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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 March 31, 2003
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.
(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
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(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 April 28, 2003, was 95,358,143.
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information
Page Number
-----------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - Assets at March 31, 2003
and December 31, 2002 .................................. 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at March 31, 2003 and December 31, 2002.......... 4
Consolidated Statements of Operations for the three months
ended March 31, 2003 and 2002 .......................... 5
Consolidated Statements of Comprehensive Income for the
three months ended March 31, 2003 and 2002 ............. 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 2003 and 2002 .......................... 6-7
Notes to Consolidated Financial Statements ............... 8-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............ 13-19
Item 3. Quantitative and Qualitative Disclosures About
Market Risk .................................... 20
Item 4. Controls and Procedures .......................... 20
Part II. Other Information
Item 1. Legal Procedures ................................. 21
Item 6. Exhibits and Reports on Form 8-K ................. 21
Signatures...................................................... 22
PART I. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
-----------------------------------------------------------------------------
March 31, December 31,
ASSETS 2003 2002
--------- ---------
Current Assets:
Cash and cash equivalents ..................... $ 23,207 $ 20,852
Short-term investments ........................ 5,420 1,304
Accounts receivable, less allowances for
doubtful accounts of $14,696 and
$14,782 respectively........................ 83,971 69,981
Deferred income taxes ......................... 35,240 35,255
Other current assets .......................... 17,463 16,183
--------- ---------
Total current assets .......................... 165,301 143,575
Long-Term Investments:
Marketable securities ......................... 64,279 67,880
Other ......................................... 62,543 62,676
--------- ---------
126,822 130,556
--------- ---------
Property and Equipment:
Land, buildings and improvements .............. 98,270 97,826
Computer equipment and software ............... 235,632 222,796
Office furniture and equipment ................ 34,943 34,518
--------- ---------
368,845 355,140
Less accumulated depreciation and
amortization................................ (163,721) (149,637)
--------- ---------
Net property and equipment .................... 205,124 205,503
--------- ---------
Goodwill......................................... 282,781 279,447
Intangible assets, less accumulated amortization
of $5,591 and $4,541, respectively ............ 53,036 54,086
Reinsurance recoverable.......................... 25,404 26,185
Other Assets..................................... 3,894 4,009
--------- ---------
$ 862,362 $ 843,361
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
-----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
2003 2002
--------- ---------
Current Liabilities:
Accounts payable .............................. $ 52,401 $ 50,841
Accrued expenses .............................. 49,021 53,535
Claims reserves ............................... 13,141 14,235
Income taxes payable .......................... 30,198 23,765
--------- ---------
Total current liabilities ..................... 144,761 142,376
Long-Term Debt................................... 185,000 120,000
Claims Reserves - Non-Current.................... 25,404 26,185
Deferred Taxes................................... 114,608 114,692
Other Non-Current Liabilities.................... 26,322 25,962
--------- ---------
Total liabilities ............................. 496,095 429,215
Commitments and Contingencies.................... -- --
Stockholders' Equity:
Common stock .................................. 1,353 1,344
Additional paid-in capital .................... 318,137 304,663
Retained earnings ............................. 556,088 519,247
Stock option loan receivable .................. (55) (287)
Accumulated other comprehensive income ........ 601 764
Treasury stock, at cost ....................... (509,857) (411,585)
--------- ---------
Total stockholders' equity .................... 366,267 414,146
--------- ---------
$ 862,362 $ 843,361
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2003 2002
--------- ---------
Revenues......................................... $ 213,753 $ 169,361
--------- ---------
Operating expenses:
Cost of services .............................. 96,177 72,972
Selling and marketing ......................... 21,036 17,078
General and administrative .................... 15,207 11,393
Healthcare benefits ........................... 5,162 3,781
Depreciation and amortization ................. 15,126 12,972
--------- ---------
152,708 118,196
--------- ---------
Income from operations........................... 61,045 51,165
Other (income) expense:
Interest expense .............................. 1,267 1,316
Interest income ............................... (1,368) (1,628)
--------- ---------
Income before income taxes....................... 61,146 51,477
Income taxes..................................... (24,305) (20,463)
