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

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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 February 28, 2003

or

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

For the transition period from ___________ to _______________

Commission file number 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 [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [X]

The number of shares outstanding of the registrant's Common Stock, $0.01 par
value, as of March 19, 2003, was 5,300,100.

INDEX

HORIZON HEALTH CORPORATION

PART I - FINANCIAL INFORMATION

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

HORIZON HEALTH CORPORATION

Consolidated Balance Sheets as of February 28, 2003 (unaudited)
and August 31, 2002 .............................................................. 3

Consolidated Statements of Operations for the three months ended
February 28, 2003 and 2002 (each unaudited) ...................................... 5

Consolidated Statements of Operations for the six months ended
February 28, 2003 and 2002 (each unaudited) ...................................... 6

Consolidated Statements of Cash Flows for the six months ended
February 28, 2003 and 2002 (each unaudited) ...................................... 7

Notes to Consolidated Financial Statements (unaudited) ........................... 8

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ..... 18

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ................................ 29

ITEM 4. CONTROLS AND PROCEDURES ................................................................... 29

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS ......................................................................... 30

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .......................................................... 31

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 OPERATIONS (UNAUDITED)

See accompanying notes to consolidated financial statements.

6

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.

7

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 AND NEW ACCOUNTING STANDARDS:

The accompanying consolidated balance sheet at February 28, 2003, the
consolidated statements of operations for the three and six months ended
February 28, 2003 and 2002, and the consolidated statements of cash flows
for the six months ended February 28, 2003 and 2002 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 February 28, 2003, and the
results of operations for the three and six months ended February 28,
2003 and 2002.

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

In December 2002, the FASB issued FAS 148, "Accounting for Stock-Based
Compensation Transition and Disclosure." This statement amends FAS 123,
"Accounting for Stock-Based Compensation," and establishes two
alternative methods of transition from the intrinsic value method to the
fair value method of accounting for stock-based employee compensation. In
addition, FAS 148 requires prominent disclosure about the effects on
reported net income and requires disclosure of these effects in interim
financial information. The provisions for the alternative transition
methods are effective for fiscal years ending after December 15, 2002,
and the amended disclosure requirements are effective for interim periods
beginning after December 15, 2002 and allow for early application. The
Company currently plans to continue accounting for stock-based
compensation under APB 25, an allowable method, with additional
disclosures as required beginning with its fiscal third quarter.

In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46") which changes
the criteria by which one company includes another entity in its
consolidated financial statements. FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. The consolidation requirements of FIN 46 apply
immediately to variable interest entities created after January 31, 2003,
and apply in the first fiscal period beginning after June 15, 2003, for
variable interest entities created prior to February 1, 2003. The Company
has a relationship with one variable interest entity as discussed in
Footnote 8, "Commitments and Contingencies". Under the new guidelines the
Company may be required to consolidate the variable interest entity, but
has not reached a final conclusion.

8

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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.

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. For recoveries
associated with previously written off accounts receivable balances, upon
actual receipt of monies, legal fees expended in the pursuit of the
outstanding amounts are considered "recovered" prior to the reversal of
any previously written off bad debt.

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
February 28, 2003 and August 31, 2002, respectively, other identifiable
intangible assets, net, consist of contracts ($3,091,488 and $3,145,605),
non-competes ($258,623 and $186,111) and trade name ($102,339 and
$93,056). 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.

9

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Accounting for these types of assets requires 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.

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 February 28,
2003, the Company repurchased 10,700 shares of its common stock pursuant
to such authorization, which remains in effect. As of February 28, 2003,
a total of 237,900 shares have been repurchased.

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

10

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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.

(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 February 28, 2003, 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 basis 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.

11

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At February 28, 2003, the Company had deferred tax assets in excess of
deferred tax liabilities of $69,488. 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.

3. EARNINGS PER SHARE

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

During fiscal years 2003 and 2002, 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 February 28, 2003 excluded 6,500 shares subject to options,
with exercise prices ranging from $16.35 to $23.75. The computation for
the quarter ended February 28, 2002 excluded 4,000 shares subject to
options, with an exercise price of $23.75. The computation for the six
months ended February 28, 2003 excluded an average of 51,600 shares
subject to options, with exercise prices ranging from $14.51 to $23.75.
The computation for the six months ended February 28, 2002 excluded an
average of 4,335 shares subject to options, with exercise prices ranging
from $13.50 to $23.75.

