**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

| **(Mark One)**                                                                                                                                                   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                             |
| **ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                   |
|                                                                                                                                                             |
| **For the quarterly period ended March 31, 2003**                                                                                                                |
|                                                                                                                                                             |
| **OR**                                                                                                                                                           |
|                                                                                                                                                             |
| **o****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   001-13083**                                                                                                                      |

 

**WELLPOINT HEALTH NETWORKS INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                                       |   | **95-4635504**                    |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction of incorporation or organization)                                     |   | (IRS Employer Identification No.) |
|                                                                                               |   |                              |
| **1 WellPoint Way, Thousand Oaks, California**                                                     |   | **91362**                         |
| (Address of principal executive offices)                                                           |   | (Zip Code)                        |
|                                                                                               |   |                              |
| Registrant’s telephone number, including area  code    **(818) 234-4000** |
|                                                                                               |
| **Not Applicable**                                                                                 |
| (Former name, former address and former fiscal year, if changed since  last report)                |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  ý  No  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theSecurities Exchange Act of 1934).  Yes  ý  No  o

 

As of May 7, 2003, there were approximately145,489,834 shares of Common Stock, $0.01 par value of the registrantoutstanding.

 

 

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**WellPoint Health Networks Inc.**

**Quarterly Report on Form 10-Q for the QuarterEnded March 31, 2003**

**Table of Contents**

 
| PART I.  FINANCIAL INFORMATION | 1                                                                                                      |
|-------------------------------------|--------------------------------------------------------------------------------------------------------|
|                                |
| ITEM 1.                             | Financial Statements                                                                                   | 1 |
|                                |
|                                | Consolidated Balance Sheets as of March 31, 2003 and   December 31, 2002                               | 1 |
|                                |                                                                                                   |
|                                | Consolidated Income Statements for the Quarters Ended   March 31, 2003 and 2002                        | 2 |
|                                |                                                                                                   |
|                                | Consolidated Statement of Changes in  Stockholders’ Equity for the   Quarter Ended March 31, 2003 | 3 |
|                                |                                                                                                   |
|                                | Consolidated Statements of Cash Flows for  the Quarters Ended March 31, 2003 and 2002                  | 4 |
|                                |                                                                                                   |
|                                | Notes to Consolidated Financial Statements                                                             | 5 |
|                                |                                                                                                   |
|                                | Report of Independent Accountants                                                                      | 25 |
|                                |
| ITEM 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations            | 26 |
|                                |                                                                                                   |
| ITEM 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                            | 53 |
|                                |                                                                                                   |
| ITEM 4.                             | Controls and Procedures                                                                                | 55 |
|                                |
| PART II.   OTHER INFORMATION   | 56                                                                                                     |
|                                |
| ITEM 1.                             | Legal Proceedings                                                                                      | 56 |
|                                |                                                                                                   |
| ITEM 6.                             | Exhibits and Reports on Form 8-K                                                                       | 56 |
|                                |
| SIGNATURES                          | 57                                                                                                     |
|                                |
| CERTIFICATIONS                      | 58                                                                                                     |
|                                |
| EXHIBIT  INDEX                      | 60                                                                                                     |
|                                     |                                                                                                        |  |  |  |  |  |  |  |  |  |

 

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PART I.FINANCIAL INFORMATION

 

ITEM 1.                       Financial Statements

 

**WellPoint Health Networks Inc.**

Consolidated Balance Sheets

 
| **(In thousands, except share data)**                                                                                      |   | **March 31,  2003** |       | **December  31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|--------|
|                                                                                                                       |   | **(Unaudited)**     |       |                    |   |
| ***ASSETS***                                                                                                               |   |                |       |                    |   |
| Current Assets:                                                                                                            |   |                |       |                    |   |
| Cash and cash equivalents                                                                                                  |   | $                   | 1,679,447  |                    | $      | 1,355,616 |   |
| Investment securities, at market value                                                                                     |   | 5,445,015           |       | 5,282,887               |   |
| Receivables, net                                                                                                           |   | 1,294,028           |       | 1,223,232               |   |
| Deferred tax assets, net                                                                                                   |   | 316,020             |       | 310,245                 |   |
| Other current assets                                                                                                       |   | 234,615             |       | 208,711                 |   |
| Total Current Assets                                                                                                       |   | 8,969,125           |       | 8,380,691               |   |
| Property and equipment, net                                                                                                |   | 348,264             |       | 346,351                 |   |
| Intangible assets, net                                                                                                     |   | 728,397             |       | 737,461                 |   |
| Goodwill, net                                                                                                              |   | 1,693,242           |       | 1,691,771               |   |
| Long-term investments, at market value                                                                                     |   | 136,890             |       | 134,274                 |   |
| Other non-current assets                                                                                                   |   | 177,592             |       | 180,083                 |   |
| Total Assets                                                                                                               |   | $                   | 12,053,510 |                    | $      | 11,470,631 |   |
|                                                                                                                       |   |                |       |                    |   |
| ***LIABILITIES AND STOCKHOLDERS' EQUITY***                                                                                 |   |                |       |                    |   |
| Current Liabilities:                                                                                                       |   |                |       |                    |   |
| Medical claims payable                                                                                                     |   | $                   | 2,508,672  |                    | $      | 2,422,331 |   |
| Reserves for future policy benefits                                                                                        |   | 73,057              |       | 68,907                  |   |
| Unearned premiums                                                                                                          |   | 503,413             |       | 495,508                 |   |
| Accounts payable and accrued expenses                                                                                      |   | 1,103,588           |       | 1,144,662               |   |
| Experience rated and other refunds                                                                                         |   | 247,665             |       | 251,743                 |   |
| Income taxes payable                                                                                                       |   | 263,860             |       | 140,881                 |   |
| Security trades pending payable                                                                                            |   | 503,869             |       | 428,851                 |   |
| Other current liabilities                                                                                                  |   | 925,264             |       | 798,966                 |   |
| Total Current Liabilities                                                                                                  |   | 6,129,388           |       | 5,751,849               |   |
| Accrued postretirement benefits                                                                                            |   | 125,260             |       | 123,042                 |   |
| Reserves for future policy benefits,  non-current                                                                          |   | 222,169             |       | 214,328                 |   |
| Long-term debt                                                                                                             |   | 1,163,565           |       | 1,011,578               |   |
| Deferred tax liabilities                                                                                                   |   | 188,618             |       | 187,020                 |   |
| Other non-current liabilities                                                                                              |   | 205,944             |       | 206,117                 |   |
| Total Liabilities                                                                                                          |   | 8,034,944           |       | 7,493,934               |   |
| Stockholders' Equity:                                                                                                      |   |                |       |                    |   |
| Preferred Stock - $0.01 par value,  50,000,000 shares authorized, none issued and outstanding                              |   | —              |       | —                  |   |
| Common Stock - $0.01 par value, 300,000,000  shares authorized, 149,748,101 issued at March 31, 2003 and December 31, 2002 |   | 1,497               |       | 1,497                   |   |
| Treasury stock, at cost, 4,653,709 and  2,697,958 shares at March 31, 2003 and December 31, 2002, respectively             |   | (304,366            | )          | (173,842                | )      |
| Additional paid-in capital                                                                                                 |   | 1,798,242           |       | 1,812,004               |   |
| Retained earnings                                                                                                          |   | 2,508,307           |       | 2,315,254               |   |
| Accumulated other comprehensive income                                                                                     |   | 14,886              |       | 21,784                  |   |
| Total Stockholders' Equity                                                                                                 |   | 4,018,566           |       | 3,976,697               |   |
| Total Liabilities and Stockholders' Equity                                                                                 |   | $                   | 12,053,510 |                    | $      | 11,470,631 |   |

 

Seethe accompanying notes to the consolidated financial statements.

 

1

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**WellPoint Health Networks Inc.**

ConsolidatedIncome Statements

(Unaudited)

 
|                                               |   | **Quarter  Ended March 31,** |      |
|----------------------------------------------------|--------|------------------------------|-----------|
| **(In thousands, except earnings per share)**      |   | **2003**                     |      | **2002** |   |
| Revenues:                                          |   |                         |      |   |   |
| Premium revenue                                    |   | $                            | 4,548,305 |   | $ | 3,698,659 |   |
| Management services and other revenue              |   | 226,171                      |      | 184,437 |   |
| Investment income                                  |   | 66,315                       |      | 59,914 |   |
|                                               |   | 4,840,791                    |      | 3,943,010 |   |
| Operating Expenses:                                |   |                         |      |   |   |
| Health care services and other benefits            |   | 3,717,500                    |      | 2,982,604 |   |
| Selling expense                                    |   | 191,997                      |      | 155,725 |   |
| General and administrative expense                 |   | 589,669                      |      | 542,089 |   |
|                                               |   | 4,499,166                    |      | 3,680,418 |   |
| Operating Income                                   |   | 341,625                      |      | 262,592 |   |
| Interest expense                                   |   | 12,774                       |      | 16,485 |   |
| Other expense, net                                 |   | 7,004                        |      | 10,923 |   |
| Income before Provision for Income Taxes           |   | 321,847                      |      | 235,184 |   |
| Provision for income taxes                         |   | 128,794                      |      | 94,084 |   |
| Net Income                                         |   | $                            | 193,053   |   | $ | 141,100 |   |
|                                               |   |                         |      |   |   |
| Earnings Per Share                                 |   | $                            | 1.33      |   | $ | 1.01 |   |
| Earnings Per Share Assuming Full Dilution          |   | $                            | 1.29      |   | $ | 0.97 |   |
|                                               |   |                         |      |   |   |
| Weighted Average Shares Outstanding                |   | 145,613                      |      | 139,089 |   |
| Fully Diluted Weighted Average Shares  Outstanding |   | 149,171                      |      | 145,856 |   |

 

Seethe accompanying notes to the consolidated financial statements.

 

2

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**WellPointHealth Networks Inc.**

Consolidated Statement of Changes in Stockholders'Equity

(Unaudited)

 
| **(In thousands)**                                                                                      |       | **Preferred  Stock** |             | **Common  Stock** |       | **Additional  Paid in  Capital** |       | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Income (loss)** |   | **Total** |     |
|---------------------------------------------------------------------------------------------------------|------------|----------------------|------------------|-------------------|------------|----------------------------------|------------|------------------------|--------|------------------------------------------------------|--------|-----------|----------|
|                                                                                                    | **Issued** |                 | **In  Treasury** |              |
|                                                                                                    | **Shares** |                 | **Amount**       |              | **Shares** |                             | **Amount** |                   |
|                                                                                                    |
| Balance as of December 31, 2002                                                                         |       | $                    | —           |              | 149,748    |                             | $          | 1,497                  |   | 2,698                                                |   | $         | (173,842 | ) | $ | 1,812,004 |   | $ | 2,315,254 |   | $ | 21,784 |   | $ | 3,976,697 |   |
| Stock grants to employees and directors                                                                 |       |                 |             |              |       |                             |       | (475                   | )      | 30,690                                               |   |      |     |   |   |   |   | 30,690 |   |
| Stock issued for employee stock option plans                                                            |       |                 |             |              |       |                             |       | (481                   | )      | 31,200                                               |   | 7,856     |     |   |   |   |   | 39,056 |   |
| Stock repurchased, at cost                                                                              |       |                 |             |              |       |                             |       | 2,912                  |   | (192,414                                             | )      |      |     |   |   |   |   | (192,414 | ) |
| Net losses from treasury stock reissued                                                                 |       |                 |             |              |       |                             |       |                   |   |                                                 |   | (21,618   | )        |   |   |   |   | (21,618 | ) |
| Comprehensive income (loss)                                                                             |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     |   |   |   |   |   |   |
| Net income                                                                                              |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     | 193,053 |   |   |   | 193,053 |   |
| Other comprehensive income, net of tax                                                                  |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     |   |   |   |   |   |   |
| Change in unrealized valuation adjustment on investment securities,  net of reclassification adjustment |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     |   |   | (6,898 | ) | (6,898 | ) |
| Total comprehensive income (loss)                                                                       |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     | 193,053 |   | (6,898 | ) | 186,155 |   |
|                                                                                                    |       |                 |             |              |       |                             |       |                   |   |                                                 |   |      |     |   |   |   |   |   |   |
| Balance as of March 31, 2003                                                                            |       | $                    | —           |              | 149,748    |                             | $          | 1,497                  |   | 4,654                                                |   | $         | (304,366 | ) | $ | 1,798,242 |   | $ | 2,508,307 |   | $ | 14,886 |   | $ | 4,018,566 |   |
|                                                                                                         |            |                      |                  |                   |            |                                  |            |                        |        |                                                      |        |           |          |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Seethe accompanying notes to the consolidated financial statements.

 

3

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**WellPoint Health Networks Inc.**

ConsolidatedStatements of Cash Flows

(Unaudited)

 
|                                                                                                                           |   | **Quarter  Ended March 31,** |      |
|--------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-----------|
| **(In thousands)**                                                                                                             |   | **2003**                     |      | **2002** |   |
| **Cash flows from operating activities:**                                                                                      |   |                         |      |   |   |
| Net Income                                                                                                                     |   | $                            | 193,053   |   | $ | 141,100 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:                                             |   |                         |      |   |   |
| Depreciation and amortization, net of  accretion                                                                               |   | 37,835                       |      | 26,398 |   |
| Gain on sales of assets, net                                                                                                   |   | (7,867                       | )         | (9,496 | ) |
| Amortization of deferred gain on sale of  building                                                                             |   | —                       |      | (1,107 | ) |
| Accretion of interest on zero coupon  convertible subordinated debentures and 6 3/8% Notes due 2012 and 6 3/8%  Notes due 2006 |   | 70                           |      | 830 |   |
| (Increase) decrease in certain assets:                                                                                         |   |                         |      |   |   |
| Receivables, net                                                                                                               |   | (169,745                     | )         | (81,186 | ) |
| Other current assets                                                                                                           |   | (26,028                      | )         | (39,452 | ) |
| Other non-current assets                                                                                                       |   | 4,530                        |      | (15,422 | ) |
| Increase (decrease) in certain liabilities:                                                                                    |   |                         |      |   |   |
| Medical claims payable                                                                                                         |   | 86,341                       |      | 138,702 |   |
| Reserves for future policy benefits                                                                                            |   | 11,991                       |      | 5,763 |   |
| Unearned premiums                                                                                                              |   | 7,905                        |      | (36,002 | ) |
| Accounts payable and accrued expenses                                                                                          |   | (40,384                      | )         | 26,795 |   |
| Experience rated and other refunds                                                                                             |   | (4,078                       | )         | 1,403 |   |
| Income taxes payable                                                                                                           |   | 128,836                      |      | 64,450 |   |
| Other current liabilities                                                                                                      |   | 89,143                       |      | 58,074 |   |
| Accrued postretirement benefits                                                                                                |   | 2,218                        |      | 2,600 |   |
| Other non-current liabilities                                                                                                  |   | (173                         | )         | 14,518 |   |
| Net cash provided by operating activities                                                                                      |   | 313,647                      |      | 297,968 |   |
| **Cash flows from investing activities:**                                                                                      |   |                         |      |   |   |
| Investments purchased                                                                                                          |   | (2,046,457                   | )         | (1,697,465 | ) |
| Proceeds from investments sold and matured                                                                                     |   | 2,045,006                    |      | 1,240,286 |   |
| Property and equipment purchased                                                                                               |   | (23,268                      | )         | (28,387 | ) |
| Proceeds from property and equipment sold                                                                                      |   | 117                          |      | 3,463 |   |
| Acquisition of new businesses, net of cash  acquired                                                                           |   | —                       |      | (310,967 | ) |
| Net cash used in investing activities                                                                                          |   | (24,602                      | )         | (793,070 | ) |
| **Cash flows from financing activities:**                                                                                      |   |                         |      |   |   |
| Net repayment of long-term debt under the  revolving credit facility                                                           |   | —                       |      | (10,000 | ) |
| Net borrowing of commercial paper                                                                                              |   | 149,878                      |      | — |   |
| Net borrowing of long-term debt under 6  3/8% Notes due 2012                                                                   |   | —                       |      | 348,905 |   |
| Change in advances on securities lending  deposits                                                                             |   | 37,050                       |      | — |   |
| Proceeds from issuance of Common Stock                                                                                         |   | 40,272                       |      | 67,049 |   |
| Common Stock repurchased                                                                                                       |   | (192,414                     | )         | (122,265 | ) |
| Net cash provided by financing activities                                                                                      |   | 34,786                       |      | 283,689 |   |
| Net increase (decrease) in cash and cash  equivalents                                                                          |   | 323,831                      |      | (211,413 | ) |
| Cash and cash equivalents at beginning of  period                                                                              |   | 1,355,616                    |      | 1,028,476 |   |
| Cash and cash equivalents at end of period                                                                                     |   | $                            | 1,679,447 |   | $ | 817,063 |   |

 

Seethe accompanying notes to the consolidated financial statements.

 

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**WellPoint Health Networks Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.**              **Organization**

 

WellPoint Health Networks Inc. (the “Company” or “WellPoint”) isone of the nation’s largest publicly traded managed health care companies.  As of March 31, 2003, WellPoint had approximately13.5 million medical members and approximately 49.2 million specialtymembers.  Through its subsidiaries, theCompany offers a broad spectrum of network-based managed care plans to thelarge and small employer, individual and senior markets.  The Company’s managed care plans includepreferred provider organizations (“PPOs”), health maintenance organizations(“HMOs”), point-of-service (“POS”) plans and other hybrid plans and traditionalindemnity plans.  In addition, theCompany offers managed care services, including underwriting, actuarialservices, network access, medical management and claims processing. The Companyalso provides a broad array of specialty and other products and servicesincluding pharmacy benefits management, dental, vision, life insurance,preventive care, disability insurance, behavioral health, COBRA and flexiblebenefits account administration.  The Company markets its products in Californiaprimarily under the name Blue Cross of California, in Georgia primarily underthe name Blue Cross Blue Shield of Georgia, in various parts of Missouri(including the greater St. Louis area) under the name Blue Cross Blue Shield ofMissouri and in various parts of the country under the name UNICARE orHealthLink. These products are marketed by the Company’s various operatingsubsidiaries throughout the United States. The Company holds the exclusiveright in California to market its products under the Blue Cross name and markand in Georgia and in 85 counties in Missouri (including the greater St. Louisarea) to market its products under the Blue Cross and Blue Shield names andmarks. The Company’s customer base is diversified, with extensive membershipamong large and small employer groups and individuals and in the Medicare andMedicaid markets.

 

**2.**              **Basis of Presentation**

 

The accompanying unauditedconsolidated financial statements of WellPoint have been prepared in accordancewith accounting principles generally accepted in the United States of America(“GAAP”) and the rules and regulations of the Securities and ExchangeCommission (“SEC”) for interim financial reporting.  In accordance with the rules and regulations of the SEC, certainfootnotes or other financial information have been condensed or omitted if theysubstantially duplicate the disclosures contained in the Company’s annualaudited financial statements.  In theopinion of management, the interim financial statements reflect all materialadjustments (which are of a normal recurring nature) necessary for a fairstatement of its financial position as of March 31, 2003, the results of itsoperations for the quarters ended March 31, 2003 and 2002, its changes instockholders’ equity for the quarter ended March 31, 2003 and its cash flowsfor the quarters ended March 31, 2003 and 2002.  The results of operations for the interim periods presented arenot necessarily indicative of the operating results for the full year.  These unaudited consolidated financialstatements should be read together with the consolidated financial statementsand notes included in the Company’s annual report on Form 10-K for the yearended December 31, 2002. The Company has reclassified certain prior yearamounts in the accompanying unaudited consolidated financial statements toconform to the 2003 presentation.

