TEAM HEALTH INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q EQUIVALENT(1)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

[ ] 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 333-80337

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TEAM HEALTH, INC.
(Exact name of registrant as specified in its charter)

TENNESSEE 62-1562558
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)

1900 WINSTON ROAD
SUITE 300
KNOXVILLE, TENNESSEE 37919
(865) 693-1000
(Address, zip code, and telephone number, including
area code, of registrant's principal executive office.)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 and 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods 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 Exchange Act Rule 12b-2) Yes [ ] No [X]

Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.

Common Stock par value $0.01 per share -- 9,797,555 shares as of August 6,
2004.
- ---------------
(1) This Form 10-Q Equivalent is only being filed solely pursuant to a
requirement contained in the indenture governing Team Health, Inc.'s 9%
Senior Subordinated Notes due 2012.

FORWARD LOOKING STATEMENTS

Statements in this document that are not historical facts are hereby
identified as "forward looking statements" for the purposes of the safe harbor
provided by Section 21E of the Securities Exchange Act of 1934 (the "Exchange
Act") and Section 27A of the Securities Act of 1933 (the "Securities Act"). Team
Health, Inc. (the "Company") cautions readers that such "forward looking
statements", including without limitation, those relating to the Company's
future business prospects, revenue, working capital, professional liability
expense, liquidity, capital needs, interest costs and income, wherever they
occur in this document or in other statements attributable to the Company, are
necessarily estimates reflecting the judgment of the Company's senior management
and involve a number of risks and uncertainties that could cause actual results
to differ materially from those suggested by the "forward looking statements".
Such "forward looking statements" should, therefore, be considered in light of
the factors set forth in "Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations".

The "forward looking statements" contained in this report are made under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations". Moreover, the Company, through its senior management,
may from time to time make "forward looking statements" about matters described
herein or other matters concerning the Company.

The Company disclaims any intent or obligation to update "forward looking
statements" to reflect changed assumptions, the occurrence of unanticipated
events or changes to future operating results over time.

TEAM HEALTH, INC.

QUARTERLY REPORT FOR THE THREE MONTHS
ENDED JUNE 30, 2004

1

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TEAM HEALTH, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to financial statements
2

TEAM HEALTH, INC

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to financial statements.
3

TEAM HEALTH, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to financial statements.
4

TEAM HEALTH, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to financial statements.
5

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the
accounts of Team Health, Inc. (the "Company") and its wholly owned subsidiaries
and have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial reporting and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and notes required by accounting principles
generally accepted in the United States for complete financial statements.
Certain prior year amounts have been reclassified to conform to the current year
presentation.

In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of normal recurring
items) necessary for a fair presentation of results for the interim periods
presented. The results of operations for any interim period are not necessarily
indicative of results for the full year. The consolidated balance sheet of the
Company at December 31, 2003 has been derived from the audited financial
statements at that date, but does not include all of the information and
disclosures required by accounting principles generally accepted in the United
States for complete financial statements. These financial statements and
footnote disclosures should be read in conjunction with the December 31, 2003
audited consolidated financial statements and the notes thereto included in the
Company's Form 10-K Equivalent.

The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
consolidated financial statements and notes. Actual results could differ from
those estimates.

Our business of providing healthcare staffing comprises a single reportable
segment under Statement of Financial Accounting Standards (SFAS) No. 131,
Disclosures About Segments of an Enterprise and Related Information.

NOTE 2. IMPLEMENTATION OF NEW ACCOUNTING STANDARDS

On December 31, 2002, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 148, Accounting
for Stock-Based Compensation -- Transition and Disclosure. SFAS No. 148 amends
SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition to the fair value method of accounting for stock-based
employee compensation under SFAS No. 123. SFAS No. 148 also amends the
disclosure provisions of SFAS No. 123 and APB Opinion No. 28, Interim Financial
Reporting, to require disclosure in the summary of significant accounting
policies of the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported earnings in annual and interim
financial statements. While the Statement does not amend SFAS No. 123 to require
companies to account for employee stock options using the fair value method, the
disclosure provisions of SFAS No. 148 are applicable to all companies with
stock-based employee compensation, regardless of whether the accounting for that
compensation is using the fair value method of SFAS No. 123 or the intrinsic
value method of Opinion 25.

As more fully discussed in Note 10, the Company adopted the disclosure
requirements of SFAS No. 148 and the fair value recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, prospectively to all new
awards granted to employees after January 1, 2003.

6

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 3. NET REVENUE

Net revenue for the three and six months ended June 30, 2004 and 2003,
respectively, consisted of the following (in thousands):

NOTE 4. IMPAIRMENT OF GOODWILL

During the six months ended June 30, 2004, the Company derived
approximately $123.9 million of revenue for services rendered to military
personnel and their dependents as a subcontractor under the TRICARE program
administered by the Department of Defense. Civilian staffing for the provision
of health care services provided under the TRICARE program is provided through
several different sources, including the direct hiring of health care related
personnel by the military, contracting with managed care support contractors to
provide health, medical and administrative support services to its eligible
beneficiaries, and through direct contracting with health care staffing
organizations. The Company has historically provided its services principally
through subcontract arrangements with managed care organizations that have
contracted directly with the TRICARE program.

On August 1, 2002, the Department of Defense issued a request for proposals
for the next generation of managed care support contracts, also known as the
"TRICARE Contracts". The intent of the TRICARE Contracts is to replace the
existing managed care support contracts on a phased-in basis between June 1 and
November 1, 2004.

The Department of Defense and its various military branches are currently
in the process of procuring the civilian positions that they require going
forward. The process of awarding healthcare staffing contracts by the government
to date has varied by branch of the military and by military base. The award
process has included soliciting requests for proposals from organizations that
provide civilian health care staffing, including the use of restrictive
government or military approved vendor lists, some of which do not include the
Company. In other instances, the military has re-bid its business on a basis
that is inclusive of existing providers, such as the Company, without the use of
restricted vendor lists. Furthermore, the awarding of certain bids has been
restricted to small business or minority qualified businesses for which the
Company is not eligible to even bid for the contracts.

As of July 15, 2004, the following is a summary of the Company's military
staffing revenues that are subject to re-bidding under the new TRICARE program
contracting process (in thousands):

Annual revenue derived from contracts subject to
re-bidding................................................ $210,700
Amount of revenue re-bid to date............................ $145,200
Amount of annual revenues submitted for re-bidding awarded
to date................................................... $132,600
Annual revenue value of bids won to date (including new
business of $26.5 million)................................ $ 93,500
Percentage of revenue retained or new business won to total
of annual revenue re-bidded and awarded to date........... 71%

The total impact on the results of operations and financial condition of
the Company resulting from the changes in the TRICARE Contracts program is not
known at this time. The remaining estimated impact on

7

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the results of operations of the Company is dependent on the Company's ability
to successfully retain its existing staffing business that is still subject to
the re-bidding process, as well as winning new business as it is put out to bid
by the military. In addition, the Company will experience as a result of the
re-bidding process a decline in its operating margins for its military business
prior to any reductions in related administrative related expenses.

Management has concluded that the Company's existing revenues and operating
margins will be materially adversely affected as a result of the re-bidding
process. The Company as of June 30, 2004, had $127.9 million of goodwill related
to its military staffing business prior to recognition of any impairment loss
related to it. Based on the results of the re-bidding process known through July
15, 2004, along with projections of the estimated results of the remaining
business to be subject to re-bidding, management has concluded that a portion of
such goodwill has been impaired. The Company has recorded an estimated goodwill
impairment loss based on the fair value of comparable healthcare staffing
companies. The amount of estimated goodwill impairment loss recorded in the
three months ended June 30, 2004 was $65.8 million. A final determination of the
impairment loss will be known following the completion of the re-bidding process
which is scheduled to be completed by November 1, 2004. The estimated impairment
loss will be adjusted, if necessary, when such final determination is known
later in 2004.

