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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2004

OR

For the transition period from                      to                      .

Commission file number: 0-31014

HEALTHEXTRAS, INC.

(Exact name of registrant as specified in its charter)

2273 Research Boulevard, 2nd Floor, Rockville, Maryland 20850

(Address of principal executive offices, zip code)

(301) 548-2900

(Registrant’s phone 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 x No ¨

As of August 6, 2004 there were 33,399,269 shares outstanding of the Registrant’s $0.01 par value common stock.

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HEALTHEXTRAS, INC.

Second Quarter 2004 Form 10-Q

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PART I. FINANCIAL INFORMATION

HEALTHEXTRAS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)

The accompanying notes are an integral part of these financial statements

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HEALTHEXTRAS, INC.

CONSLIDATED STATEMENT OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

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HEALTHEXTRAS, INC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these financial statements

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HEALTHEXTRAS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The accompanying unaudited consolidated financial statements have been prepared by HealthExtras, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated financial statements are unaudited and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments and accruals, necessary for a fair presentation of the consolidated balance sheets, statements of operations and statements of cash flows for the periods presented. Operating results for the six months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the SEC on March 15, 2004.

Managed Healthcare Systems

On June 18, 2004, the Company acquired 100% of the common stock of Managed Healthcare Systems, Inc. (“MHS”).

The purchase price for the shares of MHS consisted of:

The Company will issue:

Given the contingent nature of the non-negotiable promissory notes and warrants, the cost of the acquisition will be increased as the contingencies are resolved.

The Company’s management has reviewed the specific criteria set forth in Emerging Issues Task Force (“EITF”) 95-8, “Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination,” to determine whether the contingent consideration that is based on certain revenue and gross profit measures should be accounted for as an adjustment to the purchase price of MHS or as compensation for services. Management believes that the contingent consideration meets the criteria of being accounted for as an adjustment to the purchase price of MHS.

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The acquisition resulted in the recording of goodwill of approximately $30.8 million and intangible assets (customer contracts) of $8.0 million. The allocation of the purchase price to the net assets acquired is in the process of being finalized; thus the allocation of the purchase price to intangible assets is subject to refinement, upon receipt of an independent valuation report.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The acquisition was accounted for as a purchase. Amounts are in thousands.

The following table sets forth certain unaudited financial data assuming the acquisition of MHS had been completed as of January 1, 2003, after giving effect to purchase accounting adjustments. Amounts are in thousands, except for per share data.

The pro forma results of operations are not necessarily indicative of the results that would have occurred had the Company owned 100% of MHS at January 1, 2003, nor are these results indicative of future operating results.

In March 2004, the Company entered into an agreement to purchase all of the assets of Diabetic Sense. The financial information regarding this purchase is deemed immaterial and is not included in the above pro forma. See Note 12, “Related Party Transactions” for additional details.

The Company adopted SFAS No. 142, and discontinued the amortization of goodwill and indefinite-lived intangible assets, effective January 1, 2002. The Company completed its initial impairment testing of goodwill and concluded that no impairment of goodwill existed. The Company performed a similar test as of December 31, 2003,

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and concluded that no impairment of goodwill exists. In the first quarter of 2004, the Company did not record any changes to goodwill. In the second quarter of 2004, the goodwill acquired in acquisitions and other adjustments was approximately $31.6 million. There have been no impairments or write-downs to goodwill in the three and six-month periods ended June 30, 2004.

The changes in goodwill for the six months ended June 30 are as follows (in thousands):

As of June 30, 2004, intangible assets consisted of the following (in thousands):

The acquisitions of Catalyst Rx and Catalyst Consultants (“Catalyst”) and Pharmacy Network National Corporation (“PNNC”) are discussed in the 2003 Annual Report Form 10-K and the acquisition of MHS is discussed in Forms 8-K, as filed with the SEC on June 22 and June 23, 2004. The Catalyst and PNNC customer contracts represent the estimated fair value of customer contracts held by Catalyst and PNNC at the dates of acquisition. This estimated fair value and the weighted average useful-lives are based on income-method valuation calculations, performed by an independent consulting firm. As for the value of intangible assets relating to MHS, these calculations are in the process of being finalized; thus the allocation of the purchase price to intangible assets is subject to refinement.

