-----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, C3nBGeJSQzXPuUhGq97BLnIPzKOO0c17qXnbmbA48IT44JKlqw3iHL30xiPMWshn Qst7KzQmJvdNH8MvmhcakA== 0000926236-04-000070.txt : 20040510 0000926236-04-000070.hdr.sgml : 20040510 20040510151408 ACCESSION NUMBER: 0000926236-04-000070 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040510 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15846 FILM NUMBER: 04792708 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-Q 1 fhg04q1.txt FORM 10Q FOR QUARTERLY PERIOD ENDED MARCH 31, 2004 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 March 31, 2004 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 (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 by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). 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 April 30, 2004, was 91,579,458. First Health Group Corp. and Subsidiaries INDEX Part I. Financial Information Page Number ----------- Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets - Assets at March 31, 2004 and December 31, 2003 ................................... 4 Consolidated Balance Sheets - Liabilities and Stockholders' Equity at March 31, 2004 and December 31, 2003........... 5 Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 ........................... 6 Consolidated Statements of Comprehensive Income for the three months ended March 31, 2004 and 2003 .............. 7 Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 ........................... 8-9 Notes to Consolidated Financial Statements ................ 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............. 16 Item 3. Quantitative and Qualitative Disclosures About Market Risk ..................................... 27 Item 4. Controls and Procedures ........................... 27 Part II. Other Information Item 1. Legal Proceedings ................................. 28 Item 2. Changes in Securities and Use of Proceeds ......... 28 Item 5. Other Information ................................. 28 Item 6. Exhibits and Reports on Form 8-K .................. 29 Signatures....................................................... 30 PART I. Financial Information First Health Group Corp. and Subsidiaries CONSOLIDATED BALANCE SHEETS (in millions) (Unaudited) ----------------------------------------------------------------------------- ASSETS March 31, December 31, 2004 2003 ------ ------ Current Assets: Cash and cash equivalents .................... $ 37.7 $ 8.0 Short-term investments ....................... 1.4 2.0 Accounts receivable, less allowances for doubtful accounts of $21.5 and $21.1, respectively.................... 111.3 102.9 Deferred income taxes ........................ 26.8 26.8 Other current assets ......................... 29.2 37.4 ------ ------ Total current assets ......................... 206.4 177.1 Long-Term Investments: Marketable securities ........................ 56.5 63.0 Other ........................................ 67.1 66.7 ------ ------ 123.6 129.7 ------ ------ Property and Equipment: Land, buildings and improvements ............. 103.5 103.1 Computer equipment and software .............. 296.0 281.5 Office furniture and equipment ............... 39.4 37.9 ------ ------ 438.9 422.5 Less accumulated depreciation and amortization............................... (203.1) (186.6) ------ ------ Net property and equipment ................... 235.8 235.9 ------ ------ Goodwill........................................ 324.3 324.3 Intangible assets, less accumulated amortization of $11.1 and $9.3, respectively............... 80.8 82.6 Reinsurance recoverable......................... 25.3 24.3 Other Assets.................................... 3.4 3.5 ------ ------ $ 999.6 $ 977.4 ====== ====== See Notes to Consolidated Financial Statements First Health Group Corp. and Subsidiaries CONSOLIDATED BALANCE SHEETS (in millions) (Unaudited) ----------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY March 31, December 31, 2004 2003 ------ ------ Current Liabilities: Accounts payable ............................. $ 74.5 $ 73.2 Accrued expenses ............................. 40.4 47.8 Claims reserves .............................. 21.1 23.8 Income taxes payable ......................... 21.5 8.1 ------ ------ Total current liabilities .................... 157.5 152.9 Long-Term Debt.................................. 250.0 270.0 Claims Reserves - Noncurrent.................... 25.2 24.3 Deferred Taxes.................................. 126.6 126.5 Other Noncurrent Liabilities.................... 25.4 25.2 ------ ------ Total liabilities ............................ 584.7 598.9 ------ ------ Commitments and Contingencies................... -- -- Stockholders' Equity: Common stock ................................. 1.4 1.4 Additional paid-in capital ................... 342.9 335.5 Retained earnings ............................ 700.8 672.0 Accumulated other comprehensive income ....... (1.5) (1.7) Treasury stock, at cost ...................... (628.7) (628.7) ------ ------ Total stockholders' equity ................... 414.9 378.5 ------ ------ $ 999.6 $ 977.4 ====== ====== See Notes to Consolidated Financial Statements First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (in millions, except per share amounts) (Unaudited) ----------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Revenues......................................... $ 218.1 $ 213.8 ------ ------ Operating expenses: Cost of services .............................. 106.4 96.2 Selling and marketing ......................... 20.9 21.0 General and administrative .................... 19.6 15.2 Healthcare benefits ........................... 6.3 5.2 Depreciation and amortization ................. 18.4 15.1 ------ ------ 171.6 152.7 ------ ------ Income from operations........................... 46.5 61.1 Nonoperating expenses (income): Interest expense .............................. 1.8 1.3 Interest income ............................... (1.7) (1.3) ------ ------ Income before income taxes....................... 46.4 61.1 Income taxes..................................... (17.6) (24.3) ------ ------ Net income....................................... $ 28.8 $ 36.8 ====== ====== Weighted average shares outstanding - basic...... 91.3 96.9 ====== ====== Net income per common share - basic.............. $ .32 $ .38 ====== ====== Weighted average shares outstanding - diluted.... 92.9 99.5 ====== ====== Net income per common share - diluted............ $ .31 $ .37 ====== ====== See Notes to Consolidated Financial Statements First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in millions) (Unaudited) ----------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Net income....................................... $ 28.8 $ 36.8 ------ ------ Unrealized gains (losses) on securities, before tax..................................... 0.3 (0.2) Income tax (expense) benefit related to items of other comprehensive income..................... (0.1) 0.1 ------ ------ Other comprehensive gain (loss).................. 0.2 (0.1) ------ ------ Comprehensive income............................. $ 29.0 $ 36.7 ====== ====== See Notes to Consolidated Financial Statements First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions) (Unaudited) ----------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Cash flows from operating activities: Net Income .................................... $ 28.8 $ 36.8 ------ ------ Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and amortization ............... 18.4 15.1 Change in allowance for uncollectible receivables ............................... .4 (0.1) Tax benefits from stock options exercised ... 1.2 3.3 Income from limited partnership ............. (0.9) (0.8) Other, net .................................. (0.4) 0.2 Changes in Assets and Liabilities (net of effects of acquired businesses): Accounts receivable ......................... (8.8) (13.9) Other current assets ........................ 8.1 (1.3) Reinsurance recoverable ..................... (0.9) 0.8 Accounts payable and accrued expenses ....... (6.1) (2.9) Claims reserves ............................. (1.8) (1.9) Income taxes payable ........................ 13.4 6.5 Non-current assets and liabilities .......... 0.3 0.5 ------ ------ Net cash provided by operating activities ..... 51.7 42.3 ------ ------ Cash flows from investing activities: Purchases of investments ...................... (9.2) (12.1) Sales of investments .......................... 17.6 12.1 Acquisition of business, net of cash acquired.. -- (3.3) Purchase of property and equipment ............ (16.5) (13.7) ------ ------ Net cash used in investing activities.......... (8.1) (17.0) ------ ------ Cash flows from financing activities: Purchase of treasury stock .................... -- (97.8) Proceeds from issuance of long-term debt ...... 30.0 95.0 Repayment of long-term debt ................... (50.0) (30.0) Proceeds from issuance of common stock ........ 6.1 9.7 Stock option loan repayments .................. -- 0.2 ------ ------ Net cash used in financing activities ......... (13.9) (22.9) ------ ------ Net increase in cash and cash equivalents ....... 29.7 2.4 Cash and cash equivalents, beginning of period... 8.0 20.8 ------ ------ Cash and cash equivalents, end of period ........ $ 37.7 $ 23.2 ====== ====== First Health Group Corp. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions) (Unaudited) ----------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Supplemental cash flow data: Stock options exercised in exchange for common stock............................... $ -- $ 0.5 Health care benefits paid........................ (8.5) (6.2) Interest paid.................................... (1.9) (1.1) Interest income received......................... 0.7 0.6 Income taxes paid, net........................... (3.0) (14.6) Acquisition of businesses: Goodwill ...................................... $ -- $ 3.3 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, 2003. Accordingly, footnote disclosures which would substantially duplicate the disclosures contained in the December 31, 2003 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. In our opinion, the accompanying unaudited consolidated financial statements contain all adjustments necessary for a fair presentation. 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 October 31, 2003, the Company completed the acquisition of all of the outstanding shares of capital stock of Health Net Employer Services, Inc. ("Employer Services"), from Health Net, Inc. for approximately $79 million. Health Net Employer Services, Inc. is being renamed First Health Employer Services, Inc. The acquisition was financed with borrowings under the Company's credit facility. The allocation of the purchase price is expected to be completed in the fourth quarter of 2004 when the liability for restructuring and integration and valuation of intangible assets is finalized. Purchase price has been allocated, on a preliminary basis, as follows (in millions): Fair value of tangible assets acquired $ 17.1 Goodwill 43.5 Intangible assets 29.5 Liabilities assumed (8.0) Liability for restructuring and integration costs (2.9) ------ $ 79.2 ====== 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. The acquisition was financed with borrowings under the Company's credit facility. The purchase price allocation is expected to be completed in the fourth quarter of 2004 when the calculation of additional purchase price considerations and the valuation of intangible assets is finalized. Purchase price has been allocated, on a preliminary basis, as follows (in millions): Fair value of tangible assets acquired $ 0.6 Goodwill 6.6 Intangible assets 3.7 Liabilities assumed (0.2) Liability for restructuring and integration costs (0.3) ------ $ 10.4 ====== 3. Acquired Intangible Assets As of March 31, 2004 As of December 31, 2003 Gross Gross Carrying Accumulated Carrying Accumulated (in millions) Amount Amortization Amount Amortization ------------- ------ ------------ ------ ------------ Amortized intangible assets Customer contracts and relationships $ 78.2 $ 9.9 $ 78.2 $ 8.3 Provider Contracts 13.7 1.2 13.7 1.0 ----- ----- ----- ----- Total $ 91.9 $ 11.1 $ 91.9 $ 9.3 ===== ===== ===== ===== 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 during the three months ended March 31, 2004 and 2003, respectively, was $1.8 million and $1.0 million. 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 three months ended March 31, are as follows: (in millions) 2004 2003 ------ ------ Balance, January 1 $ 324.3 $ 279.5 Goodwill acquired -- -- Other changes -- 3.3 ------ ------ Balance, March 31 $ 324.3 $ 282.8 ====== ====== The other goodwill adjustments in 2003 represented financial performance payments made related to the 2002 acquisition of HealthCare Value Management ("HCVM"). 4. Accounts receivable valuation allowances for client-specific items were $38.1 million and $36.5 million as of March 31, 2004 and December 31, 2003, respectively. These valuation allowances for matters such as performance guarantees and claim, eligibility and data adjustments, are netted against the gross accounts receivable balance in the consolidated balance sheets. The Company's largest client (Mail Handlers Benefit Plan) ("MHBP" or the "Plan") generated revenue of approximately $51.3 million (24% of total revenues) during the three months ended March 31, 2004 and $51.6 million during the three months ended March 31, 2003 (24% of total revenues). Revenues for the Plan are recorded net of a valuation allowance established by the Company for various issues associated with the potential disallowance of certain expenses charged to the Plan and an estimate for the disallowance of certain claims due to eligibility, coordination of benefits and other Plan provisions. 5. Allowances for doubtful accounts were $21.5 million and $21.1 million as of March 31, 2004 and December 31, 2003, respectively. The allowances for doubtful accounts are established based on historical experience, current economic circumstances and contractual arrangements and are adjusted monthly based upon updated information. 6. The Company's investments in marketable securities, which are classified as available for sale, had a net unrealized gain in market value of $0.2 million, net of deferred income taxes, for the three month period ended March 31, 2004. The net unrealized gain as of March 31, 2004, included as a component of stockholders' equity, was $0.7 million, net of deferred income taxes. The Company has eight separate investments in a limited liability company that invests in equipment that is leased to third parties. The total investment as of March 31, 2004 and December 31, 2003 was $59.4 million and $59.0 million, respectively, and is accounted for using the equity method. The Company's proportionate share of the partnership's income was $0.9 million and $0.8 million for the three months ended March 31, 2004 and 2003, respectively, and is included in interest income. The total investment recorded at March 31, 2004 and December 31, 2003 is net of an unrealized loss on interest rate swaps of $2.2 million, net of $1.3 million in related taxes, which is recorded in accumulated other comprehensive income. 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. 7. The Company's Board of Directors approved the repurchase of up to 10 million shares of the Company's outstanding common stock under a prior authorization. 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 did not repurchase any shares during the quarter ended March 31, 2004. During the quarter ended March 31, 2003, the Company repurchased 4.2 million shares on the open market for approximately $97.8 million. As of March 31, 2004, approximately 6.1 million shares remain available for repurchase under the Company's current repurchase authorization. 