--------- ---------
Net income....................................... $ 36,841 $ 31,014
========= =========
Weighted average shares outstanding - basic 96,866 100,257
========= =========
Net income per common share - basic.............. $ .38 $ .31
========= =========
Weighted average shares outstanding - diluted.... 99,456 104,443
========= =========
Net income per common share - diluted............ $ .37 $ .30
========= =========
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands, except per share amounts) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2003 2002
--------- ---------
Net income....................................... $ 36,841 $ 31,014
--------- ---------
Unrealized losses on securities, before tax (246) (533)
Income tax benefit related to items of other
comprehensive income........................... 83 183
--------- ---------
Other comprehensive loss......................... (163) (350)
--------- ---------
Comprehensive income............................. $ 36,678 $ 30,664
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except per share amounts) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2003 2002
--------- ---------
Cash flows from operating activities:
Net Income .................................... $ 36,841 $ 31,014
--------- ---------
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and amortization ............... 15,126 12,972
Change in allowance for uncollectible
receivables................................ (86) 1,491
Provision for deferred income taxes ......... 14 (34)
Tax benefits from stock options exercised ... 3,278 2,237
Other, net .................................. (587) 429
Changes in Assets and Liabilities
(net of effects of acquired businesses):
Accounts receivable ......................... (13,904) (2,954)
Other current assets ........................ (1,280) 7,466
Reinsurance recoverable ..................... 781 897
Accounts payable and accrued expenses........ (2,954) 486
Claims reserves ............................. (1,875) (1,071)
Income taxes payable ........................ 6,433 9,321
Non-current assets and liabilities .......... 475 539
--------- ---------
Net cash provided by operating activities 42,262 62,793
--------- ---------
Cash flows from investing activities:
Purchases of investments ...................... (12,142) (15,435)
Sales of investments .......................... 12,145 15,928
Acquisition of business, net of cash acquired.. (3,334) --
Assets held for sale .......................... -- (1,606)
Purchase of property and equipment ............ (13,705) (7,317)
--------- ---------
Net cash used in investing activities.......... (17,036) (8,430)
--------- ---------
Cash flows from financing activities:
Purchase of treasury stock .................... (97,772) --
Proceeds from issuance of long-term debt....... 95,000 --
Repayment of long-term debt ................... (30,000) (57,500)
Proceeds from issuance of common stock......... 9,669 6,277
Stock option loan repayments .................. 232 --
--------- ---------
Net cash used in financing activities ......... (22,871) (51,223)
--------- ---------
Net increase in cash and cash equivalents........ 2,355 3,140
Cash and cash equivalents, beginning of period .. 20,852 14,001
--------- ---------
Cash and cash equivalents, end of period......... $ 23,207 $ 17,141
========= =========
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except per share amounts) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2003 2002
--------- ---------
Supplemental cash flow data:
Stock options exercised in exchange
for common stock............................... $ 500 $ --
Health care benefits paid........................ (6,217) (4,275)
Interest paid.................................... (1,050) (1,152)
Interest income received......................... 600 603
Income taxes paid, net........................... (14,592) (87)
Acquisition of businesses:
Goodwill ...................................... $ 3,334 $ --
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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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, 2002.
Accordingly, footnote disclosures which would substantially duplicate
the disclosures contained in the December 31, 2002 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. In our opinion, the
accompanying unaudited consolidated financial statements contain all
adjustments necessary for a fair presentation. 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. In conjunction with the acquisition of CCN Managed Care, Inc. ("CCN")
the Company recorded as part of the purchase price reserves 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 were
substantially complete by December 31, 2002. Components of the purchase
reserve are as follows:
Accrual
(in thousands) Total Balance Amount Balance
-------------- Charges 12/31/02 Paid 3/31/03
------ ------ ----- ------
Severance and related $13,712 $ 1,536 $ (478) $ 1,058
Facilities integration 10,370 1,117 (217) 900
Contract losses 10,000 296 193 489
Other reserves 7,031 1,031 - 1,031
------ ------ ----- ------
$41,113 $ 3,980 $ (502) $ 3,478
====== ====== ===== ======
The restructuring plan included the reduction of employees from various
offices with $0.5 million being charged to the purchase reserve during
the quarter ended March 31, 2003. The severance and related benefits
accrued at March 31, 2003 represent costs for payments over the next
nine months for headcount reductions already incurred.
