Company any Tandem SARs which are cancelled by reason of the exercise of the option and (iii) by executing such documents as the Company may reasonably request. The Committee shall have sole discretion to disapprove of an election pursuant to any of clauses (2)-(5) and in the case of an optionee who is subject to Section 16 of the Exchange Act, the Company may require that the method of making such payment be in compliance with Section 16 and the rules and regulations thereunder. Any fraction of a share of Common Stock which would be required to pay such purchase price shall be disregarded and the remaining amount due shall be paid in cash by the optionee. No certificate representing Common Stock shall be delivered until the full purchase price therefor has been paid. (d) Additional Options. The Committee shall have the authority to include in any Agreement relating to an option a provision entitling the optionee to an additional option in the event such optionee exercises the option represented by such option agreement, in whole or in part, by delivering previously owned whole -35- shares of Common Stock in payment of the purchase price in accordance with this Plan and such Agreement. Any such additional option shall be for a number of shares of Common Stock equal to the number of delivered shares, shall have a purchase price determined by the Committee in accordance with this Plan, shall be exercisable on the terms and subject to the conditions set forth in the Agreement relating to such additional option. 2.2 Stock Appreciation Rights. The Committee may, in its discretion, grant SARs to such eligible persons as may be selected by the Committee. The Agreement relating to an SAR shall specify whether the SAR is a Tandem SAR or a Free- Standing SAR. SARs shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of this Plan, as the Committee shall deem advisable: (a) Number of SARs and Base Price. The number of SARs subject to an award shall be determined by the Committee, except that the Committee shall not grant an option or SAR (or any combination of options and SARs) in any calendar year to any eligible person which, in the aggregate, gives such person an option or SAR (or any combination of options and SARs) to purchase more than 62,500 shares of Common Stock (as may be adjusted pursuant to Section 6.7). Any Tandem SAR related to an Incentive Stock Option shall be granted at the same time that such Incentive Stock Option is granted. The base price of a Tandem SAR shall be the purchase price per share of Common Stock of the related option. The base price of a Free-Standing SAR shall be determined by the Committee; provided, however, that such base price shall not be less than 100% of the Fair Market Value of a share of Common Stock on the date of grant of such SAR. (b) Exercise Period and Exercisability. The Agreement relating to an award of SARs shall specify whether such award may be settled in shares of Common Stock (including shares of Restricted Stock) or cash or a combination thereof. The period for the exercise of an SAR shall be determined by the Committee; provided, however, that no Tandem SAR shall be exercised later than the expiration, cancellation, forfeiture or other termination of the related option. The Committee may, in its discretion, establish Performance Measures which shall be satisfied or met as a condition to the exercisability of an SAR. The Committee shall determine whether an SAR may be exercised in cumulative or non- cumulative installments and in part or in full at any time. An exercisable SAR, or portion thereof, may be exercised, in the case of a Tandem SAR, only with respect to whole shares of Common Stock and, in the case of a Free-Standing SAR, only with respect to a whole number of SARs. If an SAR is exercised for shares of Restricted Stock, a certificate or certificates representing such Restricted Stock shall be issued in accordance with Section 3.2(c) and the holder of such Restricted Stock shall have such rights of a stockholder of the Company as determined pursuant to Section 3.2(d). Prior to the exercise of an SAR for shares of Common Stock, including Restricted Stock, the holder of such SAR shall have no rights as a stockholder of the Company with respect to the shares of Common Stock subject to such SAR and shall have rights as a stockholder of the Company in accordance with Section 6.10. (c) Method of Exercise. A Tandem SAR may be exercised (i) by giving written notice to the Company specifying the number of whole SARs which are being exercised, (ii) by surrendering to the Company any options which are cancelled by reason of the exercise of the Tandem SAR and (iii) by executing such documents as the Company may reasonably request. A Free-Standing SAR may be exercised (i) by giving written notice to the Company specifying the whole number of SARs which are being exercised and (ii) by executing such documents as the Company may reasonably request. 2.3 Termination of Employment or Service with the Company. (a) Disability. Subject to paragraph (f) below and Section 6.8, and unless otherwise specified in the Agreement relating to an option or SAR, as the case may be, if the employment or service with the Company of the holder of an option or SAR terminates by reason of Disability, each option and SAR held by such holder shall be exercisable only to the extent that such option or SAR, as the case may be, is exercisable on the effective date of such holder's termination of employment or service and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until and including the earliest to occur of (i) the date which is -36- three months (or such other period as set forth in the Agreement relating to such option or SAR) after the effective date of such holder's termination of employment or service and (ii) the expiration date of the term of such option or SAR. (b) Retirement. Subject to paragraph (f) below and Section 6.8, and unless otherwise specified in the Agreement relating to an option or SAR, as the case may be, if the employment or service with the Company of the holder of an option or SAR terminates by reason of retirement on or after age 65 with the consent of the Company, each option and SAR held by such holder shall be exercisable only to the extent that such option or SAR, as the case may be, is exercisable on the effective date of such holder's termination of employment or service and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until and including the earliest to occur of (i) the date which is three months (or such other period as set forth in the Agreement relating to such option or SAR) after the effective date of such holder's termination of employment or service and (ii) the expiration date of the term of such option or SAR. (c) Death. Subject to paragraph (f) below and Section 6.8, and unless otherwise specified in the Agreement relating to an option or SAR, as the case may be, if the employment or service with the Company of the holder of an option or SAR terminates by reason of death, each option and SAR held by such holder shall be exercisable only to the extent that such option or SAR, as the case may be, is exercisable on the date of such holder's death, and may thereafter be exercised by such holder's executor, administrator, legal representative, beneficiary or similar person, as the case may be, until and including the earliest to occur of (I) the date which is one year (or such other period as set forth in the Agreement relating to such option or SAR) after the date of death and (ii) the expiration date of the term of such option or SAR. (d) Other Termination. If the employment or service with the Company of the holder of an option or SAR is terminated by the Company for Cause, each option and SAR held by such holder shall terminate automatically on the effective date of such holder's termination of employment or service. Subject to paragraph (f) below and Section 6.8, and unless specified in the Agreement relating to an option or SAR, as the case may be, if the employment or service with the Company of the holder of an option or SAR terminates for any reason other than Disability, retirement on or after age 65 with the consent of the Company, death or Cause, each option and SAR held by such holder shall be exercisable only to the extent that such option or SAR is exercisable on the effective date of such holder's termination of employment or service and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until and including the earliest to occur of (I) the date which is three months (or such other period as set forth in the Agreement relating to such option or SAR) after the effective date of such holder's termination of employment or service and (ii) the expiration date of the term of such option or SAR. (e) Death Following Termination of Employment or Service. Subject to paragraph (f) below and Section 6.8, and unless otherwise specified in the Agreement relating to an option or SAR, as the case may be, if the holder of an option or SAR dies during the three-month period following termination of employment or service by reason of Disability, or if the holder of an option or SAR dies during the three-month period following termination of employment or service by reason of retirement on or after age 65 with the consent of the Company, or if the holder of an option or SAR dies during the three-month period following termination of employment or service for any reason other than Disability or retirement on or after age 65 with the consent of the Company (or, in each case, such other period as set forth in the Agreement relating to such option or SAR), each option and SAR held by such holder shall be fully exercisable and may thereafter be exercised by the holder's executor, administrator, legal representative, beneficiary or similar person, as the case may be, until and including the earliest to occur of (I) the date which is one year (or such other period as set forth in the Agreement relating to such option or SAR) after the date of death and (ii) the expiration date of the term of such option or SAR. (f) Termination of Employment or Service - Incentive Stock Options. Subject to Section 6.8 and unless otherwise specified in the Agreement relating to the option, if the employment or service with the Company of a holder of an incentive stock option terminates by reason of Permanent and Total Disability (as defined in -37- Section 22(e)(3) of the Code), each incentive stock option held by such optionee shall be exercisable only to the extent that such option is exercisable on the effective date of such optionee's termination of employment or service by reason of Permanent and Total Disability, and may thereafter be exercised by such optionee (or such optionee's legal representative or similar person) until and including the earliest to occur of (I) the date which is three months (or such other period no longer than one year as set forth in the Agreement relating to such option) after the effective date of such optionee's termination of employment or service by reason of Permanent and Total Disability and (ii) the expiration date of the term of such option. Subject to Section 6.8 and unless otherwise specified in the Agreement relating to the option, if the employment or service with the Company of a holder of an incentive stock option terminates by reason of death, each incentive stock option held by such optionee shall be exercisable only to the extent that such option is exercisable on the date of such optionee's death and may thereafter be exercised by such optionee's executor, administrator, legal representative, beneficiary or similar person until and including the earliest to occur of (I) the date which is one year (or such shorter period as set forth in the Agreement relating to such option)after the date of death and (ii) the expiration date of the term of such option. If the employment or service with the Company of the optionee of an Incentive Stock Option is terminated by the Company for Cause, each Incentive Stock Option held by such optionee shall terminate automatically on the effective date of such optionee's termination of employment or service. If the employment or service with the Company of a holder of an incentive stock option terminates for any reason other than Permanent and Total Disability, death or Cause, each incentive stock option held by such optionee shall be exercisable only to the extent such option is exercisable on the effective date of such optionee's termination of employment or service, and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until and including the earliest to occur of (I) the date which is three months after the effective date of such optionee's termination of employment or service and (ii) the expiration date of the term of such option. If the holder of an incentive stock option dies during the three-month period following termination of employment or service by reason of Permanent and Total Disability (or such shorter period as set forth in the Agreement relating to such option), or if the holder of an incentive stock option dies during the three-month period following termination of employment or service for any reason other than Permanent and Total Disability, death or Cause, each incentive stock option held by such optionee shall be exercisable only to the extent such option is exercisable on the date of the optionee's death and may thereafter be exercised by the optionee's executor, administrator, legal representative, beneficiary or similar person until and including the earliest to occur of (I) the date which is one year (or such shorter period as set forth in the Agreement relating to such option) after the date of death and (ii) the expiration date of the term of such option. 2.4 Termination of Independent Contractor. Not-withstanding anything to the contrary herein, all of the terms relating to the exercise, cancellation or other disposition of an option or SAR upon a termination of an Independent Contractor, whether by reason of Disability, retirement, death, Cause or other termination, shall be determined by the Committee. Such determination shall be made at the time of the grant of such option or SAR, as the case may be, and shall be specified in the Agreement relating to such option or SAR. III. STOCK AWARDS 3.1 Stock Awards. The Committee may, in its discretion, grant Stock Awards to such eligible persons as may be selected by the Committee. Subject to adjustment as provided in Sections 6.7 and 6.8 of this Plan, the aggregate number of shares of Common Stock available under this Plan pursuant to all Stock Awards shall not exceed 50,000 of the aggregate number of shares of Common Stock available under this Plan. The Agreement relating to a Stock Award shall specify whether the Stock Award is a Restricted Stock Award or Bonus Stock Award. -38- 3.2 Terms of Stock Awards. Stock Awards shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of this Plan, as the Committee shall deem advisable. (a) Number of Shares and Other Terms. The number of shares of Common Stock subject to a Restricted Stock Award or Bonus Stock Award and the Performance Measures (if any) and Restriction Period applicable to a Restricted Stock Award shall be determined by the Committee. (b) Vesting and Forfeiture. The Agreement relating to a Restricted Stock Award shall provide, in the manner determined by the Committee, in its discretion, and subject to the provisions of this Plan, for the vesting of the shares of Common Stock subject to such award (i) if specified Performance Measures are satisfied or met during the specified Restriction Period or (ii) if the holder of such award remains continuously in the employment or service of the Company during the specified Restricted Period and for the forfeiture of the shares of Common Stock subject to such award (x) if specified Performance Measures are not satisfied or met during the specified Restriction Period or (y) if the holder of such award does not remain continuously in the employment or service of the Company during the specified Restriction Period. Bonus Stock Awards shall not be subject to any Performance Measures or Restriction Periods. (c) Share Certificates. During the Restriction Period, a certificate or certificates representing a Restricted Stock Award shall be registered in the holder's name and may bear a legend, in addition to any legend which may be required pursuant to Section 6.6, indicating that the ownership of the shares of Common Stock represented by such certificate is subject to the restrictions, terms and conditions of this Plan and the Agreement relating to the Restricted Stock Award. All such certificates shall be deposited with the Company, together with stock powers or other instruments of assignment (including a power of attorney), each endorsed in blank with a guarantee of signature if deemed necessary or appropriate, which would permit transfer to the Company of all or a portion of the shares of Common Stock subject to the Restricted Stock Award in the event such award is forfeited in whole or in part. Upon termination of any applicable Restriction Period (and the satisfaction or attainment of applicable Performance Measures), or upon the grant of a Bonus Stock Award, in each case subject to the Company's right to require payment of any taxes in accordance with Section 6.5, a certificate or certificates evidencing ownership of the requisite number of shares of Common Stock shall be delivered to the holder of such award. (d) Rights with Respect to Restricted Stock Awards. Unless otherwise set forth in the Agreement relating to a Restricted Stock Award, and subject to the terms and conditions of a Restricted Stock Award, the holder of such award shall have all rights as a stockholder of the Company, including, but not limited to, voting rights, the right to receive dividends and the right to participate in any capital adjustment applicable to all holders of Common Stock; provided, however, that a distribution with respect to shares of Common Stock, other than a distribution in cash, shall be deposited with the Company and shall be subject to the same restrictions as the shares of Common Stock with respect to which such distribution was made. 3.3 Termination of Employment or Service. (a) Disability, Retirement and Death. Subject to Section 6.8 and unless otherwise set forth in the Agreement relating to a Restricted Stock Award, if the employment or service with the Company of the holder of such award terminates by reason of Disability, retirement on or after age 65 with the consent of the Company or death, the portion of such award which is subject to a Restriction Period shall terminate as of the effective date of such holder's termination of employment or service shall be forfeited and such portion shall be cancelled by the Company. (b) Other Termination. Subject to Section 6.8 and unless otherwise set forth in the Agreement relating to a Restricted Stock Award, if the employment or service with the Company of the holder of a Restricted Stock Award terminates for any reason other than Disability, retirement on or after age 65 with the consent of the -39- Company or death, the portion of such award which is subject to a Restriction Period on the effective date of such holder's termination of employment or service shall be forfeited and such portion shall be cancelled by the Company. 