8. Weighted average shares outstanding increased for diluted earnings per share by 1.7 million and 2.6 million for the three months ended March 31, 2004 and 2003, respectively, due to the effect of stock options outstanding. Diluted net income per share was $.01 less than basic net income per share for both the three months ended March 31, 2004 and 2003, due to the effect of stock options outstanding. 9. Effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards 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. During the quarter ended March 31, 2004, the Company initiated a plan to terminate approximately 200 employees for a total cost of $1.4 million in termination benefits. Management believes this termination plan will save the Company in excess of $7 million in salaries and benefits in the second half of 2004 and in excess of $10 million in 2005 (primarily in cost of services in the consolidated statement of operations). The plan is expected to be completed by the third quarter of 2004 with substantially all of the termination costs being incurred in the first quarter of 2004. This termination plan is solely for the Commercial segment of the Company. The following table summarizes the termination cost activity for the three months ended March 31, 2004 (in millions): Expenses Liability Incurred Amounts As of To-Date Paid March 31, 2004 ------- ---- -------------- $1.4 $0.9 $0.5 The liability is recorded in the accrued expenses line in the consolidated balance sheet. 10. 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 these plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations. No stock-based employee compensation cost is reflected in net income (other than compensation cost for consultants), as all options granted under these plans had an exercise price at least equal to the market value of the underlying common stock on the date of grant. As permitted by SFAS 123, and amended by SFAS 148, the Company follows only the disclosure requirements 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 to all outstanding and unvested awards in each period: (in millions except EPS) Three Months Ended March 31, ------------------------ ---------------------------- 2004 2003 ------ ------ Net income, as reported $ 28.8 $ 36.8 Add: Stock-based employee compensation expense included in reported net income, net of related tax effects. -- 0.1 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (2.9) (2.9) ------ ------ Pro forma net income $ 25.9 $ 34.0 ====== ====== Earnings per share: Basic, as reported $ .32 $ .38 Basic, pro forma $ .28 $ .35 Diluted, as reported $ .31 $ .37 Diluted, pro forma $ .28 $ .34 11. 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, results of operations or cash flows. 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 March 31, 2004, the Plan has approximately $405 million in reserves to cover Plan expenses, which may exceed the premiums charged and collected from the Plan participants by the Plan sponsor. There are no known Plan deficits as of March 31, 2004. FASB 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. 12. 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 that 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 primarily 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 three months ended March 31 is as follows: Three months ended March 31, 2004 ------------------------------------ Public (in millions) Commercial Sector Consolidated ------------- ---------- ------ ------------ Revenue $ 178.8 $ 39.3 $ 218.1 Net income (loss) 29.0 (0.2) 28.8 Total assets $ 961.8 $ 37.8 $ 999.6 Three months ended March 31, 2003 ------------------------------------ Public (in millions) Commercial Sector Consolidated ------------- ---------- ------ ------------ Revenue $ 174.2 $ 39.6 $ 213.8 Net income 35.3 1.5 36.8 Total assets $ 824.9 $ 37.5 $ 862.4 13. In April, 2004, the Company completed the acquisition of COMP Medical, a workers' compensation company headquartered in Woodland Hills, California that specializes in appointment setting for chronic pain management, diagnostic imaging and electrodiagnostic procedures, as well as Medicare set-aside allocations. The purchase price was $6 million, subject to additional purchase price considerations depending on future performance, and was paid with cash from operating activities. COMP Medical has been renamed First Health Priority Services, Inc. The preliminary purchase price allocation will be recorded in the second quarter of 2004. 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 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 its recently completed acquisitions; then the Company may not achieve its anticipated 2004 financial results. Overview -------- The following information concerning recent business developments is important to understanding the comparability of the 2004 and 2003 financial results. Mail Handlers Benefit Plan -------------------------- The Mail Handlers Benefit Plan ("MHBP" or the "Plan") is part of the Company's Federal Employee Health Benefit Plan ("FEHBP") sector and the Company's largest customer. Revenue was $51.3 million (24% of total Company revenue) in the first quarter of 2004 as compared to $51.6 million in the first quarter of 2003 (24% of total revenue). Revenue from the Plan for the second, third and fourth quarters of 2003 was $54.4 million, $63.1 million, and $66.9 million, respectively. Adjustments to revenue are recorded on a client specific and aggregated basis based on empirical data in each period and may be subject to further adjustments in subsequent periods. In the third and fourth quarters of 2003, the Company reported $8 million and $6 million of revenue, respectively, as a result of the internal claims reconciliation process related to 2002, net of reserves. In the third and fourth quarters of 2003, the pretax income contribution from the revenue adjustment, net of incremental marketing expenses related to future retention of MHBP members, was approximately $4 million and $(1) million, respectively. The adjustments in the third and fourth quarters of 2003 resulted primarily from factors that the Company has historically used in its internal claims reconciliation process. The internal reconciliation process involves reconciling fees and savings associated with each medical claim, the eligibility of each Plan member, the allowability of each claim in relation to the Plan definition and the coordination of benefits with other insurers. This internal claims reconciliation process has been typically performed within nine to twelve months after year-end. In addition, the MHBP may include an audit performed by a governmental agency within three to five years after a fiscal year end. This retrospective review of claims data may result in changes to previous estimates made for eligibility, coordination of benefits and other Plan provisions. The claims reconciliation process related to 2002 Plan revenue was completed in the third and fourth quarters of 2003 and increased 2003 revenue attributable to the Plan by $14 million. The MHBP contract was renegotiated as of January 1, 2003 at a significantly lower PPO savings rate which effectively reduced PPO revenue recorded in 2003 and beyond. Based upon the savings rate reduction, lower plan enrollment in 2004, lower MHBP participant utilization, lower medical trend and a changing mix of enrollment between Plan options in the first quarter of 2004, the Company lowered its revenue outlook for the full year of 2004. In addition, the Company does not anticipate a material adjustment to revenue from the 2004 internal claims reconciliation process (related to 2003 claims) due to a more efficient process and lower effective fees earned on 2003 participant savings. The Company was unable to discern this information or the related trend until the end of the first quarter of 2004. The trend with respect to the revenue from the Plan is discussed in the "2004 Outlook." See the "Critical Accounting Policies" section for a further description of revenue adjustments. 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 March 31, 2004, the Plan has approximately $405 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 March 31, 2004. 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. ("Employer Services") from Health Net, Inc. for approximately $79 million. The purchase also included Health Net Plus Managed Care Services, Inc. and Health Net CompAmerica, Inc. Employer Services is a workers' compensation managed care company based in Irvine, California. The acquisition was financed with borrowings under the Company's credit facility. Health Net Employer Services, Inc. is being renamed First Health Employer Services, Inc. On October 31, 2003, the Company also 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. In April 2004, the Company completed the acquisition of COMP Medical, a workers' compensation company headquartered in Woodland Hills, California that specializes in appointment setting for chronic pain management, diagnostic imaging and electrodiagnostic procedures, as well as Medicare set-aside allocations. The purchase price was $6 million, subject to additional purchase price considerations depending on future performance, and was paid with cash from operating activities. COMP Medical has been renamed First Health Priority Services, Inc. Termination Plan ---------------- During the quarter ended March 31, 2004, the Company initiated a plan to terminate approximately 200 employees at an estimated cost of $1.4 million in termination benefits. The Company recorded substantially all of these costs in the quarter ended March 31, 2004 with the remaining costs to be recorded over the second and third quarters of 2004. Management believes this termination plan should save the Company in excess of $7 million in salaries and related expenses during the second half of 2004 and in excess of $10 million in expenses during 2005 (primarily in cost of services in the consolidated statement of operations). Results of Operations --------------------- The Company's revenues consist primarily of fees for cost management services provided on a predetermined contractual basis or on a percentage- of-savings basis. Revenues also include insurance premium revenue from the Company's insurance company operations. The following table sets forth information with respect to the sources of the Company's revenues for the three months ended March 31, 2004 and 2003, respectively: Sources of Revenue ($ in millions) Three Months Ended March 31, ------------------------------ 2004 % 2003 % ------ ---- ------ ---- Commercial Revenue: Group Health: PPO plus Administration Services $ 84.0 39% $ 88.9 42% PPO 34.7 16 40.9 19 Premiums 9.1 4 4.2 2 ------ ---- ------ ---- Total Group Health 127.8 59 134.0 63 ------ ---- ------ ---- Workers' Compensation: PPO plus Administration Services 32.2 15 25.0 12 PPO 18.8 8 15.2 7 ------ ---- ------ ---- Total Workers' Compensation 51.0 23 40.2 19 ------ ---- ------ ---- Total Commercial Revenue 178.8 82 174.2 82 ------ ---- ------ ---- Public Sector Revenue 39.3 18 39.6 18 ------ ---- ------ ---- Total Revenue $ 218.1 100% $ 213.8 100% ====== ==== ====== ==== Supplemental Revenue Information Effective for the quarter ending March 31, 2004, the Company is providing the following supplemental information by revenue sector: ----------------------------------------------------------------------- Year ended December 31, 2001 ----------------------------------------------------------------------- 1st 2nd 3rd 4th Full (in millions) Qtr Qtr Qtr Qtr Year ------ ------ ------ ------ ------ Commercial Revenue Group Health: FEHBP $ 21.8 $ 25.0 $ 29.1 $ 24.8 $ 100.7 Corporate 46.5 45.3 46.0 44.6 182.4 Insurers/TPA 12.2 10.3 15.2 25.6 63.3 ------ ------ ------ ------ ------ Total Group Health 80.5 80.6 90.3 95.0 346.4 ------ ------ ------ ------ ------ Workers' Compensation 29.3 28.8 33.1 39.5 130.7 ------ ------ ------ ------ ------ Total Commercial 109.8 109.4 123.4 134.5 477.1 ------ ------ ------ ------ ------ Public Sector 27.2 29.5 28.8 30.5 116.0 ------ ------ ------ ------ ------ Total Revenue $ 137.0 $ 138.9 $ 152.2 $ 165.0 $ 593.1 ====== ====== ====== ====== ====== ----------------------------------------------------------------------- Year ended December 31, 2002 ----------------------------------------------------------------------- 1st 2nd 3rd 4th Full (in millions) Qtr Qtr Qtr Qtr Year ------ ------ ------ ------ ------ Commercial Revenue Group Health: FEHBP $ 30.2 $ 31.7 $ 63.4 $ 64.5 $ 189.8 Corporate 49.4 49.9 45.2 46.3 190.8 Insurers/TPA 21.3 20.3 22.3 21.7 85.6 ------ ------ ------ ------ ------ Total Group Health 100.9 101.9 130.9 132.5 466.2 ------ ------ ------ ------ ------ Workers' Compensation 39.2 41.8 40.8 39.5 161.3 ------ ------ ------ ------ ------ Total Commercial 140.1 143.7 171.7 172.0 627.5 ------ ------ ------ ------ ------ Public Sector 29.3 32.2 33.2 37.8 132.5 ------ ------ ------ ------ ------ Total Revenue $ 169.4 $ 175.9 $ 204.9 $ 209.8 $ 760.0 ====== ====== ====== ====== ====== ----------------------------------------------------------------------- Year ended December 31, 2003 ----------------------------------------------------------------------- 1st 2nd 3rd 4th Full (in millions) Qtr Qtr Qtr Qtr Year ------ ------ ------ ------ ------ Commercial Revenue Group Health: FEHBP $ 59.4 $ 62.4 $ 71.9 $ 74.6 $ 268.3 Corporate 52.2 50.9 47.8 45.7 196.6 Insurers/TPA 22.4 20.9 18.2 24.3 85.8 ------ ------ ------ ------ ------ Total Group Health 134.0 134.2 137.9 144.6 550.7 ------ ------ ------ ------ ------ Workers' Compensation 40.2 40.2 39.1 48.6 168.1 ------ ------ ------ ------ ------ Total Commercial 174.2 174.4 177.0 193.2 718.8 ------ ------ ------ ------ ------ Public Sector 39.6 44.2 42.7 45.6 172.1 ------ ------ ------ ------ ------ Total Revenue $ 213.8 $ 218.6 $ 219.7 $ 238.8 $ 890.9 ====== ====== ====== ====== ====== -------------------------------- Qtr ended (in millions) 3/31/04 -------------------------------- Commercial Revenue Group Health: FEHBP $ 58.7 Corporate 44.0 Insurers/TPA 25.1 ------ Total Group Health 127.8 ------ Workers' Compensation 51.0 ------ Total Commercial 178.8 ------ Public Sector 39.3 ------ Total Revenue $ 218.1 ====== This supplemental revenue data provides information about the mix of clients within the Company's revenue sectors. In addition to the supplemental information above, the Company has generated approximately 41%, 41%, 46% and 50% of total Company revenues on a percentage-of-savings basis for the three months ended March 31, 2004 and the years ended December 31, 2003, 2002 and 2001, respectively. Total revenue for the three months ended March 31, 2004 of $218.1 million increased $4.4 million (2%) from the first quarter of 2003 and decreased $20.6 million (9%) from the fourth quarter of 2003. The components of the Company's quarterly revenue are as follows: Group Health revenue of $127.8 million for the three months ended March 31, 2004 decreased $6.2 million (5%) from the first quarter of 2003 and decreased $16.8 million (12%) from the fourth quarter of 2003. Group Health revenue represents revenue from the corporate, FEHBP, small group carrier and third party administrator payors. Group Health PPO plus Administration Services revenue for the three months ended March 31, 2004 decreased $4.9 million (6%) from the comparable period of 2003 due in part to increased price competition plus higher client attrition than expected. PPO plus Administration Services revenue decreased $14.5 million (15%) from the fourth quarter of 2003 due primarily to a $17 million decrease in revenue from the Plan (due in part to a 10% decline in Plan enrollment and in part to $6 million in revenue recorded in the fourth quarter related to the 2002 adjustment process, net of reserves) and the increased price competition and higher client attrition mentioned above. Group Health PPO revenue for the three months ended March 31, 2004 decreased $6.1 million (15%) from the first quarter of 2003 and $2.6 