The majority of the facilities integration costs have been incurred to
consolidate CCN's offices with $0.2 million being charged to the
purchase reserve during the quarter ended March 31, 2003. The majority
of the remaining facilities integration costs are expected to be
incurred during 2003.
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
with $0.2 million being reimbursed during the quarter ended March 31,
2003.
Other reserves represent various operational liabilities the Company
has incurred to fully integrate the Company's operations. No other
reserves were charged to the purchase reserve during the quarter ended
March 31, 2003.
On May 1, 2002, the Company completed the acquisition of HealthCare
Value Management ("HCVM") for an initial purchase price of $24 million.
The Company paid an additional $6.4 million in March of 2003 based upon
certain financial performance measures that HCVM has met.
Purchase price has been allocated as follows
(in thousands):
Fair value of tangible assets acquired $ 654
Goodwill 24,618
Intangible assets acquired 5,658
Liabilities assumed (239)
Liability for restructuring and integration costs (250)
-------
$ 30,441
=======
On July 1, 2002, the Company acquired the stock of Claims Administration
Corporation ("CAC"), a subsidiary of Continental Casualty Company, for a
purchase price of $18 million.
Purchase price has been allocated as follows
(in thousands):
Fair value of tangible assets acquired $ 9,111
Goodwill 6,758
Intangible assets 9,155
Liabilities assumed (5,024)
Liability for restructuring and integration costs (2,000)
-------
$ 18,000
=======
3. Acquired Intangible Assets
As of March 31, 2003
Gross
Carrying Accumulated
(in thousands) Amount Amortization
-------------- ------ ------------
Amortized intangible assets
Customer contracts and relationships $48,700 $ 5,066
Provider Contracts 9,927 525
------ ------
Total $58,627 $ 5,591
====== ======
Customer contracts and relationships represent value added to the
Company's business for existing long-term contracts and long-term
business relationships. Provider contracts represent additions to the
First Health[R] Network that the Company has acquired. The aggregate
amortization expense recorded during the three months ended March 31,
2003 was $1,050,000. The estimated amortization expense for each of the
years ending December 31, 2003 through 2007 is $7,056,000.
The changes in the carrying amount of goodwill for the three months
ended March 31, 2003 are as follows:
(in thousands) Amount
-------------- -------
Balance, January 1, 2003 $279,447
Goodwill acquired --
Other changes 3,334
-------
Balance, March 31, 2003 $282,781
=======
The other goodwill adjustments represent the final amounts paid related
to the HCVM acquisition.
4. Accounts receivable reserves for client-specific items were $40.9
million and $41.2 million as of March 31, 2003 and December 31, 2002,
respectively. Client-specific reserves, for matters such as ineligible
members and contractual terms, are netted against the gross accounts
receivable balance in the Consolidated Balance Sheets. Allowance for
doubtful accounts reserves were $14.7 million and $14.8 million as of
March 31, 2003 and December 31, 2002, respectively. Client-specific
reserves and the allowance for doubtful accounts are established based
on historical experience, current economic circumstances and
contractual arrangements and are adjusted monthly based upon updated
information.
5. The Company's investments in marketable securities, which are
classified as available for sale, had a net unrealized loss in market
value of $163,000, net of deferred income taxes, for the three month
period ended March 31, 2003. The net unrealized gain as of March 31,
2003, included as a component of stockholders' equity, was $601,000,
net of deferred income taxes. The Company has seven separate
investments in a limited liability company that invests in equipment
that is leased to third parties. The total investment as of March 31,
2003 and December 31, 2002 was $54.6 million and $54.0 million,
respectively, and is accounted for using the equity method. The
Company's proportionate share of the partnership's income was $0.8
million for both the three months ended March 31, 2003 and 2002, and is
included in interest income. Approximately 90% of this partnership is
owned by parties related to a former member of the Company's Board of
Directors.