12

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 $3.37 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 $3.37 million exceeded the
fair value of EAP International's tangible net assets by $3,537,750 of
which $2,760,338 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 $925,185, 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.

5. PROPERTY AND EQUIPMENT

Property and equipment consist of the following at February 28, 2003 and
August 31, 2002:

Depreciation expense for the three months ended February 28, 2003 and
2002 totaled $262,540 and $302,819, respectively and for the six months
ended February 28, 2003 and 2002, depreciation expense totaled $553,936
and $604,519, 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 six months ended February 28, 2003 was $849,733. During the
quarter ended November 30, 2002, there was a $93,000

13

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 six months in the
2003 fiscal year and for each of the four succeeding fiscal years.

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 six months ended February 28, 2003. 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 February 28, 2003 and August 31, 2002, the Company had long-term debt
comprised of a revolving credit facility with outstanding balances of
$9.0 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 February 28, 2003, the
weighted average interest rate on outstanding indebtedness under the
credit facility was 3.78%. The Eurodollar Margin and Base Rate Margin
vary depending on the debt coverage ratio of the Company. The revolving
credit facility matures on May 31, 2005.

14

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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:

Rent expense for the six months ended February 28, 2003 and 2002 totaled
$1,273,000 and $1,323,304, respectively.

Effective September 1996, the Company entered into a lease arrangement
with an unconsolidated variable purpose entity (previously also known as
a "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
designed by the Company for use as its National Support Center. In
connection with the transaction, a financial institution loaned to the
variable purpose entity approximately $4.4 million. The Company
guaranteed on a limited basis approximately $900,000 of the loan. In
addition, the Company is obligated, if it does not purchase the building
(as described below), and the building is sold to an independent party
for less than the then outstanding debt balance, to pay such shortfall up
to $2.8 million in addition to the $900,000 guarantee. In effect, the
Company's obligation is up to 84% of the then outstanding debt principal.
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 December 31, 2002, Integrated Insights had approximately 303
contracts covering approximately 358,000 lives. For the year ended
December 31, 2002, Integrated Insights had revenues of approximately
$4.81 million (audited). The closing 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.

During the quarter, in connection with the civil qui tam lawsuit pending
against a subsidiary of the Company in the District of Columbia described
in Item 3 of Part I of the Company's Annual Report on Form 10-K for the
year ended August 31, 2002, the court denied the Company's motion to
dismiss and the Company recently filed an answer in the proceeding. There
were no other significant developments in connection with this lawsuit
during the quarter.

15

HORIZON HEALTH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

During the quarter, there were no significant developments in connection
with the investigation and unsealed qui tam suit pending in the Northern
District of California described in Item 3 of Part I of the Company's
Annual Report on Form 10-K for the year ended August 31, 2002.

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. As of February 28, 2003, the Company had repurchased
237,900 shares, in total and 10,700 shares during the quarter 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 591,770 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 February 28, 2003 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.

16

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 three months ended February 28,
2003 and 2002, consolidated EBITDA is derived by adding depreciation
and amortization of $644,830 and $734,629, respectively, to the
Company's operating income for the same periods of $4,038,190 and
$3,595,600, respectively. For the six months ended February 28, 2003
and 2002, consolidated EBITDA is derived by adding depreciation and
amortization of $1,403,669 and $1,483,832, respectively, to the
Company's operating income for the same periods of $7,947,404 and
$7,128,602, respectively. Consolidated cash flows from operating,
investing, and financing activities for the periods ended February 28,
2003 were $4,545,572, $(3,438,088), and $(3,617,824) respectively, and
for the period ended February 28, 2002 were $4,980,335, $(3,311,303),
and $(2,079,872), respectively, and are represented on the Statement of
Cash Flows elsewhere herein.

17

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 1,131 at February 28, 2003. As of
February 28, 2003, the Company had 875 contracts to provide EAP and managed
mental health services covering over 2.9 million lives. The Company had 139
management contracts as of February 28, 2003, with contract locations in 34
states. Of its management contracts, 109 relate to mental health treatment
programs and 30 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 February 28, 2003 the Company had contracts to provide outcome
measurement services at 111 contract locations as well as 6 PsychScope outcomes
and Phase IV clinical research project contracts. As of February 28, 2003, the
Company's nurse staffing subsidiary provided, on a monthly average, in excess of
460 nurses to over 100 different general acute care hospitals located throughout
California and Michigan.