Other Pharmacy Benefit Management (“PBM”) contracts allow the Company to provide PBM services, which are amortized over the future cash flow based on management’s best estimate. The estimated aggregate amortization expense of intangible assets through 2008 is as follows (in thousands):

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Amortization expense for the three-month periods ended June 30, 2004 and 2003 was approximately $350,000 and $204,000, respectively. Amortization expense for the six month periods ended June 30, 2004 and 2003 was approximately $566,000 and $408,000, respectively.

At December 31, 2003, the Company had in place a $25.0 million revolving credit facility with a commercial bank. The credit facility had an expiration date of May 2005 and an interest rate of LIBOR plus 2.75% payable in arrears on the fifth day of each month. The outstanding balance on the revolving credit facility at December 31, 2003 was $10.0 million.

In June 2004, the revolving credit facility was increased to $30.0 million and the term was extended to June 2006. The interest rate was negotiated to LIBOR plus 2.00% payable in arrears on the first day of each month. The effective rate at June 30, 2004 was 3.33%. The outstanding balance on the credit facility on June 30, 2004 was $24.3 million.

In June 2004, the Company entered into a $20.0 million, forty-eight month term loan facility with a commercial bank. Commencing on July 1, 2004, principal is to be paid monthly in equal installments, together with accrued and unpaid interest on the outstanding balance. The interest rate is LIBOR plus 2.00%. The effective rate at June 30, 2004 was a 3.26%. The outstanding balance on the term loan facility at June 30, 2004 was $20.0 million. Amounts are in thousands.

The Company’s assets collateralize the borrowings on the revolving credit facility and the term loan facility. Both facilities contain affirmative and negative covenants related to indebtedness, EBITDA, cash and accounts receivable.

Interest expense related to notes payable for the three month period ended June 30, 2004 and 2003 was approximately $142,000 and $161,000; interest expense related to notes payable for the six month period ended June 30, 2004 and 2003 was approximately $255,000 and $345,000.

The Company operates in two business segments, PBM and supplemental benefits. The following tables represent financial data by segment for the three and six months ended June 30, 2004, and 2003. In 2004, the Company refined its methodology for reporting segment information by allocating corporate overhead based on segment revenues and personnel. Management believes that the new methodology provides a more accurate representation of corporate overhead, assets, liabilities and operating results-of the Company’s two segments. Segment reporting disclosure for the three and six months ended June 30, 2003 has been modified to conform to this new methodology.

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Segment information for the three months ended June 30, 2004 and 2003 is as follows (in thousands):

Operating expenses of the segments exclude $1.4 million in corporate overhead that was not allocated by management in assessing segment performance for each of the three-month periods ended June 30, 2004 and 2003.

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Segment information for the six months ended June 30, 2004 and 2003 is as follows (in thousands):

Operating expenses of the segments exclude $2.6 million, and $2.7 million in corporate overhead that was not allocated by management in assessing segment performance for the six-month period ended June 30, 2004 and 2003, respectively.

Determining the consolidated provision for income taxes expense involves judgements and estimates. The Company is required to calculate and provide for income taxes in each of the state tax jurisdictions where the Company operates. This involves estimating its current tax exposures in each jurisdiction. Changes in the geographic mix or estimated level of pre-tax income can affect the overall effective tax rate. The effective rate of the tax provision was 37.7% in the second quarter of 2004; while the effective rate of the tax provision is 38.7% in the second quarter of 2003. In the three-month periods ended June 30, 2004 and 2003, the Company recorded a provision for income taxes of approximately $2.5 million and $1.4 million, respectively. The tax provision for income taxes for the six-month periods ended June 30, 2004 and 2003 are $4.6 million and $ 2.6 million, respectively.

Basic net income per common share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted

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net income per common share reflects the potential dilution that could occur (using the treasury stock method) if options and warrants to issue common stock were exercised.

