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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, 2004
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 by 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 April 30, 2004, was 91,579,458.
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, 2004
and December 31, 2003 ................................... 4
Consolidated Balance Sheets - Liabilities and Stockholders'
Equity at March 31, 2004 and December 31, 2003........... 5
Consolidated Statements of Operations for the three months
ended March 31, 2004 and 2003 ........................... 6
Consolidated Statements of Comprehensive Income for the
three months ended March 31, 2004 and 2003 .............. 7
Consolidated Statements of Cash Flows for the three months
ended March 31, 2004 and 2003 ........................... 8-9
Notes to Consolidated Financial Statements ................ 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............. 16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ..................................... 27
Item 4. Controls and Procedures ........................... 27
Part II. Other Information
Item 1. Legal Proceedings ................................. 28
Item 2. Changes in Securities and Use of Proceeds ......... 28
Item 5. Other Information ................................. 28
Item 6. Exhibits and Reports on Form 8-K .................. 29
Signatures....................................................... 30
PART I. Financial Information
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in millions) (Unaudited)
-----------------------------------------------------------------------------
ASSETS March 31, December 31,
2004 2003
------ ------
Current Assets:
Cash and cash equivalents .................... $ 37.7 $ 8.0
Short-term investments ....................... 1.4 2.0
Accounts receivable, less allowances for
doubtful accounts of $21.5
and $21.1, respectively.................... 111.3 102.9
Deferred income taxes ........................ 26.8 26.8
Other current assets ......................... 29.2 37.4
------ ------
Total current assets ......................... 206.4 177.1
Long-Term Investments:
Marketable securities ........................ 56.5 63.0
Other ........................................ 67.1 66.7
------ ------
123.6 129.7
------ ------
Property and Equipment:
Land, buildings and improvements ............. 103.5 103.1
Computer equipment and software .............. 296.0 281.5
Office furniture and equipment ............... 39.4 37.9
------ ------
438.9 422.5
Less accumulated depreciation and
amortization............................... (203.1) (186.6)
------ ------
Net property and equipment ................... 235.8 235.9
------ ------
Goodwill........................................ 324.3 324.3
Intangible assets, less accumulated amortization
of $11.1 and $9.3, respectively............... 80.8 82.6
Reinsurance recoverable......................... 25.3 24.3
Other Assets.................................... 3.4 3.5
------ ------
$ 999.6 $ 977.4
====== ======
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(in millions) (Unaudited)
-----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
2004 2003
------ ------
Current Liabilities:
Accounts payable ............................. $ 74.5 $ 73.2
Accrued expenses ............................. 40.4 47.8
Claims reserves .............................. 21.1 23.8
Income taxes payable ......................... 21.5 8.1
------ ------
Total current liabilities .................... 157.5 152.9
Long-Term Debt.................................. 250.0 270.0
Claims Reserves - Noncurrent.................... 25.2 24.3
Deferred Taxes.................................. 126.6 126.5
Other Noncurrent Liabilities.................... 25.4 25.2
------ ------
Total liabilities ............................ 584.7 598.9
------ ------
Commitments and Contingencies................... -- --
Stockholders' Equity:
Common stock ................................. 1.4 1.4
Additional paid-in capital ................... 342.9 335.5
Retained earnings ............................ 700.8 672.0
Accumulated other comprehensive income ....... (1.5) (1.7)
Treasury stock, at cost ...................... (628.7) (628.7)
------ ------
Total stockholders' equity ................... 414.9 378.5
------ ------
$ 999.6 $ 977.4
====== ======
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2004 2003
------ ------
Revenues......................................... $ 218.1 $ 213.8
------ ------
Operating expenses:
Cost of services .............................. 106.4 96.2
Selling and marketing ......................... 20.9 21.0
General and administrative .................... 19.6 15.2
Healthcare benefits ........................... 6.3 5.2
Depreciation and amortization ................. 18.4 15.1
------ ------
171.6 152.7
------ ------
Income from operations........................... 46.5 61.1
Nonoperating expenses (income):
Interest expense .............................. 1.8 1.3
Interest income ............................... (1.7) (1.3)
------ ------
Income before income taxes....................... 46.4 61.1
Income taxes..................................... (17.6) (24.3)
------ ------
Net income....................................... $ 28.8 $ 36.8
====== ======
Weighted average shares outstanding - basic...... 91.3 96.9
====== ======
Net income per common share - basic.............. $ .32 $ .38
====== ======
Weighted average shares outstanding - diluted.... 92.9 99.5
====== ======
Net income per common share - diluted............ $ .31 $ .37
====== ======
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2004 2003
------ ------
Net income....................................... $ 28.8 $ 36.8
------ ------
Unrealized gains (losses) on securities,
before tax..................................... 0.3 (0.2)
Income tax (expense) benefit related to items of
other comprehensive income..................... (0.1) 0.1
------ ------
Other comprehensive gain (loss).................. 0.2 (0.1)
------ ------
Comprehensive income............................. $ 29.0 $ 36.7
====== ======
See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2004 2003
------ ------
Cash flows from operating activities:
Net Income .................................... $ 28.8 $ 36.8
------ ------
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and amortization ............... 18.4 15.1
Change in allowance for uncollectible
receivables ............................... .4 (0.1)
Tax benefits from stock options exercised ... 1.2 3.3
Income from limited partnership ............. (0.9) (0.8)
Other, net .................................. (0.4) 0.2
Changes in Assets and Liabilities (net of
effects of acquired businesses):
Accounts receivable ......................... (8.8) (13.9)
Other current assets ........................ 8.1 (1.3)
Reinsurance recoverable ..................... (0.9) 0.8
Accounts payable and accrued expenses ....... (6.1) (2.9)
Claims reserves ............................. (1.8) (1.9)
Income taxes payable ........................ 13.4 6.5
Non-current assets and liabilities .......... 0.3 0.5
------ ------
Net cash provided by operating activities ..... 51.7 42.3
------ ------
Cash flows from investing activities:
Purchases of investments ...................... (9.2) (12.1)
Sales of investments .......................... 17.6 12.1
Acquisition of business, net of cash acquired.. -- (3.3)
Purchase of property and equipment ............ (16.5) (13.7)
------ ------
Net cash used in investing activities.......... (8.1) (17.0)
------ ------
Cash flows from financing activities:
Purchase of treasury stock .................... -- (97.8)
Proceeds from issuance of long-term debt ...... 30.0 95.0
Repayment of long-term debt ................... (50.0) (30.0)
Proceeds from issuance of common stock ........ 6.1 9.7
Stock option loan repayments .................. -- 0.2
------ ------
Net cash used in financing activities ......... (13.9) (22.9)
------ ------
Net increase in cash and cash equivalents ....... 29.7 2.4
Cash and cash equivalents, beginning of period... 8.0 20.8
------ ------
Cash and cash equivalents, end of period ........ $ 37.7 $ 23.2
====== ======
First Health Group Corp. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions) (Unaudited)
-----------------------------------------------------------------------------
Three Months Ended March 31,
----------------------------
2004 2003
------ ------
Supplemental cash flow data:
Stock options exercised in exchange
for common stock............................... $ -- $ 0.5
Health care benefits paid........................ (8.5) (6.2)
Interest paid.................................... (1.9) (1.1)
Interest income received......................... 0.7 0.6
Income taxes paid, net........................... (3.0) (14.6)
Acquisition of businesses:
Goodwill ...................................... $ -- $ 3.3
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, 2003.
