10-Q 1 fhg01q2b.txt QUARTERLY PERIOD ENDED JUNE 30, 2001 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 {X} QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 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. formerly HealthCare COMPARE Corp.) (Exact name of registrant as specified in its charter) Delaware 36-3307583 ------------------------------- ------------------------------------ (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 3200 Highland Avenue, Downers Grove, Illinois 60515 --------------------------------------------------- (Address of principal executive offices, Zip Code) (630) 737-7900 ------------------------------------------------ (Registrant's phone number, including area code) __________________________ (Former name, former address and former fiscal year, if changed since last report) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. The number of shares of Common Stock, par value $.01 per share, outstanding on August 3, 2001, was 99,195,199. First Health Group Corp. and Subsidiaries INDEX Part I. Financial Information Page Number ----------- Item 1. Financial Statements Consolidated Balance Sheets - Assets at June 30, 2001 and December 31, 2000 ................................... 3 Consolidated Balance Sheets - Liabilities and Stockholders' Equity at June 30, 2001 and December 31, 2000 ........... 4 Consolidated Statements of Operations for the three months ended June 30, 2001 and 2000 ............................ 5 Consolidated Statements of Operations for the six months ended June 30, 2001 and 2000 ............................ 6 Consolidated Statements of Comprehensive Income for the three months ended June 30, 2001 and 2000 ............... 7 Consolidated Statements of Comprehensive Income for the six months ended June 30, 2001 and 2000 ................. 7 Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 ............................ 8-9 Notes to Consolidated Financial Statements ................ 10-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............ 13-17 Item 3. Quantitative and Qualitative Disclosures About Market Risk .................................... 18 Part II. Other Information Item 4. Submission of Matters to a Vote of Security Holders................................ 19 Item 6. Exhibits and Reports on Form 8-K ................. 19 Signatures....................................................... 20 PART 1. Financial Information First Health Group Corp. and Subsidiaries CONSOLIDATED BALANCE SHEETS (Dollars in 000's) (Unaudited) ---------------------------------------------------------------------------- ASSETS June 30, 2001 December 31, 2000 ---------- ---------- Current Assets: Cash and cash equivalents ............ $ 12,089 $ 23,538 Short-term investments ............... 1,963 2,015 Accounts receivable, less allowances for doubtful accounts of $10,813 and $10,811 respectively........... 68,455 57,137 Deferred taxes ....................... 16,502 16,480 Other current assets ................. 12,007 14,443 --------- --------- Total current assets ................. 111,016 113,613 Long-Term Investments: Marketable securities ............... 65,433 58,242 Other ............................... 49,870 43,787 --------- --------- 115,303 102,029 --------- --------- Property and Equipment: Land, buildings and improvements..... 81,449 71,135 Computer equipment and software...... 172,803 148,846 Office furniture and equipment....... 18,877 16,597 --------- --------- 273,129 236,578 Less accumulated depreciation and amortization...................... (100,483) (80,861) --------- --------- Net property and equipment .......... 172,646 155,717 --------- --------- Goodwill, less accumulated amortization of $14,089 and $12,355, respectively. 88,241 89,975 Reinsurance recoverable................ 27,192 28,215 Other Assets........................... 1,928 2,047 --------- --------- $ 516,326 $ 491,596 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED BALANCE SHEETS (Dollars in 000's) (Unaudited) ---------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY June 30, 2001 December 31, 2000 --------- --------- Current Liabilities: Accounts payable .................... $ 30,242 $ 31,727 Accrued expenses .................... 28,185 28,603 Claims reserves ..................... 12,881 13,013 --------- --------- Total current liabilities ........... 71,308 73,343 Long-Term Debt......................... 62,500 127,500 Claims Reserves - Non-Current.......... 27,192 28,215 Deferred Taxes......................... 64,922 58,621 Other Non-Current Liabilities.......... 22,379 22,504 --------- --------- Total liabilities ................... 248,301 310,183 --------- --------- Commitments and Contingencies.......... -- -- Stockholders' Equity: Common stock ........................ 1,302 795 Additional paid-in capital .......... 288,169 252,092 Retained earnings ................... 583,413 534,428 Accumulated comprehensive loss....... (466) (1,509) Treasury stock, at cost ............. (604,393) (604,393) --------- --------- Total stockholders' equity .......... 268,025 181,413 --------- --------- $ 516,326 $ 491,596 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in 000's except per share amounts) (Unaudited) ---------------------------------------------------------------------------- Three Months Ended June 30, ------------------------- 2001 2000 --------- --------- Revenues............................ $ 138,949 $ 125,884 --------- --------- Operating expenses: Cost of services ................. 60,438 55,964 Selling and marketing ............ 13,233 11,914 General and administrative ....... 8,622 8,510 Healthcare benefits .............. 3,396 3,374 Depreciation and amortization .... 11,285 9,374 --------- --------- 96,974 89,136 --------- --------- Income from operations.............. 41,975 36,748 Other (income) expense: Interest expense ................. 1,119 4,079 Interest income .................. (1,714) (1,841) --------- --------- Income before income taxes.......... 42,570 34,510 Income taxes........................ (17,241) (13,977) --------- --------- Net income.......................... $ 25,329 $ 20,533 ========= ========= Weighted average shares outstanding - basic............... 97,765 95,940 ========= ========= Net income per common share - basic. $ .26 $ .21 ========= ========= Weighted average shares outstanding - diluted.............. 102,396 99,968 ========= ========= Net income per common share - diluted $ .25 $ .21 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in 000's except per share amounts) (Unaudited) ---------------------------------------------------------------------------- Six Months Ended June 30, ------------------------- 2001 2000 --------- --------- Revenues............................ $ 275,933 $ 248,359 --------- --------- Operating expenses: Cost of services ................. 120,175 111,399 Selling and marketing ............ 26,177 23,387 General and administrative ....... 16,992 17,235 Healthcare benefits .............. 7,099 5,733 Depreciation and amortization .... 21,887 18,487 --------- --------- 192,330 176,241 --------- --------- Income from operations.............. 83,603 72,118 Other (income) expense: Interest expense ................. 3,590 8,045 Interest income .................. (3,565) (3,398) --------- --------- Income before income taxes.......... 83,578 67,471 Income taxes........................ (33,849) (27,326) --------- --------- Net income.......................... $ 49,729 $ 40,145 ========= ========= Weighted average shares outstanding - basic............... 97,270 95,724 ========= ========= Net income per common share - basic. $ .51 $ .42 ========= ========= Weighted average shares outstanding - diluted.............. 102,034 99,544 ========= ========= Net income per common share - diluted $ .49 $ .40 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in 000's) (Unaudited) ---------------------------------------------------------------------------- Three Months Ended June 30, ------------------------- 2001 2000 --------- --------- Net income.................................. $ 25,329 $ 20,533 --------- --------- Unrealized gains on securities, before tax.. 79 859 Income tax expense related to items of other comprehensive income...................... (45) (348) --------- --------- Other comprehensive income.................. 34 511 --------- --------- Comprehensive income........................ $ 25,363 $ 21,044 ========= ========= Six Months Ended June 30, ------------------------- 2001 2000 --------- --------- Net income.................................. $ 49,729 $ 40,145 --------- --------- Unrealized gains on securities, before tax.. 1,673 2,644 Income tax expense related to items of other comprehensive income...................... (630) (1,051) --------- --------- Other comprehensive income.................. 1,043 1,593 --------- --------- Comprehensive income........................ $ 50,772 $ 41,738 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in 000's) (Unaudited) ---------------------------------------------------------------------------- Six Months Ended June 30, ------------------------- 2001 2000 --------- --------- Cash flows from operating activities: Cash received from customers ............ $ 265,706 $ 240,744 Cash paid to suppliers and employees .... (163,697) (158,465) Healthcare benefits paid ................ (8,545) (3,150) Interest income received ................ 2,613 2,755 Interest expense paid ................... (3,848) (6,718) Income taxes paid, net .................. (15,976) (3,516) --------- --------- Net cash provided by operating activities 76,253 71,650 --------- --------- Cash flows from investing activities: Purchases of investments ................ (22,711) (13,398) Sales of investments .................... 12,211 7,064 Purchase of property and equipment ...... (37,107) (23,682) --------- --------- Net cash provided by (used in) investing activities................... (47,607) (30,016) --------- --------- Cash flows from financing activities: Purchase of treasury stock .............. -- (10,938) Repayment of long-term debt ............. (65,000) (45,000) Stock option loans to employees ......... (1,500) (3,337) Stock option loan repayments ............ 756 3,547 Proceeds from issuance of common stock... 25,649 17,715 --------- --------- Net cash used in financing activities.... (40,095) (38,013) --------- --------- Net increase (decrease) in cash and cash equivalents.......................... (11,449) 3,621 Cash and cash equivalents, beginning of period...................... 