**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

**ý****  QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterlyperiod ended March 31, 2004**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transitionperiod from             to             **

 

**Commission FileNumber  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 4, 2004, there were approximately155,646,513 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, 2004**

**Table of Contents**

 
| PART I.  FINANCIAL INFORMATION | 1                                                                                                    |
|-------------------------------------|------------------------------------------------------------------------------------------------------|
|                                |                                                                                                 |   |
| ITEM 1.                             | Financial Statements                                                                                 | 1 |
|                                |                                                                                                 |   |
|                                | Consolidated Balance Sheets as of March 31, 2004 and December 31,  2003                              | 1 |
|                                |                                                                                                 |   |
|                                | Consolidated Income Statements for the Quarters Ended March 31, 2004  and 2003                       | 2 |
|                                |                                                                                                 |   |
|                                | Consolidated Statement of Changes in  Stockholders’ Equity for the Quarter Ended March 31, 2004 | 3 |
|                                |                                                                                                 |   |
|                                | Consolidated Statements of Cash Flows for  the Quarters Ended March 31, 2004 and 2003                | 4 |
|                                |                                                                                                 |   |
|                                | Notes to Consolidated Financial Statements                                                           | 5 |
|                                |                                                                                                 |   |
|                                | Report of Independent Accountants                                                                    | 26 |
|                                |                                                                                                 |   |
| ITEM 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations          | 27 |
|                                |                                                                                                 |   |
| ITEM 3.                             | Quantitative and Qualitative Disclosures  About Market Risk                                          | 60 |
|                                |                                                                                                 |   |
| ITEM 4.                             | Controls and Procedures                                                                              | 62 |
|                                |                                                                                                 |   |
| PART II.  OTHER INFORMATION    | 63                                                                                                   |
|                                |                                                                                                 |   |
| ITEM 1.                             | Legal Proceedings                                                                                    | 63 |
|                                |                                                                                                 |   |
| ITEM 2                              | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity  Securities                    | 63 |
|                                |                                                                                                 |   |
| ITEM 6.                             | Exhibits and Reports on Form 8-K                                                                     | 63 |
|                                |                                                                                                 |   |
| SIGNATURES                          | 65                                                                                                   |
|                                |                                                                                                 |   |
| EXHIBIT  INDEX                      | 66                                                                                                   |
|                                     |                                                                                                      |  |  |

 

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PART I.FINANCIAL INFORMATION

 

ITEM 1.                             FinancialStatements

 