 

5

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**3.**              **New Accounting Pronouncements**

 

In December 2002, the FASB amended the transition and disclosurerequirements of Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation” (“SFAS No. 123”), through theissuance of Statement of Financial Accounting Standards No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure” (“SFAS No. 148”). SFASNo. 148 amends the disclosures that a company is required to make in its annualand interim financial statements. These disclosures are required regardless ofwhether a company is using the intrinsic value method under APB Opinion No. 25,“Accounting for Stock Issued to Employees” or the fair value based method underSFAS No. 123 to account for its stock-based employee compensation. SFAS No. 148also provides alternative methods of transition for a voluntary change to thefair value based method of accounting for stock-based employee compensation.SFAS No. 148 is effective for fiscal years ending after December 15, 2002. TheCompany plans to continue to account for stock-based employee compensationunder the intrinsic value-based method. The impact of the fair value-basedmethod on reported income is disclosed in Note 8.

 

**4.**              **Acquisitions**

 

On April 30, 2002, the Company completed its acquisition of MethodistCare, Inc. (“MethodistCare”), which served over 70,000 members in the Houston,Texas and surrounding areas at the time of acquisition. This acquisition wasintended to enable UNICARE, WellPoint’s national operating unit, to expand itsproduct line by offering HMO and open-access products in the Gulf Coast andsurrounding regions in Texas, including the greater Houston-Galvestonmetropolitan area. As a result of the acquisition, the Company recognized anextraordinary gain of $8.9 million, or $0.06 per share assuming full dilution,for the year ended December 31, 2002, due to an excess of the fair value of netassets over acquisition costs.

 

On January 31, 2002, WellPoint completed its merger, through its whollyowned subsidiary, RWP Acquisition Corp., with RightCHOICE Managed Care, Inc.(“RightCHOICE”), the parent company of Blue Cross and Blue Shield of Missouri,which served approximately 2.2 million medical members as of January 31, 2002.Under the terms of the transaction, total consideration paid to all holders ofRightCHOICE common stock and holders of employee stock options in the mergerwas approximately $379.1 million in cash and 16.5 million shares of WellPoint CommonStock. The Company issued approximately 11.1 million shares from treasury stockand the remaining 5.4 million shares from newly issued shares of WellPointCommon Stock. The total purchase price of approximately $1,503.7 million wasused to purchase net assets with a fair value of approximately $308.8 million.This acquisition was accounted for under the purchase method of accounting and,accordingly, the consolidated results of operations of the Company include theresults of RightCHOICE from the date of acquisition. As a result of theacquisition of RightCHOICE, the Company incurred $52.6 million in expensesprimarily related to change-in-control payments to RightCHOICE management andtransaction costs.  Generally acceptedaccounting principles require that these

 

6

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expenses,which are not associated with the generation of future revenues and have nofuture economic benefit, be reflected as assumed liabilities in the allocationof the purchase price to the net assets acquired. Goodwill and otherintangibles totaling $1,339.9 millionincludes $108.4 million of deferred and current tax liabilities relating toidentified intangibles. With the adoption of Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”),goodwill and other intangible assets with indefinite useful lives are no longeramortized, but are instead subject to impairment tests. Identified intangibleswith definite useful lives are being amortized on a straight-line basis or thetiming of related cash flows depending upon the expected amortization patternover 15 to 20 years. The purchase price allocation between goodwill andidentifiable intangible assets was $1,073.8 million and $266.1 million,respectively.

 

**5.**              **Goodwill and Other Intangible Assets**

 

The Company adopted SFAS No. 142 on January 1, 2002 and no longeramortizes goodwill and other intangible assets with indefinite useful lives. Inaccordance with SFAS No. 142, the Company completed the transitional evaluationof its goodwill and other intangible assets at January 1, 2002 and the annualevaluation at December 31, 2002, and determined that there was no impairmentloss.

 

The changes in the carrying amount of goodwill by reportable segmentare as follows:

 
| **(In thousands)**                                                                        |   | **Health Care** |      | **Specialty** |   | **Consolidated** |   |
|-------------------------------------------------------------------------------------------|--------|-----------------|-----------|---------------|--------|------------------|--------|
| Balance as of January 1, 2002                                                             |   | $               | 646,375   |          | $      | 14,971           |   | $ | 661,346 |   |
| Goodwill acquired during 2002                                                             |   | 1,074,322       |      | —        |   | 1,074,322        |   |
| Final allocation of Cerulean goodwill and  acquired intangibles                           |   | (47,361         | )         | —        |   | (47,361          | )      |
| Reclassification from other intangible  assets, net of accumulated amortization of $2,005 |   | 3,464           |      | —        |   | 3,464            |   |
| Balance as of December 31, 2002                                                           |   | 1,676,800       |      | 14,971        |   | 1,691,771        |   |
| Final purchase accounting adjustments for  RightCHOICE goodwill                           |   | 1,471           |      | —        |   | 1,471            |   |
| Balance as of March 31, 2003                                                              |   | $               | 1,678,271 |          | $      | 14,971           |   | $ | 1,693,242 |   |

 

On January 31, 2002, WellPoint completed its merger with RightCHOICE asdiscussed in Note 4.  As a result of theacquisition of RightCHOICE, the Company recorded $1,073.8 million of goodwilland $266.1 million of identifiable intangible assets as of March 31, 2003.  The Company assumes no residual value forits amortizable intangible assets.

 

7

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The following table presents details of the acquired amortized andnon-amortized intangible assets of RightCHOICE at cost as of March 31, 2003:

 
| **(In thousands)**                                              |   | **Gross  Carrying  Value** |    | **Useful  Life  (in years)** |       | **Weighted  Average  Useful Life  (in years)** |       |
|-----------------------------------------------------------------|--------|----------------------------|---------|------------------------------|------------|------------------------------------------------|------------|
| Amortized intangible assets:                                    |   |                       |    |                         |       |                                           |       |
| Provider relationships with physicians                          |   | $                          | 4,377   |                         | 20         |                                           | 20.0       |   |
| Customer contracts and related customer  relationships          |   | 90,613                     |    | 16                           |       | 16.0                                           |       |
| Total amortized intangible assets                               |   | 94,990                     |    |                         |       | 16.2                                           |       |
|                                                            |   |                       |    |                         |       |                                           |       |
| Non-amortized intangible assets:                                |   |                       |    |                         |       |                                           |       |
| Provider relationships with hospitals and  ancillary facilities |   | $                          | 5,072   |                         | Indefinite |                                           | Indefinite |   |
| Trade names and service marks                                   |   | 166,000                    |    | Indefinite                   |       | Indefinite                                     |       |
| Total non-amortized intangible assets                           |   | 171,072                    |    |                         |       |                                           |       |
|                                                            |   |                       |    |                         |       |                                           |       |
| Total other intangible assets                                   |   | $                          | 266,062 |                         |       |                                           |       |   |

 

The grosscarrying value, accumulated amortization and net carrying value of otherintangible assets as of March 31, 2003 and December 31, 2002 were as follows:

 

*(In thousands)*
| **As of March 31, 2003**                              |   | **Gross  Carrying  Value** |    | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|-------------------------------------------------------|--------|----------------------------|---------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| Amortized intangible assets:                          |   |                       |    |                          |   |                     |   |                                   |    |
| Provider relationships                                |   | $                          | 29,974  |                          | $      | 4,240                    |   | $                                      | 25,734  |   | 10 to 25 |   |
| Customer contracts and related customer relationships |   | 352,699                    |    | 81,952                        |   | 270,747                  |   | 1.5 to 20                              |    |
| Other                                                 |   | 21,967                     |    | 8,433                         |   | 13,534                   |   | 5 to 20                                |    |
| Total amortized intangible assets                     |   | 404,640                    |    | 94,625                        |   | 310,015                  |   |                                   |    |
|                                                  |   |                       |    |                          |   |                     |   |                                   |    |
| Non-amortized intangible assets:                      |   |                       |    |                          |   |                     |   |                                   |    |
| Provider relationships                                |   | 17,122                     |    | 98                            |   | 17,024                   |   | Indefinite                             |    |
| Trade names and service marks                         |   | 404,000                    |    | 2,642                         |   | 401,358                  |   | Indefinite                             |    |
| Total non-amortized intangible assets                 |   | 421,122                    |    | 2,740                         |   | 418,382                  |   |                                   |    |
|                                                  |   |                       |    |                          |   |                     |   |                                   |    |
| Total other intangible assets                         |   | $                          | 825,762 |                          | $      | 97,365                   |   | $                                      | 728,397 |   |   |   |

 

8

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*(In thousands)*
| **As of December 31, 2002**                            |   | **Gross  Carrying  Value** |    | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|--------------------------------------------------------|--------|----------------------------|---------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| Amortized intangible assets:                           |   |                       |    |                          |   |                     |   |                                   |    |
| Provider relationships                                 |   | $                          | 29,974  |                          | $      | 3,871                    |   | $                                      | 26,103  |   | 10 to 25 |   |
| Customer contracts and related customer  relationships |   | 352,699                    |    | 73,761                        |   | 278,938                  |   | 1.5 to 20                              |    |
| Other                                                  |   | 21,967                     |    | 7,929                         |   | 14,038                   |   | 5 to 20                                |    |
| Total amortized intangible assets                      |   | 404,640                    |    | 85,561                        |   | 319,079                  |   |                                   |    |
|                                                   |   |                       |    |                          |   |                     |   |                                   |    |
| Non-amortized intangible assets:                       |   |                       |    |                          |   |                     |   |                                   |    |
| Provider relationships                                 |   | 17,122                     |    | 98                            |   | 17,024                   |   | Indefinite                             |    |
| Trade names and service marks                          |   | 404,000                    |    | 2,642                         |   | 401,358                  |   | Indefinite                             |    |
| Total non-amortized intangible assets                  |   | 421,122                    |    | 2,740                         |   | 418,382                  |   |                                   |    |
|                                                   |   |                       |    |                          |   |                     |   |                                   |    |
| Total other intangible assets                          |   | $                          | 825,762 |                          | $      | 88,301                   |   | $                                      | 737,461 |   |   |   |

 

For thequarters ended March 31, 2003 and 2002, amortization expense relating tointangible assets was $9.1 million and $8.8 million, respectively.  The following table presents the Company’sestimated annual amortization expense for amortized intangible assets for eachof the years ending December 31, 2003, 2004, 2005, 2006 and 2007 (amounts inthousands). These estimates were calculated based on the gross carrying valueof amortized intangible assets as of March 31, 2003 using the applicableamortization period.

 
| For year ending December 31, 2003 |   | $      | 36,258 |   |
|-----------------------------------|--------|--------|--------|--------|
| For year ending December 31, 2004 |   | 33,839 |   |
| For year ending December 31, 2005 |   | 31,657 |   |
| For year ending December 31, 2006 |   | 27,318 |   |
| For year ending December 31, 2007 |   | 24,394 |   |

 

9

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**6.**              **Long-Term Debt**

 

The carrying amount of theCompany’s long-term indebtedness consisted of the following:

 
| **(In thousands)**       |   | **March 31,  2003** |      | **December 31,  2002** |   |
|--------------------------|--------|---------------------|-----------|------------------------|--------|
|                     |   |                |      |                   |   |
| 6 3/8*%* Notes due 2006  |   | $                   | 464,926   |                   | $      | 462,838 |   |
| 6 3/8*%* Notes due 2012  |   | 349,003             |      | 348,982                |   |
| Commercial paper program |   | 349,636             |      | 199,758                |   |
| Total long-term debt     |   | $                   | 1,163,565 |                   | $      | 1,011,578 |   |

 

*6 3/8% Notes due 2012*

 

On January 16, 2002, theCompany issued $350.0 million aggregate principal amount at maturity of 6 3/8%Notes due January 15, 2012 (the “2012 Notes”). The net proceeds of thisoffering totaled approximately $348.9 million. The net proceeds from the saleof the 2012 Notes were used to partially finance the RightCHOICE mergerdiscussed in Note 4. The 2012 Notes bear interest at a rate of 6 3/8% perannum, payable semi-annually in arrears on January 15 and July 15 of each yearcommencing July 15, 2002. Interest is computed on the basis of a 360-day yearof twelve 30-day months. At March 31, 2003 and December 31, 2002, the Companyhad $349.0 million (based upon the principal amount of $350.0 million lessunamortized discount) of 2012 Notes outstanding. The related interest expenseand amortization of discount and issue costs for the quarters ended March 31,2003 and 2002 totaled $5.7 million and $4.8 million, respectively.

 

The 2012 Notes may beredeemed, in whole or in part, at the Company’s option at any time. Theredemption price for any 2012 Notes redeemed will be equal to the greater ofthe following amounts: 1) 100% of the principal amount of the 2012 Notes beingredeemed on the redemption date; and 2) the sum of the present values of theremaining scheduled payments of principal and interest on the 2012 Notes beingredeemed on that redemption date (not including any portion of any payments ofinterest accrued to the redemption date) discounted to the redemption date on asemiannual basis at the Treasury rate as determined by the Reference TreasuryDealer (J.P. Morgan Securities Inc. or Deutsche Banc Alex Brown or theirrespective successors), plus 25 basis points. In each case, the redemptionprice will also include accrued and unpaid interest on the 2012 Notes to theredemption date.

 

*6 3/8% Notes due 2006*

 

On June 15, 2001, the Companyissued $450.0 million aggregate principal amount at maturity of 6 3/8% Notesdue June 15, 2006 (the “2006 Notes”). The net proceeds of this offering totaledapproximately $449.0 million. The net proceeds from the sale of the 2006 Noteswere used for repayment of indebtedness under the Company’s revolving creditfacilities. The 2006 Notes bear interest at a rate of 6 3/8% per annum, payablesemi-annually in arrears on June 15 and

 

10

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December 15 of each yearcommencing December 15, 2001. Interest is computed on the basis of a 360-dayyear of twelve 30-day months. At March 31, 2003 and December 31, 2002, theCompany had $449.3 million (based upon the principal amount of $450.0 millionless unamortized discount) of 2006 Notes outstanding. The related interestexpense and amortization of discount and issue costs for each of the quartersended March 31, 2003 and 2002 was $7.4 million.

 

The 2006 Notes may beredeemed, in whole or in part, at the Company’s option at any time. Theredemption price for any 2006 Notes redeemed will be equal to the greater ofthe following amounts: 1) 100% of the principal amount of the 2006 Notes beingredeemed on the redemption date; and 2) the sum of the present values of theremaining scheduled payments of principal and interest on the 2006 Notes beingredeemed on that redemption date (not including any portion of any payments ofinterest accrued to the redemption date) discounted to the redemption date on asemi-annual basis at the Treasury rate as determined by the designatedReference Treasury Dealer (Salomon Smith Barney Inc. or UBS Warburg LLC ortheir respective successors), plus 25 basis points. In each case, theredemption price will also include accrued and unpaid interest on the 2006Notes to the redemption date.

 

With the intention ofreducing the interest expense associated with its 2006 Notes, the Company, onJanuary 15, 2002, entered into a $200.0 million notional amount interest rateswap agreement. The swap agreement is a contract to exchange a fixed 6 3/8%rate for a LIBOR-based floating rate. The swap agreement expires June 15, 2006.As of March 31, 2003 and December 31, 2002, the Company recognized a liabilityadjustment, for the change in the fair value of the interest rate swapagreement, of $15.6 million and $13.6 million, respectively, related to the2006 Notes. The Company recognized settlement income of $1.9 million and $1.0million for the quarters ended March 31, 2003 and 2002, respectively, from thisinterest rate swap, which offset the Company’s interest expense (see Note 7). 

 

The 2012 and 2006 Notes areunsecured obligations and rank equally with all of the Company’s existing andfuture senior unsecured indebtedness. All existing and future liabilities ofthe Company’s subsidiaries are and will be effectively senior to the 2012 and2006 Notes. The indenture governing the 2012 and 2006 Notes contains a covenantthat limits the ability of the Company and its subsidiaries to create liens onany of their property or assets to secure certain indebtedness without alsosecuring the indebtedness under the 2012 and 2006 Notes.

 

*Revolving Credit Facility*

 

Effective as of March 30,2001, the Company entered into two unsecured revolving credit facilitiesallowing aggregate indebtedness of $1.0 billion in principal amount. Uponexecution of these facilities (collectively, the “revolving credit facility”),the Company terminated its prior $1.0 billion unsecured revolving facility.Borrowings under these facilities bear interest at rates determined byreference to the bank’s base rate or London InterBank Offered Rate (“LIBOR”)plus a margin determined by reference to the then-current rating of theCompany’s

 

11

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unsecured long-term debt byspecified rating agencies. A facility fee based on the facility amount,regardless of utilization, is payable quarterly. The facility fee rate is alsodetermined by the senior unsecured long-term debt ratings by specified ratingagencies. One facility, which provides for borrowings not to exceed $750.0million at any time outstanding, expires as of March 30, 2006, although it maybe extended for up to two additional one-year periods under certaincircumstances. The other facility, which provides for borrowings not to exceed$250.0 million at any time outstanding, expires on March 26, 2004. Any amountoutstanding under this facility as of March 26, 2004 may be converted into aone-year term loan at the option of the Company and will bear interest at ratesdetermined by reference to the bank’s base rate or LIBOR plus a margindetermined by reference to the then-current rating of the Company’s unsecuredlong-term debt by specified rating agencies, plus 0.125% until paid in full.

 

Loans under the $250.0million facility are made on a committed basis. Loans under the $750.0 millionfacility are made on a committed basis or pursuant to an auction bid process.The $750.0 million facility also contains sublimits for letters of credit and“swingline” loans. Each credit agreement requires the Company to maintaincertain financial ratios and contains restrictive covenants, includingrestrictions on the incurrence of additional indebtedness and the granting ofcertain liens, limitations on acquisitions and investments and limitations onchanges in control. During the year ended December 31, 2002, the Company repaidthe entire outstanding principal balance under the revolving credit facility of$235.0 million at December 31, 2001, which had an effective interest rate atthe time of repayment of 2.76%. This repayment was funded in part by theCompany’s incurrence of indebtedness described below under the heading“Commercial Paper Program.” As of March 31, 2003, the Company had no amountsoutstanding under the revolving credit facility.

 

*Zero Coupon Convertible Subordinated Debentures*

 

On July 2, 1999, the Companyissued $299.0 million aggregate principal amount at maturity of zero couponconvertible subordinated debentures due 2019 (the “Debentures”). The proceedstotaled approximately $200.8 million. The Debentures accreted interest at ayield to maturity of 2.0% per year compounded semi-annually. Holders had theoption to convert the Debentures into the Company’s Common Stock at any timeprior to maturity at a rate of 13.594 shares per $1,000 principal amount atmaturity. In lieu of delivering shares of Common Stock upon conversion of anyDebentures, the Company had the option to pay cash for the Debentures in anamount equal to the last reported sales price of its Common Stock on thetrading day preceding the conversion date. The Debentures were subordinated inright of payment to all existing and future senior indebtedness. On October 6,1999, the Board of Directors authorized the repurchase of some or all of theCompany’s Debentures for cash. The Company did not repurchase any Debenturesduring the year ended December 31, 2001.

 

12

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During 2002,all of the outstanding Debentures were either redeemed by the Company orconverted. Accreted interest related to the Debentures was $0.8 million for thequarter ended March 31, 2002.