The following represents a reconciliation of the number of shares used in the basic and diluted net income per share computations (amounts in thousands, except per share data):

The following options were not included in the computation of diluted net income per share because the exercise prices were greater than the average market price of the common shares:

At June 30, 2004, the Company provided stock-based compensation plans for employees and directors. Stock-based compensation is accounted for using the intrinsic value-based method in accordance with the Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees,” and related interpretations.

Stock-based compensation is reflected in net income for those options granted under these plans that had an exercise price less than the market value of the underlying common stock on the grant date.

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The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to stock-based employees’ compensation. Amounts are in thousands, except per share data.

The fair value of these options was estimated at the date of the grants using the modified American Black-Scholes economic option-pricing model with the following assumptions for the three and six month periods ended June 30, 2004 and 2003:

In April 2004, the Company reached a legal settlement related to litigation initiated by the Company on December 3, 2002. The terms of the settlement are confidential; however, the net proceeds from the settlement constitute the significant portion of the $2.0 million of other income reported in the current quarter income statement.

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The Company’s headquarters office is currently located in approximately 19,700 square feet of office space in Rockville, Maryland under a sublease that expired on May 30, 2004. The office is currently renting on a month-to-month basis. In June 2004, the Company entered into a ten-year lease in a new office building located in Rockville, Maryland with rent commencing no later than October 15, 2004, for approximately 37,000 square feet of office space. Annual basic rent for the first year is approximately $991,000. The agreement provides for annual escalations. The Company is scheduled to move its headquarters to the new location in the third quarter of 2004.

In March of 2004, the Company entered into an agreement to purchase all of the assets of Diabetic Sense, a company specializing in diabetes management programs, from an executive vice president of the Company in exchange for 74,250 shares of the Company’s common stock. The 74,250 shares of stock were valued at $749,925 on the date of the agreement. Diabetic Sense provides specialty services to certain enrolled members who participate in arrangements for discounted purchasing of diabetes test meters, insulin and other related supplies. The programs are offered to existing client groups of HealthExtras, as well as to other clients who do not otherwise contract with HealthExtras or its affiliates for pharmacy benefit management services. The transaction closed on June 24, 2004.

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The following discussion should be read in conjunction with the interim consolidated financial statements presented in Item 1. Certain statements contained herein may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements involve a number of risks and uncertainties. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made in this report and in our other filings with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business. References in this Form 10-Q to “we,” “our,” or “us,” or the “Company,” refer to HealthExtras, Inc.

OVERVIEW

The Company

HealthExtras is a provider of pharmacy benefit management (“PBM”) services and supplemental benefits. The Company’s PBM clients include managed-care organizations, self-insured employers, and third party administrators who contract with us to cost-effectively administer the prescription drug component of their overall health benefit programs. Individual customers are the major purchasers of our supplemental benefits programs. Our PBM segment, which operates under the brand name “Catalyst Rx,” now generates the majority of our revenues and is expected to be the primary source of growth and profit potential in the future.

PHARMACY BENEFIT MANAGEMENT

Catalyst Rx

Catalyst Rx has established a nationwide network of over 53,000 retail pharmacies. In general, clients contract with us to access negotiated retail pharmacy network rates, participate in certain rebate arrangements with manufacturers based on formulary design, and benefit from the other care enhancement protocols in our system. Our primary PBM services consist of the automated online processing of prescription claims on behalf of our clients. When a member of one of our clients presents a prescription or health plan identification card to a retail pharmacist in our network, our system provides the pharmacist with access to online information regarding eligibility, patient history, health plan formulary listings, and contractual reimbursement rates. The member generally pays a co-payment to the retail pharmacy and the pharmacist fills the prescription. We electronically aggregate pharmacy benefit claims, which include prescription costs plus our claims processing fees for consolidated billing and payment. We receive payments from clients, make payments of amounts owed to the retail pharmacies pursuant to our negotiated rates, and retain the difference, including claims processing fees.

