-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Hc6wBq6c0o1WrpE2StuzDeNz3eIGPEK9CQdJa04IUsbBviSExafDWSi8Q+ZsHltz 4CecwMih+cFrgFGcDeazxw== 0000926236-04-000033.txt : 20040312 0000926236-04-000033.hdr.sgml : 20040312 20040312151823 ACCESSION NUMBER: 0000926236-04-000033 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST HEALTH GROUP CORP CENTRAL INDEX KEY: 0000812910 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 363307583 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15846 FILM NUMBER: 04665909 BUSINESS ADDRESS: STREET 1: 3200 HIGHLAND AVE STREET 2: HEALTH COMPARE CORP CITY: DOWNERS GROVE STATE: IL ZIP: 60515 BUSINESS PHONE: 6302417900 MAIL ADDRESS: STREET 1: 3200 HIGHLAND AVENUE STREET 2: 3200 HIGHLAND AVENUE CITY: DOWNERS GROVE STATE: IL ZIP: 60515 FORMER COMPANY: FORMER CONFORMED NAME: HEALTHCARE COMPARE CORP/DE/ DATE OF NAME CHANGE: 19920703 10-K 1 fhg03q4.txt FORM 10K FOR YEAR ENDED DECEMBER 31, 2003 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K {X} ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 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 0-15846 First Health Group Corp. ------------------------ (Exact name of registrant as specified in its charter) Delaware 36-3307583 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 3200 Highland Avenue Downers Grove, Illinois 60515 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (630) 737-7900 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01 par value (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ X ] No [ ] The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2003, the last business day of the registrant's most recently completed second fiscal quarter was $2,015,723,325, calculated by reference to the closing price of $27.56 for the common stock on the Nasdaq National Market on that date. For purposes of the foregoing calculation only, all directors, executive officers and five-percent stockholders of the registrant have been deemed to be affiliates. As of March 1, 2004 there were 91,130,434 shares of common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE 2003 Annual Report to Stockholders.................. Parts I, II and IV Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 13, 2004........................................ Parts I and III PART I Item 1. Business -------- Forward-Looking Statements This report includes certain forward-looking statements within the meaning of the federal securities laws. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "could" and "should" and variations of these words and similar expressions are intended to identify these forward-looking statements. Forward-looking statements made by us are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. We disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by us as a result of a number of risks, uncertainties and assumptions. For representative examples of these factors, we refer you to the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2003 Annual Report to Stockholders. General First Health Group Corp., together with its consolidated subsidiaries (referred to as "First Health," "FH," "us," "we," or "our"), is a full- service national health benefits services company. We specialize in providing large payors with integrated managed care solutions. We are a national managed care company serving the group health, workers' compensation and state agency markets. First Health is a Delaware corporation that was organized in 1982. Our executive offices are located at 3200 Highland Avenue, Downers Grove, Illinois 60515, and our telephone number is (630) 737-7900. Our Internet website is located at www.firsthealth.com. This report on Form 10-K, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available on our Internet website as soon as practicable after such reports are filed with the Securities and Exchange Commission. For additional information concerning our business, please refer to the financial statements included in our 2003 Annual Report to Stockholders. Recent Developments Acquisitions. On October 31, 2003, the Company completed the acquisition of all of the outstanding shares of capital stock of Health Net Employer Services, Inc. from Health Net, Inc. for approximately $79 million. The purchase also includes Health Net Plus Managed Care Services, Inc. and Health Net CompAmerica, Inc. Health Net Employer Services, Inc. is a workers' compensation managed care company based in Irvine, Ca. The acquisition was financed with borrowings under the Company's credit facility. On October 31, 2003 the Company completed the acquisition of PPO Oklahoma for a purchase price of $10 million, subject to certain purchase price adjustments. PPO Oklahoma operates almost exclusively in the state of Oklahoma. The acquisition was financed with borrowings under the Company's credit facility. Introduction to Our Products and Services We assist a broad range of payor clients through a portfolio of both integrated and stand-alone managed care and administrative products. These products are designed to produce a positive impact on medical care, to manage medical costs and promote a high level of service and satisfaction among end users. The components of our offerings include: * A broad, national preferred provider organization (PPO) of directly contracted, quality, cost-effective health care providers (which the Company considers to be its most important asset) * Clinical programs, including case management, disease management and return to work programs * Administrative products, including group health claims administration and business process outsourcing for the workers' compensation business, including bill review, first report of injury and front end processing * Pharmacy benefit management * Fiscal agent services (generally for state entitlement programs) * Group health insurance products These products, particularly in the group health area, are offered as part of a comprehensive, integrated package. They are supported by our integrated IT infrastructure, centralized data and consumer and client services, including: * A suite of proprietary integrated applications that allow for efficiency, control and flexibility * Centralized data that enables easy access for service, product development and analysis * Member, provider, client and consultant websites * Internal applications that support self service or interactive dialogue with First Health representatives * Consumer access to member service representatives who answer the phone 24-hours-a-day, 7-days-a-week for group health services * Account management teams dedicated to specific clients Business Sectors First Health offers its managed care and administrative products and services to commercial payors in five different sectors. First Health also serves public-sector payors. Our product and service offerings are centered around our broad, national PPO network of medical providers. Commercial Sectors Group Health Corporate ---------------------- First Health serves national, multi-site, self-insured ERISA payors with its health benefit services. A variety of stand-alone managed care services are offered in this sector, as well as a portfolio of integrated health plan offerings, which may include stop-loss insurance coverage. The Company's target market generally consists of payors with 1,000 employees or more. In addition, we service mid-size, self-insured ERISA payors in local and regional markets with an integrated health plan offering, which may include stop-loss insurance coverage. Generally, marketing in this sector is done directly to payors and through relationships with select consultants and brokers. The Company is focusing on this area for expanded growth in 2004 and beyond. In this sector, First Health competes with large and mid-size national carriers and, in some cases, third party administrators. In addition, other programs, such as HMOs, compete for the enrollment of benefit plan participants. We distinguish ourselves on the basis of the impact of our proprietary national network, as well as our comprehensive case management and disease management programs, coupled with our 24/7 member service and outreach capabilities. Federal Employee Health Benefits (FEHB) Sector ---------------------------------------------- First Health has competed in the FEHB Program for nearly two decades. The FEHB Program is the largest employer-sponsored group health program in the U.S. This is both a business-to-business and business-to-consumer sector, where federal employees have the opportunity to receive health benefits from a number of offered plans each year. For our largest client in this sector, the Mail Handlers Benefit Plan (MHBP), First Health serves as the plan administrator. For all other clients, we provide a variety of managed care and administrative services. In this sector, we market directly to the consumer to gain additional membership in the MHBP. In 2003, we launched a national consumer direct response campaign, including direct mail, print and television. We expect to continue direct marketing as a means of increasing membership in the MHBP. Various health plans are offered under the FEHB Program, including Blue Cross plans and HMOs. First Health distinguishes itself by our experience and long-term presence in this market and our ability to offer a single source program that impacts cost on a national basis. The Company anticipates that it will lose about 10% of the enrollment in the MHBP in 2004 as a result of significant increases in member contributions effective in January 2004 in response to increased costs in 2003. Group Health Third Party Administrators (TPA) --------------------------------------------- First Health offers its national PPO and other managed care products to national, regional and local TPAs. This sector is served by both the First Health brand and CCN brand networks, with CCN comprising the majority of business. This is largely a business-to-business sector, focusing on delivering managed care and administrative solutions that increase client efficiency and profit. The TPAs' sales and marketing staff has primary responsibility for offering our services to their clients, relieving us of significant marketing expense. We support these efforts through participation in the proposal process. The clients of the TPAs, to which we provide services, typically have less than 1,000 employees/members, so there is generally very little conflict with our corporate sales initiative. First Health competes largely with stand-alone national, regional and local PPOs in this sector. We distinguish ourselves on the basis of our network results as well as our ability to interact efficiently with clients in a variety of ways, including remote web repricing and electronic data interchange ("EDI") connectivity. Health Insurance Carriers ------------------------- The company offers services in this sector that include the First Health[R] Network, supplemented with a variety of product options, including clinical management programs, pharmacy benefit management and imaging/medical records repository. This is a highly regulated environment which requires investment in infrastructure to comply with regulatory requirements. The carrier sector has experienced high and increasing administrative costs, creating a market where First Health can leverage its investment in technology and related infrastructure to impact these costs. The insurance carrier's sales and marketing staff ordinarily has the responsibility for offering our services to its policyholders, mitigating significant marketing expense. These clients generally are selling to individuals and small employers (less than 250 employees) and our technology allows them to have a more cost effective offering. Competitors in the carrier sector include national, regional and local PPO networks. First Health distinguishes itself through our ability to reduce both medical and administrative costs. Workers' Compensation --------------------- First Health targets insurance carriers, TPAs, state funds, federal employees and self-insured employers with its workers' compensation programs. In this area, First Health offers managed care services, including the First Health[R] Network and business process outsourcing, including bill review, imaging and work flow management and first report of injury. This sector has experienced significant challenges in recent years due to increases in medical costs and a decline in investment income for insurance carriers. As a result, there is a demand by payors for products that target high cost and/or high volume services. In order to provide services that target increased areas for cost savings, First Health has developed products such as a subset-point-of-entry network (smaller network of providers), a managed physical therapy program, an appointment setting program, and a pain management network and will continue development of such programs. In addition, our business process outsourcing provides customers with work flow and medical records solutions to maximize the financial impact for every claim. In this sector we market to insurance carriers and TPAs, who in turn take responsibility for marketing our services to their prospects and clients. We also market directly to state funds, municipalities, self-insured payors and other distribution channels. The competition includes mostly regional managed care companies with an emphasis on PPO, clinical programs or bill review. First Health differentiates itself based on national PPO results and the ability to provide an integrated product, coupled with technology that reduces administrative cost. These commercial revenue sectors are all focused around the Company's national proprietary PPO Network and are the largest contributors to our revenue. Public Sector ------------- Our subsidiary, First Health Services, provides integrated automation, administration, payment and health care management services for public sector claims. Specifically, First Health Services includes the following programs: * Pharmacy benefit management * Health care management * Fiscal agent services We have been able to utilize our Medicaid fiscal agent expertise, our base of experience in the public sector and our client relationships with over 24 state governments to provide new products and services as the public sector health programs (primarily Medicaid) move toward more efficient utilization of health care services. Health Care Reform ------------------ In 2003, H.R. 1., the Medicare reform and prescription drug legislation, was signed into law. This bill makes sweeping changes to the Medicare program. However, most of these changes do not take effect until 2006. The Company currently derives no revenue from Medicare and the effects of the legislation are not currently estimated to have any material effect on revenue or profitability. Key parts of the legislation include: * Access to a discount drug card for Medicare beneficiaries until December 31, 2005 * Employer eligibility for a 28% federal subsidy for retiree prescription drug costs if they offer an actuarial-equivalent qualified prescription drug plan * Beginning in 2006, beneficiaries can choose to enroll in a voluntary drug benefit plan (the new Medicare Part D) * Beginning in 2006, regional PPOs will be a new option under the Medicare Advantage program * Beginning in 2004, Health Savings Accounts (HSA) are authorized and can be offered in conjunction with a high-deductible health plan. Contributions can be made by the employer or the employee and are excluded from income and wages for tax purposes. Amounts not distributed can be carried over to the next year. HSAs are portable and are owned by the individual. First Health is actively monitoring the rule-making process to determine the extent to which we will have an opportunity to participate in these new programs and to advise our employer clients on participation. Description of Products and Services Commercial ---------- Preferred Provider Organization (PPO) - The First Health[R] Network ------------------------------------------------------------------- PPOs are groups of hospitals, physicians and other health care providers that offer services through companies like ours, at pre-negotiated rates to various payors, including employee groups, workers' compensation payors or other payors such as auto liability. PPO networks offer an additional means of managing health care costs by reducing the per-unit price of medical services provided. Established in 1983, our national PPO network, known as the First Health[R] Network, incorporates both group health and workers' compensation medical providers. This is the core of our Commercial business, providing the foundation for all other products and services. As of December 31, 2003, our hospital network included approximately 4,300 hospitals in 50 states, the District of Columbia and Puerto Rico. In most cases, rates are individually negotiated for the full range of hospital services, including hospital inpatient and outpatient services. In addition, we have established an outpatient care network (OCN) comprising approximately 450,000 physicians, clinical laboratories, surgery centers, radiology facilities and other providers in 50 states, the District of Columbia and Puerto Rico. In the last several years, we have incurred substantial expense (approximately $25 million annually) in expanding our PPO network. We have increased both the number of health care providers with whom we contract within existing geographical markets and the number of geographical areas we serve. We have expanded the number of contract hospitals not only in major metropolitan markets, but also in targeted secondary and rural markets. Many of the hospital and OCN providers that we have added to our network in recent years are located in those secondary and rural markets. As health care costs continue to increase, we expect to invest in continued development of subset "specialty networks" for high cost and/or high volume illness/procedures. Specialty networks are designed to improve predictability of costs and produce the best possible patient and financial outcomes. We have already developed a number of such networks, including a national transplant network, the First Health[R] National Transplant Program. This program is designed to facilitate the cost-effective use of high quality transplant services through a fully integrated system, whereby case management coordinates the transplant process from pre-transplant evaluation through the one-year anniversary of the transplant. Similar networks have also been developed for point-of-entry workers' compensation providers and physical therapy providers. As health care costs continue to rise, we are approaching network development with strategies to attain the best possible outcomes at the most cost-effective rate. For example, bariatric surgery is a procedure that is becoming commonplace, yet it produces a wide variance in outcomes. First Health has developed a system that offers the most experienced surgeons who have documented superior outcomes and who perform the procedure at the most cost-effective hospitals. The following table sets forth information with respect to the approximate number of participating providers in The First Health[R] Network at the end of each of the past five years: December 31 -------------------------------------- 1999 2000 2001 2002 2003 ------ ------ ------ ------ ------ Number of Hospitals in Network 3,510 3,700 4,100 4,200 4,300 Outpatient Care Network Providers 321,000 348,000 390,000 412,000 450,000 The First Health[R] Network was developed in response to the needs of our national client base which is composed of a diverse group of health care payors, such as group health and workers' compensation insurance carriers, third party administrators, HMOs, self-insured employers, union trusts and government employee plans. The breadth and depth of our client base allows us to negotiate favorable rates for all payors with current and prospective healthcare providers throughout the country. Approach to Network Development. Our strategy is to create a selective network of individual providers from within The First Health[R] Network to meet the medical, financial, geographic and quality needs of individual clients and plan participants. We attempt to contract directly with each hospital and generally do not contract with groups of hospitals or provider networks established by other organizations. We believe that this provides maximum control over the composition and rates in the network and ensures provider stability in The First Health[R] Network. To further promote stability and savings in the network, when possible, we enter into multi- year agreements with our providers with nominal annual rate increases. The First Health[R] Network consists of a full array of providers, including hospitals and outpatient providers, such as physicians, laboratories, radiological facilities, outpatient surgical centers, mental health providers, physical therapists, chiropractors, and other ancillary providers. By establishing contractual relationships with the complete range of providers, we are able to impact the vast majority of our clients' health care costs and facilitate referrals within the network for all needed care. Network providers benefit from their participation in the First Health[R] Network through increased patient volume as patients are directed to them through health benefit plans maintained by our clients and other channeling mechanisms, such as our clinical and care support services and on-line provider directories. Our rate structure maximizes the savings for the client and gives incentives to providers to deliver cost-effective care. Unlike many other PPOs that negotiate price discounts or separate rates for intensive care and other specialty units, we strive to negotiate a single, all-inclusive, per diem rate for medical/surgical and intensive care unit days in hospitals. The majority of our hospital PPO contracts have such an all-inclusive rate structure. We also control the charges for hospital outpatient care through the use of reimbursement caps. These negotiated rates have resulted in typical savings from so-called "rack rates" of approximately 40% on inpatient hospital costs and 35% for physician and outpatient costs. We have utilized these negotiated rates to develop the First Health[R] Network U&C, a usual and customary schedule for non-network services. The First Health[R] Network U&C applies when non-network physicians or hospitals are used and yields plan savings equivalent to the average network rate within each geographic area. The schedule is possible because of our national network, direct provider contracts and transactional capabilities. We have established an extensive provider relations program in order to promote ongoing and long-term positive business relationships with network providers. Dedicated staff perform a variety of activities including responding to claims inquiries and conducting site visits. Due in part to the effectiveness of the provider relations program, our retention rate has been more than 99% for hospitals and more than 96% for physicians and other outpatient providers. PPO Quality Assessment. Quality assessment of network providers is a critical component in the selection and retention process. We have established an intensive program whereby we can evaluate each individual provider against standards set for various quality indicators. Provider evaluation begins prior to selection and continues as long as the provider remains in the network. Quality assessment activities include: * Physician credentialing * Peer review of applications when credentialing criteria are not met * Physician recredentialing on at least a biennial basis * Claims profiling * Hospital profiling and credentialing * Ongoing monitoring based on external data and information gathered through interaction with providers * Quality investigations First Health is currently seeking PPO accreditation through the URAC (Utilization Review Accreditation Commission) on a state-by-state basis. Our first state, Virginia, accredited us in January, 2003. In December, 2003, we received provider credentialing accreditation in Georgia and North Carolina. We are targeting other states for accreditations in 2004. PPO Acquisition Philosophy. Over the course of the last few years, the Company has made selective acquisitions that have increased the Company's client base and providers under contract. CCN. Our acquisition of CCN in August 2001 has expanded our position in the group health TPA and insurance company sectors. The addition of CCN network providers has added to the national reach of our network and offers our clients and their employees more choices for their provider selection. Healthcare Value Management (HCVM). Our acquisition of HCVM in May 2002 expanded the scope and depth of our network in New England. HCVM is headquartered in Boston. PPO Oklahoma. On October 31, 2003 the Company completed the acquisition of PPO Oklahoma. PPO Oklahoma operates almost exclusively in the state of Oklahoma. We expect to substantially improve The First Health[R] Network in Oklahoma as a result. Health Net Employer Services, Inc. On October 31, 2003, the Company completed the acquisition of Health Net