**WellPoint Health Networks Inc.**

ConsolidatedBalance Sheets

 
| **(In thousands, except share data)**                                                                                                                     |   | **March 31,  2004** |       | **December  31,  2003** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                                                                                                                                      |   | **(Unaudited)**     |       |                    | ** ** |
| **ASSETS**                                                                                                                                                |   |                |       |                    |       |
| Current Assets:                                                                                                                                           |   |                |       |                    |       |
| Cash and cash equivalents                                                                                                                                 |   | $                   | 1,136,636  |                    | $          | 1,030,327 |   |
| Investments - available-for-sale, at fair  value                                                                                                          |   | 7,565,549           |       | 6,726,802               |       |
| Securities lending collateral                                                                                                                             |   | 960,684             |       | 914,173                 |       |
| Receivables, net                                                                                                                                          |   | 1,561,341           |       | 1,356,107               |       |
| Deferred tax assets, net                                                                                                                                  |   | 316,873             |       | 355,110                 |       |
| Other current assets                                                                                                                                      |   | 261,805             |       | 258,588                 |       |
| Total Current Assets                                                                                                                                      |   | 11,802,888          |       | 10,641,107              |       |
| Property and equipment, net                                                                                                                               |   | 458,153             |       | 441,936                 |       |
| Intangible assets, net                                                                                                                                    |   | 939,197             |       | 950,954                 |       |
| Goodwill, net                                                                                                                                             |   | 2,333,702           |       | 2,321,208               |       |
| Long-term investments, at market value                                                                                                                    |   | 148,133             |       | 161,784                 |       |
| Other non-current assets                                                                                                                                  |   | 274,988             |       | 271,689                 |       |
| Total Assets                                                                                                                                              |   | $                   | 15,957,061 |                    | $          | 14,788,678 |   |
|                                                                                                                                                      |   |                |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                             |   |                |       |                    |       |
| Current  Liabilities:                                                                                                                                     |   |                |       |                    |       |
| Medical claims payable                                                                                                                                    |   | $                   | 2,639,503  |                    | $          | 2,747,074 |   |
| Reserves for future policy benefits                                                                                                                       |   | 111,763             |       | 129,135                 |       |
| Unearned premiums                                                                                                                                         |   | 665,181             |       | 629,831                 |       |
| Accounts payable and accrued expenses                                                                                                                     |   | 1,299,097           |       | 1,411,391               |       |
| Experience rated and other refunds                                                                                                                        |   | 267,996             |       | 267,382                 |       |
| Income taxes payable                                                                                                                                      |   | 350,125             |       | 241,979                 |       |
| Security trades pending payable                                                                                                                           |   | 669,111             |       | 27,456                  |       |
| Securities lending payable                                                                                                                                |   | 960,684             |       | 914,173                 |       |
| Other current liabilities                                                                                                                                 |   | 738,235             |       | 712,273                 |       |
| Total Current Liabilities                                                                                                                                 |   | 7,701,695           |       | 7,080,694               |       |
| Accrued postretirement benefits                                                                                                                           |   | 153,769             |       | 152,738                 |       |
| Reserves for future policy benefits, non-current                                                                                                          |   | 317,397             |       | 288,197                 |       |
| Long-term debt                                                                                                                                            |   | 1,238,940           |       | 1,238,267               |       |
| Deferred tax liabilities                                                                                                                                  |   | 371,001             |       | 370,737                 |       |
| Other non-current liabilities                                                                                                                             |   | 226,082             |       | 228,096                 |       |
| Total Liabilities                                                                                                                                         |   | 10,008,884          |       | 9,358,729               |       |
| 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, 157,482,946 and 157,006,322 issued at March 31, 2004 and  December 31, 2003, respectively |   | 1,575               |       | 1,570                   |       |
| Treasury stock, at cost, 2,171,017 and  4,248,172 shares at March 31, 2004 and December 31, 2003, respectively                                            |   | (164,726            | )          | (298,049                | )          |
| Additional paid-in capital                                                                                                                                |   | 2,374,327           |       | 2,348,506               |       |
| Retained earnings                                                                                                                                         |   | 3,545,704           |       | 3,250,483               |       |
| Accumulated other comprehensive income                                                                                                                    |   | 191,297             |       | 127,439                 |       |
| Total Stockholders’ Equity                                                                                                                           |   | 5,948,177           |       | 5,429,949               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                           |   | $                   | 15,957,061 |                    | $          | 14,788,678 |   |

 

Seethe accompanying notes to the Consolidated Financial Statements.

 

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**WellPoint Health Networks Inc.**

ConsolidatedIncome Statements

(Unaudited)

 
|                                           |   | **Quarter  Ended March 31,** |      |
|------------------------------------------------|--------|------------------------------|-----------|
| **(In thousands, except earnings  per share)** |   | **2004**                     |      | **2003** |   |
| Revenues:                                      |   |                         |      |   |   |
| Premium revenue                                |   | $                            | 5,256,303 |   | $ | 4,548,305 |   |
| Management services and other revenue          |   | 306,176                      |      | 226,171 |   |
| Investment income                              |   | 83,661                       |      | 66,315 |   |
|                                           |   | 5,646,140                    |      | 4,840,791 |   |
| Operating  Expenses:                           |   |                         |      |   |   |
| Health care services and other benefits        |   | 4,187,351                    |      | 3,717,500 |   |
| Selling expense                                |   | 217,122                      |      | 191,997 |   |
| General and administrative expense             |   | 725,723                      |      | 589,669 |   |
|                                           |   | 5,130,196                    |      | 4,499,166 |   |
| Operating  Income                              |   | 515,944                      |      | 341,625 |   |
| Interest expense                               |   | 12,243                       |      | 12,774 |   |
| Other expense, net                             |   | 11,666                       |      | 7,004 |   |
| Income  before Provision for Income Taxes      |   | 492,035                      |      | 321,847 |   |
| Provision for income taxes                     |   | 196,814                      |      | 128,794 |   |
| Net Income                                     |   | $                            | 295,221   |   | $ | 193,053 |   |
|                                           |   |                         |      |   |   |
| Earnings Per  Share:                           |   |                         |      |   |   |
| Net Income                                     |   | $                            | 1.92      |   | $ | 1.33 |   |
|                                           |   |                         |      |   |   |
| Earnings Per  Share Assuming Full Dilution:    |   |                         |      |   |   |
| Net Income                                     |   | $                            | 1.85      |   | $ | 1.29 |   |

 

Seethe accompanying notes to the Consolidated Financial Statements.

