HORIZON HEALTH CORP /DE/ - 10-Q Quarterly Report

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HORC
1ST QTR
FY2003

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

FORM 10-Q

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

For the quarterly period ended November 30, 2002

or

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

For the transition period from ___________ to _______________

Commission file number 1-13626

HORIZON HEALTH CORPORATION
(Exact name of registrant as specified in its charter)

Delaware 75-2293354
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1500 Waters Ridge Drive
Lewisville, Texas 75057-6011
(Address of principal executive offices, including zip code)

(972) 420-8200
(Registrant's telephone number, including area code)

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 [ ]

The number of shares outstanding of the registrant's Common Stock, $0.01 par
value, as of December 2, 2002, was 5,246,272.

INDEX

HORIZON HEALTH CORPORATION

PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS........................................................................3

HORIZON HEALTH CORPORATION

Consolidated Balance Sheets as of November 30, 2002 (unaudited)
and August 31, 2002............................................................................ 3

Consolidated Statements of Operations for the three months ended
November 30, 2002 and 2001 (each unaudited).................................................... 5

Consolidated Statements of Cash Flows for the three months ended
November 30, 2002 and 2001 (each unaudited).................................................... 6

Notes to Consolidated Financial Statements (unaudited)..........................................7

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS....................................................................17

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..............................................26

ITEM 4. CONTROLS AND PROCEDURES.................................................................................26

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.......................................................................................27

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................................................28

2

PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

HORIZON HEALTH CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

3

HORIZON HEALTH CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

4

HORIZON HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

See accompanying notes to consolidated financial statements.

5

HORIZON HEALTH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(A) Consists of the purchase of EAP International effective November 1, 2002,
the purchase of management contracts of Perspectives Health Management
effective October 1, 2001 and an adjustment to the purchase price paid for
Occupational Health Consultants of America. See Note 4.

See accompanying notes to consolidated financial statements.

6

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. ORGANIZATION

Horizon Health Corporation ("the Company") is a diversified health care
services provider. It offers employee assistance programs ("EAP") and
behavioral health services under contracts to businesses and managed care
organizations. Through its acquisition of ProCare One Nurses effective
June 13, 2002, the Company provides specialized nurse staffing services
to hospitals. The Company is also a contract manager of clinical and
related services, primarily of mental health and physical rehabilitation
programs, offered by general acute care hospitals in the United States.
The management contracts are generally for initial terms ranging from
three to five years, the majority of which have automatic renewal
provisions. In addition, the Company provides outcomes information
regarding the effectiveness of mental health programs, psychiatric data
base services, and Phase IV clinical trial services. The Company
currently has offices in the Dallas, Texas; Chicago, Illinois; Tampa,
Florida; Orlando, Florida; Denver, Colorado; Philadelphia, Pennsylvania;
Nashville, Tennessee; Santa Ana, California; and Detroit, Michigan
metropolitan areas. The Company's National Support Center is in the
Dallas suburb of Lewisville, Texas.

BASIS OF PRESENTATION:

The accompanying consolidated balance sheet at November 30, 2002, the
consolidated statements of operations for the three months ended November
30, 2002 and 2001, and the consolidated statements of cash flows for the
three months ended November 30, 2002 and 2001 are unaudited. These
financial statements should be read in conjunction with the Company's
audited financial statements for the year ended August 31, 2002. In the
opinion of Company management, the unaudited consolidated financial
statements include all adjustments, consisting only of normal recurring
accruals, which the Company considers necessary for a fair presentation
of the financial position of the Company as of November 30, 2002, and the
results of operations for the three months ended November 30, 2002 and
2001.

Operating results for the three month periods are not necessarily
indicative of the results that may be expected for a full year or
portions thereof.

2. SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES

The consolidated financial statements and accompanying notes have been
prepared in accordance with generally accepted accounting principles
applied on a consistent basis. The preparation of these financial
statements requires the use of estimates, judgements and assumptions that
affect the reported amounts of assets and liabilities, and the disclosure
of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods.

The Company continually evaluates its accounting policies and the
estimates it uses to prepare the consolidated financial statements. In
general, the estimates are based on historical experience, on information
from third party professionals and on various other assumptions that are
believed to be reasonable under the facts and circumstances. In the
Company's opinion, the significant accounting policies most important to
aid in understanding its financial results are the following:

CONSOLIDATION: The consolidated financial statements include those of
the Company and it's wholly-owned and majority owned subsidiaries.
Investments in unconsolidated affiliated companies are accounted for on
the equity method. All significant intercompany accounts and
transactions are eliminated in consolidation.

CASH AND CASH EQUIVALENTS: Cash and cash equivalents include highly
liquid investments with original maturities of three months or less when
purchased. The carrying amount approximates fair value due to the short
maturity of these instruments.

7

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ALLOWANCES FOR DOUBTFUL ACCOUNTS: The Company maintains allowances for
doubtful accounts for estimated losses which may result from the
inability of its customers to make required payments. Allowances are
based on the likelihood of recoverability of accounts receivable
considering such factors as past experience and taking into account
current collection trends that are expected to continue. Factors taken
into consideration in estimating the reserve are amounts past due, in
dispute, or a client which the Company believes might be having financial
difficulties. If economic, industry, or specific customer business trends
worsen beyond earlier estimates, the Company increases the allowances for
doubtful accounts by recording additional expense.

PROPERTY AND EQUIPMENT: Property and equipment are recorded at cost.
Depreciation expense is recorded on the straight-line basis over
estimated useful lives. The useful lives of computer hardware and
software are estimated to be three years. The useful lives of furniture
and fixtures, and transportation equipment are estimated to be five
years. The useful life of office equipment is estimated to be three
years. Building improvements are recorded at cost and amortized over the
estimated useful lives of the improvements or the terms of the underlying
lease whichever is shorter. Routine maintenance, repair items, and
customer facility and site improvements are charged to current
operations.

ACCOUNTING FOR INTANGIBLE ASSETS AND GOODWILL: The cost of acquired
companies is allocated first to their identifiable assets based on
estimated fair values, and then to goodwill. Costs allocated to
identifiable intangible assets are generally amortized on a straight-line
basis over the remaining estimated useful lives of the assets. The excess
of the purchase price over the fair value of identifiable assets
acquired, net of liabilities assumed, is recorded as goodwill. At
November 30, 2002 and August 31, 2002, respectively, other identifiable
intangible assets, net, consist of contracts (approximately $3,483,931
and $3,145,605), non-competes (approximately $237,097 and $186,112) and
trade name (approximately $113,710 and $93,055). As described in Note 6,
the Company elected to adopt the Statement of Financial Accounting
Standards ("SFAS") No. 141, Business Combinations ("SFAS 141") and SFAS
142, Goodwill and Other Intangible Assets" ("SFAS 142") on a prospective
basis as of September 1, 2001. As a result of implementing these new
standards, the Company discontinued the amortization of goodwill as of
August 31, 2001.

Accounting for these types of assets require significant estimates and
judgement, especially as to: a) the valuation in connection with the
initial purchase price allocation and b) the ongoing evaluation for
impairment. For each acquisition, a valuation was completed to determine
a reasonable purchase price allocation. Upon completion of the allocation
process an amount was assigned to various identified assets including
intangible assets and the remainder was assigned to goodwill. The
purchase price allocation process requires estimates and judgements as to
expectations for the various businesses and business strategies. For
example, certain growth rates were assumed for each business.
Additionally, different operating margins for each type of service
offering were included in the estimates. If actual growth rates or
operating margins, among other assumptions, differ significantly from the
estimate and judgements used in the purchase price allocation, a possible
impairment of the intangible assets and/or goodwill or an acceleration in
amortization expense may result.

In addition, SFAS 142 generally requires that goodwill be tested annually
using a two-step process. The first step is to identify a potential
impairment. The second step measures the amount of the impairment loss,
if any. However, intangible assets with indefinite lives are to be tested
for impairment using a one-step process that compares the fair value to
the carrying amount of the asset. Because of the significance of the
identified intangible assets and goodwill to the Company's consolidated
balance sheet, annual or interim impairment analyses are important.
Changes in key assumptions about the business and its prospects, or
changes in market conditions or other external factors, could result in
an impairment charge and such a charge could have a material adverse
effect on the Company's financial condition and results of operations.
Contracts represent the fair value of management contracts and service
contracts purchased and are being amortized using the straight-line
method over seven years. Other intangibles primarily includes the fair
value of trade names and non-compete agreements, which are being
amortized over their expected useful lives.