6. The Company's Board of Directors approved the repurchase of up to 15
million shares of the Company's outstanding common stock under a prior
authorization. In 2002, the Board approved a new authorization to
repurchase up to an additional 10 million shares of common stock.
Purchases may be made from time to time, depending on market conditions
and other relevant factors. During the quarter ended March 31, 2003,
the Company repurchased 4,196,000 shares on the open market for
approximately $97.8 million. The Company did not repurchase any shares
during the quarter ended March 31, 2002. As of March 31, 2003,
approximately 6.5 million shares remain available for repurchase under
the Company's current repurchase authorization.
7. Weighted average shares outstanding increased for diluted earnings per
share by 2,590,000 and 4,186,000 for the three months ended March 31,
2003 and 2002, respectively, due to the effect of stock options
outstanding. Diluted net income per share was $.01 less than basic net
income per share for both the three months ended March 31, 2003 and
2002, due to the effect of stock options outstanding.
8. At March 31, 2003, the Company has various stock-based employee
compensation plans that are described more fully in Note 10 to the
Consolidated Financial Statements (in the 2002 Annual Report on Form
10-K). The Company accounts for these plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock
Issued to Employees" and related Interpretations. No stock-based
employee compensation cost is reflected in net income (other than
compensation cost for consultants), as all options granted under these
plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the
effect on net income and earnings per share if the Company had applied
the fair value recognition provisions of FASB Statement No. 123,
"Accounting for Stock-Based Compensation," to all outstanding and
unvested awards in each period (in thousands except EPS):
Three Months Ended March 31,
----------------------------
2003 2002
------ ------
Net Income, as reported $36,841 $31,014
Add: Stock-based employee compensation expense
included in reported net income, net of
related tax effects. 36 --
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (2,481) (2,814)
------ ------
Pro forma net income $34,396 $28,200
====== ======
Earnings per share:
Basic, as reported $ .38 $ .31
Basic, pro forma $ .36 $ .28
Diluted, as reported $ .37 $ .30
Diluted, pro forma $ .35 $ .27
9. Effective January 1, 2003, the Company adopted SFAS No. 146 ("SFAS
146"), "Accounting for Costs Associated with Exit or Disposal
Activities", which requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at
the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain
employee severance costs that are associated with a restructuring,
discontinued operation, or other exit or disposal activity. The
adoption of SFAS 146 had no impact on the Company's financial position,
results of operations or cash flows.
Effective January 1, 2003, the Company adopted Interpretation No. 45,
("FIN 45") "Guarantees, Including Indirect Guarantees of Indebtedness
to Others", which expands previously issued accounting guidance and
disclosure requirements for certain guarantees. FIN 45 requires the
Company to recognize an initial liability for fair value of an
obligation assumed by issuing a guarantee. The adoption of FIN 45 had
no impact on the Company's financial position, results of operations or
cash flows.
10. 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. On April 23, 2003, the Company settled
an investigation by the District of Columbia Office of Inspector
General ("OIG") involving the Company's wholly owned subsidiary, First
Health Services Corporation ("Services"). 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 contributed $5.5 million to a $13 million
settlement and release of all future claims. The $5.5 million was fully
reserved at the time of the acquisition of Services. The remaining $7.5
million of the settlement was contributed by the former owner of
Services. The Company and Services have denied all liability for the
claims.
The Company's largest client (Mail Handlers Benefit Plan) generated
revenue of approximately $160 million in 2002 or 21% of total revenues.
This amount is net of a reserve established by the Company for various
issues associated with the potential disallowance of certain expenses
charged to the Plan. In addition, the provisions of the contract with
the Plan's sponsor, the National Postal Mail Handlers Union, require
that the Company fund any deficits in the Plan after the Plan's
reserves have been fully utilized. As of March 31, 2003, the Plan has
approximately $350 million in reserves to cover Plan expenses that may
exceed the premiums charged and collected from the Plan participants by
the Plan sponsor. Management believes that these reserves are adequate
to cover any Plan deficits as of March 31, 2003. There are no known
Plan deficits as of March 31, 2003.