Employer Services, Inc., which brings additional workers' compensation providers to the First Health[R] Network and additional products and services to the First Health workers' compensation portfolio. Clinical Programs ----------------- We provide clinical programs, including utilization review, case management, medication compliance and disease management through an internal staff consisting primarily of allied health professionals, registered nurses and physicians. This staff is supplemented by a nationwide network of consulting physicians with a full range of specialties. Our in-house physician staff is a resource for development of our programs, as well as clinical policies and guidelines. Our staff includes experienced, board-certified physicians in such specialties as internal medicine, obstetrics and gynecology, psychiatry, pediatrics and occupational medicine. Our staff is crucial to the development and maintenance of evidence-based medical necessity guidelines and our network quality assessment efforts. Our approach to clinical management is patient-centered, which means that we provide the level of support required to manage both costs and outcomes at an individual level. Our program focuses on proper management of illnesses and chronic conditions through early identification, intervention and education. Because we own and operate the program, we are able to aggregate data to identify at-risk members at an early stage and to monitor individual claims data to identify high-risk patients. We connect these patients with network providers and set appointments to facilitate compliance. We then work with the patients and their providers to identify and implement cost- effective treatment alternatives. In all cases, the decision to proceed with these alternatives is made by the patient and the physician. We have formal, clinical protocols for chronic disease management, supported by health status assessments and educational materials. We currently have models for the following conditions: * Asthma * Arial fibrillation * Congestive heart failure * Post myocardial infarction * Diabetes * HIV * Hepatitis C * Organ transplantation * Depression * High risk maternity In addition to these conditions, we also proactively manage other high cost cases such as accidents requiring extensive rehabilitation. Once a case is identified, the case manager continues with periodic follow- up contacts to assess the patient's knowledge of and compliance with the treatment plan. These interactions enhance our ability to assess and appropriately impact: * The patient's compliance with the treatment plan * Progress in achieving treatment goals * Return to optimal functioning * The overall cost to the plan and the patient Medical Claims Administration and Health Plan Services ------------------------------------------------------ We provide comprehensive claims administration to group health clients who purchase our managed care services, including the First Health[R] Network. We provide clients with an integrated package of health care benefits administration, including: * Managed care administration * Medical, dental and vision claims processing * Prescription drug plan administration * Flexible spending account administration * Health care reimbursement account administration * COBRA administration * Health savings account and administration * Subrogation * Access to member services representatives 24-hours-a-day, 7-days-a-week We have been using our proprietary claims administration system, the First Claim[R] system, for 20 years. Because we developed the system, we have the flexibility to support business functions in an efficient, effective manner. We have completed system upgrades incrementally so we do not expose our clients to the high risk of large-scale conversions. Because we control the system, we can offer maximum flexibility for clients who require a variety of benefit plan options or who wish to implement a customized benefit plan. Virtually all of First Health's clients have benefit plans that are unique to them and their business. Because we provide a single source environment, plan participants have just one number to call for all health benefits information. Our claims process is virtually paperless, particularly when a network provider is used. The system automatically calculates benefits and issues checks, letters and explanations of benefits to plan participants and providers. We use our imaging and indexing capabilities to increase the timeliness and accuracy of our claims processing. When we receive paper claims, they are immediately scanned into First Claim[R] and electronically date-stamped. Once the claim is scanned into the system, it is electronically routed to begin the indexing process, which populates the vital information needed to adjudicate the claim. The claim is then electronically routed to the proper claims office for adjudication and is also available for member services staff to respond to inquiries. Plan members are able to view the status of their claim online throughout the entire process, from indexing to completion. Pharmacy Benefits Management (PBM) ---------------------------------- We offer a comprehensive pharmacy program, including: * A national, proprietary, point-of-sale, pharmacy network, consisting of more than 51,000 chain and independent pharmacies * Formulary management * Mail-order service * Prospective drug utilization review * Online prescription claim adjudication The single source combination of pharmacy benefits management and medical management is critical to managing and assessing the total medical cost. Pharmacy data sources are linked with other data sources to internally identify at-risk members for disease management. Stop-Loss Insurance ------------------- Our stop-loss insurance capabilities enable us to serve as an integrated, single source for the managed care needs of our clients who are self-insured employers. Because our stop-loss rates are based on the savings and value generated through our various services, we are able to offer competitive rates and policies and multiple-year rate guarantees. These guarantees include fixed-percent increases and are based upon loss results. Stop-loss policies are written through our wholly owned insurance subsidiaries and can be written for specific and/or aggregate stop-loss insurance. This is the primary insurance product that is emphasized in our sales efforts. Bill Review ----------- The First Health[R] Bill Review system offers national and multi-regional clients a single system to integrate and manage their workers' compensation medical data. This means that our clients can implement their managed care strategies on a national basis. With our bill review system, our clients capture data from multiple sources, analyze the information and use it to implement advanced managed care strategies. First Health[R] Bill Review provides our clients a completely automated, accurate and consistent application of state fee schedule pricing, including applicable rules, regulations and clinical guidelines. The system features full integration with The First Health[R] Network and provides a seamless process for determining contracted rates. As part of the bill adjudication process, First Health subjects bills to a sophisticated, proprietary process to detect duplicate bills and correct billing irregularities and inappropriate billing practices. These billing edits represent additional bill review savings. First Health maintains and supports virtually all aspects of the system. Therefore, clients gain efficiencies in using our integrated services by decreasing the staff previously required to support client billing systems. We have the capability to program and implement client-specific enhancements, which provides truly customized bill review systems for our clients. The system supports a number of electronic data interchanges from front-end systems, including claim systems and bill entry systems. The system also supports EDI output to populate back-end systems such as payment systems, claims systems, explanation of review production and data warehousing. In addition, our bill review system has a comprehensive reporting database that produces a standard set of client savings and management reports. Clients who lease the First Health[R] Bill Review system have online access to their data and are able to create numerous reports, supported by a vast database, at their desktop. They also have online access to production and inventory reports. Through our Reporting and Evaluation Department, ad hoc and custom reports can be produced to meet ongoing needs or one-time analysis. First Report of Injury ---------------------- Early intervention is the key to achieving optimal outcomes in workers' compensation cases. Prompt notification and initiation of medical management helps ensure that injured persons receive appropriate treatment and expedites their recovery and return to work. First Health [R] First Report of Injury system is a quick and easy-to-use service that greatly simplifies the reporting process for workplace injuries, as well as non-occupational disability, property and general liability claims. First Health [R] First Report of Injury service promotes immediate intervention after such occurrences. This service can be accessed telephonically or via the Internet. The system can transmit a first report to a designated representative within 4 hours of notification. In addition to expediting reporting, our system can serve as a gateway to medical management services, including channeling patients to the First Health[R] Network or setting an appointment with a network provider. Other Services -------------- Data Analysis ------------- We provide clients with in-depth, customized information concerning cost and utilization experience. We analyze our clients' health care claims information and benefit plans and suggest appropriate plan design modifications and cost management programs. We are able to predict how changes in plan structure can affect the overall cost of a benefit program. For workers' compensation analysis, clients can customize, schedule and run their own reports through access to our web-reporting tool. Clients can quickly access more than 250 data elements and up to 36 months of paid history to produce their own reports. Users are able to produce a virtually unlimited number of reports, each with same-day turnaround. Reports can be pre-scheduled to run on specified dates and times and users can specify that their customized pre-scheduled reports be delivered via e-mail. Internet Applications/Services ------------------------------ First Health provides the following Internet services for members: Customized Member Portal (My First Health[R] Website): * Members can access the following personal information on "My Account" through a secured connection by entering their username and password: o Benefit plan summaries o Eligibility view capability for members and dependents o History of past year's medical, dental, pharmacy and vision claims, and status of current claims in-house o Ability for member to resolve pended claims o Current status of accumulator balances for medical expenses and flexible spending account balances General Benefit Information: * Electronic provider directory with mapping functionality (location, mileage from specific locations, etc.) for our medical, pharmacy and dental networks and detailed provider information, such as specialty descriptions and quality indicators * E-mail connections with our Member Services Online Department for various communications, such as claims and benefit plan inquiries, case management, pre-determination of benefits and claims appeals * E-mail communications with a First Health Medical Director (as part of First Health [R] Medical Director Q & A ) to ask questions regarding general health-related issues * Online chat service enables direct, interactive communication between members and our member services representatives Managing Care: * Disease management program registration and ability to find condition- specific information * Online general health and pharmacy information * Online health risk assessments * Average network provider fee lookup application to determine the approximate costs of selected standard health care services prior to an office visit * Hospital comparison tool that includes procedure volumes and other quality information regarding hospitals in the First Health[R] Network. * Formulary lookup (i.e. which pharmaceuticals are covered by the plan) * Side-by-side comparison of the price of highly utilized brand name drugs versus their generic equivalents * Ability to fill mail-order prescriptions * Internet visits with network providers for members participating in the First Health[R] Care Support Program Online Enrollment: * Ability to enroll directly online, thereby eliminating the need to submit benefit choices via paper First Health provides the following Internet services for clients: * Network information tools: o Electronic directory - search for a network medical, dental or pharmacy provider o Directory maker - create a customized provider directory by state/county/city or zip o Worksite posters (workers' compensation use only) - generally occupational providers that are in close proximity to workplace * View eligibility with add/edit/delete capability * Full summary of medical plan documents online * Online reporting with view, download and manipulation capabilities * Member marketing and enrollment information * E-mail connections with Client Services and Account Management departments * Claims Inventory Log, including total number of claims processed and the number of claims remaining to be processed * Ability to print temporary ID cards for members * Access to PBM formulary First Health provides the following Internet services for providers: * Administrative network guidelines and protocol * Referral directories * Client lists and inquiries * Hospital and related pre-certification submission * Claims submission * Ability to update "Practice Profiles" online. In addition to the standard name, address and hospital affiliation information, the profile may contain information about the providers, such as Web address, languages spoken and whether they are accepting new patients * E-mail connections with our Provider Relations Department and clinical staff for various communications, such as contract submission, claims appeals, care support guidelines and predetermination of benefits Compensation - Commercial Products and Services. First Health generally enters into pricing agreements where the amount of the fee varies depending on a number of factors, including number of participants, length of contract and products and services purchased. To a lesser extent, our revenue from pricing agreements is based upon a percentage of savings realized. In addition, we collect premiums from our employer stop-loss business and our small group insurance business, including a New England Financial block of business for which we bear 20% of the financial risk. Public Sector ------------- The Company believes it is one of the few health benefit services companies that provides a comprehensive solution to states which enables them to control their rising health care costs, including: pharmacy benefit management services, medical management services and fiscal agent services. Pharmacy Benefit Management (PBM) --------------------------------- First Health Services' PBM program manages pharmacy benefit plans for Medicaid programs, state senior drug programs and state-funded specialty programs. Our PBM program is one of the largest of its kind in the country and provides a full range of services, including: * Pharmacy point-of-sale eligibility verification and claims processing * Provider network development and management * Case management programs * Prospective and retrospective drug utilization reviews ("DUR") * Prescriber and provider profiling * Prescriber education, preferred drug list development and manufacturers' rebate contracting and administration * Prior authorization of pharmaceutical use * First IQ[TM], a proprietary database and decision support system for pharmacy utilization monitoring and plan management PBM services are increasingly required by both public and private third- party payors as prescription drug expenses grow. We believe our role as an independent provider of PBM services gives us a distinct competitive advantage in the growing sector of state government plans, where clinical autonomy is often a requirement. Our PBM business model is completely transparent so the benefit of all rebates and network discounts is passed directly and totally to the client. Furthermore, we believe that First Health Services is a national leader in this area with substantial experience managing pharmacy plans for Medicaid and state pharmaceutical assistance programs. This clinical and management expertise gives us a competitive advantage in the rapidly growing market of managed care organizations serving the public sector on a non-risk, fee basis. First Health Services also offers clinical management programs (CMP) to assist physicians and network pharmacies in the appropriate management of patients using pharmaceuticals. This program provides physicians with reviews of treatment appropriateness and preferred drug guidelines which have been developed by nationally recognized clinicians and medical authorities. First Health Services' CMP focuses on those patients who experience preventable therapeutic problems such as non-compliance, inappropriate therapy and adverse drug reactions. The program includes prior authorization initiatives, prospective DUR, retrospective DUR and educational intervention initiatives, known as concurrent DUR and prescriber education. Compensation. In exchange for providing our PBM services, we receive a predetermined, contractual fee that is based upon the number of transactions processed plus added fees for additional time and materials and for change orders. First Health Services neither derives any revenue from drug manufacturers or the pharmacy network contracts, nor does it provide any mail order services. Health Care Management ---------------------- First Health Services' Health Care Management program provides external quality of care evaluation, utilization review and long-term care review services to Medicaid programs, state mental health agencies and other public sector health care programs desiring to improve quality of care, contain costs, ensure appropriate care and measure outcomes. The utilization review services cover a variety of medical, surgical and behavioral health programs, including acute and chronic inpatient and outpatient treatment of children, adult and geriatric populations, residential services and other alternative services. The Health Care Management program also provides on-site quality reviews and inspection of care for community mental health centers, residential treatment centers and inpatient psychiatric programs. As state Medicaid programs and state departments of mental health spend increasing proportions of public funds on treatment for Medicaid and other needy populations, the need for utilization review services is increasing. Some states are moving toward capitated contracts with private sector firms to help manage this problem. However, many states are opting to contract for utilization review services on a fee- for-service basis to ensure appropriate health care while containing costs. Under the long-term care review services, we provide level-of-care determinations as well as pre-admission screenings and annual resident reviews to determine the need for specialized services for mental illness, mental retardation or related conditions. Compensation. As a fee for providing our health care management services, we receive fees on a transactional, or "per review" basis, and on a time and material basis. Fiscal Agent ------------ First Health Services' Fiscal Agent program administers state Medicaid health plans and other state-funded health care programs by providing clients with full fiscal agent operations and systems maintenance and enhancement. Under this product line, we provide: * Medicaid management information systems installation, maintenance and enhancement * Enrollment services * Eligibility verification and ID card issuance * Health care claims receipt, resolution, processing and payment * Provider relations * Third party liability processing * Financial reconciliation functions * Client reporting Our customers include state Medicaid agencies, state departments of human services and departments of health serving Medicaid populations and other public assistance health benefit programs. Public sector clients may also procure fiscal agent services to support other government programs, such as state employee benefit plans, early intervention programs or other health care initiatives. Typically, fiscal agent systems are modified to meet a specific state's program policy and administration requirements so that services are offered for all claim types. We are one of four major competitors in the Medicaid fiscal agent field. First Health Services has developed and operates a Center of Medicaid/Medicare Services (CMS) certified information system for each client. These systems are utilized to process and adjudicate eligibility, health care claims and encounters, pay providers under a full range of reimbursement methods and generate reports for use in managing the program. There are several additional benefits that First Health Services receives from operating the fiscal agent business: * System development is principally funded by new state contract awards * The expertise, capabilities and systems developed from these contracts have provided a platform for expansion into other products, services and customer segments, and * Customer relationships with the states have proven valuable in developing other business in the PBM and Health Care Management programs Compensation. As a fee for providing our fiscal agent services, we receive a flat fee per transaction and other predetermined, contractual fees that are based upon the volume of transactions processed, as well as fees for additional time and materials and for change orders. Fees for software development contracts are recognized as milestones are met and customer acknowledgement of such achievement of milestones is received. Clients and Marketing We primarily market our services to national, multi-site direct accounts, including self-insured employers, government employee groups and multi-employer trusts with greater than 1,000 employees or members. During 2003, one client (Mail Handlers Benefit Plan), for which we provided PPO services and claims administration services, accounted for 27% of our total revenues. No other client represents more than 4% of revenue. In addition, we market our services to and through group health and workers' compensation insurance carriers. The following are representative clients of First Health: Commercial Clients Agilent Technologies, Inc. Health Net, Inc. Albertson's, Inc. Liberty Mutual Insurance Company Boilermakers National Health McDonald's Corporation and Welfare Fund ConAgra Foods, Inc. National Association of Letter Carriers Crawford and Company Radio Shack Corporation Eaton Corporation The Sherwin-Williams Company HCA Inc. Travelers Property and Casualty Hartford Financial Services, Inc Watson Pharmaceuticals, Inc. Public Sector Clients Alaska Div of Medical Assistance Ohio Medicaid Elderly Pharmaceutical Pennsylvania Dept of Aging Insurance Coverage Florida Agency of Healthcare State of Maryland Nevada Dept of Health State of Michigan New Jersey Medicaid Virginia-Dept of Medical Assistant Services We presently have approximately 110 group health and workers' compensation insurance carrier clients. Typically, we enter into a master service agreement with an insurance carrier under which we agree to provide our cost management services to health care plans maintained by the carrier's policyholders. Our services are offered not only to new policyholders, but also to existing policyholders at the time their policies are renewed. The insurance carrier's sales and marketing staff ordinarily has the responsibility for offering our services to its policyholders, relieving us of a significant marketing expense. In 2002, we launched a national consumer advertising campaign to include print and television. We continued to use consumer advertising as a means of raising awareness with end-user customers in 2003. We typically enter into standardized service contracts with our direct accounts and master service agreements with our insurance carrier and third party administrator clients. These contracts and agreements have automatically renewable successive terms of between one and three years, and are generally terminable upon notice given one to six months prior to expiration. While these contracts are generally exclusive as to a client's ability to use other PPO companies in identified geographic areas, they are generally non-exclusive with respect to a client's right to provide in-house medical review services. Competition We compete in a highly fragmented market with national and local firms specializing in utilization review and PPO cost management