Accordingly, footnote disclosures which would substantially duplicate
the disclosures contained in the December 31, 2003 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. On October 31, 2003, the Company completed the acquisition of all of
the outstanding shares of capital stock of Health Net Employer
Services, Inc. ("Employer Services"), from Health Net, Inc. for
approximately $79 million. Health Net Employer Services, Inc. is being
renamed First Health Employer Services, Inc. The acquisition was
financed with borrowings under the Company's credit facility. The
allocation of the purchase price is expected to be completed in the
fourth quarter of 2004 when the liability for restructuring and
integration and valuation of intangible assets is finalized.
Purchase price has been allocated, on a preliminary basis,
as follows (in millions):
Fair value of tangible assets acquired $ 17.1
Goodwill 43.5
Intangible assets 29.5
Liabilities assumed (8.0)
Liability for restructuring and integration costs (2.9)
------
$ 79.2
======
On October 31, 2003, the Company completed the acquisition of PPO Oklahoma
for a purchase price of $10 million, subject to certain purchase price
considerations. The acquisition was financed with borrowings under the
Company's credit facility. The purchase price allocation is expected to be
completed in the fourth quarter of 2004 when the calculation of additional
purchase price considerations and the valuation of intangible assets is
finalized.
Purchase price has been allocated, on a preliminary basis,
as follows (in millions):
Fair value of tangible assets acquired $ 0.6
Goodwill 6.6
Intangible assets 3.7
Liabilities assumed (0.2)
Liability for restructuring and integration costs (0.3)
------
$ 10.4
======
3. Acquired Intangible Assets
As of March 31, 2004 As of December 31, 2003
Gross Gross
Carrying Accumulated Carrying Accumulated
(in millions) Amount Amortization Amount Amortization
------------- ------ ------------ ------ ------------
Amortized intangible
assets
Customer contracts
and relationships $ 78.2 $ 9.9 $ 78.2 $ 8.3
Provider Contracts 13.7 1.2 13.7 1.0
----- ----- ----- -----
Total $ 91.9 $ 11.1 $ 91.9 $ 9.3
===== ===== ===== =====
Customer contracts and relationships represent added value 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,
2004 and 2003, respectively, was $1.8 million and $1.0 million. The
estimated amortization expense for each of the years ending December
31, 2004 through 2007 is $7.3 million. The estimated amortization
expense for the year ending December 31, 2008 is $6.6 million.
The changes in the carrying amount of goodwill for the three months
ended March 31, are as follows:
(in millions) 2004 2003
------ ------
Balance, January 1 $ 324.3 $ 279.5
Goodwill acquired -- --
Other changes -- 3.3
------ ------
Balance, March 31 $ 324.3 $ 282.8
====== ======
The other goodwill adjustments in 2003 represented financial
performance payments made related to the 2002 acquisition of HealthCare
Value Management ("HCVM").
4. Accounts receivable valuation allowances for client-specific items were
$38.1 million and $36.5 million as of March 31, 2004 and December 31,
2003, respectively. These valuation allowances for matters such as
performance guarantees and claim, eligibility and data adjustments,
are netted against the gross accounts receivable balance in the
consolidated balance sheets. The Company's largest client (Mail
Handlers Benefit Plan) ("MHBP" or the "Plan") generated revenue of
approximately $51.3 million (24% of total revenues) during the three
months ended March 31, 2004 and $51.6 million during the three months
ended March 31, 2003 (24% of total revenues). Revenues for the Plan
are recorded net of a valuation allowance established by the Company for
various issues associated with the potential disallowance of certain
expenses charged to the Plan and an estimate for the disallowance of
certain claims due to eligibility, coordination of benefits and other
Plan provisions.
5. Allowances for doubtful accounts were $21.5 million and $21.1 million
as of March 31, 2004 and December 31, 2003, respectively. The
allowances for doubtful accounts are established based on historical
experience, current economic circumstances and contractual arrangements
and are adjusted monthly based upon updated information.
6. The Company's investments in marketable securities, which are
classified as available for sale, had a net unrealized gain in market
value of $0.2 million, net of deferred income taxes, for the three
month period ended March 31, 2004. The net unrealized gain as of March
31, 2004, included as a component of stockholders' equity, was $0.7
million, net of deferred income taxes. The Company has eight separate
investments in a limited liability company that invests in equipment
that is leased to third parties. The total investment as of March 31,
2004 and December 31, 2003 was $59.4 million and $59.0 million,
respectively, and is accounted for using the equity method. The
Company's proportionate share of the partnership's income was $0.9
million and $0.8 million for the three months ended March 31, 2004 and
2003, respectively, and is included in interest income. The total
investment recorded at March 31, 2004 and December 31, 2003 is net of
an unrealized loss on interest rate swaps of $2.2 million, net of $1.3
million in related taxes, which is recorded in accumulated other
comprehensive income. A member of the Company's Board of Directors is
associated with a group that owns approximately 90% of this
partnership. The Company has between a 20% and 33% interest in each
individual tranche of the partnership.
