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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, 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
---------------------------------------------------
(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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
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 July 29, 2003, was 94,872,569.
First Health Group Corp. and Subsidiaries
INDEX
Part I. Financial Information
Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets - Assets at June 30, 2003
and December 31, 2002 ................................... 3
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at June 30, 2003 and December 31, 2002 ........... 4
Consolidated Statements of Operations for the three months
ended June 30, 2003 and 2002 ............................ 5
Consolidated Statements of Operations for the six months
ended June 30, 2003 and 2002 ............................ 6
Consolidated Statements of Comprehensive Income for the
three and six months ended June 30, 2003 and 2002 ....... 7
Consolidated Statements of Cash Flows for the six months
ended June 30, 2003 and 2002 ............................ 8-9
Notes to Consolidated Financial Statements ................ 10-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............. 15-21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ..................................... 22
Item 4. Controls and Procedures ........................... 22
Part II. Other Information
Item 1. Legal Proceedings ................................. 23
Item 4. Submission of Matters to a Vote of
Security Holders ................................ 23
Item 6. Exhibits and Reports on Form 8-K .................. 23-24
Signatures....................................................... 25
PART 1. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
ASSETS June 30, 2003 December 31, 2002
---------- ----------
Current Assets:
Cash and cash equivalents ............ $ 26,791 $ 20,852
Short-term investments ............... 4,013 1,304
Accounts receivable, less allowances
for doubtful accounts of $14,638
and $ 14,782 respectively.......... 83,499 69,981
Deferred income taxes ................ 35,240 35,255
Other current assets ................. 15,495 16,183
--------- ---------
Total current assets ................. 165,038 143,575
Long-Term Investments:
Marketable securities ................ 64,988 67,880
Other ................................ 61,512 62,676
--------- ---------
126,500 130,556
--------- ---------
Property and Equipment:
Land, buildings and improvements...... 99,474 97,826
Computer equipment and software....... 250,092 222,796
Office furniture and equipment ....... 35,882 34,518
--------- ---------
385,448 355,140
Less accumulated depreciation and
amortization....................... (177,993) (149,637)
--------- ---------
Net property and equipment ........... 207,455 205,503
--------- ---------
Goodwill................................ 283,231 279,447
Intangible assets, less accumulated
amortization of $6,639 and $4,541,
respectively ......................... 51,988 54,086
Reinsurance recoverable................. 24,755 26,185
Other Assets............................ 3,955 4,009
--------- ---------
$ 862,922 $843,361
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, 2003 December 31, 2002
--------- ---------
Current Liabilities:
Accounts payable ..................... $ 61,185 $ 50,841
Accrued expenses ..................... 46,865 53,535
Claims reserves ...................... 14,945 14,235
Income taxes payable ................. 38,866 23,765
--------- ---------
Total current liabilities ............ 161,861 142,376
Long-Term Debt.......................... 150,000 120,000
Claims Reserves - Non-Current........... 24,755 26,185
Deferred Taxes.......................... 115,168 114,692
Other Non-Current Liabilities........... 26,656 25,962
--------- ---------
Total liabilities .................... 478,440 429,215
--------- ---------
Commitments and Contingencies........... -- --
Stockholders' Equity:
Common stock ......................... 1,358 1,344
Additional paid-in capital ........... 326,110 304,663
Retained earnings .................... 593,259 519,247
Stock option loan receivable ......... (55) (287)
Accumulated other comprehensive income 1,363 764
Treasury stock, at cost .............. (537,553) (411,585)
--------- ---------
Total stockholders' equity ........... 384,482 414,146
--------- ---------
$ 862,922 $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 June 30,
---------------------------
2003 2002
--------- ---------
Revenues............................ $ 218,651 $ 175,923
--------- ---------
Operating expenses:
Cost of services ................. 100,148 75,077
Selling and marketing ............ 21,356 17,755
General and administrative ....... 15,447 11,956
Healthcare benefits .............. 4,389 3,903
Depreciation and amortization .... 15,554 13,356
--------- ---------
156,894 122,047
--------- ---------
Income from operations.............. 61,757 53,876
Other (income) expense:
Interest expense ................. 1,421 1,503
Interest income .................. (1,359) (1,544)
--------- ---------