NOTE 5. OTHER INTANGIBLE ASSETS

The following is a summary of intangible assets and related amortization as
of June 30, 2004 and December 31, 2003 (in thousands):

As of June 30, 2004, the Company may have to pay up to $8.4 million in
future contingent payments as additional consideration for acquisitions made
prior to June 30, 2004. These payments will be made and recorded as additional
goodwill should the acquired operations achieve the financial targets agreed to
in the

8

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

respective acquisition agreements. During the six months ended June 30, 2004,
the Company made $2.3 million cash payments related to previous acquisitions.

NOTE 6. PROFESSIONAL LIABILITY INSURANCE

The Company provides for its estimated professional liability losses
through a combination of self-insurance and commercial insurance programs.
Beginning March 12, 2003, such risks are principally being provided for through
a self-insurance program with a portion of such risks ("claims-made" basis)
transferred to and funded into a captive insurance company. The accounts of the
captive insurance company are fully consolidated with those of the other
operations of the Company in the accompanying financial statements. The
self-insurance program includes reserves for future claims incurred but not
reported. The Company's provisions for losses under the self-insurance program
are estimated using the results of periodic actuarial studies performed by an
independent actuarial firm. Such actuarial studies include numerous underlying
estimates and assumptions, including assumptions as to future claim losses, the
severity and frequency of such projected losses, loss development factors and
others.

During the three months ended June 30, 2004, the Company reduced loss
estimates totaling $2.0 million recorded in prior years for professional
liability claims in excess of commercially insured limits. An ongoing review of
claims related to such loss estimates has now resulted in the conclusion that
such claims are more likely than not to be settled or dismissed so as to result
in no loss to the Company in excess of insured amounts for the applicable
periods. The conclusion reached in the period was based on the time elapsed from
the insured periods, the settlement of certain claims at amounts less than
insured limits and a review of remaining claims by both the Company's risk
managers and third-party claim examiners for the estimated dollar level exposure
for reported claims.

During the period March 12, 1999 through March 11, 2003, the primary source
of the Company's coverage for such risks was a professional liability insurance
policy provided through one insurance carrier. The policy with the Company's
primary insurance carrier for such coverage and period provided coverage for
potential liabilities on a "claims-made" basis. The policy included the ability
for the Company to be able to exercise a "tail" premium option. The option for
the tail premium was exercised by the Company effective March 11, 2003, and its
cost of approximately $30.6 million, was paid in April 2003. The Company had
previously recorded the cost of such option over the four-year period ended
March 11, 2003. The tail premium option included an aggregate limit of $130.0
million that included claims reported during the two-year period ended March 12,
2003, as well as all incurred but not reported claims during the period March
12, 1999 to March 11, 2003. An actuarial study of the Company's potential loss
exposure under the aggregate limit of $130.0 million done prior to exercising
the tail premium resulted in the Company recording a provision in the three
months ended March 31, 2003 of $50.8 million for projected losses in excess of
the aggregate limit. Such loss estimate was net of a discount of 4% over the
projected future payment periods

The Company's provisions for losses subsequent to March 11, 2003, that are
not covered by commercial insurance company coverage are subject to subsequent
adjustment should future actuarial projected results for such periods indicate
projected losses are greater or less than previously projected. In addition, the
results of future actuarial studies may result in the loss estimate provision
under the aggregate policy limit to be further adjusted upward or downward as
actual results are realized over time.

9

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 7. LONG-TERM DEBT

Long-term debt as of June 30, 2004, consisted of the following (in
thousands):

Term Loan B................................................. $249,375
9% Senior Subordinated Notes................................ 180,000
--------
429,375
Less current portion........................................ 2,500
--------
$426,875
========

The Company's senior credit facilities consist of the following:

- $80.0 million Senior Secured Revolving Credit Facility

- $249.4 million Senior Secured Term Loan B

The interest rates for any senior revolving credit facility borrowings are
determined by reference to a grid that is based on the consolidated ratio of
total funded debt to earnings before interest, taxes, depreciation and
amortization (EBITDA), as defined in the credit agreement. The interest rate on
the Term Loan B amount outstanding is equal to the euro dollar rate plus 3.25%
or the agent bank's base rate plus 1.75%. The interest rate at June 30, 2004,
was 4.84% for the Term Loan B. The Company also pays a commitment fee for the
revolving credit facility which was equal to 0.5% of the commitment at June 30,
2004. No funds have been borrowed under the revolving credit facility as of June
30, 2004, but the Company had $3.9 million of standby letters of credit
outstanding against the revolving credit facility commitment.

The Company has an obligation under the terms of the senior credit facility
agreement to obtain and maintain interest rate hedge agreements at amounts such
that 50% of the Company's funded debt, as defined, was at fixed rates of
interest. Such hedge agreements are required to be maintained for at least the
first three years of the senior credit facility agreement. On April 29, 2004,
the Company entered into an interest rate swap agreement that effectively
converted $35.0 million of its variable rate Term B loan to a fixed rate of 3.2%
through March 31, 2007.

The Company issued on March 23, 2004, 9% Senior Subordinated Notes in the
amount of $180.0 million, due April 1, 2012.

Aggregate maturities of long-term debt due within one year of June 30, 2004
are currently as follows (in thousands):

2005........................................................ $ 2,500
2006........................................................ 2,500
2007........................................................ 2,500
2008........................................................ 2,500
Thereafter.................................................. 419,375
--------
$429,375
========

The senior credit facility agreement and the 9% bond indenture contain both
affirmative and negative covenants, including limitations on the Company's
ability to incur additional indebtedness, sell material assets, retire, redeem
or otherwise reacquire its capital stock, acquire the capital stock or assets of
another business, pay dividends, and requires the Company to meet or exceed
certain coverage and leverage ratios. In addition, the senior credit agreement
includes a provision for the prepayment of a portion of the outstanding term
loan amounts at any year-end if the Company generates "excess cash flow" as
defined in the agreement.

10

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Effective March 23, 2004, the Company completed a tender offer for its then
outstanding 12% Senior Subordinated Notes in the amount of $100.0 million, plus
a call premium of $8.0 million and entered into its current senior credit
facilities with a group of banks. As a result of the tender offer, approximately
$91.7 million of the 12% Senior Subordinated Notes were repaid and in addition a
related call premium of approximately $7.5 million was paid on March 23, 2004.
The remainder of the approximately $8.3 million 12% Senior Subordinated Notes
outstanding were subsequently repaid on April 21, 2004, along with a call
premium of approximately $0.7 million. As a result of entering into the new
senior credit facilities and the redemption of its 12% Subordinated Notes, the
Company recognized in the six months ended June 30, 2004, refinancing costs of
approximately $14.7 million ($9.0 million net of related income tax benefit of
$5.7 million) principally relating to the write-off of capitalized financing
costs on its previously outstanding long-term debt and the incurrence of the
call premium to redeem the 12% Senior Subordinated Notes. In addition, as a
result of repayment of underlying borrowings during the three months ended March
31, 2004, the Company recorded as additional interest expense approximately $1.7
million in the three months ended March 31, 2004, related to an interest rate
swap agreement to reflect its value on a mark-to-market basis. The interest rate
swap agreement was terminated subsequent to March 31, 2004.

NOTE 8. REDEMPTION OF 10% CUMULATIVE PREFERRED STOCK

During the three months ended March 31, 2004, the Board of Directors of the
Company authorized the redemption of the Company's 10% Cumulative Preferred
Stock. On March 23, 2004, the Company redeemed its 10% Cumulative Preferred
Stock in the amount of approximately $162.4 million, including accrued
dividends.