 

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**WellPoint Health Networks Inc.**

ConsolidatedStatement of Changes in Stockholders’ Equity

(Unaudited)

 
|                                                                                                    |   |                 |       | **Common  Stock** |       | **Additional  Paid - in  Capital** |       | **Retained  Earnings** |       | **Accumulated  Other  Comprehensive  Income** |   | **Total** |     |
|---------------------------------------------------------------------------------------------------------|--------|----------------------|------------|-------------------|------------|------------------------------------|------------|------------------------|------------|-----------------------------------------------|--------|-----------|----------|
|                                                                                                    |   | **Preferred  Stock** |       | **Issued**        |       | **In  Treasury**                   |       |                   |       |                                          |   |
| **(In thousands)**                                                                                      |   |                 | **Shares** | ** **        | **Amount** | ** **                         | **Shares** | ** **             | **Amount** | ** **                                    |   |      |     |   |
| Balance as of December 31, 2003                                                                         |   | $                    | —     |              | 157,006    |                               | $          | 1,570                  |       | 4,248                                         |   | $         | (298,049 | ) | $ | 2,348,506 |   | $ | 3,250,483 |   | $ | 127,439 |   | $ | 5,429,949 |   |
| Stock grants to employees and directors                                                                 |   |                 |       |              |       | —                             |       | (514                   | )          | 33,119                                        |   |      |     |   |   |   |   | 33,119 |   |
| Stock issued for employee stock option plans and stock purchase plans                                   |   |                 |       | 477               |       | 5                                  |       | (1,563                 | )          | 100,204                                       |   | 60,782    |     |   |   |   |   | 160,991 |   |
| Net losses from treasury stock reissued                                                                 |   |                 |       |              |       |                               |       |                   |       |                                          |   | (34,961   | )        |   |   |   |   | (34,961 | ) |
| Comprehensive income                                                                                    |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     |   |   |   |   |   |   |
| Net income                                                                                              |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     | 295,221 |   |   |   | 295,221 |   |
| Other comprehensive income, net of tax                                                                  |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     |   |   |   |   |   |   |
| Change in unrealized valuation adjustment on investment securities,  net of reclassification adjustment |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     |   |   | 63,858 |   | 63,858 |   |
| Total comprehensive income                                                                              |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     | 295,221 |   | 63,858 |   | 359,079 |   |
|                                                                                                    |   |                 |       |              |       |                               |       |                   |       |                                          |   |      |     |   |   |   |   |   |   |
| Balance as of March 31, 2004                                                                            |   | $                    | —     |              | 157,483    |                               | $          | 1,575                  |       | 2,171                                         |   | $         | (164,726 | ) | $ | 2,374,327 |   | $ | 3,545,704 |   | $ | 191,297 |   | $ | 5,948,177 |   |

 

See the accompanying notes to the Consolidated Financial Statements.

 

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**WellPoint Health Networks Inc.**

ConsolidatedStatements of Cash Flows

(Unaudited)