8

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

COMMON STOCK REPURCHASE PROGRAMS: As further described in Note 9, on
October 7, 2002 the Board of Directors authorized the repurchase of up to
800,000 shares of its common stock. During the quarter ended November 30,
2002, the Company repurchased 227,200 shares of its common stock pursuant
to such authorization, which remains in effect.

MEDICAL CLAIMS: Medical claims payable represent the liability for
healthcare claims reported but not yet paid and claims incurred but not
yet reported ("IBNR") related to the Company's managed healthcare
business. The IBNR portion of medical claims payable is estimated based
upon authorized healthcare services, past claims payment experience for
member groups, enrollment data, utilization statistics and other factors.
Although variability is inherent in such estimates, management believes
the recorded liability for medical claims payable is adequate. Medical
claim payable balances are continually monitored and reviewed. Changes in
assumptions for care costs caused by changes in actual or expected
experience could cause these estimates to change significantly.

RESERVES FOR EMPLOYEE HEALTH BENEFITS: The Company retains a significant
amount of self-insurance risk for its employee health benefits. The
Company maintains stop-loss insurance such that the Company's liability
for health insurance is subject to certain individual and aggregate
limits. Each month end the Company records an accrued expense for
estimated health benefit claims incurred but unpaid or not reported at
the end of such period. The Company estimates this accrual based on a
number of factors including historical experience, industry trends and
recent claims history. This accrual estimate is subject to ongoing
revision as conditions might change and as new data may be presented.
Adjustments to estimated liabilities are recorded in the accounting
period in which the change in estimate occurs.

REVENUE RECOGNITION: Service revenue is generated by the Company's five
business segments and recognized in the following three categories:

(1) Contract management revenue, generated by Horizon Mental
Health Management and Specialty Rehabilitation Management, is
reported in the period they are provided at the estimated net
realizable amounts from contracted hospitals for contract
management services rendered. Adjustments are accrued on an
estimated basis in the period they become known and are
adjusted in future periods, as final settlement is determined.

The fees received by the Company for its services under
management contracts are paid directly by its client
hospitals. Contract management revenue is based on various
criteria such as a fixed fee and/or variable components
including per diem calculation based on patients per day, the
number of admissions or discharges, direct expenses, or any
combination of the preceding, depending on the specific
contract. Generally, contract fees are paid on a monthly
basis.

Some management contracts include a clause, which states that
the Company will indemnify the hospital for any third-party
payor denials, including Medicare. At the time the charges are
denied or anticipated to be denied, the Company records an
allowance for 100% of the potential amount. The Company
believes it has adequately provided for potential adjustments
that may result from final settlement of potential denials.

Client hospitals receive reimbursement under Medicare or
Medicaid programs or payments from insurers, self-funded
benefit plans or other third-party payors for the mental
health and physical rehabilitation services provided to the
patients of the programs managed by the Company. As a result,
the availability and amount of such reimbursements, which are
subject to change, may impact the decision of general acute
care hospitals regarding whether to offer mental health and
physical rehabilitation services pursuant to management
contract with the Company, as well as whether to continue such
contracts (subject to contract termination provisions) and the
amount of fees to be paid thereunder.

9

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(2) Premium and fees revenue, generated by Horizon Behavioral
Services, is reported in the period services are provided at
the estimated net realizable amounts as defined by client
contracts for services rendered. Adjustments are accrued on an
estimated basis in the period they become known and are
adjusted in future periods if and when necessary.

Revenues are derived from EAP services, administrative service
only contracts, and at risk managed behavioral health
services. This revenue consists primarily of capitation
payments, which are calculated on the basis of a
per-member/per-month fee, and also include fee for service
payments. For certain capitated managed care contracts the
Company is 'at risk' and bears the economic risk as to the
adequacy of capitated revenue versus the actual cost of
behavioral health care services provided to covered members.
At November 30, 2002, overall capitated revenue was more than
sufficient to meet these costs.

(3) Service revenues, generated by ProCare One Nurses and Mental
Health Outcomes, are recognized in the month in which services
are rendered, at the estimated net realizable amounts. These
revenues are generated through the Company's nurse staffing
services, its outcomes measurement, database services, and its
Phase IV clinical trial services.

EARNINGS PER SHARE: Earnings per share has been computed in accordance
with SFAS No. 128, "Earnings Per Share" ("SFAS 128"). Basic earnings per
share are computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period.
Diluted earnings per share reflect the potential dilution that may occur
if the Company's in the money stock options were exercised. Such dilutive
potential common shares are calculated using the treasury stock method.

ACCOUNTING FOR INCOME TAXES: The Company accounts for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes", which
requires that deferred tax assets and liabilities be recognized using
enacted tax rates for the effect of temporary differences between the
book and tax bases of recorded assets and liabilities. SFAS No. 109 also
requires that deferred tax assets be reduced by a valuation allowance if
it is more likely than not that some portion or all of the deferred tax
assets will not be realized.

At November 30, 2002, the Company had deferred tax assets in excess of
deferred tax liabilities of $304,100. Based upon the Company's estimates
of the sources, nature, and amount of expected future taxable income it
determined that it is more likely than not that its deferred tax assets
will be realized, resulting in no valuation allowance.

The Company evaluates quarterly the realizability of its deferred tax
assets and accordingly adjusts its valuation allowance, if any as
necessary. The factors used to assess the likelihood of realization
include the Company's estimates of future taxable income and available
tax initiatives that could be reasonably implemented to assure
realization of the net deferred tax assets. The Company has used various
appropriate tax initiatives and alternative tax treatments to realize or
to renew net deferred tax assets in order to avoid the potential loss of
tax benefits.

Failure to achieve forecasted taxable income amounts might affect the
ultimate realization of all or portions of net deferred tax assets.
Factors that may affect the Company's ability to achieve sufficient
forecasted taxable income include general business conditions, increased
competition, a change in Medicare or Medicare reimbursement, an increase
in medical services utilization, etc., resulting in a decline in sales or
margins.

USE OF ESTIMATES: The Company has made certain estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements
and the amounts of revenues and expenses recorded for the reporting
period in order to prepare the financial statements in conformity with
generally accepted accounting principles. Future actual results could
differ from those estimates.

RECLASSIFICATIONS: Certain prior year amounts have been reclassified to
conform to the current year presentation.

10

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

3. EARNINGS PER SHARE

Earnings per share has been computed in accordance with SFAS 128. Basic
earnings per share are computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflect the potential dilution
that could occur if the Company's in the money stock options were
exercised. Such potential dilutive common shares are calculated using the
treasury stock method.

The following is a reconciliation of the numerators and the denominators
of the basic and diluted earnings per share computations.

During the quarters ended November 30, 2002 and 2001, certain shares
subject to options to acquire common stock were not included in certain
computations of diluted EPS because the option exercise price was greater
than the average market price of the common shares for the quarter. The
computation for the quarter ended November 30, 2002 excluded 96,700
shares subject to options, with exercise prices ranging from $14.51 to
$23.75. The computation for the quarter ended November 30, 2001 excluded
4,000 shares subject to options, with an exercise price of $23.75.

4. ACQUISITIONS

EMPLOYEE ASSISTANCE PROGRAMS INTERNATIONAL, INC.

The Company acquired all of the outstanding capital stock of Employee
Assistance Programs International, Inc. ("EAP International") of Denver,
Colorado, on November 4, 2002, with an effective date of November 1, 2002
for approximately $3.35 million. The Company accounted for the
acquisition of EAP International using the purchase method as required by
generally accepted accounting principles. EAP International provides
employee assistance programs and other related behavioral health care
services to employers. EAP International had total revenues of
approximately $4.8 million (unaudited) for the ten months ended October
31, 2002. The purchase price of approximately $3.35 million exceeded the
fair value of EAP International's tangible net assets by $3,475,103 of
which $2,697,691 is recorded as goodwill and $727,411 as service contract
valuation and $50,000 as non-compete contracts. Tangible assets acquired
and liabilities assumed totaled $756,697 and $881,799, respectively. Pro
forma financial data is not presented because the impact of this
acquisition is not material to the Company's results of operation for any
period presented.