 

*Commercial Paper Program*

 

In April 2002, the Company commenceda commercial paper program providing for the issuance of up to $1.0 billion inaggregate maturity value of short-term indebtedness (known generally as“commercial paper”). The commercial paper is being issued by the Companywithout registration under the Securities Act of 1933, as amended (the “1933Act”) in reliance upon the exemption from registration contained in Section4(2) of the 1933 Act. The commercial paper is issued in denominations of$100,000 or integral multiples of $1,000 in excess thereof and will bear suchinterest rates, if interest-bearing, or will be sold at such discount fromtheir face amounts, as agreed upon by the Company and the dealer or dealersacting in connection with the commercial paper program. The commercial paper maybe issued with varying maturities up to a maximum of 270 days from the date ofissuance. As of March 31, 2003 and December 31, 2002, outstanding commercialpaper totaled approximately $349.6 million and $199.8 million, respectively.The average maturity for the commercial paper was 28 days for the quarter endedMarch 31, 2003. The weighted average yield on the outstanding commercial paperas of March 31, 2003 and December 31, 2002 was 1.47% and 1.62%, respectively.The Company intends to maintain commercial paper borrowings of at least theamount outstanding at March 31, 2003 for more than one year. Accordingly, forfinancial reporting purposes, the commercial paper has been classified undernon-current liabilities in the accompanying Consolidated Balance Sheets. Therelated interest expense for the quarter ended March 31, 2003 totaled $1.1million.

 

*Debt Covenants*

 

The Company’s revolvingcredit facility requires the maintenance of certain financial ratios andcontains other restrictive covenants, including restrictions on the incurrenceof additional indebtedness by subsidiaries and the granting of certain liens,limitations on acquisitions and investments and limitations on changes incontrol. As of March 31, 2003 and December 31, 2002, the Company was in compliancewith the requirements in these agreements.

 

 

13

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**7.**              **Hedging Activities**

 

The Company maintains aninterest rate risk management strategy that uses derivative instruments tominimize significant, unanticipated earnings fluctuations caused by interestrate volatility. The Company’s goal is to maintain a balance between fixed andfloating interest rates on its long-term debt.

 

By using derivative financialinstruments to hedge exposures to changes in exchange rates and interest rates,the Company exposes itself to credit risk and market risk. Market risk is theadverse effect on the value of a financial instrument that results from achange in currency exchange rates or interest rates. The Company managesexposure to market risk associated with interest rate contracts by establishingand monitoring parameters that limit the types and degree of market risk thatmay be undertaken.

 

The Company uses interestrate swap agreements to manage interest rate exposures. The principal objectiveof such contracts is to minimize the risks and/or costs associated withfinancial and investing activities. The Company does not use derivativefinancial instruments for speculative purposes. The counterparties to these contractualarrangements are major financial institutions with which the Company also hasother financial relationships. These counterparties expose the Company tocredit loss in the event of non-performance. However, the Company does notanticipate non-performance by the other parties. As of March 31, 2003, theCompany reported a derivative asset of $15.6 million related to a fair valuehedge. The cash flow hedges on the floating rate debt under the revolvingcredit facility were terminated and settled in September 2002 and are discussedin further detail below.

 

*Fair Value Hedges*

 

With the intention ofreducing the interest expense associated with its 2006 Notes, the Company, onJanuary 15, 2002, entered into a $200.0 million notional amount interest rateswap agreement. The swap agreement is a contract to exchange a fixed 6 3/8%rate for a LIBOR-based floating rate. The swap agreement expires June 15, 2006.For the quarters ended March 31, 2003 and 2002, the Company recognized $1.9million and $1.0 million, respectively, of income from this swap agreement,which was recorded as a reduction to interest expense. As of March 31, 2003 andDecember 31, 2002, the Company recognized a derivative asset of $15.6 millionand $13.6 million, respectively, related to this swap agreement.

 

14

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*Cash Flow Hedges*

 

The Company has entered intointerest rate swap agreements to reduce the impact of changes in interest rateson its floating rate debt under its revolving credit facility. The swapagreements are contracts to exchange variable-rate for fixed-rate interestpayments without the exchange of the underlying notional amounts. During thequarter ended March 31, 2002, the Company recognized net gain of $66,000, asreported in the Company’s Consolidated Income Statements, which represented thetotal ineffectiveness of all cash flow hedges during such period.

 

In September 2002, theCompany terminated and settled its $150.0 million and $50.0 million notionalamount interest rate swap agreements with original expiration dates of October17, 2003 and October 17, 2006, respectively. At termination, the Company paid$17.6 million, of which $1.8 million was accrued interest and the remaining$15.8 million represented the fair value of the swap agreements at the time oftermination. The fair value of the swap agreements was reflected in accumulatedother comprehensive income and will be amortized as a reduction to investmentincome on a straight-line basis over the shorter of the original expirationdates of the interest rate swap agreements or the expected cash flows of thecommercial paper program. The fair value of the $150.0 million and $50.0million notional amount swap agreements, at termination, were $8.0 million and$7.8 million, respectively. Amortization of other comprehensive income relatedto the terminated swaps on a pre-tax basis for the quarter ended March 31, 2003totaled $2.4 million, or $1.4 million after-tax. The unamortized amounts inother comprehensive income related to the $150.0 million and $50.0 millionnotional amount swap agreements as of March 31, 2003 totaled $4.3 million and$6.8 million, respectively. The unamortized pre-tax amounts in othercomprehensive income related to the $150.0 million and $50.0 million notionalamount swap agreements as of December 31, 2002 totaled $6.2 million and $7.3million, respectively.

 

In December 2002, the Companydecided to hedge a portion of its unrealized gain on an available-for-saleequity investment by entering into a zero-cost equity collar. The Company’sintent is to limit any cash flow impact caused by any downside price movementin the stock with its anticipated sale. As a result, the Company has designatedthe equity collar as a cash flow hedge. The collar was created by combining apurchased put option with a written call option. As of March 31, 2003, theprice of the equity investment remained within the range of the equity collarand, as a result of the changes in fair value of the option contracts (timevalue), the Company recorded approximately $125,000 of a net derivative assetand a corresponding gain in other comprehensive income.

 

15

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**8.**              **Stock-Based Compensation**

 

At March 31,2003, the Company had three stock-based employee compensation plans: the 1999Stock Incentive Plan, the 2000 Employee Stock Option Plan and the EmployeeStock Purchase Plan. The Company accounts for these plans under the recognitionand measurement principles of APB Opinion No. 25, “Accounting for Stock Issuedto Employees” and related FASB interpretations. Accordingly, compensation costfor stock options under existing plans is measured as the excess, if any, ofthe quoted market price of the Company’s Common Stock at the date of the grantover the amount an employee must pay to acquire the stock. No stock-basedemployee compensation cost is reflected in net income, as all options grantedunder those plans had an exercise price equal to the market value of theunderlying Common Stock on the date of grant.

 

The followingtable illustrates the pro forma effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No.123, “Accounting for Stock-Based Compensation” as amended by Statement ofFinancial Accounting Standards No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure,” for the quarters ended March 31, 2003and 2002.

 
|                                                                                                                                        |   | **Quarter Ended  March 31,**                 |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                                                        |   | **2003**                                     |   | **2002** |   |
|                                                                                                                                        |   | **(In millions, except  per share amounts)** |   |
|                                                                                                                                        |   |                                         |   |   |   |
| Net income—as  reported                                                                                                                |   | $                                            | 193.1  |   | $ | 141.1 |   |
| Less: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (16.8                                        | )      | (12.4 | ) |
| Net income—pro  forma                                                                                                                  |   | $                                            | 176.3  |   | $ | 128.7 |   |
|                                                                                                                                        |   |                                         |   |   |   |
| Earnings per  share—as reported                                                                                                        |   | $                                            | 1.33   |   | $ | 1.01 |   |
| Earnings per  share—pro forma                                                                                                          |   | $                                            | 1.21   |   | $ | 0.93 |   |
| Earnings per  share assuming full dilution—as reported                                                                                 |   | $                                            | 1.29   |   | $ | 0.97 |   |
| Earnings per  share assuming full dilution—pro forma                                                                                   |   | $                                            | 1.18   |   | $ | 0.88 |   |

 

The above proforma disclosures may not be representative of the effects on reported proforma net income for future years.

 

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**9.**              **Earnings Per Share**

 

The followingis an illustration of the dilutive effect of the Company’s potential CommonStock on earnings per share (“EPS”). For the quarters ended March 31, 2003 and2002, there were outstanding stock options to purchase approximately 762,000and 4,788,000 shares of Common Stock, respectively, for which the exerciseprice was greater than the average market per share price of Common Stock during the period presented.Since the effect of these options was antidilutive, they have been excludedfrom the computation of the diluted earnings per share below.

 
|                                                                             |   | **Quarter  Ended  March 31,** |    |
|----------------------------------------------------------------------------------|--------|-------------------------------|---------|
| **(In thousands, except per share data)**                                        |   | **2003**                      |    | **2002** |   |
| **Basic Earnings Per Share Calculation:**                                        |   |                          |    |   |   |
| **Numerator**                                                                    |   |                          |    |   |   |
| Net Income                                                                       |   | $                             | 193,053 |   | $ | 141,100 |   |
|                                                                             |   |                          |    |   |   |
| **Denominator**                                                                  |   |                          |    |   |   |
| Weighted average shares outstanding                                              |   | 145,613                       |    | 139,089 |   |
|                                                                             |   |                          |    |   |   |
| **Earnings Per Share**                                                           |   | $                             | 1.33    |   | $ | 1.01 |   |
|                                                                             |   |                          |    |   |   |
| **Earnings Per Share Assuming Full Dilution  Calculation:**                      |   |                          |    |   |   |
| **Numerator**                                                                    |   |                          |    |   |   |
| Net Income                                                                       |   | $                             | 193,053 |   | $ | 141,100 |   |
| Interest expense on zero coupon convertible  subordinated debentures, net of tax |   | —                        |    | 483 |   |
| Adjusted Net Income                                                              |   | $                             | 193,053 |   | $ | 141,583 |   |
|                                                                             |   |                          |    |   |   |
| **Denominator**                                                                  |   |                          |    |   |   |
| Weighted average shares outstanding                                              |   | 145,613                       |    | 139,089 |   |
| Net effect of dilutive stock options                                             |   | 3,558                         |    | 3,804 |   |
| Assumed conversion of zero coupon  convertible subordinated debentures           |   | —                        |    | 2,963 |   |
| Fully diluted weighted average shares  outstanding                               |   | 149,171                       |    | 145,856 |   |
|                                                                             |   |                          |    |   |   |
| **Earnings Per Share Assuming Full Dilution**                                    |   | $                             | 1.29    |   | $ | 0.97 |   |

 

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**10**.       **Comprehensive Income**

 

The followingsummarizes comprehensive income (loss) reclassification adjustments for thequarters ended March 31, 2003 and 2002:

 
|                                                                                                                  |   | **Quarter Ended March  31,** |    |
|-----------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|
| **(In thousands)**                                                                                                    |   | **2003**                     |    | **2002** |   |
|                                                                                                                  |   |                         |    |   |   |
| Investment  Securities:                                                                                               |   |                         |    |   |   |
| Net  holding loss on investment securities arising during the period, net of tax  benefit of  $6,794 and $31,048 |   | $                            | (10,635 | ) | $ | (50,621 | ) |
| Reclassification  adjustment for realized gain on investment securities, net of tax expense of  $2,455 and $4,516     |   | 3,737                        |    | 6,775 |   |
|                                                                                                                  |   | (6,898                       | )       | (43,846 | ) |
| Cash  Flow Hedges:                                                                                                    |   |                         |    |   |   |
| Holding  gain related to swap transactions, net of tax expense of $1,161                                              |   | —                       |    | 1,676 |   |
|                                                                                                                  |   |                         |    |   |   |
| Other:                                                                                                                |   |                         |    |   |   |
| Net  change in pension liability, net of tax expense of $295                                                          |   | —                       |    | 442 |   |
|                                                                                                                  |   |                         |    |   |   |
| Net  loss recognized in other comprehensive income, net of tax benefit of $4,339  and $25,076                         |   | $                            | (6,898  | ) | $ | (41,728 | ) |

 

 

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**11.**       **Business Segment Information**

 

As a result ofthe January 31, 2002 acquisition of RightCHOICE, the organizational structureof the Company changed effective February 1, 2002. As a result of thesechanges, the Company has the following two reportable segments: Health Care andSpecialty. The Health Care segment is an aggregation of four operating segments:California, Central, Georgia and Senior/State-Sponsored programs. These HealthCare operating segments all have similar characteristics and meet the followingfive aggregation criteria as defined under paragraph 17 of Statement ofFinancial Accounting Standards No. 131, “Disclosures About Segments of anEnterprise and Related Information” (“SFAS No. 131”):

 

(1)   All operating segmentsprovide similar health care products to similar customer types. WellPointgenerally markets the same health care products across the country for each ofits customer groups.

 

(2)   The production processes aresubstantially similar for all operating segments as they support similarcustomer groups and products.

 

(3)   Each operating segment hasthe same class of customers, primarily large employer groups and individual andsmall employer groups.

 

(4)   Each operating segment hassimilar distribution channels that are used for each of the customer types.Large employer group products are distributed primarily through health careconsultants and brokers, while individual and small group products aredistributed through agents or through captive sales forces. These methods aresimilar across geographies.

 

(5)   The health care industry ishighly regulated at both the federal and state levels. All of the geographiesmust comply with the same federal regulations. While each state’s laws are insome respects unique, many states have similar laws and regulations applicableto managed care and insurance companies.

 

The Company’sfocus on regional concentration allows management to understand and meetcustomer needs while effectively managing the cost structure. The Company’schief operating decision maker (Chief Executive Officer) reviews the results ofoperations on a regular basis and holds each Division President accountable forhis or her segment’s operating results. These operating segments comprising theHealth Care segment provide a broad spectrum of network-based health plans,including PPOs, HMOs, POS plans, other hybrid plans and traditional indemnityproducts, to large and small employers and individuals as well as other healthcare-related products, such as vision, preventive care, COBRA and flexiblebenefits account administration. The Specialty business is maintained as a separatesegment providing an array of specialty products, including pharmacy benefitsmanagement, dental, life insurance, disability insurance, behavioral health andworkers’ compensation managed care services. Amounts under the heading“Corporate and Other” include net investment income, general and administrativeexpense and interest expense not allocable to 

 

 

19

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the reportablesegments. Also included in Corporate and Other are the operating results fromthe Company’s captive general insurance agency which has not met thequantitative thresholds for an operating segment under SFAS No. 131. Theoperating results for the Company’s captive general insurance agency werereported in the Health Care segment for the quarter ended March 31, 2002.

 

The accountingpolicies of the segments are consistent with generally accepted accountingprinciples in the United States. The following tables present segmentinformation for the Health Care and Specialty segments for the quarters endedMarch 31, 2003 and 2002, respectively. The amounts for the quarter ended March31, 2002 reflect a new method of cost allocation as reviewed by the chiefoperating decision maker effective January 1, 2003.  As a result of this change, the net income for the Health Caresegment decreased by $14.2 million while the Specialty segment increased by$14.2 million.  In addition, theoperating results by segment for the quarter ended March 31, 2002 have been reclassifiedto conform to a 2003 change in a segment manager’s responsibility.  This change resulted in a $1.3 milliondecrease in management services and other revenue for the Health Care segmentwith a corresponding increase in the Specialty segment.  The related net income decreased by $1.0million for the Health Care segment while the Specialty and Corporate and Othersegments increased by $0.6 million and $0.4 million, respectively.

 

Intersegmentrevenues include internal pharmaceutical sales by the Company's mail orderpharmacy to the Health Care segment's members, utilization review fees(primarily related to behavioral health services) and claims and rebateprocessing fees recognized by the Specialty segment for pharmacy benefitmanagement services provided to the Health Care segment. For the quarter endedMarch 31, 2003, pharmaceutical sales totaled $93.1 million and utilizationreview fees and claims and rebate processing fees totaled $21.6 million. Forthe quarter ended March 31, 2002, pharmaceutical sales totaled $60.6 million.  Utilization review fees and claims andrebate processing fees for the quarter ended March 31, 2002 were not separatelyidentified; estimating such fees would be impractical. All intersegmenttransactions are eliminated in consolidation under the caption “Corporate andOther.”

 

**Quarter Ended March 31, 2003**

 
|                                  |   | **Health** |      |          |   | **Corporate** |   |             |    |
|---------------------------------------|--------|------------|-----------|---------------|--------|---------------|--------|------------------|---------|
|                                  |   | **Care**   |      | **Specialty** |   | **and Other** |   | **Consolidated** |    |
| *(In thousands)*                      |   |       |      |          |   |          |   |             |    |
| Premium revenue                       |   | $          | 4,417,465 |          | $      | 130,840       |   | $                | —  |   | $ | 4,548,305 |   |
| Management services and other revenue |   | 188,534    |      | 36,967        |   | 670           |   | 226,171          |    |
| Total revenue from external customers |   | 4,605,999  |      | 167,807       |   | 670           |   | 4,774,476        |    |
| Intersegment revenues                 |   | —     |      | 114,667       |   | (114,667      | )      | —           |    |
|                                  |   |       |      |          |   |          |   |             |    |
| Segment net income (loss)             |   | $          | 173,040   |          | $      | 31,708        |   | $                | (11,695 | ) | $ | 193,053 |   |

 

**Quarter Ended March 31, 2002**

 
|                                  |   | **Health** |      |          |   | **Corporate** |   |             |   |
|---------------------------------------|--------|------------|-----------|---------------|--------|---------------|--------|------------------|--------|
|                                  |   | **Care**   |      | **Specialty** |   | **and Other** |   | **Consolidated** |   |
| *(In thousands)*                      |   |       |      |          |   |          |   |             |   |
| Premium revenue                       |   | $          | 3,575,725 |          | $      | 122,934       |   | $                | — |   | $ | 3,698,659 |   |
| Management services and other revenue |   | 152,405    |      | 32,032        |   | —        |   | 184,437          |   |
| Total revenue from external customers |   | 3,728,130  |      | 154,966       |   | —        |   | 3,883,096        |   |
| Intersegment revenues                 |   | —     |      | 60,613        |   | (60,613       | )      | —           |   |
|                                  |   |       |      |          |   |          |   |             |   |
| Segment net income (loss)             |   | $          | 130,403   |          | $      | 19,057        |   | $                | (8,360 | ) | $ | 141,100 |   |

 

 

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**12.**       **Related Party Transactions**

 

In December2000, the Company formed The WellPoint Foundation (the “Foundation”), anon-profit organization exempt from federal taxation under Section 501(c)(3) ofthe Internal Revenue Code.  The purposeof the Foundation is to improve the health and well-being of individuals in thecommunities served by the Company and its subsidiaries.  The Foundation’s Board of Directors iscomprised solely of persons who are also officers of the Company. For the quartersended March 31, 2003 and 2002, the Company contributed or committed tocontribute $10.0 million and $15.0 million, respectively, to theFoundation.  As of March 31, 2003 andDecember 31, 2002, the Company did not have any outstanding commitments payableto the Foundation. The Company currently has no legal obligations for anyfuture commitments to the Foundation.