 
|                                                                                        |   | **Quarter  Ended March 31,** |      |
|---------------------------------------------------------------------------------------------|--------|------------------------------|-----------|
| **(In thousands)**                                                                          |   | **2004**                     |      | **2003** |   |
| **Cash flows from operating activities:**                                                   |   |                         |      |   |   |
| Net income                                                                                  |   | $                            | 295,221   |   | $ | 193,053 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:          |   |                         |      |   |   |
| Depreciation and amortization, net of  accretion                                            |   | 50,507                       |      | 37,835 |   |
| Gain on sales of assets, net                                                                |   | (15,507                      | )         | (7,867 | ) |
| Amortization of deferred gain on sale of  building                                          |   | (131                         | )         | — |   |
| Accretion of interest on 6 3/8% Notes due  2012 and 6 3/8% Notes due 2006                   |   | 74                           |      | 70 |   |
| (Increase) decrease in certain assets, net  of effect of businesses acquired and sold:      |   |                         |      |   |   |
| Receivables, net                                                                            |   | (99,414                      | )         | (169,745 | ) |
| Other current assets                                                                        |   | (3,275                       | )         | (26,028 | ) |
| Other non-current assets                                                                    |   | 96                           |      | 4,530 |   |
| Increase (decrease) in certain liabilities,  net of effect of businesses acquired and sold: |   |                         |      |   |   |
| Medical claims payable                                                                      |   | (107,585                     | )         | 86,341 |   |
| Reserves for future policy benefits                                                         |   | 11,828                       |      | 11,991 |   |
| Unearned premiums                                                                           |   | 35,350                       |      | 7,905 |   |
| Accounts payable and accrued expenses                                                       |   | (62,960                      | )         | (40,384 | ) |
| Experience rated and other refunds                                                          |   | 614                          |      | (4,078 | ) |
| Income taxes payable                                                                        |   | 175,966                      |      | 128,836 |   |
| Other current liabilities                                                                   |   | 25,927                       |      | 89,143 |   |
| Accrued postretirement benefits                                                             |   | 1,031                        |      | 2,218 |   |
| Other non-current liabilities                                                               |   | (1,883                       | )         | (173 | ) |
| Net cash provided by operating activities                                                   |   | 305,859                      |      | 313,647 |   |
| **Cash flows from investing activities:**                                                   |   |                         |      |   |   |
| Investments purchased                                                                       |   | (1,462,723                   | )         | (2,046,457 | ) |
| Proceeds from investments sold and matured                                                  |   | 1,231,876                    |      | 2,045,006 |   |
| Property and equipment purchased                                                            |   | (52,322                      | )         | (23,268 | ) |
| Proceeds from property and equipment sold                                                   |   | 7,935                        |      | 117 |   |
| Additional cash used for prior period  acquisitions                                         |   | (10,583                      | )         | — |   |
| Proceeds from sale of business, net of cash  sold                                           |   | 1,262                        |      | — |   |
| Net cash used in investing activities                                                       |   | (284,555                     | )         | (24,602 | ) |
| **Cash flows from financing activities:**                                                   |   |                         |      |   |   |
| Net borrowing of commercial paper                                                           |   | (2,795                       | )         | 149,878 |   |
| Change in advances on securities lending  deposits                                          |   | 46,511                       |      | 37,050 |   |
| Proceeds from issuance of Common Stock                                                      |   | 41,289                       |      | 40,272 |   |
| Common Stock repurchased                                                                    |   | —                       |      | (192,414 | ) |
| Net cash provided by financing activities                                                   |   | 85,005                       |      | 34,786 |   |
| Net increase  in cash and cash equivalents                                                  |   | 106,309                      |      | 323,831 |   |
| Cash and  cash equivalents at beginning of period                                           |   | 1,030,327                    |      | 1,355,616 |   |
| Cash and  cash equivalents at end of period                                                 |   | $                            | 1,136,636 |   | $ | 1,679,447 |   |

 

Seethe accompanying notes to the Consolidated Financial Statements.

 

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**WellPoint Health Networks Inc.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**1.****              Organization**

 

WellPointHealth Networks Inc. (the “Company” or “WellPoint”) is one of the nation’slargest publicly traded managed health care companies. As of March 31, 2004,WellPoint had approximately 15.4 million medical members (includingapproximately 1.2 million BlueCard “host” members) and approximately45.9 million specialty members. Through its subsidiaries, the Companyoffers a broad spectrum of network-based managed care plans to the large andsmall employer, individual, Medicaid and senior markets. The Company’s managedcare plans include preferred provider organizations (“PPOs”), healthmaintenance organizations (“HMOs”), point-of-service (“POS”) plans, otherhybrid plans and traditional indemnity plans. In addition, the Company offersmanaged care services, including underwriting, actuarial services, networkaccess, medical management and claims processing. The Company also provides abroad array of specialty and other products and services including pharmacybenefits management, dental, vision, life insurance, preventive care,disability insurance, behavioral health, COBRA and flexible benefits accountadministration. With its recent acquisition of Cobalt Corporation, the Companynow also offers workers’ compensation insurance products and is currently thelargest Medicare Part A fiscal intermediary in the nation, processingclaims for providers in all 50 states. The Company markets its products inCalifornia primarily under the name Blue Cross of California, in Georgiaprimarily under the name Blue Cross Blue Shield of Georgia, in various parts ofMissouri (including the greater St. Louis area) primarily under the name BlueCross Blue Shield of Missouri, in Wisconsin primarily under the names BlueCross Blue Shield of Wisconsin and CompcareBlue and in various parts of thecountry under the names UNICARE and HealthLink. These products are marketed bythe Company’s various operating subsidiaries throughout the United States. TheCompany’s customer base is diversified, with extensive membership among largeand small employer groups and individuals and in the Medicare and Medicaidmarkets.

