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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
{X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
{ } TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from ________ to ________
Commission file number 0-15846
First Health Group Corp.
(formerly HealthCare COMPARE Corp.)
(Exact name of registrant as specified in its charter)
Delaware 36-3307583
------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
3200 Highland Avenue, Downers Grove, Illinois 60515
---------------------------------------------------
(Address of principal executive offices, Zip Code)
(630) 737-7900
------------------------------------------------
(Registrant's phone number, including area code)
__________________________
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No ________
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
The number of shares of Common Stock, par value $.01 per share, outstanding
on August 7, 2002, was 101,299,204.
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information
Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at June 30, 2002
and December 31, 2001 ................................... 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at June 30, 2002 and December 31, 2001 ........... 4
Consolidated Statements of Operations for the three months
ended June 30, 2002 and 2001 ............................ 5
Consolidated Statements of Operations for the six months
ended June 30, 2002 and 2001 ............................ 6
Consolidated Statements of Comprehensive Income for the
three and six months ended June 30, 2002 and 2001 ....... 7
Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001 ............................ 8-9
Notes to Consolidated Financial Statements ................ 10-15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............ 16-22
Item 3. Quantitative and Qualitative Disclosures About
Market Risk .................................... 23
Part II. Other Information
Item 4. Submission of Matters to a Vote of
Security Holders ............................... 24
Item 6. Exhibits and Reports on Form 8-K ................. 24
Signatures....................................................... 25
PART 1. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
ASSETS June 30, 2002 December 31, 2001
---------- ----------
Current Assets:
Cash and cash equivalents ............ $ 31,611 $ 14,001
Short-term investments ............... 2,130 2,381
Accounts receivable, less allowances
for doubtful accounts of $16,220
and $ 14,327 respectively.......... 75,689 78,793
Deferred income taxes ................ 27,540 27,429
Other current assets ................. 15,996 20,757
Assets held for sale ................. -- 6,958
--------- ---------
Total current assets ................. 152,966 150,319
Long-Term Investments:
Marketable securities ................ 67,943 65,766
Other ................................ 56,081 55,205
--------- ---------
124,024 120,971
--------- ---------
Property and Equipment:
Land, buildings and improvements ..... 94,247 87,468
Computer equipment and software ...... 193,480 180,152
Office furniture and equipment ....... 24,449 20,282
--------- ---------
312,176 287,902
Less accumulated depreciation and
amortization....................... (127,832) (105,393)
--------- ---------
Net property and equipment ........... 184,344 182,509
--------- ---------
Goodwill, less accumulated amortization
of $ 17,341 and $ 17,341, respectively 280,105 255,855
Intangible assets, less accumulated
amortization of $ 2,447 and $ 955,
respectively ......................... 47,025 42,859
Reinsurance recoverable................. 25,277 26,140
Other Assets............................ 4,795 2,081
--------- ---------
$ 818,536 $ 780,734
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, 2002 December 31, 2001
--------- ---------
Current Liabilities:
Accounts payable ..................... $ 43,225 $ 33,257
Accrued expenses ..................... 65,102 66,384
Current maturities of long-term debt.. -- 197,500
Claims reserves ...................... 13,745 12,308
Income taxes payable ................. 13,574 --
--------- ---------
Total current liabilities ............ 135,646 309,449
Long-Term Debt.......................... 130,000 --
Claims Reserves - Non-Current........... 25,277 26,140
Deferred Taxes.......................... 84,579 84,828
Other Non-Current Liabilities........... 21,191 21,018
--------- ---------
Total liabilities .................... 396,693 441,435
--------- ---------
Commitments and Contingencies........... -- --
Stockholders' Equity:
Common stock ......................... 1,334 1,313
Additional paid-in capital ........... 289,768 255,489
Retained earnings .................... 449,807 386,309
Stock option loan receivable ......... (1,688) (1,776)
Accumulated comprehensive gain (loss). (302) 161
Treasury stock, at cost .............. (317,076) (302,197)
--------- ---------
Total stockholders' equity ........... 421,843 339,299
--------- ---------
$ 818,536 $ 780,734
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Three Months Ended June 30,
---------------------------
2002 2001
--------- ---------
Revenues............................ $ 175,923 $ 138,949
--------- ---------
Operating expenses:
Cost of services ................. 75,077 60,438
Selling and marketing ............ 17,755 13,233
General and administrative ....... 11,956 8,622
Healthcare benefits .............. 3,903 3,396
Depreciation and amortization .... 13,356 11,285
--------- ---------
122,047 96,974
--------- ---------
Income from operations.............. 53,876 41,975
Other (income) expense:
Interest expense ................. 1,503 1,119
Interest income .................. (1,544) (1,714)
--------- ---------
Income before income taxes.......... 53,917 42,570
Income taxes........................ (21,433) (17,241)
--------- ---------
Net income $ 32,484 $ 25,329
========= =========
Weighted average shares outstanding - basic 101,217 97,765
========= =========
Net income per common share - basic. $ .32 $ .26
========= =========
Weighted average shares outstanding - diluted 104,735 102,396
========= =========
Net income per common share - diluted $ .31 $ .25
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
Revenues............................ $ 345,284 $ 275,933
--------- ---------
Operating expenses:
Cost of services ................. 148,049 120,175
Selling and marketing ............ 34,833 26,177