 

**13.**       **Contingencies**

 

From time totime, the Company and certain of its subsidiaries are parties to various legalproceedings, many of which involve claims for coverage encountered in theordinary course of business. The Company, like HMOs and health insurersgenerally, excludes certain health care services from coverage under its HMO,PPO and other plans. The Company is, in its ordinary course of business,subject to the claims of its enrollees arising out of decisions to restricttreatment or reimbursement for certain services. The loss of even one suchclaim, if it results in a significant punitive damage award, could have amaterial adverse effect on the Company. In addition, the risk of potentialliability under punitive damage theories may increase significantly thedifficulty of obtaining reasonable settlements of coverage claims.

 

In June 2000,the California Medical Association filed a lawsuit in U.S. district court inSan Francisco against Blue Cross of California (“BCC”). The lawsuit allegesthat BCC violated the Racketeer Influenced and Corrupt Organizations Act(“RICO”) through various misrepresentations to and inappropriate actions againsthealth care providers. In late 1999, a number of class-action lawsuits werebrought against several of the Company’s competitors alleging, among otherthings, various misrepresentations regarding their health plans and breaches offiduciary obligations to health plan members. In August 2000, the Company wasadded as a party to *Shane v. Humana*,*et al*., a class-action lawsuitbrought on behalf of health care providers nationwide. In addition to the RICOclaims brought in the California Medical Association lawsuit, this lawsuit alsoalleges violations of the Employee Retirement Income Security Act of 1974, asamended (“ERISA”), federal and state “prompt pay” regulations and certaincommon law claims. In October 2000, the federal Judicial Panel on MultidistrictLitigation issued an order consolidating the California Medical Associationlawsuit, the *Shane* lawsuit andvarious other pending managed care class-action lawsuits against othercompanies before District Court Judge Federico Moreno in the Southern Districtof Florida for purposes of the pretrial proceedings. In March 2001, JudgeMoreno dismissed the plaintiffs’ claims based on violation of RICO, althoughthe dismissal was made without prejudice to the plaintiffs’ ability tosubsequently refile their claims. Judge Moreno also dismissed, with prejudice,the plaintiffs’ federal prompt pay law claims. On March 26, 2001, theCalifornia Medical Association filed an amended complaint in its lawsuit,alleging, among other things,

 

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revised RICOclaims and violations of California law. On May 9, 2001, Judge Moreno issued anorder requiring that all discovery in the litigation be completed by December2001, with the exception of discovery related to expert witnesses, which was tobe completed by March 15, 2002. In June 2001, the federal Court of Appeals forthe 11th Circuit issued a stay of Judge Moreno’s discovery order, pending ahearing before the Court of Appeals on the Company’s appeal of its motion tocompel arbitration (which had earlier been granted in part and denied in partby Judge Moreno). The hearing was held in January 2002 and, in March 2002, theCourt of Appeals panel issued an opinion affirming Judge Moreno’s earlieraction with respect to the motion to compel arbitration. The Company filed amotion requesting a rehearing of the matter before the entire 11th CircuitCourt of Appeals, which motion was denied by the 11th Circuit Court of Appealsin June 2002. On July 29, 2002, Judge Moreno issued an order providing thatdiscovery in the case would be allowed to re-commence on September 30, 2002. OnSeptember 26, 2002, Judge Moreno issued an additional order certifying anationwide class of physicians in the *Shane*matter, setting a trial date in May 2003 and ordering the parties toparticipate in non-binding mediation. In October 2002, the Company filed amotion with the 11th Circuit Court of Appeals seeking to appeal Judge Moreno’sclass-certification order. In December 2002, the 11th Circuit granted theCompany’s motion for interlocutory review of the class-certification order. Theparties are currently conducting pre-trial discovery. A mediator has beenappointed by Judge Moreno.

 

In March 2002,the American Dental Association and three individual dentists filed a lawsuitin U.S. district court in Chicago against the Company and BCC. This lawsuitalleges that WellPoint and BCC engaged in conduct that constituted a breach ofcontract under ERISA, trade libel and tortious interference with contractual relationsand existing and prospective business expectancies. The lawsuit seeksclass-action status. The Company filed a motion (which was granted in July2002) with the federal Judicial Panel on Multidistrict Litigation requestingthat the proceedings in this case be consolidated with a similar action broughtagainst other managed care companies that has been consolidated with the *Shane* lawsuit.

 

In July 2001,two individual physicians seeking to represent a class of physicians, hospitalsand other providers brought suit in the Circuit Court of Madison County,Illinois against HealthLink, Inc., which is now a subsidiary of the Company asa result of the acquisition of RightCHOICE. The physicians allege thatHealthLink breached the contracts with these physicians by engaging in thepractices of “bundling” and “down-coding” in its processing and payment ofprovider claims. The relief sought includes an injunction against thesepractices and damages in an unspecified amount. This litigation was dismissedwithout prejudice at the request of the plaintiffs in February 2003. A similarlawsuit was brought by physicians (including one of the physicians in the casedescribed above) in the same court in Madison County, Illinois, on behalf of anationwide class of providers who contract with Blue Cross and Blue Shieldplans against the Blue Cross and Blue Shield Association and another Blue CrossBlue Shield plan. The complaint recites that it is brought against thoseentities and their “unnamed subsidiaries, licensees, and affiliates,” listing alarge number of Blue Cross and Blue Shield plans, including “Alliance BlueCross Blue Shield of Missouri.” The plaintiffs also

 

22

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allege thatthe plans have systematically engaged in practices known as “short paying,”“bundling” and “down-coding” in their processing and payment of subscriberclaims. Blue Cross Blue Shield of Missouri has not been formally named orserved as a defendant in this lawsuit. The Blue Cross and Blue Shield Association was dismissed as a defendantin this lawsuit in August 2002.

 

On March 26, 2003, a lawsuitentitled *Irwin v. AdvancePCS, et al.*was filed in the California Superior Court in Alameda County, California.  WellPoint and certain of its wholly ownedsubsidiaries are named as defendants in the lawsuit.  The Company has not yet been served with the complaint.  The complaint alleges that the defendantsviolated California Business and Professions Code Section 17200 by engaging inunfair, fraudulent and unlawful business practices.  The complaint alleges, among other things, that pharmacy benefitmanagement companies (such as the Company’s subsidiary that does business underthe tradename WellPoint Pharmacy Management) engage in unfair practices, suchas negotiating discounts in prices of drugs from pharmacies and negotiatingrebates from drug manufacturers and retaining such discounts and rebates fortheir own benefit.  The complaint alsoalleges that drugs are included in formularies in exchange for rebates and thatthe defendants charge patient co-payments that exceed the actual cost ofgeneric drugs.

 

Prior to theCompany’s acquisition of the Group Benefits Operations of John Hancock MutualLife Insurance Company (“John Hancock”), John Hancock entered into a number ofreinsurance arrangements with respect to personal accident insurance and theoccupational accident component of workers’ compensation insurance, a portionof which was originated through a pool managed by Unicover Managers, Inc. Underthese arrangements, John Hancock assumed risks as a reinsurer and transferredcertain of such risks to other companies. These arrangements have become thesubject of disputes, including a number of legal proceedings to which JohnHancock is a party. The Company believes that it has a number of defenses toavoid any ultimate liability with respect to these matters and believes thatsuch liabilities were not transferred to the Company as part of the GBOacquisition. However, if the Company were to become subject to suchliabilities, the Company could suffer losses that might have a material adverseeffect on its financial condition, results of operations or cash flows.

 

The financialand operational impact that these and other evolving theories of recovery willhave on the managed care industry generally, or the Company in particular, isat present unknown. Certain of such legal proceedings are or may be coveredunder insurance policies or indemnification agreements. Based upon informationpresently available, the Company believes that the final outcome of all suchproceedings should not have a material adverse effect on the Company’s resultsof operations, cash flows or financial condition.

 

The Companyand its subsidiaries are party to a variety of agreements entered into in theordinary course of business that contain standard indemnity provisionsobligating the Company or such subsidiary to indemnify third parties forcertain costs and expenses incurred by such parties in connection with suchagreements. These agreements include, for example, vendor contracts,underwriting and loan agreements, consulting agreements and agreements

 

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for otherservices, such as custodial arrangements with respect to certain of the Company’sassets. The maximum amount of potential future payments pursuant to thesestandard indemnity provisions cannot be estimated because the amount of costsand expenses that may be incurred by the indemnified parties is unknown.

 

In connectionwith the formation of a joint venture providing Medicaid services in PuertoRico in 2000, the Company agreed under certain circumstances to provideadditional funds to the joint-venture entity. The Company agreed that it wouldmake a capital contribution to the joint venture of up to 80% of any amountnecessary to increase the entity’s capital to meet minimum regulatory capitalrequirements if (i) applicable law or regulation requires an increase in theentity’s capital and the entity does not then have capital sufficient to meetthe increased requirement or (ii) the entity’s medical care ratio is 100% orgreater during any 180-day period and the entity does not then meet statutorycapital requirements under the Puerto Rico Insurance Code. The amount of thisguarantee will not exceed 80% of the amount necessary to provide the entitywith a 12 to 1 premium-to-capital ratio. As of March 31, 2003, the Company’sestimated maximum potential liability pursuant to this guarantee was $26.4million. Since the formation of the joint venture in 2000, the Company has notbeen required to make any payments under this guarantee and the Company doesnot currently expect that any such payments will be made.

 

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Report of Independent Accountants

 

 

To the Stockholders and Boardof Directors of

WellPoint Health Networks Inc.

 

We have reviewed theaccompanying consolidated balance sheet of WellPoint Health Networks Inc. andits subsidiaries (“the Company”) as of March 31, 2003, and the relatedconsolidated income statements for each of the three-month periods ended March31, 2003 and 2002, and the related consolidated statement of changes instockholders’ equity for the three month period ended March 31, 2003 and theconsolidated statements of cash flows for the three month periods ended March31, 2003 and 2002.  These financialstatements are the responsibility of the Company’s management.

 

We conducted our review inaccordance with standards established by the American Institute of CertifiedPublic Accountants.  A review of interimfinancial information consists principally of applying analytical procedures tofinancial data and making inquiries of persons responsible for financial andaccounting matters.  It is substantiallyless in scope than an audit conducted in accordance with generally acceptedauditing standards, the objective of which is the expression of an opinionregarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our review, we are notaware of any material modifications that should be made to the accompanyingconsolidated interim financial statements for them to be in conformity withaccounting principles generally accepted in the United States of America.

 

We previously audited inaccordance with auditing standards generally accepted in the United States ofAmerica, the consolidated balance sheet as of December 31, 2002, and therelated consolidated income statement and consolidated change in stockholders’equity and cash flows for the year then ended (not presented herein), and inour report dated January 31, 2003 except for Note 24 as to which the date isMarch 5, 2003, we expressed an unqualified opinion on those consolidatedfinancial statements.  Our reportincluded an explanatory paragraph, that effective January 1, 2002, the Companyadopted Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*.  Accordingly, the Company ceased amortizinggoodwill and indefinite lived intangible assets as of January 1, 2002.  In our opinion, the information set forth inthe accompanying consolidated balance sheet information as of December 31,2002, is fairly stated in all material respects in relation to the consolidatedbalance sheet from which it has been derived.

 

 
| /s/  PricewaterhouseCoopers LLP |   |
|---------------------------------|--------|
|                            |
| PricewaterhouseCoopers  LLP     |
| Los Angeles,  California        |
| April 22,  2003                 |

 

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ITEM 2.                             Management’sDiscussion and Analysis of Financial Condition and Results of Operations

 

This discussion containsforward-looking statements, which involve risks and uncertainties.  The Company’s actual results may differmaterially from those anticipated in these forward-looking statements as aresult of certain factors including, but not limited to, those set forth under“Factors That May Affect Future Results of Operations.”

 

***General***

 

The Company is one of thenation’s largest publicly traded managed health care companies. As of March 31,2003, WellPoint had approximately 13.5 million medical members andapproximately 49.2 million specialty members. Through its subsidiaries, theCompany offers a broad spectrum of network-based managed care plans to thelarge and small employer, individual, Medicaid and senior markets. The Company’smanaged care plans include PPOs, HMOs, POS plans and other hybrid plans andtraditional indemnity products. In addition, the Company offers managed careservices, including underwriting, actuarial services, network access, medicalmanagement and claims processing. The Company also provides a broad array ofspecialty and other products, including pharmacy benefits management, dental,vision, life insurance, preventive care, disability insurance, behavioralhealth, COBRA and flexible benefits account administration. The Company marketsits products in California primarily under the name Blue Cross of California,in Georgia primarily under the name Blue Cross Blue Shield of Georgia, invarious parts of Missouri (including the greater St. Louis area) under the nameBlue Cross Blue Shield of Missouri and in various parts of the country underthe name UNICARE or HealthLink. The Company holds the exclusive right inCalifornia to market its products under the Blue Cross name and mark and inGeorgia and in 85 counties in Missouri (including the greater St. Louis area)to market its products under the Blue Cross and Blue Shield names and marks.

 

*Acquisition ofMethodistCare*

 

On April 30, 2002, the Companycompleted its acquisition of MethodistCare (see Note 4 to the ConsolidatedFinancial Statements), which served over 70,000 members in Houston, Texas andsurrounding areas at the time of acquisition.

 

*Acquisition ofRightCHOICE*

# * *

On October 17, 2001, theCompany entered into an Agreement and Plan of Merger with RightCHOICE, throughits wholly owned subsidiary, RWP Acquisition Corp. (see Note 4 to theConsolidated Financial Statements). On January 31, 2002, the Company completedthis transaction, pursuant to which RightCHOICE became a wholly ownedsubsidiary of the Company. At closing, the acquisition was valued atapproximately $1.5 billion, which was paid with $379.1 million in cash andapproximately 16.5 million shares of WellPoint Common Stock. RightCHOICE,through its HealthLink subsidiary, also provides network rental, administrativeservices, workers’ compensation managed care services and othernon-underwritten health benefit programs. As of January 31, 2002, RightCHOICEserved approximately 2.2 million medical members in Missouri, Arkansas,Illinois, Indiana, Iowa,

 

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Kentucky and West Virginia.RightCHOICE has historically experienced a higher general and administrativeexpense ratio than the Company’s core businesses due to its higherconcentration of administrative services business.

 

*Pending Acquisitionof CareFirst*

 

On November 20, 2001, WellPointentered into a definitive agreement to acquire CareFirst, which agreement wasamended and restated as of January 24, 2003. CareFirst is a not-for-profithealth care company which, along with its affiliates and subsidiaries, offers acomprehensive portfolio of health insurance products, direct health care andadministrative services to approximately 3.2 million people in Maryland,Delaware, the District of Columbia and Northern Virginia. CareFirst operatesthrough three wholly owned affiliates: CareFirst of Maryland, Inc., GroupHospitalization and Medical Services, Inc., doing business under the nameCareFirst BlueCross BlueShield, and Blue Cross Blue Shield of Delaware, Inc.

 

The consummation of theCareFirst transaction is subject to a number of conditions, including theapproval of the insurance regulators in Maryland, Delaware and the District ofColumbia for the conversion of CareFirst from a non-profit corporation to afor-profit entity. On March 5, 2003, the Maryland insurance commissioner issuedan order disapproving this conversion. The Maryland legislature has 90 days toreview the matter and has the power to veto the commissioner’s decision. TheCompany had 30 days from the date of the commissioner’s order to appeal theorder.  In April 2003, the Companyannounced its decision not to appeal the order.

 

*National Expansion and Other RecentDevelopments*

 

In an effort to pursue theexpansion of the Company’s business outside the state of California, theCompany acquired two businesses in 1996 and 1997, the Life and Health BenefitsManagement Division of Massachusetts Mutual Life Insurance Company and theGroup Benefits Operations (the “GBO”) of John Hancock Mutual Life InsuranceCompany. The acquisitions of Rush Prudential Health Plans and a mail-orderpharmacy, which now does business as PrecisionRx, in 2000, the acquisition ofCerulean Companies, Inc. in 2001 and the acquisitions of RightCHOICE andMethodistCare in 2002 were also components of this expansion strategy.

 

As a result of theseacquisitions, the Company has significantly expanded its operations outside ofCalifornia. In order to integrate its acquired businesses and implement itsregional expansion strategy, the Company will need to develop satisfactorynetworks of hospitals, physicians and other health care service providers,develop distribution channels for its products and successfully convertacquired books of business to the Company’s existing information systems, whichwill require continued investments by the Company.

 

In response to rising medicaland pharmacy costs, the Company has from time to time implemented premiumincreases with respect to certain of its products. The Company will continue toevaluate the need for further premium increases, plan design changes and otherappropriate actions in the future in order to maintain or restore profitmargins. There can be no assurances, however, that the Company will be able totake subsequent pricing or other actions

 

27

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or that any actions previouslytaken or implemented in the future will be successful in addressing anyconcerns that may arise with respect to the performance of certain businesses.

 

## *Legislation*

 

Federal legislation enactedduring the last several years seeks, among other things, to ensure theportability of health coverage and mandates minimum maternity hospital stays.California legislation enacted since 1999, among other things, establishes anexplicit duty on managed care entities to exercise ordinary care in arrangingfor the provision of medically necessary health care services and establishes asystem of independent medical review. In 1997, Texas adopted legislationpurporting to make managed care organizations such as the Company liable fortheir failure to exercise ordinary care when making health care treatmentdecisions. Similar legislation has also been enacted in Georgia. These andother proposed measures may have the effect of dramatically altering theregulation of health care and of increasing the Company’s medical care ratioand administrative costs or decreasing the affordability of the Company’sproducts.

 

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***ConsolidatedResults of Operations***

 

The Company’s revenues areprimarily generated from premiums earned for risk-based health care andspecialty services provided to its members; fees for administrative services,including claims processing and access to provider networks for self-insuredemployers; and investment income. Operating expenses include health careservices and other benefits expenses, consisting primarily of payments forphysicians, hospitals and other providers for health care and specialty productsclaims; selling expenses for broker and agent commissions; general andadministrative expenses; interest expense; depreciation and amortizationexpense; and income taxes.

 

The Company’s consolidatedresults of operations for the quarter ended March 31, 2003 include its acquiredoperations of RightCHOICE for the entire quarter, while operating results forthe quarter ended March 31, 2002 include the results of RightCHOICE fromJanuary 31, 2002, the date of acquisition.