NOTE 9. COMMON STOCK DIVIDEND AND RELATED COMPENSATORY BONUS PAYMENT

The Company's Board of Directors declared a cash dividend to shareholders
of record as of March 18, 2004, in the amount of approximately $27.6 million
which was subsequently paid on March 23, 2004. The Board of Directors also
authorized a compensatory payment to holders of stock options in lieu of a cash
dividend in the amount of approximately $2.4 million of which $1.3 million was
paid and expensed on March 23, 2004, with the balance of $1.1 million to be paid
and expensed in future periods as such stock options vest.

NOTE 10. STOCK OPTIONS

Effective January 1, 2003, the Company adopted the fair value recognition
provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
prospectively to all new awards granted to employees after January 1, 2003.
Prior to January 1, 2003 the Company applied the recognition and measurement
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations in accounting for options awarded. Therefore, the
expense related to stock-based employee compensation included in the
determination of net earnings (loss) for the three and six months ended June 30,
2004 and 2003 is less than that which would have been recognized if the fair
value method had been applied to all awards. The following

11

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

table illustrates the effect on net earnings (loss) if the fair value method had
been applied to all outstanding and unvested awards in each period (in
thousands):

NOTE 11. CONTINGENCIES

LITIGATION

We are party to various pending legal actions arising in the ordinary
operation of our business such as contractual disputes, employment disputes and
general business actions as well as professional liability actions. We believe
that any payment of damages resulting from these types of lawsuits would be
covered by insurance, exclusive of deductibles, would not be in excess of
related reserves, and such liabilities, if incurred, should not have a
significant negative effect on the results of operations and financial condition
of our Company.

INDEMNITY

In connection with the acquisition of a company that specializes in
providing medical staff providers to military treatment facilities on May 1,
2002, subject to certain limitations, the previous shareholders of such company
and its related entities have indemnified the Company up to a limit of $10.0
million relating to any potential claims asserted against the acquired company
during the three years subsequent to the date of its acquisition related to tax
matters whose origin was attributable to tax periods prior to May 1, 2002.

HEALTHCARE REGULATORY MATTERS

Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. Compliance with such laws and regulations
can be subject to future governmental review and interpretation as well as
significant regulatory action. From time to time, governmental regulatory
agencies will conduct inquiries and audits of the Company's practices. It is the
Company's current practice and future intent to cooperate fully with such
inquiries.

In addition to laws and regulations governing the Medicare and Medicaid
programs, there are a number of federal and state laws and regulations governing
such matters as the corporate practice of medicine and fee splitting
arrangements, anti-kickback statutes, physician self-referral laws, false or
fraudulent claims filing and patient privacy requirements. The failure to comply
with any of such laws or regulations could have an adverse impact on our
operations and financial results. It is management's belief that the Company is
in substantial compliance in all material respects with such laws and
regulations.

12

TEAM HEALTH, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ACQUISITION PAYMENTS

As of June 30, 2004, the Company may have to pay up to $8.4 million in
future contingent payments as additional consideration for acquisitions made
prior to June 30, 2004. These payments will be made and recorded as additional
purchase price should the acquired operations achieve the financial targets
agreed to in the respective acquisition agreements.

OFFICE OF INSPECTOR GENERAL INFORMATION REQUEST

On March 30, 2004, the Company received a subpoena from the Department of
Health and Human Services Office of Inspector General ("OIG") located in
Concord, California requesting certain information for the period 1999 to
present relating to the Company's billing practices. To date the Company has
produced and delivered to the OIG certain requested information. The OIG to date
has not provided the Company with the reason for the subpoena. However, based on
conversations with a representative of the OIG and the civil division of the
United States Attorney for the Northern District of California, the Company
believes the focus of the OIG relates to the Company's procedures surrounding
the processing of credit balances relating to its fee-for-service billing
volume. Based on these same conversations, the Company believes that the basis
for the issuing of this subpoena is a complaint filed by an individual on behalf
of the government.

The Company is fully cooperating with this request and has been producing
and delivering to the OIG the requested documents. However, due to the lack of
more specific information available to the Company at this time, we are unable
to ascertain the full scope of the government's inquiry. Management believes
that its billing practices are in substantial compliance with all regulatory
requirements. Nevertheless, management at this time can not predict the outcome
of the matter or whether it will have a material adverse effect on the Company's
business, financial condition or results of operations.

POTENTIAL TAX ASSESSMENT

The Company had previously received a Notice of Proposed Adjustment (NOPA)
from the Internal Revenue Service (IRS) relating to audits of its federal
corporate income tax returns for 2000 and 2001. As the result of receiving a
favorable ruling by the Office of the Regional Director of Appeals in connection
with the 1999 tax returns of two of its affiliated professional corporations,
the Company has subsequently been verbally advised by the local agent that the
proposed adjustments for the Company's 2000 and 2001 federal corporate income
tax returns have been rescinded. The Company is currently awaiting formal
confirmation of the agent's decision by the IRS.

NOTE 12. COMPREHENSIVE EARNINGS

The components of comprehensive earnings, net of related taxes, are as
follows (in thousands):

13

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

INTRODUCTION

We are a national provider of outsourced physician staffing and
administrative services to hospitals and other healthcare providers in the
United States and a provider of outsourced physician staffing and administrative
services to military treatment facilities. In addition to providing physician
staffing, we also provide a broad array of non-physician health care services,
including specialty technical staffing, para-professionals and nurse staffing on
a permanent basis to the military.

Our regional operating models include comprehensive programs for emergency
medicine, radiology, anesthesiology, inpatient care, pediatrics and other health
care services, principally within hospital departments and other healthcare
treatment facilities.

The following discussion provides an assessment of the Company's results of
operations, liquidity and capital resources and should be read in conjunction
with the consolidated financial statements of the Company and notes thereto
included elsewhere in this document.

TRICARE PROGRAM

During the six months ended June 30, 2004, the Company derived
approximately $123.9 million of revenue for services rendered to military
personnel and their dependents as a subcontractor under the TRICARE program
administered by the Department of Defense. Civilian staffing for the provision
of health care services provided under the TRICARE program is provided through
several different sources, including the direct hiring of health care related
personnel by the military, contracting with managed care support contractors to
provide health, medical and administrative support services to its eligible
beneficiaries, and through direct contracting with health care staffing
organizations. The Company has historically provided its services principally
through subcontract arrangements with managed care organizations that have
contracted directly with the TRICARE program.

On August 1, 2002, the Department of Defense issued a request for proposals
for the next generation of managed care support contracts, also known as the
"TRICARE Contracts". The intent of the TRICARE Contracts is to replace the
existing managed care support contracts on a phased-in basis between June and
November 2004.

The Department of Defense and its various military branches are currently
in the process of procuring the civilian positions that they require going
forward. The process of awarding health care staffing contracts by the
government to date has varied by branch of the military and by military base
location within the various branches of the military. The award process has
included soliciting requests for proposals from organizations that provide
civilian health care staffing, including the use of restrictive government or
military approved vendor lists, some of which do not include the Company. In
other instances, the military has re-bid its business on a basis that is
inclusive of existing providers, such as the Company, without the use of
restricted vendor lists. Furthermore, the awarding of certain bids has been
restricted to small business or minority qualified businesses for which the
Company is not eligible to even bid for the contracts.

As of July 15, 2004, the following is a summary of the Company's military
staffing revenues that are subject to re-bidding under the new TRICARE program
contracting process (in thousands):

Annual revenue derived from contracts subject to
re-bidding................................................ $210,700
Amount of revenue re-bid to date............................ $145,200
Amount of annual revenues submitted for re-bidding awarded
to date................................................... $132,600
Annual revenue value of bids won to date (including new
business of $26.5 million)................................ $ 93,500
Percentage of revenue retained or new business won to total
of annual revenue re-bidded and awarded to date........... 71%

The total impact on the results of operations and financial condition of
the Company resulting from the changes in the TRICARE Contracts program is not
known at this time. The remaining impact on the results

14

of operations of the Company is dependent on the Company's ability to
successfully retain its existing staffing business that is still subject to the
re-bidding process, as well as winning new business as it is put out to bid by
the military. In addition, the Company will experience as a result of the
re-bidding process a decline in its operating margin for its military business
prior to any reductions in its administrative related expenses.