7. The Company's Board of Directors approved the repurchase of up to 10
million shares of the Company's outstanding common stock under a prior
authorization. In 2003, the Board approved a new authorization to
repurchase up to an additional 5 million shares of common stock.
Purchases may be made from time to time, depending on market conditions
and other relevant factors. The Company did not repurchase any shares
during the quarter ended March 31, 2004. During the quarter ended March
31, 2003, the Company repurchased 4.2 million shares on the open market
for approximately $97.8 million. As of March 31, 2004, approximately
6.1 million shares remain available for repurchase under the Company's
current repurchase authorization.
8. Weighted average shares outstanding increased for diluted earnings per
share by 1.7 million and 2.6 million for the three months ended March
31, 2004 and 2003, 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, 2004 and
2003, due to the effect of stock options outstanding.
9. Effective January 1, 2003, the Company adopted Statement of Financial
Accounting Standards 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. During the quarter ended March 31, 2004, the
Company initiated a plan to terminate approximately 200 employees for a
total cost of $1.4 million in termination benefits. Management believes
this termination plan will save the Company in excess of $7 million in
salaries and benefits in the second half of 2004 and in excess of $10
million in 2005 (primarily in cost of services in the consolidated
statement of operations). The plan is expected to be completed by the
third quarter of 2004 with substantially all of the termination costs
being incurred in the first quarter of 2004. This termination plan is
solely for the Commercial segment of the Company. The following table
summarizes the termination cost activity for the three months ended
March 31, 2004 (in millions):
Expenses Liability
Incurred Amounts As of
To-Date Paid March 31, 2004
------- ---- --------------
$1.4 $0.9 $0.5
The liability is recorded in the accrued expenses line in the
consolidated balance sheet.
10. Effective January 1, 2003, the Company adopted SFAS No. 148 ("SFAS
148"), "Accounting for Stock-Based Compensation - Transition and
Disclosure," which amends SFAS No. 123 ("SFAS 123"), "Accounting for
Stock Based Compensation." 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 at least equal to the market
value of the underlying common stock on the date of grant. As permitted
by SFAS 123, and amended by SFAS 148, the Company follows only the
disclosure requirements of SFAS 123 and SFAS 148. The following table
illustrates the effect on net income and earnings per share if the
Company had applied the fair value recognition provisions to all
outstanding and unvested awards in each period:
(in millions except EPS) Three Months Ended March 31,
------------------------ ----------------------------
2004 2003
------ ------
Net income, as reported $ 28.8 $ 36.8
Add: Stock-based employee compensation
expense included in reported net
income, net of related tax effects. -- 0.1
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (2.9) (2.9)
------ ------
Pro forma net income $ 25.9 $ 34.0
====== ======
Earnings per share:
Basic, as reported $ .32 $ .38
Basic, pro forma $ .28 $ .35
Diluted, as reported $ .31 $ .37
Diluted, pro forma $ .28 $ .34
11. The Company and its subsidiaries are subject to various claims arising
in the ordinary course of business and are parties to various legal
proceedings that constitute litigation incidental to the business of
the Company and its subsidiaries. The Company does not believe that the
outcome of such matters will have a material effect on the Company's
financial position, results of operations or cash flows.
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, 2004, the Plan has approximately $405 million in reserves to
cover Plan expenses, which may exceed the premiums charged and
collected from the Plan participants by the Plan sponsor. There are no
known Plan deficits as of March 31, 2004.
FASB Interpretation No. 45, "Guarantees, Including Indirect Guarantees
of Indebtedness to Others," 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.
12. The Company operates in two segments: Commercial and Public Sector. In
the Commercial segment, the Company often bundles its products and
services to offer a comprehensive health benefits solution to the
customer centered around the First Health [R] Network. In the Public
Sector segment, the Company offers products and services more
specialized to the needs of the individual customer as public sector
health programs move toward more efficient utilization of health
services. The Company has one executive management team that reviews
and approves all strategic and resource allocations for each of the two
segments. Discreet financial information is available for each of the
two segments and is reviewed regularly by the chief operating decision
maker.
The Company calculates income from operations and net income for each
segment consistent with the accounting policies for the consolidated
financial statements. Interest expense for the Company's credit facility
is charged primarily to the Commercial segment. The Commercial segment
also includes the Company's treasury, legal, tax and other similar
corporate functions. Income taxes are computed using the consolidated
income tax rate of the Company.
Summarized segment financial information for the three months ended
March 31 is as follows:
Three months ended March 31, 2004
------------------------------------
Public
(in millions) Commercial Sector Consolidated
------------- ---------- ------ ------------
Revenue $ 178.8 $ 39.3 $ 218.1
Net income (loss) 29.0 (0.2) 28.8
Total assets $ 961.8 $ 37.8 $ 999.6
Three months ended March 31, 2003
------------------------------------
Public
(in millions) Commercial Sector Consolidated
------------- ---------- ------ ------------
Revenue $ 174.2 $ 39.6 $ 213.8
Net income 35.3 1.5 36.8
Total assets $ 824.9 $ 37.5 $ 862.4
13. In April, 2004, the Company completed the acquisition of COMP Medical,
a workers' compensation company headquartered in Woodland Hills,
California that specializes in appointment setting for chronic pain
management, diagnostic imaging and electrodiagnostic procedures, as
well as Medicare set-aside allocations. The purchase price was $6
million, subject to additional purchase price considerations depending
on future performance, and was paid with cash from operating
activities. COMP Medical has been renamed First Health Priority
Services, Inc. The preliminary purchase price allocation will be
recorded in the second quarter of 2004.