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 January 1, 2003, is a wage-adjusted rate of $240 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 $900,000 or 3.9% of
total contract management revenues for the quarter ended February 28, 2003. Of
the Company's 139 management contracts at February 28, 2003, 37 or 26.6% of the
contracts include partial hospitalization services. Of the 37 contracts
including partial hospitalization services, 29 program locations had partial
hospitalization services in operation, 7 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.

18

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 5 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 confirmed in
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.

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, subject 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. All physical
rehabilitation units in the Country will be under a 100% prospective payment
system by September 1, 2003. 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.

19

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 460 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.

20

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, include
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.

21

SUMMARY STATISTICAL DATA

RESULTS OF OPERATIONS

The following table sets forth for the three and six months ended February 28,
2003 and 2002, the percentage relationship to total revenues of certain costs,
expenses and income.

22

THREE MONTHS ENDED FEBRUARY 28, 2003 COMPARED TO THE THREE MONTHS ENDED
FEBRUARY 28, 2002

REVENUE. Total revenue increased $7.5 million, or 22.1%, to $41.5
million for the three months ended February 28, 2003, as compared to $34.0
million for the three months ended February 28, 2002.

Revenue associated with contract management of mental health programs
decreased $1.9 million, or 9.3%, to $18.5 million for the three months ended
February 28, 2003 as compared to $20.4 million for the three months ended
February 28, 2002. This decrease was primarily attributable to the decline in
the number of average inpatient psychiatric locations in operation from 116.7
for the fiscal quarter ended February 28, 2002 to 103.9 for the quarter ended
February 28, 2003, as well as a decrease in psychiatric partial hospitalization
programs in operation from 34 for the quarter ended February 28, 2002 to 29 for
the quarter ended February 28, 2003.

Revenue associated with contract management of physical rehabilitation
services increased $600,000, or 15.8%, to $4.4 million for the three months
ended February 28, 2003, as compared to $3.8 million for the three months ended
February 28, 2002. This increase was primarily due to an increase in the average
rehabilitation locations in operation from 21.1 for the three months ended
February 28, 2002 to 21.8 for the three months ended February 28, 2003 as well
as a 12.6% increase in average revenue per rehabilitation location in operation,
which is primarily attributable to an increase of 2,488 inpatient days between
the periods.

Revenue associated with the managed behavioral health care and employee
assistance program services increased by $3.0 million, or 33.0%, to $12.1
million for the three months ended February 28, 2003, as compared to $9.1
million for the three months ended February 28, 2003. Of this increase, $2.3
million was attributable to the commencement of a significant managed care
contract on April 1, 2002 and $1.4 million was due to the acquisition of EAP
International effective November 1, 2002. These increases were offset by a
decrease of $839,000 which was attributable to the termination of a significant
managed care contract on December 31, 2002.

Revenue associated with outcomes measurement and PsychScope services
increased by $34,000, or 4.4%, to $800,000 for the three months ended February
28, 2003, as compared to $766,000 for the three months ended February 28, 2002.
PsychScope revenue increased $113,000 primarily due to work done on four
significant PsychScope Phase IV clinical trial projects that commenced prior to
the current fiscal year. Outcomes revenue decreased $80,000 due to the average
number of CQI+ contracts in operation decreasing from 147.9 for the three months
ended February 28, 2002 to 113.5 for the three months ended February 28, 2003.

Revenue associated with the specialized nurse staffing services segment
was $5.8 million for the three months ended February 28, 2003. 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 $7.4
million, or 28.9%, to $33.0 million for the quarter ended February 28, 2003,
compared to $25.6 million for the quarter ended February 28, 2002. This increase
is primarily attributable to the mix of revenues, i.e. a higher percentage of
total revenues attributable to the Company's HBS subsidiary, for which costs of
services includes medical claims and ProCare subsidiary, for which cost of
services includes nurse wages. As a result, as a percent of revenue, gross
profits decreased to 20.5% for the quarter ended February 28, 2003 from 24.6%
for the quarter ended February 28, 2002

Cost of services provided associated with contract management of mental
health programs decreased by $1.5 million, or 10.6%, to $12.6 million for the
quarter ended February 28, 2003, compared to $14.1 million for the quarter ended
February 28, 2002. This decrease was primarily attributable to the decline in
the average number of psychiatric locations in operation. As a percent of
revenue, gross profits increased slightly to 31.8% for the quarter ended
February 28, 2003 from 30.5% for the quarter ended February 28, 2002, reflecting
a growth in revenue per average location as well as same store sales.