Pharmacy benefit claim payments from our clients are recorded as revenues, and prescription costs to be paid to pharmacies are recorded as direct expenses. Under our network contracts, we generally have an independent obligation to pay pharmacies for the drugs dispensed and, accordingly, have assumed that risk independent of our clients. When we administer pharmacy reimbursement contracts and do not assume a credit risk, we record only our administrative or processing fees as revenue. Rebates earned under arrangements with manufacturers are recorded as a reduction of direct expenses. The portion of manufacturer rebates due to clients is recorded as a reduction of revenue.

Member co-payments are not recorded as revenue. Under our pharmacy agreements, the pharmacy is solely obligated to collect the co-payments from the members. Under our client contracts, we do not assume liability for member co-payments in pharmacy transactions. As such, we do not include member co-payments to pharmacies in revenue or operating expenses.

Because we understand that the SEC is reviewing the accounting treatment of co-payments by PBM companies, we are providing certain supplemental information in the tables below. This information may also assist investors in comparing PBMs with differing accounting policies related to co-payments. If the SEC should ultimately decide that co-payments should be included in reported PBM revenues and operating expenses, it would result in an increase in

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reported PBM revenue and operating expenses for the three months ended June 30, 2004 and 2003 of approximately $43.2 million and $33.7 million, respectively; revenues and operating expenses for the six months ended June 30, 2004 and 2003 would increase be $85.7 million and $67.5 million. Our operating and net income, consolidated balance sheets and statements of cash flows would not be affected.

The following tables illustrate the effects on the reported PBM revenue and operating expenses if Catalyst Rx had included the actual member co-payments as indicated by our claims processing system (in thousands):

SUPPLEMENTAL BENEFITS

The Company’s supplemental benefits segment generates revenue from the sale of membership programs which provide insurance and other benefits. The Company has distribution agreements with many of the nation’s largest financial institutions (the “distributors”), along with leading affinity groups and associations. Additionally, HealthExtras has a relationship with actor and advocate Christopher Reeve to promote these benefit programs.

The primary determinant of revenue recognition for the supplemental benefits segment is monthly program enrollment. In general, program revenue is recognized based on the number of members enrolled in each reporting period multiplied by the applicable monthly fee for their specific membership program. The program revenue recognized by the Company includes the cost of membership features supplied by others, including the insurance components.

Direct program expenses consist of the costs that are a direct function of a period of membership and a specific set of program features. The coverage obligations of our benefit suppliers and the related expense are determined monthly, as are the remaining direct expenses.

Revenue from program payments received, and related direct expenses, is deferred to the extent that they are applicable to future periods or to any refund guarantee we offer. HealthExtras has committed to minimum premium volumes with respect to the insurance features of its programs supplied by others. In the event that there were insufficient members to utilize the minimum premium commitment, the differential would be expensed by the

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Company without any related revenue. The Company believes that current enrollment trends will allow the minimum future commitments at June 30, 2004 to be fully utilized by current enrollment levels.

USE OF EBITDA

As discussed in the Company’s Annual Report on Form 10-K filed for the year ended December 31, 2003, the Company’s financial statements are prepared in accordance with generally accepted accounting principals (“GAAP”). However, to assist shareholders in comparing PBMs that provide financial information regarding operating performance on many levels, the Company also discloses EBITDA, a non-GAAP measure, in addition to net income in its quarterly press releases. We believe that EBITDA is a supplemental measurement tool used by analysts and investors to help evaluate overall operating performance, the ability to incur and service debt and make capital expenditures. EBITDA is defined as net income before interest income/expense, taxes, depreciation and amortization. EBITDA does not represent funds available for discretionary use and should not be considered an alternative to net income measured under GAAP. We have reconciled EBITDA to net income in the following table for the respective periods. Amounts are shown in thousands.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003

Revenue. Revenue from operations for the three months ended June 30, 2004 was $114.2 million, consisting of $102.6 million generated from the PBM segment and $11.6 million in revenue from the supplemental benefits segment. PBM revenue increased by $22.1 million, which was attributed to new business for the PBM segment in 2004. The supplemental benefits revenue decreased by $2.0 million, largely as a result of lower levels of coverage purchased and decreased membership. Revenue for the three months ended June 30, 2003 was $94.1 million, consisting of approximately $80.5 million and $13.6 million attributable to the PBM and supplemental benefits segments, respectively.