General and administrative ....... 23,349 16,992
Healthcare benefits .............. 7,684 7,099
Depreciation and amortization .... 26,328 21,887
--------- ---------
240,243 192,330
--------- ---------
Income from operations.............. 105,041 83,603
Other (income) expense:
Interest expense ................. 2,819 3,590
Interest income .................. (3,172) (3,565)
--------- ---------
Income before income taxes.......... 105,394 83,578
Income taxes........................ (41,896) (33,849)
--------- ---------
Net income.......................... $ 63,498 $ 49,729
========= =========
Weighted average shares outstanding - basic 100,759 97,270
========= =========
Net income per common share - basic $ .63 $ .51
========= =========
Weighted average shares outstanding - diluted 104,584 102,034
========= =========
Net income per common share - diluted $ .61 $ .49
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Three Months Ended June 30,
---------------------------
2002 2001
--------- ---------
Net income.................................. $ 32,484 $ 25,329
--------- ---------
Unrealized gains (losses) on securities,
before tax................................ (179) 79
Income tax (expense) benefit related to
items of other comprehensive income....... 66 (45)
--------- ---------
Other comprehensive income (loss)........... (113) 34
--------- ---------
Comprehensive income........................ $ 32,371 $25,363
========= =========
Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
Net income.................................. $ 63,498 $ 49,729
--------- ---------
Unrealized gains (losses) on securities,
before tax................................ (712) 1,673
Income tax (expense) benefit related to
items of other comprehensive income....... 249 (630)
--------- ---------
Other comprehensive income (loss)........... (463) 1,043
--------- ---------
Comprehensive income........................ $ 63,035 $ 50,772
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Cash received from customers ............ $ 350,126 $ 265,706
Cash paid to suppliers and employees .... (202,665) (163,697)
Healthcare benefits paid ................ (7,418) (8,545)
Interest income received ................ 1,684 2,613
Interest expense paid ................... (2,500) (3,848)
Income taxes paid, net .................. (7,439) (15,976)
--------- ---------
Net cash provided by operating activities 131,788 76,253
--------- ---------
Cash flows from investing activities:
Purchases of investments ................ (30,355) (22,711)
Sales of investments .................... 27,096 12,211
Acquisition, net of cash acquired ....... (24,227) --
Assets held for sale .................... 923 --
Purchase of property and equipment ...... (27,001) (37,107)
--------- ---------
Net cash used in investing activities ... (53,564) (47,607)
--------- ---------
Cash flows from financing activities:
Purchase of treasury stock .............. (14,813) --
Issuances of long-term debt ............. 150,000 --
Repayment of long-term debt ............. (217,500) (65,000)
Stock option loans to employees ......... (2,272) (1,500)
Stock option loan repayments ............ 2,360 756
Proceeds from issuance of common stock .. 21,436 25,649
Sales of put options on common stock .... 375 --
--------- ---------
Net cash used in financing activities ... (60,414) (40,095)
--------- ---------
Net increase (decrease) in cash and
cash equivalents......................... 17,810 (11,449)
Cash and cash equivalents,
beginning of period...................... 14,001 23,538
--------- ---------
Cash and cash equivalents, end of period... $ 31,811 $ 12,089
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Six Months Ended June 30,
--------------------------
2002 2001
--------- ---------
Reconciliation of Net Income to Net Cash
Provided by Operating Activities:
Net Income.................................. $ 63,498 $ 49,729
--------- ---------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities Net
of Effects of Acquisition:
Depreciation and amortization .......... 26,328 21,887
Change in provision for uncollectible
receivables .......................... 1,893 2
Tax benefit from stock options exercised 12,423 10,935
Deferred income taxes .................. (111) 5,649
Other, net ............................. 503 (1,024)
Changes in Assets and Liabilities:
Accounts receivable .................... 1,790 (11,320)
Other current assets ................... 4,788 2,436
Reinsurance recoverable ................ 863 1,023
Accounts payable and accrued expenses... 8,206 (1,903)
Claims reserves ........................ 574 (1,155)
Income taxes payable ................... 13,574 --
Non-current assets and liabilities ..... (2,541) (6)
--------- ---------
Total adjustments ........................ 68,290 26,524
--------- ---------
Net cash provided by operating activities $ 131,788 $ 76,253
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The unaudited financial statements herein have been prepared by the
Company pursuant to the rules and regulations of the Securities and
Exchange Commission. The accompanying interim financial statements
have been prepared under the presumption that users of the interim
financial information have either read or have access to the audited
financial statements for the latest fiscal year ended December 31,
2001. Accordingly, footnote disclosures which would substantially
duplicate the disclosures contained in the December 31, 2001 audited
financial statements have been omitted from these interim financial
statements. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. Although
the Company believes that the disclosures are adequate to make the
information presented not misleading, it is suggested that these
interim financial statements be read in conjunction with the financial
statements and the notes thereto included in the Company's latest
Annual Report on Form 10-K.
2. On August 16, 2001, the Company completed the acquisition of all of the
outstanding shares of capital stock of CCN Managed Care, Inc. ("CCN")
and Preferred Works, Inc. ("PW" and together with CCN, the "CCN
Companies") from HCA-The Healthcare Company and VH Holdings, Inc.
(collectively, the "Sellers") for a purchase price of $195 million in
cash, plus a working capital adjustment which increased the purchase
price to $198 million. The allocation of the purchase price is subject
to completion of the Company's restructuring and integration plan.