Management has concluded that the Company's existing revenues and operating
margins will be materially adversely affected as a result of the re-bidding
process. The Company as of June 30, 2004, has $127.9 million of goodwill related
to its military staffing business prior to recognition of any impairment loss
related to it. Based on the results of the re-bidding process known through July
15, 2004, along with projections of the estimated results of the remaining
business to be subject to re-bidding, management has concluded that a portion of
such goodwill has been impaired. The Company has recorded an estimated goodwill
impairment loss of $65.8 million in the three months ended June 30, 2004. A
final determination of the impairment loss will be known following the
completion of the re-bidding process which is scheduled to be completed by
November 1, 2004. The estimated impairment loss will be adjusted, if necessary,
when such final determination is known later in 2004.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The consolidated financial statements of the Company are prepared in
accordance with accounting principles generally accepted in the United States,
which requires us to make estimates and assumptions. Management believes the
following critical accounting policies, among others, affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.

REVENUE RECOGNITION

Net Revenue. A significant portion (71.9%) of the Company's revenue in the
six months ended June 30, 2004, resulted from fee-for-service patient visits.
The recognition of net revenue (gross charges less contractual allowances) from
such visits is dependent on such factors as proper completion of medical charts
following a patient visit, the forwarding of such charts to one of the Company's
billing centers for medical coding and entering into the Company's billing
systems, and the verification of each patient's submission or representation at
the time services are rendered as to the payer(s) responsible for payment of
such services. Net revenues are recorded based on the information known at the
time of entering of such information into our billing systems as well as an
estimate of the net revenues associated with medical charts for a given service
period that have not been processed yet into the Company's billing systems. The
above factors and estimates are subject to change. For example, patient payer
information may change following an initial attempt to bill for services due to
a change in payer status. Such changes in payer status have an impact on
recorded net revenue due to differing payers being subject to different
contractual allowance amounts. Such changes in net revenue are recognized in the
period that such changes in payer become known. Similarly, the actual volume of
medical charts not processed into our billing systems may be different from the
amounts estimated. Such differences in net revenue are adjusted in the following
month based on actual chart volumes processed.

Net Revenue Less Provision For Uncollectibles. Net revenue less provision
for uncollectibles reflects management's estimate of billed amounts to
ultimately be collected. Management, in estimating the amounts to be collected
resulting from its over six million annual fee-for-service patient visits and
procedures, considers such factors as prior contract collection experience,
current period changes in payer mix and patient acuity indicators, reimbursement
rate trends in governmental and private sector insurance programs, resolution of
credit balances, the estimated impact of billing system effectiveness
improvement initiatives and trends in collections from self-pay patients. Such
estimates are substantially formulaic in nature and are calculated at the
individual contract level. The estimates are continuously updated and adjusted
if subsequent actual collection experience indicates a change in estimate is
necessary. Such provisions and any subsequent changes in estimates may result in
adjustments to our operating results with a corresponding adjustment to our
accounts receivable allowance for uncollectibles on our balance sheet.

Accounts Receivable. As described above and below, we determine the
estimated value of our accounts receivable based on estimated cash collection
run rates of estimated future collections by contract for patient

15

visits under our fee-for-service contract revenue. Accordingly, we are unable to
report the payor mix composition on a dollar basis of our outstanding net
accounts receivable. Our days revenue outstanding at June 30, 2004, was 54.1
days and at December 31, 2003, was 61.2 days. The number of days outstanding
will fluctuate over time due to a number of factors. The decrease in the average
days revenue outstanding of approximately 7.1 days is due to an increase in
average revenues per day of approximately 1.3 days, an increase in collections
relating to contract accounts receivable due principally to collections on
terminated contracts of 2.1 days and increased collections relating to
fee-for-service patient visits of approximately 3.7 days. Our allowance for
doubtful accounts totaled $130.6 million as of June 30, 2004. Approximately 97%
of our allowance for doubtful accounts is related to gross fees for
fee-for-service patient visits. Our principal exposure for uncollectible
fee-for-service visits is centered in self pay patients and, to a lesser extent,
for co-payments and deductibles from patients with insurance. While we do not
specifically allocate the fee-for-service allowance for doubtful accounts to
individual accounts or specific payor classifications, the allowance related to
fee-for-service patients as of June 30, 2004, was approximately 93% of self-pay
accounts outstanding as fee-for-service patient visits at June 30, 2004. Primary
responsibility for collection of fee-for-service accounts receivable resides
within our internal billing operations. Once a claim has been submitted to a
payor or an individual patient, employees within our billing operations have
responsibility for the follow up collection efforts. The protocol for follow up
differs by payor classification. For self pay patients, our billing system will
automatically send a series of dunning letters on a prescribed time frame
requesting payment or the provision of information reflecting that the balance
due is covered by another payor, such as Medicare or a third-party insurance
plan. Generally, the dunning cycle on a self pay account will run from 90 to 120
days. At the end of this period, if no collections or additional information is
obtained from the patient, the account is no longer considered an active account
and is transferred to a collection agency. Upon transfer to a collection agency,
the patient account is written-off as a bad debt. Any subsequent cash receipts
on accounts previously written off are recorded as a recovery. For non-self pay
accounts, billing personnel will follow up and respond to any communication from
payors such as requests for additional information or denials until collection
of the account is obtained or other resolution has occurred. For contract
accounts receivable, invoices for services are prepared in the various operating
areas of the Company and mailed to our customers, generally on a monthly basis.
Contract terms under such arrangements generally require payment within thirty
days of receipt of the invoice. Outstanding invoices are periodically reviewed
and operations personnel with responsibility for the customer relationship will
contact the customer to follow up on any delinquent invoices. Contract accounts
receivable will be considered as bad debt and written-off based upon the
individual circumstances of the customer situation after all collection efforts
have been exhausted, including legal action if warranted, and it is the judgment
of management that the account is not expected to be collected.

Methodology for Computing Allowance For Doubtful Accounts. The Company
employs several methodologies for determining its allowance for doubtful
accounts depending on the nature of the Net Revenue recognized. Fee-for-service
Net Revenue Less Provision For Uncollectibles represents the Company's estimated
cash to be collected from such patient visits and is estimated based on the
factors noted above. The difference between gross net revenue before contractual
allowances and Net Revenue Less Provision For Uncollectibles is allocated
between provisions for contractual allowances and uncollectible accounts based
on historical experience resulting from the adjudication of third-party payor
claims or write-off of uncollectible accounts results from the Company's over
six million annual patient visits. The significant volume of annual patient
visits and the terms of thousands of commercial and managed care contracts and
the various reimbursement policies relating to governmental health care programs
do not make it feasible to evaluate fee-for-service accounts receivable on a
specific account basis. Fee-for-service accounts receivable collection estimates
are reviewed on a quarterly basis for each of the Company's fee-for-service
contracts by period of accounts receivable origination. Such reviews include the
use of historical cash collection percentages by contract adjusted for the lapse
of time since the date of the patient visit. In addition, when actual collection
percentages differ from expected results, on a contract by contract basis
supplemental detailed reviews of the outstanding accounts receivable balances
may be performed by our billing operations to determine whether there are facts
and circumstances existing that may cause a different conclusion as to the
estimate of the collectibility of that contract's accounts receivable from the
estimate resulting from using the historical collection experience. Facts and
circumstances that may result in an adjustment to the formulaic result are

16

generally few and are usually related to third-party payor processing problems
that are temporary in nature. Contract related net revenues are billed based on
the terms of the contract at amounts expected to be collected. Such billings are
typically submitted on a monthly basis and aged trial balances prepared.
Allowances for estimated uncollectible amounts related to such contract billings
are made based upon specific accounts and invoice periodic reviews once it is
concluded that such amounts are not likely to be collected. The methodologies
employed to compute allowances for doubtful accounts were unchanged between 2004
and 2003.