FIN 45 requires the Company to disclose certain guarantees, including
contractual indemnifications, it has assumed. The Company generally
declines to provide indemnification to its customers. In limited
circumstances, to secure long-term customer contracts at favorable
rates, the Company may negotiate risk allocation through mutual
indemnification provisions that, in the Company's judgment,
appropriately allocate risk relative to the value of the customer.
Management believes that any liability under these indemnification
provisions would not be material.
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; customer contract cancellations; 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, or if the Company does not successfully
integrate the recently acquired Mail Handlers Benefit Plan administrative
assets (discussed below), then the Company may not achieve its anticipated
2003 financial results.
Significant Developments
------------------------
Overview
--------
The following information concerning significant business developments is
important to understanding the comparability of the 2003 and 2002 financial
results.
Mail Handlers Benefit Plan
--------------------------
The Company assumed the responsibility for supporting the Mail Handlers
Benefit Plan (the "Plan"), including claims administration for the Plan,
effective July 1, 2002. The comparable results for the quarter ended March
31, 2002 included only the prior PPO business of the Plan. The Plan is the
Company's largest customer with revenues earned of approximately $52
million, or 24% of total Company revenue, during the quarter ended March 31,
2003.
CCN Purchase Reserve
--------------------
The Company charged approximately $0.5 million against the CCN purchase
reserve during the quarter ended March 31, 2003. The majority of these
charges were for severance and related benefits. The purchase reserve
balance was $3.5 million as of March 31, 2003.
Results of Operations
---------------------
The Company's revenues consist primarily of fees for cost management
services provided under contracts on a percentage-of-savings basis or on a
predetermined contractual basis. As a result of the Company's insurance
company acquisitions, revenues also include premium revenue.
The Company is now reporting revenue in a new format, divided between
Commercial business and Public Sector business. The Commercial business is
segregated between Group Health revenue and Workers' Compensation revenue.
Group Health revenue is further segregated between PPO services, PPO plus
Administration Services and Premium revenue. Workers' Compensation revenue
is segregated between PPO services and PPO plus Administration Services.
Management believes this revenue format better reflects how customers
purchase and how the Company sells its services.
The following table sets forth information with respect to the sources
of the Company's revenues for the three months ended March 31, 2003 and
2002, respectively:
Sources of Revenue
($ in thousands)
Three Months Ended March 31,
------------------------------
2003 % 2002 %
------- ---- ------- ----
Commercial Revenue:
Group Health:
PPO $ 40,859 19% $ 62,859 37%
PPO plus Administration
Services 88,941 42 33,992 20
Premiums 4,235 2 4,010 2
------- ---- ------- ----
Total Group Health 134,035 63 100,861 60
------- ---- ------- ----
Workers' Compensation:
PPO 15,152 7 13,117 8
PPO plus Administration
Services 24,985 12 26,083 15
------- ---- ------- ----
Total Workers' Compensation 40,137 19 39,200 23
------- ---- ------- ----
Total Commercial Revenue 174,172 82 140,061 83
------- ---- ------- ----
Public Sector Revenue 39,581 18 29,300 17
------- ---- ------- ----
Total Revenue $213,753 100% $169,361 100%
======= ==== ======= ====
Total revenue for the three months ended March 31, 2003 of nearly $214
million increased $44.4 million (26%) from the first quarter of 2002. The
components of the Company's quarterly revenue are as follows:
Group Health revenue of $134.0 million for the three months ended March
31, 2003 increased $33.2 million (33%) from the comparable period of 2002.