3.4 Termination of Independent Contractor. Not-withstanding anything to the contrary herein, all of the terms relating to the exercise, cancellation or other disposition of a Restricted Stock Award upon a termination of an Independent Contractor, whether by reason of Disability, retirement, death, Cause or other termination, shall be determined by the Committee. Such determination shall be made at the time of the grant of such Restricted Stock Award, and shall be specified in the Agreement relating to such Restricted Stock Award. IV. PERFORMANCE SHARE AWARDS 4.1 Performance Share Awards. The Committee may, in its discretion, grant Performance Share Awards to such eligible persons as may be selected by the Committee. 4.2 Terms of Performance Share Awards. Performance Share Awards shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of this Plan, as the Committee shall deem advisable. (a) Number of Performance Shares and Performance Measures. The number of Performance Shares subject to any award and the Performance Measures and Performance Period applicable to such award shall be determined by the Committee. (b) Vesting and Forfeiture. The Agreement relating to a Performance Share Award shall provide, in the manner determined by the Committee, in its discretion, and subject to the provisions of this Plan, for the vesting of such award, if specified Performance Measures are satisfied or met during the specified Performance Period, and for the forfeiture of such award, if specified Performance Measures are not satisfied or met during the specified Performance Period. (c) Settlement of Vested Performance Share Awards. The Agreement relating to a Performance Share Award (i) shall specify whether such award may be settled in shares of Common Stock (including shares of Restricted Stock) or cash or a combination thereof and (ii) may specify whether the holder thereof shall be entitled to receive, on a current or deferred basis, dividend equivalents, and, if determined by the Committee, interest on any deferred dividend equivalents, with respect to the number of shares of Common Stock subject to such award. If a Performance Share Award is settled in shares of Restricted Stock, a certificate or certificates representing such Restricted Stock shall be issued in accordance with Section 3.2(c) and the holder of such Restricted Stock shall have such rights of a stockholder of the Company as determined pursuant to Section 3.2(d). Prior to the settlement of a Performance Share Award in shares of Common Stock, including Restricted Stock, the holder of such award shall have no rights as a stockholder of the Company with respect to the shares of Common Stock subject to such award. 4.3 Termination of Employment or Service. (a) Disability, Retirement and Death. Subject to Section 6.8 and unless otherwise set forth in the Agreement relating to a Performance Share Award, if the employment or service with the Company of the holder of such award terminates by reason of Disability, retirement on or after age 65 with the consent of the Company or death, the portion of such award which is subject to a Performance Period on the effective date of such holder's termination of employment or service shall be forfeited and such portion shall be cancelled by the Company. (b) Other Termination. Subject to Section 6.8 and unless otherwise set forth in the Agreement relating to a Performance Share Award, if the employment or service with the Company of the holder of a Performance Share Award terminates for any reason other than Disability, retirement on or after age 65 with the -40- consent of the Company or death, the portion of such award which is subject to a Performance Period on the effective date of such holder's termination of employment or service shall be forfeited and such portion shall be cancelled by the Company. 4.4 Termination of Independent Contractor. Not-withstanding anything to the contrary herein, all of the terms relating to the exercise, cancellation or other disposition of a Performance Share Award upon a termination of an Independent Contractor, whether by reason of Disability, retirement, death, Cause or other termination, shall be determined by the Committee. Such determination shall be made at the time of the grant of such Performance Share Award, and shall be specified in the Agreement relating to such Performance Share Award. V. PROVISIONS RELATING TO NON-EMPLOYEE DIRECTORS 5.1 Eligibility. Each Non-Employee Director shall be granted options to purchase shares of Common Stock in accordance with this Article V ("Director Options"). All options granted under this Article V shall constitute Non- Statutory Stock Options. 5.2 Grants of Stock Options. Each Non-Employee Director shall be granted Non-Statutory Stock Options as follows: (a) Initial Public Offering. On the date of the initial public offering by the Company, each person who is a Non-Employee Director immediately after such initial public offering or meeting of stockholders (other than any Non-Employee Director who is expected to resign in connection with the Company's initial public offering) shall be granted an option to purchase 1,000 shares of Common Stock at a purchase price per share equal to the Fair Market Value of a share of Common Stock on the date of grant of such option. (b) Annual Meeting. On the date of each annual meeting of stockholders of the Company, each person who is a Non-Employee Director immediately after such annual meeting of stockholders shall be granted an option to purchase 1,000 shares of Common Stock at a purchase price per share equal to the Fair Market Value of a share of Common Stock on the date of grant of such option. (c) New Non-Employee Directors. In addition, following the initial public offering of the Company, on the date on which a person is first elected or begins to serve as a Non-Employee Director (other than by reason of termination of employment or service) shall be granted an option to purchase 10,000 shares of Common Stock at a purchase price per share equal to the Fair Market Value of a share of Common Stock on the date of grant of such option. (d) Option Period and Exercisability. Except as otherwise provided herein, each option granted under this Article V shall become exercisable in full on the first to occur of (I) the day before the Company's annual meeting of stockholders next following the date of grant or (ii) the first anniversary of its date of grant. Each option granted under this Article V shall expire ten years after its date of grant. An exercisable option, or portion thereof, may be exercised in whole or in part only with respect to whole shares of Common Stock. Options granted under this Article V shall be exercisable in accordance with Section 2.1(c). 5.3 Termination of Directorship. (a) Disability. Subject to Section 6.8, if the holder of an option granted under this Article V ceases to be a director of the Company by reason of Disability, each such option held by such holder shall be exercisable only to the extent that such option is exercisable on the effective date of such holder's ceasing to be a director and may thereafter be exercised by such holder (or such holder's guardian, legal representative or similar person) until the earliest to occur of the (i) date which is three months after the effective date of such holder's ceasing to be a director and (ii) the expiration date of the term of such option. -41- (b) Retirement. Subject to Section 6.8, if the holder of an option granted under this Article V ceases to be a director of the Company on or after age 65, each such option held by such holder shall be exercisable only to the extent that such option is exercisable on the effective date of such holder's ceasing to be a director and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until the earliest to occur of the (i) date which is three months after the effective date of such holder's ceasing to be a director and (ii) the expiration date of the term of such option. (c) Death. Subject to Section 6.8, if the holder of an option granted under this Article V ceases to be a director of the Company by reason of death, each such option held by such holder shall be fully exercisable and may thereafter be exercised by such holder's executor, administrator, legal representative, beneficiary or similar person, as the case may be, until the earliest to occur of the (i) date which is one year after the date of death and (ii) the expiration date of the term of such option. (d) Other Termination. Subject to Section 6.8, if the holder of an option granted under this Article V ceases to be a director of the Company for any reason other than Disability, retirement on or after age 65 or death, each such option held by such holder shall be exercisable only to the extent such option is exercisable on the effective date of such holder's ceasing to be a director and may thereafter be exercised by such holder (or such holder's legal representative or similar person) until the earliest to occur of the (i) date which is three months after the effective date of such holder's ceasing to be a director and (ii) the expiration date of the term of such option. (e) Death Following Termination of Directorship. Subject to Section 6.8, if the holder of an option granted under this Article V dies during the three- month period following such holder's ceasing to be a director of the Company by reason of Disability, or if such a holder dies during the three-month period following such holder's ceasing to be a director of the Company on or after age 65, or if such a holder dies during the three-month period following such holder's ceasing to be a director for any reason other than by reason of Disability or retirement on or after age 65, each such option held by such holder shall be exercisable only to the extent that such option is exercisable on the date of the holder's death and may thereafter be exercised by the holder's executor, administrator, legal representative, beneficiary or similar person, as the case may be, until the earliest to occur of the (i) date one year after the date of death and (ii) the expiration date of the term of such option. VI. GENERAL 6.1 Effective Date and Term of Plan. This Plan shall be submitted to the stockholders of the Company for approval and, if approved by the affirmative vote of a majority of the voting power of the shares of capital stock of the Company entitled to vote thereon, shall become effective as of the commencement of the initial public offering of the Company. This Plan shall terminate ten years after its effective date unless terminated earlier by the Board. Termination of this Plan shall not affect the terms or conditions of any award granted prior to termination. Awards hereunder may be made at any time prior to the termination of this Plan, provided that no award may be made later than ten years after the effective date of this Plan. In the event that this Plan is not approved by the stockholders of the Company, this Plan and any awards hereunder shall be void and of no force or effect. 6.2 Amendments. The Board may amend this Plan as it shall deem advisable, subject to any requirement of stockholder approval required by applicable law, rule or regulation including Rule 16b-3 under the Exchange Act and Section 162(m) of the Code; provided, however, that no amendment shall be made without stockholder approval if such amendment would (a) increase the maximum number of shares of Common Stock available for issuance under this Plan (subject to Section 6.7), (b) reduce the minimum purchase price in the case of an option or the base price in the case of an SAR, (c) effect any change inconsistent with Section 422 of the Code or (d) extend the term of this Plan. No amendment may impair the rights of a holder of an outstanding award without the consent of such holder. -42- 6.3 Agreement. Each award under this Plan shall be evidenced by an Agreement setting forth the terms and conditions applicable to such award. No award shall be valid until an Agreement is executed by the Company and the recipient of such award and, upon execution by each party and delivery of the Agreement to the Company, such award shall be effective as of the effective date set forth in the Agreement. 6.4 Non-Transferability of Stock Options, SARs and Performance Shares. No option, SAR or Performance Share shall be transferable other than (i) by will, the laws of descent and distribution or pursuant to beneficiary designation procedures approved by the Company or (ii) as otherwise permitted under Rule 16b-3 under the Exchange Act as set forth in the Agreement relating to such award. Each option, SAR or Performance Share may be exercised or settled during the participant's lifetime only by the holder or the holder's legal representative or similar person. Except as permitted by the second preceding sentence, no option, SAR or Performance Share may be sold, transferred, assigned, pledged, hypothecated, encumbered or otherwise disposed of (whether by operation of law or otherwise) or be subject to execution, attachment or similar process. Upon any attempt to so sell, transfer, assign, pledge, hypothecate, encumber or otherwise dispose of any option, SAR or Performance Share, such award and all rights thereunder shall immediately become null and void. 6.5 Tax Withholding. The Company shall have the right to require, prior to the issuance or delivery of any shares of Common Stock or the payment of any cash pursuant to an award made hereunder, payment by the holder of such award of any Federal, state, local or other taxes which may be required to be withheld or paid in connection with such award. An Agreement may provide that (i) the Company shall withhold whole shares of Common Stock which would otherwise be delivered to a holder, having an aggregate Fair Market Value determined as of the date the obligation to withhold or pay taxes arises in connection with an award (the "Tax Date"), or withhold an amount of cash which would otherwise be payable to a holder, in the amount necessary to satisfy any such obligation or (ii) the holder may satisfy any such obligation by any of the following means: (1) a cash payment to the Company, (2) delivery to the Company of Mature Shares having an aggregate Fair Market Value, determined as of the Tax Date, equal to the amount necessary to satisfy any such obligation, (3) authorizing the Company to withhold whole shares of Common Stock which would otherwise be delivered having an aggregate Fair Market Value, determined as of the Tax Date, or withhold an amount of cash which would otherwise be payable to a holder, equal to the amount necessary to satisfy any such obligation, (4) in the case of the exercise of an option, a cash payment by a broker-dealer acceptable to the Company to whom the optionee has submitted an irrevocable notice of exercise or (5) any combination of (1), (2) and (3), in each case to the extent set forth in the Agreement relating to the award; provided, however, that the Committee shall have sole discretion to disapprove of an election pursuant to any of clauses (2)-(5) and that in the case of a holder who is subject to Section 16 of the Exchange Act, the Company may require that the method of satisfying such an obligation be in compliance with Section 16 and the rules and regulations thereunder. An Agreement may provide for shares of Common Stock to be delivered or withheld having an aggregate Fair Market Value in excess of the minimum amount required to be withheld. Any fraction of a share of Common Stock which would be required to satisfy such an obligation shall be disregarded and the remaining amount due shall be paid in cash by the holder. 