The increase in three months revenues for 2004 was related to the ongoing growth of our PBM revenues. The PBM revenue growth in the second three months of 2004 was primarily attributable to new accounts added during 2004 and 2003 and an overall increase in the number of pharmacy transactions processed. Total claims processed increased to approximately 2.6 million in the second three months of 2004 from approximately 2.0 million in the second three months of 2003.

In May 2004, Catalyst Rx was awarded a contract with the Office of Group Benefits for the State of Louisiana to provide PBM services to the State’s employees and retirees. The contract carries a three-year term and is expected to involve the management of benefits for approximately 200,000 members, with annual revenues of approximately $100 million, effective July 1, 2004.

Direct Expenses. Operating margins in the PBM segment were improved in 2004 through programs introduced in 2003 that provide more profitable generic drug dispensing rates, consolidation of our claims processing systems to a single more cost-effective platform, the introduction of standardized pharmacy reimbursement contract rates across

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all our business units, and more effective formulary compliance programs which result in increased margins from the use of preferred drugs.

The decrease in direct expenses in the supplemental benefits segment was largely a result of the modest decrease in membership and the negotiation of lower costs for certain of the benefits in our programs.

Direct expenses for the three months ended June 30, 2004 were $101.3 million, consisting of $92.8 million in direct costs from the PBM segment and $8.5 million in direct expenses from the supplemental benefits segment. PBM segment direct expenses increased by $19.0 million, while the supplemental benefits segment direct expenses decreased by $1.6 million. Direct expenses for the three months ended June 30, 2003 were $83.9 million, consisting of approximately $73.8 million and $10.1 million attributable to the PBM and supplemental benefit segments, respectively. The direct expenses of $101.3 million and $83.9 million for the three months ended June 30, 2004 and 2003 represented 92.5% and 92.8% of operating expenses for the respective periods.

Selling, General and Administrative. For the three-month period ended June 30, 2004, selling, general and administrative expenses increased by approximately $1.7 million over the same year-earlier quarter to $8.2 million. The increase in selling, general and administrative expenses was primarily associated with PBM segment growth, several significant marketing initiatives, and new client implementations.

Selling, general and administrative expenses for the three months ended June 30, 2004 totaled $8.2 million or 7.5% of operating expenses, $5.7 million of which was related to the Company’s PBM services segment, $1.1 million of which was related to the management of the supplemental benefits segment, and $1.4 million related to corporate overhead. These expenses include $3.7 million in compensation and benefits, $1.2 million in commissions, other professional services, insurance and taxes, $1.0 million in other expenses, $732,000 in depreciation and amortization, $547,000 for creative development, product endorsement and market research, $535,000 in facility costs, and $428,000 in travel expenses.

Selling and general administrative expenses for the three months ended June 30, 2003 were approximately $6.5 million or 7.2% of total operating expenses, $4.0 million of which related to the Company’s PBM services segment, $1.1 million of which related to the management of the supplemental benefits segment, while the remaining $1.4 related to corporate overhead. These expenses included approximately $2.6 million in compensation and benefits, $922,000 million in commissions, professional fees, insurance and taxes, $1.2 million in other expenses, $584,000 in depreciation and amortization, $454,000 for creative development, product endorsement and market research, $445,000 in facility costs, $285,000 in travel expenses.

Other income. In the second quarter of 2004, the Company reached a legal settlement related to litigation initiated by the Company on December 3, 2002. The terms of the settlement are confidential; however, the net proceeds from the settlement constitute the significant portion of the other income reported in the $2.0 million current quarter income statement.

Interest Expense, Net. Interest expense, net for the three months ended June 30, 2004, was approximately $94,000 compared to interest expense, net of $114,000 for the three month period ended June 30, 2003. This was principally due to the lower dollar amounts outstanding on the line of credit in the first two months of the second quarter of 2004. Interest expense on borrowings for second quarter of 2004 was approximately $142,000.