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
health care benefit expenses or if the Company does not successfully
integrate its recently completed acquisitions; then the Company may not
achieve its anticipated 2004 financial results.
Overview
--------
The following information concerning recent business developments is
important to understanding the comparability of the 2004 and 2003 financial
results.
Mail Handlers Benefit Plan
--------------------------
The Mail Handlers Benefit Plan ("MHBP" or the "Plan") is part of the
Company's Federal Employee Health Benefit Plan ("FEHBP") sector and the
Company's largest customer. Revenue was $51.3 million (24% of total Company
revenue) in the first quarter of 2004 as compared to $51.6 million in the
first quarter of 2003 (24% of total revenue). Revenue from the Plan for the
second, third and fourth quarters of 2003 was $54.4 million, $63.1 million,
and $66.9 million, respectively. Adjustments to revenue are recorded on a
client specific and aggregated basis based on empirical data in each period
and may be subject to further adjustments in subsequent periods. In the
third and fourth quarters of 2003, the Company reported $8 million and $6
million of revenue, respectively, as a result of the internal claims
reconciliation process related to 2002, net of reserves. In the third and
fourth quarters of 2003, the pretax income contribution from the revenue
adjustment, net of incremental marketing expenses related to future
retention of MHBP members, was approximately $4 million and $(1) million,
respectively.
The adjustments in the third and fourth quarters of 2003 resulted
primarily from factors that the Company has historically used in its
internal claims reconciliation process. The internal reconciliation process
involves reconciling fees and savings associated with each medical claim,
the eligibility of each Plan member, the allowability of each claim in
relation to the Plan definition and the coordination of benefits with other
insurers. This internal claims reconciliation process has been typically
performed within nine to twelve months after year-end. In addition, the MHBP
may include an audit performed by a governmental agency within three to five
years after a fiscal year end. This retrospective review of claims data may
result in changes to previous estimates made for eligibility, coordination
of benefits and other Plan provisions. The claims reconciliation process
related to 2002 Plan revenue was completed in the third and fourth quarters
of 2003 and increased 2003 revenue attributable to the Plan by $14 million.
The MHBP contract was renegotiated as of January 1, 2003 at a significantly
lower PPO savings rate which effectively reduced PPO revenue recorded
in 2003 and beyond. Based upon the savings rate reduction, lower plan
enrollment in 2004, lower MHBP participant utilization, lower medical trend
and a changing mix of enrollment between Plan options in the first quarter
of 2004, the Company lowered its revenue outlook for the full year of 2004.
In addition, the Company does not anticipate a material adjustment to
revenue from the 2004 internal claims reconciliation process (related to
2003 claims) due to a more efficient process and lower effective fees earned
on 2003 participant savings. The Company was unable to discern this
information or the related trend until the end of the first quarter of 2004.
The trend with respect to the revenue from the Plan is discussed in the
"2004 Outlook." See the "Critical Accounting Policies" section for a
further description of revenue adjustments.
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, 2004, the Plan has approximately $405 million in reserves to cover Plan
expenses that may exceed the premiums charged and collected from the Plan
participants by the Plan sponsor. There are no known Plan deficits as of
March 31, 2004.
Acquisitions
------------
On October 31, 2003, the Company completed the acquisition of all of the
outstanding shares of capital stock of Health Net Employer Services, Inc.
("Employer Services") from Health Net, Inc. for approximately $79 million.
The purchase also included Health Net Plus Managed Care Services, Inc. and
Health Net CompAmerica, Inc. Employer Services is a workers' compensation
managed care company based in Irvine, California. The acquisition was
financed with borrowings under the Company's credit facility. Health
Net Employer Services, Inc. is being renamed First Health Employer Services,
Inc.
On October 31, 2003, the Company also completed the acquisition of PPO
Oklahoma for a purchase price of $10 million, subject to certain purchase
price considerations. PPO Oklahoma operates almost exclusively in the state
of Oklahoma. The acquisition was financed with borrowings under the
Company's credit facility.
In April 2004, the Company completed the acquisition of COMP Medical, a
workers' compensation company headquartered in Woodland Hills, California
that specializes in appointment setting for chronic pain management,
diagnostic imaging and electrodiagnostic procedures, as well as Medicare
set-aside allocations. The purchase price was $6 million, subject to
additional purchase price considerations depending on future performance,
and was paid with cash from operating activities. COMP Medical has been
renamed First Health Priority Services, Inc.
Termination Plan
----------------
During the quarter ended March 31, 2004, the Company initiated a plan to
terminate approximately 200 employees at an estimated cost of $1.4 million
in termination benefits. The Company recorded substantially all of these
costs in the quarter ended March 31, 2004 with the remaining costs to be
recorded over the second and third quarters of 2004. Management believes
this termination plan should save the Company in excess of $7 million in
salaries and related expenses during the second half of 2004 and in excess
of $10 million in expenses during 2005 (primarily in cost of services in the
consolidated statement of operations).
Results of Operations
---------------------
The Company's revenues consist primarily of fees for cost management
services provided on a predetermined contractual basis or on a percentage-
of-savings basis. Revenues also include insurance premium revenue from the
Company's insurance company operations.