6.6 Restrictions on Shares. Each award made hereunder shall be subject to the requirement that if at any time the Company determines that the listing, registration or qualification of the shares of Common Stock subject to such award upon any securities exchange or under any law, or the consent or approval of any governmental body, or the taking of any other action is necessary or desirable as a condition of, or in connection with, the delivery of shares thereunder, such shares shall not be delivered unless such listing, registration, qualification, consent, approval or other action shall have been effected or obtained, free of any conditions not acceptable to the Company. The Company may require that certificates evidencing shares of Common Stock delivered pursuant to any award made hereunder bear a legend indicating that the sale, transfer or other disposition thereof by the holder is prohibited except in compliance with the Securities Act of 1933, as amended, and the rules and regulations thereunder. 6.7 Adjustment. Except as provided in Section 6.8, in the event of any stock split, stock dividend, recapitalization, reorganization, merger, consolidation, combination, exchange of shares, liquidation, spin-off or other similar change in capitalization or event, or any distribution to holders of Common Stock other than a -43- regular cash dividend, the number and class of securities available under this Plan, the number and class of securities subject to each outstanding option and the purchase price per security, the number of securities subject to each option to be granted to Non-Employee Directors pursuant to Article V, the terms of each outstanding SAR, the number and class of securities subject to each outstanding Stock Award, and the terms of each outstanding Performance Share shall be appropriately adjusted by the Committee, such adjustments to be made in the case of outstanding options and SARs without an increase in the aggregate purchase price or base price. The decision of the Committee regarding any such adjustment shall be final, binding and conclusive. If any such adjustment would result in a fractional security being (a) available under this Plan, such fractional security shall be disregarded, or (b) subject to an award under this Plan, the Company shall pay the holder of such award, in connection with the first vesting, exercise or settlement of such award, in whole or in part, occurring after such adjustment, an amount in cash determined by multiplying (i) the fraction of such security (rounded to the nearest hundredth) by (ii) the excess, if any, of (1) the Fair Market Value on the vesting, exercise or settlement date over (2) the exercise or base price, if any, of such award. 6.8 Change in Control. (a) (i) Notwithstanding any provision in this Plan or any Agreement (other than an Agreement with an Independent Contractor), in the event of a Change in Control pursuant to Section (b)(iii) or (iv) below, (1) all outstanding options and SARS shall immediately become exercisable in full, (2) the Restriction Period applicable to any outstanding Restricted Stock Award shall lapse, (3) the Performance Period applicable to any outstanding Performance Share shall lapse and (4) the Performance Measures applicable to any outstanding Restricted Stock Award (if any) and to any outstanding Performance Share shall be deemed to be satisfied at the maximum level. If, in connection with such Change in Control, holders of Common Stock receive solely shares of common stock that are registered under Section 12 of the Exchange Act, there shall be substituted for each share of Common Stock available under this Plan, whether or not then subject to an outstanding award, the number and class of shares into which each outstanding share of Common Stock shall be converted pursuant to such Change in Control. If, in connection with such Change in Control, holders of Common Stock receive solely cash and shares of common stock that are registered under Section 12 of the Exchange Act, each outstanding award shall be surrendered to and canceled by the Company, and the holder shall receive, within ten days of the occurrence of such Change in Control, a proportionate amount of cash in the manner provided in Section (a)(ii) below, and there shall be substituted for the award surrendered a similar award reflecting a proportionate number of the class of shares into which each outstanding share of Common Stock shall be converted to such Change in Control. In the event of any such substitution, the proportion of cash and common stock, the purchase price per share in the case of an option and the base price in the case of an SAR, and any other terms of outstanding awards shall be appropriately adjusted by the Committee, such adjustments to be made in the case of outstanding options and SARs without an increase in the aggregate purchase price or base price; provided, that the proportion of cash and common stock substituted for outstanding awards shall reflect the approximate proportion of cash and common stock received by holders of Common Stock in such Change in Control. If, in connection with a Change in Control, holders of Common Stock receive any portion of the consideration in a form other than cash or shares of common stock that are registered under Section 12 of the Exchange Act, each share of Common Stock available under this Plan, whether or not then subject to an outstanding award, shall be substituted or surrendered for such proportion of common stock, cash or other consideration as shall be determined by the Committee pursuant to Section 6.7. (ii) Notwithstanding any provision in this Plan or any Agreement (other than an Agreement with an Independent Contractor), in the event of a Change in Control pursuant to Section (b)(I) or (ii) below, or in the event of a Change in Control pursuant to Section (b)(iii) or (iv) below in connection with which the holders of Common Stock receive cash, each outstanding award shall be surrendered to the Company by the holder thereof, and each such award shall immediately be canceled by the Company, and the holder shall receive, within ten days of the occurrence of a Change in Control pursuant to Section (b)(I) or (ii) below or within ten days of the approval of the stockholders of the Company contemplated by Section -44- (b)(iii) or (iv) below, a cash payment from the Company in an amount equal to (1) in the case of an option, the number of shares of Common Stock then subject to such option, multiplied by the excess, if any, of the greater of (A) the highest per share price offered to stockholders of the Company in any transaction whereby the Change in Control takes place or (B) the Fair Market Value of a share of Common Stock on the date of occurrence of the Change in Control, over the purchase price per share of Common Stock subject to the option; (2) in the case of a Free-Standing SAR, the number of shares of Common Stock then subject to such SAR, multiplied by the excess, if any, of the greater of (A) the highest per share price offered to stockholders of the Company in any transaction whereby the Change in Control takes place or (B) the Fair Market Value of a share of Common Stock on the date of occurrence of the Change in Control, over the base price of the SAR; and (3) in the case of a Restricted Stock Award or Performance Share Award, the number of shares of Common Stock or the number of Performance Shares, as the case may be, then subject to such award, multiplied by the greater of (A) the highest per share price offered to stockholders of the Company in any transaction whereby the Change in Control takes place or (B) the Fair Market Value of a share of Common Stock on the date of occurrence of the Change in Control. In the event of a Change in Control, each Tandem SAR shall be surrendered by the holder thereof and shall be canceled simultaneously with the cancellation of the related option. The Company may, but is not required to, cooperate with any person who is subject to Section 16 of the Exchange Act to assure that any cash payment in accordance with the foregoing to such person is made in compliance with Section 16 and the rules and regulations thereunder. (b) "Change in Control" shall mean: (i) the acquisition by any individual, entity or group (a "Person"), including any "person" within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act, of Beneficial Ownership of 50% or more of either (1) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (2) the combined voting power of the then outstanding securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); excluding, however, the following: (A) any acquisition directly from the Company (excluding any acquisition resulting from the exercise of an exercise, conversion or exchange privilege unless the security being so exercised, converted or exchanged was acquired directly from the Company), (B) any acquisition by the Company, (C) any acquisition by an employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company, (D) any acquisition by an Exempt Person or (E) any acquisition by any corporation pursuant to a transaction which complies with clauses (1), (2) and (3) of subsection (iii) of this Section 6.8(b); provided further, that for purposes of clause (2), if any Person (other than an Exempt Person, the Company or any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company) shall become the Beneficial Owner of 50% or more of the Outstanding Company Common Stock or 50% or more of the Outstanding Company Voting Securities by reason of an acquisition by the Company, and such Person shall, after such acquisition by the Company, become the Beneficial Owner of any additional shares of the Outstanding Company Common Stock or any additional Outstanding Company Voting Securities and such Beneficial Ownership is publicly announced, such additional Beneficial Ownership shall constitute a Change in Control; (ii) individuals who, as of the effective date hereof, constitute the Board of Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of such Board; provided that any individual who becomes a director of the Company subsequent to the effective date hereof whose election, or nomination for election by the Company's stockholders, was approved by the vote of at least a majority of the directors then comprising the Incumbent Board shall be deemed a member of the Incumbent Board; and provided further, that any individual who was initially elected as a director of the Company as a result of an actual or threatened election contest, as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act, or any other actual or threatened solicitation of proxies or consents by or on behalf of any Person other than the Board shall not be deemed a member of the Incumbent Board; -45- (iii) approval by the stockholders of the Company of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Corporate Transaction"); excluding, however, a Corporate Transaction pursuant to which (1) all or substantially all of the individuals or entities who are the Beneficial Owners, respectively, of the Outstanding Company Common Stock and the Outstanding Company Voting Securities immediately prior to such Corporate Transaction will Beneficially Own, directly or indirectly, more than 50% of, respectively, the outstanding shares of common stock, and the combined voting power of the outstanding securities of such corporation entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Corporate Transaction (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or indirectly) in substantially the same proportions relative to each other as their Beneficial Ownership, immediately prior to such Corporate Transaction, of the Outstanding Company Common Stock and the Outstanding Company Voting Securities, as the case may be, (2) no Person (other than an Exempt Person; the Company; any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company; the corporation resulting from such Corporate Transaction; and any Person which Beneficially Owned, immediately prior to such Corporate Transaction, directly or indirectly, 50% or more of the Outstanding Company Common Stock or the Outstanding Company Voting Securities, as the case may be) will Beneficially Own, directly or indirectly, 50% or more of, respectively, the outstanding shares of common stock of the corporation resulting from such Corporate Transaction or the combined voting power of the outstanding securities of such corporation entitled to vote generally in the election of directors and (3) individuals who were members of the Incumbent Board will constitute at least a majority of the members of the board of directors of the corporation resulting from such Corporate Transaction; or (iv) approval by the stockholders of the Company of a plan of complete liquidation or dissolution of the Company. Notwithstanding anything to the contrary herein, no Change of Control shall be deemed to have taken place as a result of the issuance of shares of Common Stock by the Company or the sale of shares of Common Stock by its stockholders in connection with the Company's initial public offering. 6.9 No Right of Participation or Employment. No person shall have any right to participate in this Plan. Neither this Plan nor any award made hereunder shall confer upon any person any right to continued employment by the Company, any Subsidiary or any affiliate of the Company or affect in any manner the right of the Company, any Subsidiary or any affiliate of the Company to terminate the employment of any person at any time without liability hereunder. 6.10 Rights as Stockholder. No person shall have any right as a stockholder of the Company with respect to any shares of Common Stock or other equity security of the Company which is subject to an award hereunder unless and until such person becomes a stockholder of record with respect to such shares of Common Stock or equity security. 6.11 Governing Law. This Plan, each award hereunder and the related Agreement, and all determinations made and actions taken pursuant thereto, to the extent not otherwise governed by the Code or the laws of the United States, shall be governed by the laws of the State of Delaware and construed in accordance therewith without giving effect to principles of conflicts of laws. -46- EX-13 3 ANNUAL REPORT EXHIBIT 13 1997 ANNUAL REPORT TO STOCKHOLDERS NOTE: Attached hereto are the incorporated pages from the Company's 1997 Annual Report to Stockholders. -47-
FINANCIAL AND OTHER INFORMATION SECTION - -------------------------------------------------------------------------------- Selected Consolidated Financial and Operating Data 18 - -------------------------------------------------------------------------------- Management's Discussion and Analysis of Results of Operations and Financial Condition 20 - -------------------------------------------------------------------------------- Report of Independent Public Accountants 25 - -------------------------------------------------------------------------------- Financial Statements 26 - -------------------------------------------------------------------------------- Notes to Consolidated Financial Statements 32 - -------------------------------------------------------------------------------- Officers and Directors 43 - -------------------------------------------------------------------------------- Related Stockholder Matters and Market for the Company's Common Stock 44 - --------------------------------------------------------------------------------
17 First Commonwealth, Inc. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA - -------------------------------------------------------------------------------- The selected consolidated statement of income data and balance sheet data as of, and for, the years ended December 31, 1997, 1996 and 1995 are derived from, and are qualified by reference to, the consolidated financial statements of the Company audited by Arthur Andersen LLP, independent public accountants, appearing elsewhere in this Annual Report. The selected consolidated statement of income data and balance sheet data as of, and for, the years ended December 31, 1994 and 1993 are derived from audited financial statements of the Company not included herein. The selected consolidated financial information set forth below should be read in conjunction with "Management's Discussion and Analysis of Results of Operations and Financial Condition" and the Company's consolidated financial statements and related notes appearing elsewhere in this Annual Report. The selected operating data has been derived from the accounting records of the Company and has not been audited.