 

The following table sets forthselected operating ratios.  The medicalcare ratio for health care services and other benefits is shown as a percentageof premium revenue.  All other ratiosare shown as a percentage of premium revenue and management services revenuecombined.

 
|                                                         |   | **Quarter  Ended  March 31,** |   |
|--------------------------------------------------------------|--------|-------------------------------|--------|
|                                                         |   | **2003**                      |   | **2002** |   |
| Operating Revenues:                                          |   |                          |   |   |   |
| Premium revenue                                              |   | 95.3                          | %      | 95.3 | % |
| Management services and other revenue                        |   | 4.7                           | %      | 4.7 | % |
|                                                         |   | 100.0                         | %      | 100.0 | % |
| Operating Expenses:                                          |   |                          |   |   |   |
| Health care services and other benefits (medical care ratio) |   | 81.7                          | %      | 80.6 | % |
| Selling expense                                              |   | 4.0                           | %      | 4.0 | % |
| General and administrative expense                           |   | 12.4                          | %      | 14.0 | % |

 

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***Membership***

 

The following table sets forthmembership data and the percent change in membership:

 
| **Medical Membership  (a)(b)(c)(d)** |   | **March 31,**  |       | **Percent  Change** |       |
|--------------------------------------|--------|----------------|------------|---------------------|------------|
|                                 |   | **2003**       |       | **2002 (e)**        |       |   |
| **California**                       |   |           |       |                |       |   |   |
| Large Group                          |   | 4,812,710      |       | 4,437,222           |       | 8.5 | % |
| Individual and  Small Group          |   | 1,653,001      |       | 1,576,809           |       | 4.8 | % |
| Senior                               |   | 246,605        |       | 232,470             |       | 6.1 | % |
|                                 |   |           |       |                |       |   |   |
| Total  California                    |   | 6,712,316      |       | 6,246,501           |       | 7.5 | % |
|                                 |   |           |       |                |       |   |   |
| **Georgia**                          |   |           |       |                |       |   |   |
| Large Group                          |   | 1,646,197      |       | 1,577,508           |       | 4.4 | % |
| Individual and  Small Group          |   | 449,054        |       | 365,294             |       | 22.9 | % |
| Senior                               |   | 69,191         |       | 70,872              |       | -2.4 | % |
|                                 |   |           |       |                |       |   |   |
| Total Georgia                        |   | 2,164,442      |       | 2,013,674           |       | 7.5 | % |
|                                 |   |           |       |                |       |   |   |
| **Central Region (f)**               |   |           |       |                |       |   |   |
| **Missouri**                         |   |           |       |                |       |   |   |
| Large Group                          |   | 1,197,082      |       | 1,143,721           |       | 4.7 | % |
| Individual and  Small Group          |   | 235,779        |       | 228,464             |       | 3.2 | % |
| Senior                               |   | 41,726         |       | 43,585              |       | -4.3 | % |
|                                 |   |           |       |                |       |   |   |
| Total Missouri                       |   | 1,474,587      |       | 1,415,770           |       | 4.2 | % |
| **Illinois**                         |   |           |       |                |       |   |   |
| Large Group                          |   | 574,366        |       | 756,805             |       | -24.1 | % |
| Individual and  Small Group          |   | 113,759        |       | 123,530             |       | -7.9 | % |
| Senior                               |   | 12,497         |       | 12,653              |       | -1.2 | % |
|                                 |   |           |       |                |       |   |   |
| Total Illinois                       |   | 700,622        |       | 892,988             |       | -21.5 | % |
| **Texas**                            |   |           |       |                |       |   |   |
| Large Group                          |   | 323,503        |       | 340,581             |       | -5.0 | % |
| Individual and  Small Group          |   | 187,456        |       | 188,905             |       | -0.8 | % |
| Senior                               |   | 1,260          |       | 511                 |       | 146.6 | % |
|                                 |   |           |       |                |       |   |   |
| Total Texas                          |   | 512,219        |       | 529,997             |       | -3.4 | % |
| **Other States**                     |   |           |       |                |       |   |   |
| Large Group                          |   | 1,763,314      |       | 1,642,564           |       | 7.4 | % |
| Individual and  Small Group          |   | 98,814         |       | 92,230              |       | 7.1 | % |
| Senior                               |   | 24,917         |       | 20,823              |       | 19.7 | % |
|                                 |   |           |       |                |       |   |   |
| Total Other  States                  |   | 1,887,045      |       | 1,755,617           |       | 7.5 | % |
| **Total Medical  Membership**        |   | **13,451,231** | ** ** | **12,854,547**      |       | 4.6 | % |
|                                 |   |           |       |                |       |   |   |
| **ASO Membership (g)**               |   |           | ** ** |                | ** ** |   | ** ** |
| California                           |   | 1,580,422      |       | 1,454,017           |       | 8.7 | % |
| Georgia                              |   | 865,441        |       | 894,569             |       | -3.3 | % |
| Central Region                       |   | 2,709,712      |       | 2,805,355           |       | -3.4 | % |
|                                 |   |           | ** ** |                | ** ** |   | ** ** |
| **Total ASO Membership**             |   | **5,155,575**  | ** ** | **5,153,941**       |       | 0.0 | % |
|                                 |   |           | ** ** |                | ** ** |   | ** ** |
| **Risk Membership**                  |   |           | ** ** |                | ** ** |   | ** ** |
| California                           |   | 5,131,894      |       | 4,792,484           |       | 7.1 | % |
| Georgia                              |   | 1,299,001      |       | 1,119,105           |       | 16.1 | % |
| Central Region                       |   | 1,864,761      |       | 1,789,017           |       | 4.2 | % |
|                                 |   |           | ** ** |                | ** ** |   | ** ** |
| **Total Risk Membership**            |   | **8,295,656**  | ** ** | **7,700,606**       |       | 7.7 | % |
|                                 |   |           | ** ** |                | ** ** |   | ** ** |
| **Total Medical  Membership**        |   | **13,451,231** | ** ** | **12,854,547**      |       | 4.6 | % |

 

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| **State-Sponsored  Programs (h)** |   | **March 31,** |   | **Percent  Change** |   |
|-----------------------------------|--------|---------------|--------|---------------------|--------|
|                              |   | **2003**      |   | **2002**            |   |   |
| Medi-Cal/Medicaid                 |   |          |   |                |   |   |   |
| California                        |   | 835,273       |   | 755,979             |   | 10.5 | % |
| Virginia                          |   | 41,893        |   | 36,841              |   | 13.7 | % |
| Puerto Rico                       |   | 274,723       |   | 212,476             |   | 29.3 | % |
| Other                             |   | 80,776        |   | 62,088              |   | 30.1 | % |
|                              |   |          |   |                |   |   |   |
| Total                             |   | 1,232,665     |   | 1,067,384           |   | 15.5 | % |
|                              |   |          |   |                |   |   |   |
| Healthy Families                  |   | 264,102       |   | 215,159             |   | 22.7 | % |
|                              |   |          |   |                |   |   |   |
| MRMIP / AIM / IHRP                |   | 18,190        |   | 17,509              |   | 3.9 | % |
|                              |   |          |   |                |   |   |   |
| California Kids                   |   | 19,114        |   | 19,908              |   | -4.0 | % |
|                              |   |          |   |                |   |   |   |
| Total                             |   | 1,534,071     |   | 1,319,960           |   | 16.2 | % |

 

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(a)          Membershipnumbers are approximate and include some estimates based upon the number ofcontracts at the relevant date and an actuarial estimate of the number ofmembers represented by the contract.

(b)         Classification betweenstates for employer groups is determined by the zip code of the subscriber.

(c)          Medicalmembership includes management services and network services members, which areprimarily included in the Large Group membership for each state.

(d)         Senior membershipincludes members covered under both Medicare risk and Medicare supplementproducts.

(e)          Medicalmembership numbers as of March 31, 2002 as previously reported by the Companyhave been revised to exclude 164,493 behavioral health members, 9,345 flexiblespending account members and 3,205 dental members associated with theRightCHOICE acquisition.

The revised medical membership numbers also reflect a reduction of12,607 behavioral health members from two Company-owned rental networks.  All of these members were previously reportedas medical members.

(f)            CentralRegion - Large Group membership includes network access services members,primarily from HealthLink, of 1,427,476 and 1,430,910 as of March 31, 2003 andMarch 31, 2002, respectively.

(g)         ASOMembership represents members for which the Company provides administrativeservices only and does not assume full insurance risk.

(h)         Medi-Calmembership is included in California - Large Group.  Medicaid membership for Virginia, Puerto Rico and Other areincluded in Other States - Large Group. Healthy Families, MRMIP (Major Risk Medical Insurance Program) /AIM(Access for Infants and Mothers) / IHRP (Interim High Risk Program) andCalifornia Kids members are included in California - Large Group.

 

***Specialty Membership***

*** ***
|                                    |   | **March 31,** |   | **Percent  Change** |   |
|-----------------------------------------|--------|---------------|--------|---------------------|--------|
|                                    |   | **2003**      |   | **2002**            |   |
|                                    |   |          |   |                |   |   |   |
| Pharmacy Benefits Management            |   | 35,998,130    |   | 27,904,746          |   | 29.0 | % |
| Dental                                  |   | 2,655,528     |   | 2,712,116           | (a)    | -2.1 | % |
| Life/Accidental Death and Dismemberment |   | 2,732,911     |   | 2,317,633           |   | 17.9 | % |
| Disability                              |   | 511,002       |   | 526,430             |   | -2.9 | % |
| Behavioral Health                       |   | 7,307,468     |   | 6,677,986           | (a)    | 9.4 | % |

 

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(a)          Specialtymembership numbers as of March 31, 2002 as previously reported by the Companyhave been revised to include 164,493 behavioral health members and 3,205 dentalmembers associated with the RightCHOICE acquisition. The revised specialtymembership numbers also reflect an addition of 12,607 behavioral health members from two Company-ownedrental networks. All of these members were previously reported as medicalmembers.

 

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***Comparison of Results of Operations for theQuarter Ended March 31, 2003 to the Quarter Ended March 31, 2002***

 

The operating results for thequarter ended March 31, 2003 compared to the quarter ended March 31, 2002 wereimpacted by the RightCHOICE acquisition, which was consummated on January 31,2002. Specifically, the Company’s operating results for the quarterended March 31, 2003 include three months of operating results attributable tothe acquired RightCHOICE business, whereas the Company’s operating results forthe quarter ended March 31, 2002 include only two months (February 2002 andMarch 2002) of operating results attributable to the acquired RightCHOICEbusiness.  In order to provide a moremeaningful comparison of the Company’s results of operations for the firstquarter of 2003 versus the first quarter of 2002, the following discussionpresents financial measures that exclude operating results attributable to theacquired RightCHOICE business for the month of January 2003, which we refer toas “Same-Store.” The Company also uses Same-Store measures for purposes ofreporting comparative financial results to its Board of Directors.

 

As a result of the January 31,2002 acquisition of RightCHOICE, the organizational structure of the Companychanged effective February 1, 2002. As a result of these changes, the Companyhas the following two reportable segments: Health Care and Specialty. (See Note11 to the Consolidated Financial Statements for further discussion.) The HealthCare segment provides a broad spectrum of network-based health plans, includingPPOs, HMOs, POS plans, other hybrid plans and traditional indemnity products,to large and small employers and individuals as well as other healthcare-related products, such as vision, preventive care, COBRA, and flexiblebenefits account administration. The Specialty business is maintained as aseparate segment providing an array of specialty products, including pharmacybenefits management, dental, life insurance, disability insurance, behavioralhealth and workers’ compensation managed care services.

 

The following table depictspremium revenue by reportable segment:

 
| **(In  thousands)** |   | **Quarter Ended****March 31, 2003** |      | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Quarter Ended****March 31, 2003  (Same-Store)** |   | **Quarter Ended****March 31, 2002** |      |
|---------------------|--------|-------------------------------------|-----------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|-------------------------------------|-----------|
| Health Care         |   | $                                   | 4,417,465 |                                                                             | $      | 109,386                                           |   | $                                   | 4,308,079 |   | $ | 3,575,725 |   |
| Specialty           |   | 130,840                             |      | 673                                                                              |   | 130,167                                           |   | 122,934                             |      |
| Consolidated        |   | $                                   | 4,548,305 |                                                                             | $      | 110,059                                           |   | $                                   | 4,438,246 |   | $ | 3,698,659 |   |

 

Premiumrevenue increased 23.0%, or $849.6 million, to $4,548.3 million for the quarterended March 31, 2003 from $3,698.7 million for the quarter ended March 31,2002.  Excluding premium revenueattributable to the acquired RightCHOICE business of $110.1 million for themonth of January 2003, premium revenue increased $739.5 million or 20.0%.  Excluding insured membership attributable tothe acquired RightCHOICE business for the month of January 2003, insured membermonths increased approximately 6.5% for the quarter ended March 31, 2003compared to the quarter ended March 31, 2002. This growth occurred across allregions of the

 

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HealthCare segment, but was more pronounced in the California, Georgia andSenior/State-Sponsored Programs regions of the Health Care segment. In additionto the increase in insured member months, the increase in premium revenue wasalso due to the implementation of premium increases primarily in the Californiaregion of the Health Care segment.

 

The following table depictsmanagement services and other revenue by reportable segment:

 
| **(In  thousands)** |   | **Quarter Ended****March 31, 2003** |    | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Quarter Ended****March 31, 2003  (Same-Store)** |   | **Quarter Ended  March 31, 2002** |    |
|---------------------|--------|-------------------------------------|---------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|-----------------------------------|---------|
| Health Care         |   | $                                   | 188,534 |                                                                             | $      | 13,288                                            |   | $                                 | 175,246 |   | $ | 152,405 |   |
| Specialty           |   | 36,967                              |    | 173                                                                              |   | 36,794                                            |   | 32,032                            |    |
| Corporate and Other |   | 670                                 |    | —                                                                           |   | 670                                               |   | —                            |    |
| Consolidated        |   | $                                   | 226,171 |                                                                             | $      | 13,461                                            |   | $                                 | 212,710 |   | $ | 184,437 |   |

 

Managementservices and other revenue increased 22.7%, or $41.8 million, to$226.2 million for the quarter ended March 31, 2003 from$184.4 million for the quarter ended March 31, 2002. Excluding managementservices and other revenue attributable to the acquired RightCHOICE business of$13.5 million for the month of January 2003, management services and otherrevenue increased $28.3 million or 15.3%. The increases were primarily due toan increase in management services revenue from the California region of $15.4million and the Georgia region of $10.3 million and a $3.3 million increaseattributable to pharmacy benefit management services revenues. These increaseswere slightly offset by a decrease in the Central region after excludingJanuary 2003 management services and other revenue from the acquiredRightCHOICE business.

 

Investmentincome was $66.3 million for the quarter ended March 31, 2003, compared to$59.9 million for the quarter ended March 31, 2002, an increase of $6.4million or 10.7%.  The increase wasprimarily due to net realized gains in the first quarter of 2003 of $6.2million as compared to net realized losses in the first quarter of 2002 of $1.2million. This increase was partially offset by a decrease in gross investmentincome of approximately $0.7 million due to lower investment yields and anincrease in investment manager fees of $0.2 million.

 

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The following table depictshealth care services and other benefits expense by reportable segment:

 
| **(In  thousands)** |   | **Quarter Ended****March 31, 2003** |      | **Less: Acquired  RightCHOICE  Business for One  Month Ended  January 31, 2003** |   | **Quarter Ended****March 31, 2003  (Same-Store)** |   | **Quarter Ended****March 31, 2002** |      |
|---------------------|--------|-------------------------------------|-----------|----------------------------------------------------------------------------------|--------|---------------------------------------------------|--------|-------------------------------------|-----------|
| Health Care         |   | $                                   | 3,616,857 |                                                                             | $      | 85,730                                            |   | $                                   | 3,531,127 |   | $ | 2,897,036 |   |
| Specialty           |   | 100,643                             |      | 334                                                                              |   | 100,309                                           |   | 85,568                              |      |
| Consolidated        |   | $                                   | 3,717,500 |                                                                             | $      | 86,064                                            |   | $                                   | 3,631,436 |   | $ | 2,982,604 |   |

 

Health care services and otherbenefits expense increased 24.6%, or$734.9 million, to $3,717.5 million for the quarter ended March 31,2003 from $2,982.6 million for the quarter ended March 31, 2002. Excludinghealth care services and other benefits expense attributable to RightCHOICE of $86.1 million for the month of January2003, health care services and other benefits expense increased $648.8 million or 21.8%, slightly morethan the increase in premium revenue.

 

The Company’s medical careratio was 81.7% for the quarter ended March 31, 2003 compared to 80.6% for thequarter ended March 31, 2002. The medicalcare ratio attributable to the Health Care segment was 81.9% for the quarterended March 31, 2003, compared to 81.0% for the quarter ended March 31,2002.  The medical care ratioattributable to the Specialty segment was 76.9% for the quarter ended March 31,2003 compared to 69.6% for the quarter ended March 31, 2002. Health careservices and other benefits expense and medical care ratio information isprovided for each segment so investors can compare the performance of eachsegment to the other segment and to the Company as a whole. Excluding premium revenue of $109.4 million andhealth care services and other benefits expense of $85.7 million attributableto the acquired RightCHOICE business with respect to the Health Care segmentfor the month of January 2003, the Company’s medical care ratio attributable tothe Health Care segment for the quarter ended March 31, 2003 increased slightlyto 82.0% compared to 81.0% for the quarter ended March 31, 2002, primarily dueto higher health care services expense per claim, primarily in the Californiaregion of the Health Care segment. The health care services and other benefitsexpense includes an estimate of claims incurred during the period that have notbeen reported to the Company.  Thisestimate is actuarially determined based on a variety of factors and isinherently subject to a number of highly variable circumstances.  Consequently, the actual results coulddiffer materially from the amount recorded in the consolidated financialstatements. See “Critical Accounting Policies” for a discussion of this itemand its potential effect on the Company’s reported results of operations.

 

Sellingexpense consists of commissions paid to outside brokers and agents representingthe Company.  The selling expense ratioremained constant at 4.0% for the quarters ended March 31, 2003 and 2002.Excluding selling expense of $4.7 million and combined premium revenue and

 

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managementservices and other revenue of $123.5 million attributable to the acquiredRightCHOICE business for the month of January 2003, the Company’s sellingexpense ratio remained constant at 4.0% for the quarters ended March 31, 2003and 2002.

 

Thegeneral and administrative expense ratio decreased to 12.4% for the quarterended March 31, 2003 from 14.0% for the quarter ended March 31, 2002. Excludinggeneral and administrative expense of $19.5 million and combined premiumrevenue and management services and other revenue of $123.5 million attributableto the acquired RightCHOICE business for the month of January 2003, theCompany’s general and administrative expense ratio would have decreased to12.3% for the quarter ended March 31, 2003 compared to 14.0% for the quarterended March 31, 2002. The decrease in the general and administrative expenseratio resulted from administrative efficiencies from technology investments andsystems convergence efforts and fixed administrative costs spread over a largermembership base.

 

Interestexpense decreased $3.7 million to $12.8 million for the quarter endedMarch 31, 2003, compared to $16.5 million for the quarter ended March 31,2002.  The decrease in interest expensewas primarily due to the reduction in the weighted average interest rate (whichincludes fees associated with the Company’s borrowings and interest rate swapagreements) for the quarter ended March 31, 2003 of 4.4%, compared to 6.4% forthe quarter ended March 31, 2002.

 

Other expense, net decreased$3.9 million to $7.0 million for the quarter ended March 31, 2003,compared to $10.9 million for the quarter ended March 31, 2002.  Prior to 2003, results of the Company’sinsurance general agency subsidiary were reported on a “net basis” in otherexpense, net.  For the quarter endedMarch 31, 2003, the results have been recorded on a “gross basis” with externalrevenue reported in management services and other revenue, commissions reportedin selling expense and other costs reported in general and administrativeexpense.  The impact of this change is areduction of $3.8 million in other expense, net for the quarter ended March 31,2003.

 

TheCompany’s net income for the quarter ended March 31, 2003 was$193.1 million, compared to $141.1 million for the quarter endedMarch 31, 2002.  Earnings per share totaled$1.33 and $1.01 for the quarters ended March 31, 2003 and 2002,respectively.  Earnings per shareassuming full dilution totaled $1.29 and $0.97 for the quarters ended March 31,2003 and 2002, respectively.

 

Earningsper share for the quarter ended March 31, 2003 is based upon weighted averageshares outstanding of 145.6 million shares, excluding potential common stock,and 149.2 million shares, assuming full dilution.  Earnings per share for the quarter endedMarch 31, 2002 is based upon 139.1 million shares, excluding potential commonstock, and 145.9 million shares, assuming full dilution.  The increase in weighted average sharesoutstanding primarily resulted from the issuance of shares related to the RightCHOICEacquisition and the Company’s employee stock option and purchase plans.