million (7%) from the fourth quarter of 2003 due primarily to clients taking advantage of a wider array of the Company's services (which is reported under PPO plus Administration Services). Premium revenue for the three months ended March 31, 2004 increased $4.8 million (114%) from the comparable period of 2003 as a result of new-client activity, particularly due to the New England Financial ("NEF") block of small group, multi-sited business the Company signed in the fourth quarter of 2003. This business is expected to generate approximately $20 million in annual premium revenue for the Company. The Company ceded 80% of the premiums and related policy benefits to a highly rated insurance carrier. Premium revenue was consistent with the fourth quarter of 2003. Workers' Compensation revenue of $51.0 million for the three months ended March 31, 2004 increased $10.9 million (27%) and $2.5 million (5%) from the first and fourth quarters of 2003, respectively. The increase from the first quarter of 2003 is due primarily to $15.7 million in revenue from the Employer Services acquisition. Absent the acquisition, workers' compensation revenue would have decreased due to lower volumes from existing clients and to new legislation in California regarding fee schedule rates for ambulatory care services. The increase from the fourth quarter of 2003 is due primarily to a full quarter of Employer Services activity in the first quarter of 2004 versus two months of activity in the fourth quarter of 2003. Approximately 74%, 71% and 73% of Workers' Compensation revenue is generated on a percentage-of-savings basis during the quarter ended March 31, 2004, the quarter ended March 31, 2003 and the quarter ended December 31, 2003, respectively. Public Sector revenue of $39.3 million for the three months ended March 31, 2004 was consistent with the same period of 2003. Public Sector revenue decreased $6.3 million (14%) from the fourth quarter of 2003 due primarily to a decrease in revenue from one-time HIPAA support implementations and fees associated with pharmacy programs that were completed in 2003. None of the Public Sector revenue is generated on a percentage-of-savings basis. Cost of services increased $10.2 million (11%) for the three months ended March 31, 2004 from the comparable period in 2003 due primarily to costs associated with the Employer Services acquisition and, to a lesser extent, costs associated with the Company's termination plan. Cost of services was essentially flat compared to the fourth quarter of 2003. 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 increased to 48.8% for the three months ended March 31, 2004 from 45.0% and 44.5% in the first and fourth quarters of 2003, respectively. The increase as a percentage of revenue is due primarily to a change in the mix of Company business from PPO business to more cost-intensive administration services. The Company has taken a number of key steps in 2004 to improve profitability (see "Termination Plan" above and "2004 Outlook" below). Selling and marketing costs for the three months ended March 31, 2004 decreased $0.1 million (1%) and $6.5 million (24%) from the first and fourth quarters of 2003, respectively. The decrease is due primarily to the reduction in spending on national advertising campaigns, particularly for the Plan. The Company incurred in excess of $7 million of incremental costs during the fourth quarter of 2003 related to the open season enrollment of MHBP members. General and administrative costs for the three months ended March 31, 2004 increased $4.4 million (29%) from the comparable period in 2003 due primarily to increases in professional liability insurance and other professional fees associated with cost savings initiatives designed to improve efficiencies and profitability. General and administrative costs were essentially flat compared to the fourth quarter of 2003. Healthcare benefits represent medical losses incurred by insureds of the Company's insurance entities. Healthcare benefits for the three months ended March 31, 2004 increased $1.2 million (22%) from the comparable period of 2003 and decreased $1.1 million (15%) from the fourth quarter of 2003. The increase from the first quarter of 2003 is due primarily to new business, particularly the NEF block of business discussed above. The decrease from the fourth quarter of 2003 is due to better experience within the Company's small group business (particularly in the NEF block of business). The loss ratio (healthcare benefits as a percent of premium revenue) was 70% for the three months ended March 31, 2004 compared to 122% for the first quarter of 2003 and 85% in the fourth quarter of 2003. The decrease in the loss ratio is due primarily to improved stop-loss experience and NEF experience in 2004. Management continues to review the book of business in detail to minimize the loss ratio. Stop-loss insurance is related to the Company's integrated Commercial services and is used as a way to attract additional PPO business, which is the Company's most profitable product. Depreciation and amortization expenses for the three months ended March 31, 2004 increased $3.3 million (22%) from the first quarter of 2003 and $1.7 million (10%) from the fourth quarter of 2003 due primarily to increased infrastructure investments made over the course of the past few years, and, to a lesser extent, amortization of intangible assets related to the various acquisitions the Company has made. Depreciation expense will continue to grow primarily as a result of continuing investments the Company is making in its infrastructure. Income from operations of $46.5 million for the three months ended March 31, 2004 decreased $14.5 million (24%) and $14.9 million (24%) from the first and fourth quarters of 2003, respectively. Operating margin (income from operations as a percentage of revenue) decreased to 21.3% in the first quarter of 2004 from 28.6% in the first quarter of 2003 and 25.7% in the fourth quarter of 2003. The decrease in income from operations and operating margin is due to the change in mix of revenue discussed above to lower-margin administrative services business as well as the expenses the Company has incurred in the first quarter of 2004 associated with cost savings initiatives. Interest income for the three months ended March 31, 2004 increased $0.4 million (27%) from the first quarter of 2003 and $0.1 million (3%) from the fourth quarter of 2003. The Company has used $20 million of its available cash in 2004 to repay debt. Interest expense for the three months ended March 31, 2004 increased $0.5 million (41%) and $0.1 million (4%) from the first and fourth quarters of 2003, respectively. Interest expense has increased as the outstanding debt increased from $185 million at March 31, 2003 to $250 million at March 31, 2004. The effective marginal interest rate on March 31, 2004 was approximately 2% per annum. Diluted net income per common share for the three months ended March 31, 2004 decreased 16% to $.31 per share from the first quarter of 2003 and decreased 23% from the fourth quarter of 2003. The decrease in net income per common share was due primarily to the change in revenue mix and the expenses associated with cost savings initiatives discussed above. For the three months ended March 31, 2004, diluted common shares outstanding decreased 7% from the first quarter of 2003 and 2% from the fourth quarter of 2003. Segment Information ------------------- The Company reports its financial results 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 state and local governments. The Commercial Group Health market represents payors from the FEHBP, corporate and third party administrators/insurers sectors. Management believes this presentation 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, pharmacy benefit management, clinical management) 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 Three months ended March 31, (in millions except %) 2004 2003 ---------------------- ------ ------ Revenues $ 178.8 $ 174.2 Operating expenses 132.0 115.6 ------ ------ Income from operations 46.8 58.6 ------ ------ Operating margin 26% 34% Interest income (1.7) (1.3) Interest expense 1.8 1.3 ------ ------ Income before income taxes 46.7 58.6 Income taxes (17.7) (23.3) ------ ------ Net income $ 29.0 $ 35.3 ====== ====== The decline in income from operations and net income for the Commercial segment is due to a number of factors including: increased price competition (particularly in the Corporate sector); new business in the lower margin third party administrator/insurance sector; lower PPO savings in the FEHBP sector; and the costs incurred associated with savings initiatives. The termination plan discussed above is designed to improve the profitability of the Commercial segment beginning in the second half of 2004. Public Sector Three months ended March 31, (in millions except %) 2004 2003 ---------------------- ------ ------ Revenues $ 39.3 $ 39.6 Operating expenses 39.6 37.1 ------ ------ Income (loss) from operations (0.3) 2.5 Operating margin (1)% 6% Interest income -- -- Interest expense -- -- ------ ------ Income (loss) before income taxes (0.3) 2.5 Income tax (expense) benefit 0.1 (1.0) ------ ------ Net income (loss) $ (0.2) $ 1.5 ====== ====== The decline in income from operations and net income in the Public Sector segment is due primarily to the timing of costs associated with various government contracts. The revenue and profitability is expected to increase going forward in 2004, as certain contract milestones are met and efficiency initiatives are put in place to help control costs. Liquidity and Capital Resources ------------------------------- The Company had $48.9 million in working capital on March 31, 2004 compared with working capital of $24.1 million at December 31, 2003. Total cash and investments amounted to $162.7 million at March 31, 2004 compared to $139.7 million at December 31, 2003. Cash and cash equivalents at March 31, 2004 include $29.9 million accumulated in the accounts of the Company's insurance entities due to the timing of the collection of insurance premiums in advance of the related payments for commissions and payments to re-insurers. Additionally, $6.0 million was set aside in anticipation of the pending acquisition of COMP Medical. The Company continues to generate the majority of cash from collection of its accounts receivables although this amount has declined from the end of 2003 due to a decrease in Company revenues. The Company has collected $8 million in reinsurance recoverable balances due at the end of 2003 (in "Other current assets" in the consolidated balance sheets). Cash collected from the exercise of stock options has declined as was anticipated in the Company's 2003 Annual Report on Form 10-K. The Company's most significant uses of cash continue to be for payment of operating expenses, income taxes and capital expenditures. Management currently expects that capital expenditures for 2004 will be approximately 8% of revenues, slightly below the 10% investment of the past several years. The Company anticipates that its operating expenses will decrease in the second half of 2004 when the steps taken to increase profitability are expected to take full effect. The Company's outstanding debt at March 31, 2004 decreased to $250 million from $270 million at December 31, 2003 as the Company used cash generated from operations to pay down its debt. The following table summarizes the contractual obligations the Company has outstanding as of March 31, 2004: (in millions) Payments due by period ---------------------- Less than 1-3 3-5 Over 5 Contractual Obligations Total 1 year years years years ----------------------- ----- ------ ----- ----- ----- Long-term debt $250.0 $ - $ - $250.0 $ - Operating leases 53.9 14.1 20.6 12.9 6.3 Purchase obligations 1.0 1.0 - - - ----- ----- ----- ----- ----- Total $304.9 $ 15.1 $ 20.6 $262.9 $ 6.3 ===== ===== ===== ===== ===== The purchase obligation is a commitment to a limited partnership investment. The Company has no capital lease obligations, off-balance sheet financing arrangements or other contractual obligations as of March 31, 2004. 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. 2004 Outlook ------------ In April 2004, the Company revised its revenue and earnings expectations for 2004 to take into account the negative trend it discerned, primarily with respect to MHBP, at the end of the first quarter of 2004. The Company's previous revenue estimate related to the FEHBP business was too high, especially with respect to MHBP revenue. MHBP revenues are expected to decline in 2004 due primarily to the savings rate reduction, lower Plan enrollment (approximately 10%), lower MHBP participant utilization, lower medical trend and a changed mix of enrollment between Plan options. Moreover, the Company does not anticipate that the adjustments expected to be made in 2004, which are attributable to 2003 Plan revenue, will be in amounts similar to the adjustments that were made in 2003 attributable to 2002 Plan revenue. See "Overview" and "Critical Accounting Policies" for further discussion of the claims reconciliation process. Revenue expectations in the Corporate Sector have declined as price competition has accelerated and the Company has realized less new business than expected. The Company's smallest sector, third party administrators and insurers, is expected to report revenue in 2004 that will be higher than 2003, but slightly less than previously estimated. Workers' Compensation revenue is expected to grow rapidly in 2004, principally due to the Employer Services acquisition, but previous estimates anticipated earlier decisions from potential new customers and a more profitable mix of new business. The Company anticipates its Public Sector revenue for 2004 will be flat with both last year and with previous estimates. The Company has taken a number of key steps to improve profitability including the Company's termination plan, operational leadership consolidation, growth initiatives to develop new market opportunities (especially in the workers' compensation and public sectors) and initiatives to drive operational efficiencies (especially in the group health and public sectors). Critical Accounting Policies ---------------------------- The consolidated financial statements are prepared in accordance 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 these judgments and estimates would not have a material impact on the Company's financial position or results of operations. 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 client's inability to resubmit claims adjustments to the Company's repricing system. In addition, the Company performs a claims reconciliation process which varies client-by-client and, in some cases, such as with the MHBP, is performed a number of months after year-end. The claims reconciliation process is affected by a number of items including: size of enrollment; volume of claims data; a client's technological infrastructure; structure of the benefit plan(s); and the specific terms of the client contract. MHBP is the Company's largest client and presents a complex combination of these items above which results in a lengthy reconciliation process. The Company records adjustments in the current accounting period; further adjustments may be made in future periods based on new information that becomes available in such future periods. In some cases, such as with the MHBP, the adjustment process is also subject to an external audit performed by a governmental agency. The use of such estimates and the claims reconciliation process enables the Company to report PPO fee revenue more accurately as information becomes available to support entitlement to fees, net of actual adjustments. Revenue adjustments are estimated on a client-specific and aggregated basis using actual, historical adjustment data. Valuation allowances recorded for such matters were $38.1 million at March 31, 2004 and $36.5 million at December 31, 2003. Total adjustments to revenue amounted to a reduction of less than 1% of total Company revenue for the three months ended March 31, 2004 and a positive revenue adjustment of less than 1% of total Company revenue for the three months ended March 31, 2003. 