Year Ended December 31, ----------------------- 1997 1996(3) 1995 1994 1993 ---- ------ ---- ---- ---- (in thousands, except for per share and operating data) Consolidated Statement of Income Data: Subscriber revenue......................................................... $ 56,594 $ 44,099 $ 33,315 $ 22,077 $ 17,337 Benefit coverage expenses.................................................. 37,932 27,873 20,286 12,321 9,429 -------- -------- -------- -------- -------- Gross margin............................................................... 18,662 16,226 13,029 9,756 7,908 Selling, general and administrative expense................................ 13,550 12,273 9,883 7,458 6,263 -------- -------- -------- -------- -------- Operating income........................................................... 5,112 3,953 3,146 2,298 1,645 Interest income, net....................................................... 495 642 194 59 32 -------- -------- -------- -------- -------- Income before income taxes................................................. 5,607 4,595 3,340 2,357 1,677 Provision for income taxes................................................. 2,284 1,864 1,336 1,009 672 -------- -------- -------- -------- -------- Net income................................................................. $ 3,323 $ 2,731 $ 2,004 $ 1,348 $ 1,005 ======== ======== ======== ======== ======== Basic earnings per share (1)............................................... $ 0.92 $ 0.79 $ 0.69 $ 0.48 $ 0.36 ======== ======== ======== ======== ======== Diluted earnings per share (1)............................................. $ 0.89 $ 0.76 $ 0.67 $ 0.47 $ 0.36 ======== ======== ======== ======== ======== Selected Operating Data: Members at end of period: Managed Care............................................................... 450,400 341,600 265,800 215,700 181,800 Indemnity/PPO.............................................................. 65,300 56,200 36,700 11,600 11,300 Fee Income................................................................. 76,600 34,000 6,100 NC (2) NC(2) -------- -------- -------- -------- -------- Total Members........................................................... 592,300 431,800 308,600 227,300 193,100 ======== ======== ======== ======== ========
See notes on following page. 18 First Commonwealth, Inc. SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA--continued
- ------------------------------------------------------------------------------------------------------------------ Year Ended December 31, ---------------------- 1997 1996(3) 1995 1994 1993 ---- ------ ---- ---- ---- (in thousands, except for per share and operating data) Consolidated Balance Sheet Data (at end of period): Total current assets....................................... $16,554 $21,023 $16,889 $5,716 $3,941 Total assets............................................... 31,896 34,454 19,111 7,217 5,203 Total current liabilities.................................. 8,325 14,331 7,280 3,977 3,276 Total liabilities.......................................... 8,573 14,498 7,405 4,077 3,414 Preferred stock............................................ -- -- -- 892 892 Stockholders' equity....................................... 23,323 19,956 11,706 2,248 898
(1) Earnings per share reflects the conversion of all outstanding shares of Series B Preferred Stock upon the consummation of initial public offering in November 1995. See Note 2 of the Notes to Consolidated Financial Statements. (2) 1994 and 1993 members are not comparable. (3) Reflects results of the acquisition of Smileage Dental Services, Inc. from July 18, 1996. Balance sheet data (but not income or operating data) as of December 31, 1996 includes amounts relating to Champion Dental Services, Inc., which was acquired as of December 31, 1996. 19 First Commonwealth, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - -------------------------------------------------------------------------------- The following discussion and analysis of the Company's consolidated results of operations and consolidated financial condition should be read in conjunction with the Selected Consolidated Financial and Operating Data and the Company's consolidated financial statements, including the notes thereto appearing elsewhere in this Annual Report. Overview - -------------------------------------------------------------------------------- The Company began operations in the Chicago area in 1988 and has grown to be a leading provider of managed dental benefits in the upper Midwest, including the metropolitan areas of Chicago, Milwaukee, St. Louis, Detroit and Indianapolis. As of December 31, 1997, the Company had 450,400 members in its managed care plans, 65,300 members in its fully insured indemnity/PPO plans, and 76,600 members eligible to access the Company's PPO network and covered under its administrative services only ("ASO") arrangements. In 1992, the Company began marketing indemnity plans as part of its Managed Choice/SM/ products. Since the introduction of Managed Choice/SM/ products in 1992, the Company has experienced significant enrollment growth in this product line, particularly among large employers. In January 1996, the Company introduced its new PPO product (Managed Choice/SM/ Triple Option), which integrates a managed component, the PPO option, into the Company's indemnity plans. The Indemnity/PPO revenue line includes revenue from both indemnity business that includes the PPO component as well as indemnity business that does not include the PPO component. The PPO component was available to approximately 19% of the Company's Indemnity/PPO members as of December 31, 1997. The Company's Managed Choice/SM/ products enable the Company to completely replace an employer's existing indemnity plan with the Company's combined managed care and indemnity/PPO plan. Acquisitions - -------------------------------------------------------------------------------- Effective July 18, 1996, the Company completed the acquisition of Smileage Dental Services, Inc. ("Smileage"), a Wisconsin-based dental HMO administrator, which provided services to approximately 50,000 members, and an associated reinsurance transaction, for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through the issuance of the Company's common stock. Effective December 31, 1996, the Company completed the acquisition of Champion Dental Services, Inc. ("Champion"), a Missouri-based prepaid dental plan, which provided services to approximately 60,000 members, for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through proceeds from the Company's initial public offering and was paid in cash on January 2, 1997. Both acquisitions offer managed care products that are typically at a lower gross margin level than what the Company has experienced in the past. Revenues - -------------------------------------------------------------------------------- The Company's annual revenues have increased from $33.3 million in 1995 to $56.6 million in 1997. Revenues increased to $56.6 million for 1997 from $44.1 million for 1996. Revenue growth for 1997 has been strong both in dollar and percentage terms, primarily as the result of the addition of new managed care and indemnity/PPO members as well as the full year effect of the acquisition of Smileage in July 1996 and the acquisition of Champion. The Company believes that the rate of revenue growth in its current markets will decline from historical levels primarily as a result of its higher revenue base. The Company's product pricing varies based on the type of plan, the services provided and the member copayment (or coinsurance). In addition, pricing varies by marketplace based on employer and employee preference and competition. Pricing also may vary as a result of different pricing terms of the plans in effect at companies when acquired by the Company. As a result, per member pricing can fluctuate based on product mix, shifting marketplace preferences and acquisition timing. As contracts are renewed, the Company will seek to improve profitability on lower margin plans by increasing pricing, by offering plans with additional services at higher prices and margins, and by offering higher margin plans with fewer services at lower costs. The largest source of Company revenue is derived from members enrolled in managed care plans. From 1995 to 1997, the Company's revenue from its managed care products grew from $25.7 million to $43.5 million. This increase is primarily attributable to managed care enrollment growth and, to a lesser degree, a shift toward managed care products with higher benefit and premium levels, as well as the acquisition of Smileage and Champion in 1996. In 1995 and 1997, managed care enrollment accounted for approximately 77% of total revenue. 20 First Commonwealth, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--continued - -------------------------------------------------------------------------------- The second largest source of Company revenue is generated from indemnity/PPO plan premiums. From 1995 to 1997, the Company's revenue from its indemnity/PPO products grew from $6.9 million to $12.2 million. For 1997, revenue from indemnity/ PPO enrollment accounted for approximately 22% of total revenue compared to approximately 21% of total revenue in 1995. The Company believes that revenue from indemnity/PPO enrollment will continue to increase in the future. The third largest source of revenue is fee income which is generated from the Company's PPO network rental program and ASO arrangements. Under the network rental program, PPO network providers offer services according to a reduced fee schedule negotiated by the Company. The Company charges its PPO groups a monthly fee for each member eligible to access under such reduced fee arrangements. The Company does not make any payments to its PPO network providers on behalf of the eligible members access under such reduced fee arrangements. Under the Company's ASO arrangements, the Company provides claims payments and related services for self-insured employers' indemnity plans. Under these arrangements the Company does not assume any of the underwriting risk for the indemnity claims. Benefit Coverage Expenses - -------------------------------------------------------------------------------- From 1995 to 1997, total benefit coverage expenses increased from $20.3 million to $37.9 million. Between 1995 and 1997, total benefit coverage expenses as a percentage of revenues increased from 60.9% to 67.0% of total revenue. This increase is largely the result of increases in the benefit coverage expenses of the Company's managed care products (primarily associated with the Company's acquisitions) and increases in benefit coverage expenses associated with indemnity/PPO plans. Gross Margin - -------------------------------------------------------------------------------- From 1995 to 1997, gross margin increased from $13.0 million to $18.7 million. Between 1995 and 1997, gross margin as a percentage of total revenue decreased from 39.1% to 33.0% of total revenue. This change is due to a decline in the gross margin of the Company's managed care products, primarily due to the lower gross margin on the managed care products sold in the Wisconsin and Missouri marketplaces, and the decrease in the gross margin on the Company's indemnity/PPO products in 1997. The Company believes that the decline in gross margin percentage by product line should cease in the near future as a result of price increases passed on to both the indemnity/PPO and managed care clients. Overall gross margin percentages will vary if the mix of the Company's indemnity/PPO and managed care business changes from current levels. Selling, General and Administrative - -------------------------------------------------------------------------------- Selling, general and administrative ("SG&A") expenses as a percent of revenues declined from 29.7% in 1995 to 23.9% in 1997. The change is primarily the result of economies of scale in meeting the administrative needs of increased enrollment due to the relatively fixed nature of certain SG&A expenses, higher revenues relative to the SG&A expenses associated with indemnity/PPO plans, and cost containment moves by the Company in 1997 to offset the decline in gross margin. This decrease in SG&A expenses as a percentage of revenue from 1995 through 1997 to a large degree offsets the decreases in the gross margin percentage during that period. The Company does not expect SG&A expenses as a percentage of revenue to decline further in the near future. Year 2000 Issue - -------------------------------------------------------------------------------- The Company is currently in the process of evaluating its information technology infrastructure for Year 2000 compliance and should be substantially completed by the end of 1998. The Company does not expect the cost to modify its information technology infrastructure to be Year 2000 compliant to be material to its financial condition or results of operations. The Company does not currently have any information concerning the Year 2000 compliance status of its customers. In the event that any of the Company's significant customers do not successfully and timely achieve Year 2000 compliance, the Company does not believe that its business or operations would be adversely affected. 21 First Commonwealth, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--continued - -------------------------------------------------------------------------------- Results of Operations - -------------------------------------------------------------------------------- The following tables set forth certain information from the Company's consolidated statements of income for the periods indicated. In the opinion of management, these tables have been prepared on the same basis as the audited consolidated financial statements appearing elsewhere in this Annual Report and fairly present the results of operations of the Company for the periods covered thereby.