services and with major insurance carriers and third party administrators that have implemented their own internal cost management services. In addition, other managed care programs, such as HMOs and group health insurers, compete for the enrollment of benefit plan participants. We are subject to intense competition in each market segment in which we compete and many of our competitors have greater financial and marketing resources than we do. We distinguish ourselves on the basis of the quality and cost-effectiveness of our programs, our proprietary computer-based integrated information system, our emphasis on commitment to service with a high degree of physician involvement, the penetration of our network into secondary and tertiary markets and our role as an integrated provider of PBM services. The insured market for workers' compensation programs is somewhat concentrated, with the top ten insurers controlling over 50% of the insured market. We have focused our efforts on the top tier of the workers' compensation market. The acquisition of Health Net, which traditionally has sold services to smaller employers and payors, expands the market for our services. Although we currently include several regional offices of six of the top ten workers' compensation insurers among our clients, we compete with a multitude of PPOs, technology companies that provide bill review services, clinical case management companies and rehabilitation companies for the business of these insurers. While experience differs with various clients, obtaining a workers' compensation insurer as a new client typically requires extended discussions and a significant investment of time. Given these characteristics of the competitive landscape, client relationships are critical to the success of our workers' compensation products. Employees As of December 31, 2003, we had approximately 6,000 employees, including approximately 2,300 employees involved in claims processing and related activities, 900 employees directly administering the Mail Handlers Benefit Plan, 700 employees in information systems, 500 employees in various clinical management and quality assessment activities, 600 employees in PPO development and operations, 600 employees in sales, account management and marketing and the remainder involved with accounting, legal, human resources, facilities, and other administrative, support and executive functions. We also have a nationwide network of conferring physicians in various specialties, most of whom are compensated on an hourly or per visit basis when they are requested to render consulting services on our behalf. None of our employees are presently covered by a collective bargaining agreement and we consider our relations with our employees to be good. Information Systems First Health utilizes an enterprise system architecture that is structured in three basic tiers. These layers consist of databases, middleware and proprietary applications, all of which run on a clustered hardware platform. The structure operates in a centralized manner enabling a consistent national operation across all locations. Hardware is clustered for scalability and flexible data storage. Multiple clustered computers have controlled access to a set of shared peripherals such as disk and tape devices. The computing power of our clusters can be increased at any time by adding processor boards to one or more computers and/or adding computers to the cluster. Our clusters also shift work to other machines in the event of a system failure. With a common storage area for VMS, Unix, NT and NetWare, First Health's platform is compatible from the smallest Web server to the largest database server. Our hardware set-up has enabled a doubling of power and storage capacity annually. Storage capacity has increased more than 1,000 times over a ten-year period. All of this is accomplished through upgrades rather than conversions. Middleware is used to deliver information from the databases to the various applications. This transaction process system resides between the application and databases. Using middleware allows multiple applications to share common routines, promoting logical consistency and reducing maintenance complexity. This tier also separates applications from database changes and provides improved performance over the wide area network. At the third level are the proprietary applications, which support all of First Health's services. These applications are integrated through their access to the centralized databases. First Health develops its applications to allow for maximum customization and maintain its strict principles of architectural integration. The portion of the application that controls user interface runs on Intel Pentium workstations that are members of a Novell NetWare local area network (LAN). A LAN at each corporate site is linked to form a wide area network (WAN) so applications run at distributed locations, but data they access is maintained centrally on our database servers in our corporate data center. First Health's data center in Scottsdale, Arizona is secured for physical or electronic access and is protected from power failure by battery-operated, uninterruptible power supplies backed up by natural gas generators. The backup data center provides business continuity in an emergency. AlphaServer systems and necessary storage capacity support critical applications. First Health also avoids downtime due to single component failure through live, redundant components. Government Regulations ---------------------- Federal-Level Regulation ------------------------ Managed health care programs are subject to various federal laws and regulations. Both the nature and degree of applicable government regulation vary greatly depending upon the specific activities involved. Generally, parties that actually provide or arrange for the provision of health care services, assume financial risk related to the provision of those services, or undertake direct responsibility for making payment or payment decisions for those services, are subject to a number of complex regulatory schemes that govern many aspects of their conduct and operations. While our management and information services typically have not been the subject of extensive regulation by the federal government, the last decade has witnessed increased regulation of our industry. In particular, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) has imposed obligations previously unknown to managed health care service providers. HIPAA is designed to reduce the amount of administrative waste in the health care industry and to protect the privacy of patients' medical information. Among other things, HIPAA established new requirements for the privacy of patient health information and standard formats for the secure transmission of health care data among healthcare providers, payors and plans. The regulations regarding the standard formats for the secure transmission of health care information became effective in October 2003 (for 2005 compliance) and the regulations regarding privacy issues became effective in April 2003. We formed a corporate HIPAA Administrative Simplification Committee and Workgroup to identify processes, systems or policies that will require modification and to implement appropriate remediation and contingency plans to avoid any adverse impact on our ability to perform services in accordance with the applicable standards. We communicated with significant third-party business partners to assess their readiness and the extent to which we will need to modify our relationship with these third parties when conducting EDI or e-commerce. We also formed a Security Committee and Workgroup to address electronic security, specifically, HIPAA security requirements. The cost of this compliance effort was approximately $5 million. State-Level Regulation ---------------------- Our activities are subject to state regulations applicable to managed health care service providers and as a licensed insurance carrier. We believe that we are in compliance in all material respects with all current state regulatory requirements applicable to our business as it is presently conducted. However, changes in our business or in state regulations could affect the level of services that we are required to provide or could affect the rates we can charge for our health care products and services. The workers' compensation segment of our business is more sensitive to state governmental regulation. Historically, governmental strategies to contain medical costs in the workers' compensation field have been limited to legislation on a state-by-state basis. For example, 42 states have implemented fee schedules that list maximum reimbursement levels for health care procedures. In certain states that have not authorized the use of a fee schedule, we adjust bills to the usual and customary levels authorized by the payor. In addition to the laws governing workers' compensation in each state, over 25 states have enacted specific managed care legislation. This legislation creates additional opportunities to offer comprehensive managed care programs. Item 2. Properties ---------- We own seven office buildings consisting of an aggregate of approximately 670,000 square feet of space. Our headquarters are located in Downers Grove, Illinois and our other six offices are located in West Sacramento and San Diego, California; Houston, Texas; Pittsburgh, Pennsylvania; and Tucson and Scottsdale, Arizona. Additionally, we lease significant office space in Salt Lake City, Utah; Rockville, Maryland; Milwaukee, Wisconsin; Richmond, Virginia; Tampa, Florida; Boise, Idaho and Irvine, CA. We also have numerous smaller leased facilities throughout the nation. All of our buildings and equipment are being utilized, have been maintained adequately and are in good operating condition. These assets, together with planned capital expenditures, are expected to meet our operating needs in the foreseeable future. Item 3. Legal Proceedings ----------------- The Company and its subsidiaries are subject to various claims arising in the ordinary course of business and are parties to various legal proceedings that constitute litigation incidental to the business of the Company and its subsidiaries. The Company does not believe that the outcome of such matters will have a material effect on the Company's financial position or results of operations. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- No matters were submitted to a vote of the Company's stockholders during the fourth quarter of the year ended December 31, 2003. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. --------------------------------------------------------------------- Our common stock has been quoted on the Nasdaq National Market under the symbol "FHCC" since our corporate name change on January 1, 1998 and prior to that was quoted under the symbol "HCCC". Information concerning the range of high and low sales prices of our common stock on the Nasdaq National Market and the approximate number of holders of record of our common stock is set forth under "Common Stock" in our 2003 Annual Report to Stockholders. Information concerning our dividend policy is set forth under "Dividend Policy" in our 2003 Annual Report to Stockholders. All such information is incorporated herein by reference. Item 6. Selected Financial Data. ------------------------ Selected financial data for each of our last five fiscal years is set forth under "Selected Financial Data" in our 2003 Annual Report to Stockholders. Such information is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operation. --------------------- The information required by this item is set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2003 Annual Report to Stockholders and is incorporated herein by reference. Item 7a. Quantitative and Qualitative Disclosures About Market Risk. ---------------------------------------------------------- The disclosures required by this item are contained in our 2003 Annual Report under the caption "Market Risk" and are incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. -------------------------------------------- The financial statements required by this item are contained in our 2003 Annual Report to Stockholders on the pages indicated below and are incorporated herein by reference. Financial Statements: Page No. -------------------- ------- Report of Independent Auditors 57 Consolidated Balance Sheets as of December 31, 2002 and 2003 60-63 Consolidated Statements of Operations for the Years Ended December 31, 2001, 2002 and 2003 64-65 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2001, 2002 and 2003 66-67 Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2002 and 2003 68-71 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2001, 2002 and 2003 72-75 Notes to Consolidated Financial Statements 76-111 Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure -------------------- Not applicable. Item 9a. Controls and Procedures ----------------------- The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As of December 31, 2003, the end of the quarter covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on the foregoing, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at the reasonable assurance level. There has been no change in the Company's internal controls over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal controls over financial reporting. PART III Item 10. Directors and Executive Officers of the Registrant. --------------------------------------------------- Executive Officers of the Company Name Age Position --------------------- ---- ------------------------------------------- James C. Smith 63 Chairman of the Board Member of Board of Directors Edward L. Wristen 52 President and Chief Executive Officer Member of Board of Directors A. Lee Dickerson 54 Executive Vice President Patrick G. Dills 50 Executive Vice President and President, CCN Susan Oberling 44 Senior Vice President, Operations Joseph E. Whitters 45 Executive Vice President, Treasurer and Chief Financial Officer Susan Smith 53 Vice President, General Counsel and Secretary James C. Smith has served as Chairman of the Board since January 2001. He had served as the Chief Executive Officer from January 1984 through December 2001. Edward L. Wristen joined First Health in November 1990 as Director of Strategic Planning. He served in various senior and executive level positions from 1991 through August 1998. In September 1998, Mr. Wristen became Chief Operating Officer. In January 2001, Mr. Wristen became President of the Company. In January 2002, Mr. Wristen became Chief Executive Officer of the Company. Mr. Wristen has over 25 years experience in the health care industry. A. Lee Dickerson joined First Health in 1988 as Regional Director, Hospital Contracting. Mr. Dickerson was promoted into his current position in November 1995. Previously he held various senior level positions in the Company's Provider Networks area. Mr. Dickerson has over 25 years experience in the health care industry. Patrick G. Dills joined First Health in 1988 as Senior National Director, Sales and Marketing. Mr. Dills was promoted to Executive Vice President, Managed Care Sales in January 1994 and to Executive Vice President, Sales in 1998. He was appointed President of CCN in August 2001. Susan Oberling joined First Health in 1987 in our Clinical Management organization. Ms. Oberling was promoted into her current position in 2003. She has previously held various senior level positions within the Company's operations including our benefit administration and member services areas. Joseph E. Whitters joined the Company as Controller in October 1986 and has served as its Chief Financial Officer since March 1988. He was promoted to Executive Vice President in 2003. Susan T. Smith joined the Company as Director of the Legal Department in 1993. She was appointed Associate General Counsel in 1994 and assumed her role as General Counsel in 1997. She was appointed Secretary of the Company in 2000. The Company's officers serve at the discretion of the Board of Directors. Other information regarding our executive officers, as well as certain information regarding First Health's directors, will be included in the Proxy Statement for our Annual Meeting of Stockholders to be held on May 13, 2004 (the "Proxy Statement"), and such information is incorporated herein by reference. Item 11. Executive Compensation. ----------------------- The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference. However, the Report of the Compensation Committee of the Board of Directors on Executive Compensation contained in the Proxy Statement is not incorporated by reference herein, in any of our previous filings under either the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, or in any of our future filings. Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------- The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. ----------------------------------------------- The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference. Item 14. Principal Accounting Fees and Services -------------------------------------- The information required by this Item will be included in the Proxy Statement and is incorporated herein by reference. PART IV Item 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K. ---------------------------------------------------------------- (a) The following documents are filed as part of this report: (1) The Index to Financial Statements is set forth on page 19 of this report. (2) Consolidated Financial Statements Schedules: Schedule II - Valuation and Qualifying Accounts and Reserves. Schedule IV - Reinsurance (3) Exhibits (b) Reports on Form 8-K: The Company furnished a report on Form 8-K dated November 3, 2003 reporting under Item 12 the results of operations and financial condition for the three and nine months ended September 30, 2003. The Company filed a report on Form 8-K dated November 5, 2003 reporting under Item 5 announcing it had completed the acquisition of the stock of Health Net Employer Services, Inc. First Health Group Corp. Schedule II - Valuation and Qualifying Accounts and Reserves Years Ended December 31, 2003, 2002 and 2001 Balance at Additions Charged Adjustments Balance at Beginning to Revenues or and End of Description of Period Expenses Charge-offs Period ------------ ---------- ---------- ----------- ---------- Year Ended December 31, 2003 ---------------------------- Allowance for Doubtful Accounts $14,782,000 $ 8,616,000(2) $(2,325,000) $21,073,000 ========== ========== =========== ========== Contractual Reserves (4) $41,227,000 $ 3,080,000 $(7,780,000) $36,527,000 ========== ========== =========== ========== Accrued Restructuring Expenses $11,393,000 $ 3,300,000(1) $(9,589,000) $ 5,104,000 ========== ========== =========== ========== Year Ended December 31, 2002: ---------------------------- Allowance for Doubtful Accounts $14,327,000 $ 600,000 $ (145,000)(2) $14,782,000 ========== ========== =========== ========== Contractual Reserves (4) $18,152,000 $23,893,000 $ (818,000) $41,227,000 ========== ========== =========== ========== Accrued Restructuring Expenses $36,475,000 $ 2,250,000(1) $(27,332,000)(3) $11,393,000 ========== ========== =========== ========== Year Ended December 31, 2001: ----------------------------- Allowance for Doubtful Accounts $10,811,000 $ 4,003,000(2) $ (487,000) $14,327,000 ========== ========== =========== ========== Contractual Reserves (4) $23,401,000 $(4,435,000) $ (814,000) $18,152,000 ========== ========== =========== ========== Accrued Restructuring Expenses $ 4,249,000 $41,113,000(1) $ (8,887,000) $36,475,000 ========== ========== =========== ========== (1) Additions in 2001 represent accrued restructuring expenses that were included in the purchase accounting adjustments related to the acquisition of CCN Managed Care, Inc., not charged to expenses. In 2002, additions include accrued restructuring expenses that were included in the purchase accounting adjustments related to the CAC and HCVM acquisitions, not charged to expenses. In 2003, additions include accrued restructuring expenses that were included in the purchase accounting adjustments related to the Health Net and PPO Oklahoma acquisitions, not charged to expenses. (2) Additions in 2001 represent allowance for doubtful accounts that were included in the purchase accounting adjustments related to the acquisition of CCN Managed Care, Inc., not charged to expenses. In 2002, adjustments include a $3 million reduction related to the true-up of the CCN allowance for doubtful accounts. In 2003, additions include $6.4 million for the allowance for doubtful accounts related to the Health Net and PPO Oklahoma acquisitions. (3) Amount includes a reclass of $5.2 million of purchase accounting reserves to deferred income tax liability. Amount also includes a $14.4 million reduction to the CCN restructuring reserve for a true up of the liability amounts. (4) Contractual reserves represent reserves for items such as non- covered services, ineligible members, other insurance, performance guarantees, etc. These amounts are netted against gross accounts receivable in the consolidated balance sheets. Beginning in 2002, this also relates to reserves established for various contingencies associated with potential disallowance of certain expenses charged to the Mail Handlers Benefit Plan.
First Health Group Corp. Schedule IV - Reinsurance Years Ended December 31, 2003, 2002 and 2001 Percentage Ceded Assumed of Amount Direct to Other from Other Net Assumed Amount Companies Companies Amount to Net ----------- -------------- ----------- ----------- --- Year ended 12/31/03: ------------------- Life insurance in force: $147,187,000 $ (140,133,000) $216,860,000 $223,914,000 97% =========== ============== =========== =========== === Premiums: Life insurance 1,725,000 (1,649,000) 318,000 394,000 81% Accident and health insurance 21,534,000 (26,535,000) 26,167,000 21,166,000 124% ----------- -------------- ----------- ----------- --- Total premiums $ 23,259,000 $ (28,184,000) $ 26,485,000 $ 21,560,000 123% =========== ============== =========== =========== === Year ended 12/31/02: -------------------- Life insurance in force: $157,963,000 $ (150,501,000) $ 5,420,000 $ 12,882,000 42% =========== ============== =========== =========== === Premiums: Life insurance 1,813,000 (1,705,000) 32,000 140,000 23% Accident and health insurance 18,986,000 (4,142,000) 557,000 15,401,000 4% ----------- -------------- ----------- ----------- --- Total premiums $ 20,799,000 $ (5,847,000) $ 589,000 $ 15,541,000 4% =========== ============== =========== =========== === Year ended 12/31/01: ------------------- Life insurance in force: $172,677,000 $ (163,781,000) $ -- $ 8,896,000 --% =========== ============== =========== =========== === Premiums: Life insurance 2,129,000 (2,032,000) 37,000 134,000 28% Accident and health insurance 16,491,000 (2,860,000) 907,000 14,538,000 6% ----------- -------------- ----------- ----------- --- Total premiums $ 18,620,000 $ (4,892,000) $ 944,000 $ 14,672,000 6% =========== ============== =========== =========== ===