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 nonpayment 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 Commercial 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 appropriations issues. The allowance for doubtful accounts totaled $21.5 million at March 31, 2004 and $21.1 million at December 31, 2003. 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. New Accounting Pronouncements ----------------------------- Effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards 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 effect of SFAS 146 is discussed earlier in the MD&A (under the caption "Termination Plan") and in Note 8 to the consolidated financial statements. Effective January 1, 2003, the Company adopted FASB 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- The Company's market risk exposure as of March 31, 2004 was consistent with the types of market risk and amount of exposure presented in its 2003 Annual Report on Form 10-K. Item 4. 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 March 31, 2004, the end of the quarter covered by this report, management carried out an evaluation, with the participation of the Company's Chief Executive Officer and 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 as of March 31, 2004. 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 II Item 1. 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 2. Changes in Securities and Use of Proceeds ----------------------------------------- The following table summarizes any purchases of the Company common stock made by or on behalf of the Company for the quarter ended March 31, 2004. Total # of Maximum # of shares purchased shares that as part of may yet be Total # Average publicly purchased of shares price paid announced under the Period purchased per share programs programs ------ --------- --------- -------- --------- Jan 1 - Jan 31 -- -- -- 6,109,841 Feb 1 - Feb 29 -- -- -- 6,109,841 March 1 - Mar 31 -- -- -- 6,109,841 --------- --------- -------- --------- Total -- -- -- 6,109,841 ========= ========= ======== ========= Item 5. Other Information ----------------- There has been no material change to the procedures by which security holders may recommend nominees to the Company's Board of Directors. Item 6. Exhibits and Reports on Form 8-K -------------------------------- Exhibits: (a) Exhibit 10.1 - Employment Agreement dated March 22, 2004 between First Health Group Corp. and William R. McManaman. (b) Exhibit 10.2 - Stock Option Agreements dated March 22, 2004 by and between First Health Group Corp. and William R. McManaman (c) Exhibit 11 - Computation of Basic Earnings Per Common Share and Diluted Earnings Per Common Share (d) Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Rule pursuant 13a - 14(a) and Rule 15d - 14(a), promulgated under the Securities Exchange Act of 1934, as amended. (e) Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Rule pursuant 13a - 14(a) and Rule 15d - 14(a), promulgated under the Securities Exchange Act of 1934, as amended. (f) Exhibit 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. (g) Exhibit 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. Reports on Form 8-K: The Company furnished a report on Form 8-K dated February 17, 2004 reporting under Item 12 the results of operations and financial condition for the year ended December 31, 2003. The Company filed a report on Form 8-K dated March 22, 2004 reporting under Item 5 announcing the appointment of William R. McManaman as Senior Vice President and Chief Financial Officer. 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: May 10, 2004 /s/Edward L. Wristen ------------------------------------- Edward L. Wristen President and Chief Executive Officer Dated: May 10, 2004 /s/William R. McManaman ------------------------------------- William R. McManaman Senior Vice President and Chief Financial Officer (Principal Financial Officer) EX-10.1 2 exh10-1.txt EMPLOYMENT AGREEMENT EXHIBIT 10.1 EMPLOYMENT AGREEMENT This AGREEMENT is made this 22nd day of March 2004 by and between First Health Group Corp., a Delaware corporation headquartered in Illinois ("Company"), and William McManaman ("Employee"). BACKGROUND A. Company desires to employ Employee, and Employee desires to be employed by Company. B. For and in consideration of the promises and of the mutual covenants hereinafter set forth, it is hereby agreed by and between the parties as follows: AGREEMENT 1. Employment. Effective March 22, 2004 (the "Effective Date") Company hereby agrees to employ Employee to perform the duties set forth in Section 3 hereof ("Employee Services"). Employee hereby accepts employment to perform Employee Services for Employer under the terms and conditions of this Agreement. 2. Term. Subject to earlier termination pursuant to Section 8 hereof, the term of Employee's employment under this Agreement will be for four (4) years beginning on the Effective Date (the "Initial Term") and will automatically renew for consecutive one (1) year terms (each a "Renewal Term" and collectively with the Initial Term the "Term"), unless earlier terminated pursuant to Section 6 hereof on or before a date which is one year prior to the end of the Initial Term or the Renewal Term, as applicable, provided, however, automatic renewal shall not preclude termination by either party upon notice pursuant to Section 6(a) and subject to the obligations of such party under Section 6. 3. Duties. Employee will initially serve as Senior Vice President _ Finance. On March 17, 2004, Employee will be nominated and appointed, subject to approval by the Company's Board of Directors (the "Board"), as Chief Financial Officer. Employee will perform all responsibilities and duties as are assigned, or delegated to Employee, by the President and Chief Executive Officer of the Company ("CEO"), which responsibilities and duties include but are not limited to all the functions and responsibilities set forth in the Bylaws of the Company and all financial, accounting and similar responsibilities and obligations of the Company. Employee will report to and is subject to supervision by the CEO, President or Chairman. 4. Time Commitment. Employee will devote Employee's entire business time, attention and energies to the performance of Employee Services. Employee may not be associated with, consult, advise, work for, be employed by, contract with, or otherwise devote any of the Employee's time to the pursuit of any other work or business activities which may interfere with the performance of services hereunder. Notwithstanding the foregoing, with the written approval of the CEO Employee may serve on corporate, civic or charitable boards, provided that such service does not interfere with the performance of the Employee Services. Employee is currently serving as a member of the Board of Directors of AMCORE Financial, Inc., and such service is hereby approved. 5. Compensation and Benefits. Company will pay the following compensation to Employee in full consideration for performance of Employee Services hereunder in accordance with Company's then-current payroll policies and procedures. (a) Salary. Employee will receive a gross annual salary of $450,000 ("Base Salary"). This salary is payable in accordance with Company's then - current payroll policies and procedures. The gross annual salary will be subject to annual review by the Company and the Board of Directors. (b) Incentive Compensation. As soon as practicable after the end of each fiscal year of the Company during the Term and commencing with the year ending December 31, 2004, the Company's Pretax Income for such fiscal year (as determined in accordance with generally accepted accounting principles) will be compared to the Company's Pretax Income for the immediately preceding fiscal year (Threshold Year). If Pretax Income has increased by 5% or more for the year, the resulting percentage increase (rounded to the nearest whole number) will be used to determine any Incentive Compensation payable to Employee in accordance with the following table: Incentive Compensation Factor Pretax Income Increase (as % of Threshold Year Base Salary) ---------------------- ------------------------------------ 5% - 9% 25% - 49% 10% - 19% 50% - 74% 20% - 29% 75% - 99% 30% - 39% 100% - 124% 40% - 49% 125% - 149% 50% and above 150% In example, if Base Salary equals $450,000 and the Pretax Income increases 7%, Employee will receive $157,500 or 35% of Threshold Year Base Salary as Incentive Compensation (the relative incremental difference between 25% and 49%. Provided, however, that for the year ending December 31, 2004, the amount of Employee's Incentive Compensation shall not be less than 50% of his Base Salary. For purposes of this Agreement Employee's "Target Bonus" shall be 50% of Base Salary as from time to time in effect. If a merger, acquisition, accounting pronouncement or other unusual financial event of the Company causes a material change to the Pretax Income for any year, Employee and Company agree that for the purpose of this Agreement only, Pretax Income will not include the unusual event and/or will be modified to neutralize the financial effect of the event. If the Company makes revisions to the senior executive incentive compensation plan, then the Incentive Compensation provisions set forth in this Section 5(b) shall be similarly amended. Additionally, if the Company adopts a new incentive compensation plan for its senior executives which would provide Employee with a greater bonus opportunity than provided in this Section 5(b), then Employee will be eligible to participate in such incentive compensation plan and the provisions of this Section 5(b) shall thereafter no longer be applicable to Employee. (c) Expenses. Company will reimburse Employee for all reasonable and necessary expenses incurred by Employee in connection with the performance of Employee Services upon submission by Employee of expense reports with substantiating vouchers, in accordance with the Company's then current expense reimbursement policy. (d) Stock Options. As an inducement to his entering into this Agreement, upon the Effective Date, the Company shall grant to the Employee options to purchase a total of 250,000 shares of Common Stock of the Company, each such option to be on the terms and subject to the conditions of the respective stock option agreements (the "Option Agreements") to be entered into between the Company and the Employee, the forms of which are attached hereto as Exhibits 1, 2, 3 and 4. In addition, for years after 2004, Employee will be eligible for awards of options or other equity compensation as determined by the Board in accordance with the Company's stock option plan applicable to senior executives at the time. (e) Benefits and Flexible Time Off. Employee shall be entitled to participate in such group life insurance, major medical, and other employee benefit plans (collectively "Benefit Plans") as established by Company in accordance with the applicable terms and conditions of such Benefit Plans, which Benefit Plans may be modified or discontinued by Company at any time; provided, however that Employee shall meet the requirements of the Benefit Plans for participation and in no event, including breach or wrongful termination of this Agreement, shall Employee be entitled to any amount of compensation in lieu of participation, unless otherwise provided by the terms of the Benefit Plan. Employee shall also be entitled to paid time off in accordance with Company's then current Flexible Time Off ("FTO") program. Employee shall accrue such FTO at the rate specified in the FTO program. Flexible Time Off shall be taken with due consideration for the services required of Employee and to the requirements of Company. 6. Termination. (a) Either party may terminate this Agreement at any time during the Term, without cause, upon no less than one hundred and twenty (120) day's prior written notice. If requested by Company, Employee will continue to render Employee Services and be paid Employee's regular compensation up to the date of termination in accordance with Company's then-current payroll policies and procedures. (b) Employee may terminate his employment with the Company for Good Reason (as herein defined) fourteen (14) days following delivery of written notice of intent to terminate for Good Reason (subject to Company's limited right to cure), and such notice will set forth in specific detail the basis for the termination for Good Reason. "Good Reason" means (i) failure to be elected as Chief Financial Officer at the Company's annual meeting of shareholder in 2004, (ii) a material diminution in his title; (iii) a material change in his responsibilities such that he no longer reports directly to the CEO, President, or Chairman, (iv) a requirement that he relocate his personal residence more than fifty (50) miles from Chicago, Illinois (or from such other locations to which Employee agreed to relocate), or (v) any material breach of this Agreement by the Company (whether or not also described in clauses (i) through (iv) above); provided that no act or omission will constitute Good Reason unless Employee gives Company written notice of such act or omission and Company fails to cure such act or omission within fourteen (14) days after delivery of such notice (except that Employee will not be required to provide such notice more than once in cases of repeated acts or omissions). Any notice by Employee of Good Reason will be ineffective unless it is given not later than six (6) months after Employee has knowledge of any act or omission, the occurrence of which is claimed to constitute Good Reason. (c) Either party may terminate this Agreement at anytime for cause upon fourteen (14) days written notice. "Cause" includes, without limitation, breach of any provision of this Agreement or Employee's failure to adhere to the Company's policies and procedures. If the cause is not cured within the 14 day period, the Agreement may then be terminated by written notice. An opportunity to cure is not required if the party receiving notice of termination has previously been given notice of termination and the opportunity to cure the same or similar cause. (d) Company may terminate this Agreement by written notice at anytime during the Term immediately for the following reasons: (i) Death or legal incapacity of Employee; (ii) Employee's conviction of a felony; (iii) willful violation of the Company's policies or standards including without limitation, Corporate Compliance standards such as Insider Trading, Code of Ethics and Conflict of Interest, confidentiality and nondisclosure; or (iv) theft or dishonesty. (e) Company may terminate at any time during the Term by written notice upon Employee's other incapacity or inability to perform Employee Services for a period of at least 90 consecutive days because of impairment of Employee's physical, or mental health making it impossible or impractical for Employee to perform Employee Services. (f) If Employee's employment is terminated under Sections 6(a), or (b) Employee shall be entitled to receive the following as severance: (i) continued Base Salary for the remainder of the Initial Term, or if such termination is during the Renewal Term, for the remainder of the then one year Renewal Term, payable in installments according to the Company's normal payroll practices applicable to senior executives; and (ii) an amount equal to his Target Bonus for each year of the remainder of the Initial Term, or if such termination is during the Renewal Term, for the Renewal Term, payable each year at the same time as the