Income before income taxes.......... 61,695 53,917
Income taxes........................ (24,524) (21,433)
--------- ---------
Net income.......................... $ 37,171 $ 32,484
========= =========
Weighted average shares outstanding - basic 95,273 101,217
========= =========
Net income per common share - basic. $ .39 $ .32
========= =========
Weighted average shares outstanding - diluted 97,696 104,735
========= =========
Net income per common share - diluted $ .38 $ .31
========= =========
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts) (Unaudited)
----------------------------------------------------------------------------
Six Months Ended June 30,
-------------------------
2003 2002
--------- ---------
Revenues............................ $ 432,404 $ 345,284
--------- ---------
Operating expenses:
Cost of services ................. 196,325 148,049
Selling and marketing ............ 42,392 34,833
General and administrative ....... 30,654 23,349
Healthcare benefits .............. 9,551 7,684
Depreciation and amortization .... 30,680 26,328
--------- ---------
309,602 240,243
--------- ---------
Income from operations.............. 122,802 105,041
Other (income) expense:
Interest expense ................. 2,688 2,819
Interest income .................. (2,727) (3,172)
--------- ---------
Income before income taxes.......... 122,841 105,394
Income taxes........................ (48,829) (41,896)
--------- ---------
Net income.......................... $ 74,012 $ 63,498
========= =========
Weighted average shares outstanding - basic 96,174 100,759
========= =========
Net income per common share - basic. $ .77 $ .63
========= =========
Weighted average shares outstanding - diluted 98,689 104,584
========= =========
Net income per common share - diluted $ .75 $ .61
========= =========
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,
---------------------------
2003 2002
--------- ---------
Net income.................................. $ 37,171 $ 32,484
--------- ---------
Unrealized gains (losses) on securities,
before tax................................ 1,219 (179)
Income tax (expense) benefit related to
items of other comprehensive income....... (457) 66
--------- ---------
Other comprehensive income (loss)........... 762 (113)
--------- ---------
Comprehensive income........................ $ 37,933 $ 32,371
========= =========
Six Months Ended June 30,
-------------------------
2003 2002
--------- ---------
Net income.................................. $ 74,012 $ 63,498
--------- ---------
Unrealized gains (losses) on securities,
before tax................................ 973 (712)
Income tax (expense) benefit related to
items of other comprehensive income....... (374) 249
--------- ---------
Other comprehensive income (loss)........... 599 (463)
--------- ---------
Comprehensive income........................ $ 74,611 $ 63,035
========= =========
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,
-------------------------
2003 2002
--------- ---------
Cash flows from operating activities:
Net Income ................................. $ 74,012 $ 63,498
--------- ---------
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and amortization ............ 30,680 26,328
Change in allowance for uncollectible
receivables ............................ (144) 1,893
Provision for deferred income taxes ...... 117 (111)
Tax benefits from stock options exercised. 6,215 12,423
Income from limited partnership .......... (1,274) (1,501)
Other, net ............................... 26 1,604
Changes in Assets and Liabilities (net of
effects of acquired businesses):
Accounts receivable ...................... (13,866) 1,790
Other current assets ..................... 688 4,788
Reinsurance recoverable .................. 1,430 863
Accounts payable and accrued expenses..... (2,570) 8,206
Claims reserves .......................... (720) 574
Income taxes payable ..................... 15,101 13,574
Non-current assets and liabilities ....... 748 (2,541)
--------- ---------
Net cash provided by operating activities... 110,443 131,388
--------- ---------
Cash flows from investing activities:
Purchases of investments ................... (20,701) (30,355)
Sales of investments ....................... 24,349 27,096
Acquisition of business,
net of cash acquired ..................... (3,442) (24,027)
Assets held for sale ....................... -- 923
Purchase of property and equipment ......... (30,571) (27,001)
--------- ---------
Net cash used in investing activities....... (30,365) (53,364)
--------- ---------
Cash flows from financing activities:
Purchase of treasury stock ................. (119,074) (14,813)
Proceeds from issuance of long-term debt 105,000 150,000
Repayment of long-term debt ................ (75,000) (217,500)
Proceeds from issuance of common stock...... 14,703 21,436
Stock option loans to employees ............ -- (2,272)
Stock option loan repayments ............... 232 2,360
Sales of put options on common stock ....... -- 375
--------- ---------
Net cash used in financing activities ...... (74,139) (60,414)
--------- ---------
Net increase in cash and cash equivalents..... 5,939 17,610
Cash and cash equivalents, beginning of period 20,852 14,001