Cost of services provided associated with contract management of
physical rehabilitation services increased by $300,000, or 10.7%, to $3.1
million for the three months ended February 28, 2003, as compared to $2.8
million for the three months ended February 28, 2002. $189,000 of the increase
is due the commencement of one significant client contract that has three
separate operating locations. In addition, $134,000 of the increase is due to
the commencement of a skilled nursing unit at an existing contract location in
April 2002. As a percent of revenue, gross profits increased to 29.1% for the
three months ended February 28, 2003 from 26.1% for the three months ended
February 28, 2002, also reflecting larger more profitable contract locations.

23

Cost of services provided associated with managed behavioral health
care and employee assistance program services increased by $3.5 million, or
44.3%, to $11.4 million for the three months ended February 28, 2003, as
compared to $7.9 million for the three months ended February 28, 2002. A net
$2.1 million was attributable to an increase in medical claim expense associated
with managed behavioral health care, with $2.2 million attributable to the
commencement, on April 1, 2002, of a significant managed care contract which was
partially offset by a decrease of $530,000 related to the termination of a
significant managed care contract effective December 31, 2002. The remaining
$450,000 increase in the medical claim expense was the result of an increase in
existing client claims, other than the contracts mentioned above, due to a 14.8%
increase in the average cost per day and a 17.4% increase in inpatient days. An
additional $1.1 million increase was attributable to the acquisition of EAP
International effective November 1, 2002. As a percent of revenue, gross profits
decreased to 5.3% for the three months ended February 28, 2003 from 13.0% for
the six months ended February 28, 2002.

Cost of services provided associated with outcomes measurement and
PsychScope services decreased by $159,000, or 19.7%, to $649,000 for the three
months ended February 28, 2003, compared to $808,000 for the three months ended
February 28, 2002. $81,000 of this decrease is due to a reduction in force of
6.0 full time equivalents related to cost control initiatives. The remaining
decrease is primarily due to being past the higher start up cost segments of the
Phase IV clinical research services. As a percent of revenue, gross profits
increased to 18.8% for the three months ended February 28, 2003 from negative
5.4% for the three months ended February 28, 2002.

Cost of services provided associated with the specialized
nurse-staffing segment was $5.3 million for the three months ended February 28,
2003. As a percent of revenue, gross profits were 8.0% for the three months
ended February 28, 2003.

SELLING, GENERAL AND ADMINISTRATIVE. Total selling, general, and
administrative expenses, on a net basis, increased $100,000, or 2.6%, to $3.9
million for the three months ended February 28, 2003, compared to $3.8 million
for the three months ended February 28, 2002. There were no significant
fluctuations in expense categories.

PROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts
expense was a net recovery of $105,000 for the fiscal quarter ended February 28,
2003, as compared to expense of $272,000 for the fiscal quarter ended February
28, 2002, a decrease of $377,000. This decrease is primarily the result of the
recovery of amounts expensed in prior periods due to receiving payments related
to old receivables, net of legal costs including the complete recovery of
$720,224 of which $600,727 was recorded as a bad debt recovery for a hospital
that declared bankruptcy in 1998. These recoveries were partially offset by
reserves recorded for contract locations in which collectibility is uncertain.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
for the three months ended February 28, 2003 was $645,000 representing a
decrease of $90,000 or 12.2% as compared to depreciation and amortization
expense of $735,000 for the corresponding period in the prior fiscal year. 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 February 28, 2003 resulted in
a net expense of $48,000, as compared to $2,000 for the corresponding period in
the prior fiscal year. This change is primarily the result of an increase in
interest expense of $44,000 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 February 28, 2003
was $9.9 million with an ending balance of $9.0 million. The weighted average
outstanding balance for the corresponding period in the prior fiscal year was
$4.6 million with an ending balance of $4.5 million.