Company pays bonuses to its employees; provided, that at Employee's election, the Base Salary described in clause (i) and the amount of Target Bonus described in clause (ii) shall instead be paid in an immediate lump sum discounted to present value applying a discount interest rate equal to the interest rate of the Company's revolving credit facility at the time of termination. (g) If Employee's employment is terminated under Sections (c) _ (e), then Employee shall be entitled only to such severance as Employee would otherwise be entitled under the Company's severance policy in effect for senior executives of the Company at the time of such termination. (h) Notwithstanding any other provisions of this Employment Agreement, if Employee's employment is terminated by the Company under Section 6(a) or by Employee for Good Reason under Section 6(b) at anytime during the two year period following a change in control of the Company then Employee will receive as severance a cash payment equal to two times the sum of (I) Employees Base Salary at the time of termination, plus (II) Employee's Target Bonus. Such payment will include all severance due to Employee under any Company severance plan but is not inclusive of any other benefit or right due or available to Employee under any other Company plan or Section 6 of this Agreement. "Change in control" for the purposes of this Agreement shall mean a change in the ownership or effective control of the Company, or the ownership of a substantial portion of the assets of the Company, within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), and the regulations issued thereunder. If it shall be determined by the Company that any payment, provision of any benefit or other amount to Employee pursuant to this Agreement or any other payment, provision of any benefit or other amount from the Company or any affiliate of the Company, is or would be subject to the excise tax imposed by Section 4999 of the Code, then the Company will pay an Excise Neutralization Payment (defined below) to Employee with respect to such excise tax. For purposes of this Agreement, an "Excise Neutralization Payment" means an additional payment in an amount such that, after payment by Employee of all income, and excise taxes on such additional amount, Employee retains an amount from such additional amount equal to the excise or similar tax to be neutralized under this Section 6(h). 7. Confidentiality. Employee agrees not to directly or indirectly use or disclose, for the benefit of any person, firm or entity other than Company and its subsidiary companies, the Confidential Business Information of Company. Confidential Business Information means information or material which is not generally available to or used by others or the utility or value of which is not generally known or recognized as a standard practice, whether or not the underlying details are in the public domain, including but not limited to its computerized and manual systems, procedures, reports, client lists, review criteria and methods, financial methods and practices, plans, pricing and marketing techniques as well as information regarding Company's past, present and prospective clients and their particular needs and requirements, and their own confidential information. The obligations of Employee under this provision continue after termination. Upon termination of employment, with or without cause, Employee agrees to return to Company all policy and procedure manuals, records, notes, data, memoranda, and reports of any nature (including computerized and electronically stored information) which are in Employee's possession and/or control which relate to (i) the Confidential Business Information of Company, (ii) Employee's employment with Company, or (iii) the business activities or facilities of Company or its past, present, or prospective clients. 8. Restrictive Covenant. During the period of employment and for a period of one (1) year from the date of termination, with or without cause, Employee will not directly or indirectly, within the United States or in any foreign market in which Employee was engaged in activities on behalf of Company, own, engage or participate in any way in any business which is similar to or competitive with any actual or planned business activity engaged in or planned by Company at the time the employment was terminated if in the course of such ownership or employment, if it could reasonably be anticipated that Employee would be required to use or disclose the Confidential Business Information of Company. However, this Agreement shall not prohibit ownership of up to two percent (2%) of the shares of stock of any such corporation whose stock is listed on a national securities exchange or is traded in the over-the-counter market. Employee further agrees that, for a period of one (1) year after termination of employment with Company, with or without cause, Employee will promptly notify Company of any business with whom Employee is associated or in which has an ownership interest and provide Company with a description of Employee's duties or interests. For a period of one year after termination of employment, with or without cause, Employee will not directly or indirectly, for the purpose of selling services provided or planned by Company at the time the employment was terminated, call upon, solicit or divert any actual customer or prospective customer of Company. An actual customer, for purposes of this Section, is any customer to whom Company has provided services within one year prior to Employee's termination. A prospective customer, for purposes of this Section, is any prospective customer to whom Company sought to provide services within one (1) year prior to the date of Employee's termination and Employee has knowledge or and was involved in such solicitation. 9. Non-Solicitation of Employees. Employee further agrees that for a period of one year from the date of Employee's termination, with or without cause, Employee shall not directly or indirectly solicit or hire any person who is currently or was an employee of Company at any time during the twelve months prior to Employee's termination. 10. Remedies. In the event Employee breaches or threatens to breach Sections 7, 8 or 9 of this Agreement, Company shall be entitled to injunctive relief, enjoining or restraining such breach or threatened breach. Employee acknowledges that Company's remedy at law is inadequate and that Company will suffer irreparable injury if such conduct is not prohibited. Employee and Company agree that, because of the difficulty of ascertaining the amount of damages in the event that Employee breaches Section 9 of this Agreement, Company shall be entitled to recover, at its option, as liquidated damages and not as a penalty, a sum equal to one year's annual salary of the employee(s) solicited to leave Company's employ. The parties further agree that the existence of this remedy will not preclude employer from seeking or receiving injunctive relief. Employee further agrees that the covenants contained in Sections 7, 8 or 9 shall be construed as separate and independent of other provisions of this Agreement and the existence of any claim by Employee against Company shall not constitute a defense to the enforcement by Company of either of these paragraphs. 11. Property Rights. All discoveries, designs, improvements, ideas, inventions, creations, and works of art, whether or not patentable or subject to copyright, relating to the business of Company or its clients, conceived, developed or made by Employee during employment by Company, either solely or jointly with others (hereafter "Developments") shall automatically become the sole property of Company. Employee shall immediately disclose to Company all such Developments and shall, without additional compensation, execute all assignments, application or any other documents deemed necessary by Company to perfect Company's rights therein. These obligations shall continue for a period of one year beyond the termination of employment with respect to Developments conceived, developed or made by Employee during employment with Company. Company acknowledges and agrees that the provisions of this section shall not apply to inventions for which no equipment, supplies, facility or trade secret information of Company or its clients were used by Employee and which were developed entirely on Employee's own time unless (a) such inventions relate (i) to the business of Company or (ii) to Company's actual or demonstrably anticipated research or development or (b) such inventions result from any work performed by Employee for Company. 12. Legal Fees. The Company will reimburse Employee for up to twenty thousand dollars ($20,000) of reasonable attorneys' fees, costs and expenses ("Legal Fees") incurred by Employee in connection with the negotiation, drafting, consultation and advice with respect to this Agreement, upon submission of invoices for the Legal Fees. 13, Assignments. Neither party shall have the right or power to assign any rights or duties under this Agreement without the written consent of the other party, provided, however, that Company shall have the right to assign this Agreement without consent pursuant to any corporate reorganization, merger, joint venture or other transaction involving a change of control of Company or to any subsidiary company; further provided, however, that in the event of any such permitted assignment, the Company shall remain jointly and severally liable for the obligations of the Company or other employer under this Agreement unless such assignment has the written consent of Employee, which consent shall not be unreasonably withheld. Any attempted assignment in breach of this Section 12 shall be void. 14. Severability. Each section, paragraph, clause, sub-clause and provision (collectively "Provisions") of this Agreement shall be severable from each other, and if for any reason the paragraph, clause, sub-clause or provision is invalid or unenforceable, such invalidity or unenforceability shall not prejudice or in any way affect the validity or enforceability of any other Provision hereof. 15. Miscellaneous. (a) This Agreement, the schedules and any amendments hereto contain the entire agreement of the parties with respect to the employment of the Employee and supersedes all other understandings whether written or oral; provided, however, that Employee shall comply with all policies, procedures, codes of ethics and other requirements of Company as established in the Colleague Handbook and Corporate Policy Manuals, not inconsistent with this Agreement. (b) Failure on the part of either party to insist upon strict compliance by the other with respect to any of the terms, covenants and conditions hereof, shall not be deemed a subsequent waiver of such term, covenant or condition. (c) The provisions of any paragraph containing a continuing obligation after termination shall survive such termination whether with or without cause and even if occasioned by Company's breach or wrongful termination. (d) This Agreement may not be modified except in writing as signed by the parties; provided, however, that Company may amend or terminate its Benefit Plans, Incentive Plan, Corporate Policies and/or employees' rules and regulations in its sole discretion. (e) In the event Employee is the prevailing party in any litigation under this Agreement, the Company shall reimburse Employee's reasonable attorneys' and expert witness fees promptly upon his reasonable substantiation thereof to the Company. 16. Notices. All notices hereunder shall be in writing and delivered by hand, by nationally-recognized delivery service that guarantees overnight delivery, or by first-class, registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to the Company: First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515-1223 Attention: General Counsel with a copy to: Stephen S. Bowen Latham & Watkins, LLP 233 S. Wacker Drive, Suite 5800 Chicago, Illinois 60606 If to Employee, to: William McManaman (at his most recent home address and/or facsimile number on file with Company) With copy to: Roger C. Siske, Esq. Sonnenschein Nath & Rosenthal LLP 8000 Sears Tower Chicago, IL 60606 Either party may from time to time designate a new address by notice given in accordance with this Section. Notice shall be effective when actually received by the addressee. 17. Governing Law. It is the intention of the parties hereto that all questions with respect to the construction, formation, and performance of this Agreement and the rights and liabilities of the parties hereto shall be determined in accordance with the laws of the State of Illinois. The parties hereto submit to the jurisdiction and venue of the courts of DuPage County Illinois in respect to any matter or thing arising out of this agreement pursuant hereto. IN WITNESS WHEREOF, the parties hereto have executed this Employment Agreement in the State of Illinois as of the day and year first above written. The Company: First Health Group Corp. By: ------------------------------------- Its: President and Chief Executive Officer Employee: ------------------------------------- William McManaman EX-10.2 3 exh10-2.txt STOCK OPTION AGREEMENTS EXHIBIT 10.2 Exhibit 1 FIRST HEALTH GROUP CORP. STOCK OPTION AGREEMENT THIS AGREEMENT is made and entered into as of the 22nd day of March, 2004, by and between FIRST HEALTH GROUP CORP. a Delaware corporation (the "Company"), and WILLIAM MCMANAMAN (the "Employee"). WHEREAS, the Employee is a valued employee of the Company and the Company wishes to induce him to enter into an employment agreement dated as of March 22, 2004 (the "Employment Agreement") and to provide financial incentives to further encourage him in the performance of his duties thereunder by granting him an option to purchase shares of common stock, $.01 par value, of the Company (the "Common Stock"); WHEREAS, the Employee wishes to acquire the right to purchase shares of Common Stock. NOW, THEREFORE, for good and valuable consideration, the parties hereto, intending to be legally bound, hereby agrees as follows: 1. Grant of Option. Subject to the provisions of Section 2 hereof, the Company hereby grants to the Employee effective as of the date hereof the right, privilege and option to purchase on the terms and conditions hereinafter set forth up to 62,500 shares of Common Stock at a purchase price of $21.08 per share (the "Option") pursuant to the Company's 2001 Stock Option Plan (the "Plan"). The Option is intended to be an "Incentive Stock Option" as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), subject to Section 422 of the Code, to the extent permitted by the Code, and a nonstatutory option with respect to the balance. In addition to the terms and conditions set forth in this Stock Option Agreement, the Option is governed by and subject to the terms and conditions of the Plan. 2. Time for Exercise of Option. Subject to the provisions of Section 3 and 7 hereof, the Option may be exercised by the Employee from time to time, in whole or in part, beginning on March 22, 2005 and ending on March 22, 2011, or within such shorter period as is provided in Section 3 hereof. 