23,538 35,639 --------- --------- Cash and cash equivalents, end of period... $ 12,089 $ 39,260 ========= ========= Non-cash financing activity: Stock options exercised in exchange for common stock..................... $ -- $ 8,733 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in 000's) (Unaudited) ---------------------------------------------------------------------------- Six Months Ended June 30, ------------------------- 2001 2000 --------- --------- Reconciliation of Net Income to Net Cash Provided by Operating Activities: Net Income.................................. $ 49,729 $ 40,145 --------- --------- Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and amortization .......... 21,887 18,487 Change in provision for uncollectible receivables........................... 2 (92) Tax benefit from stock options exercised 10,935 7,632 Deferred income taxes .................. 5,649 13,408 Other, net ............................. (1,024) (625) Changes in Assets and Liabilities: Accounts receivable .................... (11,320) (8,916) Other current assets ................... 2,436 (1,192) Reinsurance recoverable ................ 1,023 15,678 Accounts payable and accrued expenses... (1,903) (2,653) Claims reserves ........................ (1,155) (13,094) Income taxes payable ................... -- 2,773 Non-current assets and liabilities ..... (6) 99 --------- --------- Total adjustments ........................ 26,524 31,505 --------- --------- Net cash provided by operating activities $ 76,253 $ 71,650 ========= ========= See Notes to Consolidated Financial Statements
First Health Group Corp. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. The unaudited financial statements herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying interim financial statements have been prepared under the presumption that users of the interim financial information have either read or have access to the audited financial statements for the latest fiscal year ended December 31, 2000. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2000 audited financial statements have been omitted from these interim financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Although the Company believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these interim financial statements be read in conjunction with the financial statements and the notes thereto included in the Company's latest Annual Report on Form 10-K. 2. On May 22, 2001, the Company's Board of Directors authorized a 2-for-1 common stock split in the form of a 100% stock distribution. The stock split was paid on June 25, 2001 to stockholders of record on June 4, 2001. All historical common share amounts, per share amounts and stock option data for all periods presented have been restated to give effect to this 100% stock distribution. 3. The Company's investments in marketable securities which are classified as available for sale had a net unrealized gain in market value of $1,043,000, net of deferred income taxes, for the six month period ended June 30, 2001. The net unrealized loss as of June 30, 2001, included as a component of stockholders' equity, was $466,000, net of deferred income taxes. The Company has six separate investments in a limited partnership which invests in equipment which is leased to third parties. The total investment as of June 30, 2001 was $44.2 million and is accounted for using the equity method since the Company owns between a 20% and 25% interest in each particular tranche of the limited partnership. The Company's proportionate share of the partnership's income was $1,357,000 and $1,082,000 for the six months ended June 30, 2001 and 2000, respectively, and is included in interest income. 4. The Company's Board of Directors has approved the repurchase of up to 15 million shares of the Company's outstanding common stock under its current authorization. Purchases may be made from time to time, depending on market conditions and other relevant factors. As of June 30, 2001, approximately 5.2 million shares remain available for repurchase under the Company's current repurchase authorization. 5. Weighted average shares outstanding increased for diluted earnings per share by 4,631,000 and 4,764,000 and by 4,028,000 and 3,820,000 respectively, for the three and six months ended June 30, 2001 and 2000 due to the effect of stock options outstanding. Diluted net income per share was $.01 and $.02 less than basic net income per share for the three and six months ended June 30, 2001 due to the effect of stock options outstanding. Diluted net income per share was equal to basic net income per share for the three months ended June 30, 2000 but was $.02 less than basic income per share for the six months ended June 30, 2000 due to the effect of stock options outstanding. 6. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standard No. 133, ("SFAS No. 133), "Accounting For Derivative Instruments and Hedging Activities". SFAS No. 133 requires that all derivative instruments be recognized as either assets or liabilities in the balance sheet and that derivative instruments be measured at fair value. This statement also requires changes in the fair value of derivatives to be recorded each period in current earnings or comprehensive income depending on the intended use of the derivative. There was no material effect on the Company's results of operations or financial position as a result of the adoption of SFAS No. 133. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. 7. 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's wholly owned subsidiary, First Health Services Corporation ("Services") continues to be subject to an investigation by the District of Columbia Office of Inspector General (OIG"). In July 2000, the OIG issued a report evaluating the District of Columbia's ("the District") Medicaid program and suggesting ways to improve the program. Services, a subsidiary of the Company that was acquired in July 1997, has acted as the program's fiscal agent intermediary for 20 years. The OIG report included allegations that from 1993 to 1996, Services, in its role as fiscal agent intermediary, made erroneous Medicaid payments to providers on behalf of patients no longer eligible to receive Medicaid benefits. The Company does not believe that the claim or the investigation will have a material adverse effect on the Company's business or financial position. 8. On May 21, 2001, the Company announced that it had entered into a definitive agreement to acquire CCN Managed Care, Inc. ("CCN"), a national group health, workers' compensation and auto managed care company based in San Diego, CA from HCA- The Healthcare Company. The Company will acquire 100% of the capital stock of CCN and 100% of the capital stock of Preferred Works, Inc., a wholly owned subsidiary of CCN, for a purchase price of approximately $195 million in cash which will be financed through the Company's revolving line of credit. On July 2, 2001, the Company received a second request for information from the Department of Justice and is working closely with the Department of Justice to complete the regulatory review process. First Health Group Corp. and Subsidiaries Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Unaudited) Forward-Looking Information 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 obligations 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; 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 at 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 healthcare benefit expenses, the Company may not achieve its projected 2001 financial results (discussed below). Recent Developments On May 21, 2001, the Company announced that it had entered into a definitive agreement to acquire CCN Managed Care, Inc. ("CCN"), a national group health, workers' compensation and auto managed care company based in San Diego, CA from HCA - The Healthcare Company. The Company will acquire 100% of the capital stock of CCN and 100% of the capital stock of Preferred Works, Inc., a wholly owned subsidiary of CCN for a purchase price of approximately $195 million in cash which will be financed through the Company's revolving line of credit. On July 2, 2001, the Company received a second request for information from the Department of Justice and is working closely with the Department of Justice to complete the regulatory review process. On May 22, 2001, the Company's Board of Directors authorized a 2-for-1 common stock split in the form of a 100% stock distribution. The split was payable on June 25, 2001 to stockholders of record on June 4, 2001. All historical common share amounts, per share amounts and stock option data for all periods presented have been restated to give effect to this 100% stock distribution. Results of Operations The Company's revenues consist primarily of fees for cost management services provided under contracts on a percentage of savings basis (PPO) or on a predetermined contractual basis (claims administration, fee schedule, pharmacy benefit management and clinical management services). As a result of the Company's insurance company acquisitions, revenues also include premium revenue. The following table sets forth information with respect to the sources of the Company's revenues for the three and six months ended June 30, 2001 and 2000, respectively: Sources of Revenue ($ in thousands) Three Months Ended June 30, ----------------------------- 2001 % 2000 % ------- --- ------- --- Sources of Revenue: PPO Services $ 78,104 56% $ 67,683 54% Claims Administration 42,529 31 37,381 30 Clinical Management Services 6,824 5 8,120 6 Fee Schedule Services 7,759 5 9,743 8 Premiums, Net 3,733 3 2,714 2 Service -- -- 243 -- ------- --- ------- --- Total Revenue $138,949 100% $125,884 100% ======= === ======= === ($ in thousands) Six Months Ended June 30, ------------------------------ 2001 % 2000 % ------- --- ------- --- Sources of Revenue: PPO Services $153,815 56% $132,600 53% Claims Administration 84,074 30 74,926 30 Clinical Management Services 13,911 5 15,831 7 Fee Schedule Services 16,513 6 18,701 8 Premiums, Net 7,620 3 5,622 2 Service -- -- 679 -- ------- --- ------- --- Total Revenue $275,933 100% $248,359 100% ======= === ======= === Revenue for the three and six months ended June 30, 2001 increased $13,065,000 (10%) and $27,574,000 (11%), respectively, from the same periods of 2000 due to strong PPO revenue which increased 15% from the second quarter of 2000. The increase in PPO revenue for the three and six months ended June 30, is due to new client activity, existing clients utilizing more PPO services and the overall increase in PPO providers. Claims administration revenue increased $5,148,000 (14%) and $9,148,000 (12%) from the same