Year Ended December 31, --------------------------- 1997 1996 1995 ---- ---- ---- (in thousands) Consolidated Statement of Income Data: Subscriber revenue Managed care......................... $43,509 $32,807 $25,739 Indemnity/PPO........................ 12,204 10,629 6,893 Fee income........................... 881 663 683 ------- ------- ------- Total subscriber revenue......................... 56,594 44,099 33,315 ------- ------- ------- Benefit coverage expenses Managed care......................... 27,468 19,555 14,835 Indemnity/PPO........................ 10,464 8,318 5,451 Fee income........................... -- -- -- ------- ------- ------- Total benefit coverage expenses............... 37,932 27,873 20,286 ------- ------- ------- Gross margin Managed care......................... 16,041 13,252 10,904 Indemnity/PPO........................ 1,740 2,311 1,442 Fee income........................... 881 663 683 ------- ------- ------- Total gross margin.............. $18,662 $16,226 $13,029 ======= ======= =======
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 Total subscriber revenue increased by $12.5 million, or 28.3%, to $56.6 million in 1997 from $44.1 million in 1996. Of this increase, $3.3 million, or 26.4%, was attributable to the operations added through the acquisition of Champion. The remaining $9.2 million increase was a 20.9% increase in revenues and was primarily attributable to increased enrollment in the Company's managed care and indemnity/PPO dental plans, as well as a full year effect of the Smileage transaction. Managed care revenue increased $10.7 million over the same period, primarily due to an increase in new members and $3.3 million from Champion. Indemnity/PPO revenue increased $1.6 million to $12.2 million in 1997 from $10.6 million in 1996, primarily as a result of adding new indemnity/PPO plan members. Total gross margin increased by $2.5 million, or 15.4%, to $18.7 million in 1997 from $16.2 million in 1996. Total gross margin as a percentage of revenue was 33.0% in 1997 as compared to 36.8% in 1996. This percentage decline was the result of the lower gross margin from the Champion and Smileage acquisitions as well as from a decrease in gross margin in the Company's indemnity/PPO plans. Managed care gross margin as a percentage of revenue was 36.9% in 1997 as compared to 40.4% in 1996. This percentage decline was primarily the result of revenue acquired through the two acquisitions which had a combined gross margin percentage of 28.0% as compared with the existing managed care business which had a gross margin percentage of 40.0%. The level of indemnity/PPO gross margin as a percentage of revenue decreased to 14.3% in 1997 from 21.7% in 1996. This decline in indemnity/PPO gross margin was the result of increased expenses in the Company's indemnity/PPO plans, primarily attributable to higher utilization patterns. 22 First Commonwealth, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--continued - -------------------------------------------------------------------------------- SG&A expenses increased by $1.3 million, or 10.6%, to $13.6 million for 1997 from $12.3 million in 1996. As a percentage of revenue, SG&A expenses dropped to 23.9% for 1997 from 27.8% for 1996. The change is primarily the result of economies of scale in meeting the administrative needs of increased enrollment due to the relatively fixed nature of certain SG&A expenses, higher revenues relative to the SG&A expenses associated with indemnity/PPO plans, and cost containment moves by the Company in 1997 to offset the decline in gross margin. Included in the SG&A total is $265,000 and $64,000, respectively, for 1997 and 1996, for the amortization of goodwill associated with the acquisitions. Operating income increased by $1.2 million, or 29.3%, to $5.1 million for 1997 from $3.9 million in 1996. As a percentage of revenue, operating income was 9.0% in 1997 and 1996. The effective tax rate for 1997 was 40.7% compared to 40.6% for 1996. Net income increased by $592,000, or 21.9%, to $3.3 million for 1997 from $2.7 million for 1996. Year Ended December 31, 1996 Compared to Year Ended December 31, 1995 - -------------------------------------------------------------------------------- Total subscriber revenue increased by $10.8 million, or 32.4%, to $44.1 million in 1996 from $33.3 million in 1995. Of this increase, $3.6 million, or 33.3%, was attributable to the operations added through the acquisition of Smileage and the associated reinsurance transaction. The remaining $7.2 million increase was a 21.6% growth in revenues and was primarily attributable to increased enrollment in the Company's managed care and indemnity/PPO dental plans. Managed care revenue increased $7.1 million over the same period, primarily due to the $3.6 million from Smileage and from an increase in new members. Indemnity/PPO revenue increased $3.7 million to $10.6 million in 1996 from $6.9 million in 1995, primarily as a result of adding new indemnity/PPO plan members. Total gross margin increased by $3.2 million, or 24.5%, to $16.2 million in 1996 from $13.0 million in 1995. Total gross margin as a percentage of revenue was 36.8% in 1996 as compared to 39.1% in 1995. This percentage decline was primarily the result of a shift in the Company's product mix toward a higher percentage of overall revenues being generated by the Company's indemnity/PPO products, which have a relatively lower percentage gross margin than the Company's managed care products. Managed care gross margin as a percentage of revenue was 40.4% in 1996 as compared to 42.4% in 1995. This percentage decline was primarily the result of revenue acquired through the Smileage transaction which has a gross margin percentage of 22.2% as compared with the existing managed care business which had a gross margin percentage of 42.6%. The level of indemnity/PPO gross margin as a percentage of revenue increased to 21.7% in 1996 from 20.9% in 1995. This improved indemnity/PPO gross margin is the result of increased premium rates charged for the Company's indemnity/PPO plans. SG&A expenses increased by $2.4 million, or 24.2%, to $12.3 million for 1996 from $9.9 million in 1995. As a percentage of revenue, SG&A expenses dropped to 27.8% for 1996 from 29.7% for 1995. The change is primarily the result of economies of scale in meeting the administrative needs of increased enrollment due to the relatively fixed nature of certain SG&A expenses as well as higher revenues relative to the SG&A expenses associated with indemnity/PPO plans. Commissions to independent brokers increased 34.1% primarily due to higher revenue. As a percentage of total revenue, commissions for 1996 declined to 4.3% from 5.3% for 1995 as a result of a higher proportion of direct sales and lower commissions associated with the Company's growing indemnity/PPO business. In 1996, included in the SG&A total is $64,000 for the amortization of goodwill associated with the acquisition of Smileage. Operating income increased by $807,000, or 25.7%, to $4.0 million for 1996 from $3.1 million in 1995. As a percentage of revenue, operating income was 9.0% in 1996 as compared to 9.4% in 1995. The percentage decline was due primarily to the decrease in the overall percentage gross margin which was partially offset by lower SG&A expenses as a percentage of revenue. The effective tax rate for 1996 was 40.6% compared to 40.0% for 1995. The tax rate for 1996 was higher primarily as the result of the non-deductibility of the amortization of goodwill from the Smileage acquisition. Net income increased by $727,000, or 36.3%, to $2.7 million for 1996 from $2.0 million for 1995. 23 First Commonwealth, Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--continued - -------------------------------------------------------------------------------- Liquidity and Capital Resources - -------------------------------------------------------------------------------- The Company's historical operating cash requirements have been met principally through operating cash flows. The primary uses of cash have been for operating activities and capital investments in the business. The acquisition of Champion was financed through proceeds from the Company's initial public offering and was paid in cash on January 2, 1997. The Company believes that cash generated from operations will be adequate to finance its anticipated operating needs for the foreseeable future. Cash flow (used in) provided by operations was ($0.6) million, $3.7 million and $4.2 million for the years ended December 31, 1997, 1996 and 1995, respectively. The Company primarily receives premium payments in advance of disbursing managed care dentist capitation payments and indemnity/PPO claims payments. Cash balances in excess of current needs are invested in interest-bearing accounts or cash equivalents. Cash flow provided by operations consist primarily of subscriber premiums and investment income net of capitation payments to network dentists, claims paid, brokers' commissions, general and administrative expenses and income taxes. In 1997, $2.0 million was transferred to restricted cash for the formation of an insurance company. Excluding cash transferred to restricted funds, cash flow provided by operations was $1.5 million, $4.1 million, and $4.7 million for the years ended December 31, 1997, 1996, and 1995, respectively. Capital expenditures were $682,000 for 1997 mainly for computer system enhancements, furniture, and leasehold improvements. Capital expenditures were $745,000 and $765,000 for the years ended December 31, 1996 and 1995 respectively, primarily for office furniture and new computer systems. Cash provided by (used in) financing activities was $43,000, ($45,000), and ($103,000) (excluding the $6.6 million net proceeds received from the initial public offering) for the years ended December 31, 1997, 1996 and 1995, primarily for payments on capital leases and dividends on preferred stock. As of December 31, 1997, the Company had cash and cash equivalents of $9.0 million and no debt outstanding. As of December 31, 1996, included in other current liabilities is a payable to the parent of Champion for the $5.5 million purchase price. In addition, the Company has a committed unsecured line of credit (the "Credit Agreement") available which expires June 30, 1998. Pursuant to this Credit Agreement, the Company may borrow up to $5 million at the rate of LIBOR plus one-half percent. To the extent the Company makes acquisitions, a portion of the purchase price may be financed through borrowings. Under applicable insurance laws of the states in which the Company conducts business, the Company's subsidiaries operating in the particular state are required to maintain a minimum level of net worth and reserves. The Company may be required from time to time to invest funds in one or more of its subsidiaries to meet regulatory requirements, or to expand its operations into new geographic areas. In addition, applicable laws generally limit the ability of the Company's subsidiaries to pay dividends to the extent that required regulatory capital or surplus would be impaired. Impact of Inflation - -------------------------------------------------------------------------------- The Company does not believe the impact of inflation has significantly affected the Company's operations. 24 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS - -------------------------------------------------------------------------------- To the Stockholders and Board of Directors of First Commonwealth, Inc.: We have audited the accompanying consolidated balance sheets of FIRST COMMONWEALTH, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Commonwealth, Inc. and Subsidiaries as of December 31, 1997, 1996 and 1995, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Chicago, Illinois February 11, 1998 25 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- As of December 31, 1997, 1996 and 1995
ASSETS 1997 1996 1995 - ------ ---- ---- ---- CURRENT ASSETS: Cash and cash equivalents........................... $ 9,047,214 $15,817,498 $12,680,153 Accounts receivable, net of allowances of $334,012, $289,554 and $197,316 at December 31, 1997, 1996 and 1995, respectively................................... 3,443,661 3,010,585 1,751,376 Other receivables................................... 163,329 220,819 52,091 Deposit under reinsurance agreement................. 752,284 696,564 431,522 Prepaid expenses.................................... 2,288,559 408,447 1,289,973 Deferred tax asset.................................. 859,000 869,000 665,000 Income taxes receivable............................. -- -- 19,000 ----------- ----------- ----------- Total current assets........................... 16,554,047 21,022,913 16,889,115 ----------- ----------- ----------- PROPERTY AND EQUIPMENT, at cost....................... 4,029,771 3,347,829 2,464,782 Less Accumulated depreciation....................... (2,319,790) (1,725,450) (1,086,279) ----------- ----------- ----------- Property and equipment, net.................... 1,709,981 1,622,379 1,378,503 ----------- ----------- ----------- OTHER ASSETS: Restricted cash equivalents and government securities on deposit, at cost which approximates market................................. 3,263,820 1,222,022 798,744 Goodwill and other intangibles, net of accumulated amortization of $328,442 and $63,814 at December 31, 1997 and 1996, respectively......... 10,264,298 10,482,110 -- Deposits and other.................................. 103,495 104,554 44,700 ----------- ----------- ----------- Total other assets............................. 13,631,613 11,808,686 843,444 ----------- ----------- ----------- Total assets................................... $31,895,641 $34,453,978 $19,111,062 =========== =========== ===========
The accompanying notes to consolidated financial statements are an integral part of these balance sheets. 26 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS--continued - -------------------------------------------------------------------------------- As of December 31, 1997, 1996 and 1995
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996 1995 - ------------------------------------ ----------- ----------- ----------- CURRENT LIABILITIES: Accounts payable--trade............................... $ 88,399 $ 338,000 $ 364,349 Accounts payable--dental service providers............ 394,946 347,529 399,206 Claims liability...................................... 1,604,329 1,579,669 1,257,681 Accrued payroll and related costs..................... 485,166 739,292 846,263 Other accrued expenses................................ 355,429 648,000 760,555 Deferred subscriber revenue........................... 4,444,468 4,448,953 3,262,791 Payable under reinsurance agreement................... 752,427 627,789 389,254 Income taxes payable.................................. 200,327 101,472 -- Other current liabilities (Note 2).................... -- 5,500,000 -- ----------- ----------- ----------- Total current liabilities........................ 8,325,491 14,330,704 7,280,099 DEFERRED TAX LIABILITY.................................. 247,300 167,157 125,157 ----------- ----------- ----------- Total liabilities................................ 8,572,791 14,497,861 7,405,256 ----------- ----------- ----------- STOCKHOLDERS' EQUITY: Common stock ($.001 par value; 15,000,000 shares authorized, 3,636,951 shares in 1997, 3,600,996 shares in 1996 and 3,365,375 shares in 1995 issued and outstanding).......................... 3,637 3,601 3,365 Capital in excess of par value........................ 13,251,815 13,206,633 7,676,536 Retained earnings..................................... 10,080,858 6,757,451 4,025,905 Less 495 shares and 425 shares of common stock held in treasury at December 31, 1997 and 1996, respectively, at cost.................. (13,460) (11,568) -- ----------- ----------- ----------- Total stockholders' equity....................... 23,322,850 19,956,117 11,705,806 ----------- ----------- ----------- Total liabilities and stockholders' equity....... $31,895,641 $34,453,978 $19,111,062 =========== =========== ===========
The accompanying notes to consolidated financial statements are an integral part of these balance sheets. 27 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- SUBSCRIBER REVENUE............. $56,594,410 $44,098,529 $33,315,410 BENEFIT COVERAGE EXPENSES...... 37,932,044 27,872,976 20,286,131 ----------- ----------- ----------- Gross margin................ 18,662,366 16,225,553 13,029,279 SELLING, GENERAL AND ADMINISTRATIVE EXPENSE......... 13,549,645 12,272,835 9,883,288 ----------- ----------- ----------- Operating income............ 5,112,721 3,952,718 3,145,991 INTEREST INCOME, net........... 494,686 642,828 193,531 ----------- ----------- ----------- Income before income taxes.. 5,607,407 4,595,546 3,339,522 PROVISION FOR INCOME TAXES..... 2,284,000 1,864,000 1,336,000 ----------- ----------- ----------- NET INCOME..................... $ 3,323,407 $ 2,731,546 $ 2,003,522 =========== =========== =========== BASIC EARNINGS PER SHARE....... $ 0.92 $ 0 .79 $ 0.69 =========== =========== =========== DILUTED EARNINGS PER SHARE..... $ 0.89 $ 0 .76 $ 0.67 =========== =========== ===========
The accompanying notes to consolidated financial statements are an integral part of these statements. 28 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995