Income Tax Provision. In the three-month periods ended June 30, 2004 and 2003, the Company recorded a provision for income taxes of approximately $2.5 million and $1.4 million, respectively. Determining the consolidated provision for income taxes expense involves judgment. The Company is required to calculate and provide for income taxes in each of the tax jurisdictions where the Company operates. This involves estimating our current tax exposures in each jurisdiction. Change in the geographic mix or estimated level of pre-tax income can affect the overall effective tax rate. The effective rate of the tax provision was 37.7% in the first six months of 2004 while the effective rate was 38.7% in the first six months of 2003.

Net Income. Net income for the three months ended June 30, 2004 increased by approximately $1.9 million over the same period in 2003. The increase in operating income was primarily a function of an increase in other income and increased gross margins in the PBM segment. PBM segment gross margins increased to $9.8 million in 2004 from $6.7 million in 2003, an increase

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largely attributable to the $22.1 million increase in PBM revenues from the three months ended June 30, 2003 to the three months ended June 30, 2004.

Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003

Revenue. Revenue from operations for the six months ended June 30, 2004 was $224.7 million, consisting of $201.2 million generated from the PBM segment and $23.5 million from the supplemental benefits segment. PBM revenue increased by $42.3 million, which was attributed to new business for the PBM segment in 2004. The supplemental benefits revenue decreased by $3.4 million, largely as a result of lower levels of coverage purchased and decreased membership. Revenue for the six months ended June 30, 2003 was $185.9 million, consisting of approximately $158.9 million and $26.9 million attributable to the PBM and supplemental benefits segments, respectively.

The increase in revenues for 2004 was related to the ongoing growth of our PBM revenues. Revenue growth in the PBM in the first six months of 2004 was primarily attributable to new accounts added during 2004 and 2003 and an overall increase in the number of pharmacy transactions processed. Total claims processed increased to approximately 5.0 million in the first six months of 2004 from approximately 4.1 million in the first six months of 2003.

Direct Expenses. Operating margins in the PBM segment were improved in 2004 through programs introduced in 2003 that provide more profitable generic drug dispensing rates, consolidation of our claims processing systems to a single more cost-effective platform, the introduction of standardized pharmacy reimbursement contract rates across all our business units and more effective formulary compliance programs which result in increased margins from the use of preferred drugs. The decrease in direct expenses in the supplemental benefits segment was largely a result of the modest decrease in membership and the negotiation of lower costs for certain of the benefits in our programs.

Direct expenses for the six months ended June 30, 2004 were $199.0 million, consisting of $181.8 million from the PBM segment and $17.2 million from the supplemental benefits segment. PBM segment direct expenses increased by $35.7 million, while the supplemental benefits segment direct expenses decreased by $3.0 million. Direct expenses for the six months ended 2003 were $166.3 million, consisting of approximately $146.1 million and $20.2 million attributable to the PBM and supplemental benefit segments, respectively. The direct expenses of $199.0 million and $166.3 million for the six months ended June 30, 2004 and 2003 represented 92.8% and 93% of operating expenses for the respective periods.

Selling, General and Administrative. For the six-month period ended June 30, 2004, selling, general and administrative expenses increased by approximately $2.9 million over the same year-earlier quarter to $15.5 million. The increase in selling, general and administrative expenses was primarily associated with PBM segment growth, several significant marketing initiatives, and new client implementations.

Selling, general and administrative expenses for the six months ended June 30, 2004 totaled $15.5 million or 7.2% of operating expenses, $10.7 million of which was related to the Company’s PBM services segment, $2.2 million of which was related to the management of the supplemental benefits segment, while the remaining $2.6 million related to corporate overhead. These expenses include $7.2 million in compensation and benefits, $2.2 million in commissions, other professional services, insurance and taxes, $2.0 million in other expenses, $1.3 million in depreciation and amortization, $1.0 million for creative development, product endorsement and market research, $1.1 million in facility costs, and $676,000 in travel expenses.