11

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

5. PROPERTY AND EQUIPMENT

Property and equipment consist of the following at November 30, 2002 and
August 31, 2002:

Depreciation expense for the three months ended November 30, 2002 and
2001 totaled $291,395 and $301,700, respectively.

6. GOODWILL AND OTHER INTANGIBLE ASSETS

In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. ("SFAS") 141, Business
Combinations ("SFAS 141") and SFAS 142, Goodwill and Other Intangible
Assets ("SFAS 142"). SFAS 141 addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a
business combination. SFAS 142 addresses the initial recognition and
measurement of intangible assets acquired outside of a business
combination, whether acquired individually or with a group of other
assets, and the accounting and reporting for goodwill and other
intangibles subsequent to their acquisition. These standards require all
future business combinations to be accounted for using the purchase
method of accounting and goodwill not to be amortized, but instead to be
subject to impairment tests at least annually. The Company elected to
adopt SFAS 141 and SFAS 142 on a prospective basis as of September 1,
2001; however, certain provisions of these new standards also apply to
any acquisitions concluded subsequent to June 30, 2001. As a result of
implementing these new standards, the Company discontinued the
amortization of goodwill as of August 31, 2001.

The costs of certain management contracts and other intangible assets
acquired by the Company remain subject to amortization. Amortization of
recorded values for contracts, non-compete agreements, and trade names
for the three months ended November 30, 2002 was $467,445. During the
quarter ended November 30, 2002, there was a $93,000 acceleration of the
final portions of contract valuation amortization associated with a 1997
acquisition that has now been fully amortized. The following table sets
forth the estimated amortization expense for intangibles subject to
amortization for the remaining nine months in the 2003 fiscal year and
for each of the four succeeding fiscal years.

12

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table sets forth by business segment of the Company the
amount of goodwill as of August 31, 2002 that is subject to impairment
tests rather than amortization and the adjustments, if any, to the amount
of such goodwill in the three months ended November 30, 2002. No
impairment adjustments were deemed necessary.

(A) Horizon Behavioral Services provides managed behavioral care and employee
assistance programs. Goodwill acquired during the period relates to the
purchase of EAP International.

(B) Horizon Mental Health Management provides mental health contract management
services to general acute care hospitals.

(C) Specialty Rehab Management provides physical rehabilitation contract
management services to general acute care hospitals.

(D) Mental Health Outcomes provides outcome measurement information regarding
the effectiveness of mental health treatment programs, data base services
and Phase IV Clinical Research services.

(E) ProCare One Nurses provides specialized nurse staffing services to
hospitals primarily in California and Michigan. Goodwill acquired during
the period related to a purchase price accounting reclassification of
$100,000 to "other intangibles", net of a purchase price adjustment of
$5,904.

7. LONG-TERM DEBT

At November 30, 2002 and August 31, 2002, the Company had long-term debt
comprised of a revolving credit facility with outstanding balances of
$15.0 million and $10.0 million, respectively.

On May 23, 2002, the Company entered into a Second Amended and Restated
Credit Agreement (the "Second Amended Credit Agreement"), with JPMorgan
Chase Bank, as Agent, and Bank of America, NA which refinanced the loans
then outstanding under the existing credit agreement. The Second Amended
Credit Agreement is a five year facility which consists of a $30 million
three year revolving/two year term credit facility (which has provisions
to allow for its expansion to a $50 million facility) to fund ongoing
working capital requirements, refinance existing debt, and finance future
acquisitions by the Company, and for other general corporate purposes.

The revolving credit facility bears interest at (1) the Base Rate plus
the Base Rate Margin, as defined or (2) the Adjusted Eurodollar Rate,
plus the Eurodollar Margin, as defined. At November 30, 2002, the
weighted average interest rate on outstanding indebtedness under the
credit facility was 4.25%. The Eurodollar Margin varies depending on the
debt coverage ratio of the Company. The revolving credit facility matures
on May 31, 2005.

8. COMMITMENTS AND CONTINGENCIES

The Company leases various office facilities and equipment under
operating leases. The following is a schedule of minimum rental payments
under these leases, which expire at various dates:

Nine months ending August 31, 2003 $ 1,757,974
For the year ending August 31, 2004 1,866,031
For the year ending August 31, 2005 1,436,536
For the year ending August 31, 2006 844,411
For the years ending August 31, 2007 and thereafter 438,580
-------------
$ 6,343,532
=============

Rent expense for the three months ended November 30, 2002 and 2001
totaled $608,175 and $670,373, respectively.

13

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Effective September 1996, the Company entered into a lease arrangement
with an unconsolidated special purpose entity. The lease agreement, which
had an initial term of five years that has been extended to May 2007, is
for a building that had been constructed for an office building as
designed by the Company for use as its National Support Center. In
connection with the transaction, a financial institution loaned to the
special purpose entity approximately $4.4 million. The Company guaranteed
on a limited basis approximately $900,000 of the loan. The loan is due at
the end of the lease term. The Company also agreed to purchase the
building for approximately $4.4 million at the end of the lease term,
currently May 2007, if either the building is not sold to a third party
or the Company does not further extend its lease. A recent independent
appraisal indicated the fair market value of the building is at least
equal to the loan amount and purchase price.

On November 18, 2002, the Company signed a definitive agreement to
acquire privately held Health and Human Resource Center, Inc., d/b/a
Integrated Insights, headquartered in San Diego, California. The
definitive agreement contemplates a stock purchase in which the Company
will acquire all the capital stock of Integrated Insights. As a result of
the transaction, Integrated Insights will become a wholly owned
subsidiary of the Company. Integrated Insights provides employee
assistance programs under contracts directly with employers. It holds a
California Knox-Keene License to operate as a specialized health care
plan. At October 31, 2002, Integrated Insights had approximately 295
contracts covering approximately 378,000 lives. For the year ended
December 31, 2001, Integrated Insights had revenues of approximately
$4.59 million (unaudited). For the nine-month period ending September 30,
2002, Integrated Insights had revenues of approximately $3.62 million
(unaudited). The closing of the transaction is subject to the
satisfaction of various conditions, including approval by the California
Department of Managed Health Care.

The Company's liability and property risk management program involves a
cost-effective balance of insured risks and self-insured retentions. The
Company carries general liability, malpractice and professional
liability, comprehensive property damage, workers' compensation,
directors and officers and other insurance coverages that management
considers reasonable and adequate for the protection of the Company's
assets, operations and employees. There can be no assurance, however,
that the coverage limits of such policies will be adequate. A successful
claim against the Company in excess of its insurance coverage or several
claims for which the Company's self-insurance components are significant
in the aggregate could have a material adverse effect on the Company.

In late 1999, the Company became aware that a civil qui tam lawsuit had
been filed under seal naming the Company's psychiatric contract
management subsidiary, Horizon Mental Health Management (Horizon), as one
of the defendants therein. In March 2001, the relators served the
complaint in the lawsuit brought under the Federal False Claims Act. The
U.S. Department of Justice had previously declined to intervene in the
lawsuit. The complaint alleges that certain on-site Company personnel
acted in concert with other non-Company personnel to improperly inflate
certain Medicare reimbursable costs associated with psychiatric services
rendered at a Tennessee hospital prior to August 1997. The lawsuit names
the hospital, the parent corporation of the hospital and a home health
agency as additional defendants. The Company has filed a motion to
dismiss and discovery proceedings have been deferred until the court
rules on the motion. The Company does not believe the claims asserted in
the lawsuit, based on present allegations, represent a material liability
to the Company.

In early December 2000, the Company was served with a U.S. Department of
Justice subpoena issued by the U.S. Attorney's Office for the Northern
District of California. The subpoena requested the production of
documents related to certain matters such as patient admissions, patient
care, patient charting, and marketing materials, pertaining to hospital
gero-psychiatric programs managed by the Company. The Company furnished
documents in response to the subpoena in January 2001 and there has been
no further activity in relation to the subpoena since that time. On
October 30, 2002, the Company received a letter from the Civil Division
of the U.S. Department of Justice proposing a preliminary meeting to
discuss possible False Claim Act violations alleged in a qui tam suit and
also to discuss the findings of the U.S. Department of Justice after its
review of certain records. The Company met with the U.S. Department of
Justice in December 2002 and furnished additional information regarding
what appear to be the allegations. The qui tam suit remains under seal
and the U.S. Government is still considering whether or not it will
intervene in the suit. The Company has not been served with the suit. The
allegations and the records

14

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

reviewed relate to the same matters that were the subject of the 2000
U.S. Department of Justice subpoena. At this time, the Company cannot
predict the ultimate scope or any particular future outcome of the qui
tam suit or the investigation. It is possible that eventually allegations
could be asserted against the Company involving claims anywhere from
minor to significant in amount.