--------- ---------
Cash and cash equivalents, end of period...... $ 26,791 $ 31,611
========= =========
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)
----------------------------------------------------------------------------
Six Months Ended June 30,
-------------------------
2003 2002
--------- ---------
Supplemental cash flow data:
Stock options exercised in exchange
for common stock............................ $ 500 $ 66
Health care benefits paid..................... (8,725) (7,418)
Interest paid................................. (2,325) (2,500)
Interest income received...................... 1,593 1,684
Income taxes paid, net........................ (27,512) (7,439)
Acquisition of businesses:
Fair value of assets acquired,
net of cash acquired...................... $ (492) $ 643
Goodwill ................................... 3,784 21,284
Intangible Assets .......................... -- 5,658
Fair value of liabilities assumed .......... 150 (3,558)
--------- ---------
$ 3,442 $ 24,027
========= =========
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, 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")
in 2001, the Company recorded reserves for restructuring and
integration costs. The specific actions included in the restructuring
plan were substantially complete by December 31, 2002. Components of
the purchase reserve as of June 30, 2003 are as follows:
Accrual
(in thousands) Total Balance Amount Balance
-------------- Charges 12/31/02 Paid 6/30/03
------ ----- ---- ------
Severance and related $13,712 $1,536 $(609) $ 927
Facilities integration 10,370 1,117 (330) 787
Contract losses 10,000 296 180 476
Other reserves 7,031 1,031 1 1,032
------ ----- ---- ------
$41,113 $3,980 $(758) $ 3,222
====== ===== ==== ======
The Company charged $0.8 million to the purchase reserve during the six
months ended June 30, 2003. The severance and related benefits payments
were $0.6 million for headcount reductions already incurred. Facilities
integration charges were $0.3 million and the Company was reimbursed
$0.2 million related to contract losses. The majority of the remaining
$3.2 million of the purchase reserve is expected to be paid out during
2003.
3. Acquired Intangible Assets
As of June 30, 2003
Gross
Carrying Accumulated
(in thousands) Amount Amortization
-------------- ------ ------------
Amortized intangible assets
Customer contracts and relationships $48,700 $ 5,990
Provider Contracts 9,927 649
------ ------
Total $58,627 $ 6,639
====== ======
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 HealthR Network that the Company has acquired. The aggregate
amortization expense recorded during the six months ended June 30, 2003
was $2.1 million. The estimated amortization expense for each of the
years ending December 31, 2003 through 2007 is $4.2 million.
The changes in the carrying amount of goodwill for the six months ended
June 30, 2003 are as follows (in thousands):
Amount
-------
Balance, January 1, 2003 $279,447
Goodwill acquired --
Other changes 3,784
-------
Balance, June 30, 2003 $283,231
=======
The other goodwill adjustments represent $3.5 million in financial
performance payments made related to the HealthCare Value Management
("HCVM") acquisition and $0.3 million related to the finalization of
the purchase price allocation.
4. Accounts receivable reserves for client-specific items were $42.3
million and $41.2 million as of June 30, 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 $14.6 million and $14.8 million as of
June 30, 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 gain in market
value of $0.6 million, net of deferred income taxes, for the six month
period ended June 30, 2003. The net unrealized gain as of June 30,
2003, included as a component of stockholders' equity, was $1.4
million, 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 June 30,
2003 and December 31, 2002 was $54.8 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 $1.3
million and $1.5 million for the six months ended June 30, 2003 and
2002, respectively, 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. 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 six months ended June 30, 2003, the Company
repurchased 5.2 million shares (1 million shares in the second quarter)
on the open market for approximately $125.5 million ($27.7 million in
the second quarter). The actual cash paid (of $119.1 million) excludes
$6.4 million for trades dated in June that were settled during the
first 3 days of July. The Company repurchased 0.5 million shares
during the six months ended June 30, 2002. As of June 30, 2003,
approximately 5.5 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 2.4 million and 2.5 million and by 3.5 million and 3.8 million
respectively, for the three and six months ended June 30, 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 June 30, 2003 and 2002, due to
the effect of stock options outstanding. Diluted net income per share
was $.02 less than basic net income per share for both the six months
ended June 30, 2003 and 2002, due to the effect of stock options
outstanding. The 5.2 million shares of common share repurchases had a
consistent impact on both basic and diluted share calculations.