Selling and general administrative expenses for the first six months of 2003 were approximately $12.6 million or 7.0% of total operating expenses, $7.6 million of which related to the Company’s PBM services segment, $2.3 million of which related to the management of the supplemental benefits segment, while the remaining $2.7 million related to corporate overhead. These expenses included approximately $5.1 million in compensation and benefits, $2.1 million in commissions, professional fees, insurance and taxes, $1.9 million in other expenses, $1.2 million in depreciation and amortization, $892,000 for creative development, product endorsement and market research, $851,000 in facility costs, $545,000 in travel expenses.

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Other income. In the second quarter of 2004, the Company reached a legal settlement related to litigation initiated by the Company on December 3, 2002. The terms of the settlement are confidential; however, the net proceeds from the settlement constitute the significant portion of the other income reported in the 2004 income statement.

Interest Expense, Net. Interest expense, net for the six months ended June 30, 2004, was approximately $172,000 compared to interest expense, net of $263,000 for the six-month period ended June 30, 2003. This was principally due to the lower dollar amounts outstanding on the line of credit in the first five months of 2004. Interest expense on borrowings for 2004 was approximately $255,000.

Income Tax Provision. In the six-month periods ended June 30, 2004 and 2003, the Company recorded a provision for income taxes of approximately $4.6 million and $2.6 million, respectively. Determining the consolidated provision for income taxes expense involves judgment. The Company is required to calculate and provide for income taxes in each of the tax jurisdictions where the Company operates. This involves estimating our current tax exposures in each jurisdiction. Change in the geographic mix or estimated level of pre-tax income can affect the overall effective tax rate. The effective rate of the tax provision was 37.7% in the first six months of 2004; the effective rate was 38.7% in the first six months of 2003.

Net Income. Net income for 2004 increased by approximately $3.5 million over the same period in 2003. The increase in operating income was primarily a function of an increase in other income as well as increased gross margins in the PBM segment. PBM segment gross margins increased to $19.4 million in 2004 from $12.8 million in 2003, an increase largely attributable to the $42.3 million increase in PBM revenues from the first six months of 2003 to the first six months of 2004.

LIQUIDITY AND CAPITAL RESOURCES

The $9.8 million increase in the Company’s reported cash position from December 31, 2003 to June 30, 2004 was primarily attributable to the six months pre-tax income of $12.1 million, the collection of almost $1.1 million in trade receivables offset by the reduction in trade payables of approximately $1.0 million, debt payments of $3.0 million, borrowings of $37.3 million offset by $37.6 million paid in cash for acquisitions and non-cash depreciation expense of approximately $760,000. The Company generated positive operating cash flow over the six months of 2004 and anticipates no material changes to that pattern.

Cash and cash equivalents at June 30, 2004 totaled $38.7 million compared to $26.2 million at June 30, 2003. During the six months ended June 30, 2004, we generated $12.5 million in cash from operating activities, paid approximately $151,000 in cash for capital expenditures, received $37.3 million from borrowings; repaid approximately $3.0 million in cash on the revolving credit facility and received approximately $683,000 in proceeds from the exercise of stock options.

Net Cash Provided by Operating Activities. Our overall operating activities generated $12.5 million of net cash from operations during the first six months of 2004, a $1.2 million decrease from the $13.7 million of net cash provided in the six months of 2003. The decrease is primarily due to the timing of payments to vendors included in accounts payable and the timing of payments from clients included in accounts receivable in 2004.

Net Cash Used in Investing Activities. Net cash used in investing activities for the six-month period ended June 30, 2004, was $37.8 million compared to $1.2 million for the six months of 2003. The decrease is primarily due to the fact that in the first six months of 2004 , the Company paid $37.6 million in cash for the MHS acquisition and additional PBM customer contracts.