# * *

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# ***FinancialCondition***

 

The Company’s consolidatedassets increased by $582.9 million, or 5.1%, to $12,053.5 million as of March31, 2003 from $11,470.6 million as of December 31, 2002. The increase in totalassets was primarily due to growth in cash and investments of $488.6 million asa result of operating cash flows attributable to net income recognized in thefirst quarter of 2003 and timing of the receipts of receivables and payments ofaccounts payable. Cash and investments totaled $7.3 billion as of March 31,2003, or 60.2% of total assets.

 

Overall claims liabilities,which is comprised of medical claims payable and reserves for future policybenefits, increased $98.3 million, or 3.6%, to $2,803.9 million as of March 31,2003 from $2,705.6 million as of December 31, 2002. This increase was due togrowth in medical members of 228,000 and specialty members of 1.1 million. See“Critical Accounting Policies” for a discussion of medical claims payable andreserves for future policy benefits. As of March 31, 2003, the Company’slong-term indebtedness was $1,163.5 million, of which $464.9 million wasrelated to the Company’s 6 3/8*%*Notes due 2006 (which includes a fair value adjustment of $15.6 million),$349.0 million was related to the Company’s 6 3/8*%* Notes due 2012 and $349.6 million was related to thecommercial paper program. The 6 3/8*%*Notes due 2012, with an aggregate principal amount at maturity of $350.0million, were issued to partially finance the RightCHOICE acquisition. TheCompany’s revolving credit facility indebtedness of $235.0 million at December31, 2001 was repaid during the year ended December 31, 2002, with $200.0million obtained through the commercial paper program and operating cash of$35.0 million. In the first quarter of 2003, the Company issued an additional$149.9 million in commercial paper (net of repayments made during the quarter)to repurchase Common Stock of the Company. (See Note 6 to the ConsolidatedFinancial Statements.)

 

Stockholders’ equity totaled$4,018.6 million as of March 31, 2003, an increase of $41.9 million from$3,976.7 million as of December 31, 2002. The increase was primarily due to netincome of $193.1 million for the quarter ended March 31, 2003 and a netincrease of $69.7 million from the reissuance of treasury stock related to theCompany’s employee 401(k) plan, stock option and stock purchase plans.Partially offsetting these increases were the repurchase of 2.9 million sharesof the Company’s Common Stock for $192.4 million, net losses for the reissuanceof treasury stock of $21.6 million and a net unrealized loss from investmentsecurities of $6.9 million, net of taxes.

 

***Liquidity and Capital Resources***

 

As ofMarch 31, 2003, consolidated cash and investments were $7.3 billion, of which$1.7 billion was in cash and cash equivalents. The Company’s primary sources ofcash are premium and management services revenues and investment income.  The Company’s primary uses of cash includehealth care claims and other benefits, capitation payments, income taxes,repayment and repurchases of long-term debt, interest expense, broker and agentcommissions, administrative expenses, Common Stock repurchases and capitalexpenditures.  In addition to theforegoing, other uses of cash include provider network and systems developmentcosts and costs associated with the integration of acquired businesses.

 

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TheCompany generally receives premium revenue in advance of anticipated claims forrelated health care services and other benefits.  The Company’s investment policies are designed to provide safetyand preservation of capital, sufficient liquidity to meet cash flow needs, theintegration of investment strategy with the business operations and objectivesof the Company, and attainment of a competitive after-tax total return.

 

TheCompany’s strategy for achieving its investment goals is broad diversificationof its investments, both across and within asset classes.  As of March 31, 2003, the Company’sinvestment portfolio consisted primarily of investment grade fixed-incomesecurities.  The Company’s portfolio alsoincluded large capitalization and small capitalization domestic equities, foreignequities, tax-exempt municipal bonds and a small amount of non-investment gradedebt securities.  The fixed-incomeassets include both short and long-duration securities with an attempt to matchthe Company’s funding needs.  TheCompany’s investment policy contains limitations regarding concentration inindividual securities and industries and generally prohibits speculative andleveraged investments.  Cash andinvestment balances maintained by the Company are sufficient to meet applicableregulatory financial stability and net worth requirements, including licenserequirements of the Blue Cross and Blue Shield Association.

 

Cash flowprovided by operating activities was $313.6 million for the quarter endedMarch 31, 2003, compared with $298.0 million for the quarter ended March 31,2002.  Cash flow from operations for thequarter ended March 31, 2003 was due primarily to net income of$193.1 million, an increase in medical claims payable of $86.3 million dueto membership growth and higher health care expenses per claim and an increasein income taxes payable of $128.8 million due to timing in payments to theInternal Revenue Service. Partially offsetting these increases was a decreasein receivables, net of  $169.7 milliondue to timing of cash receipts.

 

Net cashused in investing activities for the quarter ended March 31, 2003 totaled$24.6 million, compared with $793.1 million for the quarter endedMarch 31, 2002.  The cash used in thefirst quarter of 2003 was primarily attributable to the purchase of investmentsof $2.0 billion, and of property and equipment, net of sales proceeds of $23.2million, which were partially offset by proceeds from investments sold of $2.0billion.

 

Net cashprovided by financing activities totaled $34.8 million in the firstquarter of 2003 compared with $283.7 million for the quarter ended March 31,2002.  The net cash provided in thefirst quarter of 2003 was primarily attributable to additional debt of $149.9million incurred to partially finance the $192.4 million repurchase of CompanyCommon Stock, in addition to the receipt of proceeds from the issuance ofCommon Stock related to the Company’s employee stock option plans of $40.3million and additional advances on securities lending deposits of $37.1 millionin the first quarter of 2003.

 

Effective March 30, 2001, theCompany entered into two new unsecured revolving credit facilities allowingaggregate indebtedness of $1.0 billion in principal amount. Upon execution ofthese facilities, the Company terminated its prior $1.0 billion unsecuredrevolving facility. Borrowings under these facilities (which are generallyreferred to collectively in this quarterly report on Form 10-Q as the Company’s“revolving credit facility”) bear interest at rates determined by reference to thebank’s base rate or to the London InterBank Offered Rate

 

37

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(“LIBOR”) plus a margindetermined by reference to the then-current rating of the Company’s seniorunsecured long-term debt by specified rating agencies. One facility, whichprovides for borrowings not to exceed $750.0 million at any time outstanding,expires as of March 30, 2006, although it may be extended for up to twoadditional one-year periods under certain circumstances. The other facility,which provides for borrowings not to exceed $250.0 million at any timeoutstanding, expires on March 26, 2004. Any amount outstanding under thisfacility as of March 26, 2004 may be converted into a one-year term loan at theoption of the Company and will bear interest at rates determined by referenceto the bank’s base rate or LIBOR plus a margin determined by reference to thethen-current rating of the Company’s unsecured long-term debt by specifiedrating agencies, plus 0.125% until paid in full. Loans under the $250.0 millionfacility are made on a committed basis. Loans under the $750.0 million facilityare made on a committed basis or pursuant to an auction bid process. The $750.0million facility also contains sublimits for letters of credit and “swingline”loans. Each credit agreement requires the Company to maintain certain financialratios and contains restrictive covenants, including restrictions on theincurrence of additional indebtedness and the granting of certain liens,limitations on acquisitions and investments and limitations on changes incontrol (see Note 6 to the Consolidated Financial Statements). As of March 31,2003 and December 31, 2002, there were no amounts outstanding under therevolving credit facility.

 

In April 2002, the Companycommenced a commercial paper program providing for the issuance of up to $1.0billion in aggregate maturity value of short-term indebtedness (known generallyas “commercial paper”). The commercial paper is being issued by the Companywithout registration under the Securities Act of 1933, as amended (the “1933Act”) in reliance upon the exemption from registration contained in Section4(2) of the 1933 Act. The commercial paper is issued in denominations of$100,000 or integral multiples of $1,000 in excess thereof and will bear suchinterest rates, if interest-bearing, or will be sold at such discount fromtheir face amounts, as agreed upon by the Company and the dealer or dealersacting in connection with the commercial paper program. The commercial papermay be issued with varying maturities up to a maximum of 270 days from the dateof issuance. The commercial paper ranks equally with all other unsecured andunsubordinated indebtedness of the Company. As of March 31, 2003 and December31, 2002, the outstanding commercial paper borrowings totaled $349.6 millionand $199.8 million, respectively, with various maturity dates and had interestrates ranging from 1.42% to 1.55% as of March 31, 2003 and interest ratesranging from 1.60% to 1.65% as of December 31, 2002. The weighted average yieldon the outstanding commercial paper as of March 31, 2003 and December 31, 2002was 1.47% and 1.62%, respectively. The Company intends to maintain commercialpaper borrowings of at least the amount outstanding at March 31, 2003 for morethan one year. Accordingly, for financial reporting purposes, the commercialpaper has been classified under non-current liabilities in the ConsolidatedFinancial Statements.

 

In anticipation of theRightCHOICE acquisition on January 31, 2002, the Company on January 16, 2002issued $350.0 million aggregate principal amount at maturity of 6 3/8*%* Notes due January 15, 2012 (the “2012Notes”). The net proceeds of this offering totaled approximately $348.9million. The 2012 Notes bear interest at a rate of 6 3/8*%* per annum, payable semi-

 

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annually in arrears on January15 and July 15 of each year commencing July 15, 2002. Interest is computed onthe basis of a 360-day year of twelve 30-day months.

 

The 2012 Notes may be redeemed,in whole or in part, at the Company’s option at any time. The redemption pricefor any 2012 Notes redeemed will be equal to the greater of the followingamounts: 1) 100% of the principal amount of the 2012 Notes being redeemed onthe redemption date; and 2) the sum of the present values of the remainingscheduled payments of principal and interest on the 2012 Notes being redeemedon that redemption date (not including any portion of any payments of interestaccrued to the redemption date) discounted to the redemption date on asemiannual basis at the Treasury rate as determined by the Reference TreasuryDealer (J.P. Morgan Securities Inc. or Deutsche Banc Alex Brown or theirrespective successors), plus 25 basis points. In each case, the redemptionprice will also include accrued and unpaid interest on the 2012 Notes to theredemption date.

 

On June 15, 2001, the Companyissued $450.0 million aggregate principal amount at maturity of 6 3/8*%* Notes due June 15, 2006 (the “2006Notes”). The net proceeds of this offering totaled approximately $449.0million. The net proceeds from the sale of the 2006 Notes were used to repayindebtedness under the Company’s revolving credit facilities. The 2006 Notesbear interest at a rate of 6 3/8*%*per annum, payable semi-annually in arrears on June 15 and December 15 of eachyear commencing December 15, 2001. Interest is computed on the basis of a360-day year of twelve 30-day months.

 

The 2006 Notes may be redeemed,in whole or in part, at the Company’s option at any time. The redemption pricefor any 2006 Notes redeemed will be equal to the greater of the followingamounts: 1) 100% of the principal amount of the 2006 Notes being redeemed onthe redemption date; and 2) the sum of the present values of the remainingscheduled payments of principal and interest on the 2006 Notes being redeemedon that redemption date (not including any portion of any payments of interestaccrued to the redemption date) discounted to the redemption date on a semi-annualbasis at the Treasury rate as determined by the designated Reference TreasuryDealer (Salomon Smith Barney Inc. or UBS Warburg LLC or their respectivesuccessors), plus 25 basis points. In each case, the redemption price will alsoinclude accrued and unpaid interest on the 2006 Notes to the redemption date.

 

The 2006 and 2012 Notes areunsecured obligations and rank equally with all of the Company’s existing andfuture senior unsecured indebtedness. All existing and future liabilities ofthe Company’s subsidiaries are and will be effectively senior to the 2006 and2012 Notes. The indenture governing the 2006 and 2012 Notes contains a covenantthat limits the ability of the Company and its subsidiaries to create liens onany of their property or assets to secure certain indebtedness without alsosecuring the indebtedness under the 2006 and 2012 Notes.

 

On October 2, 2002, the Companyannounced that it had elected to redeem the Debentures as of October 28, 2002.Substantially all of the Debentures were tendered for conversion into theCompany’s Common Stock prior to the redemption date. Approximately $50,000principal amount at maturity of the Debentures were settled in cash. Thisconversion did not have an extraordinary income statement impact. (See Note 6to the Consolidated Financial Statements.)

 

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Prior to the Company’sannouncement of its election to redeem the Debentures, Debentureholders in 2002converted $18.0 million in aggregate principal amount at maturity of theCompany’s Debentures with a carrying value (including accreted interest) of$12.6 million. In lieu of delivering shares of Common Stock upon conversion ofthese Debentures, the Company elected to pay cash of $18.9 million, which resultedin an extraordinary after-tax loss of $3.8 million, as shown on the Company’sConsolidated Income Statements for the year ended December 31, 2002.

 

As a part of a hedging strategyto limit its exposure to variable interest rate increases, the Company has fromtime to time entered into interest rate swap agreements in order to reduce thevolatility of interest expense resulting from changes in interest rates. Theswap agreements are contracts to exchange variable-rate interest payments(weighted average rate for the year ended December 31, 2002 of 2.25%) forfixed-rate interest payments (weighted average rate for the year ended December31, 2002 of 7.08%) without the exchange of the underlying notional amounts. TheCompany had entered into $200.0 million of fixed-rate swap agreements, whichconsisted of a $150.0 million notional amount swap agreement at 6.99% maturingon October 17, 2003 and a $50.0 million notional amount swap agreement at 7.06%maturing on October 17, 2006. In September 2002, the Company terminated thesetwo fixed-rate swap agreements with an aggregate cash settlement of $17.6million, of which $1.8 million was accrued interest and the remaining $15.8million represented the fair value of the swap agreements at the time oftermination and is being amortized over the term of the original swapagreements. As of March 31, 2003, the remaining balance of the swap agreementswas $11.1 million. (See Note 7 to the Consolidated Financial Statements.)

 

In order to reduce the interestexpense associated with the 2006 Notes, the Company, on January 15, 2002,entered into a $200.0 million notional amount interest rate swap agreement,which matures on June 15, 2006. The swap agreement is a contract to exchange afixed 6 3/8*%* rate for aLIBOR-based floating rate (weighted average variable rate of 2.45% for thequarter ended March 31, 2003).

 

Certain of the Company’ssubsidiaries are required to maintain minimum capital requirements prescribedby various regulatory agencies, including the California Department of ManagedHealth Care and the Departments of Insurance in various states, includingGeorgia, Missouri and Delaware. As of March 31, 2003 (or the most recent datewith respect to which compliance is required), those subsidiaries of theCompany were in compliance with all minimum capital requirements.

 

The Company believes that cashflow generated by operations and its cash and investment balances, supplementedby the Company’s ability to borrow under its existing revolving creditfacility, commercial paper program or through public or private financingsources, will be sufficient to fund continuing operations and expected capitalrequirements for the foreseeable future.

 

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# ***CriticalAccounting Policies***

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresthe Company’s management to make a variety of estimates and assumptions. Theseestimates and assumptions affect, among other things, the reported amounts ofassets and liabilities, the disclosure of contingent liabilities and thereported amounts of revenues and expenses. Actual results could differ from theamounts previously estimated, which were based on the information available atthe time the estimates were made.

 

The critical accountingpolicies described below are those that the Company believes are important tothe portrayal of the Company’s financial condition and results of operations,and which require management to make difficult, subjective and/or complexjudgments. Critical accounting policies cover accounting matters that areinherently uncertain because the future resolution of such matters is unknown.The Company believes that critical accounting policies include medical claimspayable, reserves for future policy benefits, goodwill and other intangibleassets and investments.

 

## *Medical ClaimsPayable*

 

Medical claims payable includesclaims in process as well as provisions for the estimate of incurred but notreported claims and provisions for disputed claims obligations. Such estimatesare developed using actuarial principles and assumptions that consider, amongother things, contractual requirements, historical utilization trends andpayment patterns, benefits changes, medical inflation, product mix,seasonality, membership and other relevant factors. In developing its bestestimate of medical claims payable, the Company consistently applies theprinciples and assumptions listed above from year to year, while also givingdue consideration to the potential variability of these factors. Becausemedical claims payable includes various actuarially developed estimates, theCompany’s actual health care services expense may be more or less than theCompany’s previously developed estimates. Claim processing expenses are alsoaccrued based on an estimate of expenses necessary to process such claims. Suchreserves are continually monitored and reviewed, with any adjustments reflectedin current operations.

 

Capitation costs representmonthly fees paid one month in advance to physicians, certain other medicalservice providers and hospitals in the Company’s HMO networks as retainers forproviding continuing medical care. The Company maintains various programs thatprovide incentives to physicians, certain other medical service providers andhospitals participating in its HMO networks through the use of risk-sharingagreements and other programs. Payments under such agreements are made based onthe providers’ performance in controlling health care costs while providingquality health care. Expenses related to these programs, which are based inpart on estimates, are recorded in the period in which the related services arerendered. The Company believes that its reserves for medical claims payable areadequate to satisfy its ultimate claim liability. However, these estimates areinherently subject to a number of highly variable circumstances. Consequently,the actual results could differ materially from the amount recorded in theconsolidated financial statements.

 

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Health care services and otherbenefits expense includes the costs of health care services, capitationexpenses and expenses related to risk-sharing agreements with participatingphysicians, medical groups and hospitals and incurred losses on the Company’sdisability and life products. The costs of health care services are accrued asservices are rendered, including an estimate for claims incurred but not yetreported.

 

For many of the Company’s HMOplans (including substantially all of its California HMO plans), the Companycontracts with physicians, hospitals and other health care providers throughcapitation fee arrangements as a means to manage health care costs. The Companyhas two general types of capitation arrangements. The predominant type is theso-called “professional” capitation arrangement. Under professional capitationarrangements, the Company pays the health care provider, such as aparticipating medical group, a fixed amount per member per month, and thehealth care provider assumes the risk of the member’s utilization of certainspecified health care services. Typically, under professional capitationarrangements, the health care provider does not assume the risk of the member’sutilization of any hospital-based services. The second type is the so-called“global” capitation arrangement. Under global capitation arrangements, theCompany also pays the health care provider, such as a participating medicalgroup, a fixed amount per member per month. However, under global capitationarrangements, the health care provider generally assumes the risk of themember’s utilization of all health care services (subject to certain limitedexceptions and state regulatory requirements). As of March 31, 2003 andDecember 31, 2002, the Company had approximately eight and 10 global capitationarrangements, respectively, covering approximately 166,000 and 179,000 members,respectively. In addition, one of the Company’s subsidiaries owns a 51% equityinterest in a community health partnership network (the “CHPN”) operating inthe greater Atlanta area. The CHPN is a locally based equity venture betweenthe Company’s subsidiary and local physician and hospital groups. The Company’ssubsidiary has entered into a global arrangement with the CHPN. As of March 31,2003 and December 31, 2002, approximately 564,000 and 535,000 members,respectively, were covered by this arrangement.

 

For the quarters ended March31, 2003 and 2002, the Company’s capitation expenses of $393.7 million and$368.9 million, represented 10.6% and 12.4%, respectively, of the Company’stotal health care services and other benefits expense. As of March 31, 2003 andDecember 31, 2002, the Company’s capitation expenses payable of $149.0 million and$137.0 million represented 5.9% and 5.7%, respectively, of the Company’s totalmedical claims payable.