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST HEALTH GROUP CORP. By: /s/Edward L. Wristen ---------------------------- Edward L. Wristen, President and Chief Executive Officer Date: March 11, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 11, 2004: Signature Title ------------------------------ ------------------------------------ /s/James C. Smith Chairman of the Board ------------------------------ Director James C. Smith /s/Edward L. Wristen President and Chief Executive Officer ------------------------------ Director (Principal Executive Officer) Edward L. Wristen /s/Joseph E. Whitters Executive Vice President, Treasurer ------------------------------ and CFO (Principal Financial and Joseph E. Whitters Accounting Officer) /s/Michael J. Boskin Director ------------------------------ Michael J. Boskin /s/Daniel Brunner Director ------------------------------ Daniel Brunner /s/Raul Cesan Director ------------------------------ Raul Cesan /s/Robert S. Colman Director ------------------------------ Robert S. Colman /s/Ronald H. Galowich Director ------------------------------ Ronald H. Galowich /s/Harold S. Handelsman Director ------------------------------ Harold S. Handelsman /s/Don Logan Director ------------------------------ Don Logan /s/William Mayer Director ------------------------------ William Mayer /s/John C. Ryan Director ------------------------------ John C. Ryan /s/David Simon Director ------------------------------ David Simon INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders First Health Group Corp. Downers Grove, IL 60515 We have audited the consolidated financial statements of First Health Group Corp. as of December 31, 2003 and 2002, and for each of the three years in the period ended December 31, 2003 and have issued our report thereon, dated March 8, 2004 (which expressed an unqualified opinion and included an explanatory paragraph related to the adoption of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"); such consolidated financial statements and report are included in the Company's 2003 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of First Health Group Corp. listed in Item 15. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based upon our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. DELOITTE & TOUCHE LLP Chicago, Illinois March 8, 2004 INDEX TO EXHIBITS Exhibit No. Description ---------------------------------------------------------------------------- 3.1. Restated Certificate of Incorporation of the Company. {3.1} (1) 3.2. Amendment to Restated Certificate of Incorporation of the Company. {3.2} (4) 3.3. Restated Certificate of Designation of Preferences, Rights and Limitations. {3.3} (1) 3.4. Amended and Restated By-Laws of the Company. {3.4} (1) 3.5. Amendment, dated as of May 20, 1987, to Amended and Restated By-Laws of the Company {3.5} (2) 3.6. Amendment to Amended and Restated By-Laws of the Company.{3.6} (3) 3.7. Amendment to Amended and Restated By-Laws of the Company.{3.7} (3) 4. Specimen of Stock Certificate for Common Stock. {4} (2) 10.1. Form of Consulting Physician Agreement, {10.1} (2) 10.2. Form of Consulting Specialist Agreement. {10.2} (2) 10.3. 1995 Employee Stock Option Plan. (10.3) (5) 10.4. Agreement dated as of September 1, 1995 between HealthCare COMPARE Corp. and Electronic Data Systems. {10.4} (6) 10.5. Stock Purchase Agreement among HealthCare COMPARE Corp., First Financial Management Corporation and First Data Corporation dated as of May 22, 1997, incorporated by reference from the Company's Second Quarter 1997 Form 10-Q dated August 13, 1997. {10.5} (7) 10.6. 1998 Stock Option Plan {10.6} (8) 10.7. 1998 Directors Stock Option Plan {10.7} (9) 10.8. Shareholder Rights Agreement dated as of March 19, 1999 between First Health Group Corp., Illinois Stock Transfer Company and LaSalle National Bank {10.8} (10) 10.9. Employment Agreement dated May 1, 1999 between First Health Group Corp. and Ed Wristen. {10.9} (11) 10.10. Employment Agreement dated May 1, 1999 between First Health Group Corp. and Susan T. Smith. {10.10} (11) Exhibit No. Description ---------------------------------------------------------------------------- 10.11. Employment Agreement dated May 1, 1999 between First Health Group Corp. and A. Lee Dickerson. {10.11} (11) 10.12. Employment Agreement dated May 1, 1999 between First Health Group Corp. and Joseph E. Whitters. {10.12} (11) 10.13. Employment Agreement dated May 1, 1999 between First Health Group Corp. and Patrick G. Dills. {10.13} (11) 10.14. Option Agreement dated as of May 18, 1999 by and between the Company and James C. Smith {10.14} (12) 10.15. Option Agreement dated as of May 18, 1999 by and between the Company and James C. Smith {10.15} (12) 10.16. 2000 Stock Option Plan {10.16} (13) 10.17. Option Agreements dated March 20, 2002 between First Health Group Corp. and Edward L. Wristen. {10.17} (14) 10.18. Director's Stock Option Plan {10.18} (15) 10.19. 2001 Stock Option Plan {10.19} (16) 10.20. Stock Purchase Agreement dated as of May 18, 2002, among the Company and HCA-the Healthcare Company and VH Holdings, Inc. {10.20} (17) 10.21. Agreement and Acknowledgment with respect to the Stock Purchase Agreement, dated as of August 16, 2002, among the Company and HCA-the Healthcare Company and VH Holdings, Inc. {10.21} (17) 10.22. Credit Agreement among the Company as borrower, Bank of America, N.A. as administrative agent, certain subsidiaries of the Company as guarantors; and other financial institutions party thereto as lenders {10.22} (18) 10.23. Employment Agreement dated January 1, 2002, as amended on September 17, 2002 between First Health Group Corp. and James C. Smith. {10.23} (19) 10.24. 2002 Restatement of the First Health Group Corp. Retirement Savings Plan. {10.24} (19) 10.25. First Amendment to the 2002 Restatement of the First Health Group Corp. Retirement Savings Plan. {10.25} (19) Exhibit No. Description ---------------------------------------------------------------------------- 10.26. Second Amendment to the 2002 Restatement of the First Health Group Corp. Retirement Savings Plan. {10.26} (19) 10.27. Health Benefits Services Agreement dated as of January 1, 2003, among the National Postal Mail Handlers Union and First Health Group Corp. {10.27} (19) 10.28. Agreement dated as of April 15, 2002, among the National Postal Mail Handlers Union, First Health Life and Health Insurance Company, Cambridge Life Insurance Company and Federal Employee Plans, Inc. {10.28} (19) 10.29. First Amendment to the Employment Agreement dated May 1, 1999 between First Health Group Corp. and Joseph E. Whitters. 10.30. First Amendment to the Employment Agreement dated January 1, 2001 between First Health Group Corp. and Edward L. Wristen 10.31. Second Amendment to the Employment Agreement dated May 1, 1999 between First Health Group Corp. and Patrick G. Dills. 11. Computation of Basic and Diluted Earnings Per Share. 13. 2003 Annual Report to Stockholders. 21. Subsidiaries of the Company. 23. Consent of Deloitte & Touche LLP 31.1. Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. 31.2. Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. 32.1. Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2. Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit No. Description ---------------------------------------------------------------------------- { } Exhibits so marked have been previously filed with the Securities and Exchange Commission as exhibits to the filings shown below under the exhibit number indicated following the respective document description and are incorporated herein by reference. (1) Registration Statement on Form S-1 ("Registration Statement"), as filed with the Securities and Exchange Commission on April 17, 1987. (2) Amendment No. 2 to Registration Statement, as filed with the Securities and Exchange Commission on May 22, 1987. (3) Registration Statement on Form S-1, as filed with the Securities and Exchange Commission on July 12, 1988. (4) Annual Report on Form 10-K for the year ended December 31, 1990, as filed with the Securities and Exchange Commission on March 30, 1991. (5) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on September 20, 1995. (6) Annual Report on Form 10-K for the year ended December 31, 1996 as filed with the Securities and Exchange Commission on March 27, 1997. (7) Annual Report on Form 10-K for the year ended December 31, 1997 and filed with the Securities and Exchange Commission on March 25, 1998. (8) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on December 15, 1998. (9) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on December 15, 1998. (10) Current Report on Form 8-K as filed with the Security and Exchange Commission on March 24, 1999. (11) Annual Report on Form 10-K for the year ended December 31, 1999 and filed with the Securities and Exchange Commission on March 24, 2001. (12) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on March 19, 2002. (13) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on March 19, 2002. Exhibit No. Description ---------------------------------------------------------------------------- (14) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on August 15, 2002. (15) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on August 15, 2002. (16) Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on August 15, 2002. (17) Current Report on Form 8-K as filed with the Securities and Exchange Commission on August 27, 2002. (18) Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on May 13, 2002. (19) Annual Report on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission on March 26, 2003. EX-10.29 3 exh10-29.txt AMENDMENT TO EMPLOYMENT AGREEMENT EXHIBIT 10.29 FIRST AMENDMENT TO THE EMPLOYMENT AGREEMENT DATED MAY 1, 1999, BETWEEN FIRST HEALTH GROUP CORP. AND JOSEPH E. WHITTERS THIS FIRST AMENDMENT is entered into as of the 1st day of November, 2003, by and between First Health Group Corp. ("First Health") and Joseph E. Whitters ("Employee"). WHEREAS, First Health and Employee have previously entered into that certain Employment Agreement, dated May 1, 1999 (the "Agreement"), under which First Health employs Employee; WHEREAS, First Health and Employee desire to amend the Agreement to change Employee's annual salary. NOW THEREFORE, in consideration of the mutual covenants contained in this Amendment and in the Agreement and other good and valuable consideration, the parties agree to amend the Agreement as follows: 1. Effective on and after January 1, 2003, the first sentence in Section 5(a) of the Agreement is replaced with the following: (a) Salary. Employee will receive an annual salary of $250,000. 2. The parties ratify and affirm the Agreement and agree that it is valid as amended herein. The terms of this Amendment shall prevail over any conflict with the terms of the Agreement. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first written above. Employee: First Health Group Corp. _________________________ By: _________________________ Joseph E. Whitters Edward L. Wristen Date: ___________________ Title: President & Chief Executive Officer Date: _______________________ EX-10.30 4 exh10-30.txt AMENDMENT TO EMPLOYMENT AGREEMENT EXHIBIT 10.30 FIRST AMENDMENT TO THE EMPLOYMENT AGREEMENT, DATED AS OF JANUARY 1, 2001, BETWEEN FIRST HEALTH GROUP CORP. AND EDWARD L. WRISTEN THIS AMENDMENT is made and entered into as of the 31st day of December, 2003 (the "Effective Date"), by and between First Health Group Corp. ("First Health") and Edward L. Wristen (the "Colleague"). WHEREAS, First Health and Colleague have previously entered into a certain EMPLOYMENT AGREEMENT, dated as of January 1, 2001, under which First Health employs Colleague (the "Agreement"); and WHEREAS, First Health and Colleague desire to amend the Agreement to memorialize the parties' agreement to extend the term of the Agreement to March 31, 2004. NOW, THEREFORE, in consideration of the mutual covenants set forth herein and in the Agreement, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. As of the Effective Date, Section 3(e) of the Agreement is hereby deleted and replaced in its entirety with the following: 3. Term. The term of Employee's employment under this Agreement shall commence on January 1, 2001 and shall terminate on March 31, 2004 unless otherwise terminated in accordance with the terms hereof. 2. The parties ratify and affirm the Agreement and agree that it is valid as amended herein. This Amendment will prevail over any conflict with the Agreement. IN WITNESS WHEREOF the duly authorized representatives of the parties have executed this Amendment effective on the day and year first written above. Colleague: First Health Group Corp. _____________________________ By: _____________________________________ Name: Edward L. Wristen James C. Smith, Chairman of the Board Date: _______________________ Date: ____________________________________ EX-10.31 5 exh10-31.txt AMENDMENT TO EMPLOYMENT AGREEMENT EXHIBIT 10.31 SECOND AMENDMENT TO EMPLOYMENT AGREEMENT DATED MAY 1, 1999, BETWEEN FIRST HEALTH GROUP CORP. AND PATRICK G. DILLS THIS AMENDMENT is entered into this 10th day of January 2002 ("Amendment Effective Date") by and between First Health Group Corp. ("Company") and Patrick G. Dills ("Employee"). WHEREAS, Company and Employee have previously entered into a certain Employment Agreement, dated May 1, 1999 ("Agreement"), amended February 1, 2000; and WHEREAS, Company and Employee desire to amend the Agreement with respect to term and time commitment. NOW, THEREFORE, in consideration of the initial covenants and agreements set forth herein and in the Agreement, the parties agree as follows: 1. Section 2 Term is deleted and replaced with the following: Term. Beginning on the Effective Date of the Agreement, the Initial Term of this Agreement will be through December 31, 2003, and will automatically renew, unless earlier terminated pursuant to Section 6 hereof. 2. Section 4 Time Commitment is amended by the addition of the following phrase to the second sentence of the Section: "; provided, however, that after March 31, 2003, Employee may request a reduction in his time commitment with an appropriate adjustment to compensation, which request will be given reasonable consideration by Company." IN WITNESS WHEREOF, the parties hereto have executed this Second Amendment to the Employment Agreement, in the State of Illinois, as of the date and year first above written. The Company: First Health Group Corp. By: _______________________ Its: President and Chief Executive Officer Employee: ____________________________ Patrick G. Dills EX-11 6 exh11.txt COMPUTATION OF EARNINGS PER SHARE Exhibit 11 First Health Group Corp. Computation of Diluted Earnings Per Common Share (In 000's except per share amounts) Year Ended December 31, ----------------------- 2001 2002 2003 ------- ------- ------- Net Income $102,920 $132,938 $152,734 ======= ======= ======= Weighted average number of common shares outstanding: Shares outstanding from beginning of period 96,408 100,023 98,676 Purchase of treasury stock -- (1,043) (4,985) Other issuances of common stock 1,925 1,717 1,192 Common share equivalents: Assumed exercise of common stock options 4,722 3,561 2,316 ------- ------- ------- Weighted average common and common share equivalents 103,055 104,258 97,199 ======= ======= ======= Net income per share $ 1.00 $ 1.28 $ 1.57 ======= ======= ======= First Health Group Corp. Computation of Basic Earnings Per Common Share (In 000's except per share amounts) Year Ended December 31, ----------------------- 2001 2002 2003 ------- ------- ------- Net Income $102,920 $132,938 $152,734 ======= ======= ======= Weighted average number of common shares outstanding: Shares outstanding from beginning of period 96,408 100,023 98,676 Purchase of treasury stock -- (1,043) (4,985) Other issuances of common stock 1,925 1,717 1,192 ------- ------- ------- Weighted average common and common share equivalents 98,333 100,697 94,883 ======= ======= ======= Net income per share $ 1.05 $ 1.32 $ 1.61 ======= ======= ======= EX-13 7 exh13.txt 2003 ANNUAL REPORT EXHIBIT 13 Selected Financial Data ----------------------- Years Ended December 31, (in thousands except per share data) 1999 2000 2001 2002 2003 -------------------------------------------------------------------------------------- Statement of operations data: Revenues $ 458,493 $ 506,741 $ 593,108 $ 759,966 $ 890,926 -------------------------------------------------------------------------------------- Operating expenses: Cost of services 215,480 225,783 261,985 336,094 401,335 Selling and marketing 45,588 48,377 58,416 77,878 92,977 General and administrative 36,549 34,201 39,598 55,057 66,104 Health care benefits 6,192 13,044 13,293 15,455 21,462 Depreciation and amortization 29,445 38,389 46,527 56,077 63,033 -------------------------------------------------------------------------------------- Total operating expenses 333,254 359,794 419,819 540,561 644,911 -------------------------------------------------------------------------------------- Income from operations 125,239 146,947 173,289 219,405 246,015 -------------------------------------------------------------------------------------- Nonoperating expenses (income): Interest income (6,293) (6,639) (6,844) (6,698) (5,928) Interest expense 15,017 14,731 7,152 5,454 5,586 -------------------------------------------------------------------------------------- Income before income taxes 116,515 138,855 172,981 220,649 246,357 Income taxes (47,218) (56,236) (70,061) (87,711) (93,623) -------------------------------------------------------------------------------------- Net income $ 69,297 $ 82,619 $102,920 $132,938 $152,734 -------------------------------------------------------------------------------------- Weighted average shares outstanding-basic(1) 100,540 95,698 98,333 100,697 94,883 Net income per common share-basic(1) $ .69 $ .86 $ 1.05 $ 1.32 $ 1.61 -------------------------------------------------------------------------------------- Weighted average shares outstanding-diluted(1) 102,006 99,740 103,055 104,258 97,199 Net income per common share-diluted(1) $ .68 $ .83 $ 1.00 $ 1.28 $ 1.57 -------------------------------------------------------------------------------------- Balance sheet data: -------------------------------------------------------------------------------------- Cash and investments $ 128,596 $127,582 $137,353 $152,712 $139,729 Working capital 31,425 40,270 (159,130) 1,199 24,121 Total assets 488,734 491,596 780,734 843,361 977,411 Total liabilities (excluding debt) 162,002 182,683 243,935 309,215 328,933 Debt outstanding 240,000 127,500 197,500 120,000 270,000 Stockholders' equity $ 86,732 $181,413 $339,299 $414,146 $378,478 -------------------------------------------------------------------------------------- (1) All historical common share data have been adjusted for a 2-for-1 stock split in the form of a 100% stock distribution paid on June 25, 2001 to stockholders of record on June 4, 2001.
Management's Discussion and Analysis ------------------------------------ of Financial Condition and Results of Operations ------------------------------------------------ This Management's Discussion and Analysis of Financial Condition and Results of Operations may include certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including (without limitation) statements with respect to anticipated future operating and financial performance, growth and acquisition opportunities and other similar forecasts and statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "could" and "should" and variations of these words and similar expressions, are intended to identify these forward-looking statements. Forward-looking statements made by the Company and its management are based on estimates, projections, beliefs and assumptions of management at the time of such statements and are not guarantees of future performance. The Company disclaims any obligation to update or revise any forward-looking statement based on the occurrence of future events, the receipt of new information or otherwise. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements made by the Company and its management as a result of a number of risks, uncertainties and assumptions. Representative examples of these factors include (without limitation) general industry and economic conditions; interest rate trends; cost of capital and capital requirements; competition from other managed care companies; customer contract cancellations; the ability to expand certain areas of the Company's business; shifts in customer demands; changes in operating expenses including employee wages, benefits and medical inflation; governmental and public policy changes and the continued availability of financing in the amounts and on the terms necessary to support the Company's future business. In addition, if the Company does not continue to successfully implement new contracts and programs and control health care benefit expenses; or if the Company does not successfully integrate the recently completed acquisitions of Health Net Employer Services and PPO Oklahoma (discussed below); then the Company may not achieve its anticipated 2004 financial results. Significant Developments. Overview. The following information concerning significant business developments is important to understanding the comparability of the 2003, 2002 and 2001 financial results. Mail Handlers Benefit Plan. The Company assumed the responsibility for supporting the Mail Handlers Benefit Plan (the "Plan"), including claims administration for the Plan, effective July 1, 2002. Prior to that date, the Plan purchased only PPO services from the Company. Consequently, 2003 results include a full year of PPO plus Administration Service business for the Plan while 2002 results include six months of PPO service only and six months of PPO plus Administration Service business for the Plan. The Plan is the Company's largest customer with revenues earned of approximately $236 million (27% of total Company revenue) during the year ended December 31, 2003 compared with $160 million in revenues earned during the year ended December 31, 2002 (21% of total revenue) and $75 million in revenues earned during the year ended December 31, 2001 (13% of total revenue). Revenues from the Plan are recorded net of a reserve established by the Company for various contingencies associated with the potential disallowance of certain expenses charged to the Plan. In addition, the provisions of the contract with the Plan's sponsor, the National Postal Mail Handlers Union, require that the Company fund any deficits in the Plan after the Plan's reserves have been fully utilized. As of December 31, 2003, the Plan has approximately $346 million in reserves to cover Plan expenses that may exceed the premiums charged and collected from the Plan participants by the Plan sponsor. There are no known Plan deficits as of December 31, 2003. Health Net Acquisition. On October 31, 2003, the Company completed the acquisition of all of the outstanding shares of capital stock of Health Net Employer Services, Inc. ("Health Net") from Health Net, Inc. for approximately $79 million. The purchase also included Health Net Plus Managed Care Services, Inc. and Health Net CompAmerica, Inc. Health Net Employer Services, Inc. is a workers' compensation managed care company based in Irvine, California. The acquisition was financed with borrowings under the Company's credit facility. PPO Oklahoma Acquisition. On October 31, 2003, the Company completed the acquisition of PPO Oklahoma for a purchase price of $10 million, subject to certain purchase price considerations. PPO Oklahoma operates almost exclusively in the state of Oklahoma. The acquisition was financed with borrowings under the Company's credit facility. CCN Acquisition. On August 16, 2001, the Company completed the acquisition of all of the outstanding shares of capital stock of CCN Managed Care, Inc. ("CCN") and Preferred Works, Inc. ("PW" and together with CCN, the "CCN Companies") from HCA - The Healthcare Company and VH Holdings, Inc. for a purchase price of approximately $198 million. The acquisition was financed from borrowings under the Company's line of credit. The integration of the CCN operations was substantially completed by December 31, 2003. HCVM Acquisition. On May 1, 2002, the Company completed the acquisition of HealthCare Value Management ("HCVM") for an initial purchase price of approximately $24 million plus $6.5 million paid in 2003 based on financial performance measures that HCVM met. The acquisition was financed from borrowings under the Company's line of credit. The integration of the HCVM operations was substantially completed by December 31, 2002. Consolidated Results of Operations. The following table presents the Company's sources of revenues and percentages of those revenues represented by certain statement of operations items. Years Ended December 31, ------------------------------------------------------------------------------ Sources of revenue: ($ in thousands): 2001 % 2002 % 2003 % ------------------------------------------------------------------------------ Commercial Revenue: Group Health PPO plus Admin Services $ 131,205 22 $ 239,800 32 $ 375,664 42 PPO 200,497 34 210,846 28 153,511 17 Premiums 14,672 2 15,541 2 21,560 3 -------- --- -------- --- -------- --- Total Group Health 346,374 58 466,187 62 550,735 62 -------- --- -------- --- -------- --- Workers' Compensation PPO Plus Admin Services 90,297 15 106,363 14 105,325 12 PPO 40,429 7 54,961 7 62,785 7 -------- --- -------- --- -------- --- Total Workers' Compensation 130,726 22 161,324 21 168,110 19 -------- --- -------- --- -------- --- Total Commercial Revenue 477,100 80 627,511 83 718,845 81 -------- --- -------- --- -------- --- Public Sector Revenue 116,008 20 132,455 17 172,081 19 -------- --- -------- --- -------- --- Total Revenue $ 593,108 100 $ 759,966 100 $ 890,926 100 ======== === ======== === ======== === Years Ended December 31, ------------------------------------------------------------------------ Percent of revenue: 2001 2002 2003 ------------------------------------------------------------------------ Expenses: Cost of services 44% 44% 45% Selling and marketing 10 10 11 General and administrative 7 7 8 Health care benefits 2 2 3 Depreciation and amortization 8 8 7 Interest income (1) (1) (1) Interest expense 1 1 1 ------------------------------------------------------------------------ Subtotal 71 71 72 ------------------------------------------------------------------------ Income before income taxes 29 29 28 ------------------------------------------------------------------------ Net income 17% 17% 17% ------------------------------------------------------------------------ Revenues. The Company's revenues consist primarily of fees for cost management services provided on a predetermined contractual basis or on a percentage-of-savings basis. Revenues also include premium revenue from the Company's insurance company operations. Effective January 1, 2003, the Company is reporting revenue in a new format which includes Group Health and Workers' Compensation revenue (which together make up the Commercial Business) and Public Sector revenue. The Group Health business is further broken down into PPO Services, PPO plus Administration Services and Premium revenue. The Workers' Compensation business is further broken down into PPO Services and PPO plus Administration Services. There is no premium revenue