Group Health revenue represents revenue from the corporate, FEHBP, small
group carrier and third party administrator payors. Group Health PPO
services for the three months ended March 31, 2003 decreased $22.0 million
(35%) from the comparable period of 2002 as clients, especially Mail
Handlers, are taking advantage of a full array of the Company's services. As
these clients purchase additional services, the revenue is then reported
under the PPO plus Administration Services caption. PPO plus Administration
Services revenue for the three months ended March 31, 2003 increased $54.9
million (162%) due to numerous new clients that have been added this year,
existing clients utilizing more services and the addition of new medical
providers to our PPO network. Premium revenue for the three months ended
March 31, 2003 increased $0.2 million (6%) from the comparable period of
2002 as a result of new and existing clients that were sold stop-loss
insurance contracts.
Workers' Compensation revenue of $40.1 million for the three months
ended March 31, 2003 increased $0.9 million (2%) from the comparable period
of 2002. Although this business has grown, the growth has been limited due
to some historic workers' compensation clients that have exited various
markets.
Public Sector revenue of $39.6 million for the three months ended March
31, 2003 increased $10.3 million (35%) from the same period of 2002. This
increase is due primarily to new clients, such as the State of Nevada, and
increased activities, especially in pharmacy benefit administration, for
various state Medicaid and entitlement programs.
Cost of services increased $23.2 million (32%) for the three months ended
March 31, 2003 from the comparable period in 2002 due primarily to the
inclusion of costs associated with the administration of the Plan. 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
increased to 45% for the three months ended March 31, 2003, respectively,
from 43% in the comparable period last year. The increase as a percentage of
revenue is due primarily to the addition of costs associated with the
administration of the Plan.
Selling and marketing costs for the three months ended March 31, 2003
increased $4.0 million (23%) from the comparable period in 2002 primarily as
a result of the addition of costs associated with the administration of the
Plan. To a lesser extent, the increase in selling and marketing costs is due
to the addition of new sales personnel.
General and administrative costs for the three months ended March 31,
2003 increased $3.8 million (33%) from the comparable period in 2002 due
primarily to the inclusion of costs associated with the administration of
the Plan.
Healthcare benefits represent medical losses incurred by insureds of the
Company's insurance entities. Healthcare benefits increased $1.4 million
(37%) for the three months ended March 31, 2003 from the comparable period
of 2002. This increase was due primarily to new client activity and
unusually high medical claims in the period. The loss ratio (healthcare
benefits as a percent of premium revenue) was 122% for the three months
ended March 31, 2003 compared to 94% for the comparable period of 2002.
Management continues to review the book of business in detail to minimize
the loss ratio. Stop-loss insurance is related to the PPO and claims
administration businesses and is used as a way to attract additional PPO
business, which is the Company's most profitable product.
Depreciation and amortization expenses increased $2.2 million (17%) for
the three months ended March 31, 2003 from the comparable period in 2002 due
primarily to increased infrastructure investments made over the course of
the past few years, and, to a lesser extent, amortization of intangible
assets related to the various acquisitions the Company has made.
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 months ended March 31, 2003 decreased $0.3
million (16%) from the comparable period of 2002. Interest income has
remained fairly constant, as the Company has used much of its available cash
to repay debt and repurchase its common stock.
Interest expense for the three months ended March 31, 2003 decreased $0.1
million (4%) from the comparable period in 2002. Interest expense has
remained fairly constant as the average debt outstanding has remained fairly
constant between the comparable periods. The effective interest rate on
March 31, 2003 was approximately 3% per annum and the Company had $185
million of debt outstanding.
Net income for the three months ended March 31, 2003 increased $5.8
million (19%) from the comparable period of 2002. This increase is due
primarily to the increase in 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 months ended March 31,
2003 increased 23% to $.37 per share from the comparable period of 2002. The
increase in net income per common share was favorably impacted by the
repurchase of 4.2 million shares of Company common stock during the three
months ended March 31, 2003. For the three months ended March 31, 2003,
diluted common shares outstanding decreased 5% from the comparable period of
2002.