Changes to the preliminary purchase price allocation resulting from the
finalization of these items may be material. The allocation of the
purchase price to the fair value of assets acquired and liabilities
assumed is as follows:
(in thousands)
Purchase price $195,000
Working capital adjustment 3,514
Transaction costs 2,000
-------
Total estimated purchase price $200,514
-------
Purchase price has been allocated as follows:
Fair value of assets acquired $ 33,611
Assets held for sale 9,965
Goodwill 177,350
Intangible assets acquired 43,814
Liabilities assumed (23,113)
Liability for restructuring and integration costs (41,113)
-------
$200,514
-------
In conjunction with the acquisition, the Company recorded as part of
the purchase price a $41.1 million reserve for restructuring and
integration costs as part of an overall plan to reduce operating
expenses and integrate the business of the acquired companies. The
specific actions included in the restructuring plan are expected to be
substantially complete by December 31, 2002. Components of the
purchase reserve are as follows:
Accrual 2002 Accrual
(in thousands) Total Balance Balance Amount
-------------- Charges 1/01/02 Incurred 6/30/02
------- ------- -------- -------
Severance and related $13,712 $ 6,031 $(2,766) $ 3,265
benefits
Facilities integration 10,370 9,528 (693) 8,835
Contract losses 10,000 9,750 (267) 9,483
Other reserves 7,031 7,028 (21) 7,007
------- ------- -------- -------
Total $41,113 $32,337 $(3,747) $28,590
======= ======= ======== =======
The restructuring plan includes the reduction of employees from various
offices within the United States. The Company expects to reduce the
number of CCN employees from approximately 1,300 at the time of the
acquisition to approximately 650 at December 31, 2002. There were
approximately 700 such employees as of June 30, 2002. During the first
six months of 2002, approximately $2.8 million was charged to the
purchase reserve for severance and related employee benefits with $1.6
million of such costs charged during the second quarter.
Facilities integration costs represent the costs the Company expects to
incur to integrate CCN's facilities into the Company's existing
operations. The majority of the facilities integration costs will be
incurred to consolidate CCN's former corporate headquarters and various
sales offices throughout the United States. Approximately $0.7 million
of costs for facilities integration was charged to the purchase reserve
in the first six months of 2002 with $0.4 million charged during the
second quarter.
Contract losses relate to the anticipated net loss to be incurred on an
assumed contract to provide certain screening services to individuals
who have agreed to be bound by a proposed settlement in a legal matter.
CCN signed a contract in March 2000 to provide these services for four
years and the Company has agreed to have its network providers provide
these services as part of the acquisition of CCN. The Company estimates
as many as 250,000 covered persons may seek such screening services and
the Company will incur a significant administrative burden in completing
claims to the satisfaction of the contractual terms. Approximately
$0.3 million of costs under this contract was charged to the purchase
reserve during the six months ended June 30, 2002 with $0.1 million
charged during the second quarter.
Other reserves represent various operational and tax liabilities the
Company expects to incur to fully integrate the Company's operations.
Approximately $21,000 was charged to the purchase reserve in the six
months ended June 30, 2002, none in the second quarter.
The Company reviewed the various businesses comprising the CCN
Companies and determined to hold the PW and the Resource Opportunity,
Inc. ("ROI") businesses of CCN for sale. The sale of ROI was completed
on December 28, 2001 for a sale price of $9 million. The sale of PW
was completed on June 28, 2002 for a sale price of $4.1 million. The
Company adjusted the goodwill on the CCN acquisition from $171.3
million to $177.3 million as a result of the completion of these sales.
The following unaudited pro forma information reflects the results of
the Company's operations as if the acquisition had occurred at the
beginning of 2001 adjusted for (i) the effect of recurring charges
related to the acquisition, primarily the amortization of intangible
assets over estimated useful lives of 15 or 20 years, as appropriate,
and the recording of interest expense on borrowings to finance the
acquisition; (ii) the reduction of depreciation expense due to the
write-down to fair value of fixed assets, the reduction of amortization
expense related to the CCN Companies' preexisting goodwill at the date
of acquisition and the elimination of compensation and benefit expenses
for certain executives of the CCN Companies who were terminated at or
immediately subsequent to the acquisition and will not be replaced; and
(iii) the removal of revenues and related cost of services and expenses
for acquired businesses that are held for sale.
Three Months Six Months
Ended June 30, Ended June 30,
2001 2001
(In thousands except per share data) -------------- --------------
Pro forma:
Revenue $163,834 $325,703
Net income 24,892 49,394
Net income per common share - basic .25 .51
Net income per common share - diluted .24 .48
These pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of what operating results
would have been had the acquisition actually taken place at the
beginning of 2001, nor do they purport to represent results of future
operations of the merged companies.
On May 1, 2002, the Company completed the acquisition of HealthCare
Value Management ("HCVM") for an initial purchase price of $24 million.
The Company may pay an additional $16 million over the next three years
based upon certain HCVM performance measures. HCVM is a small New
England based PPO company, headquartered in suburban Boston. The
acquisition was accounted for by the purchase method of accounting in
accordance with Statement of Financial Accounting Standards No. 141.
The acquisition was financed from borrowings under the Company's
existing line of credit. The results of operations and assets acquired
are immaterial to the consolidated financial statements of the Company.
Consequently, no pro forma financial results are included herein.