The Company is, and may be in the future, party to litigation arising in
the ordinary course of its business. While the Company has no reason to
believe that any such pending claims are material, there can be no
assurance that the Company's insurance coverage will be adequate to
substantially cover liabilities arising out of such claims or that any
such claims will be covered by the Company's insurance. Any material
claim that is not covered by insurance may have an adverse effect on the
Company's business. Claims against the Company, regardless of their merit
or outcome, may also have an adverse effect on the Company's reputation
and business.

9. STOCK REPURCHASES

On October 12, 2000 the Board of Directors authorized the repurchase of
up to 1,000,000 shares of its common stock and on February 15, 2001 the
Board of Directors authorized the repurchase of an additional 325,000
shares of its common stock. As of August 31, 2002, the Company had
repurchased 1,103,563 shares of its common stock pursuant to such
authorizations, which had previously expired. On October 7, 2002 the
Board of Directors authorized the repurchase of up to 800,000 shares of
its common stock. During the quarter ended November 30, 2002, the Company
repurchased 227,200 shares of its common stock pursuant to such
authorization, which remains in effect. The stock repurchase plans, as
approved by the Board of Directors, authorized the Company to make
purchases of its outstanding common stock from time to time in the open
market or through privately negotiated transactions, depending on market
conditions and applicable securities regulations. The repurchased shares
are added to the treasury shares of the Company and may be used for
employee stock plans and for other corporate purposes. A total of 515,339
and 493,660 treasury shares had been reissued pursuant to the exercise of
certain stock options and in connection with the Employee Stock Purchase
Plan as of November 30, 2002 and August 31, 2002, respectively. The
shares were repurchased utilizing available cash and borrowings under the
Company's credit facility. The Company accounts for the treasury stock
using the cost method.

15

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

10. SEGMENT INFORMATION

The following schedule represents revenues and operating results for the
periods indicated by operating subsidiary:

(A) Horizon Mental Health Management provides mental health contract
management services to general acute care hospitals.

(B) Specialty Rehab Management provides physical rehabilitation contract
management services to general acute care hospitals.

(C) Horizon Behavioral Services provides managed behavioral care and
employee assistance programs.

(D) Mental Health Outcomes provides outcomes information regarding the
effectiveness of mental health programs, psychiatric data base
services, and Phase IV clinical trial services.

(E) ProCare One Nurses provides specialized nurse staffing services to
hospitals primarily in California and Michigan.

(F) "Other" represents the Company's primary general and administrative
costs, i.e., expenses associated with the corporate offices and
National Support Center located in the Dallas suburb of Lewisville,
Texas which provides management, financial, human resources, and
information system support for the Company and its subsidiaries.

(G) EBITDA is a presentation of "earnings before interest, taxes,
depreciation, and amortization." EBITDA is the unit of measure reviewed
by the chief operating decision makers in determining segment operating
performance. EBITDA may not be comparable to similarly titled measures
reported by other companies. In addition, EBITDA is a non-GAAP measure
and should not be considered an alternative to operating or net income
in measuring company results. For the period ended November 30 2002 and
2001, consolidated EBITDA is derived by adding depreciation and
amortization of $758,839 and $749,203, respectively, to the Company's
operating income for the same periods of $3,909,214 and $3,533,002,
respectively. Consolidated cash flows from operating, investing, and
financing activities for the period ended November 30, 2002 were
$(799,575) $(3,347,760), and $2,422,814, respectively, and for the
period ended November 30, 2001 were $2,791,787, $(3,015,498), and
$25,103, respectively, and are represented on the Statement of Cash
Flows elsewhere herein.

16

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

OVERVIEW

The Company is a diversified health care services provider. It offers
employee assistance programs ("EAP") and managed behavioral health services to
employers, HMO's, and insurance companies. Through its acquisition of ProCare
One Nurses ("ProCare"), effective June 13, 2002, the Company provides
specialized nurse staffing services to hospitals. The Company also is a leading
contract manager of psychiatric and physical rehabilitation clinical programs
offered by general acute care hospitals in the United States. In addition, the
Company provides outcomes information regarding the effectiveness of mental
health programs, psychiatric data base services, and Phase IV clinical trial
services.

The Company has grown both internally and through acquisitions,
increasing both the variety of its treatment programs and services, and the
number of its contracts, which totaled 1,149 at November 30, 2002. As of
November 30, 2002, the Company had 878 contracts to provide EAP and managed
mental health services covering approximately 3.2 million lives. The Company had
137 management contracts as of November 30, 2002, with contract locations in 34
states and the District of Columbia. Of its management contracts, 110 relate to
mental health treatment programs and 27 relate to physical rehabilitation
programs. The Company has also developed a proprietary mental health outcomes
measurement system known as CQI+ as well as outcomes and Phase IV clinical
research services known as "PsychScope". At November 30, 2002 the Company had
contracts to provide outcome measurement services at 125 contract locations as
well as 9 PsychScope outcomes and Phase IV clinical research project contracts.
As of November 30, 2002, the Company's nurse staffing subsidiary provided, on a
monthly average, in excess of 500 nurses to over 100 different general acute
care hospitals.

See Note 10 to the Consolidated Financial Statements, included
elsewhere herein, for additional information concerning the business segments of
the Company.

REVENUES

Contract Management Services (Horizon Mental Health Management and
Specialty Rehabilitation Management)

The fees received by the Company for its services under management
contracts are paid directly by its client hospitals. Generally, contract fees
are paid on a monthly basis. The client hospitals receive reimbursement under
either the Medicare or Medicaid programs or payments from insurers, self-funded
benefit plans or other third-party payors for the mental health and physical
rehabilitation services provided to patients of the programs managed by the
Company. As a result, the availability and amount of such reimbursement, which
are subject to change, impacts the decisions of general acute care hospitals
regarding whether to offer mental health and physical rehabilitation services
pursuant to management contracts with the Company, as well as whether to
continue such contracts (subject to contract termination provisions) and the
amount of fees to be paid thereunder.

Horizon Mental Health Management

The Balanced Budget Act of 1997 mandated the elimination of cost-based
reimbursement of mental health partial hospitalization services. Implementation
began August 1, 2000. The resulting reimbursement for partial hospitalization
services based on the Medicare outpatient prospective payment system utilizes a
fixed reimbursement amount per patient day. The current base reimbursement rate,
which was effective April 1, 2002, is a wage-adjusted rate of $212 per day. This
change in reimbursement methodology lowered Medicare reimbursement levels to
many hospitals for partial hospitalization services. This change adversely
affected the ability of the Company to maintain and/or obtain management
contracts for partial hospitalization services and the amount of fees paid to
the Company under such contracts.

Revenues from partial hospitalization services were $1.0 million or 4.3%
of total contract management revenues for the quarter ended November 30, 2002.
Of the Company's 137 management contracts at November 30, 2002, 40 or 29.2% of
the contracts include partial hospitalization services. Of the 40 contracts
including partial hospitalization services, 31 program locations had partial
hospitalization services in operation, 8 program locations were in operation but
the partial hospitalization services were not in operation, and 1 program
location was not yet in operation for any services.

17

In April 2000, CMS adopted new rules requiring a CMS determination that
a facility has provider-based status before a provider can bill Medicare for the
services rendered at the facility. On August 1, 2002 the Centers for Medicare
and Medicaid Services or "CMS" (formerly Health Care Financing Administration or
"HCFA") issued final amendments to the provider based regulations, which in
addition to requirements applicable to all provider based facilities, provide
specific requirements for provider based status of "off-campus" locations and
additional specific requirements applicable to "off-campus" locations
operational under a management contract. The Company estimates that the revised
regulations, while still subject to clarification as to specific applicability,
may have an effect on 6 of its management contracts. In addition, CMS delayed
from October 1, 2002 to July 1, 2003, the implementation date of the new
regulations for facilities and organizations treated as provider based prior to
October 1, 2000. The Company believes that the final amendments will not have a
significant impact on its current operations of inpatient psychiatric units
located within general hospitals. In February 2002, it was announced by CMS that
inpatient rehabilitation units do not have to meet provider-based status to bill
Medicare for services rendered to patients. This announcement was supported by
the August 1, 2002 Federal Register.