Liquidity and Capital Resources
-------------------------------
The Company had $20.5 million in working capital on March 31, 2003
compared with working capital of $1.2 million at December 31, 2002. Through
the first three months of the year, operating activities provided $42.3
million of cash. Investment activities used $17.0 million of cash
representing purchases of fixed assets of $13.7 million and acquisition
payments of $3.3 million (related to the HCVM acquisition). Financing
activities used $22.9 million of cash representing $97.8 million in
purchases of Company common stock partially offset by $9.7 million in
proceeds from issuance of common stock (representing 0.8 million shares),
$65.0 million in proceeds from debt issuance (net of $30.0 million in debt
repayment) and $0.2 million in stock option loan repayments.
The Company's outstanding debt at March 31, 2003 increased to $185
million from $120 million at December 31, 2002 as the Company borrowed funds
against its credit facility to finance repurchases of its common stock. The
Company has no off-balance sheet financing arrangements or material long-
term purchase obligations.
The following table summarizes the contractual obligations the Company has
outstanding as of March 31, 2003:
(in thousands)
---------------------------------------------------------------------
Years Ending Revolving Line
December 31, Leases of Credit Total
---------------------------------------------------------------------
2003 $ 9,692 $ -- $ 9,692
2004 10,344 -- 10,344
2005 8,242 -- 8,242
2006 4,957 -- 4,957
2007 3,848 185,000 188,848
Thereafter 7,282 -- 7,282
---------------------------------------------------------------------
Total $ 44,365 $185,000 $ 229,365
---------------------------------------------------------------------
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.
Critical Accounting Policies
----------------------------
The consolidated financial statements are prepared with accounting
principles generally accepted in the United States of America and include
amounts based on management's prudent judgments and estimates. To the extent
that the estimates used differ from actual results, adjustments to the
statement of operations and the balance sheet would be necessary. Some of
the more significant estimates include the recognition of revenue, allowance
for doubtful accounts and insurance claim reserves. The Company uses the
following techniques to determine estimates:
Revenue recognition - The Company receives revenues for PPO services,
claims administration services, fee schedule services, clinical cost
management and other services on a predetermined contractual basis (such as
a percentage of the derived savings). Revenues on a percentage of savings
basis for PPO services are recognized based upon client claims processed.
Additionally, the Company records revenues based upon a fixed fee per
covered participant, and the fee varies depending upon the programs selected
or on a per-transaction basis. Within the Company's public sector business,
the Company has certain contracts to develop software for Medicaid claims
adjudication. The Company's policy is to recognize revenue for services
under these contracts as milestones are met and customer acknowledgment of
such achievement of milestones is received.
PPO revenue and, to a lesser extent, claims administration revenue are
recognized net of estimated fees associated with claims that a client is not
responsible for reimbursing (such as claims from ineligible members, non-
insured services and other insurance being the primary payor). In a limited
number of cases, client contracts include performance guarantees.
Adjustments to revenue related to guarantee amounts are recognized as known
and/or earned. In other cases, estimates are made of the annual savings
rates and revenues are recognized in accordance with these estimates.
Periodically, specific client-related accounts receivable issues may impact
revenue recognition including issues where a client disputes specific items
from the current year's monthly billings.
Allowance for doubtful accounts - The allowance for doubtful accounts
is maintained at an amount management considers appropriate in relation to
the outstanding receivable balance based on factors such as portfolio credit
risk quality, historical loss experience and current economic circumstances.
These factors require management judgment; different assumptions or changes
in economic circumstances could result in changes to the allowance for
doubtful accounts.
Insurance claim reserves - Claims reserves are developed based on
medical claims payment history adjusted for specific benefit plan elements
(such as deductibles) and expected savings generated by utilization of The
First Health[R] Network. Based upon this process, management believes that
the insurance claims reserves are appropriate; however, actual claims
incurred and actual settlement values of claims may differ from the original
estimates requiring adjustments to the reserves.
New Accounting Pronouncements
-----------------------------
Effective January 1, 2003, the Company adopted SFAS No. 146 ("SFAS
146"), "Accounting for Costs Associated with Exit or Disposal Activities",
which requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to
an exit or disposal plan. Examples of costs covered by the standard include
lease termination costs and certain employee severance costs that are
associated with a restructuring, discontinued operation, or other exit or
disposal activity. The adoption of SFAS 146 had no impact on the Company's
financial position, results of operations or cash flows.