Capital Total ------- ----- Common Stock in Excess Retained Treasury Stock Stockholders' ------------ --------- -------- -------------- ------------- Shares Dollars of Par Earnings Shares Dollars Equity ------ ------- --------- -------- ------ ------- ------ BALANCE, December 31, 1994...... 1,049,000 $ 1,049 $ 175,801 $ 2,071,443 -- $ -- $ 2,248,293 Preferred dividends.......... -- -- -- (49,060) -- -- (49,060) Net income................... -- -- -- 2,003,522 -- -- 2,003,522 Conversion of preferred shares....................... 1,784,000 1,784 890,216 -- -- -- 892,000 Stock issued................. 532,375 532 6,610,519 -- -- -- 6,611,051 --------- --------- ---------- --------- ------ -------- ----------- BALANCE, December 31, 1995...... 3,365,375 3,365 7,676,536 4,025,905 -- -- 11,705,806 Net income................... -- -- -- 2,731,546 -- -- 2,731,546 Stock issued................. 235,621 236 5,530,097 -- -- -- 5,530,333 Treasury stock purchased..... -- -- -- -- (425) (11,568) (11,568) --------- --------- ---------- --------- ------ -------- ----------- BALANCE, December 31, 1996...... 3,600,996 3,601 13,206,633 6,757,451 (425) (11,568) 19,956,117 Net income................... -- -- -- 3,323,407 -- -- 3,323,407 Stock issued................. 35,955 36 45,182 -- -- -- 45,218 Treasury stock purchased..... -- -- -- -- (70) (1,892) (1,892) --------- ---------- ----------- ----------- ------ -------- ----------- BALANCE, December 31, 1997...... 3,636,951 $ 3,637 $13,251,815 $10,080,858 (495) $(13,460) $23,322,850 ========= ========== =========== =========== ====== ======== ===========
The accompanying notes to consolidated financial statements are an integral part of these statements. 29 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Cash received from subscribers................. $ 55,767,127 $ 43,124,110 $ 34,107,857 Cash paid to providers of care................. (26,593,902) (15,202,299) (13,984,854) Cash paid to employees, brokers and suppliers.. (15,887,165) (14,465,535) (9,385,336) Claims paid.................................... (10,300,714) (8,063,681) (4,581,969) Interest paid.................................. -- (514) (4,995) Interest received.............................. 459,212 624,373 179,154 Income taxes paid.............................. (1,993,502) (1,911,500) (1,662,677) Cash transferred to restricted funds........... (2,035,911) (373,158) (436,107) ------------ ------------ ------------ Net cash (used in) provided by operating activities...................... (584,855) 3,731,796 4,231,073 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment, net........ (681,939) (745,509) (765,418) Purchase of short-term investments............. (517,130) (5,161,968) -- Proceeds from sale of short-term investments... 517,130 5,097,314 -- Cash received in acquisition................... -- 432,326 -- Cost of acquisitions........................... (5,546,816) (171,680) -- ------------ ------------ ------------ Net cash used in investing activities..... (6,228,755) (549,517) (765,418) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock....................... 45,218 7,010 6,611,051 Principal payments on capital leases........... -- (26,996) (61,425) Purchase of treasury stock..................... (1,892) (11,568) -- Payments of preferred dividends................ -- (13,380) (41,540) ------------ ------------ ------------ Net cash provided by (used in) financing activities...................... 43,326 (44,934) 6,508,086 ------------ ------------ ------------ Net (decrease) increase in cash and cash equivalents.......................... (6,770,284) 3,137,345 9,973,741 CASH AND CASH EQUIVALENTS, beginning of year................................ 15,817,498 12,680,153 2,706,412 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, end of year...................................... $ 9,047,214 $ 15,817,498 $ 12,680,153 ============ ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 30 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- RECONCILIATIONS OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ----------- ---------- ----------- Net income............................................... $ 3,323,407 $2,731,546 $ 2,003,522 Adjustments to reconcile net income to net cash provided by operating activities-- Depreciation and amortization.......................... 858,965 648,247 411,927 Loss on sale of equipment.............................. -- -- 60,420 (Increase) decrease in assets-- Accounts receivable, net.......................... (433,076) (1,109,339) (187,929) Other receivables................................. 57,490 (149,728) (19,523) Deposit under reinsurance agreement............... (55,720) (265,042) (431,522) Prepaid expenses.................................. (1,880,112) 881,526 (187,719) Deferred tax asset................................ 10,000 (154,000) (446,410) Income taxes receivable........................... -- -- 73,249 Restricted cash equivalents and government securities on deposit.................. (2,041,798) (373,158) (436,107) Deposits and other................................ 1,059 (59,854) 8,771 Increase (decrease) in current liabilities- Accounts payable--trade........................... (249,601) (26,349) 215,602 Accounts payable--dental service providers........ 47,417 (67,676) 106,003 Claims liability.................................. 24,660 321,988 869,967 Accrued payroll and related costs................. (254,126) (78,972) 254,486 Other accrued expenses............................ (292,571) (91,022) 491,512 Deferred subscriber revenue....................... (4,485) 1,186,160 1,002,910 Payable under reinsurance agreement............... 124,638 238,535 389,254 Income taxes payable.............................. 98,855 56,934 -- Increase in long-term liabilities- Deferred tax liability............................ 80,143 42,000 52,660 ---------- ---------- ----------- Net cash (used in) provided by operating activities...... $ (584,855) $3,731,796 $ 4,231,073 ========== ========== ===========
The accompanying notes to consolidated financial statements are an integral part of these statements. 31 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 1. ORGANIZATION - -------------------------------------------------------------------------------- The accompanying consolidated financial statements include the accounts of First Commonwealth, Inc. ("FC Inc."), First Commonwealth of Illinois, Inc. ("FCI"), First Commonwealth Limited Health Services Corporation ("LHSC"), First Commonwealth Health Services Corporation ("HSC"), First Commonwealth Reinsurance Company ("FCRC"), First Commonwealth Insurance Company ("FC Insurance"), First Commonwealth Limited Health Service Corporation ("LHSCWI"), Smileage Dental Services, Inc. ("SDS") and First Commonwealth of Missouri, Inc. ("FCMO"), formerly Champion Dental Services, Inc. ("CDS"). These companies are collectively referred to hereinafter as "the Company". As discussed in Note 15, FC Inc. completed the acquisitions of SDS on July 18, 1996, and CDS on December 31, 1996. Included in the consolidated statement of income for the year ended December 31, 1996, are the results of SDS since its acquisition. SDS's and CDS's balance sheets are also included in the accompanying consolidated balance sheet beginning December 31, 1996. The Company is a provider of managed dental benefits in the upper Midwest, including the metropolitan areas of Chicago, Milwaukee, Detroit and Indianapolis, and with the acquisition of CDS, St. Louis. The Company provides dental care coverage and/or arranges for dental care services to be provided to its subscribers primarily on a prepaid basis. The Company also provides indemnity/Preferred Provider Organization dental coverage and administrative claim services. FC Inc. operates as an Illinois and Michigan licensed Third Party Administrator ("TPA"). As a TPA, FC Inc. provides administrative and marketing services to certain subsidaries pursuant to management agreements. It also provides claim processing services for self-funded employers. FCI is an Illinois corporation and is a wholly owned subsidiary of FC Inc. FCI operates as a Preferred Provider Administrator which directly contracts with general dentists and specialists. These provider arrangements are made available to LHSC, LHSCWI, FCMO and HSC, as well as health maintenance organizations and self-funded employers. In making these provider arrangements available, FCI does not undertake any underwriting risk. LHSC is an Illinois for-profit corporation and is a wholly owned subsidiary of FC Inc. LHSC is licensed under the Illinois Limited Health Service Organization Act ("LHSO Act"). LHSC is also licensed by the Indiana Department of Insurance as a Limited Service Health Maintenance Organization. LHSC has entered into a Provider Agreement with FCI whereby FCI arranges for dental care services to LHSC's subscribers through FCI's network of private practice dentists. Consistent with its authority under the LHSO Act, LHSC also provides reimbursement for covered dental care provided outside of this network. In providing such services, LHSC undertakes underwriting risk. The LHSO Act requires, among other provisions, that LHSC meet certain net worth and deposit requirements discussed in Note 4. It is management's opinion that LHSC was in compliance with these provisions as of December 31, 1997, 1996 and 1995. HSC is an affiliated Illinois corporation, licensed under the Voluntary Health Services Plans Act (the "VHSP Act"). In accordance with the VHSP Act, HSC is operated and conducted not for profit and is also governed by the provisions of the General Not for Profit Corporation Act. HSC was initially capitalized by FC Inc. through the purchase of a subordinated note. That note and accrued interest thereon (both of which are eliminated in consolidation) may be repaid, in whole or in part, only from HSC's earned surplus, subject to the written approval of the Director of the Illinois Department of Insurance. Certain officers and trustees of HSC are common to the officers and directors of the Company. Consistent with its authority under the VHSP Act, HSC provides reimbursement to its members for covered dental care. The VHSP Act requires, among other provisions, that HSC not expend more than 20% of its annual subscriber revenue for administrative costs and 10% for marketing costs. It is management's opinion that HSC was in compliance with these provisions as of December 31, 1997, 1996 and 1995. FCRC was incorporated in Arizona during 1994 and is a wholly owned subsidiary of FC Inc. It is licensed by the Arizona Department of Insurance as a domestic life and disability reinsurer. 32 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 FC Insurance was incorporated in Illinois during 1997 and is a wholly owned subsidiary of FC Inc. It is currently licensed as a domestic life, accident and health insurer with the intent to underwrite indemnity dental business and is awaiting additional licensure under the LHSO Act. As of December 31, 1997, it had not yet commenced business. LHSCWI was incorporated in Wisconsin in 1996 and is a wholly owned subsidiary of FC Inc. LHSCWI is licensed to operate as a Limited Service Health Organization under chapter 611 of the Wisconsin insurance statutes ("Statutes") and is registered with the Office of the Commissioner of Insurance of Wisconsin. The Statutes require, among other provisions, that LHSCWI meet certain net worth and deposit requirements discussed in Note 4. It is management's opinion that LHSCWI was in compliance with these provisions as of December 31, 1997. SDS, a wholly owned subsidiary of FC Inc., is a Wisconsin based dental health maintenance organization administrator. FCMO is a Missouri corporation and is a wholly owned subsidiary of FC Inc. FCMO is a St. Louis, Missouri based prepaid dental plan corporation organized under Section 379.900RSMo. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - -------------------------------------------------------------------------------- Principles of Consolidation The accompanying financial statements include all the accounts of the Company. All material intercompany transactions and balances have been eliminated in consolidation. HSC, a not-for-profit company managed by FC Inc., has been included in the accompanying consolidated financial statements. HSC's financial position and results of operations are not material to the Company's financial statements. Cash and Cash Equivalents For purposes of these statements, the Company considers all cash and short-term investments with original maturities of less than 90 days to be cash and cash equivalents. Accounts Receivable and Deferred Subscriber Revenue The Company invoices most of its subscriber groups prior to the month in which the groups' members will be entitled to service. The Company records these invoices as accounts receivable on the date the invoices are sent and also records as deferred subscriber revenue those amounts either invoiced or received in advance of the period of service. Revenue Recognition Subscriber revenue collected for dental care is recognized as revenue in the period in which the member is entitled to service. Related costs for dental care are expensed in the period the Company is obligated to provide such service. Prepaid Expenses The Company pays its providers to render covered dental care to eligible enrolled subscribers and dependents. Payment is typically made during the month prior to the month in which the subscribers and dependents become eligible for coverage. This payment is recorded as a prepaid expense at December 31, 1997 and 1995. 33 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 Property and Equipment Depreciation is calculated using the straight-line method over the assets' estimated useful lives which are as follows: Leasehold improvements 5 years or life of lease Furniture 10 years Office equipment 5 years Computer equipment and software 3 years Property and equipment consist of the following:
December 31 ---------------------------------- 1997 1996 1995 ---- ---- ---- Leasehold improvements $ 433,409 $ 422,231 $ 349,658 Furniture 830,220 780,967 562,400 Office equipment 567,954 513,566 442,668 Computer equipment and software 2,198,188 1,631,065 1,110,056 ---------- ---------- ---------- Total property and equipment $4,029,771 $3,347,829 $2,464,782 ========== ========== ==========
Goodwill The excess of cost over fair value of net assets acquired resulting from the SDS and CDS acquisitions, accounted for using the purchase method, is being amortized using the straight-line method over 40 years. Accounts Payable--Dental Service Providers The Company records payables to dental service providers for certain services not included in the monthly prepayment to such providers discussed above. Other Current Liabilities Other current liabilities at December 31, 1996, represents the Company's liability relating to its acquisition of CDS. This amount was paid on January 2, 1997. Claims Liability The Company provides indemnity dental coverage for certain customers and records a liability for incurred but not reported and unpaid claims related to this coverage. Generally, this liability is estimated based on the age of existing claims and the Company's historical lag with respect to the reporting and payment of such claims. Changes in these estimates are reflected in the results of operations in the period in which such changes occur. Reinsurance Activity Effective January 1, 1995, LHSC entered into an agreement with a third party insurer ("Insurer") whereby LHSC ceded certain losses on indemnity insurance policies to the Insurer. Concurrent with the execution of this agreement, Insurer entered into an agreement with FCRC whereby Insurer ceded certain losses related to LHSC policies to FCRC. In 1997, a separate independent third party insurer was inserted into the agreement between Insurer and FCRC. The Company has effectively retained all insurance risk on these LHSC losses ceded to Insurer. Accordingly, LHSC accounts for net payments to Insurer as deposits and records a claims liability for all incurred and unpaid losses on such policies. FCRC records a payable to Insurer for amounts Insurer has deposited with FCRC. The Company does not recognize any revenue from these reinsurance arrangements. In addition, in 1997, FC Inc., acting as agent for Insurer and according to a fronting arrangement, began selling managed care and indemnity dental insurance policies in the state of Michigan. According to the same agreement, Insurer ceded all managed care and indemnity dental insurance policies in Michigan to the same separate independent third party insurer who ceded these policies to FCRC. 34 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 Earnings Per Share In 1997, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." Under SFAS No. 128, primary earnings per share is replaced by "Basic" earnings per share ("EPS"), which excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. "Diluted" EPS, which is computed similarly to fully diluted EPS, reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. All prior-period EPS information (including interim EPS) has been restated to conform with the provisions of SFAS No. 128. The following table reconciles the numerators (Net income) and denominators (Share) of the basic and diluted earnings per share computations.