8. At June 30, 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):
Six Months Ended June 30,
-------------------------
2003 2002
------ ------
Net Income, as reported $74,012 $63,498
Add: Stock-based compensation expense included
in reported net income, net of related tax
effects. 43 --
Deduct: Total stock-based compensation expense
determined under fair value based method
for all awards, net of related tax
effects (7,574) (8,692)
------ ------
Pro forma net income $66,481 $54,806
====== ======
Earnings per share:
Basic, as reported $ .77 $ .63
Basic, pro forma $ .69 $ .54
Diluted, as reported $ .75 $ .61
Diluted, pro forma $ .67 $ .52
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"). The Company
contributed $5.5 million to a $13 million settlement and a release of
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 June 30, 2003, the Plan has
approximately $359 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 June 30, 2003. There are no known Plan
deficits as of June 30, 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 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 six months ended June
30, 2002 included only the prior PPO business of the Plan. The Plan is the
Company's largest customer with revenues earned of approximately $106
million ($54 million in the second quarter), or 25% of total Company
revenue, during the six months ended June 30, 2003 compared with $47 million
in revenues earned during the six months ended June 30, 2002.
Results of Operations
---------------------
The Company's revenues consist primarily of fees for cost management
services provided under contracts on a percentage-of-savings basis or on a
predetermined contractual basis. As a result of the Company's insurance
company acquisitions, revenues also include premium revenue.
Effective January 1, 2003, the Company is now reporting revenue in a
new format which includes Group Health and Workers' Compensation revenue
(which together make up the Commercial Business) and Public Sector revenue.
The Commercial business is further broken down into PPO Services, PPO plus
Administration Services and Premium revenue on the Group Health side. The
Workers' Compensation business is further broken down into PPO Services and
PPO plus Administration Services (there is no premium revenue). PPO Service
is where the Company provides its national PPO network to clients without
any other services. PPO plus Administration Service is where the Company
provides PPO plus other services such as claims administration, health plan
administration, fee schedule, front end, first report of injury, pharmacy
benefit management and/or disease management.
The following table sets forth information with respect to the sources
of the Company's revenues for the three and six months ended June 30, 2003
and 2002, respectively:
Sources of Revenue
($ in thousands)
Three Months Ended June 30,
--------------------------- % Change
2003 % 2002 % 2002 to 2003
------- --- ------- --- ------------
Commercial Revenue:
Group Health:
PPO plus Administration
Services $ 91,087 41% $ 32,512 19% 180%
PPO 38,936 18 65,561 37 (41)
Premiums 4,122 2 3,810 2 8
------- --- ------- --- ---
Total Group Health 134,145 61 101,883 58 32
------- --- ------- --- ---
Workers' Compensation:
PPO plus Administration
Services 25,174 12 27,206 16 (7)
PPO 15,132 7 14,663 8 3
------- --- ------- --- ---
Total Workers' Compensation 40,306 19 41,869 24 (4)
------- --- ------- --- ---
Total Commercial Revenue 174,451 80 143,752 82 21
------- --- ------- --- ---
Public Sector Revenue 44,200 20 32,171 18 37
------- --- ------- --- ---
Total Revenue $218,651 100% $175,923 100% 24%
======= === ======= === ===
($ in thousands)
Six Months Ended June 30,
--------------------------- % Change
2003 % 2002 % 2002 to 2003
------- --- ------- --- ------------
Commercial Revenue:
Group Health:
PPO plus Administration
Services $180,028 42% $ 66,504 20% 171%
PPO 79,795 18 128,420 37 (38)
Premiums 8,357 2 7,820 2 7
------- --- ------- --- ---
Total Group Health 268,180 62 202,744 59 32
------- --- ------- --- ---
Workers' Compensation:
PPO plus Administration
Services 50,159 12 53,289 15 (6)
PPO 30,284 7 27,780 8 9
------- --- ------- --- ---
Total Workers' Compensation 80,443 19 81,069 23 1
------- --- ------- --- ---
Total Commercial Revenue 348,623 81 283,813 82 23
------- --- ------- --- ---
Public Sector Revenue 83,781 19 61,471 18 36
------- --- ------- --- ---
Total Revenue $432,404 100% $345,284 100% 25%
======= === ======= === ===
Total revenue for the three and six months ended June 30, 2003