in the Workers' Compensation business. PPO Services is where the Company provides its national PPO network to clients without any other services. PPO plus Administration Services is where the Company provides PPO in addition to other services such as claims administration, health plan administration, fee schedule, front end, first report of injury, pharmacy benefit management and/or disease management. Total revenues increased $131.0 million (17%) from 2002 to 2003 and increased $166.9 million (28%) from 2001 to 2002. The increase in revenues from 2002 to 2003 is due primarily to a full year of revenue associated with the administration of the Plan compared to six months of Plan administration revenue in 2002. The increase in revenue from 2001 to 2002 was due primarily to six months of revenue from the administration of the Plan compared to PPO revenue only in 2001. Group Health revenue increased $84.5 million (18%) from 2002 to 2003 and $119.8 million (35%) from 2001 to 2002. Group Health revenue represents revenue from the corporate, Federal Employees Health Benefits Programs, small group carrier and third party administrator payors. PPO plus Administration Services revenue increased $135.9 million (57%) from 2002 to 2003 and $108.6 million (83%) from 2001 to 2002. This increase is due to new-client activity ($11 million in 2003) and existing clients utilizing more services, principally Mail Handlers ($123 million of the increase in 2003). Group Health PPO services decreased $57.3 million (27%) from 2002 to 2003 as clients, especially Mail Handlers, are taking advantage of a wider array of the Company's services. PPO services increased $10.3 million (5%) from 2001 to 2002 due primarily to new clients. Premium revenue increased $6.0 million (39%) from 2002 to 2003 and $0.9 million (6%) from 2001 to 2002 due to new-client activity. Workers' Compensation revenue increased $6.8 million (4%) from 2002 to 2003 due primarily to $11 million in revenues earned from the acquisition of Health Net, which offset the loss of some historic workers' compensation clients that have exited various markets. Workers' Compensation revenue increased $30.6 million (23%) from 2001 to 2002 due primarily to numerous new clients. Public Sector revenue increased $39.6 million (30%) from 2002 to 2003 and $16.4 million (14%) from 2001 to 2002. Public Sector revenue represents fees associated with pharmacy benefit management, fiscal agent services and health care management from clients within the public sector. The $39.6 million increase from 2002 to 2003 is due primarily to new clients, such as the State of Nevada, one-time HIPAA support implementations and fees associated with pharmacy programs. The $16.4 million increase in Public Sector revenue from 2001 to 2002 was due primarily to new-client relationships. Cost of Services. Cost of services increased $65.2 million (19%) from 2002 to 2003 due primarily to operating costs associated with the increased Public Sector revenue ($21 million of the increase), the inclusion of a full year of costs associated with the administration of the Plan in 2003 compared to six months in 2002 ($30 million of the increase) and $7 million in costs for Health Net. Cost of services increased $74.1 million (28%) from 2001 to 2002 due primarily to the inclusion of CCN costs ($20 million) and the costs associated with the administration of the Plan ($37 million). Cost of services consists primarily of salaries and related costs for personnel involved in claims administration, PPO administration, development and expansion, clinical management programs, fee schedule, information technology and other cost management and administrative services offered by the Company. To a lesser extent, it includes telephone expenses, facility expenses and information processing costs. Cost of services as a percent of revenue increased from 44% in 2001 and 2002 to 45% in 2003 as clients are utilizing more of the Company's lower margin services. Selling and Marketing. Selling and marketing expenses increased $15.1 million (19%) from 2002 to 2003 due primarily to costs associated with the administration of the Plan and to increased marketing efforts to increase the enrollment in the Plan. Selling and marketing expenses increased $19.5 million (33%) from 2001 to 2002 due primarily to increased expenditures for the Company's national marketing campaign ($4 million) and to the addition of CCN costs ($6 million). As a percentage of revenues, selling and marketing expenses have remained between 10% and 11% from 2001 to 2003. General and Administrative. General and administrative expenses increased $11.0 million (20%) from 2002 to 2003 due to the inclusion of a full year of costs associated with the administration of the Plan ($1 million) as well as increases in professional liability insurance ($3 million) and other professional fees ($2 million). General and administrative expenses increased $15.5 million (39%) from 2001 to 2002 due primarily to the inclusion of CCN costs ($3 million) and costs associated with the administration of the Plan ($9 million). Health Care Benefits. Health care benefit expenses increased $6.0 million (39%) from 2002 to 2003 and $2.2 million (16%) from 2001 to 2002. These expenses represent medical losses incurred by insureds of the Company's insurance entities. The medical loss ratio (health care benefits as a percent of premiums) was 91% for 2001, 99% for 2002 and 100% for 2003. The Company's insurance business is small and volatile, so the loss ratio is somewhat unpredictable. Management continues to review the book of business in detail to minimize the loss ratio. Stop-loss insurance is related to the PPO and claims administration businesses and is used as a way to attract additional PPO business, which is the Company's most profitable product. Income from Operations. Income from operations was $246.0 million in 2003 compared to $219.4 million in 2002 and $173.3 million in 2001. The increase from 2001 to 2003 was due to the significant growth in the Company's revenues. Operating margin (Income from Operations as a percent of revenue) was 28% in 2003, 29% in 2002 and 29% in 2001. The decline in the operating margin from 2002 to 2003 was due primarily to the significant growth in the lower margin Public Sector business and a change in the mix of services toward lower margin claims administration services. Depreciation and Amortization. Depreciation and amortization expenses increased $7.0 million (12%) from 2002 to 2003 and $9.6 million (21%) from 2001 to 2002. These expenses increased from 2001 to 2003 principally as a result of the significant infrastructure investments made over the past several years and, to a lesser extent, amortization of intangible assets related to the various acquisitions the Company has made. As a percentage of revenues, these costs decreased from 8% in 2001 and 2002 to 7% in 2003. Depreciation expense will continue to grow primarily as a result of continuing investments the Company is making in its infrastructure. The increase was partially offset by the reduction in goodwill amortization of $5.0 million in 2002 due to the adoption of Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets" (see Note 1 to the consolidated financial statements). Interest Income. Interest income decreased $0.8 million (11%) from 2002 to 2003 and $0.1 million (2%) from 2001 to 2002. Interest income represented 1% of revenues in 2001, 2002 and 2003. Interest income has remained fairly constant as the Company has used much of its available cash to repay debt and repurchase its common stock. Interest Expense. Interest expense increased $0.1 million (2%) from 2002 to 2003 due to the borrowings related to the Health Net and PPO Oklahoma acquisitions. Interest expense decreased $1.7 million (24%) from 2001 to 2002 due primarily to the debt repayment the Company has made with its available cash. Interest expense represents interest incurred on the Company's revolving credit agreement. The floating interest rate incurred was between 2.5% and 7% from 2001 to 2003. Income Taxes. Income taxes were provided at an effective rate of approximately 38% in 2003 compared to 40% in 2002 and 2001. The Company lowered its effective tax rate in 2003 due to changes in its cost of performance structure used for state tax calculation. The reduction was done in the third quarter, as the full state tax effect was determined with the filing of various state tax returns. The higher than statutory rate for the three years includes provisions for state income taxes and expenses that are not deductible for income tax purposes. Segment Information. The Company is now reporting under two segments: the Commercial segment where the Company provides its health benefit services to Commercial customers in the Group Health and Workers' Compensation markets and the Public Sector segment where the Company services are provided to customers within the public sector. Management believes this presentation better reflects how the Company markets and sells its products and services. In the Commercial sector, the Company often bundles its products and services to offer a comprehensive health benefits solution and it does not sell administrative services (claims administration, bill review, PBM, clinical management, etc.) on a stand-alone basis without PPO network services. In the Public Sector, the Company offers products and services more specialized to the needs of the individual customer as public sector health programs move toward more efficient utilization of health services. Commercial (in thousands except %) 2001 2002 2003 ----------------------- -------- -------- -------- Revenues $ 477,100 $ 627,511 $ 718,845 Operating expenses 304,175 410,130 482,615 -------- -------- -------- Income from operations 172,925 217,381 236,230 Operating margin 36% 35% 33% Interest income (6,844) (6,698) (5,928) Interest expense 7,138 5,417 5,560 -------- -------- -------- Income before income taxes 172,631 218,662 236,598 Income taxes (69,919) (86,921) (89,915) -------- -------- -------- Net income $ 102,712 $ 131,741 $ 146,683 ======== ======== ======== The increase in income from operations and net income for the Commercial segment from 2001 to 2003 is due to the significant growth in revenue combined with operating efficiencies achieved from the CCN acquisition. Operating margin, however, has declined from 36% in 2001 to 35% in 2002 to 33% in 2003. This decrease is due primarily to clients taking advantage of a full array of the Company's services (rather than PPO services only), principally Mail Handlers. Depreciation and amortization expenses have increased significantly from 2001 to 2003 due to the continuing investments the Company is making in its infrastructure. Public Sector (in thousands except %) 2001 2002 2003 -------- -------- -------- Revenues $116,008 $ 132,455 $ 172,081 Operating expenses 115,644 130,431 162,296 -------- -------- -------- Income from operations 364 2,024 9,785 Operating margin 0% 2% 6% Interest expense 14 37 26 -------- -------- -------- Income before income taxes 350 1,987 9,759 Income taxes (142) (790) (3,708) -------- -------- -------- Net income $ 208 $ 1,197 $ 6,051 ======== ======== ======== The increase in income from operations and net income for the Public Sector segment from 2001 to 2003 is due to significant revenue growth, particularly in nonrecurring revenue items in 2003. Operating margin increased to 6% in 2003 from 2% in 2002 and 0% in 2001 as the Company has seen gradual improvement in the efficiency of its Public Sector business, particularly in its fiscal agent services. Seasonality. The Company has historically experienced increases in salaries and related costs during its first and fourth calendar quarters in anticipation of an increase in the number of new participants in client- sponsored health care plans. Since group health care plans typically offer an open enrollment period for new participants during December or January of each year, the Company anticipates that its future first and fourth quarters will continue to reflect similar cost increases. The Company's future earnings could be adversely affected if the Company were to incur costs in excess of those necessary to service the actual number of new participants resulting from the open enrollment. Inflation. Although inflation has not had a significant effect on the Company's operations to date, management believes that the rate at which health care costs have increased has contributed to the demand for PPO, clinical cost management and other cost management services, including the services provided by the Company. Other Information. There continues to be discussion of health care reform. Although specific features of any legislation that ultimately may be enacted into law cannot be predicted at this time, based on the Company's review of legislation previously considered by Congress and various state legislatures, management believes that the Company's existing programs and those under development provide a foundation that will help prevent any material adverse affect on the operations of the Company. Liquidity and Capital Resources. The Company had positive working capital of $24.1 million at December 31, 2003 compared to positive working capital of $1.2 million at December 31, 2002 and negative working capital of $159.1 million at December 31, 2001. All of the Company's outstanding debt at December 31, 2001 was classified as a current liability as the Company's credit facility was due to expire on June 30, 2002. On April 23, 2002, the Company obtained a new credit facility that matures in 2007; consequently, the outstanding debt is now classified as long-term. Total cash and investments of the Company amounted to $139.7 million at December 31, 2003, $152.7 million at December 31, 2002 and $137.4 million at December 31, 2001. The Company generated $209.4 million of cash from operating activities during the year ended December 31, 2003 compared with $277.5 million in 2002 and $151.3 million in 2001. The operating cash generated in 2002 was unusually high due to nonrecurring cash collections from clients and a change in the timing of income tax payments. The Company's most significant source of cash is its accounts receivable collections. Accounts receivable balances will generally increase from year- to-year as the Company's revenues increase. Since revenues have grown substantially over the past several years, the cash collected has grown substantially as well. Management believes the Company revenues will continue to grow, so the operating cash generated will continue to grow as well. The Company has historically generated a substantial amount of cash from the issuance of common stock from stock option exercises. Any decrease in future cash generated from common stock issuance, however, is not expected to have a material effect on the Company's ability to fund operations or future expansion plans. The Company's most significant uses of cash are for payment of operating expenses, income taxes and capital expenditures. The Company's earnings margins (net income as a percent of revenues) have historically been in excess of 17%, so cash generated from operations has been more than sufficient to cover those needs. The Company has historically invested 8-10% of its revenues in capital expenditures, and management expects this level of investment will continue. The Company has a revolving line of credit in the amount of $400 million which is due to expire on April 23, 2007. The facility has a five-year term and provides for interest at a Euro-dollar rate (which approximates LIBOR) plus a variable margin and a facility fee that fluctuate based on the Company's debt rating. The Company has used this credit facility to fund acquisitions and common stock repurchases. As of December 31, 2003, $270 million was outstanding under the credit facility. The following table summarizes the contractual obligations the Company has outstanding as of December 31, 2003: (In thousands) Payments due by period --------------------------------------------------- Contractual Less than 1-3 3-5 Over Obligations Total 1 year years years 5 years ----------- -------- ------- ------- ------- ------ Long-term debt $ 270,000 $ - $ - $270,000 $ - Operating leases 55,967 14,591 21,142 13,163 7,071 Purchase obligations 1,000 1,000 - - - -------- ------- ------- ------- ------ Total $ 326,967 $ 15,591 $ 21,142 $283,163 $ 7,071 ======== ======= ======= ======= ====== The purchase obligation is a commitment to a limited partnership investment. The Company has no capital lease obligations or other contractual obligations as of December 31, 2003. The Company believes that its working capital, long-term investments, credit facility and cash generated from future operations will be sufficient to fund the Company's operations and anticipated expansion plans. Company Stock Options. The Company maintains employee and director stock option plans that provide for the granting of options to employees, directors and consultants of the Company and its subsidiaries to purchase common stock at or above the fair market value at date of grant. The Company has granted stock options to all employees meeting certain defined performance requirements annually since 1988. Management believes this plan has been invaluable in finding, attracting, retaining and providing incentive to employees by offering them an ownership interest in the Company. The Company elected the disclosure-only provisions of SFAS No. 123, as amended by SFAS No. 148. The Company continues to account for its employee and director stock compensation under the intrinsic value method in accordance with APB No. 25. Market Risk. Market risk is the risk that the Company will incur losses due to adverse changes in interest rates and prices. The Company's market risk exposure is limited to the $65.0 million and $69.2 million of marketable securities owned by the Company at December 31, 2003 and 2002, respectively, and the $270 million and $120 million of variable rate debt owed by the Company at December 31, 2003 and 2002, respectively. The Company does not hold any market risk-sensitive instruments for trading purposes. The Company has established policies and procedures to manage sensitivity to interest rate and market risk. These procedures include the monitoring of the Company's level of exposure to each market risk and the use of derivative financial instruments to reduce risk. The Company's marketable equity and debt securities are classified as available for sale and are recorded in the consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of other comprehensive income (loss) in stockholders' equity, net of applicable deferred taxes. As of December 31, 2003, the fair value of the Company's marketable securities was $65.0 million, consisting of $64.9 million invested in debt securities and $0.1 million invested in equity securities. As of December 31, 2002, the fair value of the Company's marketable securities was $69.2 million, consisting of $64.9 million invested in debt securities and $4.3 million invested in equity securities. The Company measures its interest rate risk by estimating the net amount by which potential future net earnings would be impacted by hypothetical changes in market interest rates related to all interest rate sensitive assets and liabilities, including derivative financial instruments. Assuming a hypothetical 20% increase in interest rates as of December 31, 2003, the estimated reduction in future earnings, net of tax, would be less than $1.0 million. Assuming the same 20% increase in interest rates as of December 31, 2002, the estimated reduction in future earnings, net of tax, would also have been less than $1.0 million. Equity price risk arises when the Company could incur economic losses due to adverse changes in a particular stock index or price. The Company's investments in equity securities are exposed to equity price risk and the fair value of the portfolio is correlated to the S&P 500. At December 31, 2003, management estimates that an immediate 10% decrease in the S&P 500 would result in a negligible decrease in the fair value of its equity securities. Management estimated that a 10% decrease in the S&P 500 at December 31, 2002 would have affected the fair value of its equity securities by less than $1.0 million. Critical Accounting Policies. The consolidated financial statements are prepared with accounting principles generally accepted in the United States of America and include amounts based on management's prudent judgments and estimates. Management believes that any reasonable deviation from those judgments and estimates would not have a material impact on the Company's financial position or results of operations. However, to the extent that the estimates used differ from actual results, adjustments to the statement of operations and the balance sheet would be necessary. Some of the more significant estimates include the recognition of revenue, allowance for doubtful accounts and insurance claim reserves. The Company uses the following techniques to determine estimates: Revenue recognition - Significant estimates used in recognizing revenue relate to performance guarantees, other client-specific claim, eligibility and other data adjustments and recoverability of receivables. Adjustments to PPO savings, and, therefore, PPO revenues, occur due to client corrections of member eligibility data as originally submitted or due to certain clients' inability to resubmit claim adjustments to the Company's repricing system. This enables the Company to report PPO fee revenue more accurately until information is available to support our entitlement to these fees, net of actual adjustments. Revenue adjustments are estimated on a client- specific and aggregated basis using actual, historical adjustment data. Reserves recorded for such matters were $36.5 million, $41.2 million and $18.2 million in 2003, 2002 and 2001, respectively. Total adjustments to revenue amounted to less than 3% of revenues in each year presented. The increase from 2001 to 2003 relates to the Company's business with the Plan discussed above. Allowance for doubtful accounts - The Company provides reserves for uncollectible revenue due to client collectibility issues as an allowance for doubtful accounts. The primary reason for non-payment of these accounts receivable is due to client bankruptcy, insolvency or disputes over eligibility. The methodology for calculating the allowance for doubtful accounts includes an assessment of specific receivables that are aged and an assessment of the aging of the total receivable pool. Substantially all of the Public Sector revenue is received from state and local governments. The Company's experience with recovering receivables related to Public Sector revenue is impacted primarily by contract disputes, changes in administrative personnel and the timing of fiscal appropriations relative to the billing of our services. The reserving methodology for Public Sector receivables provides for a longer collection period compared to Group Health and Workers' Compensation receivables. The Company evaluates the recoverability of Public Sector receivables based on the aging of receivables, with additional consideration given to clients with known fiscal appropriation issues. The allowance for doubtful accounts totaled $21.1 million, $14.8 million and $14.3 million at December 31, 2003, 2002 and 2001, respectively. The increase in 2003 primarily related to reserves recorded for the Health Net acquisition. Insurance claim reserves - Claims reserves are developed based on medical claims payment history adjusted for specific benefit plan elements (such as deductibles) and expected savings generated by utilization of The First Health[R] Network. Based upon this process, management believes that the insurance claims reserves are appropriate; however, actual claims incurred and actual settlement values of claims may differ from the original estimates requiring adjustments to the reserves. Derivative Financial Instruments. As discussed in Note 14 to the consolidated financial statements, the Company may use derivative financial instruments to reduce interest rate risk and potentially increase the return on invested funds and to manage the cost of its common stock repurchase programs. Investments in derivative financial instruments are approved by the Board of Directors of the Company. The Company has an investment in a limited liability company, accounted for under the equity method of accounting, which uses interest rate swaps to reduce interest rate risk. The Company has recorded its equity portion of the unrealized loss on these derivatives as other comprehensive income in its Consolidated Balance Sheet and Consolidated Statement of Comprehensive Income in 2003. The Company has no other derivatives outstanding at December 31, 2003. HIPAA Administrative Simplification. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") directed the Department of Health and Human Services ("HHS") to issue regulations setting standards for the electronic exchange of health care claims information among health care providers, payors, and plans ("EDI"), as well as security for the exchange of information via the internet ("e-commerce"). This directive is commonly referred to as HIPAA Administrative Simplification. HHS has issued several rules with various implementation dates between 2002 and 2005. The Company has met and management anticipates the Company will meet all the current and future implementation dates and continues to monitor HHS activity for future decisions that may affect the Company's business operations. The Company instituted a corporate HIPAA Administrative Simplification Committee and Workgroup to identify processes, systems or policies that will require modification and to implement appropriate remediation and contingency plans to avoid any adverse impact on its ability to perform services in accordance with the applicable standards. The Company also communicated with significant third-party business partners to assess their readiness and the extent to which the Company needed to modify its relationship with these third parties when conducting EDI (Electronic Data Interchange) or e-commerce. The Company also formed a Security Committee and Workgroup to address electronic security, specifically, HIPAA security requirements. The cost for this compliance effort was approximately $5 million. Additionally, the Company received reimbursement directly from a number of its clients due to the nature of the contractual arrangement with these entities. New Accounting Pronouncements. Effective January 1, 2003, the Company adopted SFAS No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, or other exit or disposal activity. The adoption of SFAS 146 had no impact on the Company's financial position, results of operations or cash flows. Effective January 1, 2003, the Company adopted Interpretation No. 45, ("FIN 45") "Guarantees, Including Indirect Guarantees of Indebtedness to Others," which expands previously issued accounting guidance and disclosure requirements for certain guarantees. FIN 45 requires the Company to disclose certain guarantees, including contractual indemnifications, it has assumed. The Company generally declines to provide indemnification to its customers. In limited circumstances, to secure long-term customer contracts at favorable rates, the Company may negotiate risk allocation through mutual indemnification provisions that, in the Company's judgment, appropriately allocate risk relative to the value of the customer. Management believes that any liability under these indemnification provisions would not be material. The adoption of FIN 45 had no impact on the Company's financial position, results of operations or cash flows. Effective July 1, 2003, the Company adopted SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The adoption of SFAS 150 had no impact on the Company's financial position, results of operations or cash flows. Commitments and Contingencies. The Company and its subsidiaries are subject to various claims arising in the ordinary course of business and are parties to various legal proceedings that constitute litigation incidental to the business of the Company and its subsidiaries. The Company does not believe that the outcome of such matters will have a material effect on the Company's financial position or results of operations. Independent Auditors' Report ---------------------------- Board of Directors and Stockholders, First Health Group Corp. Downers Grove, Illinois We have audited the consolidated balance sheets of First Health Group Corp. and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, of comprehensive income, of cash flows and of stockholders' equity for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of First Health Group Corp. and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and intangible assets to conform to Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." Deloitte & Touche LLP Chicago, Illinois March 8, 2004 Report by Management -------------------- Management is responsible for the preparation and integrity of the consolidated financial statements and financial comments appearing in this annual report. The financial statements were prepared in accordance with accounting principles generally accepted in the United States of America and include certain amounts based on management's best estimates and judgments. Other financial information presented in the annual report is consistent with the financial statements. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that transactions are executed as authorized and are recorded and reported properly. This system of controls is based upon written policies and procedures, appropriate divisions of responsibility and authority, and careful selection and training of personnel. Policies and procedures prescribe that the Company and all employees are to maintain the highest ethical standards and that business practices are to be conducted in a manner which is above reproach. Deloitte & Touche LLP, independent auditors, has audited the Company's consolidated financial statements and its report is presented herein. Management has made available to Deloitte & Touche LLP all the Company's financial records and related data, as well as the minutes of the Board of Directors' meetings. Management believes that all representations made to Deloitte & Touche LLP during its audit were valid and appropriate. The Board of Directors has an Audit Committee composed solely of outside Directors. The independent auditors have direct access to the Audit Committee and periodically meet with the Audit Committee to discuss accounting, auditing and financial reporting matters. First Health Group Corp. Downers Grove, Illinois March 8, 2004 Consolidated Balance Sheets --------------------------- (in thousands, except share amounts) December 31, Assets 2002 2003 ------------------------------------------------------------------------- Current assets: Cash and cash equivalents $ 20,852 $ 8,047 Short-term investments 1,304 1,973 Accounts receivable, less allowances for doubtful accounts of $14,782 and $21,073, respectively 69,981 102,895 Deferred taxes 35,255 26,790 Other current assets 16,183 37,318 ------------------------------------------------------------------------- Total current assets 143,575 177,023 ------------------------------------------------------------------------- Long-term investments: Marketable securities 67,880 62,994 Other 62,676 66,715 ------------------------------------------------------------------------- Total long-term investments 130,556 129,709 ------------------------------------------------------------------------- Property and equipment: Land, building and improvements 97,826 103,088 Computer equipment and software 222,796 281,495 Office furniture and equipment 34,518 37,910 ------------------------------------------------------------------------- 355,140 422,493 Less accumulated depreciation and amortization (149,637) (186,603) ------------------------------------------------------------------------- Total property and equipment, net 205,503 235,890 ------------------------------------------------------------------------- Goodwill 279,447 324,335 Intangible assets, less accumulated amortization of $4,541 and $9,250, respectively 54,086 82,615 Reinsurance recoverable 26,185 24,331 Other assets 4,009 3,508 ------------------------------------------------------------------------- $ 843,361 $ 977,411 ------------------------------------------------------------------------- December 31, Liabilities and Stockholders' Equity 2002 2003 ------------------------------------------------------------------------- Current liabilities: Accounts payable $ 50,841 $ 73,261 Accrued expenses 53,535 47,778 Claims reserves 14,235 23,797 Income taxes payable 23,765 8,066 ------------------------------------------------------------------------- Total current liabilities 142,376 152,902 ------------------------------------------------------------------------- Long-term debt 120,000 270,000 Claims reserves 26,185 24,331 Deferred taxes 114,692 126,474 Other noncurrent liabilities 25,962 25,226 ------------------------------------------------------------------------- Total liabilities 429,215 598,933 ------------------------------------------------------------------------- Commitments and contingencies - - Stockholders' equity: Preferred stock, par value $1.00; authorized 1,000,000 shares; none issued - - Common stock, par value $.01; authorized 155,000,000 shares; issued and outstanding 134,491,000 and 136,475,000 shares, respectively 1,344 1,365 Additional paid-in capital 304,663 335,548 Retained earnings 518,960 671,981 Accumulated other comprehensive income 764 (1,726) Treasury stock, at cost; 35,815,000 and 45,403,000 shares, respectively (411,585) (628,690) ------------------------------------------------------------------------- Total stockholders' equity 414,146 378,478 ------------------------------------------------------------------------- $ 843,361 $ 977,411 ------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. Consolidated Statements of Operations ------------------------------------- (in thousands, except share amounts) Years Ended December 31, 2001 2002 2003 ----------------------------------------------------------------------------- Revenues $ 593,108 $ 759,966 $ 890,926 ----------------------------------------------------------------------------- Operating expenses: Cost of services 261,985 336,094 401,335 Selling and marketing 58,416 77,878 92,977 General and administrative 39,598 55,057 66,104 Health care benefits 13,293 15,455 21,462 Depreciation and amortization 46,527 56,077 63,033 ----------------------------------------------------------------------------- Total operating expenses 419,819 540,561 644,911 ----------------------------------------------------------------------------- Income from operations 173,289 219,405 246,015 ----------------------------------------------------------------------------- Nonoperating expenses (income): Interest income (6,844) (6,698) (5,928) Interest expense 7,152 5,454 5,586 ----------------------------------------------------------------------------- Income before income taxes 172,981 220,649 246,357 Income taxes (70,061) (87,711) (93,623) ----------------------------------------------------------------------------- Net income $ 102,920 $ 132,938 $ 152,734 ----------------------------------------------------------------------------- Weighted average shares outstanding-basic 98,333 100,697 94,883 ----------------------------------------------------------------------------- Net income per common share-basic $ 1.05 $ 1.32 $ 1.61 ----------------------------------------------------------------------------- Weighted average shares outstanding-diluted 103,055 104,258 97,199 ----------------------------------------------------------------------------- Net income per common share-diluted $ 1.00 $ 1.28 $ 1.57 ----------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. Consolidated Statements of Comprehensive Income ----------------------------------------------- (in thousands) Years Ended December 31, 2001 2002 2003 ----------------------------------------------------------------------------- Net income $ 102,920 $ 132,938 $ 152,734 Other comprehensive income, before tax: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period 3,125 989 (1,882) Less: reclassification adjustment for gains (losses) included in net income (479) (35) 1,529 Unrealized losses on limited partnership derivatives -- -- (3,460) ----------------------------------------------------------------------------- Other comprehensive income (loss), before tax 2,646 954 (3,813) Income tax benefit (expense) related to items of other comprehensive income (976) (351) 1,323 ----------------------------------------------------------------------------- Other comprehensive income (loss) 1,670 603 (2,490) ----------------------------------------------------------------------------- Comprehensive income $ 104,590 $ 133,541 $ 150,244 ----------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. Consolidated Statements of Cash Flows ------------------------------------- (in thousands) Years Ended December 31, 2001 2002 2003 ----------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 102,920 $ 132,938 $ 152,734 Adjustments to reconcile net income to net cash provided by operating activities: Change in provision for uncollectible accounts receivable (487) 3,455 (144) Depreciation and amortization 46,527 56,077 63,033 Provision for deferred income taxes 26,858 10,448 27,677 Tax benefits from stock options exercised 16,634 16,521 8,920 Income from limited partnership (2,851) (3,096) (3,031) Other, net 1,262 299 362 Changes in assets and liabilities (net of effects of acquired businesses): Accounts receivable (10,764) 13,495 (21,688) Other current assets (10,401) 4,920 (20,999) Reinsurance recoverable 2,075 (45) 1,854 Accounts payable and accrued expenses (16,337) 13,833 8,047 Claims reserves (2,780) 1,972 7,708 Income taxes payable - 23,698 (16,299) Noncurrent assets and liabilities (1,308) 3,016 1,270 ----------------------------------------------------------------------------- Net cash provided by operating activities 151,348 277,531 209,444 ----------------------------------------------------------------------------- Cash flows from investing activities: Acquisition of businesses, net of cash acquired (198,645) (42,959) (91,981) Purchases of investments (50,233) (80,269) (50,418) Sales or maturities of investments 35,985 75,923 49,872 Assets held for sale 9,000 923 -- Purchases of property and equipment (63,654) (71,583) (84,801) ----------------------------------------------------------------------------- Net cash used in investing activities (267,547) (117,965) (177,328) ----------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of long-term debt 215,000 240,000 317,000 Principal payments of long-term debt (145,000) (317,500) (167,000) Purchase of treasury stock - (109,322) (216,605) Stock option loans to employees (1,739) (2,272) -- Stock option loan repayments 1,594 3,761 287 Proceeds from issuance of common stock 36,807 32,243 21,397 Proceeds from sales of put options on common stock - 375 -- ----------------------------------------------------------------------------- Net cash provided by (used in) financing activities 106,662 (152,715) (44,921) ----------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (9,537) 6,851 (12,805) Cash and cash equivalents, beginning of period 23,538 14,001 20,852 ----------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 14,001 $ 20,852 $ 8,047 ----------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. Years Ended December 31, 2001 2002 2003 ----------------------------------------------------------------------------- Supplemental cash flow data: Acquisition of businesses: Fair value of assets acquired, net of cash acquired $ 41,893 $ 10,686 $ 16,335 Goodwill 166,865 28,042 46,388 Intangible assets 43,814 14,813 33,238 Fair value of liabilities assumed (53,927) (7,513) (3,980) Future payments on acquisition - (3,069) -- ----------------------------------------------------------------------------- Net cash paid $ 198,645 $ 42,959 $ 91,981 ----------------------------------------------------------------------------- Stock options exercised in exchange for common stock $ - $ 66 $ 500 Health care benefits paid (15,369) (14,748) (20,905) Interest paid (7,713) (5,087) (4,925) Interest income received 4,571 3,587 3,088 Income taxes paid, net (38,493) (29,461) (73,283) See Notes to Consolidated Financial Statements. Consolidated Statements Of Stockholders' Equity ----------------------------------------------- (in thousands) Accumulated Common Stock Additional Other Treasury Stock ------------ Paid-In Retained Comprehensive ------------------ Shares Amount Capital Earnings Income (loss) Shares Amount ---------------------------------------------------------------------------------------------------------------- Balance, January 1, 2001 79,501 $ 795 $ 252,092 $ 534,428 $ (1,509) 31,298 $(604,393) 2-for-1 stock split Effective June 25, 2001 48,203 482 (50,008) (252,670) - - 302,196 Issuance of common stock through stock option and purchase plans 3,616 36 36,771 - - - - Tax benefit related to stock options exercised - - 16,634 - - - - Change in unrealized holding gain on marketable securities, net of tax - - - - 1,670 - - Loans granted to employees to exercise stock options - - - (1,739) - - - Repayment of employee stock option loans - - - 1,594 - - - Net income - - - 102,920 - - - ---------------------------------------------------------------------------------------------------------------- Balance, December 31, 2001 131,320 $1,313 $ 255,489 $ 384,533 $ 161 31,298 $(302,197) Issuance of common stock through stock option and purchase plans 3,171 31 32,278 - - - - Purchase of treasury stock - - - - - 4,517 (109,388) Tax benefit related to stock options exercised - - 16,521 - - - - Change in unrealized holding gain on marketable securities, net of tax - - - - 603 - - Sale of put options on common stock - - 375 - - - - Loans granted to employees to exercise stock options - - - (2,272) - - - Repayment of employee stock option loans - - - 3,761 - - - Net Income - - - 132,938 - - - ---------------------------------------------------------------------------------------------------------------- Balance, December 31, 2002 134,491 $1,344 $ 304,663 $ 518,960 $ 764 35,815 $(411,585) Issuance of common stock through stock option and purchase plans 1,984 21 21,876 - - - - Purchase of treasury stock - - - - - 9,588 (217,105) Tax benefit related to stock options exercised - - 8,920 - - - - Change in unrealized loss on limited partnership derivatives - - - - (2,243) - - Change in unrealized holding gain on marketable securities, net of tax - - - - (247) - - Compensation expense for option grants, net of tax - - 89 - - - - Repayment of employee stock option loans - - - 287 - - - Net income - - - 152,734 - - - ---------------------------------------------------------------------------------------------------------------- Balance, December 31, 2003 136,475 $1,365 $ 335,548 $ 671,981 $ (1,726) 45,403 $(628,690) ---------------------------------------------------------------------------------------------------------------- See Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies: The Company: First Health Group Corp. ("the Company") is a full-service national health benefits services company. The Company specializes in providing large payors with integrated managed care solutions. The Company is a unique national managed care company serving the group health, workers' compensation and state agency markets. Principles of consolidation: The financial statements include the accounts of the Company and its wholly owned subsidiaries. Material intercompany balances and transactions have been eliminated. Use of estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and cash equivalents and investments: Cash and cash equivalents are defined as all highly liquid investments with original maturities of three months or less at date of purchase. Investments with maturities between three months and 12 months, equity investments and other investments needed for current cash requirements are classified as short-term investments. All remaining investments are classified as long-term. Investments, which are classified as available-for- sale securities, are reported at fair value. The fair value of marketable securities is estimated based on quoted market prices, when available. If a quoted price is not available, fair value is estimated using quoted market prices for similar financial instruments. The difference between amortized cost and fair value is recorded as an adjustment to accumulated other comprehensive income, net of applicable deferred taxes. Realized gains and losses from sales of investments are based upon the specific identification method. Property and equipment: Property and equipment are stated at cost. Expenditures for the maintenance and repair of property and equipment are charged to expense as incurred. Expenditures for major replacement or betterment are capitalized. In accordance with AICPA Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," certain internal payroll and payroll-related costs are capitalized during the application development stage of a project and depreciated over the computer software's useful life. The Company capitalized approximately $10.2 million of such internal costs during 2003, $8.1 million of such costs during 2002 and $5.3 million of such costs during 2001 that would have otherwise been expensed. In accordance with SOP 98-1, the Company also capitalizes external consulting costs related to software development. The total of the internal and external costs are considered work-in-progress until the software is put into use. Computer equipment and software includes approximately $21.3 million of work-in-progress as of December 31, 2003 related to internally developed software programs. There were approximately $16.6 million of such work-in-progress amounts as of December 31, 2002. The Company recorded amortization expense related to developed software in the amount of $23.0 million, $21.8 million and $13.5 million in 2003, 2002 and 2001, respectively. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method. These lives range from 5 years to 31.5 years for buildings and improvements, 1.5 years to 5 years for computer equipment and software and 3 years to 5 years for office furniture and equipment. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the term of the lease. Long-lived assets: The carrying amount of all long-lived assets is evaluated periodically to determine if adjustment to the depreciation and amortization period or to the unamortized balance is warranted. Such evaluation is based principally on the expected utilization of the long-lived assets and the projected, undiscounted cash flows of the operations in which the long-lived assets are deployed. Fair value of financial instruments: The carrying amounts for cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of their fair value. The fair value of marketable securities and investments is discussed in Note 4 to the consolidated financial statements. The carrying value of long-term debt is a reasonable estimate of its fair value as amounts are borrowed at current market rates. Revenue recognition: The Company's proprietary, national PPO network, The First Health[R] Network, includes hospitals, physicians and other health care providers that offer services at prenegotiated rates to health care payors. PPO services are provided at varying fee structures to our clients based on specific contractual arrangements. PPO revenues are earned based on either a percentage of savings in medical costs achieved by our clients when their covered participants utilize our national network of health care providers or on a per-employee, per-month basis (capitated basis). Percentage of savings revenue is determined using the difference between charges billed by contracted medical providers and the contracted reimbursement rates for the services billed. Contracted rates are specified in our contracts and are maintained in the Company's claims repricing systems. The Company recognizes revenue, on a contractual basis per client, as a portion of savings achieved (the difference between provider billings and provider reimbursement). Revenue for claims administrative services is recognized based on a contractual per-member, per-month rate using client-provided enrollment data. This rate is based on a number of factors including the number of participants, length of contract, products selected and services purchased. Revenue for fee schedule services is recognized on a per-transaction basis. Revenue for clinical management services is recognized either on a capitated basis or on a time and material basis. In a limited number of cases, contracts include performance guarantees. Performance guarantees are client specific and are of two basic types: administrative guarantees and financial guarantees. Administrative guarantees relate to an obligation to meet certain claims administration metrics agreed to by the client and First Health such as telephonic response time for member calls and claim payment turnaround. If these contractual metrics are not met, there are certain penalties that apply. Penalties paid by the Company for failure to meet certain performance guarantees were less than $50,000 in each of the years between 2001 and 2003. Financial guarantees take various forms including, among others, achieving an annual aggregate savings threshold, achieving a targeted level of savings per-member, per-month or achieving overall network penetration in defined demographic markets. Only 25 client contracts include performance guarantees. Negative revenue adjustments related to performance guarantees are recorded in the quarter they are known. Positive revenue adjustments related to performance guarantees are recorded in the quarter they are billed to the client. Performance guarantees are structured and measured annually. Guarantees in subsequent years can be recalculated to protect the Company from unforeseen changes in the various parameters used in calculating performance guarantees. Other adjustments to PPO revenues are recorded related to member eligibility and other client resubmission of repricing information. Adjustments to revenue are recorded on a client-specific and aggregated basis based