3. Termination of Employment. (a) If the Employee's employment by the Company is terminated by the Company without cause, then, notwithstanding the provisions of Section 2 of this Agreement, upon such termination of employment, the Option shall become exercisable in full and the Employee may, for a period of 90 days following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (b) If the Employee's employment by the Company is terminated due to death or incapacity (as this term is defined in Employee's Employment Agreement) or by voluntary, not for cause reasons as allowed under the Employment Agreement, then, notwithstanding Section 2 of this Agreement, the Option shall be entirely vested and exercisable in full and Employee or his legal representative may, for a period of two years following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (c) If (i) the Employee's employment by the Company is terminated voluntarily by the Employee and (ii) pursuant to Section 2 hereof the Option has heretofore vested, the Employee may, for a period of 30 days after the date of the termination (but before expiration of the original exercise period), exercise the Option, in whole or in part. (d) If the Employee's employment by the Company is terminated by the Company for cause (as such term is defined in the Employment Agreement), the Option shall terminate on the date on which the Employee's employment is terminated, and the Employee shall have no further rights hereunder. (e) The Employee acknowledges and understands that certain exercises of the Option pursuant to this Section 3 may cause disqualification of the Option as an Incentive Stock Option. 4. Method of Exercise. The Option may be exercised by written notice (the "Notice") addressed and delivered to the Company (Attention: Chief Financial Officer), specifying the number of shares of Common Stock to be purchased and accompanied by (i) a check, or (ii) that number of shares of Common Stock which have an aggregate fair market value as of the date of exercise equal to the exercise price, or (iii) any combination thereof. For purposes of this Agreement, "fair market value" of a share of Common Stock shall mean: (i) if the Common Stock is traded on a national stock exchange on the date of exercise of the Option, fair market value shall be the closing price reported by the applicable composite transactions report on such day, or if the Common Stock is not traded on such date, the mean between the closing bid-and-asked prices thereof on that date on such exchange; (ii) if the Common Stock is traded over-the counter and is classified as a national market issue on the date of exercise of the Option, fair market value shall be the last reported transaction price quoted by the NASDAQ on that day; (iii) if the Common Stock is traded over-the-counter and is not classified as a national market issue on the date of exercise of the Option, fair market value shall be the mean between the last representative bid-and-asked prices quoted by the NASDAQ on that day; or (iv) if none of the foregoing provisions is applicable, fair market value as of the date of exercise of the Option shall be determined by the Board of Directors in good faith on such basis as it deems appropriate. In all cases, the determination of fair market value shall be binding and conclusive on all persons. 5. Delivery of Stock Certificates. The Option shall be deemed to have been exercised upon receipt by the Company of the Notice accompanied by the exercise price (the "Exercise Date"). The certificate representing the shares of Common Stock purchased upon exercise of the Option shall be issued as of the Exercise Date and delivered by the Company to the Employee free and clear of all claims, liens and encumbrances, within five days following the Exercise Date or as soon thereafter as practicable. As a condition to the exercise of the Option, the Company may require the Employee to represent and warrant at the time of any such exercise that the shares of Common Stock are being purchased for investment purposes only, for the account of the Employee and without any intention to distribute such shares. If the shares of Common Stock issuable upon exercise of the Option have not previously been registered under the Securities Act of 1933, as amended (the "Securities Act") as contemplated by this Agreement, each certificate evidencing shares of Common Stock acquired upon exercise of the Option shall contain on its face, or on the reverse side thereof, the following legend: "These shares have not been registered under the Securities Act of 1933 or under any applicable state law They may not be offered for sale, sold, transferred, or pledged without (1) registration under the Securities Act of 1933 and any applicable state law, or (2) an opinion (satisfactory to the corporation) that registration is not required" 6. Adjustment Provisions. If, during the term of this Agreement, there shall be any stock dividend, stock rights distribution, stock split, recapitalization, merger, consolidation, sale of assets, reorganization or other similar change or transaction of or by the Company, an appropriate adjustment shall be made to the number and kind of shares remaining to be acquired upon exercise of the Option and to the exercise price of the Option so that the value to be received by the Employee upon exercise of the Option shall, in the aggregate, be the same as if none of the foregoing transactions had occurred. 7. Merger; Consolidation or Sale of Assets. In the event the Company enters into an agreement providing for (i) the sale of all or substantially all of the assets of the Company or (ii) a merger, consolidation or reorganization which would result in the stockholders of the Company immediately prior to such transaction owning less than 50% of the surviving corporation, the Option shall become exercisable in full without regard to any vesting limitations, and the Employee shall be entitled, commencing at least ten days prior to the effective date of such transaction, to exercise the Option in whole or in part, to the extent not previously exercised. 8. Withholding Obligations. In the event that the Company is required to satisfy withholding obligations under the Code as a result of the exercise of the Option, the Employee may request that, in lieu of withholding amounts from the Employee's paycheck or requiring that the Employee write a check to the Company in the amount of the withholding obligation, the Company withhold that number of shares of Common Stock which have a fair market value (determined in accordance with the provisions of the Plan) on the Exercise Date equal to the amount required to be withheld. 9. Non-Transferability. The Option is not transferable or assignable by the Employee other than by will or by the laws of descent and distribution and are exercisable during the lifetime of the Employee only by the Employee. 10. Compliance with Law. By accepting the Option, the Employee agrees for himself and his legal representative that the Company shall not be required to deliver any shares of Common Stock upon the exercise of the Option until such shares have been qualified for delivery under applicable securities laws and regulations as determined by the Company or its legal counsel. 11. Rights as a Stockholder; Not an Employment Agreement. The Employee shall have no rights as a stockholder of the Company with respect to shares of Common Stock subject to the Option until the Option has been exercised and payment made as herein provided and certificates representing the shares as to which the Option has been exercised have been delivered to the Employee. Nothing contained in this Agreement shall be construed to be a contract of employment between the Company and the Employee. 12. Construction. (a) Successors. This Agreement and all the terms and provisions hereof shall be binding upon and shall inure to the benefit of the parties hereto and their respective legal representatives, heirs and successors, except as expressly herein otherwise provided. (b) Entire Agreement Modification. This Agreement contains the entire understanding between the parties with respect to the matters referred to herein, and such agreement shall not be modified, except by written instrument signed by the parties hereto. (c) Headings; Pronouns; Governing Law. The descriptive headings of the respective sections and subsections of this Agreement are inserted for convenience of reference only and shall not be deemed to modify or construe the provisions which follow them. Any use of any masculine pronoun shall include the feminine and vice-versa, and any use of a singular, the plural and vice-versa,, as the context and facts may require. The construction and interpretation of this Agreement shall be governed in all respects by the laws of the State of Delaware. (d) Notices. All communications between the parties shall be in writing and shall be deemed to have been duly given as of the date and time of hand delivery or three days after mailing via certified or registered mail, return receipt requested, proper postage prepaid following or such other addresses of which the parties shall from time to time notify another: If to the Company: Chief Executive Officer First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 If to the Employee: Mr. William McManaman First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 (e) Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement or the application thereof to any party or circumstance shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the minimal extent of such provision or the remaining provisions of this Agreement or the application of such provision to other parties or circumstances. IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement as of the date first above written. FIRST HEALTH GROUP CORP. ------------------------------------- Edward L. Wristen President and Chief Executive Officer ------------------------------------- William McManaman Exhibit 2 FIRST HEALTH GROUP CORP. STOCK OPTION AGREEMENT THIS AGREEMENT is made and entered into as of the 22nd day of March, 2004, by and between FIRST HEALTH GROUP CORP. a Delaware corporation (the "Company"), and WILLIAM MCMANAMAN (the "Employee"). WHEREAS, the Employee is a valued employee of the Company and the Company wishes to induce him to enter into an employment agreement dated as of March 22, 2004 (the "Employment Agreement") and to provide financial incentives to further encourage him in the performance of his duties thereunder by granting him an option to purchase shares of common stock, $.01 par value, of the Company (the "Common Stock"); WHEREAS, the Employee wishes to acquire the right to purchase shares of Common Stock. NOW, THEREFORE, for good and valuable consideration, the parties hereto, intending to be legally bound, hereby agrees as follows: 1. Grant of Option. Subject to the provisions of Section 2 hereof, the Company hereby grants to the Employee effective as of the date hereof the right, privilege and option to purchase on the terms and conditions hereinafter set forth up to 62,500 shares of Common Stock at a purchase price of $22.134 per share (the "Option") pursuant to the Company's 2001 Stock Option Plan (the "Plan"). The Option is intended to be an "Incentive Stock Option" as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), subject to Section 422 of the Code, to the extent permitted by the Code, and a nonstatutory option with respect to the balance. In addition to the terms and conditions set forth in this Stock Option Agreement, the Option is governed by and subject to the terms and conditions of the Plan. 2. Time for Exercise of Option. Subject to the provisions of Section 3 and 7 hereof, the Option may be exercised by the Employee from time to time, in whole or in part, beginning on March 22, 2006 and ending on March 22, 2011, or within such shorter period as is provided in paragraph 3 hereof. 3. Termination of Employment. (a) If the Employee's employment by the Company is terminated by the Company without cause, then, notwithstanding the provisions of Section 2 of this Agreement, upon such termination of employment, the Option shall become exercisable in full and the Employee may, for a period of 90 days following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (b) If the Employee's employment by the Company is terminated due to death or incapacity (as this term is defined in Employee's Employment Agreement) or by voluntary, not for cause reasons as allowed under the Employment Agreement, then, notwithstanding Section 2 of this Agreement, the Option shall be entirely vested and exercisable in full and Employee or his legal representative may, for a period of two years following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (c) If (i) the Employee's employment by the Company is terminated voluntarily by the Employee and (ii) pursuant to Section 2 hereof the Option has heretofore vested, the Employee may, for a period of 30 days after the date of the termination (but before expiration of the original exercise period), exercise the Option, in whole or in part. (d) If the Employee's employment by the Company is terminated by the Company for cause (as such term is defined in the Employment Agreement), the Option shall terminate on the date on which the Employee's employment is terminated, and the Employee shall have no further rights hereunder. (e) The Employee acknowledges and understands that certain exercises of the Option pursuant to this Section 3 may cause disqualification of the Option as an Incentive Stock Option. 4. Method of Exercise. The Option may be exercised by written notice (the "Notice") addressed and delivered to the Company (Attention: Chief Executive Officer), specifying the number of shares of Common Stock to be purchased and accompanied by (i) a check, or (ii) that number of shares of Common Stock which have an aggregate fair market value as of the date of exercise equal to the exercise price, or (iii) any combination thereof. For purposes of this Agreement, "fair market value" of a share of Common Stock shall mean: (i) if the Common Stock is traded on a national stock exchange on the date of exercise of the Option, fair market value shall be the closing price reported by the applicable composite transactions report on such day, or if the Common Stock is not traded on such date, the mean between the closing bid-and-asked prices thereof on that date on such exchange; (ii) if the Common Stock is traded over-the counter and is classified as a national market issue on the date of exercise of the Option, fair market value shall be the last reported transaction price quoted by the NASDAQ on that day; (iii) if the Common Stock is traded over-the-counter and is not classified as a national market issue on the date of exercise of the Option, fair market value shall be the mean between the last representative bid-and-asked prices quoted by the NASDAQ on that day; or (iv) if none of the foregoing provisions is applicable, fair market value as of the date of exercise of the Option shall be determined by the Board of Directors in good faith on such basis as it deems appropriate. In all cases, the determination of fair market value shall be binding and conclusive on all persons. 5. Delivery of Stock Certificates. The Option shall be deemed to have been exercised upon receipt by the Company of the Notice accompanied by the exercise price (the "Exercise Date"). The certificate representing the shares of Common Stock purchased upon exercise of the Option shall be issued as of the Exercise Date and delivered by the Company to the Employee free and clear of all claims, liens and encumbrances, within five days following the Exercise Date or as soon thereafter as practicable. As a condition to the exercise of the Option, the Company may require the Employee to represent and warrant at the time of any such exercise that the shares of Common Stock are being purchased for investment purposes only, for the account of the Employee and without any intention to distribute such shares. If the shares of Common Stock issuable upon exercise of the Option have not previously been registered under the Securities Act of 1933, as amended (the "Securities Act") as contemplated by this Agreement, each certificate evidencing shares of Common Stock acquired upon exercise of the Option shall contain on its face, or on the reverse side thereof, the following legend: "These shares have not been registered under the Securities Act of 1933 or under any applicable state law They may not be offered for sale, sold, transferred, or pledged without (1) registration under the Securities Act of 1933 and any applicable state law, or (2) an opinion (satisfactory to the corporation) that registration is not required" 6. Adjustment Provisions. If, during the term of this Agreement, there shall be any stock dividend, stock rights distribution, stock split, recapitalization, merger, consolidation, sale of assets, reorganization or other similar change or transaction of or by the Company, an appropriate adjustment shall be made to the number and kind of shares remaining to be acquired upon exercise of the Option and to the exercise price of the Option so that the value to be received by the Employee upon exercise of the Option shall, in the aggregate, be the same as if none of the foregoing transactions had occurred. 