periods last year due primarily to new business particularly in the commercial sector. Revenue from clinical cost management services decreased $1,296,000 (16%) and $1,920,000 (12%) for the three and six months ended June 30, 2001 from the comparable periods in 2000. This decrease is due principally to the termination of certain healthcare management contracts with various state Medicaid programs. Revenue from fee schedule services decreased $1,984,000 (20%) and $2,188,000 (12%) from the comparable periods in 2000 due to a loss of business primarily from General Motors and some smaller workers' compensation carriers who have exited the business. Premium revenue increased $1,019,000 (38%) and $1,998,000 (36%) for the three and six months ended June 30, 2001 due primarily to the addition of new stop loss insurance clients. Risk-related service revenue decreased $243,000 (100%) and $679,000 (100%) from the comparable periods of 2000 as the Company no longer offers this product. Cost of services increased $4,474,000 (8%) and $8,776,000 (8%) for the three and six months ended June 30, 2001 from the comparable periods of 2000. Cost of services consists primarily of salaries and related costs for personnel involved in claims administration, PPO administration, development and expansion, utilization management programs, fee schedule and other cost management and administrative services offered by the Company. To a lesser extent, cost of services includes telephone expenses, facility expenses and information processing costs. As a percentage of revenue, cost of services decreased to 43% and 44%, respectively, from 44% and 45% in the comparable periods last year. This decrease is due primarily to efficiencies achieved as the Company's business continues to expand. Selling and marketing costs for the three and six months ended June 30, 2001 increased $1,319,000 (11%) and $2,790,000 (12%) from the comparable periods of 2000. The increase is due primarily to increased expenditures for the Company's focused national marketing campaign which began in the first quarter of 2000 and to the addition of new sales personnel. General and administrative costs for the three and six months ended June 30, 2001 increased $112,000 (1%) and decreased $243,000 (1%) from the comparable periods of 2000. These expenditures are comparable to prior quarters and reflect the increased efficiencies achieved in the administrative operations. Healthcare benefits represent medical losses incurred by insureds of the Company's insurance entities. Healthcare benefits increased $22,000 (1%) and $1,366,000 (24%) for the three and six months ended June 30, 2001 from the comparable periods of 2000. This increase is due primarily to new client activity. The loss ratio (healthcare benefits as a percent of premiums) was 91% and 93% for the three and six months ended June 30, 2001 compared to 124% and 102% for the comparable periods of 2000. Management has reviewed its insurance business in detail and has taken appropriate action at renewal in an effort to reduce the loss ratio going forward. Depreciation and amortization expenses increased $1,911,000 (20%) and $3,400,000 (18%) for the three and six months ended June 30, 2001 from the comparable periods of 2000 due primarily to increased technology infrastructure investments made over the course of the past few years as well as various software applications which came on-line during 2000 and 2001. Depreciation expense will continue to grow primarily as a result of continuing investments the Company is making in its information technology infrastructure. Interest income for the three and six months ended June 30, 2001 is comparable to the same periods in 2000 as the Company has used much of its cash generated from operations to repay debt in 2001. Interest expense decreased $2,960,000 (73%) and $4,455,000 (55%) from the comparable periods of 2000 as the outstanding debt has decreased from $240 million at June 30, 2000 to $62.5 million at June 30, 2001. The interest rate at June 30, 2001 was approximately 5% per annum. Net income for the three and six months ended June 30, 2001, increased $4,796,000 (23%) and $9,584,000 (24%) from the comparable periods of 2000. This increase is due primarily to the increase in PPO revenue as well as increased efficiency in the Company operations and, to a lesser extent, the other factors discussed above. Diluted net income per common share for the three and six months ended June 30, 2001 increased 19% to $.25 per share and 23% to .49 per share from the comparable periods of 2000. For the three months and six months ended June 30, 2001, diluted common shares outstanding increased 2% and 3% from the comparable periods of 2000. Liquidity and Capital Resources The Company had $39,708,000 in working capital at June 30, 2001 compared with working capital of $40,270,000 at December 31, 2000. Through the first six months of the year, operating activities provided $76,253,000 of cash. Investment activities used $47,607,000 of cash representing purchases of fixed assets of $37,107,000 and net purchases of investments of $10,500,000. Financing activities used $40,095,000 of cash representing $65,000,000 in repayment of long-term debt and $744,000 in loans to employees to exercise stock options (net of $756,000 in loan repayments) partially offset by $25,649,000 in proceeds from issuance of common stock. The Company has a revolving credit agreement in the amount of $350 million. As of June 30, 2001, $62.5 million was outstanding under this facility. 