3. On April 23, 2002, the Company obtained a $400 million revolving credit
facility to replace its previous $350 million credit facility that was
due to expire on June 30, 2002. This new credit facility has a five-
year term and provides for interest at a Euro dollar rate (which
approximates LIBOR) plus a variable margin which fluctuates based on
the Company's debt rating. The facility also has a corresponding fee
calculated at a variable rate of the available facility balance
depending on the debt rating of the Company. The interest rate at June
30, 2002 was approximately 5% per annum. No principal payments are due
on this facility until its maturity.
4. The Company's investments in marketable securities which are classified
as available for sale had a net unrealized loss in market value of
$463,000, net of deferred income taxes, for the six month period ended
June 30, 2002. The net unrealized loss as of June 30, 2002, included
as a component of stockholders' equity, was $302,000, net of deferred
income taxes. The Company has six separate investments in a limited
partnership which invests in equipment which is leased to third
parties. The total investment as of June 30, 2002 and December 31,
2001 was $47.9 million and $47.1 million, respectively, and is
accounted for using the equity method. The Company's proportionate
share of the partnership's income was $1.5 million and $1.4 million for
the six months ended June 30, 2002 and 2001, respectively, and is
included in interest income. Approximately 90 percent of this
partnership is owned by parties related to a former member of the
Company's Board of Directors. All transactions are made on an arms-
length basis at equal terms between all limited partners.
5. The Company's Board of Directors has approved the repurchase of up to
15 million shares of the Company's outstanding common stock under its
current authorization. Purchases may be made from time to time,
depending on market conditions and other relevant factors. During the
quarter ended June 30, 2002 the Company repurchased 525,000 shares on
the open market for approximately $14.8 million. As of June 30, 2002,
approximately 4.7 million shares remain available for repurchase under
the Company's current repurchase authorization. In connection with
this stock repurchase plan, during the quarter ended June 30, 2002, the
Company sold put options which obligated the Company, at the election
of the option holders, to repurchase up to 500,000 shares of common
stock at a price of $26.45. No such put options were outstanding as of
June 30, 2001.
6. Weighted average shares outstanding increased for diluted earnings per
share by 3,518,000 and 3,825,000 and by 4,631,000 and 4,764,000
respectively, for the three and six months ended June 30, 2002 and 2001
due to the effect of stock options outstanding. Diluted net income per
share was .01 and .02 less than basic net income per share for the
three and six months ended June 30, 2002 due to the effect of stock
options outstanding. Diluted net income per share was .01 and .02 less
than basic net income per share for the three and six months ended June
30, 2001 due to the effect of stock options outstanding.
7. Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, ("SFAS No. 133), "Accounting For
Derivative Instruments and Hedging Activities". SFAS No. 133 requires
that all derivative instruments be recognized as either assets or
liabilities in the balance sheet and that derivative instruments be
measured at fair value. This statement also requires changes in the
fair value of derivatives to be recorded each period in current
earnings or comprehensive income depending on the intended use of the
derivative. There was no material effect on the Company's results of
operations or financial position as a result of the adoption of SFAS
No. 133.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"),
"Business Combinations." SFAS 141 requires the purchase method of
accounting for business combinations initiated after June 30, 2001 and
eliminates the pooling-of-interests method. In July 2001, the FASB
issued Statement of Financial Accounting Standards No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets", which the Company
adopted effective January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization effective December
31, 2001. In addition, the standard includes provisions for the
reassessment of the useful lives of existing recognized intangibles and
the identification of reporting units for purposes of assessing
potential future impairments of goodwill.
In accordance with these pronouncements, the Company accounted for the
acquisition of CCN as a purchase and allocated the purchase price to
all identifiable tangible and intangible assets and liabilities. The
goodwill resulting from this acquisition of approximately $177 million
has not been amortized. Goodwill and intangible assets of approximately
$102 million acquired in business combinations completed before July 1,
2001 was amortized through December 31, 2001. In accordance with SFAS
142, none of the Company's $280 million in net goodwill was amortized
during the six months ended June 30, 2002.
The following table reflects the effect of SFAS 142 on net income and
earnings per share as if SFAS 142 had been in effect for all periods
presented:
Three Months Six Months
(in thousands) Ended Ended
June 30, June 30,
2001 2001
------- -------
Net income $25,329 $49,729
Add back goodwill amortization 867 1,734
Tax effect of amortization (351) (702)
------- -------
Adjusted net income $25,845 $50,761
======= =======
Adjusted income per common share - Basic $ .26 $ .52
======= =======
Adjusted income per common share - Diluted $ .25 $ .50
======= =======
In accordance with the provisions of SFAS 142, the Company completed a
transitional goodwill impairment test within six months of the date of
adoption. The Company used standard valuation techniques including an
analysis of expected business performance and analysis of recent
acquisitions within the healthcare industry. There was no impairment
in goodwill amounts as a result of this transitional impairment test.
The Company will perform an annual impairment during the third quarter
of each year or at such earlier time that circumstances warrant an
interim valuation.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144 ("SFAS 144"), "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS 144 addresses
accounting and reporting for the impairment or disposal of long-lived
assets, including discontinued operations, and establishes a single
accounting model for long-lived assets to be disposed of by sale. The
adoption of this pronouncement did not have a material impact on the
financial position and results of operations of the Company.
8. On July 1, 2002, the Company completed its acquisition of the
operational and administrative assets from CNA Insurance Company for a
purchase price of $20 million. Included in this transaction is the
transfer of approximately 1,000 CNA employees and related assets which
support the Mail Handlers Benefit Plan (the "Plan") offices in various
cities. The acquisition relates to a long-term contract that the
Company announced in April 2002 to provide its comprehensive health
plan services to the Plan.