The following table sets forth information with respect to the sources of
the Company's revenues for the three months ended March 31, 2004 and 2003,
respectively:
Sources of Revenue
($ in millions)
Three Months Ended March 31,
------------------------------
2004 % 2003 %
------ ---- ------ ----
Commercial Revenue:
Group Health:
PPO plus Administration
Services $ 84.0 39% $ 88.9 42%
PPO 34.7 16 40.9 19
Premiums 9.1 4 4.2 2
------ ---- ------ ----
Total Group Health 127.8 59 134.0 63
------ ---- ------ ----
Workers' Compensation:
PPO plus Administration
Services 32.2 15 25.0 12
PPO 18.8 8 15.2 7
------ ---- ------ ----
Total Workers' Compensation 51.0 23 40.2 19
------ ---- ------ ----
Total Commercial Revenue 178.8 82 174.2 82
------ ---- ------ ----
Public Sector Revenue 39.3 18 39.6 18
------ ---- ------ ----
Total Revenue $ 218.1 100% $ 213.8 100%
====== ==== ====== ====
Supplemental Revenue Information
Effective for the quarter ending March 31, 2004, the Company is providing
the following supplemental information by revenue sector:
-----------------------------------------------------------------------
Year ended December 31, 2001
-----------------------------------------------------------------------
1st 2nd 3rd 4th Full
(in millions) Qtr Qtr Qtr Qtr Year
------ ------ ------ ------ ------
Commercial Revenue
Group Health:
FEHBP $ 21.8 $ 25.0 $ 29.1 $ 24.8 $ 100.7
Corporate 46.5 45.3 46.0 44.6 182.4
Insurers/TPA 12.2 10.3 15.2 25.6 63.3
------ ------ ------ ------ ------
Total Group Health 80.5 80.6 90.3 95.0 346.4
------ ------ ------ ------ ------
Workers' Compensation 29.3 28.8 33.1 39.5 130.7
------ ------ ------ ------ ------
Total Commercial 109.8 109.4 123.4 134.5 477.1
------ ------ ------ ------ ------
Public Sector 27.2 29.5 28.8 30.5 116.0
------ ------ ------ ------ ------
Total Revenue $ 137.0 $ 138.9 $ 152.2 $ 165.0 $ 593.1
====== ====== ====== ====== ======
-----------------------------------------------------------------------
Year ended December 31, 2002
-----------------------------------------------------------------------
1st 2nd 3rd 4th Full
(in millions) Qtr Qtr Qtr Qtr Year
------ ------ ------ ------ ------
Commercial Revenue
Group Health:
FEHBP $ 30.2 $ 31.7 $ 63.4 $ 64.5 $ 189.8
Corporate 49.4 49.9 45.2 46.3 190.8
Insurers/TPA 21.3 20.3 22.3 21.7 85.6
------ ------ ------ ------ ------
Total Group Health 100.9 101.9 130.9 132.5 466.2
------ ------ ------ ------ ------
Workers' Compensation 39.2 41.8 40.8 39.5 161.3
------ ------ ------ ------ ------
Total Commercial 140.1 143.7 171.7 172.0 627.5
------ ------ ------ ------ ------
Public Sector 29.3 32.2 33.2 37.8 132.5
------ ------ ------ ------ ------
Total Revenue $ 169.4 $ 175.9 $ 204.9 $ 209.8 $ 760.0
====== ====== ====== ====== ======
-----------------------------------------------------------------------
Year ended December 31, 2003
-----------------------------------------------------------------------
1st 2nd 3rd 4th Full
(in millions) Qtr Qtr Qtr Qtr Year
------ ------ ------ ------ ------
Commercial Revenue
Group Health:
FEHBP $ 59.4 $ 62.4 $ 71.9 $ 74.6 $ 268.3
Corporate 52.2 50.9 47.8 45.7 196.6
Insurers/TPA 22.4 20.9 18.2 24.3 85.8
------ ------ ------ ------ ------
Total Group Health 134.0 134.2 137.9 144.6 550.7
------ ------ ------ ------ ------
Workers' Compensation 40.2 40.2 39.1 48.6 168.1
------ ------ ------ ------ ------
Total Commercial 174.2 174.4 177.0 193.2 718.8
------ ------ ------ ------ ------
Public Sector 39.6 44.2 42.7 45.6 172.1
------ ------ ------ ------ ------
Total Revenue $ 213.8 $ 218.6 $ 219.7 $ 238.8 $ 890.9
====== ====== ====== ====== ======
--------------------------------
Qtr ended
(in millions) 3/31/04
--------------------------------
Commercial Revenue
Group Health:
FEHBP $ 58.7
Corporate 44.0
Insurers/TPA 25.1
------
Total Group Health 127.8
------
Workers' Compensation 51.0
------
Total Commercial 178.8
------
Public Sector 39.3
------
Total Revenue $ 218.1
======
This supplemental revenue data provides information about the mix
of clients within the Company's revenue sectors. In addition to the
supplemental information above, the Company has generated approximately 41%,
41%, 46% and 50% of total Company revenues on a percentage-of-savings basis
for the three months ended March 31, 2004 and the years ended December 31,
2003, 2002 and 2001, respectively.
Total revenue for the three months ended March 31, 2004 of $218.1
million increased $4.4 million (2%) from the first quarter of 2003 and
decreased $20.6 million (9%) from the fourth quarter of 2003. The components
of the Company's quarterly revenue are as follows:
Group Health revenue of $127.8 million for the three months ended March
31, 2004 decreased $6.2 million (5%) from the first quarter of 2003 and
decreased $16.8 million (12%) from the fourth quarter of 2003. Group Health
revenue represents revenue from the corporate, FEHBP, small group carrier
and third party administrator payors. Group Health PPO plus Administration
Services revenue for the three months ended March 31, 2004 decreased $4.9
million (6%) from the comparable period of 2003 due in part to increased
price competition plus higher client attrition than expected. PPO plus
Administration Services revenue decreased $14.5 million (15%) from the
fourth quarter of 2003 due primarily to a $17 million decrease in revenue
from the Plan (due in part to a 10% decline in Plan enrollment and in part
to $6 million in revenue recorded in the fourth quarter related to the 2002
adjustment process, net of reserves) and the increased price competition and
higher client attrition mentioned above. Group Health PPO revenue for the
three months ended March 31, 2004 decreased $6.1 million (15%) from the
first quarter of 2003 and $2.6 million (7%) from the fourth quarter of 2003
due primarily to clients taking advantage of a wider array of the Company's
services (which is reported under PPO plus Administration Services). Premium
revenue for the three months ended March 31, 2004 increased $4.8 million
(114%) from the comparable period of 2003 as a result of new-client
activity, particularly due to the New England Financial ("NEF") block of
small group, multi-sited business the Company signed in the fourth quarter
of 2003. This business is expected to generate approximately $20 million in
annual premium revenue for the Company. The Company ceded 80% of the
premiums and related policy benefits to a highly rated insurance carrier.