INCOME TAX EXPENSE. For the three-month period ended February 28, 2003,
the Company recorded federal and state income taxes of $1.5 million resulting in
a combined tax rate of 38.7%. For the three-month period ended February 28,
2002, the Company recorded federal and state income taxes of $1.4 million
resulting in a combined tax rate of 38.8%.

24

SIX MONTHS ENDED FEBRUARY 28, 2003 COMPARED TO THE SIX MONTHS ENDED
FEBRUARY 28, 2002

REVENUE. Total revenue increased $15.8 million, or 23.3%, to $83.5
million for the six months ended February 28, 2003, as compared to $67.7 million
for the six months ended February 28, 2002.

Revenue associated with contract management of mental health programs
decreased $2.9 million, or 7.2%, to $37.5 million for the six months ended
February 28, 2003 as compared to $40.4 million for the six months ended February
28, 2002. This decrease was primarily attributable to the decline in the number
of average inpatient psychiatric locations in operation from 114.7 for the six
months ended February 28, 2002 to 105.5 for the six months ended February 28,
2003, as well as a decrease in psychiatric partial hospitalization programs in
operation from 34 for the six months ended February 28, 2002 to 29 for the six
months ended February 28, 2003.

Revenue associated with contract management of physical rehabilitation
services increased $1.4 million, or 18.9%, to $8.8 million for the six months
ended February 28, 2003, as compared to $7.4 million for the six months ended
February 28, 2002. This increase was primarily due to an increase in the average
locations in operation from 20.9 for the six months ended February 28, 2002 to
21.8 for the six months ended February 28, 2003 as well as a 13.1% increase in
average revenue per rehab location in operation which is primarily attributable
to an increase of 6,131 inpatient days between the periods.

Revenue associated with the managed behavioral health care and employee
assistance program services increased by $5.7 million, or 31.1%, to $24.0
million for the six months ended February 28, 2003, as compared to $18.3 million
for the six months ended February 28, 2003. Of this increase, $4.5 million was
attributable to the commencement of a significant managed care contract on April
1, 2002 and $1.8 million was due to the acquisition of EAP International on
effective November 1, 2002. These increases were offset by a decrease of
$874,000 which was attributable to the termination of a significant managed care
contract on December 31, 2002.

Revenue associated with outcomes measurement and PsychScope services
increased by $100,000, or 5.9%, to $1.8 million for the six months ended
February 28, 2003, as compared to $1.7 million for the six months ended February
28, 2002. PsychScope revenue increased $239,000 primarily due to work completed
on four significant PsychScope Phase IV clinical trial projects that commenced
prior to the current fiscal year. Outcomes revenue decreased $121,000 due to the
average number of CQI+ contracts in operations decreasing from 135.2 for the six
months ended February 28, 2002 to 119.7 for the six months ended February 28,
2003.

Revenue associated with the specialized nurse staffing services segment
was $11.5 million for the six months ended February 28, 2003. 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 $15.3
million, or 30.4%, to $65.7 million for the six months ended February 28, 2003,
compared to $50.4 million for the six months ended February 28, 2002. This
increase is primarily attributable to the mix of revenues, i.e. a higher
percentage of total revenues attributable to the Company's HBS subsidiary, for
which costs of services includes medical claims and ProCare subsidiary, for
which cost of services includes nurse wages. As a result, as a percent of
revenue, gross profits decreased to 21.3% for the six months ended February 28,
2003 from 25.6% for the six months ended February 28, 2002.

Cost of services provided associated with contract management of mental
health programs decreased by $2.2 million, or 7.9%, to $25.6 million for the six
months ended February 28, 2003, compared to $27.8 million for the six months
ended February 28, 2002. This decrease was primarily attributable to the decline
in the average number of psychiatric locations in operation. As a percent of
revenue, gross profits increased slightly to 31.8% for the six months ended
February 28, 2003 from 31.1% for the six months ended February 28, 2002,
reflecting a growth in revenue per average location as well as same store sales.

Cost of services provided associated with contract management of
physical rehabilitation services increased by $900,000, or 16.7%, to $6.3
million for the six months ended February 28, 2003, as compared to $5.4 million
for the six months ended February 28, 2002. $405,000 of the increase is due to
the commencement of one significant client contract that has three separate
operating locations. $280,000 of the increase is due to the commencement of a
skilled nursing unit at an existing contract location in April 2002. In
addition, $125,000 of this increase is related to an anticipated expense
contribution related to renovation costs for one contract location. As a percent
of revenue, gross profits increased to 28.5% for the six months ended February
28, 2003 from 26.9% for the six months ended February 28, 2002.