Effective January 1, 2003, the Company adopted Interpretation No. 45,
("FIN 45") "Guarantees, Including Indirect Guarantees of Indebtedness to
Others", which expands previously issued accounting guidance and disclosure
requirements for certain guarantees. FIN 45 requires the Company to
recognize an initial liability for fair value of an obligation assumed by
issuing a guarantee. The adoption of FIN 45 had no impact on the Company's
financial position, results of operations or cash flows.
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. On April 23, 2003, the Company settled an investigation by the
District of Columbia Office of Inspector General ("OIG") involving the
Company's wholly owned subsidiary, First Health Services Corporation
("Services"). 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 contributed $5.5 million to a $13 million settlement and release of
all future claims. The $5.5 million was fully reserved at the time of the
acquisition of Services. The remaining $7.5 million of the settlement was
contributed by the former owner of Services. The Company and Services have
denied all liability for the claims.
The Company's largest client (Mail Handlers Benefit Plan) generated
revenue of approximately $160 million in 2002 or 21% of total revenues. This
amount is net of a reserve established by the Company for various issues
associated with the potential disallowance of certain expenses charged to
the Plan. In addition, the provisions of the contract with the Plan's
sponsor, the National Postal Mail Handlers Union, require that the Company
fund any deficits in the Plan after the Plan's reserves have been fully
utilized. As of March 31, 2003, the Plan has approximately $350 million in
reserves to cover Plan expenses that may exceed the premiums charged and
collected from the Plan participants by the Plan sponsor. Management
believes that these reserves are adequate to cover any Plan deficits as of
March 31, 2003. There are no known Plan deficits as of March 31, 2003.
FIN 45 requires the Company to disclose certain guarantees, including
contractual indemnifications, it has assumed. The Company generally declines
to provide indemnification to its customers. In limited circumstances, to
secure long-term customer contracts at favorable rates, the Company may
negotiate risk allocation through mutual indemnification provisions that, in
the Company's judgment, appropriately allocate risk relative to the value of
the customer. Management believes that any liability under these
indemnification provisions would not be material.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
---------------------------------------------------------
The Company's market risk exposure as of March 31, 2003 was consistent
with the types of market risk and amount of exposure presented in its 2002
Annual Report on Form 10-K.
Item 4. Controls and Procedures
-----------------------
Within the 90 days prior to the filing date of this report, the Company
carried out an evaluation, under the supervision and with the participation
of the Company's management, including the Company's Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-15
under the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Based upon that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective. Disclosure controls and procedures are controls
and procedures that are designed to ensure that information required to be
disclosed in Company reports filed or submitted under the Exchange Act is
recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms.
There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent
to the date we carried out this evaluation.
PART II
Item 1. Legal Proceedings
-----------------
The information provided in Management's Discussion and Analysis
of Financial Condition and Results of Operations under the heading
"Legal Proceedings" is hereby incorporated by reference.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibits:
(a) Exhibit 10.01 - Employment Agreement dated May 1, 1999 as
amended on February 1, 2000 and January 10,
2002 between First Health Group Corp. and
Patrick G. Dills
(b) 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:
The Company filed a report on Form 8-K dated April 28, 2003
reporting under Item 12 the results of operations and financial
condition for the three months ended March 31, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
First Health Group Corp.
Dated: May 1, 2003 /s/Edward L. Wristen
-------------------------------------
Edward L. Wristen
President and Chief Executive Officer
Dated: May 1, 2003 /s/Joseph E. Whitters
------------------------------------
Joseph E. Whitters
Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
CERTIFICATIONS
I, Edward L. Wristen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Health
Group Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 1, 2003
/s/ Edward L. Wristen
President and Chief Executive Officer
I, Joseph E. Whitters, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Health
Group Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 1, 2003
/s/ Joseph E. Whitters
Vice President, Finance and Chief Financial Officer