Premium revenue was consistent with the fourth quarter of 2003.
Workers' Compensation revenue of $51.0 million for the three months
ended March 31, 2004 increased $10.9 million (27%) and $2.5 million (5%)
from the first and fourth quarters of 2003, respectively. The increase from
the first quarter of 2003 is due primarily to $15.7 million in revenue
from the Employer Services acquisition. Absent the acquisition, workers'
compensation revenue would have decreased due to lower volumes from existing
clients and to new legislation in California regarding fee schedule rates
for ambulatory care services. The increase from the fourth quarter of 2003
is due primarily to a full quarter of Employer Services activity in the
first quarter of 2004 versus two months of activity in the fourth quarter of
2003. Approximately 74%, 71% and 73% of Workers' Compensation revenue is
generated on a percentage-of-savings basis during the quarter ended March
31, 2004, the quarter ended March 31, 2003 and the quarter ended December
31, 2003, respectively.
Public Sector revenue of $39.3 million for the three months ended March
31, 2004 was consistent with the same period of 2003. Public Sector revenue
decreased $6.3 million (14%) from the fourth quarter of 2003 due primarily
to a decrease in revenue from one-time HIPAA support implementations and
fees associated with pharmacy programs that were completed in 2003. None of
the Public Sector revenue is generated on a percentage-of-savings basis.
Cost of services increased $10.2 million (11%) for the three months
ended March 31, 2004 from the comparable period in 2003 due primarily to
costs associated with the Employer Services acquisition and, to a lesser
extent, costs associated with the Company's termination plan. Cost of
services was essentially flat compared to the fourth quarter of 2003. 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 48.8% for the three months ended March 31, 2004 from 45.0% and
44.5% in the first and fourth quarters of 2003, respectively. The increase
as a percentage of revenue is due primarily to a change in the mix of
Company business from PPO business to more cost-intensive administration
services. The Company has taken a number of key steps in 2004 to improve
profitability (see "Termination Plan" above and "2004 Outlook" below).
Selling and marketing costs for the three months ended March 31, 2004
decreased $0.1 million (1%) and $6.5 million (24%) from the first and fourth
quarters of 2003, respectively. The decrease is due primarily to the
reduction in spending on national advertising campaigns, particularly for
the Plan. The Company incurred in excess of $7 million of incremental costs
during the fourth quarter of 2003 related to the open season enrollment of
MHBP members.
General and administrative costs for the three months ended March 31,
2004 increased $4.4 million (29%) from the comparable period in 2003 due
primarily to increases in professional liability insurance and other
professional fees associated with cost savings initiatives designed to
improve efficiencies and profitability. General and administrative costs
were essentially flat compared to the fourth quarter of 2003.
Healthcare benefits represent medical losses incurred by insureds of
the Company's insurance entities. Healthcare benefits for the three months
ended March 31, 2004 increased $1.2 million (22%) from the comparable period
of 2003 and decreased $1.1 million (15%) from the fourth quarter of 2003.
The increase from the first quarter of 2003 is due primarily to new
business, particularly the NEF block of business discussed above. The
decrease from the fourth quarter of 2003 is due to better experience within
the Company's small group business (particularly in the NEF block of
business). The loss ratio (healthcare benefits as a percent of premium
revenue) was 70% for the three months ended March 31, 2004 compared to 122%
for the first quarter of 2003 and 85% in the fourth quarter of 2003. The
decrease in the loss ratio is due primarily to improved stop-loss experience
and NEF experience in 2004. Management continues to review the book of
business in detail to minimize the loss ratio. Stop-loss insurance is
related to the Company's integrated Commercial services and is used as a way
to attract additional PPO business, which is the Company's most profitable
product.
Depreciation and amortization expenses for the three months ended March
31, 2004 increased $3.3 million (22%) from the first quarter of 2003 and
$1.7 million (10%) from the fourth quarter of 2003 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.
Income from operations of $46.5 million for the three months ended
March 31, 2004 decreased $14.5 million (24%) and $14.9 million (24%) from
the first and fourth quarters of 2003, respectively. Operating margin
(income from operations as a percentage of revenue) decreased to 21.3% in
the first quarter of 2004 from 28.6% in the first quarter of 2003 and 25.7%
in the fourth quarter of 2003. The decrease in income from operations and
operating margin is due to the change in mix of revenue discussed above to
lower-margin administrative services business as well as the expenses the
Company has incurred in the first quarter of 2004 associated with cost
savings initiatives.
Interest income for the three months ended March 31, 2004 increased
$0.4 million (27%) from the first quarter of 2003 and $0.1 million (3%) from
the fourth quarter of 2003. The Company has used $20 million of its
available cash in 2004 to repay debt.
Interest expense for the three months ended March 31, 2004 increased
$0.5 million (41%) and $0.1 million (4%) from the first and fourth quarters
of 2003, respectively. Interest expense has increased as the outstanding
debt increased from $185 million at March 31, 2003 to $250 million at March
31, 2004. The effective marginal interest rate on March 31, 2004 was
approximately 2% per annum.
Diluted net income per common share for the three months ended March
31, 2004 decreased 16% to $.31 per share from the first quarter of 2003 and
decreased 23% from the fourth quarter of 2003. The decrease in net income
per common share was due primarily to the change in revenue mix and the
expenses associated with cost savings initiatives discussed above. For the
three months ended March 31, 2004, diluted common shares outstanding
decreased 7% from the first quarter of 2003 and 2% from the fourth quarter
of 2003.