The Balanced Budget Refinement Act of 1999 mandates that a prospective
payment system for inpatient psychiatric services be developed. The system shall
include an adequate patient classification system that reflects the differences
in patient resource use and costs, i.e. acuity. In addition, the law states that
the payment system must be budget neutral and be a per diem system, however a
per case rate system alternative is being considered.

The law outlined that the Secretary shall submit to the appropriate
committees of Congress a report that includes a description of the system no
later than October 1, 2001, and that the system must be implemented by October
1, 2002. Not withstanding these deadlines, both dates have passed and no
description of the system has been presented as yet. In early 2002, Tom Scully,
Administrator for CMS, gave a speech in which he predicted that a proposed
prospective payment system for inpatient psychiatric services would be released
in the Spring of 2003, subjected to a comment period, and then implemented in
2004. The Healthcare Financial Management Association (HFMA) newsletter on
November 22, 2002 stated that CMS had recently informed HFMA that the proposed
rules for PPS will be written and perhaps published by April or May of 2003,
with an implementation date that may take effect January 1, 2004. However, CMS
also indicated that the new PPS rule is likely to generate significant public
response, and recommendations for change could delay its implementation.

A prospective payment system with reimbursement based on a patient
classification system may raise or lower Medicare reimbursement levels to
hospitals for inpatient psychiatric services. To the extent client hospital
reimbursement decreases, this could adversely affect the ability of the Company
to maintain and obtain management contracts for inpatient psychiatric services
and the amount of fees paid to the Company under such contracts.

Recent amendments to the Medicare statutes also provide for a phase-out
of cost-based reimbursement of physical rehabilitation services over a two-year
period, which began January 1, 2002. Depending on a hospital's Medicare fiscal
year, the phase out period could be from 12 to 24 months. The phase in of a
prospective payment system with reimbursement based on a functional patient
classification may raise or lower Medicare per patient and/or overall
reimbursement levels to hospitals for physical rehabilitation services, subject
to the subsequent relative changes in per patient costs and patient volumes.
Where lower, this could adversely affect the ability of the Company to maintain
and/or obtain management contracts for physical rehabilitation services and the
amount of fees paid to the Company under such contracts. The Company believes
its hospital based service delivery system is a cost efficient model in general
terms as compared to alternative structures in the marketplace. While the
Company is generally not experiencing adverse consequences as a result of this
change in reimbursement, at this time, the Company cannot meaningfully predict
the ultimate impact prospective payment will have on the programs it currently
manages or on its opportunities for obtaining new programs.

Managed Behavioral Health Care Services and Employee Assistance
Programs

Through its subsidiary Horizon Behavioral Services ("HBS"), the Company
offers an array of behavioral health care products to corporate clients,
self-funded employer groups, insurance companies, commercial HMO and PPO plans,
government agencies, and third-party payors. Revenues are derived from employee
assistance program services ("EAP"), administrative services only contracts, and
at risk managed behavioral health services. Generally fees are paid on a monthly
basis.

18

Revenues from EAP contracts are typically based on a per employee per
month capitated rate applied to the number of eligible employees. The rate for
EAP plans is dependent upon the type and scope of services provided under the
contract terms. Each plan is specifically written to fulfill the clients' needs
and can offer different numbers of counseling sessions and other benefits, such
as work life services (including child care and elder care consultation),
referral resources and critical incident debriefing and intervention.

Revenues for administrative services only contracts relate to the
management of behavioral health benefits and are dependent upon the number of
contracts and the services provided. Fees are usually a case rate or a per
employee per month fee applied to the number of eligible members. The client is
able to benefit from the Company's expertise in clinical case management, the
mental health professionals employed by the Company and the independent health
care providers contracted by the Company at favorably discounted rates.

The primary factors affecting revenues derived from managed care
services are the scope of behavioral health benefits provided and the number of
members covered. Fees are based on a per employee per month capitated fee. The
capitated rate is dependent upon the benefit designs and actuarially determined
anticipated utilization of the customer's covered employees and is set forth in
the contract, usually as a per member per month capitated rate, which is applied
to the number of eligible members to determine a monthly fee.

In October 2000, HBS was awarded a three year, Full Accreditation (the
highest level) from the National Committee for Quality Assurance (NCQA) under
its 2000 standards for managed behavioral health care organizations (MBHOs).
NCQA is an independent, not-for-profit organization dedicated to assessing and
reporting on the quality of managed behavioral health care and other related
organizations. The NCQA accreditation process is a voluntary review that
evaluates how well a managed behavioral health care organization manages all
parts of its delivery system in order to continuously improve health care for
its members and to help organizations achieve the highest level of performance
possible.

Mental Health Outcomes

MHO provides outcomes measurement services to acute care hospital-based
programs, free standing psychiatric hospitals, community mental health centers,
residential centers and outpatient clinics. The contracts for outcomes
measurement services are generally for one to two years with an automatic
renewal provision. The rates for the outcomes measurement services are
negotiated based on the module selected and the number of patients and are
generally paid on a monthly basis. In 1999, MHO developed and began marketing
PsychScope research services, which allow pharmaceutical marketers and
researchers to access non-identifiable information on the clinical treatment of
patients in behavioral health programs across the U.S. In addition, PsychScope
research services allow pharmaceutical companies to implement customized
outcomes and Phase IV clinical research within the behavioral health research
network MHO continues to build. The PsychScope contracts are negotiated based on
the number of patients and depth of analysis, and in addition, Phase IV
contracts are based on the number of participating clinical sites. Revenues are
recognized in the month in which services are rendered, at the estimated net
realizable amounts. Contract payments are usually made on a schedule based on
completion stages of the project.

Specialized Nurse Staffing Services

The Company's acquisition of ProCare, in June 2002, expanded the
Company's operations in healthcare services by entering into the specialized
nurse staffing industry. The Company provides an on-call, twenty-four hour per
day, seven days a week, specialized nurse staffing service to hospitals. The
fees received by the Company for its services related to specialized nurse
staffing services are paid directly by its client hospitals. Generally,
nurse-staffing fees are determined by the number of hours worked. Fees are
billed and paid on a weekly basis. These hourly rates vary based on the
specialty of nurse required, day of the week, and time of shift to be filled.
Fees are generally billed based on a predetermined rate for each specialty and
shift as specified in a fee schedule with the client hospital. The Company
typically provides more than 500 nurses to more than 100 client hospitals
monthly. Revenues are recognized in the month in which services are rendered, at
the estimated net realizable amounts.

19

OPERATING EXPENSE

Contract Management Services

The primary factors affecting operating expenses for the Company's
contract management business in any period is the number of programs in
operation in the period and the volume of patients at those locations. Operating
expenses consist primarily of salaries and benefits paid to program management,
clinicians, therapists and supporting personnel. Mental health programs managed
by the Company generally have an independent psychiatric medical director, a
program director who is usually a psychologist or a social worker, a community
education coordinator and additional social workers or therapists as needed.
Physical rehabilitation programs managed by the Company generally have an
independent medical director, a program director, and additional clinical staff
tailored to meet the needs of the program and the client hospital, which may
include physical and occupational therapists, a speech pathologist, a social
worker and other appropriate supporting personnel. Medical directors have a
contract with the Company under which on-site administrative services needed to
administer the program are provided. Except for the nursing staff, which is
typically provided by the hospital, the other program personnel are generally
employees of the Company.

Managed Behavioral Health Care and Employee Assistance Programs

Operating expenses for the Company's managed behavioral health care
services and employee assistance programs are comprised primarily of salaries
and benefits for its clinical, operations and supporting personnel and medical
claims from clinical providers. Medical claims, the largest component, includes
payments to independent health care professionals providing services under the
capitated mental health services contracts and employee assistance programs
offered by the Company. Other costs and expenses include items such as
credentialing services, marketing costs and expenses, consulting, accounting and
legal fees and expenses, employee recruitment and relocation expenses, rent,
utilities, telecommunications costs, and property taxes.