9. The Company and its subsidiaries are subject to various claims arising
in the ordinary course of business and are parties to various legal
proceedings that constitute litigation incidental to the business of
the Company and its subsidiaries. The Company's wholly owned
subsidiary, First Health Services Corporation ("Services") continues to
be subject to an investigation by the District of Columbia Office of
Inspector General ("OIG"). In July 2000, the OIG issued a report
evaluating the District of Columbia's Medicaid program and suggesting
ways to improve the program. Services, a subsidiary of the Company
that was acquired in July 1997, has acted as the program's fiscal agent
intermediary for more than 20 years. The OIG report included
allegations that from 1993 to 1996, Services, in its role as fiscal
agent intermediary, made erroneous Medicaid payments to providers on
behalf of patients no longer eligible to receive Medicaid benefits.
The Company does not believe that the outcome of the claim or the
investigation will have a material adverse effect on the Company's
business or financial position.
First Health Group Corp. and Subsidiaries
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Unaudited)
Forward-Looking Information
---------------------------
This Management's Discussion and Analysis of Financial Condition and
Results of Operations may include certain forward-looking statements, within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
(without limitation) statements with respect to anticipated future operating
and financial performance, growth and acquisition opportunities and other
similar forecasts and statements of expectation. Words such as "expects",
"anticipates", "intends", "plans", "believes", "seeks", "estimates", "could"
and "should" and variations of these words and similar expressions, are
intended to identify these forward-looking statements. Forward-looking
statements made by the Company and its management are based on estimates,
projections, beliefs and assumptions of management at the time of such
statements and are not guarantees of future performance. The Company
disclaims any obligation to update or revise any forward-looking statement
based on the occurrence of future events, the receipt of new information or
otherwise.
Actual future performance, outcomes and results may differ materially
from those expressed in forward-looking statements made by the Company and
its management as a result of a number of risks, uncertainties and
assumptions. Representative examples of these factors include (without
limitation) general industry and economic conditions; interest rate trends;
cost of capital and capital requirements; competition from other managed
care companies; the ability to expand certain areas of the Company's
business; shifts in customer demands; changes in operating expenses,
including employee wages, benefits and medical inflation; governmental and
public policy changes and the continued availability of financing in the
amounts and on the terms necessary to support the Company's future business.
In addition, if the Company does not continue to successfully implement new
contracts and programs and control healthcare benefit expenses; if the
Company is not able to successfully integrate CCN (defined below) and
achieve the cost synergies anticipated as a result of the acquisition; or if
the Company does not successfully integrate the recently acquired Mail
Handlers Benefit Plan administrative assets (discussed below); the Company
may not achieve its anticipated 2002 financial results.
Recent Developments
-------------------
Mail Handlers Benefit Plan
--------------------------
On April 16, 2002, the Company entered into a long-term contract with the
National Postal Mail Handlers Union, the sponsor of the Mail Handlers
Benefit Plan (the "Plan"), whereby the Company will provide its
comprehensive health plan services to the Plan. The Plan has nearly 400,000
federal employees and annuitants representing approximately one million
members nationwide, and is one of the nation's largest health plans. This
new contract builds on an existing agreement which the Company has to
provide the First Health NetworkR to the Plan's members. The new contract
is valued at over $1.3 billion in service revenue over the initial five-year
term.
On July 1, 2002, the Company completed the acquisition of the operational
and administrative assets used to provide the various services required by
this new contract (see Note 8) for a purchase price of $20 million. The
transaction includes the transfer of approximately 1,000 CNA employees and
related assets which support the Plan in various offices throughout the
United States. These employees will assume the same function for First
Health providing the Company with an experienced team of personnel already
accustomed to administering the one-million-member plan. The Company
believes this acquisition will significantly reduce the need for typical
implementation efforts related to the new contract.
CCN Acquisition
---------------
On August 16, 2001, the Company completed the acquisition of all of the
outstanding shares of capital stock of CCN Managed Care, Inc. ("CCN") and
Preferred Works, Inc. ("PW" and together with CCN, the "CCN Companies") from
HCA-The Healthcare Company and VH Holdings, Inc. (collectively, the
"Sellers") for a purchase price of $195 million in cash, plus a working
capital adjustment which increased the purchase price to $198 million. The
acquisition was effected pursuant to the terms of a Stock Purchase
Agreement, dated as of May 18, 2001 (as amended as of August 16, 2001),
among the Company and the Sellers. The acquisition was financed from
borrowings under the Company's previous line of credit. The Company
reviewed the various businesses comprising the CCN Companies and determined
to hold the PW and the Resource Opportunity, Inc. ("ROI") businesses of CCN
for sale. The Company completed the sale of ROI on December 28, 2001 for a
sale price of $9 million. The sale of PW was completed on June 28, 2002 for
a sale price of $4.1 million.