Net Cash Provided by Financing Activities. Net cash provided by financing activities for the six-month period ended June 30, 2004 was $35.0 million compared to cash provided by financing activities of $2.0 million in 2003. In 2004, we made payments totaling $3.0 million on the outstanding line of credit compared to payments of $4.0 million in the first six months of 2003, and increased our borrowings by $37.3 million, while in 2004; the Company received approximately $683,000 in proceeds from the exercise of stock options.

We anticipate continuing to generate positive operating cash flow which, combined with available cash resources, should be sufficient to meet our planned working capital, capital expenditures and operating expenses. However,

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there can be no assurance that we will not require additional capital. Even if such funds are not required, we may seek additional equity or debt financing. We cannot be assured that such financing will be available on acceptable terms, if at all, or that such financing will not be dilutive to our stockholders.

There have been no significant changes in our market risk from that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003.

General Statement of Responsibility. The management of the Company is responsible for the preparation, integrity and objectivity of the Consolidated Financial Statements and the other information included in this report. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and accordingly include certain amounts that represent management’s best estimates and judgments. Actual amounts could differ from those estimates. Management maintains internal control systems to assist it in fulfilling its responsibility for financial reporting. These systems include business, accounting and reporting policies and procedures, selection of personnel, and segregation of duties. While no system can ensure elimination of all errors and irregularities, the Company’s systems, which are reviewed and modified in response to changing conditions, have been designed to provide reasonable assurance that assets are safeguarded, policies and procedures are followed, transactions are properly executed and reported and appropriate disclosures are made. The concept of reasonable assurance is based on the recognition that there are limitations in all systems of internal controls and that the costs of such systems should not exceed their benefits.

Evaluation of Disclosure Controls and Procedures. As of June 30, 2004, the Company evaluated the effectiveness of the design and operations of its disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed in the Company’s periodic filings under the Exchange Act is accumulated and communicated to such officers to allow timely decisions regarding required disclosures. There was no change in the Company’s internal control over financial reporting during the first quarter of 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

In the ordinary course of business, the Company may become subject to legal proceedings and claims. The Company is not aware of any legal proceedings or claims, which, in the opinion of management, will have a material effect on the financial condition or results of operations of the Company.

Following the end of the quarter, the Company reached a legal settlement with S.G. Cowen related to litigation initiated by the Company on December 3, 2002 regarding the private placement of securities in 2001. The terms of the settlement are confidential; however, proceeds from the settlement, net of related expenses, were included in Other income in the quarter ended June 30, 2004. See Note 10 to the accompanying June 30, 2004 financial statements.

ON June 18, 2004, the Company acquired 100% of the common stock of Managed Healthcare Systems, Inc. A portion of the purchase price was the issuance of 100,739 shares of the Company’s common stock. The Company may issue warrants to purchase, for up to ten years, up to an aggregate of 300,000 shares of the Company’s common stock at a purchase price of $15.75 per share, subject to the provision of the warrants, including performance based standards.

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None

On June 1, 2004, the Company held its annual meeting of stockholders for the purpose of the election of three directors, approval of the HealthExtras, Inc. 2004 Employee Stock Purchase Plan, approval of the Amended & Restated 2000 Directors’ Stock Option Program, and ratification of PricewaterhouseCoopers LLP as the Company’s independent auditors. The number of votes cast at the meeting as to each matter to be acted upon was as follows:

The Directors whose terms continued and the years their terms expire are as follows: David T. Blair (2005), Frederick H. Graefe (2005), Thomas J. Graf (2005), Thomas L. Blair (2006), Steven B. Epstein (2006), Carey G. Jury (2006), and Dale B. Wolf (2006).

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None

On April 29, 2004, the Company furnished a Current Report on Form 8-K announcing the Company’s financial results for the quarter ended March 31, 2004.

On June 22, 2004, the Company filed Current Report on Form 8-K announcing the acquisition of Managed Healthcare Services, Inc.

On June 23, 2004, the Company filed Current Report on Form 8-K announcing that on June 18, 2004, the Company entered into an agreement to purchase all of the issued and outstanding capital stock of Managed Healthcare Systems, Inc. from Kenneth J. Sack and the Sack Family Trust.

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SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) 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.

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