25

Cost of services provided associated with managed behavioral health
care and employee assistance program services increased by $6.4 million, or
40.3%, to $22.3 million for the six months ended February 28, 2003, as compared
to $15.9 million for the six months ended February 28, 2002. $4.6 million was
attributable to an increase in medical claim expense associated with managed
behavioral health care. Of this amount, $4.3 million was attributable to the
commencement, on April 1, 2002, of a significant managed care contract which was
partially offset by a decrease of $695,000 related to the termination of
significant managed care contract effective December 31, 2002. The remaining
$1.0 million increase in the medical claim expense was the result of an increase
in existing client claims, other than the contracts mentioned above, due to a
27.9% increase in the average cost per day and a 9.9% increase in inpatient
days. An additional $1.4 million was the result of the acquisition of EAP
International effective November 1, 2002. As a percent of revenue, gross profits
decreased to 6.9% for the six months ended February 28, 2003 from 13.5% for the
six months ended February 28, 2002.

Cost of services provided associated with outcomes measurement and
PsychScope services decreased by $200,000, or 13.3%, to $1.3 million for the six
months ended February 28, 2003, compared to $1.5 million for the six months
ended February 28, 2002. $87,000 of this decrease is due to a decrease of 5.3
full time equivalents related to cost control initiatives. The remaining
decrease is primarily due to the higher start up cost segments of the Phase IV
clinical research services. As a percent of revenue, gross profits increased to
29.1% for the six months ended February 28, 2003 from 12.4% for the six months
ended February 28, 2002.

Cost of services provided associated with the specialized
nurse-staffing segment was $10.5 million for the six months ended February 28,
2003. As a percent of revenue, gross profits were 9.2% for the six months ended
February 28, 2003.

SELLING, GENERAL AND ADMINISTRATIVE. Total selling, general, and
administrative expenses, on a net basis, increased $400,000, or 4.9%, to $8.6
million for the six months ended February 28, 2003, compared to $8.2 million for
the six months ended February 28, 2002. Sales commissions were $219,000 higher
from period to period primarily attributable to an increase in commissions paid
in the current period. Recruitment placement fees increased $124,000 during the
six months ended February 28, 2003, primarily attributable to the initiation of
5 managerial employee searches.

PROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts
expense was a net recovery of $105,000 for the six months ended February 28,
2003, as compared to expense of $547,000 for the six months ended February 28,
2002, a decrease of $655,000. This decrease is primarily the result of the
recovery of amounts expensed in prior periods due to receiving payments related
to old receivables, net of legal costs including the complete recovery of
$720,224 of which $600,727 was recorded as a bad debt recovery for a hospital
that declared bankruptcy in 1998. These recoveries were partially offset by
reserves recorded for contract locations in which collectibility is uncertain
including two locations that filed for bankruptcy.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
for the six months ended February 28, 2003 was $1.4 million representing a
decrease of $100,000 or 6.7% as compared to depreciation and amortization
expense of $1.5 million for the corresponding period in the prior fiscal year.
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 six months ended February 28, 2003 resulted in a
net expense of $126,000, as compared to $51,000 for the corresponding period in
the prior fiscal year. This change is primarily the result of an increase in
interest expense of $80,000 related to an increase in the weighted average
outstanding credit facility balance between periods. The weighted average
outstanding credit facility balance for the six months ended February 28, 2003
was $10.3 million with an ending balance of $9.0 million. The weighted average
outstanding balance for the corresponding period in the prior fiscal year was
$5.2 million with an ending balance of $4.5 million.

26

INCOME TAX EXPENSE. For the six-month period ended February 28, 2003,
the Company recorded federal and state income taxes of $3.0 million resulting in
a combined tax rate of 38.6%. For the six-month period ended February 28, 2002,
the Company recorded federal and state income taxes of $2.7 million resulting in
a combined tax rate of 38.7%.