1997 EPS 1996 EPS 1995 EPS ---- ---- ---- Net income $3,323,407 $2,731,456 $2,003,522 ========== ========== ========== Basic Shares/EPS (1) 3,617,994 $0.92 3,470,871 $0.79 2,898,174 $0.69 ===== ===== ===== Effect of dilutive common stock options 109,340 128,694 95,145 ---------- ---------- ---------- Diluted Shares/EPS 3,727,334 $0.89 3,599,565 $0.76 2,993,319 $0.67 ========== ===== ========== ===== ========== =====
Notes: (1) In 1995, reflects the number of shares of common stock into which the Series B Preferred Stock were converted upon the occurrence of the initial public offering for the period prior to the initial public offering. Options to purchase shares of common stock outstanding during 1997 and 1996 that were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares are summarized in the following table. 1997 1996 ---- ---- Weighted average shares under option 17,875 31,167 Weighted average option price $ 16.78 $ 23.10 Weighted average contractual life (in years) 8.6 9.4
Subsequent to December 31, 1997, the Company issued 61,000 options to various key employees at the option price of $11.25 per share. 3. USE OF ESTIMATES AND ASSUMPTIONS - -------------------------------------------------------------------------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 4. REGULATORY REQUIREMENTS AND RESTRICTED FUNDS - -------------------------------------------------------------------------------- The State of Illinois statutes and related regulations of the Illinois Department of Insurance require LHSC, which is licensed under the LHSO Act, to maintain a minimum net worth of $500,000. LHSC maintains a deposit with the State of $200,000 in accordance with the State of Illinois requirements. The State of Indiana statutes and related regulations of the Indiana Department of Insurance require LHSC, which is licensed as a Limited Service Health Maintenance Organization, to maintain a $50,000 deposit with the State. 35 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 The State of Arizona statutes and related regulations of the Arizona Department of Insurance require FCRC, which is licensed as a domestic life and disability reinsurer, to maintain a minimum of $100,000 deposited in trust with the State and a minimum surplus of $25,000. FCRC is required to maintain a trust account equal to the amount of claims payable on all insurance ceded. At December 31, 1997, 1996 and 1995, balances of $632,767, $705,867 and $450,374, respectively, were required in the trust account. The State of Illinois statutes and related regulations of the Illinois Department of Insurance require HSC, which is licensed under the VHSP Act, to maintain a contingency reserve in contributed capital of $19,037, $15,674 and $11,939 at December 31, 1997, 1996 and 1995. The State of Wisconsin insurance statutes require, among other provisions, that LHSCWI maintain a minimum capital of $100,000, apply a ten percent compulsory surplus factor to Point of Service/Indemnity ("POS") premium, and limits POS business to ten percent of total premium volume. LHSCWI has a certificate of deposit for $102,682 at a Wisconsin bank and had POS business of $189,788 in 1997 and none in 1996. The State of Missouri statutes and related regulations of the Missouri Department of Insurance require FCMO, which is licensed as a Prepaid Dental Plan Corporation, to maintain a $50,000 deposit with the state and to maintain a maximum net worth of $150,000. The State of Illinois statutes and related regulations of the Illinois Department of Insurance require FC Insurance to maintain a minimum net worth of $1.5 million. FC Insurance maintains a deposit with the State of $1.6 million in accordance with State requirements. It is management's opinion that the Company was in compliance with these provisions at December 31, 1997, 1996 and 1995. Interest income earned on restricted funds is included in interest income, net in the consolidated statements of income. 5. CLAIMS LIABILITY - -------------------------------------------------------------------------------- The Company's claims liability, claims incurred and payments related to indemnity/PPO policies for the years ended December 31, 1997, 1996 and 1995, are as follows:
December 31 --------------------------------------- 1997 1996 1995 ---- ---- ---- Claims liability, beginning of year $ 1,579,669 $ 1,257,681 $ 387,714 Add-- Claims incurred 10,506,867 8,341,669 5,451,936 Less-- Claims payments-- Current year (9,042,693) (7,274,355) (4,421,539) Prior years (1,439,514) (745,326) (160,430) ----------- ----------- ----------- Claims liability, end of year $ 1,604,329 $ 1,579,669 $ 1,257,681 =========== =========== ===========
6. Lease Obligations - -------------------------------------------------------------------------------- The Company leases office space and various office equipment which are accounted for as operating leases. Rental costs under the operating lease agreements approximated $617,000, $486,000 and $350,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Minimum future obligations under operating leases in effect at December 31, 1997, are: Years ending December 31- 1998 $322,409 1999 310,796 2000 47,138 -------- Total $680,343 ======== 36 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 7. Income Taxes - -------------------------------------------------------------------------------- The current and deferred components of the provision for taxes are as follows:
December 31 ------------------------------------- 1997 1996 1995 ---- ---- ---- Current provision $2,195,000 $1,962,000 $1,706,000 Deferred provision (benefit) 89,000 (98,000) (370,000) ---------- ---------- ---------- Total tax provision $2,284,000 $1,864,000 $1,336,000 ========== ========== ==========
A reconciliation of the effective tax rate from statutory U.S. federal income tax rate of 34% for 1997, 1996 and 1995, is as follows: 1997 1996 1995 ---- ---- ---- Statutory rate 34% 34% 34% State tax, net of federal benefit 5 5 5 Goodwill and other permanent items 2 2 1 ---- ---- ---- Effective tax rate 41% 41% 40% ==== ==== ====
As of December 31, 1997, 1996 and 1995, total net current deferred tax assets were $859,000, $869,000 and $665,000, respectively, and total net noncurrent deferred tax liabilities were $247,300, $167,157 and $125,157, respectively. The temporary differences that give rise to deferred tax assets and liabilities are as follows:
December 31 ------------------------------------- 1997 1996 1995 ---- ---- ---- Claims liability $ 608,804 $ 616,100 $ 490,500 Allowance for doubtful accounts 130,265 112,900 54,400 Vacation accrual 52,566 54,700 39,500 Miscellaneous 67,365 85,300 80,600 --------- --------- --------- Total current tax asset 859,000 869,000 665,000 --------- --------- --------- Accumulated amortization (80,103) -- -- Accumulated depreciation and other (167,197) (167,157) (125,157) --------- --------- --------- Total noncurrent tax liability (247,300) (167,157) (125,157) --------- --------- --------- Total $ 611,700 $ 701,843 $ 539,843 ========= ========= =========
37 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 8. Sources of Revenue (Unaudited) - -------------------------------------------------------------------------------- The following table shows the percentage of revenue attributable to each type of product offered:
1997 1996 1995 ---- ---- ---- Managed care 77% 74% 77% Indemnity/PPO 22 24 21 Fee income 1 2 2 ---- ---- ---- Total 100% 100% 100% ==== ==== ====
9. Significant Customers - -------------------------------------------------------------------------------- There are no customers that account for a significant amount of the Company's subscriber revenue in the years ended December 31, 1997 and 1996 and 1995. 10. Line of Credit - -------------------------------------------------------------------------------- The Company has a committed unsecured line of credit (the "Credit Agreement") available with a Chicago bank that expires June of 1998, which to date has not been utilized. Pursuant to this Credit Agreement, the Company may borrow up to $5 million at the rate of LIBOR plus one-half percent. 11. Preferred Stock - -------------------------------------------------------------------------------- During 1995, the Board of Directors and stockholders of the Company approved an amendment and restatement of its Restated Certificate of Incorporation to, among other things, authorize 1,000,000 shares of preferred stock, $.001 par value, which may be issued from time to time in one or more series with such rights, preferences and qualifications as the Company's Board of Directors may determine. The Board of Directors has designated 150,000 shares of the preferred stock as Series A Junior Participating Preferred Stock. There are no shares issued or outstanding of the Series A Junior Participating Preferred Stock. 6% Series B Preferred Stock Concurrent with the closing of the initial public offering discussed in Note 12, each share of 6% Series B Preferred Stock ("Series B Stock") was converted into 2,000 shares of common stock in accordance with the Series B Stock conversion features. Following the offering, no shares of Series B Stock were issued or authorized for issuance. While outstanding, the Series B Stock had voting rights equal to the number of common shares into which such shares could be converted. The Series B Stockholders were able to elect two of six directors. The Series B Stock was also entitled to certain dividend rights. 12. Common stock - -------------------------------------------------------------------------------- In November, 1995, the Company completed an initial public offering of 530,000 shares of its common stock at $15 per share. As discussed in Note 11, concurrent with the initial public offering, each share of Series B Stock was converted into 2,000 shares of common stock. The holder of each share of common stock is entitled to one vote on each matter submitted to a vote to the stockholders of the Company. 38 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 The Company has two incentive plans, a 1987 Statutory-Nonstatutory Stock Option Plan ("1987 Plan") and a 1995 Long-Term Incentive Plan ("1995 Plan"), which were approved by the Board of Directors and stockholders. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's two stock option plans been determined based on the fair value at the grant date for awards in 1997, 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net income (in thousands) and diluted earnings per share would have been reduced to the pro forma amounts of $3,268 and $0.88 in 1997, $2,645 and $0.73 in 1996 and $1,987 and $0.66 in 1995. The weighted average grant-date fair values of options granted in 1997, 1996 and 1995 were $6.80, $12.25 and $8.14, respectively. The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions for options issued in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.8%, 6.5% and 5.8%; expected lives of 7 years; expected volatility of 41% in 1997 and 42% in 1996 and 1995; and no expected dividends. Under the 1987 Plan, the Company can award up to 250,000 options to key employees, granted at a price equal to the fair market value at the date of the grant as determined by the Board of Directors or the Stock Option Compensation Committee, and vesting ratably over a period of two to four years from the date of the grant. The Company had granted 248,125 total options as of December 31, 1997, 1996 and 1995, to key employees and directors at option prices ranging from $.50 to $15.00 per share. Of the total options granted, 133,375, 148,950 and 134,959 had vested and were exercisable as of December 31, 1997, 1996 and 1995, respectively, and 87,925, 60,675 and 51,375 of the total options, granted and vested had been exercised as of December 31, 1997, 1996 and 1995, respectively. In connection with the initial public offering, the Company adopted the 1995 Long-Term Incentive Plan (the "1995 Plan"). Under the 1995 Plan, the Company may grant incentive stock options or nonqualified stock options. The 1995 Plan also provides for the grant of stock appreciation rights, bonus stock awards which are vested upon grant, stock awards which may be subject to a restriction period and specified performance measures, and performance shares. A total of 200,000 shares of common stock have been reserved for issuance under the 1995 Plan. Subsequent to December 31, 1997, the Board of Directors has approved increasing the shares from 200,000 to 350,000, subject to shareholders' approval. Under the 1995 Plan, options are granted at a price equal to the fair market value at the date of the grant as determined by the Board of Directors and vest ratably over a period of one to four years from the date of the grant. As of December 31, 1997, 1996 and 1995, the Company had granted 94,000, 105,500 and 39,000, respectively, total options to key employees and directors at option prices ranging from $11.75 to $28.625 per share. Of the total options granted, 38,813 and 11,000 had vested and were exercisable as of December 31, 1997 and 1996, respectively. In addition, 77,238 and 42,000 options were rescinded as of December 31, 1997 and 1996, respectively and in 1995, in connection with the initial public offering, stock bonus awards totaling 1,865 shares of common stock were granted to non-officer employees. A summary of the status of the Company's two stock option plans at December 31, 1997, 1996 and 1995 and changes during the years then ended is presented in the table on the following page. 39 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ---- ---- ---- Weighted Weighted Weighted Average Average Average Shares Option Price Shares Option Price Shares Option Price ------ ------------ ------ ------------ ------ ------------ Outstanding at beginning of year 289,950 $ 7.90 235,750 $ 4.15 191,250 $ 1.31 Granted 94,000 12.26 105,500 22.06 49,000 15.00 Exercised (29,012) 1.56 (9,300) 0.75 (2,375) 1.15 Forfeited (16,238) 10.36 (2,000) 21.81 (2,125) 1.49 Cancelled (61,000) 20.47 (40,000) 24.12 -- -- ------- ------- ------- Outstanding at end of year 277,700 7.08 289,950 7.90 235,750 4.15 ======= ======= ======= Exercisable at end of year 172,188 4.38 159,950 2.43 134,959 1.19 ======= ======= =======