Mental Health Outcomes

The primary factors affecting operating expenses for the outcome
measurement services and PsychScope services are the number of patients covered
and the number of clinical sites participating in the studies, with the primary
expense being salary and benefit costs for the personnel involved in the
research. In addition, operating costs related to conducting Phase IV studies
are also comprised of direct costs such as patient participation fees, location
fees, and hospital and/or physician coordination and implementation fees.

Specialized Nurse Staffing Services

The primary factor affecting operating expenses for the Company's
specialized nurse staffing business in any period is the number of shifts filled
in the period and the mix of wage rates, including overtime, for the placed
nurses. Operating expenses consist primarily of salaries and benefits paid to
the Company's nursing pool.

20

SUMMARY STATISTICAL DATA

NURSING SERVICES

As of November 30, 2002, the Company's nurse staffing subsidiary provided, on a
monthly average, in excess of 500 nurses to over 100 different general acute
care hospitals.

RESULTS OF OPERATIONS

The following table sets forth for the three months ended November 30, 2002 and
2001, the percentage relationship to total revenues of certain costs, expenses
and income.

21

THREE MONTHS ENDED NOVEMBER 30, 2002 COMPARED TO THE THREE MONTHS ENDED
NOVEMBER 30, 2001

REVENUE. Total revenue increased $8.2 million, or 24.3%, to $42.0
million for the three months ended November 30, 2002, as compared to $33.8
million for the three months ended November 30, 2001.

Revenue associated with contract management of mental health programs
decreased $900,000, or 4.5%, to $19.1 million for the three months ended
November 30, 2002 as compared to $20.0 million for the three months ended
November 30, 2001. This decrease was primarily attributable to the decline in
the number of average inpatient psychiatric locations in operation from 112.8
for the fiscal quarter ended November 30, 2001 to 107.1 for the quarter ended
November 30, 2002, as well as a decrease in psychiatric partial hospitalization
programs in operation from 38 for the quarter ended November 30, 2001 to 31 for
the quarter ended November 30, 2002.

Revenue associated with the contract management of physical
rehabilitation services increased $700,000, or 18.9%, to $4.4 million for the
three months ended November 30, 2002, as compared to $3.7 million for the three
months ended November 30, 2001. This increase was primarily due to an increase
in the average locations in operation from 20.6 for the three months ended
November 30, 2001 to 21.8 for the three months ended November 30, 2002, as well
as a 13.5% increase in average revenue per rehab location in operation.

Revenue associated with the managed behavioral health care and employee
assistance program services increased by $2.7 million, or 29.3%, to $11.9
million for the three months ended November 30, 2002, as compared to $9.2
million for the three months ended November 30, 2001. Of this increase, $2.3
million was attributable to the commencement of a significant managed care
contract on April 1, 2002 and $469,000 is due to the acquisition of EAP
International on November 1, 2002.

Revenue associated with outcomes measurement and PsychScope services
increased by $84,000, or 9.2%, to $998,000 for the three months ended November
30, 2002, as compared to $914,000 for the three months ended November 30, 2001.
PsychScope revenue increased $295,000 due to work completed on two significant
PsychScope Phase IV projects that commenced in the prior fiscal year. This
increase was offset by a $169,000 a decrease in PsychScope revenue due to the
decrease of three retrospective PsychScope projects in operation when compared
to the same quarter in the prior fiscal year. Outcomes measurement revenue
decreased $36,000 due to the decrease in contract management CQI+ locations in
operation from 46 as of November 30, 2001 to 40 as of November 30, 2002.

Revenue associated with the specialized nurse staffing services segment
was $5.7 million for the three months ended November 30, 2002. The Company
entered into this business segment with the acquisition of ProCare One Nurses
effective June 13, 2002.

COST OF SERVICES. Total costs of services provided increased $7.9
million, or 31.9%, to $32.7 million for the quarter ended November 30, 2002,
compared to $24.8 million for the quarter ended November 30, 2001. As a percent
of revenue, gross profits decreased to 22.1% for the quarter ended November 30,
2002 from 26.5% for the quarter ended November 30, 2001, primarily attributable
to the mix of revenues, i.e. a higher percentage of total revenues attributable
to the Company's lower margin HBS and ProCare subsidiaries.

Costs of services provided associated with the mental health contract
management business segment decreased by $700,000, or 5.1%, to $13.0 million for
the quarter ended November 30, 2002, compared to $13.7 million for the quarter
ended November 30, 2001. This decrease was primarily attributable to the decline
in the average number of psychiatric locations in operation. As a percent of
revenue, the mental health contract management business segment's gross profits
decreased slightly to 31.9% for the quarter ended November 30, 2002 from 32.0%
for the quarter ended November 30, 2001.

Costs of services provided associated with contract management of
physical rehabilitation services increased by $600,000, or 23.1%, to $3.2
million for the three months ended November 30, 2002, compared to $2.6 million
for the three months ended November 30, 2001. Of this increase, $125,000 is
related to anticipated renovation costs for one contract location recorded as an
expense during the three months ended November 30, 2002. The remainder of this
increase is primarily due to the increase in average locations in operation. As
a percent of revenue, gross profits increased to 28.0% for the three months
ended November 30, 2002 from 27.8% for the three months ended November 30, 2001.

22

Cost of services provided associated with managed behavioral health
care and employee assistance program services increased by $3.0 million, or
38.0%, to $10.9 million for the three months ended November 30, 2002, as
compared to $7.9 million for the three months ended November 30, 2001. $2.2
million was attributable to the commencement of a significant managed care
contract, which had a higher level of utilization and $362,000 from the
additional EAP International business acquired effective November 1, 2002. An
additional $220,000 was the result of an increase in other client medical claims
experience due to a 27.9% increase in the average cost per inpatient day,
partially offset by a 5.5% decrease in inpatient days. The resultant medical
loss ratio was 48% as compared to 35% for the prior year. In addition, legal
fees associated with obtaining a Knox Keene license in California increased
$58,000 between the periods. As a percent of revenue, gross profits decreased to
8.6% for the quarter ended November 30, 2002 from 13.9% for the quarter ended
November 30, 2001.

Costs of services provided associated with outcomes measurement and
PsychScope services decreased by $38,000, or 5.7%, to $626,000 for the quarter
ended November 30, 2002, compared to $664,000 for the quarter ended November 30,
2001. As a percent of revenue, gross profits increased to 37.2% for the quarter
ended November 30, 2002 from 27.3% for the quarter ended November 30, 2001.

Cost of services provided associated with the specialized nurse
staffing segment was $5.1 million for the three months ended November 30, 2002.
As a percent of revenue, gross profits were 10.4% for the three months ended
November 30, 2002.

SELLING, GENERAL AND ADMINISTRATIVE. Total selling, general, and
administrative expenses, on a net basis, increased $200,000,or 4.5%, to $4.6
million for the three months ended November 30, 2002, compared to $4.4 million
for the three months ended November 30, 2001. Sales commissions were $154,000
higher from period to period primarily due to a lower commissions expense in
2001 resulting from a termination of a contract and its associated commissions.
In addition, commissions recorded in the current quarter reflected the current
period portion of a significant managed care contract. Recruitment placement
fees increased $140,000 for the three months ended November 30, 2002, compared
to the three months ended November 30, 2001, primarily due to the initiation of
five managerial employee recruiting searches.

PROVISION FOR DOUBTFUL ACCOUNTS. The net provision for doubtful
accounts expense for the fiscal quarter ended November 30, 2002 was zero, a
decrease of $275,000 as compared to the fiscal quarter ended November 30, 2001.
This net zero amount is primarily the result of the reversal of reserves
recorded in prior periods for old receivables, due to recently received
information on expected collectibility.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for
the three months ended November 30, 2002 was $759,000 representing an increase
of $10,000 or 1.3% as compared to depreciation and amortization expense of
$749,000 for the corresponding period in the prior fiscal year. The variance is
primarily attributable to an increase of $93,000 resulting from the acceleration
of amortizing the final portion of contract valuation associated with a 1997
acquisition. In addition, due to the Company's limited capital expenditure
requirements, depreciation generated from assets acquired during the period did
not exceed a reduction in depreciation associated with items becoming fully
depreciated.