increased $42.7 million (24%) and $87.1 million (25%) from the comparable
periods of 2002. The components of the Company's quarterly revenue are as
follows:
Group Health revenue of $134.1 million and $268.2 million for the three
and six months ended June 30, 2003 increased $32.3 million (32%) and $65.4
million (32%) from the comparable periods 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 and six
months ended June 30, 2003 decreased $26.6 million (41%) and $48.6 million
(38%) from the comparable periods of 2002 as clients, especially Mail
Handlers, are taking advantage of most 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 and six months ended June 30, 2003 increased $58.6
million (180%) and $113.5 million (171%) 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 and six months ended June 30, 2003 increased $0.3 million (8%) and
$0.5 million (7%) from the comparable periods of 2002 as a result of new and
existing clients that purchased the Company's stop-loss insurance.
Workers' Compensation revenue of $40.3 million and $80.4 million for
the three and six months ended June 30, 2003 decreased $1.6 million (4%) and
$0.6 million (1%) from the comparable periods of 2002. This decrease is due
primarily to some historic workers' compensation clients that have exited
various markets.
Public Sector revenue of $44.2 million and $83.8 million for the three
and six months ended June 30, 2003 increased $12.0 million (37%) and $22.3
million (36%) from the same periods of 2002. Public Sector revenue
represents fees associated with pharmacy benefit management, fiscal agent
services and healthcare management from clients within the public sector.
This increase in revenue is due primarily to new clients, such as the State
of Nevada, non-recurring HIPPA support implementations and implementation
fees associated with pharmacy programs. Approximately $11.5 million and
$21.0 million in revenue was due to non-recurring consulting items for the
three and six months ended June 30, 2003 compared to $2.0 million and $4.0
million for the comparable periods of 2002.
Cost of services increased $25.1 million (33%) and $48.3 million (33%)
for the three and six months ended June 30, 2003 from the comparable periods
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 45.8% and 45.4% for the
three and six months ended June 30, 2003, respectively, from 42.7% and 42.9%
in the comparable periods 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 and six months ended June 30,
2003 increased $3.6 million (20%) and $7.6 million (22%) from the comparable
periods 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 and six months ended June
30, 2003 increased $3.5 million (29%) and $7.3 million (31%) from the
comparable periods 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 $0.5 million
(12%) and $1.9 million (24%) for the three and six months ended June 30,
2003 from the comparable periods 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 106%
and 114% for the three and six months ended June 30, 2003 compared to 102%
and 98% for the comparable periods 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 (16%) and
$4.4 million (17%) for the three and six months ended June 30, 2003 from
the comparable periods 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 and six months ended June 30, 2003
decreased $0.2 million (12%) and $0.4 million (14%) from the comparable
periods of 2002. Interest income has decreased as the Company has used much
of its available cash to repay debt and repurchase its common stock.
Interest expense for both the three and six months ended June 30, 2003
decreased $0.1 million (5%) from the comparable periods 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 June 30, 2003 was approximately 2.75% per annum and the
Company had $150 million of debt outstanding.
Net income for the three and six months ended June 30, 2003 increased
$4.7 million (14%) and $10.5 million (17%) from the comparable periods of
2002. This increase is due primarily to the increase in revenue associated
with the Mail Handlers Benefit Plan and, to a lesser extent, growth in the
public sector business.
Diluted net income per common share for the three and six months ended
June 30, 2003 increased 23% to $.38 per share and 23% to $.75 per share from
the comparable periods of 2002. The increase in net income per common share
was favorably impacted by the repurchase of 5.2 million shares of Company
common stock during the six months ended June 30, 2003. For the three and
six months ended June 30, 2003, diluted common shares outstanding decreased
7% and 6% from the comparable periods of 2002.