In conjunction with the acquisition, the Company recorded as part of the
purchase price a $41.1 million reserve for restructuring and integration
costs as part of an overall plan to reduce operating expenses and integrate
the business of the acquired companies. The specific actions included in
the restructuring plan are expected to be substantially complete by December
31, 2002. The actions taken to implement the restructuring plan are
expected to generate in excess of $25 million in annualized savings for the
Company from lower salaries and benefits costs and lower overall operating
expenses, beginning in 2002. Components of the purchase reserve are as
follows:
Accrual 2002 Accrual
(in thousands) Total Balance Amount Balance
-------------- Charges 1/01/02 Incurred 6/30/02
------- ------- -------- -------
Severance and related benefits $13,712 $ 6,031 $ (2,766) $ 3,265
Facilities integration 10,370 9,528 (693) 8,835
Contract losses 10,000 9,750 (267) 9,483
Other reserves 7,031 7,028 (21) 7,007
------- ------- -------- -------
Total $41,113 $32,337 $ (3,747) $28,590
======= ======= ======== =======
The restructuring plan includes the reduction of employees from various
offices within the United States. The Company expects to reduce the number
of CCN employees from approximately 1,300 at the time of the acquisition to
approximately 650 at December 31, 2002. There were approximately 680 such
employees as of June 30, 2002. During the first six months of 2002,
approximately $2.8 million was charged to the purchase reserve for severance
and related employee benefits with $1.6 million of such costs charged during
the second quarter.
Facilities integration costs represent the costs the Company expects to
incur to integrate CCN's facilities into the Company's existing operations.
The majority of the facilities integration costs will be incurred to
consolidate CCN's former corporate headquarters and various sales offices
throughout the United States. Approximately $0.7 million of costs for
facilities integration was charged to the purchase reserve in the first six
months of 2002 with $0.4 million charged during the second quarter.
Contract losses relate to the anticipated net loss to be incurred on an
assumed contract to provide certain screening services to individuals who
have agreed to be bound by a proposed settlement in a legal matter. CCN
signed a contract in March 2000 to provide these services for four years and
the Company has agreed to have its network providers provide these services
as a part of the acquisition of CCN. The Company estimates as many as
250,000 covered persons may seek such screening services and the Company
will incur a significant administrative burden in completing claims to the
satisfaction of the contractual terms. Approximately $0.3 million of costs
under this contract was charged to the purchase reserve during the six
months ended June 30, 2002 with $0.1 million charged during the second
quarter.
Other reserves represent various operational and tax liabilities the
Company has incurred to fully integrate the Company's operations.
Approximately $21,000 was charged to the reserve in the six months ended
June 30, 2002, none during the second quarter.
HCVM Acquisition
----------------
On May 1, 2002, the Company completed the acquisition of HealthCare Value
Management ("HCVM") for an initial purchase price of $24 million. The
Company may pay an additional $16 million over the next three years if HCVM
meets certain performance measures. HCVM is a small New England based PPO
company, headquartered in suburban Boston. The acquisition was financed
from borrowings under the Company's existing line of credit.
Results of Operations
---------------------
The Company's revenues consist primarily of fees for cost management
services provided under contracts on a percentage of savings basis (PPO) or
on a predetermined contractual basis (claims administration, fee schedule,
pharmacy benefit management and clinical management services). As a result
of the Company's insurance company acquisitions, revenues also include
premium revenue.
The following table sets forth information with respect to the sources of
the Company's revenues for the three and six months ended June 30, 2002 and
2001, respectively:
Sources of Revenue
($ in thousands)
Three Months Ended June 30,
---------------------------
2002 % 2001 %
------- --- ------- ---
Sources of Revenue:
PPO Services $110,078 63% $ 78,104 56%
Claims Administration 44,491 25 42,529 31
Fee Schedule Services 10,583 6 7,759 5
Clinical Management Services 6,961 4 6,824 5
Premiums, Net 3,810 2 3,733 3
------- --- ------- ---
Total Revenue $175,923 100% $138,949 100%
======= === ======= ===
($ in thousands)
Six Months Ended June 30,
---------------------------
2002 % 2001 %
------- --- ------- ---
Sources of Revenue:
PPO Services $214,999 62% $153,815 56%
Claims Administration 88,311 26 84,074 30
Fee Schedule Services 20,614 6 16,513 6
Clinical Management Services 13,540 4 13,911 5
Premiums, Net 7,820 2 7,620 3
------- --- ------- ---
Total Revenue $345,284 100% $275,933 100%
======= === ======= ===
Revenue for the three and six months ended June 30, 2002 increased
$36,974,000 (27%) and $69,351,000 (25%), respectively, from the same periods
of 2001 due to strong PPO revenue which increased 41% from the second
quarter of 2001. The increase in PPO revenue for the three and six months
ended June 30, was due to new client activity, existing clients utilizing
more PPO services, the overall increase in PPO providers and the addition of
CCN and HCVM revenue. Claims administration revenue increased $1,962,000
(5%) and $4,237,000 (5%) from the same periods last year due primarily to
new business particularly in the commercial sector. Revenue from fee
schedule services increased $2,824,000 (36%) and $4,101,000 (25%) from the
comparable periods in 2001 due primarily to the inclusion of CCN business.
Revenue from clinical cost management services increased $137,000 (2%) for
the three months ended June 30, 2002 and decreased $371,000 (3%) for the six
months ended June 30, 2002 from the comparable periods in 2001. The overall
decrease is due principally to the termination of certain healthcare
management contracts with various state Medicaid programs. Premium revenue
increased $77,000 (2%) and $200,000 (3%) for the three and six months ended
June 30, 2002 due primarily to the addition of new stop loss insurance
clients.