Segment Information
-------------------
The Company reports its financial results under two segments: the
Commercial segment where the Company provides its health benefit services to
Commercial customers in the Group Health and Workers' Compensation markets
and the Public Sector segment where the Company services are provided to
customers within state and local governments. The Commercial Group Health
market represents payors from the FEHBP, corporate and third party
administrators/insurers sectors. Management believes this presentation
reflects how the Company markets and sells its products and services. In the
Commercial sector, the Company often bundles its products and services to
offer a comprehensive health benefits solution and it does not sell
administrative services (claims administration, bill review, pharmacy
benefit management, clinical management) on a stand-alone basis without PPO
network services. In the Public Sector, the Company offers products and
services more specialized to the needs of the individual customer as public
sector health programs move toward more efficient utilization of health
services.
Commercial Three months ended March 31,
(in millions except %) 2004 2003
---------------------- ------ ------
Revenues $ 178.8 $ 174.2
Operating expenses 132.0 115.6
------ ------
Income from operations 46.8 58.6
------ ------
Operating margin 26% 34%
Interest income (1.7) (1.3)
Interest expense 1.8 1.3
------ ------
Income before income taxes 46.7 58.6
Income taxes (17.7) (23.3)
------ ------
Net income $ 29.0 $ 35.3
====== ======
The decline in income from operations and net income for the Commercial
segment is due to a number of factors including: increased price competition
(particularly in the Corporate sector); new business in the lower margin
third party administrator/insurance sector; lower PPO savings in the FEHBP
sector; and the costs incurred associated with savings initiatives. The
termination plan discussed above is designed to improve the profitability of
the Commercial segment beginning in the second half of 2004.
Public Sector Three months ended March 31,
(in millions except %) 2004 2003
---------------------- ------ ------
Revenues $ 39.3 $ 39.6
Operating expenses 39.6 37.1
------ ------
Income (loss) from operations (0.3) 2.5
Operating margin (1)% 6%
Interest income -- --
Interest expense -- --
------ ------
Income (loss) before
income taxes (0.3) 2.5
Income tax (expense) benefit 0.1 (1.0)
------ ------
Net income (loss) $ (0.2) $ 1.5
====== ======
The decline in income from operations and net income in the Public Sector
segment is due primarily to the timing of costs associated with various
government contracts. The revenue and profitability is expected to increase
going forward in 2004, as certain contract milestones are met and efficiency
initiatives are put in place to help control costs.
Liquidity and Capital Resources
-------------------------------
The Company had $48.9 million in working capital on March 31, 2004
compared with working capital of $24.1 million at December 31, 2003. Total
cash and investments amounted to $162.7 million at March 31, 2004 compared
to $139.7 million at December 31, 2003.
Cash and cash equivalents at March 31, 2004 include $29.9 million
accumulated in the accounts of the Company's insurance entities due to the
timing of the collection of insurance premiums in advance of the related
payments for commissions and payments to re-insurers. Additionally, $6.0
million was set aside in anticipation of the pending acquisition of COMP
Medical.
The Company continues to generate the majority of cash from collection
of its accounts receivables although this amount has declined from the end
of 2003 due to a decrease in Company revenues. The Company has collected $8
million in reinsurance recoverable balances due at the end of 2003 (in
"Other current assets" in the consolidated balance sheets). Cash collected
from the exercise of stock options has declined as was anticipated in the
Company's 2003 Annual Report on Form 10-K.
The Company's most significant uses of cash continue to be for payment
of operating expenses, income taxes and capital expenditures. Management
currently expects that capital expenditures for 2004 will be approximately
8% of revenues, slightly below the 10% investment of the past several years.
The Company anticipates that its operating expenses will decrease in the
second half of 2004 when the steps taken to increase profitability are
expected to take full effect.
The Company's outstanding debt at March 31, 2004 decreased to $250
million from $270 million at December 31, 2003 as the Company used cash
generated from operations to pay down its debt.
The following table summarizes the contractual obligations the Company has
outstanding as of March 31, 2004:
(in millions) Payments due by period
----------------------
Less than 1-3 3-5 Over 5
Contractual Obligations Total 1 year years years years
----------------------- ----- ------ ----- ----- -----
Long-term debt $250.0 $ - $ - $250.0 $ -
Operating leases 53.9 14.1 20.6 12.9 6.3
Purchase obligations 1.0 1.0 - - -
----- ----- ----- ----- -----
Total $304.9 $ 15.1 $ 20.6 $262.9 $ 6.3
===== ===== ===== ===== =====
The purchase obligation is a commitment to a limited partnership
investment. The Company has no capital lease obligations, off-balance sheet
financing arrangements or other contractual obligations as of March 31,
2004.
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 operations and anticipated expansion plans.
2004 Outlook
------------
In April 2004, the Company revised its revenue and earnings
expectations for 2004 to take into account the negative trend it discerned,
primarily with respect to MHBP, at the end of the first quarter of 2004. The
Company's previous revenue estimate related to the FEHBP business was too
high, especially with respect to MHBP revenue. MHBP revenues are expected
to decline in 2004 due primarily to the savings rate reduction, lower
Plan enrollment (approximately 10%), lower MHBP participant utilization,
lower medical trend and a changed mix of enrollment between Plan options.
Moreover, the Company does not anticipate that the adjustments expected
to be made in 2004, which are attributable to 2003 Plan revenue,
will be in amounts similar to the adjustments that were made in 2003
attributable to 2002 Plan revenue. See "Overview" and "Critical Accounting
Policies" for further discussion of the claims reconciliation process.
Revenue expectations in the Corporate Sector have declined as price
competition has accelerated and the Company has realized less new business
than expected. The Company's smallest sector, third party administrators and
insurers, is expected to report revenue in 2004 that will be higher than
2003, but slightly less than previously estimated. Workers' Compensation
revenue is expected to grow rapidly in 2004, principally due to the Employer
Services acquisition, but previous estimates anticipated earlier decisions
from potential new customers and a more profitable mix of new business. The
Company anticipates its Public Sector revenue for 2004 will be flat with
both last year and with previous estimates.