on empirical adjustment data. In addition, an allowance for doubtful accounts is recorded based on an evaluation of client-specific financial risks and aging of receivables. Total accounts receivable reserves were $57.6 million, $56.0 million and $32.5 million as of December 31, 2003, 2002 and 2001, respectively, and are netted against the gross accounts receivable balance in the consolidated balance sheets. Insurance operations: Claims Reserves - Claims reserves include traditional life insurance, such as whole life insurance, term life insurance, stop-loss insurance and accident and health insurance, as well as universal life insurance policies and annuity contracts that do not have significant mortality or morbidity risk. A substantial portion of life insurance reserves represents business ceded to National Farmers Union Life Insurance Company ("National Farmers"). Stop-loss reserves and accident and health reserves are established based on medical claims payment history adjusted for specific benefit plan elements (such as deductibles) and expected savings generated by utilization of the First Health[R] Network. Reinsurance Recoverable - Reinsurance recoverable represents the amount due from other insurance companies as a result of the cession of a portion of the Company's insurance risk to such companies. Reinsurance recoverable is divided between current amounts ($1.4 million and $14.5 million as of December 31, 2002 and 2003, respectively) and noncurrent amounts ($26.2 million and $24.3 million as of December 31, 2002 and 2003, respectively). The current portion has increased significantly as the Company has entered into several new ceding arrangements in its small group insurance business. The current amounts are included in the "Other current assets" line on the consolidated balance sheets. The noncurrent portion is all due from National Farmers in a prior business arrangement. Net income per common share: Net income per common share-basic is based on the weighted average number of common shares outstanding during the period. Net income per common share-diluted is based on the weighted average number of common shares and common share equivalents outstanding during the period. In calculating earnings per share, earnings are the same for the basic and diluted calculations. Weighted average shares outstanding increased for diluted earnings per share by 4,722,000, 3,561,000 and 2,316,000 for 2001, 2002 and 2003, respectively, due to the effect of stock options. Diluted net income per share was lower than basic by $0.05 for 2001 and by $0.04 for 2002 and 2003 as a result of the increased weighted average shares outstanding due to the effect of stock options. All historical common share data have been adjusted for a 2-for-1 stock split in the form of a 100% stock distribution paid on June 25, 2001, to stockholders of record on June 4, 2001. Treasury shares were not split. However, an adjustment was made to the stockholders' equity section of the Consolidated Balance Sheet to split the cost of treasury stock (in effect, a cancellation of treasury shares by reducing paid-in-capital and retained earnings). New Accounting Pronouncements: In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which the Company adopted effective January 1, 2002. SFAS 142 specifies that goodwill and certain intangible assets will not be amortized but rather are subject to periodic impairment testing. Consequently, goodwill acquired in business combinations completed before July 1, 2001, was amortized through December 31, 2001. Goodwill acquired in business combinations subsequent to July 1, 2001 has not been amortized. The following table reflects the effect of SFAS 142 on net income and earnings per share as if SFAS 142 had been in effect for all periods presented: (in thousands, Years ended December 31, except per share amounts) 2001 2002 2003 ------------------------- ------- ------- ------- Net income $102,920 $132,938 $152,734 Add back goodwill amortization 4,986 -- -- ------- ------- ------- Adjusted net income $107,906 $132,938 $152,734 ======= ======= ======= Basic net income per share: Reported net income per share $ 1.05 $ 1.32 $ 1.61 Goodwill amortization .05 -- -- ------- ------- ------- Adjusted net income per share $ 1.10 $ 1.32 $ 1.61 ======= ======= ======= Diluted net income per share: Reported net income per share $ 1.00 $ 1.28 $ 1.57 Goodwill amortization .05 -- -- ------- ------- ------- Adjusted net income per share $ 1.05 $ 1.28 $ 1.57 ======= ======= ======= Effective January 1, 2003, the Company adopted SFAS No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal Activities," which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, or other exit or disposal activity. The adoption of SFAS 146 had no impact on the Company's financial position, results of operations or cash flows. Effective January 1, 2003, the Company adopted SFAS No. 148 ("SFAS 148"), "Accounting for Stock Based Compensation - Transition and Disclosure," which amends SFAS No. 123 ("SFAS 123"), "Accounting for Stock Based Compensation." The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees." No stock-based employee compensation cost is reflected in net income as all options granted under those plans had an exercise price at least equal to the market value of the stock at date of grant. As permitted by SFAS 123, and amended by SFAS 148, the Company follows the disclosure requirements only of SFAS 123 and SFAS 148. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123. (in thousands, except per share amounts) 2001 2002 2003 ------------------------- ------- ------- ------- Net Income: $102,920 $132,938 $152,734 Add: Stock-based employee -- -- 89 compensation expense included in reported net income net of related tax effects. Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards net of related tax effect. (9,815) (15,173) (12,717) ------- ------- ------- Pro forma net income $ 93,105 $117,765 $140,106 ======= ======= ======= Earnings per share-basic As reported $ 1.05 $ 1.32 $ 1.61 Pro forma $ .95 $ 1.17 $ 1.48 Earnings per share-diluted As reported $ 1.00 $ 1.28 $ 1.57 Pro forma $ .91 $ 1.13 $ 1.44 Effective July 1, 2003, the Company adopted SFAS No. 150 ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity," which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The adoption of SFAS 150 had no impact on the Company's financial position, results of operations or cash flows. 2. Acquisitions: On August 16, 2001, the Company completed the acquisition of all of the outstanding shares of capital stock of CCN Managed Care, Inc. ("CCN") and Preferred Works, Inc. ("PW" and together with CCN, the "CCN Companies") from HCA-The Healthcare Company and VH Holdings, Inc. (collectively, the "Sellers") for a purchase price of $195 million in cash, plus a working capital adjustment that increased the purchase price to approximately $198 million. The acquisition was accounted for by the purchase method of accounting. The integration of the CCN operations was substantially completed by December 31, 2003. The allocation of the purchase price to the fair value of assets acquired and liabilities assumed was as follows: (Dollars in thousands) ---------------------- Purchase price $195,000 Working capital adjustment 3,514 Transaction costs 2,000 ------- Total purchase price $200,514 ------- Purchase price has been allocated as follows: Fair value of tangible assets acquired $ 33,471 Assets held for sale 9,965 Goodwill 161,697 Intangible assets 43,814 Liabilities assumed (22,275) Liability for restructuring and integration costs (26,158) ------- $200,514 ------- The following unaudited pro forma information reflects the results of the Company's operations as if the acquisition had occurred at the beginning of 2001 adjusted for (i) the effect of recurring charges related to the acquisition, primarily the amortization of intangible assets over estimated useful lives of 15 or 20 years, as appropriate, and the recording of interest expense on borrowings to finance the acquisition; (ii) the reduction of depreciation expense due to the write-down to fair value of fixed assets, the elimination of amortization expense related to the CCN Companies' preexisting goodwill at the date of acquisition and the elimination of compensation and benefit expenses for certain executives of the CCN Companies who were terminated at or immediately subsequent to the acquisition and were not replaced, and (iii) the removal of revenues and related cost of services and expenses for acquired businesses that were held for sale. (in thousands except per share data) Year ended December 31, 2001 Pro forma: ----------------- Revenue $655,455 Net income 103,564 Net income per common share - basic 1.05 Net income per common share - diluted 1.00 These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what operating results would have been had the acquisition actually taken place at the beginning of 2001, nor do they purport to represent results of future operations of the merged companies. On May 1, 2002, the Company completed the acquisition of HealthCare Value Management ("HCVM") for an initial purchase price of $24 million. The Company paid an additional $6.5 million in 2003 for contractual obligations based on financial performance measures that HCVM has met. HCVM is a New England-based PPO company, headquartered in suburban Boston. The acquisition was accounted for by the purchase method of accounting and was financed from borrowings under the Company's credit facility. The integration of the HCVM operations was substantially completed by December 31, 2002. The results of operations and assets acquired are immaterial to the consolidated financial statements of the Company. Consequently, no pro forma financial results are included herein. Purchase price has been allocated as follows: Fair value of tangible assets acquired $ 161 Goodwill 23,568 Intangible assets 5,658 Liabilities assumed (239) Liability for restructuring and integration costs (100) ------- $ 29,048 ------- On July 1, 2002, the Company acquired the stock of Claims Administration Corporation ("CAC") for a purchase price of approximately $18 million. Included in this transaction was the transfer of approximately 1,000 CAC employees and related assets that support the Mail Handlers Benefit Plan (the "Plan"). The acquisition relates to long-term contracts that the Company was awarded in April 2002 to provide its comprehensive health plan services to the Plan. The acquisition was accounted for by the purchase method of accounting and was financed with borrowings under the Company's credit facility. The results of operations and assets acquired are immaterial to the consolidated financial statements of the Company. Consequently, no pro forma financial results are included herein. Purchase price has been allocated as follows: Fair value of tangible assets acquired $ 9,111 Goodwill 4,507 Intangible assets 9,155 Liabilities assumed (5,024) Liability for restructuring and integration costs (185) ------- $ 17,564 ------- On October 31, 2003, the Company completed the acquisition of all of the outstanding shares of capital stock of Health Net Employer Services, Inc. ("Health Net") from Health Net, Inc. for approximately $79 million. The purchase also includes Health Net Plus Managed Care Services, Inc. and Health Net CompAmerica, Inc. Health Net Employer Services, Inc. is a workers' compensation managed care company based in Irvine, California. The acquisition was accounted for by the purchase method of accounting and was financed with borrowings under the Company's credit facility. The results of operations and assets acquired are immaterial to the consolidated financial statements of the Company. Consequently, no pro forma financial results are included herein. Purchase price has been allocated, on a preliminary basis, as follows: Fair value of tangible assets acquired $ 17,070 Goodwill 43,524 Intangible assets 29,512 Liabilities assumed (7,968) Liability for restructuring and integration costs (2,950) ------- $ 79,188 ------- On October 31, 2003, the Company completed the acquisition of PPO Oklahoma for a purchase price of $10 million, subject to certain purchase price considerations. PPO Oklahoma operates almost exclusively in the state of Oklahoma. The acquisition was accounted for by the purchase method of accounting and was financed with borrowings under the Company's credit facility. The results of operations and assets acquired are immaterial to the consolidated financial statements of the Company. Consequently, no pro forma financial results are included herein. Purchase price has been allocated, on a preliminary basis, as follows: Fair value of tangible assets acquired $ 622 Goodwill 6,499 Intangible assets 3,726 Liabilities assumed (172) Liability for restructuring and integration costs (350) ------- $ 10,325 ------- 3. Acquired Intangible Assets The following table summarizes the intangible asset amounts as of December 31, 2002 and 2003: As of December 31, 2002 As of December 31, 2003 Gross Gross Carrying Accumulated Carrying Accumulated (in thousands) Amount Amortization Amount Amortization -------------- ------ ------------ ------ ------------ Amortized intangible assets Customer contracts and relationships $48,700 $4,140 $78,161 $8,289 Provider contracts 9,927 401 13,704 961 ------ ----- ------ ----- Total $58,627 $4,541 $91,865 $9,250 ====== ===== ====== ===== Customer contracts and relationships represent added value to the Company's business for existing long-term contracts and long-term business relationships. Provider contracts represent additions to The First Health[R] Network that the Company has acquired. The aggregate amortization expense recorded in 2002 and 2003 was $3.6 million and $4.7 million, respectively. The estimated amortization expense for each of the years ending December 31, 2004 through 2007 is $7.3 million. The estimated amortization expense for the year ending December 31, 2008 is $6.6 million. The changes in the carrying amount of goodwill for the years ended December 31, are as follows: (in thousands) 2002 2003 -------------- -------- -------- Balance, January 1, $ 255,855 $ 279,447 Goodwill acquired during year 28,042 50,023 Other changes (4,450) (5,135) -------- -------- Balance, December 31, $ 279,447 $ 324,335 ======== ======== The goodwill acquired during 2003 represents $43.5 million acquired in the Health Net acquisition and $6.5 million acquired in the PPO Oklahoma acquisition. The other goodwill adjustments in 2003 represent a reduction of $5.2 million in tax and other liabilities related to the CCN acquisition and a $1.9 million reduction related to the finalization of the allocation of the purchase price related to the CAC and HCVM acquisitions partially offset by $2.0 million in financial performance payments made related to the HCVM acquisition. In accordance with the provisions of SFAS 142, the Company completed an annual goodwill impairment test during the third quarter of 2003. There was no impairment in goodwill amounts as a result of the annual impairment test. 4. Marketable Securities and Investments: Information related to the Company's marketable securities and investments at December 31 is as follows: 2002 2003 Amortized Fair Amortized Fair (in thousands) Cost Value Cost Value ----------------------------------------------------------------------------- United States Government securities $20,875 $21,725 $17,985 $18,387 State and municipal securities 6,616 6,858 1,516 1,541 Foreign government securities 625 531 389 394 Corporate securities 29,120 30,589 29,291 30,487 Mortgage and asset-backed securities 5,146 5,201 14,003 14,049 ----------------------------------------------------------------------------- Total debt securities 62,382 64,904 63,184 64,858 Equity securities 4,769 4,280 100 109 ----------------------------------------------------------------------------- Total $67,151 $69,184 $63,284 $64,967 Less-classified as current 1,304 1,973 ----------------------------------------------------------------------------- Classified as long-term $67,880 $62,994 ----------------------------------------------------------------------------- Gross unrealized gains and (losses) were $2,863,000 and $(830,000), respectively, at December 31, 2002, and $1,945,000 and $(263,000) respectively, at December 31, 2003. Contractual maturities of marketable debt securities at December 31 are as follows: 2002 2003 Amortized Fair Amortized Fair (in thousands) Cost Value Cost Value ----------------------------------------------------------------------------- Due in one year or less $ 1,310 $ 1,304 $ 1,848 $ 1,864 Due after one year through five years 33,385 34,689 24,767 25,662 Due after five years through ten years 7,689 8,150 7,003 7,343 Due after ten years 19,998 20,761 29,566 29,989 ----------------------------------------------------------------------------- Total debt securities $62,382 $64,904 $63,184 $64,858 ----------------------------------------------------------------------------- Gross realized gains and (losses) on sales or maturities of marketable securities were $672,000 and $(1,071,000), respectively, for the year ended December 31, 2001; $1,045,000 and $(643,000) respectively, for the year ended December 31, 2002, and $2,207,000 and $(580,000) respectively, for the year ended December 31, 2003. The following table shows the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003. Less than 12 months 12 months or more Total Fair Unrealized Fair Unrealized Fair Unrealized (in thousands) Value Losses Value Losses Value Losses --------------------------------------------------------------------------------------------- United States Government securities $1,468 $ 34 $ 241 $ 9 $1,709 $ 43 Foreign government securities 84 6 -- -- 84 6 Corporate securities 4,397 107 341 2 4,738 109 Mortgage and asset-backed securities 3,099 101 186 4 3,285 105 --------------------------------------------------------------------------------------------- Total $9,048 $ 248 $ 768 $ 15 $9,816 $ 263 ---------------------------------------------------------------------------------------------
The Company continually monitors the market values of its marketable securities to determine if any unrealized holding loss should be classified as other than a temporary impairment. Securities that have been in a continuous unrealized loss position for more than 12 months are generally written down to their fair value. All of the securities that represent the $263,000 in unrealized losses as of December 31, 2003 are considered to have immaterial and temporary declines in market value due to fluctuations in interest rates. These securities are all high-grade bonds spread over a variety of investment vehicles. Included in other long-term investments at December 31, 2001, 2002 and 2003 is an investment in a limited liability company ("LLC") which invests in equipment that is leased to third parties. The investment is accounted for on the equity method. The total investment in this LLC was $54.0 million at December 31, 2002 and $59.0 million at December 31, 2003, including $6.7 million invested during 2003. The Company's proportionate share of the partnership's income was $2.9 million in 2001, $3.1 million in 2002 and $3.0 million in 2003, and is included in interest income. This LLC recorded an unrealized loss on interest rates swaps in 2003, of which the Company recorded its equity portion of $2.2 million, net of $1.3 million in related taxes. The Company recorded this unrealized loss in its Consolidated Statement of Comprehensive Income for the year ended December 31, 2003 and as part of its accumulated comprehensive income on its Consolidated Balance Sheet as of December 31, 2003. A member of the Company's Board of Directors is associated with a group that owns approximately 90% of this partnership. The Company has between a 20% and 33% interest in each individual tranche of the partnership. 5. Reinsurance: On October 1, 1996, in anticipation of being acquired by the Company, First Health Life and Health Insurance Company, formerly known as Loyalty Life Insurance Company ("Loyalty"), entered into a reinsurance agreement whereby it ceded 100% of its life insurance and annuity contracts in force ("pre- acquisition business") to a former affiliate, National Farmers. Under the terms of the reinsurance agreement, all premiums and deposits received by Loyalty that relate to pre-acquisition business are transferred to National Farmers. Additionally, the cash and investments transferred by Loyalty to National Farmers, which support ceded insurance liabilities, are held in escrow for the benefit of Loyalty's policyholders. Premiums and policy benefits, which are not material in amount, are ceded to National Farmers and shown net of such cessions in the consolidated statements of operations. Loyalty has received approvals from the insurance regulators to transfer the pre-acquisition business. As the policyholders of each state agree to the legal replacement of Loyalty by National Farmers, Loyalty will be released from future liability for its pre-acquisition business, and that will result in the removal of such policy liabilities from the Company's consolidated balance sheets. These liabilities are included in long-term claims reserves on the Company's consolidated balance sheets. The Company also assumes and cedes reinsurance with other insurance companies in the normal course of business. Reinsurance is ceded primarily to limit losses from large exposures and to permit recovery of a portion of direct losses. The Company continues to have primary liability as the direct insurer for all ceded risks. In 2003, the Company entered into a reinsurance agreement with New England Financial ("NEF") whereby the Company ceded 80% of the premiums and related policy benefits (to a highly-rated carrier) on a new block of small group, multi-sited business. The NEF agreement substantially increased the recoverable amount at December 31, 2003. Reinsurance is assumed to increase the Company's revenues and to provide additional diversification of its insured risks. The effects of reinsurance on premiums and contract charges earned are as follows: Years Ended December 31, (in thousands) 2001 2002 2003 ------------------------------------------------------------ Life and health premiums and contract charges: Direct $18,620 $20,799 $23,259 Assumed 944 589 26,485 Ceded (4,892) (5,847) (28,184) ------------------------------------------------------------ Net $14,672 $15,541 $21,560 ------------------------------------------------------------ The recoverable amounts at December 31, 2003 include $34.1 million estimated by the Company with respect to ceded unpaid losses (including claims incurred but not reported), which are not billable until the losses are paid. Estimating amounts of reinsurance recoverable is impacted by the uncertainties involved in the establishment of loss reserves. Management believes the recoverables are appropriately established; however, the amount ultimately recoverable may vary from amounts currently recorded. 6. Claims Reserves: The Company establishes claims reserves on reported and unreported medical claims pertaining to insured losses. These reserve estimates are based on known facts and circumstances including historical trends and claims payment history adjusted for specific benefit plan elements (such as deductibles) and expected savings generated by utilization of the First Health[R] Network. The Company classifies claims reserves as either short or long-term based on whether a claim is expected to be settled within the next 12 months. The short-term reserves are composed primarily of either stop-loss or small group accident and health reserves. The long-term reserves represent the pre-acquisition business discussed in Note 5 to the consolidated financial statements. Reserve estimates are regularly reviewed and updated, using the most current information available. Any resulting adjustments, which may be material, are reflected in current operations. The following table summarizes claims reserve activity for the years ending December 31: (in thousands) 2002 2003 ----------------------------------------------------------------- Balance, beginning of year $ 38,448 $ 40,420 Less reinsurance recoverables (25,701) (26,966) ------- ------- Net balance, beginning of year 12,747 13,454 ------- ------- Incurred losses and adjustments related to: Current year 16,996 22,879 Prior years (1,541) (1,417) ------- ------- Total incurred 15,455 21,462 ------- ------- Losses and adjustments paid related to: Current year 8,769 13,672 Prior years 5,979 7,233 ------- ------- Total paid 14,748 20,905 ------- ------- Net balance, end of year 13,454 14,011 Plus reinsurance recoverables 26,966 34,117 ------- ------- Balance, end of year $ 40,420 $ 48,128 ======= ======= ----------------------------------------------------------------- Management believes that the claims reserves as of December 31, 2003 are appropriate and adequate to cover the ultimate cost of reported and unreported claims. 7. Accrued Expenses: Accrued expenses at December 31, 2002 include approximately $11. 4 million for merger-related restructuring expenses; $22.6 million for accrued salaries, wages and benefits; and $6.0 million for insurance accruals. Accrued expenses at December 31, 2003 include approximately $5.1 million for merger-related restructuring expenses; $27.0 million for accrued salaries, wages and benefits; and $5.3 million for insurance accruals. 