INSURANCE RESERVES

The nature of the Company's business is such that it is subject to
professional liability lawsuits. Historically, to mitigate a portion of this
risk, the Company has maintained insurance for individual professional liability
claims with per incident and annual aggregate limits per physician for all
incidents. Prior to March 12, 2003, such insurance coverage has been provided by
a commercial insurance company provider. Professional liability lawsuits are
routinely reviewed by the Company's insurance carrier and management for
purposes of establishing ultimate loss estimates. Provisions for estimated
losses in excess of insurance limits have been provided at the time such
determinations are made. In addition, where as a condition of a professional
liability insurance policy the policy includes a self-insured risk retention
layer of coverage, the Company has recorded a provision for estimated losses
likely to be incurred during such periods and within such limits based on its
past loss experience following consultation with its outside insurance experts
and claims managers.

Subsequent to March 11, 2003, the Company has provided for a significant
portion of its professional liability loss exposures through the use of a
captive insurance company and through greater utilization of self-insurance
reserves. Accordingly, beginning on March 12, 2003, a substantial portion of the
Company's provision for professional liability losses is based on periodic
actuarially determined estimates of such losses for periods subsequent to March
11, 2003. An independent actuary firm is responsible for preparation of the
periodic actuarial studies. Management's estimate of the Company's professional
liability costs resulting from such actuarial studies is significantly
influenced by assumptions, which are limited by the uncertainty of predicting
future events, and assessments regarding expectations of several factors. These
factors include, but are not limited to: the frequency and severity of claims,
which can differ significantly by jurisdiction; coverage limits of third-party
insurance; the effectiveness of the Company's claims management process; and the
outcome of litigation.

The Company's commercial insurance policy for professional liability losses
for the period March 12, 1999 through March 11, 2003, included insured limits
applicable to such coverage in the period. The Company in March 2003 had an
actuarial projection made of its potential exposure for losses under the
provisions of its commercial insurance policy that ended March 11, 2003. The
results of that actuarial study indicated that the Company would incur a loss
for claim losses and expenses in excess of the $130.0 million aggregate limit.
Accordingly, the Company recorded a loss estimate, discounted at 4%, of $50.8
million in its statement of operations for the three months ended March 31,
2003.

The payment of any losses realized by the Company under the aggregate loss
provision discussed above will only be after the Company's previous commercial
insurance carrier has paid such losses and expenses up to $130.0 million for the
applicable prior periods. The pattern of payment for professional liability
losses for any incurrence year typically is as long as six years. Accordingly,
the Company's portion of its loss exposure under the aggregate policy feature,
if realized, is not expected to result in a cash outflow in 2004.

Since March 12, 2003, the Company's professional liability costs consist of
annual projected costs resulting from an actuarial study along with the cost of
certain professional liability commercial insurance premiums and programs
available to the Company that remain in effect. The provisions for professional
liability costs will fluctuate as a result of several factors, including hours
of exposure as measured by hours of physician and related professional staff
services as well as actual loss development trends. As noted above, due to the
long pattern of payout for such exposures, the Company anticipates that a
substantial portion of such

17

latter amount will not be realized in the form of actual cash outlays from the
Company's captive insurance subsidiary until periods beyond 2004.

The Company's provisions for losses under the aggregate loss limits of its
policy in effect prior to March 12, 2003, and under its captive insurance and
self-insurance programs since March 12, 2003, are subject to periodic actuarial
reevaluation. The results of such periodic actuarial studies may result in
either upward or downward adjustment to the Company's previous loss estimates.

IMPAIRMENT OF INTANGIBLE ASSETS

In assessing the recoverability of the Company's intangibles the Company
must make assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates or their
related assumptions change in the future, the Company may be required to record
impairment charges for these assets.

The Company's critical accounting policies have been disclosed in its 2003
Annual Report on Form 10-K Equivalent. There have been no changes to these
critical accounting policies or their application during the six months ended
June 30, 2004.

RESULTS OF OPERATIONS

The following discussion provides an analysis of our results of operations
and should be read in conjunction with our unaudited consolidated financial
statements. The operating results of the periods presented were not
significantly affected by general inflation in the U.S. economy. Net revenue
less the provision for uncollectibles is an estimate of future cash collections
and as such it is a key measurement by which management evaluates performance of
individual contracts as well as the Company as a whole. The following table sets
forth the components of net loss as a percentage of net revenue less provision
for uncollectibles for the periods indicated:

18

THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2003

Net Revenues. Net revenues for the three months ended June 30, 2004
increased $29.8 million, or 8.3%, to $388.7 million from $359.0 million for the
three months ended June 30, 2003. The increase in net revenues of $29.8 million
included an increase of $34.7 million in fee-for-service revenue, offset by
decreases in contract revenue of $3.9 million and $1.0 million in other revenue.
For the three month periods ended June 30, 2004 and 2003, fee-for-service
revenue was 72.1% of net revenue in 2004 compared to 68.4% in 2003, contract
revenue was 25.9% of net revenue in 2004 compared to 29.2% in 2003 and other
revenue was 2.0% of net revenue in 2004 compared to 2.4% in 2003.

Provision for Uncollectibles. The provision for uncollectibles was $132.7
million for the three months ended June 30, 2004 compared to $108.8 million for
the three months ended June 30, 2003, an increase of $23.9 million or 21.9%. The
provision for uncollectibles as a percentage of net revenue was 34.1% for the
three months ended June 30, 2004 compared to 30.3% for the three months ended
June 30, 2003. The provision for uncollectibles is primarily related to revenue
generated under fee-for-service contracts that is not expected to be fully
collected. The increase in the provision for uncollectibles resulted from fee
schedule and average acuity pricing increases in excess of increased average
collection rates for self-pay patients. During the three months ended June 30,
2004, a provision totaling $0.9 million related to a contract receivable from a
financially troubled hospital client for which collection is now doubtful was
also recorded. In addition to the aforementioned factors, the increase in the
provision for uncollectibles as a percentage of revenues was affected by an
estimated 0.4% payer mix shift toward more self-pay patient encounters in 2004.

Net Revenue Less Provision for Uncollectibles. Net revenue less provision
for uncollectibles for the three months ended June 30, 2004 increased $5.9
million, or 2.3%, to $256.0 million from $250.1 million for the corresponding
three months in 2003. The increase between periods was primarily due to an
increase in same contract revenue. Same contract revenue less provision for
uncollectibles, which consists of contracts under management in both periods,
increased $5.1 million, or 2.2%, to $229.6 million in 2004 from $224.6 million
in 2003. The increase in same contract revenue of 2.2% includes the net effect
of higher estimated net revenue per billing unit offset by decreased overall
dollar volume between periods. Same contract revenue increased approximately
3.9% between periods due to higher estimated net revenue per billing unit. While
same contract fee-for-service volumes increased approximately 1.0% between
periods, contract revenues declined due to lower billable hours in the Company's
locum tenens and radiology staffing contract based services, principally as a
result of terminating certain operating services and contracts in those staffing
areas. A decline in other revenue of approximately $1.0 million between years is
principally due to favorable managed care payer settlements received in 2003
totaling $1.2 million related to disputed billings on prior years' claims.

Professional Service Expenses. Professional service expenses, which
includes physician costs, billing and collection expenses and other professional
expenses, totaled $191.2 million for the three months ended June 30, 2004
compared to $187.0 million for the three months ended June 30, 2003, an increase
of $4.2 million or 2.3%. The increase of $4.2 million in professional service
expenses included approximately $2.2 million resulting from increases in steady
state contract costs. The increase of approximately $2.2 million resulted
principally from increases in average rates paid per hour of provider service on
a same contract basis.