NEWLY ISSUED ACCOUNTING STANDARDS

In December 2002, the FASB issued FAS 148, "Accounting for Stock-Based
Compensation Transition and Disclosure." This statement amends FAS 123,
"Accounting for Stock-Based Compensation," and establishes two alternative
methods of transition from the intrinsic value method to the fair value method
of accounting for stock-based employee compensation. In addition, FAS 148
requires prominent disclosure about the effects on reported net income and
requires disclosure of these effects in interim financial information. The
provisions for the alternative transition methods are effective for fiscal years
ending after December 15, 2002, and the amended disclosure requirements are
effective for interim periods beginning after December 15, 2002 and allow for
early application. The Company currently plans to continue accounting for
stock-based compensation under APB 25, an allowable method, with additional
disclosures as required beginning with its fiscal third quarter.

In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46") which changes the
criteria by which one company includes another entity in its consolidated
financial statements. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003, and apply in the first fiscal period beginning after
June 15, 2003, for variable interest entities created prior to February 1, 2003.
The Company has a relationship with one variable interest entity as discussed
below in "Liquidity and Capital Resources". Under the new guidelines the Company
may be required to consolidate the variable interest entity, but has not reached
a final conclusion.

LIQUIDITY AND CAPITAL RESOURCES

The Company believes that its future cash flow from operations (which
was $13.5 million for the most recent twelve months ended February 28, 2003 and
$4.5 million for the six months ended February 28, 2003), along with cash of
$1.5 million at February 28, 2003, and the $30 million revolving credit facility
(of which $15.4 million was available at February 28, 2003), will be sufficient
to cover operating cash requirements over the next 12 months, including
estimated capital expenditures of $485,000. 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 February 28, 2003, the Company had borrowings of $9.0
million outstanding against the revolving credit facility (and $5.6 million in
letter of credit commitments outstanding).

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

27

$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 February 28, 2003, the Company was
in compliance with the 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 February 28, 2003, the Company had
repurchased 237,900 shares with a total purchase price of approximately $2.8
million.

Effective September 1996, the Company entered into a lease arrangement
with an unconsolidated, unaffiliated variable purpose entity (previously also
known as "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 variable purpose entity approximately $4.4 million. The Company guaranteed
on a limited basis approximately $900,000 of the loan. In addition, the Company
is obligated, if it does not purchase the building (as described below), and the
building is sold to an independent party for less than the then outstanding debt
balance, to pay such shortfall up to $2.8 million in addition to the $900,000
guarantee. In effect, the Company's obligation is up to 84% of the then
outstanding debt principal. 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 December 31, 2002, Integrated Insights had approximately
303 contracts covering approximately 358,000 lives. For the year ended December
31, 2002, Integrated Insights had revenues of approximately $4.81 million
(audited). 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 those accounting policies and
estimates considered critical by 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,

28

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 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 February 28, 2003, the Company had approximately $9.0 million of
debt obligations outstanding with a weighted average interest rate of 3.78%. A
hypothetical 10% change in the effective interest rate for these borrowings,
assuming debt levels as of February 28, 2003, would change interest expense by
approximately $34,002 annually. This would be funded out of cash flows from
operations, which were $13.6 million for the twelve most recent months ended
February 28, 2003.

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.

29

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

During the quarter, in connection with the civil qui tam lawsuit pending against
a subsidiary of the Company in the District of Columbia described in Item 3 of
Part I of the Company's Annual Report on Form 10-K for the year ended August 31,
2002, the court denied the Company's motion to dismiss and the Company recently
filed an answer in the proceeding. There were no other significant developments
in connection with this lawsuit during the quarter.

During the quarter, there were no significant developments in connection with
the investigation and unsealed qui tam suit pending in the Northern District of
California described in Item 3 of Part I of the Company's Annual Report on Form
10-K for the year ended August 31, 2002.

30

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 March 28, 2003 (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 March 28, 2003(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 February 28,
2003. The items reported were Item 5, Other Events, announcing a
publicly available conference call regarding the Company's second
quarter financial results on March 28, 2003 and an officer's sale of
stock pursuant to SEC Rule 10b5-1[c].

31

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: MARCH 28, 2003

HORIZON HEALTH CORPORATION

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

32

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: March 28, 2003 /s/ JAMES W. MCATEE
-------------------------------------
James W. McAtee
President and Chief Executive Officer

33

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: March 28, 2003 /s/ RONALD C. DRABIK
-----------------------
Ronald C. Drabik
Chief Financial Officer

34

INDEX TO EXHIBITS