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 anticipated operations and expansion plans. 2001 Outlook The Company is currently targeting revenue growth in the 10% area to approximately $560 million in 2001 (excluding any effects of the pending CCN acquisition). Diluted earnings per share (EPS) percentage growth is currently estimated to be in the 20% area to approximately $1.00 per share for the year. Revenue growth is anticipated to be led by our PPO business which is expected to grow in the mid teen area. The Company anticipates that our claims administration business will grow in the double digits area and that fee schedule revenue will decline due to a loss of business from General Motors and some small workers' compensation carriers who exited the business. See "Forward-Looking Information". New Accounting Pronouncements Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that all derivative instruments be recognized as either assets or liabilities in the balance sheet and that derivative instruments be measured at fair value. This statement also requires changes in the fair value of derivatives to be recorded each period in current earnings or comprehensive income depending on the intended use of the derivatives. There was no material effect on the Company's results of operations or financial position as a result of the adoption of SFAS No. 133. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. The Company does not believe that the adoption of SFAS 141 will have a significant impact on its financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS 142 also requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently assessing but has not yet determined the impact of SFAS 142 on its financial position and results of operations. 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's wholly owned subsidiary, First Health Services Corporation ("Services") continues to be subject to an investigation by the District of Columbia Office of Inspector General (OIG"). In July 2000, the OIG issued a report evaluating the District of Columbia's ("the District") Medicaid program and suggesting ways to improve the program. Services, a subsidiary of the Company that was acquired in July 1997, has acted as the program's fiscal agent intermediary for 20 years. The OIG report included allegations that from 1993 to 1996, Services, in it role as fiscal agent intermediary, made erroneous Medicaid payments to providers on behalf of patients no longer eligible to receive Medicaid benefits. The Company does not believe that the claim or the investigation will have a material adverse effect on the Company's business or financial position. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company's market risk exposure at June 30, 2001 is consistent with the types of market risk and amount of exposure presented in its 2000 Annual Report on Form 10-K. PART II Item 4. Submission of Matters to a Vote of Security Holders At the annual meeting of stockholders of the Company on May 22, 2001, all directors of the Company who stood for reelection were re-elected. The number of votes cast for and withheld for each director were as follows: For Withheld ---------- --------- Michael J. Boskin 39,701,133 366,835 Daniel S. Brunner 39,697,333 370,635 Robert S. Colman 39,868,028 199,940 Ronald H. Galowich 39,190,133 877,835 Harold S. Handelsman 39,697,783 370,135 Don Logan 39,871,028 196,940 Thomas J. Pritzker 39,702,333 365,635 David E. Simon 39,192,924 875,044 James C. Smith 32,993,190 7,074,778 Edward L. Wristen 39,701,085 366,883 A proposal to approve the Company's 2001 Directors' Stock Option Plan was approved with 31,556,319 shares cast for, 5,095,523 shares against and 125,210 shares abstaining. A proposal to approve the Company's 2001 Stock Option Plan was approved with 29,357,593 shares cast for, 7,277,899 shares against and 141,560 shares abstaining. A proposal to approve the performance based compensation provision of the employment agreement with the Company's President and Chief Operating Officer was approved with 35,898,785 shares cast for, 736,722 shares against and 141,495 shares abstaining. A proposal to approve the grant of four stock options to the Company's President and Chief Operating Officer was approved with 33,398,271 shares cast for, 3,226,877 shares against and 151,904 shares withheld. Item 6. Exhibits and Reports on Form 8-K Exhibits: (a) Exhibit 11 - Computation of Basic Earnings Per Common Share (b) Exhibit 11 - Computation of Diluted Earnings Per Common Share Reports on Form 8-K: The Company filed a Report on Form 8-K dated May 21, 2001 reporting under Item 5 its announcement that it had entered into a definitive agreement to acquire CCN Managed Care, Inc. from HCA-The Healthcare Company. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. First Health Group Corp. Dated: August 8, 2001 /s/James C. Smith ------------------------------------ James C. Smith Chairman and Chief Executive Officer Dated: August 8, 2001 /s/Joseph E. Whitters ------------------------------------ Joseph E. Whitters Chief Financial Officer (Principal Financial Officer)