Professional Liability Costs. Professional liability costs were $13.6
million in 2004 compared with $14.5 million in 2003 for a decrease of $0.9
million. The decrease in professional liability expenses includes the reduction
of $2.0 million of self-insured retention reserves for excess limits provided to
certain physicians in prior years as a result of a review of remaining
outstanding claims and estimated loss exposures there under. A review of
remaining outstanding claims resulted in the conclusion that such claims are now
more likely than not to be settled within policy limits.

Gross Profit. Gross profit was $51.1 million for the three months ended
June 30, 2004, compared to $48.6 million in 2003. The increase in gross profit
is attributable to an increased contribution from steady state contracts
(including the $2.0 million reduction in certain professional liability
reserves) partially offset by lower gross profit due to terminated contracts
between periods. Gross profit as a percentage of revenue less

19

provision for uncollectibles for the three months ended June 30, 2004 was 20.0%
compared to 19.4% for the three months ended June 30, 2003.

General and Administrative Expenses. General and administrative expenses
for the three months ended June 30, 2004 decreased to $24.1 million from $24.4
million for the three months ended June 30, 2003, for a decrease of $0.3 million
between periods or 1.4%. General and administrative expenses as a percentage of
net revenue less provision for uncollectibles were 9.4% for the three months
ended June 30, 2004, compared to 9.8% for the three months ended June 30, 2003.
The decrease in general and administrative expenses between years was
principally due to decreases in management incentive costs of approximately $1.4
million and in legal and consulting costs of approximately $0.7 million related
to a disputed contract settlement in 2003, offset by increases in salaries and
benefits of $1.4 million and an increase of $0.9 million for professional
consulting expenses relating to improving our billing and collection processes.

Management Fee and Other Operating Expenses. Management fee and other
operating expenses were $0.5 million for the three months ended June 30, 2004
and $0.1 million for the corresponding period in 2003. Other operating expenses
in 2004 included a loss on asset disposal totaling $0.3 million.

Estimated Impairment Loss. During the three months ended June 30, 2004, an
estimated impairment loss in the amount of $65.8 million was recorded related to
goodwill associated with our military staffing business. The results of the
re-bidding of our healthcare staffing contracts under the military's Tricare
Program to date has indicated a net loss of contract revenues and margin related
to such staffing services. Based on the results of the re-bidding to date and an
estimate of contract re-bidding still to occur through November 1, 2004, an
impairment analysis using expected future cash flows and estimated fair market
values relating to the underlying business to which the goodwill applies
indicated that the goodwill previously recorded in the amount of $127.9 million
was impaired. The estimated impairment loss recorded of $65.8 million is subject
to further adjustment and finalization following completion of the military's
re-bidding process now scheduled to be completed by November 1, 2004.

Depreciation and Amortization. Depreciation and amortization was $3.5
million for the three months ended June 30, 2004 and $5.6 million for the three
months ended June 30, 2003. Amortization expense decreased by $1.9 million
between periods due to certain of the Company's intangibles becoming fully
amortized in 2003.

Net Interest Expense. Net interest expense increased $0.8 million to $7.0
million for the three months ended June 30, 2004 compared to $6.2 million for
the corresponding period in 2003. The increase in net interest expense includes
approximately $2.2 million due to an increased level of net outstanding debt
between periods, partially offset by lower interest rates between periods.

Earnings (Loss) before Income Taxes. Loss before income taxes for the
three months ended June 30, 2004, was a loss of $49.7 million compared to
earnings of $12.2 million for the three months ended June 30, 2003.

Provision for Income Taxes. Provision for income taxes for the three
months ended June 30, 2004 was $6.2 million compared to $4.6 million for the
three months ended June 30, 2003.

Net Earnings (Loss). Net loss for the three months ended June 30, 2004 was
a loss of $55.9 million compared to net earnings of $7.7 million for the three
months ended June 30, 2003.

Dividends on Preferred Stock. In the three months ended June 30, 2003, we
incurred $3.6 million of dividends on our then outstanding Class A mandatory
redeemable preferred stock.

SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2003

Net Revenues. Net revenues for the six months ended June 30, 2004
increased $76.9 million, or 10.8%, to $786.0 million from $709.1 million for the
six months ended June 30, 2003. The increase in net revenues of $76.9 million
included an increase of $73.2 million in fee-for-service revenue and $4.4
million in contract revenue offset by a decrease of $0.7 million in other
revenue. For the six month periods ended June 30, 2004 and 2003, fee-for-service
revenue was 71.9% of net revenue in 2004 compared to 69.4% in 2003, contract
20

revenue was 26.2% of net revenue in 2004 compared to 28.4% in 2003 and other
revenue was 1.9% of net revenue in 2004 compared to 2.2% in 2003.

Provision for Uncollectibles. The provision for uncollectibles was $268.6
million for the six months ended June 30, 2004 compared to $220.6 million for
the six months ended June 30, 2003, an increase of $48.0 million or 21.8%. The
provision for uncollectibles as a percentage of net revenue was 34.2% for the
six months ended June 30, 2004 compared to 31.1% for the six months ended June
30, 2003. The provision for uncollectibles is primarily related to revenue
generated under fee-for-service contracts that is not expected to be fully
collected. The increase in the provision for uncollectibles percentage resulted
from fee schedule and average acuity pricing increases in excess of increased
average collection rates for self-pay patients. In addition, the increase in the
provision for uncollectibles as a percentage of revenue was affected by an
estimated 0.9% payer mix shift toward more self-insured patient encounters in
2004.

Net Revenue Less Provision for Uncollectibles. Net revenue less provision
for uncollectibles for the six months ended June 30, 2004 increased $28.9
million, or 5.9%, to $517.4 million from $488.5 million for the corresponding
six months in 2003. Same contract revenue less provision for uncollectibles,
which consists of contracts under management in both periods, increased $23.7
million, or 5.6%, to $447.6 million in 2004 from $423.9 million in 2003. The
increase in same contract revenue of 5.6% is principally due to increased net
revenue per billing unit as patient volumes increased less than 1% between
periods. Acquisitions contributed $3.5 million and new contracts obtained
through internal sales contributed $39.3 million of the increase. The
aforementioned increases were partially offset by $37.7 million of revenue
derived from contracts that terminated during the periods. A decline in other
revenue of approximately $0.7 million between periods is principally due to
favorable managed care settlements totaling $1.2 million received in 2003
related to disputed billings on prior years' claims.

Professional Service Expenses. Professional service expenses, which
includes physician costs, billing and collection expenses and other professional
expenses, totaled $385.9 million for the six months ended June 30, 2004 compared
to $369.0 million for the six months ended June 30, 2003, an increase of $16.9
million or 4.6%. The increase of $16.9 million in professional service expenses
included approximately $4.7 million resulting from acquisitions and net growth
in new contract sales. The remaining increase of approximately $12.2 million
resulted principally from increases in average rates paid per hour of provider
service on a same contract basis.

Professional Liability Costs. Professional liability costs were $29.9
million in 2004 compared with $76.1 million in 2003 for a decrease of $46.2
million. The decrease in professional liability expenses is due primarily to a
provision for losses in excess of an aggregate insured limit for periods prior
to March 12, 2003 of $50.8 million in 2003. Excluding the $50.8 million
provision, professional liability expenses increased $4.6 million between
periods. The Company's cost of professional liability insurance in 2004 is based
on an actuarial estimate of losses under the Company's captive insurance
program. In 2003, such costs reflected premium costs under a premium based
commercial insurance program in effect through March 11, 2003, with actuarial
estimates of losses under the Company's self-insurance program thereafter. The
increase of $4.6 million is net of the reduction of $2.0 million in 2004 of
self-insured retention reserves for excess limits provided for certain
physicians in prior years as a result of a review of remaining outstanding
claims pertaining to such coverage periods and approximately $1.6 million in
2004 resulting from favorable actuarial results related to 2003 initial
self-insured loss year reserves.