 

The Company’s future results ofoperations will depend in part on its ability to predict and control healthcare costs through underwriting criteria, medical management, product designand negotiation of favorable provider and hospital contracts. The Company’sability to contain such costs may be adversely affected by changes inutilization rates, demographic characteristics, the regulatory environment,health care practices, inflation, new technologies, clusters of high-costcases, continued consolidation of physician, hospital and other providergroups, acts of terrorism and bioterrorism or other catastrophes, including warand numerous other factors. The inability to mitigate any or all of theabove-listed or other factors may adversely affect the Company’s futureprofitability.

## * *

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## *Reserves forFuture Policy Benefits*

 

The estimate of reserves forfuture policy benefits relates to life and disability insurance policieswritten in connection with health care contracts. Reserves for future lifebenefit coverage are based on projections of past experience. Reserves forfuture policy and contract benefits for certain long-term disability productsand group paid-up life products are based upon interest, mortality andmorbidity assumptions from published actuarial tables, modified based upon theCompany’s experience. Reserves are continually monitored and reviewed, and assettlements are made or reserves adjusted, differences are reflected in currentoperations. The current portion of reserves for future policy benefits relatesto the portion of such reserves that the Company expects to pay within oneyear. The Company believes that its reserves for future policy benefits areadequate to satisfy its ultimate benefit liability. However, these estimatesare inherently subject to a number of highly variable circumstances.Consequently, the actual results could differ materially from the amountrecorded in the consolidated financial statements. As of March 31, 2003 andDecember 31, 2002, the reserves for future policy benefits were $295.2 millionand $283.2 million, respectively.

 

## *IntangibleAssets and Goodwill*

 

The Company has made severalacquisitions in the past several years that included a significant amount ofgoodwill and other intangible assets. Under generally accepted accountingprinciples in effect through December 31, 2001, these assets were amortized overtheir useful lives, and were tested periodically to determine if they wererecoverable from operating earnings on an undiscounted basis over their usefullives.

 

In June 2001, the FinancialAccounting Standards Board issued Statement of Financial Accounting StandardsNo. 141, “Business Combinations” (“SFAS No. 141”) and Statement of FinancialAccounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No.142”). SFAS No. 141 requires that all business combinations initiated afterJune 30, 2001 be accounted for using the purchase method. The provisions ofSFAS No. 141 also apply to all business combinations consummated after June 30,2001. SFAS No. 142, which became effective for fiscal years beginning afterDecember 15, 2001, eliminates amortization of goodwill and other intangibleassets with indefinite useful lives. Rather, these assets are subject toimpairment tests at least annually. The Company is required to make estimatesof fair value and apply certain assumptions, such as a discount factor inapplying these annual impairment tests. Such estimates could producesignificantly different results if other assumptions, which could also beconsidered reasonable, were to be used. Intangible assets with definite usefullives are being amortized using a straight-line basis or the timing of relatedcash flows over periods ranging from five to 25 years. An intangible assetsubject to amortization must be reviewed for impairment pursuant to Statementof Financial Accounting Standards No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets.”

 

The Company adopted SFAS No.142 on January 1, 2002 and, accordingly, no longer amortizes goodwill and otherintangible assets with indefinite useful lives. In accordance with SFAS No.142, the Company completed the transitional evaluation of its goodwill andother intangible assets at January 1, 2002 and the annual evaluation atDecember 31, 2002, and

 

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determined that there was noimpairment loss. As of March 31, 2003 and December 31, 2002, total goodwill andother intangible assets were $2.4 billion. (See Note 5 to the ConsolidatedFinancial Statements for further discussion of the Company’s goodwill and otherintangible assets.)

 

## *Investments*

 

As of March 31, 2003, theCompany’s investment securities at market value, totaled $5.4 billion, of which89.7% was invested in fixed-income securities and the remaining 10.3% wasinvested in equity securities. As of December 31, 2002, the Company’s investmentsecurities at market value totaled $5.3 billion, of which 89.6% was invested infixed-income securities and the remaining 10.4% was invested in equitysecurities. These investment securities are generally used to support currentoperations and, accordingly, have been classified as current assets. TheCompany’s long-term investments as of March 31, 2003 and December 31, 2002 were$136.9 million and $134.3 million, respectively, and consisted primarily ofrestricted assets, certain equities and other investments. Total current andlong-term investments comprised 46.3% and 47.2% of total assets as of March 31,2003 and December 31, 2002, respectively.

 

With the majority ofinvestments in fixed-income securities, the Company maintains an investmentportfolio that is primarily structured to maximize investment income whilepreserving the principal asset base and provide a source of liquidity foroperating needs. The Company records investment income when earned, andrealized gains or losses when sold, as determined using the first-in-first-outmethod.

 

The Company regularly evaluatesthe appropriateness of investments relative to its internal investmentguidelines. The Company operates within these guidelines by maintaining awell-diversified portfolio, both across and within asset classes. The Companyhas from time to time retained an independent consultant to advise the Companyon the appropriateness of its investment policy. The Company performs aquarterly evaluation of its investment securities, using both quantitative andqualitative factors to determine whether a decline in investment value isother-than-temporary. When a decline in an investment’s fair value isdetermined to be other-than-temporary, a loss is recorded against investmentincome. When determining whether a decline in an investment’s fair value isother-than-temporary, the Company considers the extent and duration to which asecurity’s market value has been less than its cost, the financial conditionand future earnings potential of the issuer, recommendations and opinions fromoutside investment managers and the current economic environment. For thequarters ended March 31, 2003 and 2002, the Company recorded investment lossesthat the Company believed to be other-than-temporary of approximately $23.9million and $2.2 million, respectively. The Company believes that it hasperformed an adequate review for impairment of the investment portfolio andthat investments are carried at fair value. Changing economic and marketconditions in the future, however, may cause the Company to reassess itsjudgment regarding impairment, which could result in realized losses relatingto other-than-temporary declines being charged against future income.

 

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As of March 31, 2003 andDecember 31, 2002, net unrealized gains from the Company’s fixed-maturitysecurities totaled $175.6 million and $184.5 million, respectively, primarilyresulting from a general decrease in interest rates. The Company had a net unrealizedloss in its equity securities portfolio as of March 31, 2003 and December 31,2002 of $53.2 million and $49.5 million, respectively. The Company believesthat these fluctuations are temporary as a result of current market conditions.

 

***FactorsThat May Affect Future Results of Operations***

 

Certain statements containedherein, such as statements concerning potential or future medical care ratios,pending acquisitions and other statements regarding matters that are nothistorical facts, are forward-looking statements (as such term is defined inthe Securities Exchange Act of 1934, as amended). Such statements involve anumber of risks and uncertainties that could cause actual results to differmaterially from those projected. Factors that could cause actual results todiffer materially from those projected include, but are not limited to, thosediscussed below and those discussed from time to time in the Company’s variousfilings with the Securities and Exchange Commission.

 

The Company’s operations aresubject to substantial regulation by federal, state and local agencies in alljurisdictions in which the Company operates. Many of these agencies haveincreased their scrutiny of managed health care companies in recent periods orare expected to increase their scrutiny as newly passed legislation becomeseffective. From time to time, the Company and its subsidiaries receive requestsfor information from regulatory agencies or are notified that such agencies areconducting reviews, investigations or other proceedings with respect to certainof the Company’s activities. The Company also provides insurance products toMedicare and Medicaid beneficiaries in various states, including to Medi-Calbeneficiaries in various California counties under contracts with the CaliforniaDepartment of Health Services (or delegated local agencies), and providesadministrative services to the Centers for Medicare and Medicaid Services invarious capacities. There can be no assurance that acting as a governmentcontractor in these circumstances will not increase the risk of heightenedscrutiny by such government agencies or that such scrutiny will not have amaterial adverse effect on the Company, either through negative publicity aboutthe Company or through an adverse impact on the Company’s results ofoperations. In addition, profitability from this business may be adverselyaffected by inadequate premium rate increases due to governmental budgetaryissues. Future actions by any regulatory agencies may have a material adverseeffect on the Company’s business.

 

In connection with theRightCHOICE and Cerulean transactions, the Company incurred significantadditional indebtedness to fund the cash payments made to the acquiredcompanies’ stockholders. In addition, the Company may incur additionalindebtedness to fund potential future acquisitions. This existing or newindebtedness may result in a significant percentage of the Company’s cash flowbeing applied to the payment of interest, and there can be no assurance thatthe Company’s operations will generate sufficient future cash flow to servicethis indebtedness. The Company’s current indebtedness, as well as anyindebtedness that the Company may incur in the future (such as indebtednessincurred to fund repurchases of its Common Stock or to fund potential futureacquisitions), may adversely affect the Company’s 

 

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ability to finance itsoperations and could limit the Company’s ability to pursue businessopportunities that may be in the best interests of the Company and itsstockholders.

 

As part of the Company’sbusiness strategy, the Company has acquired substantial operations in newgeographic markets over the last seven years. These businesses, some of whichinclude substantial indemnity-based insurance operations, have experiencedvarying profitability or losses in recent periods. Since the relevant dates ofacquisition of Cerulean, RightCHOICE and MethodistCare, the Company hascontinued to work extensively on the integration of these businesses. However,there can be no assurances regarding the ultimate success of the Company’sintegration efforts or regarding the ability of the Company to maintain orimprove the results of operations of the acquired businesses. The Company has incurredand will, among other things, need to continue to incur considerableexpenditures for provider networks, distribution channels and informationsystems in addition to the costs associated with the integration of theseacquisitions. The integration of these complex businesses may result in, amongother things, temporary increases in claims inventory or other service-relatedissues that may negatively affect the Company’s relationship with its customersand contribute to increased attrition of such customers. The Company’s resultsof operations could be adversely affected in the event that the Companyexperiences such problems or is otherwise unable to implement fully itsexpansion strategy.

 

The Company and certain of itssubsidiaries are subject to capital surplus requirements by the CaliforniaDepartment of Managed Health Care, the California, Delaware, Georgia andMissouri Departments of Insurance, various other state Departments of Insuranceand the Blue Cross and Blue Shield Association. Although the Company believesthat it is currently in compliance in all material respects with all applicablerequirements, there can be no assurances that applicable requirements will notbe increased in the future.

 

From time to time, the Companyand certain of its subsidiaries are parties to various legal proceedings, manyof which involve claims for coverage encountered in the ordinary course ofbusiness. The Company, like HMOs and health insurers generally, excludescertain health care services from coverage under its HMO, PPO and other plans.The Company is, in its ordinary course of business, subject to the claims ofits enrollees arising out of decisions to restrict treatment or reimbursementfor certain services. The loss of even one such claim, if it results in asignificant punitive damage award, could have a material adverse effect on theCompany. In addition, the risk of potential liability under punitive damagetheories may increase significantly the difficulty of obtaining reasonablesettlements of coverage claims.

 

In June 2000, the CaliforniaMedical Association filed a lawsuit in U.S. district court in San Franciscoagainst Blue Cross of California (“BCC”). The lawsuit alleges that BCC violatedthe Racketeer Influenced and Corrupt Organizations Act (“RICO”) through variousmisrepresentations to and inappropriate actions against health care providers.In late 1999, a number of class-action lawsuits were brought against several ofthe Company’s competitors alleging, among other things, various misrepresentationsregarding their health plans and breaches of fiduciary obligations to healthplan members. In August 2000, the Company was added as a party to *Shane v. Humana*, *et al*., a class-action lawsuit brought onbehalf of health care providers nationwide. In addition to the RICO claimsbrought in the California Medical

 

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Association lawsuit, thislawsuit also alleges violations of the Employee Retirement Income Security Actof 1974, as amended (“ERISA”), federal and state “prompt pay” regulations andcertain common law claims. In October 2000, the federal Judicial Panel onMultidistrict Litigation issued an order consolidating the California MedicalAssociation lawsuit, the *Shane*lawsuit and various other pending managed care class-action lawsuits againstother companies before District Court Judge Federico Moreno in the SouthernDistrict of Florida for purposes of the pretrial proceedings. In March 2001,Judge Moreno dismissed the plaintiffs’ claims based on violation of RICO,although the dismissal was made without prejudice to the plaintiffs’ ability tosubsequently refile their claims. Judge Moreno also dismissed, with prejudice,the plaintiffs’ federal prompt pay law claims. On March 26, 2001, the CaliforniaMedical Association filed an amended complaint in its lawsuit, alleging, amongother things, revised RICO claims and violations of California law. On May 9,2001, Judge Moreno issued an order requiring that all discovery in thelitigation be completed by December 2001, with the exception of discoveryrelated to expert witnesses, which was to be completed by March 15, 2002. InJune 2001, the federal Court of Appeals for the 11th Circuit issued a stay ofJudge Moreno’s discovery order, pending a hearing before the Court of Appealson the Company’s appeal of its motion to compel arbitration (which had earlierbeen granted in part and denied in part by Judge Moreno). The hearing was heldin January 2002 and, in March 2002, the Court of Appeals panel issued an opinionaffirming Judge Moreno’s earlier action with respect to the motion to compelarbitration. The Company filed a motion requesting a rehearing of the matterbefore the entire 11th Circuit Court of Appeals, which motion was denied by the11th Circuit Court of Appeals in June 2002. On July 29, 2002, Judge Morenoissued an order providing that discovery in the case would be allowed tore-commence on September 30, 2002. On September 26, 2002, Judge Moreno issuedan additional order certifying a nationwide class of physicians in the *Shane* matter, setting a trial date in May2003 and ordering the parties to participate in non-binding mediation. InOctober 2002, the Company filed a motion with the 11th Circuit Court of Appealsseeking to appeal Judge Moreno’s class-certification order. In December 2002,the 11th Circuit granted the Company’s motion for interlocutory review of theclass-certification order. The parties are currently conducting pre-trialdiscovery. A mediator has been appointed by Judge Moreno.

 

In March 2002, the AmericanDental Association and three individual dentists filed a lawsuit in U.S.district court in Chicago against the Company and BCC. This lawsuit allegesthat WellPoint and BCC engaged in conduct that constituted a breach of contractunder ERISA, trade libel and tortious interference with contractual relationsand existing and prospective business expectancies. The lawsuit seeksclass-action status. The Company filed a motion (which was granted in July2002) with the federal Judicial Panel on Multidistrict Litigation requestingthat the proceedings in this case be consolidated with a similar action broughtagainst other managed care companies that has been consolidated with the *Shane* lawsuit.

 

In July 2001, two individualphysicians seeking to represent a class of physicians, hospitals and otherproviders brought suit in the Circuit Court of Madison County, Illinois againstHealthLink, Inc., which is now a subsidiary of the Company as a result of theacquisition of RightCHOICE. The physicians allege that HealthLink breached thecontracts with these physicians by engaging in the practices of “bundling” and“down-coding” in its processing and payment of provider claims. The reliefsought includes an injunction against these practices

 

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and damages in an unspecifiedamount. This litigation was dismissed without prejudice at the request of theplaintiffs in February 2003. A similar lawsuit was brought by physicians(including one of the physicians in the case described above) in the same courtin Madison County, Illinois, on behalf of a nationwide class of providers whocontract with Blue Cross and Blue Shield plans against the Blue Cross and BlueShield Association and another Blue Cross Blue Shield plan. The complaintrecites that it is brought against those entities and their “unnamedsubsidiaries, licensees, and affiliates,” listing a large number of Blue Crossand Blue Shield plans, including “Alliance Blue Cross Blue Shield of Missouri.”The plaintiffs also allege that the plans have systematically engaged inpractices known as “short paying,” “bundling” and “down-coding” in theirprocessing and payment of subscriber claims. Blue Cross Blue Shield of Missourihas not been formally named or served as a defendant in this lawsuit.  The Blue Cross and Blue Shield Associationwas dismissed as a defendant in this lawsuit in August 2002.

 

On March 26, 2003, a lawsuit entitled *Irwinv. AdvancePCS, et al.* was filed in the California Superior Court inAlameda County, California.  WellPointand certain of its wholly owned subsidiaries are named as defendants in thelawsuit.  The Company has not yet beenserved with the complaint.  Thecomplaint alleges that the defendants violated California Business andProfessions Code Section 17200 by engaging in unfair, fraudulent and unlawfulbusiness practices.  The complaintalleges, among other things, that pharmacy benefit management companies (suchas the Company’s subsidiary that does business under the tradename WellPointPharmacy Management) engage in unfair practices such as negotiating discountsin prices of drugs from pharmacies and negotiating rebates from drugmanufacturers and retaining such discounts and rebates for their own benefit.  The complaint also alleges that drugs areincluded in formularies in exchange for rebates and that the defendants chargepatient co-payments that exceed the actual cost of generic drugs.

 

The Company’s future resultswill depend in part on its ability to accurately predict health care costs andto control future health care costs through product and benefit design,underwriting criteria, medical management and negotiation of favorable providercontracts. Changes in utilization rates, demographic characteristics, the regulatoryenvironment and health care practices, inflation, newpharmaceuticals/technologies, clusters of high-cost cases and numerous otherfactors are beyond the control of any health plan provider and may adverselyaffect the Company’s ability to predict and control health care costs andclaims, as well as the Company’s financial condition, results of operations orcash flows. Periodic renegotiations of hospital and other provider contracts,coupled with continued consolidation of physician, hospital and other providergroups, may result in increased health care costs and limit the Company’sability to negotiate favorable rates. In recent years, large physician practicemanagement companies have experienced extreme financial difficulties, includingbankruptcy, which may subject the Company to increased credit risk related toprovider groups and cause the Company to incur duplicative health care servicesexpense. Additionally, the Company faces competitive pressure to containpremium prices. Fiscal concerns regarding the continued viability ofgovernment-sponsored programs such as Medicare and Medicaid may causedecreasing reimbursement rates for these programs. Any limitation on theCompany’s ability to increase or maintain its premium levels, design products, implementunderwriting criteria or negotiate competitive provider contracts may adverselyaffect the Company’s financial condition or results of operations.

 

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Managed care organizations,both inside and outside California, operate in a highly competitive environmentthat has undergone significant change in recent years as a result of businessconsolidations, new strategic alliances, aggressive marketing practices bycompetitors and other market pressures. Additional increases in competition(including competition from market entrants offering Internet-based productsand services) could adversely affect the Company’s financial condition, cashflows or results of operations.

 

The Company is dependent on theservices of independent agents and brokers in the marketing of its health careplans, particularly with respect to individuals, seniors and small employergroup members. Such independent agents and brokers are typically notexclusively dedicated to the Company and may frequently also market health careplans of the Company’s competitors. The Company faces intense competition forthe services and allegiance of independent agents and brokers.

 

As a result of the Company’sacquisitions, the Company operates on a select geographic basis nationally andoffers a spectrum of health care and specialty products through variousrisk-sharing arrangements. The Company’s health care products include a varietyof managed care offerings as well as traditional fee-for-service coverage. Withrespect to product type, fee-for-service products are generally less profitablethan managed care products. A component of the Company’s expansion strategy isto transition over time the traditional insurance members of the Company’s acquiredbusinesses to more managed care products.

 

With respect to therisk-sharing nature of products, managed care products that involve greaterpotential risk to the Company generally tend to be more profitable thanmanagement services products and those managed care products where the Companyis able to shift risks to employer groups. Individuals and small employergroups are more likely to purchase the Company’s higher-risk managed careproducts because such purchasers are generally unable or unwilling to beargreater liability for health care expenditures. Typically, government-sponsoredprograms involve the Company’s higher-risk managed care products. Over the pastfew years, the Company has experienced a slight decline in margins in itshigher-risk managed care products and to a lesser extent on its lower-riskmanaged care and management services products. This decline is primarilyattributable to product mix change, product design, competitive pressure andgreater regulatory restrictions applicable to the small employer group market.From time to time, the Company has implemented price increases in certain ofits managed care businesses. While these price increases are intended toimprove profitability, there can be no assurance that this will occur. Subsequentunfavorable changes in the relative profitability between the Company’s variousproducts could have a material adverse effect on the Company’s results ofoperations and on the continued merits of the Company’s geographic expansionstrategy.