Cost of services increased $14,639,000 (24%) and $27,874,000 (23%) for
the three and six months ended June 30, 2002 from the comparable periods of
2001 due primarily to the inclusion of CCN and HCVM costs. Cost of services
consists primarily of salaries and related costs for personnel involved in
claims administration, PPO administration, development and expansion,
utilization management programs, fee schedule and other cost management and
administrative services offered by the Company. To a lesser extent, cost of
services includes telephone expenses, facility expenses and information
processing costs. As a percentage of revenue, cost of services decreased to
42.7% and 42.9% for the three and six months ended June 30, 2002,
respectively, from 43.5% and 43.6% in the comparable periods last year.
More importantly, cost of services remained consistent with the fourth
quarter of 2001 due to the synergies associated with combining various CCN
and First Health operations.
Selling and marketing costs for the three and six months ended June 30,
2002 increased $4,522,000 (34%) and $8,656,000 (33%) from the comparable
periods of 2001 also as a result of the addition of CCN costs. To a lesser
extent, the increase is due to increased expenditures for the Company's
focused national marketing campaign which began in the first quarter of 2000
and to the addition of new sales personnel.
General and administrative costs for the three and six months ended June
30, 2002 increased $3,334,000 (39%) and $6,357,000 (37%) from the comparable
periods of 2001 due primarily to the inclusion of CCN costs. These expenses
remain consistent with the fourth quarter of 2001 as a result of synergies
achieved by combining CCN and First Health operations.
Healthcare benefits represent medical losses incurred by insureds of the
Company's insurance entities. Healthcare benefits increased $507,000 (15%)
and $585,000 (8%) for the three and six months ended June 30, 2002 from the
comparable periods of 2001. This increase was due primarily to new client
activity. The loss ratio (healthcare benefits as a percent of premiums) was
102% and 98% for the three and six months ended June 30, 2002 compared to
91% and 93% for the comparable periods of 2001. Management continues to
review the book of business in detail to minimize the loss ratio. Stop-loss
insurance is related to the PPO business and is used as a way to attract
additional PPO business, which is the Company's most profitable product.
Depreciation and amortization expenses increased $2,071,000 (18%) and
$4,441,000 (20%) for the three and six months ended June 30, 2002 from the
comparable periods of 2001 due primarily to increased infrastructure
investments made over the course of the past few years as well as various
software applications which came on-line during 2001 and 2002. The increase
was partially offset by the reduction in goodwill amortization of $867,000
and $1,734,000 for the three and six months ended June 30, 2002 (See Note
7). Depreciation expense will continue to grow primarily as a result of
continuing investments the Company is making in its infrastructure.
Interest income for the three and six months ended June 30, 2002
decreased $170,000 (10%) and $393,000 (11%), respectively, from the
comparable periods of 2001 due primarily to the aggressive debt repayments
the Company has made with its available cash as well as the overall
reduction in interest rates earned on marketable securities.
Interest expense for the three and six months ended June 30, 2002,
increased $384,000 (34%) and decreased $771,000 (21%) from the comparable
periods of 2001. The fluctuations in interest expense are primarily due to
changes in the interest rate on the Company's credit facility. The interest
rate at June 30, 2002 was approximately 5% per annum and the Company had
$130 million of debt outstanding.
Net income for the three and six months ended June 30, 2002, increased
$7,155,000 (28%) and $13,769,000 (28%) from the comparable periods of 2001.
This increase is due primarily to the increase in PPO revenue as well as the
synergies achieved in combining CCN and First Health and, to a lesser
extent, the other factors discussed above.
Diluted net income per common share for the three and six months ended
June 30, 2002 increased 24% to $.31 per share and 24% to .61 per share from
the comparable periods of 2001. The increase in net income per common share
was favorably impacted by the repurchase of 525,000 shares of Company common
stock during the second quarter of 2002. The increase was also favorably
impacted by the adoption of SFAS No. 142 (See Note 7 and "New Accounting
Pronouncements"). For the three months and six months ended June 30, 2002,
diluted common shares outstanding increased 2% from the comparable periods
of 2001.
Liquidity and Capital Resources
-------------------------------
The Company had $17,320,000 in working capital at June 30, 2002 compared
with negative working capital of $159,130,000 at December 31, 2001. All of
the Company's outstanding debt at December 31, 2001 was classified as a
current liability as the Company's credit facility was due to expire on June
30, 2002. On April 23, 2002, management obtained a new credit facility
which matures in 2007; consequently, the outstanding debt is now classified
as long-term. Through the first six months of the year, operating
activities provided $131,788,000 of cash. Investment activities used
$53,564,000 of cash representing purchases of fixed assets of $27,001,000,
the acquisition of HCVM for $24,227,000 and net purchases of investments of
$3,259,000 partially offset by $923,000 in changes in assets held for sale.
Financing activities used $60,414,000 of cash representing $67,500,000 in
repayment of long-term debt (net of $150,000,000 in debt issuance),
$14,813,000 in purchases of Company common stock partially offset by
$21,436,000 in proceeds from issuance of common stock, $375,000 in proceeds
from the sale of put options and $88,000 in stock option loan repayments
(net of $2,272,000 in stock option loans granted).
The Company had a revolving line of credit in the amount of $350 million
which was due to expire on June 30, 2002. On April 23, 2002, the Company
obtained a new $400 million revolving line of credit that replaced the
previous credit facility. The new facility has a five-year term and
provides for interest at a Euro dollar rate (which approximates LIBOR) plus
a variable margin and a facility fee that fluctuate based on the Company's
debt rating. As of June 30, 2002, $130 million was outstanding under the new
facility.