The Company has taken a number of key steps to improve profitability
including the Company's termination plan, operational leadership
consolidation, growth initiatives to develop new market opportunities
(especially in the workers' compensation and public sectors) and initiatives
to drive operational efficiencies (especially in the group health and public
sectors).
Critical Accounting Policies
----------------------------
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States of America and
include amounts based on management's prudent judgments and estimates.
Management believes that any reasonable deviation from these judgments and
estimates would not have a material impact on the Company's financial
position or results of operations. 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 - Significant estimates used in recognizing revenue
relate to performance guarantees, other client-specific claim, eligibility
and other data adjustments, and recoverability of receivables. Adjustments
to PPO savings, and, therefore, PPO revenues, occur due to client
corrections of member eligibility data as originally submitted or due to
certain client's inability to resubmit claims adjustments to the Company's
repricing system. In addition, the Company performs a claims reconciliation
process which varies client-by-client and, in some cases, such as with
the MHBP, is performed a number of months after year-end. The claims
reconciliation process is affected by a number of items including:
size of enrollment; volume of claims data; a client's technological
infrastructure; structure of the benefit plan(s); and the specific terms of
the client contract. MHBP is the Company's largest client and presents a
complex combination of these items above which results in a lengthy
reconciliation process. The Company records adjustments in the current
accounting period; further adjustments may be made in future periods based
on new information that becomes available in such future periods. In some
cases, such as with the MHBP, the adjustment process is also subject to
an external audit performed by a governmental agency. The use of such
estimates and the claims reconciliation process enables the Company to
report PPO fee revenue more accurately as information becomes available to
support entitlement to fees, net of actual adjustments. Revenue adjustments
are estimated on a client-specific and aggregated basis using actual,
historical adjustment data. Valuation allowances recorded for such matters
were $38.1 million at March 31, 2004 and $36.5 million at December 31,
2003. Total adjustments to revenue amounted to a reduction of less than 1%
of total Company revenue for the three months ended March 31, 2004 and a
positive revenue adjustment of less than 1% of total Company revenue for the
three months ended March 31, 2003.
Allowance for doubtful accounts - The Company provides reserves for
uncollectible revenue due to client collectibility issues as an allowance
for doubtful accounts. The primary reason for nonpayment of these accounts
receivable is due to client bankruptcy, insolvency or disputes over
eligibility. The methodology for calculating the allowance for doubtful
accounts includes an assessment of specific receivables that are aged and an
assessment of the aging of the total receivable pool. Substantially all
of the Public Sector revenue is received from state and local governments.
The Company's experience with recovering receivables related to Public
Sector revenue is impacted primarily by contract disputes, changes in
administrative personnel and the timing of fiscal appropriations relative to
the billing of our services. The reserving methodology for Public Sector
receivables provides for a longer collection period compared to Commercial
receivables. The Company evaluates the recoverability of Public Sector
receivables based on the aging of receivables, with additional consideration
given to clients with known fiscal appropriations issues. The allowance for
doubtful accounts totaled $21.5 million at March 31, 2004 and $21.1 million
at December 31, 2003.
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 Statement of Financial
Accounting Standards 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 effect of SFAS 146 is discussed earlier in the MD&A (under the caption
"Termination Plan") and in Note 8 to the consolidated financial statements.
Effective January 1, 2003, the Company adopted FASB 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 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. The adoption of FIN 45 had no impact on the Company's financial
position, results of operations or cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
The Company's market risk exposure as of March 31, 2004 was consistent
with the types of market risk and amount of exposure presented in its 2003
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 March 31, 2004, the end of the quarter covered by this report,
management carried out an evaluation, with the participation of the
Company's Chief Executive Officer and 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 as of March 31, 2004.
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 Company and its subsidiaries are subject to various claims arising
in the ordinary course of business and are parties to various legal
proceedings that constitute litigation incidental to the business of the
Company and its subsidiaries. The Company does not believe that the outcome
of such matters will have a material effect on the Company's financial
position or results of operations.
Item 2. Changes in Securities and Use of Proceeds
-----------------------------------------
The following table summarizes any purchases of the Company common
stock made by or on behalf of the Company for the quarter ended March 31,
2004.
Total # of Maximum # of
shares purchased shares that
as part of may yet be
Total # Average publicly purchased
of shares price paid announced under the
Period purchased per share programs programs
------ --------- --------- -------- ---------
Jan 1 - Jan 31 -- -- -- 6,109,841
Feb 1 - Feb 29 -- -- -- 6,109,841
March 1 - Mar 31 -- -- -- 6,109,841
--------- --------- -------- ---------
Total -- -- -- 6,109,841
========= ========= ======== =========
Item 5. Other Information
-----------------
There has been no material change to the procedures by which security
holders may recommend nominees to the Company's Board of Directors.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibits:
(a) Exhibit 10.1 - Employment Agreement dated March 22,
2004 between First Health Group Corp. and William R.
McManaman.
(b) Exhibit 10.2 - Stock Option Agreements dated March 22,
2004 by and between First Health Group Corp. and
William R. McManaman
(c) Exhibit 11 - Computation of Basic Earnings Per Common
Share and Diluted Earnings Per Common Share
(d) Exhibit 31.1 - Certification of Chief Executive
Officer pursuant to Rule pursuant 13a - 14(a) and
Rule 15d - 14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
(e) Exhibit 31.2 - Certification of Chief Financial
Officer pursuant to Rule pursuant 13a - 14(a) and
Rule 15d - 14(a), promulgated under the Securities
Exchange Act of 1934, as amended.
(f) 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.
(g) 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 February 17, 2004
reporting under Item 12 the results of operations and financial
condition for the year ended December 31, 2003.
The Company filed a report on Form 8-K dated March 22, 2004
reporting under Item 5 announcing the appointment of William R.
McManaman as Senior Vice President and Chief Financial Officer.
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 10, 2004 /s/Edward L. Wristen
-------------------------------------
Edward L. Wristen
President and Chief Executive Officer
Dated: May 10, 2004 /s/William R. McManaman
-------------------------------------
William R. McManaman
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)