7. Merger; Consolidation or Sale of Assets. In the event the Company enters into an agreement providing for (i) the sale of all or substantially all of the assets of the Company or (ii) a merger, consolidation or reorganization which would result in the stockholders of the Company immediately prior to such transaction owning less than 50% of the surviving corporation, the Option shall become exercisable in full without regard to any vesting limitations, and the Employee shall be entitled, commencing at least ten days prior to the effective date of such transaction, to exercise the Option in whole or in part, to the extent not previously exercised. 8. Withholding Obligations. In the event that the Company is required to satisfy withholding obligations under the Code as a result of the exercise of the Option, the Employee may request that, in lieu of withholding amounts from the Employee's paycheck or requiring that the Employee write a check to the Company in the amount of the withholding obligation, the Company withhold that number of shares of Common Stock which have a fair market value (determined in accordance with the provisions of the Plan) on the Exercise Date equal to the amount required to be withheld. 9. Non-Transferability. The Option is not transferable or assignable by the Employee other than by will or by the laws of descent and distribution and are exercisable during the lifetime of the Employee only by the Employee. 10. Compliance with Law. By accepting the Option, the Employee agrees for himself and his legal representative that the Company shall not be required to deliver any shares of Common Stock upon the exercise of the Option until such shares have been qualified for delivery under applicable securities laws and regulations as determined by the Company or its legal counsel. 11. Rights as a Stockholder; Not an Employment Agreement. The Employee shall have no rights as a stockholder of the Company with respect to shares of Common Stock subject to the Option until the Option has been exercised and payment made as herein provided and certificates representing the shares as to which the Option has been exercised have been delivered to the Employee. Nothing contained in this Agreement shall be construed to be a contract of employment between the Company and the Employee. 12. Construction. (a) Successors. This Agreement and all the terms and provisions hereof shall be binding upon and shall inure to the benefit of the parties hereto and their respective legal representatives, heirs and successors, except as expressly herein otherwise provided. (b) Entire Agreement Modification. This Agreement contains the entire understanding between the parties with respect to the matters referred to herein, and such agreement shall not be modified, except by written instrument signed by the parties hereto. (c) Headings; Pronouns; Governing Law. The descriptive headings of the respective sections and subsections of this Agreement are inserted for convenience of reference only and shall not be deemed to modify or construe the provisions which follow them. Any use of any masculine pronoun shall include the feminine and vice-versa, and any use of a singular, the plural and vice-versa,, as the context and facts may require. The construction and interpretation of this Agreement shall be governed in all respects by the laws of the State of Delaware. (d) Notices. All communications between the parties shall be in writing and shall be deemed to have been duly given as of the date and time of hand delivery or three days after mailing via certified or registered mail, return receipt requested, proper postage prepaid following or such other addresses of which the parties shall from time to time notify another: If to the Company: Chief Executive Officer First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 If to the Employee: Mr. William McManaman First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 (e) Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement or the application thereof to any party or circumstance shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the minimal extent of such provision or the remaining provisions of this Agreement or the application of such provision to other parties or circumstances. IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement as of the date first above written. FIRST HEALTH GROUP CORP. ------------------------------------- Edward L. Wristen President and Chief Executive Officer ------------------------------------- William McManaman Exhibit 3 FIRST HEALTH GROUP CORP. STOCK OPTION AGREEMENT THIS AGREEMENT is made and entered into as of the 22nd day of March, 2004, by and between FIRST HEALTH GROUP CORP. a Delaware corporation (the "Company"), and WILLIAM MCMANAMAN (the "Employee"). WHEREAS, the Employee is a valued employee of the Company and the Company wishes to induce him to enter into an employment agreement dated as of March 22, 2004 (the "Employment Agreement") and to provide financial incentives to further encourage him in the performance of his duties thereunder by granting him an option to purchase shares of common stock, $.01 par value, of the Company (the "Common Stock"); WHEREAS, the Employee wishes to acquire the right to purchase shares of Common Stock. NOW, THEREFORE, for good and valuable consideration, the parties hereto, intending to be legally bound, hereby agrees as follows: 1. Grant of Option. Subject to the provisions of Section 2 hereof, the Company hereby grants to the Employee effective as of the date hereof the right, privilege and option to purchase on the terms and conditions hereinafter set forth up to 62,500 shares of Common Stock at a purchase price of $23.188 per share (the "Option") pursuant to the Company's 2001 Stock Option Plan (the "Plan"). The Option is intended to be an "Incentive Stock Option" as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), subject to Section 422 of the Code, to the extent permitted by the Code, and a nonstatutory option with respect to the balance. In addition to the terms and conditions set forth in this Stock Option Agreement, the Option is governed by and subject to the terms and conditions of the Plan. 2. Time for Exercise of Option. Subject to the provisions of Section 3 and 7 hereof, the Option may be exercised by the Employee from time to time, in whole or in part, beginning on March 22, 2007 and ending on March 22, 2011, or within such shorter period as is provided in paragraph 3 hereof. 3. Termination of Employment. (a) If the Employee's employment by the Company is terminated by the Company without cause, then, notwithstanding the provisions of Section 2 of this Agreement, upon such termination of employment, the Option shall become exercisable in full and the Employee may, for a period of 90 days following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (b) If the Employee's employment by the Company is terminated due to death or incapacity (as this term is defined in Employee's Employment Agreement) or by voluntary, not for cause reasons as allowed under the Employment Agreement, then, notwithstanding Section 2 of this Agreement, the Option shall be entirely vested and exercisable in full and Employee or his legal representative may, for a period of two years following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (c) If (i) the Employee's employment by the Company is terminated voluntarily by the Employee and (ii) pursuant to Section 2 hereof the Option has heretofore vested, the Employee may, for a period of 30 days after the date of the termination (but before expiration of the original exercise period), exercise the Option, in whole or in part. (d) If the Employee's employment by the Company is terminated by the Company for cause (as such term is defined in the Employment Agreement), the Option shall terminate on the date on which the Employee's employment is terminated, and the Employee shall have no further rights hereunder. (e) The Employee acknowledges and understands that certain exercises of the Option pursuant to this Section 3 may cause disqualification of the Option as an Incentive Stock Option. 4. Method of Exercise. The Option may be exercised by written notice (the "Notice") addressed and delivered to the Company (Attention: Chief Executive Officer), specifying the number of shares of Common Stock to be purchased and accompanied by (i) a check, or (ii) that number of shares of Common Stock which have an aggregate fair market value as of the date of exercise equal to the exercise price, or (iii) any combination thereof. For purposes of this Agreement, "fair market value" of a share of Common Stock shall mean: (i) if the Common Stock is traded on a national stock exchange on the date of exercise of the Option, fair market value shall be the closing price reported by the applicable composite transactions report on such day, or if the Common Stock is not traded on such date, the mean between the closing bid-and-asked prices thereof on that date on such exchange; (ii) if the Common Stock is traded over-the counter and is classified as a national market issue on the date of exercise of the Option, fair market value shall be the last reported transaction price quoted by the NASDAQ on that day; (iii) if the Common Stock is traded over-the-counter and is not classified as a national market issue on the date of exercise of the Option, fair market value shall be the mean between the last representative bid-and-asked prices quoted by the NASDAQ on that day; or (iv) if none of the foregoing provisions is applicable, fair market value as of the date of exercise of the Option shall be determined by the Board of Directors in good faith on such basis as it deems appropriate. In all cases, the determination of fair market value shall be binding and conclusive on all persons. 5. Delivery of Stock Certificates. The Option shall be deemed to have been exercised upon receipt by the Company of the Notice accompanied by the exercise price (the "Exercise Date"). The certificate representing the shares of Common Stock purchased upon exercise of the Option shall be issued as of the Exercise Date and delivered by the Company to the Employee free and clear of all claims, liens and encumbrances, within five days following the Exercise Date or as soon thereafter as practicable. As a condition to the exercise of the Option, the Company may require the Employee to represent and warrant at the time of any such exercise that the shares of Common Stock are being purchased for investment purposes only, for the account of the Employee and without any intention to distribute such shares. If the shares of Common Stock issuable upon exercise of the Option have not previously been registered under the Securities Act of 1933, as amended (the "Securities Act") as contemplated by this Agreement, each certificate evidencing shares of Common Stock acquired upon exercise of the Option shall contain on its face, or on the reverse side thereof, the following legend: "These shares have not been registered under the Securities Act of 1933 or under any applicable state law They may not be offered for sale, sold, transferred, or pledged without (1) registration under the Securities Act of 1933 and any applicable state law, or (2) an opinion (satisfactory to the corporation) that registration is not required" 6. Adjustment Provisions. If, during the term of this Agreement, there shall be any stock dividend, stock rights distribution, stock split, recapitalization, merger, consolidation, sale of assets, reorganization or other similar change or transaction of or by the Company, an appropriate adjustment shall be made to the number and kind of shares remaining to be acquired upon exercise of the Option and to the exercise price of the Option so that the value to be received by the Employee upon exercise of the Option shall, in the aggregate, be the same as if none of the foregoing transactions had occurred. 7. Merger; Consolidation or Sale of Assets. In the event the Company enters into an agreement providing for (i) the sale of all or substantially all of the assets of the Company or (ii) a merger, consolidation or reorganization which would result in the stockholders of the Company immediately prior to such transaction owning less than 50% of the surviving corporation, the Option shall become exercisable in full without regard to any vesting limitations, and the Employee shall be entitled, commencing at least ten days prior to the effective date of such transaction, to exercise the Option in whole or in part, to the extent not previously exercised. 8. Withholding Obligations. In the event that the Company is required to satisfy withholding obligations under the Code as a result of the exercise of the Option, the Employee may request that, in lieu of withholding amounts from the Employee's paycheck or requiring that the Employee write a check to the Company in the amount of the withholding obligation, the Company withhold that number of shares of Common Stock which have a fair market value (determined in accordance with the provisions of the Plan) on the Exercise Date equal to the amount required to be withheld. 9. Non-Transferability. The Option is not transferable or assignable by the Employee other than by will or by the laws of descent and distribution and are exercisable during the lifetime of the Employee only by the Employee. 10. Compliance with Law. By accepting the Option, the Employee agrees for himself and his legal representative that the Company shall not be required to deliver any shares of Common Stock upon the exercise of the Option until such shares have been qualified for delivery under applicable securities laws and regulations as determined by the Company or its legal counsel. 11. Rights as a Stockholder; Not an Employment Agreement. The Employee shall have no rights as a stockholder of the Company with respect to shares of Common Stock subject to the Option until the Option has been exercised and payment made as herein provided and certificates representing the shares as to which the Option has been exercised have been delivered to the Employee. Nothing contained in this Agreement shall be construed to be a contract of employment between the Company and the Employee. 