Gross Profit. Gross profit was $101.6 million for the six months ended
June 30, 2004, compared to $43.5 million in 2003. The increase in gross profit
is attributable to the effect of the aggregate provision for professional
liability insurance losses of $50.8 million in 2003 and increased contribution
from steady state operations. Gross profit as a percentage of revenue less
provision for uncollectibles for the six months ended June 30, 2004 was 19.6%
compared to 19.3% before the provision for excess losses for the six months
ended June 30, 2003.

General and Administrative Expenses. General and administrative expenses
for the six months ended June 30, 2004 increased to $48.8 million from $45.9
million for the six months ended June 30, 2003, for an increase of $2.9 million
between periods. General and administrative expenses as a percentage of net
revenue less provision for uncollectibles were 9.4% in both periods. Included in
general and administrative expenses in
21

2004 is approximately $1.3 million related to a bonus paid to stock option
holders in connection with a refinancing of the Company's debt structure.
Excluding the effect of the stock option bonus expense, general and
administrative expenses increased approximately $1.6 million, or 3.5%. The
remaining increase in general and administrative expenses between years was
principally due to increases in salaries and benefits of approximately $1.8
million and $1.7 million for professional consulting expenses related to
improving our billing and collection processes partially offset by nonrecurring
costs related to a legal settlement in 2003 of $0.7 million and a decrease in
cost of approximately $1.2 million under our management incentive plan.

Management Fee and Other Operating Expenses. Management fee and other
operating expenses were $0.6 million for the six months ended June 30, 2004 and
$0.3 million for the corresponding period in 2003. Other operating expenses in
2004 included a loss on asset disposal totaling $0.3 million.

Estimated Impairment Loss. During the six months ended June 30, 2004, an
estimated impairment loss in the amount of $65.8 million was recorded related to
goodwill associated with our military staffing business. The results of the
re-bidding of our healthcare staffing contracts under the military's Tricare
Program to date has indicated a net loss of contract revenues and margin related
to such staffing services. Based on the results of the re-bidding to date and an
estimate of contract re-bidding still to occur through November 1, 2004, an
impairment analysis using expected future cash flows and estimated fair market
values relating to the underlying business to which the goodwill applies
indicated that the goodwill previously recorded in the amount of $127.9 million
was impaired. The estimated impairment loss recorded of $65.8 million is subject
to further adjustment and finalization following completion of the military's
re-bidding process now scheduled to be completed by November 1, 2004.

Depreciation and Amortization. Depreciation and amortization was $6.9
million for the six months ended June 30, 2004 and $11.1 million for the six
months ended June 30, 2003. Amortization expense decreased by $3.8 million
between periods due to certain of the Company's intangibles becoming fully
amortized in 2003.

Net Interest Expense. Net interest expense increased $1.9 million to $14.3
million for the six months ended June 30, 2004, compared to $12.4 million for
the corresponding period in 2003. The increase in net interest expense includes
approximately $2.6 million due to an increased level of net outstanding debt
between periods and a realized hedge instrument loss of approximately $1.3
million in 2004 partially offset by lower interest rates and non-cash
amortization of loan costs between periods.

Refinancing Costs. The Company expensed $14.7 million of deferred
financing costs and bond repayment premiums related to its previously
outstanding bank and bond borrowings that were refinanced in 2004.

Loss before Income Taxes. Loss before income taxes for the six months
ended June 30, 2004 was $49.7 million compared to $26.2 million for the six
months ended June 30, 2003.

Provision (Benefit) for Income Taxes. Provision for income taxes for the
six months ended June 30, 2004 was $6.3 million compared to a benefit of $9.1
million for the six months ended June 30, 2003.

Net Loss. Net loss for the six months ended June 30, 2004 was $56.0
million compared to a net loss of $17.1 million for the six months ended June
30, 2003.

Dividends on Preferred Stock. The Company recognized $3.6 million of
dividends for the six months ended June 30, 2004 and $7.2 million for the six
months ended June 30, 2003, on its Class A mandatory redeemable preferred stock.

LIQUIDITY AND CAPITAL RESOURCES

Our principal ongoing uses of cash are to meet working capital
requirements, fund debt obligations and to finance our capital expenditures and
acquisitions. Funds generated from operations during the past two years, with
the exception of the acquisition of a provider of medical staffing to military
treatment facilities on May 1, 2002, have been sufficient to meet the
aforementioned cash requirements.

22

In 2004, we restructured our capital structure. The restructuring resulted
in the following transactions occurring:

- Our Board of Directors authorized the redemption of our 10% Cumulative
Preferred Stock in the amount of approximately $162.4 million, including
accrued dividends.

- We completed a tender offer for our outstanding 12% Senior Subordinated
Notes resulting in $100.0 million of such bonds being repaid, plus
payment of a call premium of $8.2 million.

- We issued new 9% Senior Subordinated Notes in the amount of $180.0
million.

- We retired our existing bank debt in the amount of $199.4 million and
entered into a new senior bank credit facility, including a $250.0
million senior secured term loan and an $80.0 million revolving credit
facility.

- We incurred and paid approximately $7.8 million in costs through June 30,
2004 (in addition to an $8.2 million call premium on our previously
outstanding 12% Senior Subordinated Bonds) to complete the above
transactions.

In addition, the Board of Directors declared and paid to our shareholders a
cash dividend of approximately $27.6 million on March 23, 2004. The Board of
Directors also authorized a cash payment to holders of stock options in the form
of a compensatory bonus in the approximate amount of $1.3 million.

As a result of the above transactions, we have total debt outstanding of
$429.4 million as of June 30, 2004, compared to $299.4 million as of December
31, 2003

Cash provided from operating activities in the six months ended June 30,
2004 was $21.4 million compared to cash provided by operating activities in the
corresponding period in 2003 of $11.7 million. The $9.7 million increase in cash
provided by operating activities was principally due to an increase in cash
collections on accounts receivable as well as net cash retained under a
self-insured professional liability insurance program. Cash provided from
investing activities in the six months ended June 30, 2004, was $2.6 million
compared to a use of cash in 2003 of $10.3 million. The $12.9 million increase
in cash provided by investing activities was principally due to the redemption
of assets held in a deferred compensation plan which were liquidated as part of
the refinancing, as well as reduced levels of capital expenditures in 2004. Cash
used in financing activities in the six months ended June 30, 2004 and 2003 was
$70.0 million and $15.1 million, respectively. The $54.9 million decrease in
cash resulting from financing activities was due to the debt restructuring and
dividend paid in 2004.

We spent $2.6 million in the first six months of 2004 and $5.9 million in
the first six months of 2003 for capital expenditures. These expenditures were
primarily for information technology investments and related development
projects.

We have historically been an acquirer of other physician staffing
businesses and interests. Such acquisitions in recent years have been completed
for cash. Cash payments made in connection with acquisitions, including
contingent payments, were $2.3 million during the six months ended June 30, 2004
and $1.6 million in the corresponding period in 2003. Future contingent payment
obligations are approximately $8.4 million as of June 30, 2004.

We made scheduled debt maturity payments of $0.6 million in the first six
months of 2004 in accordance with its applicable term loan facilities in effect
at the time.

We began providing effective March 12, 2003, for professional liability
risks in part through a captive insurance company. Prior to such date we insured
such risks principally through the commercial insurance market. The change in
the professional liability insurance program has resulted in increased cash flow
due to the retention of cash formerly paid out in the form of insurance premiums
to a commercial insurance company coupled with a long period (typically 2-4
years or longer on average) before cash payout of such losses occurs. A portion
of such cash retained will be retained within our captive insurance company and
therefore not immediately available for general corporate purposes. As of June
30, 2004, cash or cash equivalents and related investments held within the
captive insurance company totaled approximately $21.5 million. Based on
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the results of our most recent actuarial report and renewal of our fronting
carrier program effective June 1, 2004, anticipated cash outflow to the captive
insurance company and to its third-party fronting carrier during the period July
1, 2004 through May 31, 2005, is estimated at $23.9 million.

