Add
FHCC to Portfolio
Set Alert
Email to a
Friend
| |||
|
|
Quotes & Info
|
| FHCC > SEC Filings for FHCC > Form 10-Q on 10-May-2004 | All Recent SEC Filings |
10-May-2004
Quarterly Report
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.
|
|