INTEREST AND OTHER INCOME (EXPENSE), NET. Interest expense, interest
income and other income for the three months ended November 30, 2002 resulted in
a net expense of $78,000, as compared to $49,000 for the corresponding period in
the prior fiscal year. This change is primarily the result of an increase in
interest expense of $35,000 related to an increase in the weighted average
outstanding credit facility balance between periods. The weighted average
outstanding credit facility balance for the three months ended November 30, 2002
was $10.6 million with an ending balance of $15.0 million. The weighted average
outstanding balance for the corresponding period in the prior fiscal year was
$8.2 million with an ending balance of $6.9 million.

INCOME TAX EXPENSE. For the three-month period ended November 30, 2002,
the Company recorded federal and state income taxes of $1.5 million resulting in
a combined tax rate of 38.5%. For the three-month period ended November 30,
2001, the Company recorded federal and state income taxes of $1.3 million
resulting in a combined tax rate of 38.6%.

23

LIQUIDITY AND CAPITAL RESOURCES

For the three months ended November 30, 2002 the Company had operating
income of $3.9 million and EBITDA of $4.7 million as compared to $3.5 million
and $4.3 million, respectively, for the prior year. However, net cash from
operating activities after giving effect to the change in working capital
(excluding the November 1, 2002 acquisition of EAP International) was a negative
$800,000 as compared to a positive $2.8 million for the prior year first fiscal
quarter. This difference was primarily the result of the impact of business
payment patterns associated with the Thanksgiving Holiday. In 2001, Thanksgiving
occurred in the third week of November (11/22/01) allowing for the normal Friday
payment cycle for most hospitals to occur in the last week of the month. In
2002, Thanksgiving occurred in the fourth week of November (11/28/02)
eliminating the final payment cycle, with a shift in payments to the first week
in December. This resulted in an approximately $2.0 million greater accounts
receivable balance at the November 30, 2002 fiscal quarter end (as reflected by
the higher 38 days revenue outstanding) which was received by the Company in the
first half of December. An additional significant factor contributing to the
difference between years, which accounts for the balance of the change in
working capital, was a lower general level of payables and accruals in the
fiscal 2003 first quarter due to 13 less contract management locations in
operation as well as the payment of certain obligations amounts associated with
recent acquisitions.

The Company believes that its future cash flow from operations (which was
$10.4 million for the most recent twelve months ended November 30, 2002), along
with cash of $2.3 million at November 30, 2002, and the $30 million revolving
credit facility (of which $9.4 million was available at November 30, 2002), will
be sufficient to cover operating cash requirements over the next 12 months,
including estimated capital expenditures of $700,000. The Company may require
additional capital to fund acquisitions.

Effective May 23, 2002, the Company entered into a Second Amended and
Restated Credit Agreement with JPMorgan Chase Bank, as Agent, and Bank of
America, NA to refinance the loans outstanding under the existing credit
agreement and to provide expanded credit availability. The Credit Agreement is
a five year $30.0 million facility consisting of a three-year revolving/two
year term credit facility with provisions to allow for its expansion to a $50.0
million facility. As of November 30, 2002, the Company had borrowings of $15.0
million outstanding against the revolving credit facility.

The following summary of certain material provisions of the Credit
Agreement does not purport to be complete, and is subject to, and qualified in
its entirety by reference to, the Second Amended Credit Agreement, a copy of
which was previously filed as Exhibit 10.1 in the May 2002 Form 10-Q.

The Company and one of its subsidiaries are the borrowers under the
Credit Agreement, which is unconditionally guaranteed by all material
subsidiaries of the Company. Loans outstanding under the Credit Agreement bears
interest at the "Base Rate" (the greater of the Agent's "prime rate" or the
federal funds rate plus .5%) plus .5% to 1.25% (depending on the Company's
Indebtedness to EBITDA Ratio), or the "Eurodollar Rate" plus 2.00% to 2.75%
(depending on the Company's Indebtedness to EBITDA Ratio), as selected by the
Company. The Company pays interest quarterly and incurs quarterly commitment
fees of .5% per annum on the unused portion of the revolving credit facility.

The Company is subject to certain covenants which include prohibitions
against (i) incurring additional debt or liens, except specified permitted debt
or permitted liens, (ii) certain material acquisitions, other than specified
permitted acquisitions (including any single acquisition not greater than $10.0
million or cumulative acquisitions not in excess of $25.0 million) during any
twelve consecutive monthly periods without prior bank approval, (iii) certain
mergers, consolidations or asset dispositions by the Company or changes of
control of the Company, (iv) certain management vacancies at the Company, and
(v) material change in the nature of business conducted. In addition, the terms
of the revolving credit facility require the Company to satisfy certain ongoing
financial covenants. The revolving credit facility is secured by a first lien or
first priority security interest in and/or pledge of substantially all of the
assets of the Company and of all present and future material subsidiaries of the
Company. As of November 30, 2002, the Company was in compliance with all
covenants of the agreement.

As of October 4, 2002, the Credit Agreement was amended to allow the
Company to finance the redemption or repurchase of its capital stock subject to
certain conditions. The amendment allows the Company to expend up to $7.5
million for the repurchasing of shares. As of November 30, 2002, the Company has
repurchased 227,200 shares with a total purchase price of approximately $2.6
million.

24

Effective September 1996, the Company entered into a lease arrangement
with an unconsolidated, unaffiliated special purpose entity. The lease
agreement, which had an initial term of five years that has been extended to May
2007, is for a building constructed to the Company's specifications for use as
its National Support Center. In connection with the transaction, a financial
institution loaned to the special purpose entity approximately $4.4 million. The
Company guaranteed on a limited basis approximately $900,000 of the loan. The
loan is payable on an interest only basis with all principal due at the end of
the lease term. The Company also agreed to purchase the building for
approximately $4.4 million at the end of the lease term, currently May 2007, if
either the building is not sold to a third party or the Company does not extend
its lease. A recent independent appraisal indicated the fair market value of the
building is at least equal to the loan amount and purchase price.

On November 18, 2002, the Company signed a definitive agreement to
acquire privately held Health and Human Resource Center, Inc., d/b/a Integrated
Insights, headquartered in San Diego, California. The definitive agreement
contemplates a stock purchase in which the Company will acquire all the capital
stock of Integrated Insights. As a result of the transaction, Integrated
Insights will become a wholly owned subsidiary of the Company. Integrated
Insights provides employee assistance programs under contracts directly with
employers. It holds a California Knox-Keene License to operate as a specialized
health care plan. At October 31, 2002, Integrated Insights had approximately 295
contracts covering approximately 378,000 lives. For the year ended December 31,
2001, Integrated Insights had revenues of approximately $4.59 million
(unaudited). For the nine-month period ending September 30, 2002, Integrated
Insights had revenues of approximately $3.62 million (unaudited). The closing
transaction is subject to the satisfaction of various conditions, including
approval by the California Department of Managed Health Care.

Effective June 13, 2002, the Company acquired all of the membership
interests of ProCare One Nurses for approximately $12.5 million. The acquisition
was funded by incurring debt of $11.5 million under the revolving credit
facility, and $1.0 million from existing cash.

The Company acquired all of the outstanding capital stock of Employee
Assistance Programs International on November 4, 2002 with an effective date of
November 1, 2002 for approximately $3.4 million. The acquisition was funded by
incurring debt of $1.5 million under the revolving credit facility and $1.9
million from existing cash.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

See "Management's Discussion and Analysis" of "Critical Accounting
Policies" presented in the Company's August 31, 2002 Form 10-K, incorporated
herein by reference, for information concerning the accounting policies and
estimates of the Company.