8. Long-Term Obligations: The Company has a $400 million revolving credit facility. As of December 31, 2002 and 2003, $120 million and $270 million, respectively, was outstanding under the facility. The credit facility has a five-year term and provides for interest at a Euro-dollar rate (which approximates LIBOR) plus a variable margin that fluctuates based on the Company's debt rating. The facility also has a corresponding fee calculated at a variable rate of the available facility balance depending on the debt rating of the Company. As of December 31, 2002 and 2003, the effective marginal interest rate was approximately 3.5% and 2% per annum, respectively. No principal payments are due on this facility until its maturity. The agreement contains provisions that require the Company to maintain a specified level of net worth and comply with various financial ratios and includes, among other provisions, restrictions on investments, dividend payments, acquisitions and incurrence of additional indebtedness. At December 31, 2003, $471 million was available for dividend distributions under these provisions. The Company was in compliance with all provisions as of December 31, 2003. 9. Income Taxes: Components of the provision for income taxes are as follows: Years Ended December 31, (in thousands) 2001 2002 2003 ---------------------------------------------------------------------- Current provision: Federal $ 33,216 $ 62,497 $ 60,525 State 9,987 14,766 5,421 ---------------------------------------------------------------------- 43,203 77,263 65,946 ---------------------------------------------------------------------- Deferred provision: Federal 24,974 10,569 25,134 State 1,884 (121) 2,543 ---------------------------------------------------------------------- 26,858 10,448 27,677 ---------------------------------------------------------------------- Provision for income taxes $ 70,061 $ 87,711 $ 93,623 ---------------------------------------------------------------------- Deferred tax assets and (liabilities) comprise the following, as of December 31: (in thousands) 2002 2003 ---------------------------------------------------------------------- Current assets: Revenue adjustments $ 16,214 $ 13,213 Allowance for doubtful accounts 5,807 5,554 Vacation accrual 5,006 5,811 Purchase accounting reserves 4,743 -- Other, net 3,485 2,212 ---------------------------------------------------------------------- Total current assets 35,255 26,790 ---------------------------------------------------------------------- Noncurrent assets (liabilities): Tax benefit of limited partnership investment (67,580) (76,478) Internally developed software (25,001) (30,609) Intangible assets (17,816) (18,759) Revenue adjustments 2,360 1,900 Purchase accounting reserves (4,707) 1,940 Depreciation (1,746) (6,501) Unrealized loss on limited partnership derivatives -- 1,217 Market value adjustment (703) (597) Other, net 501 1,413 ---------------------------------------------------------------------- Total noncurrent liabilities (114,692) (126,474) ---------------------------------------------------------------------- Net deferred tax liabilities $(79,437) $(99,684) ---------------------------------------------------------------------- Income tax benefits associated with the exercise of stock options were $16,634,000 in 2001, $16,521,000 in 2002 and $8,920,000 in 2003. Such amounts are credited to additional paid-in-capital. Years Ended December 31, (in thousands) 2001 2002 2003 ---------------------------------------------------------------------- Provision for income taxes at federal statutory rate $60,545 $77,227 $86,225 State taxes, net of federal benefit 7,548 10,267 6,823 Expenses not deductible for income tax purposes 2,127 311 629 Nontaxable interest income and dividends (159) (94) (54) ---------------------------------------------------------------------- Provision for income taxes $70,061 $87,711 $93,263 ---------------------------------------------------------------------- 10. Employment Agreements: The Company has employment agreements that expire between 2004 and 2008 with certain officers and key employees. The agreements provide for, among other things, annual base salaries aggregating $2.8 million plus additional incentive compensation. The Company recorded incentive compensation to certain key officers and employees in the aggregate amount of $3,150,000, $4,100,000 and $3,250,000 in 2001, 2002 and 2003, respectively. 11. Stockholders' Equity: Employee Stock Purchase Plan: The Company maintains an Employee Stock Purchase Plan that allows employees of the Company and its subsidiaries to purchase shares of common stock on the last day of two six-month purchase periods (i.e., February 28 or 29 and August 31 of each year) at a purchase price that is 85% of the closing sale price of the shares as quoted on the NASDAQ national market on the first or last day of such purchase period, whichever is lower. A maximum of 4.0 million shares has been authorized for issuance under the plan. As of December 31, 2003, 3.5 million shares had been issued pursuant to the plan with approximately 0.2 million shares issued during each of years from 2001 to 2003. Stock options: The Company maintains an Employee Stock Option Plan that provides for the granting of options to employees and consultants of the Company and its subsidiaries to purchase common stock at a price not less than 100% of fair market value at date of grant. These grants have contractual lives that range from 5 to 10 years. The Company also maintains a Stock Option Plan that provides for the granting of options to purchase common stock at or above fair market value at date of grant to nonemployee members of its Board of Directors. These grants have a 10-year contractual life. The Company has also granted options to certain of its employees and members of its Board of Directors under individual option agreements, which expire between 2006 and 2008. The Company had extended loans to various members of management to enable them to exercise options to purchase shares of Company common stock. Each loan was secured by the common stock purchased and the Company had full recourse in the event of default. There were $0.3 million of such loans outstanding at December 31, 2002. No such loans are outstanding at December 31, 2003. Such loans were classified as an offset to stockholders' equity. The Company no longer grants these loans to executive officers. The following table summarizes changes in common stock under option plans. Years Ended December 31, 2001 2002 2003 - -------------------------------------------------------------------------------- Wtd.Avg. Wtd.Avg. Wtd.Avg. # of Exercise # of Exercise # of Exercise Shares Price Shares Price Shares Price ------------------------------------------------------------------------------- (Number of shares in thousands): Outstanding at beginning of the year 13,294 $10.34 13,378 $14.83 11,429 $17.38 Granted 3,705 26.40 1,243 26.64 1,165 26.60 Exercised (3,457) 9.97 (3,008) 9.66 (1,789) 10.00 Canceled/expired (164) 14.13 (184) 20.34 (275) 24.19 - -------------------------------------------------------------------------------- Outstanding at end of the year 13,378 14.83 11,429 17.38 10,530 19.48 - -------------------------------------------------------------------------------- Exercisable at December 31 5,331 $12.40 6,655 $14.73 6,829 $17.27 Available for grant 4,429 3,369 3,978 - -------------------------------------------------------------------------------- The following table summarizes information about stock options outstanding and exercisable at December 31, 2003: (Number of shares in thousands) Options Outstanding Options Exercisable --------------------------------------------------------------------------- Wtd. Avg. Remaining Range of Contractual Wtd. Avg. Wtd. Avg. Exercise # of Life Exercise # of Exercise Price Shares In Years Price Shares Price --------------------------------------------------------------------------- $ 1.00 to $10.00 1,942 2.25 $ 7.84 1,332 $ 7.84 $10.01 to $20.00 2,725 4.04 12.83 2,723 12.83 $20.01 to $30.00 5,863 5.18 $26.42 2,774 $26.15 The weighted average fair values at date of grant for options granted during 2001, 2002 and 2003 were $12.20, $11.69 and $9.05, respectively, and were estimated using the Black-Scholes option pricing model with the following assumptions: Years ended December 31, 2001 2002 2003 ---------------------------------------------------------------------- Risk-free interest rate 4.16% 3.35% 2.59% Dividend yield - - - Expected volatility 47.37% 45.62% 40.29% Expected life in years 1 to 7 1 to 7 1 to 7 Treasury Stock: In 2002, the Company's Board of Directors approved the repurchase of up to 10 million shares of the Company's outstanding common stock. In 2003, the Board approved a new authorization to repurchase up to an additional 5 million shares of common stock. Purchases may be made from time to time depending on market conditions and other relevant factors. The Company had approximately 6.1 million shares available for repurchase under these repurchase authorizations as of December 31, 2003. The Company did not repurchase any common stock shares during 2001. During 2002, the Company repurchased 4.5 million shares of its outstanding common stock in the open market for a total cost of $109.3 million. During 2003, the Company repurchased 9.6 million shares of its outstanding common stock in the open market for a total cost of $216.6 million. The repurchased stock was recorded as treasury stock, at cost, and is available for general corporate purposes. In connection with the exercise of options to purchase 8,000 shares of common stock during 2002, a certain employee paid the exercise price by delivering to the Company approximately 2,000 shares of previously acquired stock. In connection with the exercise of options to purchase 94,000 shares of common stock during 2003, a certain employee paid the exercise price by delivering to the Company approximately 20,000 shares of previously acquired stock. Employee Benefit Plan: The Company maintains a Savings and Investment Plan that allows eligible employees to allocate up to 15% of their salary, through payroll deductions, among various mutual funds. The Company matches 85% of the employee's contribution, up to 6% of his or her salary. The cost of this plan (net of forfeitures) was $4.2 million in 2001, $5.3 million in 2002 and $7.1 million in 2003. 12. Commitments and Contingencies: The Company and its subsidiaries are subject to various claims arising in the ordinary course of business and are parties to various legal proceedings that constitute litigation incidental to the business of the Company and its subsidiaries. The Company does not believe that the outcome of such matters will have a material effect on the Company's financial position or results of operations. The Company's largest client (Mail Handlers Benefit Plan) generated revenue of approximately $236 million in 2003, or 27% of total revenues. This amount is net of a reserve established by the Company for various issues associated with the potential disallowance of certain expenses charged to the Plan. In addition, the provisions of the contract with the Plan's sponsor, the National Postal Mail Handlers Union, require that the Company fund any deficits in the Plan after the Plan's reserves have been fully utilized. As of December 31, 2003, the Plan has approximately $346 million in reserves to cover Plan expenses, which may exceed the premiums charged and collected from the Plan participants by the Plan sponsor. Management believes that these reserves are adequate to cover any Plan deficits as of December 31, 2003. There are no known Plan deficits as of December 31, 2003. Financial Interpretation No. 45, "Guarantees, Including Indirect Guarantees of Indebtedness to Others," requires the Company to disclose certain guarantees, including contractual indemnifications, it has assumed. The Company generally declines to provide indemnification to its customers. In limited circumstances, to secure long-term customer contracts at favorable rates, the Company may negotiate risk allocation through mutual indemnification provisions that, in the Company's judgment, appropriately allocate risk relative to the value of the customer. Management believes that any liability under these indemnification provisions would not be material. Leases: The Company leases office facilities under leases through 2010. At December 31, 2003, future minimum annual rental commitments, gross of $1.4 million in future income under noncancelable contractual sublease agreements, were as follows: (in thousands) ------------------------------------ Years Ending December 31, Amount ------------------------------------ 2004 $14,591 2005 12,364 2006 8,778 2007 7,505 2008 5,658 Thereafter 7,071 ------------------------------------ Total $55,967 ------------------------------------ Total rent expense, recognized under the straight-line method, was $9.9 million in 2001, $13.3 million in 2002 and $13.9 million in 2003. Agreement with EDS: The Company has an agreement (the "EDS Agreement") with Electronic Data Systems Corporation ("EDS"), primarily for the purpose of developing and jointly marketing medical and administrative cost management services to workers' compensation payors. The initial term of the EDS Agreement was scheduled to end on January 1, 2005, and has been extended to at least 2010. EDS provides data processing, electronic claims transmission and marketing support services to the Company. Fees paid by the Company to EDS for its medical cost management services are based upon a per-bill charge plus percentage of savings method. 13. Major Customers: During 2001, 2002 and 2003, the Company had one customer (Mail Handlers Benefit Plan) that accounted for 13%, 21% and 27%, respectively, of revenues. 14. Derivative Financial Instruments: The use of derivatives by the Company has not been material, although they have been used from time to time to reduce interest rate risks, potentially increase the return on invested funds and manage the cost of common stock repurchase programs. Investments in derivative financial instruments are approved by the Board of Directors of the Company. The Company invests in an LLC that uses interest rate swaps to reduce interest rate risk. The Company recorded its equity portion of the unrealized loss on these derivatives in 2003, in the amount of $2.2 million, net of $1.3 million in related taxes, in its Consolidated Statement of Comprehensive Income. The Company has no other derivatives as of December 31, 2003. 15. Segment Information: The Company operates in two segments: Commercial and Public Sector. In the Commercial segment, the Company often bundles its products and services to offer a comprehensive health benefits solution to the customer centered around the First Health[R] Network. In the Public Sector segment, the Company offers products and services more specialized to the needs of the individual customer as public sector health programs move toward more efficient utilization of health services. The Company has one executive management team who reviews and approves all strategic and resource allocations for each of the two segments. Discreet financial information is available for each of the two segments and is reviewed regularly by the chief operating decision maker. The Company calculates income from operations and net income for each segment consistent with the accounting policies for the consolidated financial statements. Interest expense for the Company's credit facility is charged solely to the Commercial segment. The Commercial segment also includes the Company's treasury, legal, tax and other similar corporate functions. Income taxes are computed using the consolidated income tax rate of the Company. Summarized segment financial information for the years ended December 31 is as follows: (in thousands except %) 2001 2002 2003 ----------------------- ------- ------- ------- Commercial Group Health revenue $346,374 $466,187 $550,735 Workers' Compensation revenue 130,726 161,324 168,110 ------- ------- ------- Total revenues $477,100 $627,511 $718,845 ------- ------- ------- Depreciation and amortization $37,958 $47,959 $53,392 Interest expense 7,138 5,417 5,560 Interest income 6,844 6,698 5,928 Income taxes 69,919 86,921 89,915 Net income 102,712 131,741 146,683 Goodwill 201,704 225,296 270,184 Equity method investments 53,054 61,937 66,715 Capital expenditures 50,613 64,346 70,986 Total assets $756,641 $807,897 $940,620 Public Sector Revenues $116,008 $132,455 $172,081 Depreciation and amortization 8,569 8,118 9,641 Interest expense 14 37 26 Income taxes 142 790 3,708 Net income 208 1,197 6,051 Goodwill 54,151 54,151 54,151 Capital expenditures 13,041 7,237 13,815 Total assets $ 24,093 $ 35,464 $ 36,791 Consolidated Group Health revenue $346,374 $466,187 $550,735 Workers' Compensation revenue 130,726 161,324 168,110 Public Sector revenue 116,008 132,455 172,081 ------- ------- ------- Total revenues $593,108 $759,966 $890,926 ------- ------- ------- Depreciation and amortization $ 46,527 $ 56,077 $ 63,033 Interest expense 7,152 5,454 5,586 Interest income 6,844 6,698 5,928 Income taxes 70,061 87,711 93,623 Net income 102,920 132,938 152,734 Goodwill 255,855 279,447 324,335 Equity method investments 53,054 61,937 66,715 Capital expenditures 63,654 71,583 84,801 Total assets $780,734 $843,361 $977,411 16. Quarterly Financial Data (Unaudited): The following is a summary of unaudited results of operations (in thousands except per share data) for the years ended December 31, 2002 and 2003. Year Ended December 31, 2002 First Second Third Fourth Quarter Quarter Quarter Quarter --------------------------------------------------------------------------- Revenue $169,361 $175,923 $204,928 $209,754 Net income $ 31,014 $ 32,484 $ 33,743 $ 35,697 Net income per common share - basic $ .31 $ .32 $ .33 $ .36 Weighted average shares outstanding - basic 100,257 101,217 101,526 100,204 Net income per common share - diluted $ .30 $ .31 $ .32 $ .35 Weighted average shares outstanding - diluted 104,443 104,735 104,972 103,342 --------------------------------------------------------------------------- Year Ended December 31, 2003 First Second Third Fourth Quarter Quarter Quarter Quarter --------------------------------------------------------------------------- Revenue $213,753 $218,651 $219,736 $238,786 Net income $ 36,841 $ 37,171 $ 40,656 $ 38,066 Net income per common share - basic $ .38 $ .39 $ .43 $ .41 Weighted average shares outstanding - basic 96,866 95,273 94,680 92,644 Net income per common share - diluted $ .37 $ .38 $ .42 $ .40 Weighted average shares outstanding - diluted 99,456 97,696 97,051 94,591 --------------------------------------------------------------------------- Corporate and Investor Information ---------------------------------- Form 10-K. The Company has filed an Annual Report on Form 10-K for the year ended December 31, 2003 with the Securities and Exchange Commission. Stockholders may obtain a copy of this report, without charge, by writing: The office of the Chief Financial Officer, First Health Group Corp., 3200 Highland Avenue, Downers Grove, IL 60515. Additionally, it is available on the Internet by accessing the Company's website at www.firsthealth.com. The Company's Code of Business Conduct can also be accessed on the Company's website. Common Stock. First Health Group Corp. common stock is quoted on the NASDAQ National Market under the symbol FHCC. The following tables show the quarterly range of high and low sales prices of the common stock during the calendar periods indicated: High Low ---------------------------------- 2002 First Quarter $26.25 $22.00 Second Quarter 30.15 23.75 Third Quarter 28.35 23.49 Fourth Quarter 29.60 20.79 ---------------------------------- 2003 First Quarter $26.25 $20.70 Second Quarter 28.80 23.01 Third Quarter 28.88 24.44 Fourth Quarter 26.97 17.90 ---------------------------------- 2004 Through March 4 $22.27 $18.95 As of March 4, 2004, the Company had 797 stockholders of record. Dividend Policy. The Company has not paid any dividends on its common stock and expects that its earnings will continue to be retained for use in the operation and expansion of its business. Independent Auditors Deloitte & Touche LLP Chicago, Illinois Corporate Counsel Latham & Watkins Chicago, Illinois Transfer Agent & Registrar The LaSalle National Bank of Chicago Chicago, Illinois EX-21 8 exh21.txt SUBSIDIARIES Exhibit 21 SUBSIDIARIES OF FIRST HEALTH GROUP CORP. First Health Strategies, Inc. First Health Insurance Services, Inc. Incorporated in Delaware Incorporated in Illinois First Health Services Corporation First Health Benefits Administrators Incorporated in Virginia Corp. Incorporated in Illinois First Health Life & Health Insurance American Life and Health Insurance Company Incorporated in Texas Company Incorporated in Missouri First Health Realty, Inc. First Health Strategies of Ohio, Inc. Incorporated in Utah Incorporated in Ohio First Health Services of Arkansas, Inc. Cambridge Life Insurance Company Incorporated in Arkansas Incorporated in Missouri CCN Managed Care, Inc. Preferred Works, Inc. Incorporated in Delaware Incorporated in Delaware First Health Services of South Carolina, First Health Strategies of Utah, Inc. Inc. Incorporated in Delaware Incorporated in Utah First Health Strategies of Texas, Inc. First Health Insurance Agency, Inc. Incorporated in Texas Incorporated in Massachusetts First Health Strategies of New Mexico, First Health Services of Tennessee, Inc. Incorporated in New Mexico Inc. Incorporated in Tennessee First Health Strategies of Pennsylvania First Health Services of Florida, Inc. Inc. Incorporated in Pennsylvania Incorporated in Delaware Midwest Benefits Corporation First Health Services of Montana, Inc. Incorporated in Michigan Incorporated in Delaware First Peer Review of Tennessee, Inc. First Peer Review of Oregon Incorporated in Delaware Incorporated in Delaware First Health Services of North First Peer Review of Michigan, Inc. Carolina, Inc. Incorporated in Delaware Incorporated in Delaware First Health Services of New York, Inc. First Peer Review of Ohio, Inc. Incorporated in Delaware Incorporated in Delaware First Peer Review of Colorado First Peer Review of Arizona, Inc. Incorporated in Delaware Incorporated in Delaware PPO Alliance Claims Administration Corp. Incorporated in California Incorporated in Maryland HealthCare Value Management, Inc. Federal Employee Plans, Inc. Incorporated in Massachusetts Incorporated in Delaware Health Net Employer Services, Inc. Health Net Plus Managed Care Services, Incorporated in California Inc. Incorporated in California Health Net Comp-America, Inc. PPO Oklahoma, Inc. Incorporated in Delaware Incorporated in Oklahoma Physicians CHOICE, LLC Winterbrook Healthcare Management II, Incorporated in Oklahoma LLC Incorporated in Texas EX-23 9 exh23.txt CONSENT EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT First Health Group Corp.: We consent to the incorporation by reference in the Registration Statements of First Health Group Corp. on Form S-8 (file numbers 333-67570, 333-67568, 333-67566, 333-57228, 333-57226, 333-68941, 333-68943, 33-26640, and 33- 62747) of our reports dated March 8, 2004 (which expressed an unqualified opinion and included an explanatory paragraph as to the Company's change in its accounting for goodwill and intangible assets in 2002), appearing in this Annual Report on Form 10-K of First Health Group Corp. for the year ended December 31, 2003. Deloitte & Touche, LLP Chicago, Illinois March 10, 2004 EX-31.1 10 exh31-1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 31.1 CERTIFICATIONS I, Edward L. Wristen, certify that: 1. I have reviewed this Annual Report on Form 10-K of First Health Group Corp.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 12, 2004 /s/ Edward L. Wristen President and Chief Executive Officer EX-31.2 11 exh31-2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICE Exhibit 31.2 CERTIFICATIONS I, Joseph E. Whitters, certify that: 1. I have reviewed this Annual Report on Form 10-K of First Health Group Corp.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 12, 2004 /s/ Joseph E. Whitters Executive Vice President, Treasurer and Chief Financial Officer EX-32.1 12 exh32-1.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of First Health Group Corp. (the "Company") on Form 10-K for the period ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Edward L. Wristen, Chief Executive Officer of the Company, do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Edward L. Wristen Edward L. Wristen President and Chief Executive Officer March 12, 2004 EX-32.2 13 exh32-2.txt CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of First Health Group Corp. (the "Company") on Form 10-K for the period ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph E. Whitters, Chief Financial Officer of the Company, do hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Joseph E. Whitters Joseph E. Whitters Executive Vice President, Treasurer and Chief Financial Officer March 12, 2004 -----END PRIVACY-ENHANCED MESSAGE-----