Liquidity and Capital Resources
-------------------------------
The Company had $3.2 million in working capital on June 30, 2003 compared
with working capital of $1.2 million at December 31, 2002. Through the first
six months of the year, operating activities provided $110.4 million of
cash. Investment activities used $30.4 million of cash representing
purchases of fixed assets of $30.6 million and acquisition payments of $3.4
million (related to the HCVM acquisition) partially offset by $3.6 million
in net sales of investments. Financing activities used $74.1 million of cash
representing $119.1 million in purchases of Company common stock (net of
$6.4 million in stock repurchases for trades dated in June that settled
during the first 3 days of July) partially offset by $14.7 million in
proceeds from issuance of common stock (representing 1.3 million shares),
$30.0 million in proceeds from debt issuance (net of $75.0 million in debt
repayment) and $0.2 million in stock option loan repayments.
The Company's outstanding debt at June 30, 2003 increased to $150 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 June 30, 2003:
(in thousands)
-----------------------------------------------------------
Years Ending Revolving Line
December 31, Leases of Credit Total
-----------------------------------------------------------
2003 $ 6,760 $ -- $ 6,760
2004 11,145 -- 11,145
2005 9,050 -- 9,050
2006 5,922 -- 5,922
2007 4,575 150,000 154,575
Thereafter 7,628 -- 7,628
-----------------------------------------------------------
Total $ 45,080 $ 150,000 $ 195,080
-----------------------------------------------------------
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. In accordance with Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements,"
revenue is recognized when customer acceptance has been received for the
services performed.
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"). The Company contributed $5.5 million to a $13 million
settlement and a release of 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 June 30, 2003, the Plan has approximately $359 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
June 30, 2003. There are no known Plan deficits as of June 30, 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 June 30, 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
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the
Company's Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms and that such information is accumulated and
communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow for timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As of June 30, 2003, the end of the quarter covered by 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 the Company's Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on the foregoing, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective at the reasonable
assurance level.
There has been no change in the Company's internal controls over
financial reporting during the Company's most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the
Company's internal controls over financial reporting.
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 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders of the Company on May 13,
2003, 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 85,326,489 3,345,363
Daniel S. Brunner 66,747,845 21,924,007
Raul Cesan 85,024,179 3,647,673
Robert S. Colman 87,654,950 1,016,902
Ronald H. Galowich 66,827,863 21,843,989
Harold S. Handlesman 84,882,451 3,789,401
Don Logan 87,655,964 1,015,888
William Mayer 87,625,970 1,045,882
John C. Ryan 87,658,429 1,013,423
David E. Simon 86,935,160 1,736,692
James C. Smith 68,983,993 19,687,859
Edward L. Wristen 86,753,079 1,918,773
A proposal to approve an increase in the number of shares
available to be issued pursuant to the Directors' Stock Option
plan from 500,000 shares to 2,000,000 shares was approved with
73,455,516 shares cast for, 14,788,883 shares against and 427,453
shares abstaining.
A proposal to ratify the reappointment of Deloitte & Touche LLP as
the Company's independent auditors for the fiscal year 2003 was
approved with 84,941,301 shares cast for 3,682,992 shares against
and 47,559 shares abstaining.
Item 6. Exhibits and Reports on Form 8-K
Exhibits:
(a) Exhibit 11 - Computation of Basic Earnings Per Common Share and
Diluted Earnings Per Common Share
(b) Exhibit 31.1 - Certification of Chief Executive Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under
the Securities Exchange Act of 1934, as amended.
(c) Exhibit 31.2 - Certification of Chief Financial Officer pursuant
to Rule 13a-14(a) and Rule 15d-14(a), promulgated under
the Securities Exchange Act of 1934, as amended.
(d) Exhibit 32.1 - Certification of Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(e) Exhibit 32.2 - Certification of Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Reports on Form 8-K:
The Company furnished 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: August 8, 2003 /s/Edward L. Wristen
------------------------------------
Edward L. Wristen
President and Chief Executive Officer
Dated: August 8, 2003 /s/Joseph E. Whitters
------------------------------------
Joseph E. Whitters
Vice President, Finance and Chief
Financial Officer (Principal
Financial Officer)