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

Certain written and oral statements made or incorporated by reference
from time to time by the Company or its representatives in this report, other
reports, filings with the Commission, press releases, conferences, or otherwise,
are "forward looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements include, without limitation, any
statement that may predict, forecast, indicate, or imply future results,
performance or achievements, and may contain the words "believe," "anticipate,"
"expect," "estimate," "project," "will be," "will continue," "will likely
result," or words or phrases of similar meaning. Such statements involve risks,
uncertainties or other factors which may cause actual results to differ
materially from the future results, performance or achievements expressed or
implied by such forward looking statements. Certain risks, uncertainties and
other important factors are detailed in this report and will be detailed from
time to time in reports filed by the Company with the Commission, including
Forms 8-K, 10-Q, and 10-K, and include, among others, the following: general
economic and business conditions which are less favorable than expected;
unanticipated changes in industry trends; decreased demand by general hospitals
for the Company's services; the Company's inability to retain existing
management contracts or to obtain additional contracts or maintain customer
relationships; adverse changes in reimbursement to general hospitals by Medicare
or other third-party payers for costs of providing mental health or physical
rehabilitation or nursing; adverse changes to other regulatory requirements
relating to the provision of mental health or physical rehabilitation or nursing
services; adverse consequences of investigations by governmental regulatory
agencies; adverse judgements rendered in the qui tam lawsuits pending against
the Company; fluctuations and difficulty in forecasting operating results; the
ability of the Company to sustain, manage or forecast its growth; the ability of
the Company to successfully integrate acquired

25

businesses on a cost effective basis; heightened competition, including
specifically the intensification of price competition; the entry of new
competitors and the development of new products or services by new and existing
competitors; changes in business strategy or development plans; inability to
carry out marketing and sales plans; business disruptions; liability and other
claims asserted against the Company; loss of key executives; the ability to
attract and retain qualified personnel; adverse publicity; demographic changes;
and other factors referenced or incorporated by reference in this report and
other reports or filings with the Commission. Moreover, the Company operates in
a very competitive and rapidly changing environment. New risk factors emerge
from time to time and it is not possible for management to predict all such risk
factors, nor can it assess the impact of all such risk factors on the Company's
business or the extent to which any factor may cause actual results to differ
materially from those contained in any forward looking statements. These
forward-looking statements represent the estimates and assumptions of management
only as of the date of this report. The Company expressly disclaims any
obligation or undertaking to disseminate any updates or revisions to any forward
looking statement contained herein to reflect any change in its expectations
with regard thereto or any change in events, conditions or circumstances on
which any statement is based. Given these risks and uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction of
actual results.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In its normal operations, the Company has market risk exposure to
interest rates due to its interest bearing debt obligations, which were entered
into for purposes other than trading purposes. To manage its exposure to changes
in interest rates, the Company uses both variable rate debt and fixed rate debt
of short duration with maturities ranging from 30 to 180 days. The Company has
estimated its market risk exposure using sensitivity analyses assuming a 10%
change in market rates.

At November 30, 2002, the Company had approximately $15.0 million of
debt obligations outstanding with a weighted average interest rate of 4.25%. A
hypothetical 10% change in the effective interest rate for these borrowings,
assuming debt levels as of November 30, 2002, would change interest expense by
approximately $64,000 annually. This would be funded out of cash flows from
operations, which were $10.4 million for the twelve most recent months ended
November 30, 2002.

ITEM 4. CONTROLS AND PROCEDURES

Within 90 days prior to the filing date of this report, the Company's
Chief Executive Officer and the Company's Chief Financial Officer evaluated the
effectiveness of the design and operation of the Company's "disclosure controls
and procedures". Based on that evaluation, the Company's Chief Executive Officer
and the Company's Chief Financial Officer have concluded that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in the reports that it files and submits
under the Exchange Act is recorded, processed, summarized and reported as and
when required, and are effective to ensure that such information is accumulated
and communicated to the Company's management, including its Chief Executive
Officer and its Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. Subsequent to the date of evaluation,
there have been no significant changes in the internal controls or in other
factors that would significantly affect the internal controls, and no corrective
actions were considered necessary or taken with regard to significant
deficiencies and material weaknesses in the internal controls.

26

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is, and may be in the future, party to litigation arising
in the ordinary course of its business. While the Company has no reason to
believe that any such pending claims are material, there can be no assurance
that the Company's insurance coverages will be adequate to substantially cover
liabilities arising out of such claims or that any such claims will be covered
by the Company's insurance. Any material claim which is not covered by insurance
may have an adverse effect on the Company's business. Claims against the
Company, regardless of their merit or outcome, may also have an adverse effect
on the Company's reputation and business.

In late 1999, the Company became aware that a civil qui tam lawsuit had
been filed under seal naming the Company's psychiatric contract management
subsidiary, Horizon Mental Health Management (Horizon), as one of the defendants
therein. In March 2001, the relators served the complaint in the lawsuit brought
under the Federal False Claims Act. The U.S. Department of Justice had
previously declined to intervene in the lawsuit. The complaint alleges that
certain on-site Company personnel acted in concert with other non-Company
personnel to improperly inflate certain Medicare reimbursable costs associated
with psychiatric services rendered at a Tennessee hospital prior to August 1997.
The lawsuit names the hospital, the parent corporation of the hospital and a
home health agency as additional defendants. The Company has filed a motion to
dismiss and discovery proceedings have been deferred until the court rules on
the motion. The Company does not believe the claims asserted in the lawsuit,
based on present allegations, represent a material liability to the Company.

In early December 2000, the Company was served with a U.S. Department
of Justice subpoena issued by the U.S. Attorney's Office for the Northern
District of California. The subpoena requested the production of documents
related to certain matters such as patient admissions, patient care, patient
charting, and marketing materials, pertaining to hospital gero-psychiatric
programs managed by the Company. The Company furnished documents in response to
the subpoena in January 2001 and there has been no further activity in relation
to the subpoena since that time. On October 30, 2002, the Company received a
letter from the Civil Division of the U.S. Department of Justice proposing a
preliminary meeting to discuss possible False Claim Act violations alleged in a
qui tam suit and also to discuss the findings of the U.S. Department of Justice
after its review of certain records. The Company met with the U.S. Department of
Justice in December 2002 and furnished additional information regarding what
appear to be the allegations. The qui tam suit remains under seal and the U.S.
Government is still considering whether or not it will intervene in the suit.
The Company has not been served with the suit. The allegations and the records
reviewed relate to the same matters that were the subject of the 2000 U.S.
Department of Justice subpoena. At this time, the Company cannot predict the
ultimate scope or any particular future outcome of the qui tam suit or the
investigation. It is possible that eventually allegations could be asserted
against the Company involving claims anywhere from minor to significant in
amount.

27

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

NUMBER EXHIBIT

3.1 Certificate of Incorporation of the Company, as amended
(incorporated herein by reference to Exhibit 3.1 to the
Company's Current Report on Form 8-K dated August 11, 1997).

3.2 Amended and Restated Bylaws of the Company, as amended
(incorporated herein by reference to Exhibit 3.2 to Amendment
No. 2 as filed with the Commission on February 16, 1995 to the
Company's Registration Statement on Form S-1 filed with the
Commission on January 6, 1995 (Registration No. 33-88314)).

4.1 Specimen certificate for the Common Stock, $.01 par value of
the Company (incorporated herein by reference to Exhibit 4.1
to the Company's Current Report on Form 8-K dated August 11,
1997).

4.2 Rights Agreement, dated February 6, 1997, between the Company
and American Stock Transfer & Trust Company, as Rights Agent
(incorporated herein by reference to Exhibit 4.1 to the
Company's Registration Statement on Form 8-A, Registration
No. 000-22123, as filed with the Commission on
February 7, 1997).

11.1 Statement Regarding Computation of Per Share Earnings (filed
herewith).

99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, signed by James W. McAtee, President and Chief
Executive Officer, dated December 20, 2002 (filed herewith).

99.2 Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, signed by Ronald C. Drabik, Senior Vice
President, Finance and Administration, dated December 20, 2002
(filed herewith).

(b) The Company filed the following reports on Form 8-K during
the quarter covered by this report:

Current report on Form 8-K filed with the Commission on
November 27, 2002. The item reported was Item 5, Other Events,
announcing a publicly available conference call regarding the
Company's first quarter financial results on December 19,
2002.

28

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.

DATE: DECEMBER 20, 2002
HORIZON HEALTH CORPORATION

BY: /s/ RONALD C. DRABIK
------------------------------------------------
RONALD C. DRABIK
SENIOR VICE PRESIDENT-FINANCE AND ADMINISTRATION
AND TREASURER (PRINCIPAL FINANCIAL
AND ACCOUNTING OFFICER)

29

CERTIFICATION

I, James W. McAtee, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Horizon Health
Corporation;

2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: December 20, 2002 /s/ JAMES W. MCATEE
-------------------------------------
James W. McAtee
President and Chief Executive Officer

30

CERTIFICATION

I, Ronald C. Drabik, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Horizon Health
Corporation;

2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):

a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

Date: December 20, 2002 /s/ RONALD C. DRABIK
-------------------------
Ronald C. Drabik
Chief Financial Officer

31

INDEX TO EXHIBITS