The Company believes that its working capital, long-term investments,
credit facility and cash generated from future operations will be sufficient
to fund the Company's anticipated operations and expansion plans.
New Accounting Pronouncements
-----------------------------
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards No. 133, ("SFAS No. 133), "Accounting For Derivative
Instruments and Hedging Activities". SFAS No. 133 requires that all
derivative instruments be recognized as either assets or liabilities in the
balance sheet and that derivative instruments be measured at fair value.
This statement also requires changes in the fair value of derivatives to be
recorded each period in current earnings or comprehensive income depending
on the intended use of the derivative. There was no material effect on the
Company's results of operations or financial position as a result of the
adoption of SFAS No. 133.
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations." SFAS 141 requires the purchase method of accounting for
business combinations initiated after June 30, 2001 and eliminates the
pooling-of-interests method. In July 2001, the FASB issued Statement of
Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other
Intangible Assets", which the Company adopted effective January 1, 2002.
SFAS 142 requires, among other things, the discontinuance of goodwill
amortization effective December 31, 2001. In addition, the standard
includes provisions for the reassessment of the useful lives of existing
recognized intangibles and the identification of reporting units for
purposes of assessing potential future impairments of goodwill.
In accordance with these pronouncements, the Company accounted for the
acquisition of CCN as a purchase and allocated the purchase price to all
identifiable tangible and intangible assets and liabilities. The goodwill
resulting from this acquisition of approximately $177 million has not been
amortized. Goodwill and intangible assets of approximately $102 million
acquired in business combinations completed before July 1, 2001 was
amortized through December 31, 2001. In accordance with SFAS 142, none of
the Company's $280 million in net goodwill was amortized during the six
months ended June 30, 2002. The Company recorded goodwill amortization
expense of approximately $0.9 million and $1.7 million, respectively, during
the three and six months ended June 30, 2001.
In accordance with the provisions of SFAS 142, the Company completed a
transitional goodwill impairment test within six months of the date of
adoption. The Company used standard valuation techniques including an
analysis of expected business performance and analysis of recent
acquisitions within the healthcare industry. There was no impairment in
goodwill amounts as a result of this transitional impairment test. The
Company will perform an annual impairment during the third quarter of each
year or at such earlier time that circumstances warrant an interim
valuation.
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS 144 addresses accounting and reporting
for the impairment or disposal of long-lived assets, including discontinued
operations, and establishes a single accounting model for long-lived assets
to be disposed of by sale. The adoption of this pronouncement did not have
a material impact on the financial position and results of operations of the
Company.
Legal Proceedings
-----------------
The Company and its subsidiaries are subject to various claims arising in
the ordinary course of business and are parties to various legal proceedings
that constitute litigation incidental to the business of the Company and its
subsidiaries. The Company's wholly owned subsidiary, First Health Services
Corporation ("Services") continues to be subject to an investigation by the
District of Columbia Office of Inspector General (OIG"). In July 2000, the
OIG issued a report evaluating the District of Columbia's Medicaid program
and suggesting ways to improve the program. Services, a subsidiary of the
Company that was acquired in July 1997, has acted as the program's fiscal
agent intermediary for more than 20 years. The OIG report included
allegations that from 1993 to 1996, Services, in it role as fiscal agent
intermediary, made erroneous Medicaid payments to providers on behalf of
patients no longer eligible to receive Medicaid benefits. The Company does
not believe that the outcome of the claim or the investigation will have a
material adverse effect on the Company's business or financial position.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company's market risk exposure at June 30, 2002 is consistent with
the types of market risk and amount of exposure presented in its 2001 Annual
Report on Form 10-K.
PART II
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company on May 15, 2002, all
directors of the Company who stood for reelection were re-elected. The
number of votes cast for and withheld for each director were as follows:
For Withheld
---------- ---------
Michael J. Boskin 91,441,076 2,366,606
Daniel S. Brunner 91,936,325 1,871,357
Raul Cesan 92,482,680 1,325,002
Robert S. Colman 92,487,930 1,319,752
Ronald H. Galowich 91,015,254 2,792,428
Harold S. Handelsman 91,320,918 2,486,764
Don Logan 92,485,151 1,322,531
William Mayer 92,488,240 1,319,442
David E. Simon 87,519,392 6,288,290
James C. Smith 77,072,545 16,735,137
Edward L. Wristen 91,932,667 1,875,015
A proposal to approve an amendment to the Company's restated certificate of
incorporation to increase the number of authorized shares of common stock
from 155,000,000 shares to 400,000,000 shares was approved with 81,817,429
shares cast for, 11,180,033 shares against and 810,220 shares abstaining.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
(a) Exhibit 11 - Computation of Basic Earnings Per Common Share
(b) Exhibit 11 - Computation of Diluted Earnings Per Common Share
(c) Exhibit 99.1 - Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 - Edward L.
Wristen
(d) Exhibit 99.2 - Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 - Joseph E.
Whitters
Reports on Form 8-K:
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
First Health Group Corp.
Dated: August 13, 2002 /s/Edward L. Wristen
------------------------------------
Edward L. Wristen
President and Chief Executive Officer
Dated: August 13, 2002 /s/Joseph E. Whitters
------------------------------------
Joseph E. Whitters
Vice President, Finance and Chief
Financial Officer (Principal
Financial Officer)