 

One of the Company’s whollyowned subsidiaries operates as a pharmacy benefit manager (“PBM”) under thetrade name WellPoint Pharmacy Management. The PBM industry faces a number ofrisks and uncertainties in addition to those facing the Company’s core healthplan business. Such risks and uncertainties include the application of federaland state anti-remuneration laws (generally known as “anti-kickback” laws),whether PBMs operate as

 

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fiduciaries under the EmployeeRetirement Income Security Act of 1974 (“ERISA”) and are in compliance withtheir fiduciary obligations under ERISA in connection with the development andimplementation of items such as formularies, preferred drug listings andtherapeutic intervention programs, and potential liability regarding the use ofpatient-identifiable medical information. In addition, a number of federal andstate legislative proposals are being considered that could affect a variety ofPBM industry practices, such as the receipt of rebates from pharmaceuticalmanufacturers. The Company believes that its PBM business is currently beingconducted in compliance in all material respects with applicable legalrequirements. However, there can be no assurance that the Company’s PBM businesswill not be subject to challenge under various laws and regulations, or thatany such challenge will not have a material adverse effect upon the Company’sresults of operations or financial condition. In addition, future legislativeenactments affecting the PBM industry could have a material adverse effect uponthe Company’s results of operations and financial condition.

 

Substantially all of theCompany’s investment assets are in interest-yielding debt securities of varyingmaturities or equity securities. The value of fixed-income securities is highlysensitive to fluctuations in short- and long-term interest rates, with thevalue decreasing as such rates increase and increasing as such rates decrease.In addition, the value of equity securities can fluctuate significantly withchanges in market conditions. Changes in the value of the Company’s investmentassets, as a result of interest rate fluctuations, can affect the Company’sresults of operations and stockholders’ equity. There can be no assurances thatinterest rate fluctuations will not have a material adverse effect on theresults of operations or financial condition of the Company.

 

The Company’s operations aredependent on retaining existing employees, attracting additional qualifiedemployees and achieving productivity gains from the Company’s investment intechnology. The Company faces intense competition for qualified informationtechnology personnel and other skilled professionals. There can be noassurances that an inability to retain existing employees or attract additionalemployees will not have a material adverse effect on the Company’s results ofoperations.

 

Prior to the Company’sacquisition of the GBO, John Hancock Mutual Life Insurance Company (“JohnHancock”) entered into a number of reinsurance arrangements with respect topersonal accident insurance and the occupational accident component of workers’compensation insurance, a portion of which was originated through a poolmanaged by Unicover Managers, Inc. Under these arrangements, John Hancockassumed risks as a reinsurer and transferred certain of such risks to othercompanies. These arrangements have become the subject of disputes, including anumber of legal proceedings to which John Hancock is a party. The Companybelieves that it has a number of defenses to avoid any ultimate liability withrespect to these matters and believes that such liabilities were nottransferred to the Company as part of the GBO acquisition. However, if theCompany were to become subject to such liabilities, the Company could sufferlosses that might have a material adverse effect on its financial condition,results of operations or cash flows.

 

In December 2000, a whollyowned subsidiary of the Company completed its acquisition of certain mail orderpharmaceutical service assets and now conducts business as a mail order

 

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pharmacy. The pharmacy businessis subject to extensive federal, state and local regulations which are in manyinstances different from those under which the Company’s core health planbusiness currently operates. The failure to properly adhere to these and otherapplicable regulations could result in the imposition of civil and criminalpenalties, which could adversely affect the Company’s results of operations orfinancial condition. In addition, pharmacies are exposed to risks inherent inthe packaging and distribution of pharmaceuticals and other health careproducts. Although the Company maintains professional liability and errors andomissions liability insurance, there can be no assurances that the coveragelimits under such insurance programs will be adequate to protect against futureclaims or that the Company will be able to maintain insurance on acceptableterms in the future.

 

Following the terrorist attacksof September 11, 2001, there have been various incidents of suspectedbioterrorist activity in the United States. To date, these incidents haveresulted in related isolated incidents of illness and death. However, federaland state law enforcement officials have issued public warnings aboutadditional potential terrorist activity involving biological and other weapons.If the United States were to experience more widespread bioterrorist or otherattacks, the Company’s covered medical expenses could rise and the Companycould experience a material adverse effect on its results of operations,financial condition and cash flow.

 

In April and May 2002, one ofthe Company’s wholly owned subsidiaries acting as a pharmacy benefit managementbusiness under the trade name WellPoint Pharmacy Management received twoadministrative subpoenas duces tecum issued by the U.S. Attorney’s Office inBoston Massachusetts. The Company does not believe that its pharmacy benefitmanagement business is presently a target of investigation by the U.S.Attorney. The subpoenas appear to focus primarily on WellPoint PharmacyManagement’s relationship with TAP Pharmaceuticals, including TAP’s drugsLupron and Prevacid. The Company has responded to the subpoenas by producingcertain requested documents. The Company believes that it is in compliance inall material respects with all laws and regulations applicable to the pharmacybenefit management business.

 

As a result of the generalnationwide economic downturn, many states are currently experiencing budgetdeficits. State legislators are exploring a variety of alternatives to addressthis situation. In order to address the budget shortfalls, various states maypropose reductions in payments received by Medicaid managed care providers suchas the Company. Alternatively, state legislators may seek to impose greaterstate taxes. Any significant reduction in payments received by the Company inconnection with its Medicaid managed care business could have a materialadverse effect on the Company’s results of operations or financial condition.Additionally, any increase in state taxes could prolong or exacerbate thecurrent economic downturn, which could in turn have a material adverse effecton the Company’s results of operations or financial condition. Budget cutbackscould also result in reduced employment levels in public sector accounts forwhich the Company provides insured or administrative services products.

 

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***Review by Independent Accountants***

 

With respect to the unauditedconsolidated financial information of WellPoint Health Networks Inc. for thethree-month periods ended March 31, 2003 and 2002, PricewaterhouseCoopers LLP(“PricewaterhouseCoopers”) reported that they have applied limited proceduresin accordance with professional standards for a review of such information.However, their separate report dated April 22, 2003 appearing herein, statesthat they did not audit and they do not express an opinion on that unauditedconsolidated financial information. Accordingly, the degree of reliance ontheir report on such information should be restricted in light of the limitednature of the review procedures applied. PricewaterhouseCoopers is not subject tothe liability provisions of Section 11 of the Securities Act of 1933 for theirreport on the unaudited consolidated financial information because that reportis not a “report” or a “part” of the registration statement prepared orcertified by PricewaterhouseCoopers within the meaning of Sections 7 and 11 ofthe Act.

 

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ITEM 3.     Quantitativeand Qualitative Disclosures About Market Risk

 

The Company regularly evaluatesits asset and liability interest rate risks, as well as the appropriateness ofinvestments, relative to its internal investment guidelines. The Companyoperates within these guidelines by maintaining a well-diversified portfolio,both across and within asset classes. The Company has from time to timeretained an independent consultant to advise the Company on the appropriatenessof its investment policy.

 

Asset interest rate risk ismanaged within a duration band tied to the Company’s liability interest raterisk. Credit risk is managed by maintaining high average quality ratings and awell-diversified portfolio.

 

The Company’s use of derivativeinstruments is generally limited to hedging purposes and has principallyconsisted of forward exchange contracts and interest rate swaps. The Company’sinvestment policy prohibits the use of derivatives for leveraging purposes aswell as the creation of risk exposures not otherwise allowed within the policy.

 

From time to time, the Companyhas entered into interest rate swap agreements primarily to minimizesignificant, unanticipated earnings fluctuations caused by interest ratevolatility. The Company’s goal is to maintain a balance between fixed andfloating interest rates on its long-term debt. The Company believes that thisallows it to better anticipate its interest payments while helping to managethe asset-liability relationship.

 

# *Interest Rate Risk*

 

The Company is exposed tomarket rate risks associated with its investments and borrowings. Market riskrepresents the risk of loss in value of a financial instrument resulting fromchanges in interest rates and equity prices.

 

As of March 31, 2003, theCompany’s investment securities at market value, totaled $5.4 billion, of which89.7% was invested in fixed-income securities and the remaining 10.3% wasinvested in equity securities. The Company has evaluated the net impact to thefair value of its fixed-income investments from a hypothetical change in allinterest rates of 100, 200 and 300 basis points (“bp”). In doing so,optionality was addressed through Monte Carlo simulation of the price behaviorof securities with embedded options. In addressing prepayments onmortgage-backed securities, the model follows the normal market practice ofestimating a non-interest rate sensitive component (primarily related torelocations) and an interest-sensitive component (primarily related torefinancings) separately. The model is based on statistical techniques appliedto historical prepayment and market data, and then incorporates forward-lookingmortgage market research and judgments about future prepayment behavior.Changes in the fair value of the investment portfolio, net of tax, arereflected in the balance sheet through stockholders’ equity. The results ofthis analysis as of March 31, 2003 are shown in the table below. The table alsoshows the change in valuation of the $200.0 million notional

 

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amount 6 3/8*%* fixed for LIBOR-based floating interestrate swap agreement as of March 31, 2003.

 
|                                       |   | **Decrease in fair value  given an interest rate increase of:** |   |
|--------------------------------------------|--------|-----------------------------------------------------------------|--------|
|                                       |   | **100 bp**                                                      |   | **200 bp** |   | **300 bp** |   |
|                                       |   | **(In millions)**                                               |   |
|                                       |   |                                                            |   |   |   |   |   |
| Fixed Income Portfolio                     |   | $                                                               | (137.8 | ) | $ | (298.9 | ) | $ | (469.1 | ) |
| Valuation of Interest Rate  Swap Agreement |   | (6.0                                                            | )      | (11.7 | ) | (17.2 | ) |
|                                       |   | $                                                               | (143.8 | ) | $ | (310.6 | ) | $ | (486.3 | ) |

 

The Company believes that aninterest rate shift in a 12-month period of 100 bp represents a moderatelyadverse outcome, while a 200 bp shift is significantly adverse and a 300 bpshift is unlikely given historical precedents. Although the Company holds itsbonds as “available for sale” for purposes of Statement of Financial AccountingStandards No. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” the Company’s cash flows and the short duration of its investmentportfolio should allow it to hold securities to maturity, thereby avoiding therecognition of losses should interest rates rise significantly.

 

# *Interest Rate SwapAgreements*

 

On January 15, 2002, theCompany entered into a $200.0 million notional amount interest rate swapagreement with respect to its 2006 Notes. The swap agreement is a contract toexchange a fixed 6 3/8*%* rate fora LIBOR-based floating rate. For the quarters ended March 31, 2003 and 2002,the Company recognized settlement income of $1.9 million and $1.0 million fromthis swap agreement. (See Note 6 to the Consolidated Financial Statements.)

 

The Company has from time totime entered into additional interest rate swap agreements in order to reducethe volatility of interest expense resulting from changes in interest rates. Asof December 31, 2001, the Company had entered into $200.0 million of floatingto fixed-rate swap agreements, which consisted of a $150.0 million notionalamount swap agreement at 6.99% and a $50.0 million notional amount swap agreementat 7.06%. As of December 31, 2001, the Company also had $235.0 million ofLIBOR-based floating rate debt outstanding. In September 2002, the Companyterminated these two fixed-rate swap agreements with an aggregate cashsettlement of $17.6 million, of which $1.8 million was accrued interest and theremaining $15.8 million represented the fair value of the swap agreements atthe time of termination and is being amortized over the term of the originalswap agreements. As of March 31, 2003, the remaining balance of the swapagreements was $11.1 million. (See Note 7 to the Consolidated FinancialStatements for further discussion.)

 

# *Equity Price Risk*

 

As of March 31, 2003, theCompany’s equity securities were comprised primarily of domestic stocks.Assuming an immediate decrease of 10% in market value, as of March 31, 2003,the 

 

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hypothetical pre-tax loss infair value of stockholders’ equity is estimated to be approximately $56.2million.

 

ITEM 4.     Controlsand Procedures

 

The Company maintains“disclosure controls and procedures,” as such term is defined under Rule13a-14(c) of the rules and regulations under the Securities Exchange Act of1934, as amended (the “Exchange Act”). These disclosure controls and procedures are designed to ensure thatinformation required to be disclosed in the Company’s Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission (the “SEC”),and that such information is accumulated and communicated to the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosures.  The Company has carried out an evaluation,within the 90 days prior to the date of filing of this quarterly report on Form10-Q, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures. Based upon their evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective in ensuring that materialinformation relating to the Company is made known to the Chief ExecutiveOfficer and Chief Financial Officer by others within the Company during theperiod in which this quarterly report on Form 10-Q was being prepared.

 

There have been no significantchanges in the Company’s internal controls or in other factors that couldsignificantly affect these controls subsequent to the date the Companycompleted its evaluation.

 

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PART II.                         OTHERINFORMATION

 

ITEM 1.                  Legal Proceedings

 

See “Factors That May Affect Future Results of Operations” for adiscussion of various pending legal matters involving the Company and itssubsidiaries. The Company’s annual report on Form 10-K for the year endedDecember 31, 2002 also contains a discussion of various pending legal matters.

 

ITEM 6.                  Exhibits and Reports on Form 8-K

 

(a)          Exhibits

 

See ExhibitIndex.

 

(b)         Reports on Form 8-K

 

On January 24,2003, the Company filed a current report on Form 8-K dated January 24, 2003announcing the signing of an amended and restated merger agreement withCareFirst, Inc. A copy of the amended and restated merger agreement was alsoprovided.

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
| **WELLPOINT HEALTH NETWORKS INC.** |
|------------------------------------|
| Registrant                         |
|                               |
|                               |   |
| Date: May  15, 2003                |   | By: | /s/ LEONARD  D. SCHAEFFER |   |
|                               | Leonard D.  Schaeffer |
|                               | Chairman of  the Board of Directors  and Chief Executive Officer |
|                               |   |
|                               |   |
| Date: May  15, 2003                |   | By: | /s/ DAVID C.  COLBY |   |
|                               | David C.  Colby |
|                               | Executive  Vice President  and Chief Financial Officer |
|                               |   |
|                               |   |
| Date: May  15, 2003                |   | By: | /s/ KENNETH  C. ZUREK |   |
|                               | Kenneth C.  Zurek |
|                               | Senior Vice  President, Controller  and Taxation |

 

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**CERTIFICATIONS**

** **

I, Leonard D. Schaeffer, Chairman of theBoard and Chief Executive Officer, certify that:

 

1.             Ihave reviewed this quarterly report on Form 10-Q of WellPoint Health NetworksInc.;

 

2.            Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.            Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.            The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)                designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)               evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)                presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.            The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)                all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)               any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.            The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  May 15, 2003 |                       |
|--------------------------|----------------------------|
|                     |                       |
|                     | /s/  LEONARD D. SCHAEFFER  |   |
|                     | Leonard  D. Schaeffer      |   |
|                     | Chairman  of the Board and |   |
|                     | Chief  Executive Officer   |   |

 

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I, David C. Colby, Executive Vice Presidentand Chief Financial Officer, certify that:

 

1.             Ihave reviewed this quarterly report on Form 10-Q of WellPoint Health NetworksInc.;

 

2.            Based on my knowledge, this quarterly reportdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.            Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.            The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a)                designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

b)               evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

c)                presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.            The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a)                all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

b)               any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.            The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  May 15, 2003 |                                                   |
|--------------------------|--------------------------------------------------------|
|                     |                                                   |
|                     | /s/  DAVID C. COLBY                                    |   |
|                     | David  C. Colby                                        |   |
|                     | Executive  Vice President  and Chief Financial Officer |   |

# * *

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# ***EXHIBIT INDEX***

 
| **Exhibit  Number** |   | **Exhibit**                                                                                                                                                                                                                                                                                                                                     |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.01                |   | Amended and Restated Recapitalization  Agreement dated as of March 31, 1995 by and among the Registrant, Blue Cross  of California, Western Health Partnerships and Western Foundation for Health  Improvement, incorporated by reference to Exhibit 2.1 to the Registrant’s  Registration Statement on Form S-4 dated April 8, 1996. |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 2.02                |   | Amended and Restated  Agreement and Plan of Merger dated as of November 29, 2000 by and among  Cerulean Companies, Inc., the Registrant and Water Polo Acquisition Corp.,  incorporated by reference to Exhibit 2.01 to the Registrant’s Current Report  on Form 8-K dated March 15, 2001.                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 2.03                |   | Agreement and Plan of  Merger dated as of October 17, 2001 by and among the Registrant, RightCHOICE  Managed Care, Inc. and RWP Acquisition Corp., incorporated by reference to  Exhibit 2.1 to the Registrant’s Registration Statement on Form S-4  (Registration No. 333-73382).                                                    |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 2.04                |   | Amended and Restated  Agreement and Plan of Merger dated as of January 24, 2003 by and among the  Registrant, CareFirst, Inc. and Congress Acquisition Corp., incorporated by  reference to Exhibit 99.2 to the Registrant’s Current Report on Form 8-K  dated January 24, 2003.                                                      |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 3.01                |   | Restated Certificate of  Incorporation of the Registrant, incorporated by reference to Exhibit 3.1 to  the Registrant’s Current Report on Form 8-K dated August 4, 1997 (File  No. 001-13083).                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 3.02                |   | Bylaws of the Registrant,  incorporated by reference to Exhibit 4.2 to the Registrant’s Registration  Statement on Form S-8 (Registration No. 333-90701).                                                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.01                |   | Specimen of Common Stock  certificate of the Registrant, incorporated by reference to Exhibit 4.01 to  the Registrant’s Annual Report on Form 10-K for the year ended December 31,  2002.                                                                                                                                                  |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.02                |   | Restated Certificate of  Incorporation of the Registrant (included in Exhibit 3.01).                                                                                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.03                |   | Bylaws of the Registrant  (included in Exhibit 3.02).                                                                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.04                |   | Amended and Restated  Indenture dated as of June 8, 2001 by and between the Registrant and the Bank  of New York, as trustee, incorporated by reference to Exhibit 4.3 to the  Registrant’s Current Report on Form 8-K dated June 7, 2001.                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.05                |   | Form of Note  evidencing the Registrant’s 6 3 / 8% Notes due 2006, incorporated by  reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K  dated June 12, 2001.                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 4.06                |   | Form of Note  evidencing the Registrant’s 6 3 / 8% Notes due 2012, incorporated by  reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K  dated January 11, 2002.                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                            |
| 10.01               |   | Second Amendment to  364-Day Credit Agreement dated as of March 28, 2003, by and among the  Registrant, the lenders from time to time party thereto, Bank of America,  N.A., as                                                                                                                                                                 |

 

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|   |   | administrative agent, and  JPMorgan Chase Bank, as syndication agent.                                                                                                                                                                                 |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                  |
| 10.02  |   | First Amendment to Five  Year Credit Agreement dated as of March 28, 2003, by and among the  Registrant, the lenders from time to time party thereto, Bank of America,  N.A., as administrative agent, and JPMorgan Chase Bank, as syndication agent. |
|   |   |                                                                                                                                                                                                                                                  |
| 15.01  |   | Letter on unaudited  interim financial information.                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                  |
| 99.01  |   | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                  |
| 99.02  |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                         |

 

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