12. Construction. (a) Successors. This Agreement and all the terms and provisions hereof shall be binding upon and shall inure to the benefit of the parties hereto and their respective legal representatives, heirs and successors, except as expressly herein otherwise provided. (b) Entire Agreement Modification. This Agreement contains the entire understanding between the parties with respect to the matters referred to herein, and such agreement shall not be modified, except by written instrument signed by the parties hereto. (c) Headings; Pronouns; Governing Law. The descriptive headings of the respective sections and subsections of this Agreement are inserted for convenience of reference only and shall not be deemed to modify or construe the provisions which follow them. Any use of any masculine pronoun shall include the feminine and vice-versa, and any use of a singular, the plural and vice-versa,, as the context and facts may require. The construction and interpretation of this Agreement shall be governed in all respects by the laws of the State of Delaware. (d) Notices. All communications between the parties shall be in writing and shall be deemed to have been duly given as of the date and time of hand delivery or three days after mailing via certified or registered mail, return receipt requested, proper postage prepaid following or such other addresses of which the parties shall from time to time notify another: If to the Company: Chief Executive Officer First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 If to the Employee: Mr. William McManaman First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 (e) Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement or the application thereof to any party or circumstance shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the minimal extent of such provision or the remaining provisions of this Agreement or the application of such provision to other parties or circumstances. IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement as of the date first above written. FIRST HEALTH GROUP CORP. ------------------------------------- Edward L. Wristen President and Chief Executive Officer ------------------------------------- William McManaman Exhibit 4 FIRST HEALTH GROUP CORP. STOCK OPTION AGREEMENT THIS AGREEMENT is made and entered into as of the 22nd day of March, 2004, by and between FIRST HEALTH GROUP CORP. a Delaware corporation (the "Company"), and WILLIAM MCMANAMAN (the "Employee"). WHEREAS, the Employee is a valued employee of the Company and the Company wishes to induce him to enter into an employment agreement dated as of March 22, 2004 (the "Employment Agreement") and to provide financial incentives to further encourage him in the performance of his duties thereunder by granting him an option to purchase shares of common stock, $.01 par value, of the Company (the "Common Stock"); WHEREAS, the Employee wishes to acquire the right to purchase shares of Common Stock. NOW, THEREFORE, for good and valuable consideration, the parties hereto, intending to be legally bound, hereby agrees as follows: 1. Grant of Option. Subject to the provisions of Section 2 hereof, the Company hereby grants to the Employee effective as of the date hereof the right, privilege and option to purchase on the terms and conditions hereinafter set forth up to 62,500 shares of Common Stock at a purchase price of $24.242 per share (the "Option") pursuant to the Company's 2001 Stock Option Plan (the "Plan"). The Option is intended to be an "Incentive Stock Option" as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), subject to Section 422 of the Code, to the extent permitted by the Code, and a nonstatutory option with respect to the balance. In addition to the terms and conditions set forth in this Stock Option Agreement, the Option is governed by and subject to the terms and conditions of the Plan. 2. Time for Exercise of Option. Subject to the provisions of Section 3 and 7 hereof, the Option may be exercised by the Employee from time to time, in whole or in part, beginning on March 22, 2008 and ending on March 22, 2011, or within such shorter period as is provided in Section 3 hereof. 3. Termination of Employment. (a) If the Employee's employment by the Company is terminated by the Company without cause, then, notwithstanding the provisions of Section 2 of this Agreement, upon such termination of employment, the Option shall become exercisable in full and the Employee may, for a period of 90 days following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (b) If the Employee's employment by the Company is terminated due to death or incapacity (as this term is defined in Employee's Employment Agreement) or by voluntary, not for cause reasons as allowed under the Employment Agreement, then, notwithstanding Section 2 of this Agreement, the Option shall be entirely vested and exercisable in full and Employee or his legal representative may, for a period of two years following such termination (but before expiration of the original exercise period), exercise the Option in whole or in part. (c) If (i) the Employee's employment by the Company is terminated voluntarily by the Employee and (ii) pursuant to Section 2 hereof the Option has heretofore vested, the Employee may, for a period of 30 days after the date of the termination (but before expiration of the original exercise period), exercise the Option, in whole or in part. (d) If the Employee's employment by the Company is terminated by the Company for cause (as such term is defined in the Employment Agreement), the Option shall terminate on the date on which the Employee's employment is terminated, and the Employee shall have no further rights hereunder. (e) The Employee acknowledges and understands that certain exercises of the Option pursuant to this Section 3 may cause disqualification of the Option as an Incentive Stock Option. 4. Method of Exercise. The Option may be exercised by written notice (the "Notice") addressed and delivered to the Company (Attention: Chief Executive Officer), specifying the number of shares of Common Stock to be purchased and accompanied by (i) a check, or (ii) that number of shares of Common Stock which have an aggregate fair market value as of the date of exercise equal to the exercise price, or (iii) any combination thereof. For purposes of this Agreement, "fair market value" of a share of Common Stock shall mean: (i) if the Common Stock is traded on a national stock exchange on the date of exercise of the Option, fair market value shall be the closing price reported by the applicable composite transactions report on such day, or if the Common Stock is not traded on such date, the mean between the closing bid-and-asked prices thereof on that date on such exchange; (ii) if the Common Stock is traded over-the counter and is classified as a national market issue on the date of exercise of the Option, fair market value shall be the last reported transaction price quoted by the NASDAQ on that day; (iii) if the Common Stock is traded over-the-counter and is not classified as a national market issue on the date of exercise of the Option, fair market value shall be the mean between the last representative bid-and-asked prices quoted by the NASDAQ on that day; or (iv) if none of the foregoing provisions is applicable, fair market value as of the date of exercise of the Option shall be determined by the Board of Directors in good faith on such basis as it deems appropriate. In all cases, the determination of fair market value shall be binding and conclusive on all persons. 5. Delivery of Stock Certificates. The Option shall be deemed to have been exercised upon receipt by the Company of the Notice accompanied by the exercise price (the "Exercise Date"). The certificate representing the shares of Common Stock purchased upon exercise of the Option shall be issued as of the Exercise Date and delivered by the Company to the Employee free and clear of all claims, liens and encumbrances, within five days following the Exercise Date or as soon thereafter as practicable. As a condition to the exercise of the Option, the Company may require the Employee to represent and warrant at the time of any such exercise that the shares of Common Stock are being purchased for investment purposes only, for the account of the Employee and without any intention to distribute such shares. If the shares of Common Stock issuable upon exercise of the Option have not previously been registered under the Securities Act of 1933, as amended (the "Securities Act") as contemplated by this Agreement, each certificate evidencing shares of Common Stock acquired upon exercise of the Option shall contain on its face, or on the reverse side thereof, the following legend: "These shares have not been registered under the Securities Act of 1933 or under any applicable state law They may not be offered for sale, sold, transferred, or pledged without (1) registration under the Securities Act of 1933 and any applicable state law, or (2) an opinion (satisfactory to the corporation) that registration is not required" 6. Adjustment Provisions. If, during the term of this Agreement, there shall be any stock dividend, stock rights distribution, stock split, recapitalization, merger, consolidation, sale of assets, reorganization or other similar change or transaction of or by the Company, an appropriate adjustment shall be made to the number and kind of shares remaining to be acquired upon exercise of the Option and to the exercise price of the Option so that the value to be received by the Employee upon exercise of the Option shall, in the aggregate, be the same as if none of the foregoing transactions had occurred. 7. Merger; Consolidation or Sale of Assets. In the event the Company enters into an agreement providing for (i) the sale of all or substantially all of the assets of the Company or (ii) a merger, consolidation or reorganization which would result in the stockholders of the Company immediately prior to such transaction owning less than 50% of the surviving corporation, the Option shall become exercisable in full without regard to any vesting limitations, and the Employee shall be entitled, commencing at least ten days prior to the effective date of such transaction, to exercise the Option in whole or in part, to the extent not previously exercised. 8. Withholding Obligations. In the event that the Company is required to satisfy withholding obligations under the Code as a result of the exercise of the Option, the Employee may request that, in lieu of withholding amounts from the Employee's paycheck or requiring that the Employee write a check to the Company in the amount of the withholding obligation, the Company withhold that number of shares of Common Stock which have a fair market value (determined in accordance with the provisions of the Plan) on the Exercise Date equal to the amount required to be withheld. 9. Non-Transferability. The Option is not transferable or assignable by the Employee other than by will or by the laws of descent and distribution and are exercisable during the lifetime of the Employee only by the Employee. 10. Compliance with Law. By accepting the Option, the Employee agrees for himself and his legal representative that the Company shall not be required to deliver any shares of Common Stock upon the exercise of the Option until such shares have been qualified for delivery under applicable securities laws and regulations as determined by the Company or its legal counsel. 11. Rights as a Stockholder; Not an Employment Agreement. The Employee shall have no rights as a stockholder of the Company with respect to shares of Common Stock subject to the Option until the Option has been exercised and payment made as herein provided and certificates representing the shares as to which the Option has been exercised have been delivered to the Employee. Nothing contained in this Agreement shall be construed to be a contract of employment between the Company and the Employee. 12. Construction. (a) Successors. This Agreement and all the terms and provisions hereof shall be binding upon and shall inure to the benefit of the parties hereto and their respective legal representatives, heirs and successors, except as expressly herein otherwise provided. (b) Entire Agreement Modification. This Agreement contains the entire understanding between the parties with respect to the matters referred to herein, and such agreement shall not be modified, except by written instrument signed by the parties hereto. (c) Headings; Pronouns; Governing Law. The descriptive headings of the respective sections and subsections of this Agreement are inserted for convenience of reference only and shall not be deemed to modify or construe the provisions which follow them. Any use of any masculine pronoun shall include the feminine and vice-versa, and any use of a singular, the plural and vice-versa,, as the context and facts may require. The construction and interpretation of this Agreement shall be governed in all respects by the laws of the State of Delaware. (d) Notices. All communications between the parties shall be in writing and shall be deemed to have been duly given as of the date and time of hand delivery or three days after mailing via certified or registered mail, return receipt requested, proper postage prepaid following or such other addresses of which the parties shall from time to time notify another: If to the Company: Chief Executive Officer First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 If to the Employee: Mr. William McManaman First Health Group Corp. 3200 Highland Avenue Downers Grove, Illinois 60515 IN WITNESS WHEREOF, the parties have executed or caused to be executed this Agreement as of the date first above written. FIRST HEALTH GROUP CORP. ------------------------------------- Edward L. Wristen President and Chief Executive Officer ------------------------------------- William McManaman EX-11 4 exh11.txt COMPUTATION OF EARNINGS PER COMMON SHARE First Health Group Corp. and Subsidiaries EXHIBIT 11 COMPUTATION OF BASIC EARNINGS PER COMMON SHARE (In millions except per share amounts) (Unaudited) ---------------------------------------------------------------------------- Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Net income ..................................... $ 28.8 $ 36.8 ====== ====== Weighted average number of common shares outstanding: Shares outstanding from beginning of period... 91.1 98.7 Other issuances of common stock .............. 0.2 0.4 Purchases of treasury stock .................. -- (2.2) ------ ------ Weighted average common and common share equivalents................................... 91.3 96.9 ====== ====== Net income per common share..................... $ .32 $ .38 ====== ====== First Health Group Corp. and Subsidiaries EXHIBIT 11 COMPUTATION OF DILUTED EARNINGS PER COMMON SHARE (In millions except per share amounts) (Unaudited) Three Months Ended March 31, ---------------------------- 2004 2003 ------ ------ Net income ..................................... $ 28.8 $ 36.8 ====== ====== Weighted average number of common shares outstanding: Shares outstanding from beginning of period 91.1 98.7 Other issuances of common stock .............. 0.2 0.4 Purchases of treasury stock .................. -- (2.2) Common Stock Equivalents: Additional equivalent shares issuable from assumed exercise of common stock options.... 1.6 2.6 ------ ------ Weighted average common and common share equivalents................................... 92.9 99.5 ====== ====== Net income per common share.................... $ .31 $ .37 ====== ====== EX-31.1 5 exh31-1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER Exhibit 31.1 CERTIFICATIONS I, Edward L. Wristen, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q 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: May 10, 2004 /s/ Edward L. Wristen President and Chief Executive Officer EX-31.2 6 exh31-2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER Exhibit 31.2 CERTIFICATIONS I, William R. McManaman, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q 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: May 10, 2004 /s/ William R. McManaman Senior Vice President and Chief Financial Officer EX-32.1 7 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 Quarterly Report of First Health Group Corp. (the "Company") on Form 10-Q for the period ended March 31, 2004, 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 May 10, 2004 EX-32.2 8 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 Quarterly Report of First Health Group Corp. (the "Company") on Form 10-Q for the period ended March 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William R. McManaman, 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/ William R. McManaman William R. McManaman Senior Vice President and Chief Financial Officer May 10, 2004 -----END PRIVACY-ENHANCED MESSAGE-----