Our senior credit facility at June 30, 2004 provides for up to $80.0
million of borrowings under a senior revolving credit facility and $250.0
million of term loans. Borrowings outstanding under the senior credit facility
mature in various years with a final maturity date of March 31, 2011. The senior
credit facility agreement contains both affirmative and negative covenants,
including limitations on our ability to incur additional indebtedness, sell
material assets, retire, redeem or otherwise reacquire its capital stock,
acquire the capital stock or assets of another business, pay dividends, and
requires us to meet or exceed certain coverage, leverage and indebtedness
ratios. The senior credit agreement also includes a provision for the prepayment
of a portion of the outstanding term loan amounts at any year-end if we generate
"excess cash flow," as defined in the agreement.

Approximately $210.7 million of annual revenue resulting from providing
staffing services to the military has been subjected to a re-bidding process
with awards effective at various dates between June 1 and November 1, 2004.
Based on awards related to approximately $132.6 million of such annual revenue,
we have been successful in winning existing or new business contracts of
approximately $93.5 million in annual revenues or 71% of our annual revenue that
has been re-bid and awarded to date. In addition, the operating margins expected
to be realized from such awards have generally been lower than existing margins.
Based on the results of the re-bidding awards to date and management's
expectations of future awards, we expect a decline beginning in the second half
of 2004 in annual earnings and cash flow from our military staffing business. We
do not expect the decline in earnings and cash flow from its military staffing
business, based on our estimates of such earnings and cash flow, to result in
any violations of debt covenant financial ratio requirements under our senior
credit agreement.

We had as of June 30, 2004, total cash and cash equivalents of
approximately $55.0 million and a revolving credit facility borrowing
availability of $76.1 million. Our ongoing cash needs in the six months ended
June 30, 2004 were met from internally generated operating sources and there
were no borrowings under our revolving credit facility.

We believe that our cash needs, other than for significant acquisitions,
will continue to be met through the use of its remaining existing available
cash, cash flows derived from future operating results and cash generated from
borrowings under our senior revolving credit facility.

INFLATION

We do not believe that general inflation in the U.S. economy has had a
material impact on our financial position or results of operations.

SEASONALITY

Historically, our revenues and operating results have reflected minimal
seasonal variation due to the significance of revenues derived from patient
visits to emergency departments, which are generally open on a 365 day basis,
and also due to our geographic diversification. Revenue from our non-emergency
department staffing lines is dependent on a healthcare facility being open
during selected time periods. Revenue in such instances will fluctuate depending
upon such factors as the number of holidays in the period.

RECENTLY ISSUED ACCOUNTING STANDARDS

None.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risk related to changes in interest rates.
The Company does not use derivative financial instruments for speculative or
trading purposes.

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The Company's earnings are affected by changes in short-term interest rates
as a result of its borrowings under its senior credit facilities. Interest rate
swap agreements are used to manage a portion of the Company's interest rate
exposure.

The Company was obligated under the terms of its senior credit facility
agreement to obtain within 90 days of the date of entering into the agreement
interest rate hedge agreements at amounts such that 50% of the Company's funded
debt, as defined, was at fixed rates of interest. Such hedge agreements are
required to be maintained for at least the first three years of the senior
credit facility agreement. On April 29, 2004, the Company entered into an
interest rate swap agreement that effectively converted $35.0 million of its
variable rate Term Loan B to a fixed rate of 3.2% through March 31, 2007. The
agreement is a contract to exchange, on a quarterly basis, floating interest
rate payments based on the eurodollar rate, for fixed interest rate payments
over the life of the agreement. This agreement exposes the Company to credit
losses in the event of non-performance by the counterparty to the financial
instrument. The counterparty to the Company's interest rate swaps agreement is a
creditworthy financial institution and the Company believes the counterparty
will be able to fully satisfy its obligations under the contracts.

The Company had previously entered into a forward interest rate swap
agreement effective November 7, 2002, to effectively convert $62.5 million of
floating-rate borrowings to 3.86% fixed-rate borrowings. The contract had a
final expiration date of April 30, 2005. As a result of the payment of the
underlying borrowings in 2004, the Company realized a loss of approximately $1.7
million related to this interest rate hedge agreement to reflect its value on a
mark to market basis.

At June 30, 2004, the fair value of the Company's total debt, which has a
carrying value of $429.4 million, was approximately $424.9 million. The Company
had $249.4 million of variable debt outstanding at June 30, 2004. If the market
interest rates for the Company's variable rate borrowings averaged 1% more
during the twelve months subsequent to June 30, 2004, the Company's interest
expense would increase, and earnings before income taxes would decrease, by
approximately $2.5 million. This analysis does not consider the effects of the
reduced level of overall economic activity that could exist in such an
environment. Further, in the event of a change of such magnitude, management
could take actions to further mitigate its exposure to the change. However, due
to the uncertainty of the specific actions that would be taken and their
possible effects, the sensitivity analysis assumes no changes in the Company's
financial structure.

ITEM 4. CONTROLS AND PROCEDURES

(a) The Company carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's Chairman
and Chief Executive Officer along with the Company's Executive Vice President of
Finance and Administration, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures as defined in Rule 13a-15(e)
and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Based upon that evaluation the Company's Chief Executive
Officer along with the Company's Executive Vice President of Finance and
Administration concluded that as of the end of the period covered by this report
the Company's disclosure controls and procedures (1) were effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
filings and (2) were adequate to ensure that information required to be
disclosed by the Company in the reports filed or submitted by the Company under
the Exchange Act is recorded, processed and summarized and reported within the
time periods specified in the SEC's rules and forms.

(b) There have been no significant changes in the Company's internal
control over financial reporting identified in connection with the evaluation
described in paragraph (a) above, that have materially affected or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.

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PART 2. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Team Health is a party to various pending legal actions arising in the
ordinary operation of its business such as contractual disputes, employment
disputes and general business actions as well as malpractice actions. Team
Health does not believe that the results of such legal actions, individually or
in the aggregate, will have a material adverse effect on the Company's business
or its results of operations, cash flows or financial condition.

See note 11 to the consolidated financial statements for a description of
legal actions to which we are party.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

31.1 Certification by Lynn Massingale, M.D. pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by Robert J. Abramowski pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

(b) Reports of Form 8-K

On April 6, 2004, the Company furnished a Report on Form 8-K relating to
the announcement of the extension of the consent date with respect to its tender
offer for any and all of its $100.0 million aggregate principal amount of 12%
Senior Subordinated Notes due 2009.

On April 6, 2004, the Company furnished a Report on Form 8-K relating to
the announcement of the completion of its cash tender offer and consent
solicitation for any and all of its $100.0 million aggregate principal amount of
12% Senior Subordinated Notes due 2009.

On May 24, 2004, the Company furnished a Report on Form 8-K announcing its
earnings for the quarter ended March 31, 2004.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report on Form 10-Q
Equivalent to be signed on its behalf by the undersigned thereunto duly
authorized in the City of Knoxville, Tennessee.

TEAM HEALTH, INC.

/s/ H. LYNN MASSINGALE, M.D.
August 10, 2004 --------------------------------------
H. Lynn Massingale
Chief Executive Officer

/s/ ROBERT J. ABRAMOWSKI
August 10, 2004 --------------------------------------
Robert J. Abramowski
Executive Vice President Finance and
Administration

/s/ DAVID P. JONES
August 10, 2004 --------------------------------------
David P. Jones
Chief Financial Officer

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