Of the 277,700 total options outstanding at December 31, 1997, 146,500 have option prices between $.50 and $1.70, with a weighted average option price of $1.39 and a weighted average remaining contractual life of three years. 133,375 of these options are exercisable at December 31, 1997, with a weighted average option price of $1.36. Of the total options outstanding at December 31, 1997, 71,700 have option prices of $11.75, with a weighted average remaining contractual life of ten years. 11,063 of these options are exercisable at December 31, 1997, with a weighted average option price of $11.75. Of the total options outstanding at December 31, 1997, 57,500 have option prices between $15.00 and $17.00, with a weighted average option price of $14.85 and a weighted average remaining contractual life of eight years. 25,750 of these options are exercisable at December 31, 1997, with a weighted average option price of $15.00. The remaining 2,000 options outstanding at December 31, 1997, have option prices of $28.625, with a weighted average remaining contractual life of eight years. These options are exercisable at December 31, 1997. During 1995, the Board of Directors adopted a stockholders rights plan. Under the stockholders rights plan, each share of common stock will have associated with it one preferred share purchase right (a "Right"). Under certain circumstances, each Right would entitle the holders thereof to purchase one one- hundredth of a share of Series A Junior Participating Preferred Stock for a price of $40 per one one-hundredth of a share. The Rights are not presently exercisable and are transferable only with the related shares of common stock. The Rights would become exercisable at the specified exercise price upon the occurrence of certain events, including the acquisition of 15% or more of the Company's common stock by a person or group, as defined. The Rights may be redeemed, as a whole, at a redemption price of $.01 per Right, subject to adjustment, at the direction of the Board of Directors, at any time prior to the occurrence of certain events. In addition, in certain circumstances, the Board of Directors may direct the exchange of shares of common stock (or preferred shares) for all or any part of the Rights at the exchange rate of one share of common stock (or one one-hundredth of a preferred share) per Right, subject to adjustment. 40 First Commonwealth, Inc. and Subsidiaries - -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 13. Quarterly Financial Data (unaudited) - -------------------------------------------------------------------------------- (in thousands, except per share data)
Quarter ---------------------------------- First Second Third Fourth ------- ------- ------- ------- 1997 - ---- Subscriber revenue $13,463 $13,856 $14,519 $14,756 Gross margin 4,700 4,733 4,573 4,656 Net income 760 798 882 883 Basic earnings per common share .21 .22 .24 .24 Diluted earnings per common share .20 .21 .24 .24 1996 - ---- Subscriber revenue $ 9,773 $10,019 $11,786 $12,521 Gross margin 3,747 3,799 4,220 4,460 Net income 669 698 667 697 Basic earnings per common share .20 .21 .19 .19 Diluted earnings per common share .19 .20 .18 .19 1995 - ---- Subscriber revenue $ 7,934 $ 8,204 $ 8,528 $ 8,649 Gross margin 3,100 3,197 3,291 3,441 Net income 501 532 513 458 Basic earnings per common share .18 .19 .18 .16 Diluted earnings per common share .18 .19 .18 .14
41 First Commonwealth, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--continued - -------------------------------------------------------------------------------- For the years ended December 31, 1997, 1996 and 1995 14. RETIREMENT PLAN - -------------------------------------------------------------------------------- The Company has a 401(k) salary deferral plan in which all employees of the Company who have completed at least ninety days of service are eligible to participate. Under the plan, the Company provides a matching contribution of $.50 for every dollar an employee invests in the plan up to an annual maximum of 2% of the employee's compensation for the year. The Company may make additional discretionary contributions to the plan. The Company incurred 401(k) contributions expense of $91,949, $58,937 and $44,427 during the years ended December 31, 1997, 1996 and 1995, respectively. 15. BUSINESS COMBINATIONS - -------------------------------------------------------------------------------- Effective July 18, 1996, the Company completed the acquisition of SDS and an associated reinsurance transaction, for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through the issuance of 231,399 shares of the Company's common stock. The acquisition resulted in the excess of cost over fair value of net assets acquired of approximately $5.6 million. Effective December 31, 1996, the Company completed the acquisition of CDS for an aggregate purchase price (including transaction costs) of $5.6 million. The acquisition was financed through proceeds from the Company's initial public offering and was paid in cash on January 2, 1997. The acquisition resulted in the excess of cost over fair value of net assets acquired of approximately $4.9 million. The acquisitions of SDS and CDS were accounted for using the purchase method of accounting with SDS's results of operations included in the accompanying consolidated statement of income for the year ended December 31, 1996 from the effective date of the acquisition. Unaudited pro forma combined results of operations of the Company for the years ended December 31, 1996 and 1995 for the acquisitions are as follows: Revenues (in thousands) for the years ended December 31, 1996 and 1995 would be $50,860 and $42,058, respectively; Net income (in thousands) for the years ended December 31, 1996 and 1995 would be $2,856 and $2,444, respectively; and Diluted Net Income per share for the years ended December 31, 1996 and 1995 would be $0.77 and $0.66, respectively. This pro forma information has been prepared assuming the acquisitions of SDS and CDS and the Company's initial public offering had occurred as of January 1, 1995. The pro forma results include the historical accounts of the Company and the historical accounts of the acquired businesses and pro forma adjustments including the amortization of the excess purchase price over the fair value of the net assets acquired, the reduction of salaries and expenses which will not be incurred on an ongoing basis, and the applicable income tax effects of these adjustments. The pro forma results of operations are not necessarily indicative of actual results which may have occurred had the operations of the acquired companies been combined in prior periods. 42 OFFICERS AND DIRECTORS - -------------------------------------------------------------------------------- Officers Christopher C. Multhauf Chairman and Chief Executive Officer David W. Mulligan President and Chief Operating Officer, Secretary Gregory D. Stobbe Senior Vice President, Operations Mark R. Lundberg Vice President, Sales Scott B. Sanders Chief Financial Officer and Treasurer, Assistant Secretary Directors Christopher C. Multhauf Chairman and Chief Executive Officer David W. Mulligan President and Chief Operating Officer, Secretary Richard M. Burdge, Sr. Executive Vice President-Retired, CIGNA Corporation William J. McBride Chairman, Novaeon, Inc.; President-Retired, Value Health, Inc., a managed healthcare company Jackson W. Smart, Jr. Chairman and Chief Executive Officer-Retired, MSP Communications, Inc., a radio broadcasting company 43 RELATED STOCKHOLDER MATTERS AND MARKET FOR THE COMPANY'S COMMON STOCK - -------------------------------------------------------------------------------- Form 10-K A copy of the Form 10-K, which is filed with the Securities and Exchange Commission, will be sent free to any shareholder upon written request. Write to: Mr. Scott B. Sanders Chief Financial Officer, Assistant Secretary 444 N. Wells Street, Suite 600 Chicago, IL 60610 Transfer Agent & Registrar First Chicago Trust Co. of New York Analyst Contacts Security analyst inquiries are welcomed. Please call: Mr. Scott B. Sanders Chief Financial Officer (312) 644-1800 Annual Meeting May 5, 1998 Chicago, Illinois Dividend Policy The Company has never paid cash dividends on its Common Stock. The Company currently intends to retain earnings to finance the growth and development of its business and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. Any payment of cash dividends in the future will depend upon the financial condition, capital requirements and earnings of the Company, limitations on dividend payments by susidiaries of the Company under applicable state laws requiring the maintenance of specified levels of capital and surplus and such other factors as the Board of Directors may deem relevant. Stock Trading and Common Stock Prices The Company's Common Stock trades on the Nasdaq Stock Market/SM/ under the symbol FCWI. At February 28, 1998, there were 154 registered shareholders and the Company believes there are at least 400 round lot shareholders of beneficial interest. The following table sets forth the high and low closing prices by quarter for 1996 and 1997.
1996 - ---- Quarter ending High Low - -------------- ------ ------ March 31 $27.00 $24.00 June 30 $29.00 $24.25 September 30 $29.00 $20.75 December 31 $24.50 $16.50 1997 - ---- Quarter ending - -------------- March 31 $21.25 $14.75 June 30 $19.50 $11.25 September 30 $20.50 $14.75 December 31 $15.25 $11.25
44 EX-21 4 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT
- ------------------------------------------------------------------------------------------- Jurisdiction Name of Subsidiary Of Incorporation Doing Business As ------------------ ---------------- ----------------- - ------------------------------------------------------------------------------------------- First Commonwealth Limited Health Illinois First Services Corporation Commonwealth, Inc. - ------------------------------------------------------------------------------------------- First Commonwealth of Illinois, Inc. Illinois First Commonwealth, Inc. - ------------------------------------------------------------------------------------------- First Commonwealth Insurance Illinois First Company Commonwealth, Inc. - ------------------------------------------------------------------------------------------- First Commonwealth Reinsurance Arizona First Company Commonwealth, Inc. - ------------------------------------------------------------------------------------------- First Commonwealth Limited Health Wisconsin First Service Corporation Commonwealth, Inc. - ------------------------------------------------------------------------------------------- Smileage Dental Services, Inc. Wisconsin First Commonwealth, Inc. - ------------------------------------------------------------------------------------------- First Commonwealth of Missouri, Missouri First Inc. Commonwealth, Inc. - -------------------------------------------------------------------------------------------
EX-23 5 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23 CONSENT OF ARTHUR ANDERSEN LLP As independent public accountants, we hereby consent to the incorporation by reference in this Form 10- K of First Commonwealth, Inc., of our report, dated February 11, 1998, on the consolidated financial statements of First Commonwealth, Inc. and Subsidiaries (the "Company") included in the Company's 1997 Annual Report to Stockholders, and to the incorporation of our report, dated February 11, 1998, on the financial statement schedule of the Company, and included in this Form 10-K, into the Company's previously filed S-3 Registration Statement, File No. 333-18379, and S-8 Registration Statement, File No. 333- 00474. ARTHUR ANDERSEN LLP Chicago, Illinois March 30, 1998 EX-27 6 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from The Consolidated Financial Statements of First Commonwealth, Inc. as of December 31, 1997 and for the twelve months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 9,047 0 3,444 334 0 16,554 4,029 2,320 31,896 8,325 0 0 0 4 23,323 31,896 0 56,594 0 51,277 0 205 0 5,607 2,284 3,323 0 0 0 3,323 0.92 0.89
EX-27.1 7 FINANCIAL DATA SCHEDULE AS OF 9/30/97
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of September 30, 1997, and for the nine months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 10,336 0 3,841 352 0 17,420 3,927 2,161 30,552 7,915 0 0 0 4 22,406 30,552 0 41,838 0 37,549 0 153 0 4,136 1,696 2,440 0 0 0 2,440 0.68 0.65
EX-27.2 8 FINANCIAL DATA SCHEDULE AS OF 6/30/97
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of June 30, 1997, and for the six months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 6-MOS DEC-31-1997 JAN-01-1997 JUN-30-1997 8,246 511 4,156 367 0 16,567 3,761 2,008 29,778 8,051 0 0 0 4 21,516 29,778 0 27,319 0 24,574 0 102 0 2,643 1,085 1,558 0 0 0 1,558 0.43 0.42
EX-27.3 9 FINANCIAL DATA SCHEDULE AS OF 3/31/97
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of March 31, 1997, and for the three months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 10,094 515 3,297 350 0 17,110 3,534 1,870 30,581 9,671 0 0 0 4 20,719 30,581 0 13,463 0 12,229 0 51 0 1,290 530 760 0 0 0 760 0.21 0.20
EX-27.4 10 FINANCIAL DATA SCHEDULE AS OF 12/31/96
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of December 31, 1996, and for the twelve months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 15,817 0 3,011 290 0 21,023 3,348 1,725 34,454 14,331 0 0 0 4 19,956 34,454 0 44,099 0 40,042 0 104 0 4,595 1,864 2,731 0 0 0 2,731 0.79 0.76
EX-27.5 11 FINANCIAL DATA SCHEDULE AS OF 9/30/96
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of September 30, 1996, and for the nine months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1996 JAN-01-1996 SEP-30-1996 10,820 3,015 2,421 231 0 18,704 3,131 1,579 27,076 7,725 0 0 0 4 19,222 27,076 0 31,578 0 28,567 0 81 0 3,412 1,378 2,034 0 0 0 2,034 0.59 0.57
EX-27.6 12 FINANCIAL DATA SCHEDULE AS OF 6/30/96
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of June 30, 1996, and for the six months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 6-MOS DEC-31-1996 JAN-01-1996 JUN-30-1996 9,272 4,121 1,933 219 0 18,049 2,770 1,328 20,660 7,472 0 0 0 3 13,060 20,660 0 19,792 0 17,779 0 54 0 2,281 914 1,367 0 0 0 1,367 0.41 0.39
EX-27.7 13 FINANCIAL DATA SCHEDULE AS OF 3/31/96
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of March 31, 1996, and for the three months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1996 JAN-01-1996 MAR-31-1996 10,551 2,141 2,840 224 0 18,100 2,540 1,201 20,458 7,957 0 0 0 3 12,373 20,458 0 9,773 0 8,793 0 27 0 1,115 446 669 0 0 0 669 0.20 0.19
EX-27.8 14 FINANCIAL DATA SCHEDULE AS OF 12/31/95
5 This schedule contains summary financial information extracted from the Consolidated Financial Statements of First Commonwealth, Inc. as of December 31, 1995, and for the twelve months then ended, and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1995 JAN-01-1995 DEC-31-1995 12,680 0 1,751 197 0 16,889 2,465 1,086 19,111 7,280 0 0 0 3 11,703 19,111 0 33,315 0 29,976 0 193 0 3,340 1,336 2,004 0 0 0 2,004 0.69 0.67
-----END PRIVACY-ENHANCED MESSAGE-----