 

**2.****              Basisof Presentation**

 

Theaccompanying unaudited consolidated financial statements of WellPoint have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) and the rules and regulations of theSecurities and Exchange Commission (“SEC”) for interim financialreporting.  In accordance with the rulesand regulations of the SEC, certain footnotes or other financial informationhave been condensed or omitted if they substantially duplicate the disclosurescontained in the Company’s annual audited financial statements.  In the opinion of management, the interimfinancial statements reflect all material adjustments (which are of a normalrecurring nature) necessary for a fair statement of its financial position asof March 31, 2004, the results of its operations for the quarters ended March31, 2004 and 2003, its changes in stockholders’ equity for the quarter endedMarch 31, 2004 and its cash flows for the quarters ended March 31, 2004 and2003.  The results of operations for theinterim periods presented are not necessarily indicative of the operatingresults for the full year.  Theseunaudited consolidated financial statements should be read together with theconsolidated financial statements and notes included in the Company’s annualreport on Form 10-K for the year ended December 31, 2003. The Company has

 

5

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reclassifiedcertain prior year amounts in the accompanying unaudited consolidated financialstatements to conform to the 2004 presentation.

 

**3.****              New AccountingPronouncements**

 

InDecember 2003, the FASB issued Statement of Financial Accounting StandardsNo. 132 (revised 2003), “Employers’ Disclosures about Pensions and OtherPostretirement Benefits - an amendment of FASB Statements No. 87, 88, and106” (“SFAS No. 132R”). SFAS No. 132R retains the disclosurerequirements contained in FASB Statement No. 132, “Employers’ Disclosures aboutPensions and Other Postretirement Benefits” (“SFAS No. 132”), and alsorequires additional disclosures to those in the original SFAS No. 132 thata company is required to make in its annual and interim financial statements.Except as noted, disclosures required by SFAS No. 132R are effective forfinancial statements with fiscal years ending after December 15, 2003. Thedisclosure of estimated future benefit payments required by SFAS No. 132Ris effective for fiscal years ending after June 15, 2004. The adoption ofSFAS No. 132R did not have a material effect on the consolidated financialstatements of the Company.

 

OnDecember 8, 2003, the Medicare Prescription Drug, Improvement andModernization Act of 2003 (“MMA”) was signed into law. MMA introduced avoluntary Medicare Part D prescription drug benefit and created a new 28%federal subsidy for the sponsors of the postretirement prescription drugbenefits that are at least actuarially equivalent to the new MedicarePart D benefit. In January 2004, the FASB issued FASB Staff PositionNo. FAS 106-1, “Accounting and Disclosure Requirements Related to the MedicarePrescription Drug, Improvement and Modernization Act of 2003” (“FSPFAS 106-1”). Under FSP FAS 106-1, which guidance is based on FASBStatement of Financial Accounting Standards No. 106, “Accounting forPostretirement Benefits Other Than Pensions,” sponsors must consider the twonew features of MMA in measuring the accumulated postretirement benefitobligation (“APBO”) and net periodic postretirement benefit cost. In accordancewith FSP FAS 106-1, the Company made a one-time election to recognize theimpact of MMA. Accordingly, any measures of APBO and net periodicpostretirement benefit cost in the Company’s consolidated financial statementsand the related footnotes for the year ended December 31, 2003 include theeffects of MMA. The adoption of the FSP FAS 106-1 did not have a materialeffect on the consolidated financial statements of the Company. Currently,specific authoritative guidance on the accounting for the federal subsidy ispending and that guidance, when issued, could require the Company to change previouslyreported information.

 

**4.****              Acquisitions**

 

OnOctober 31, 2003, Company completed its acquisition of Health Core Inc.(“Health Core”). Health Core currently provides outcomes research services tohealth plans and pharmaceutical organizations. The purchase price and relatedacquisition costs of approximately $4.1 million exceeded the estimatedfair value of net assets acquired by $2.9 million. Under the purchasemethod of accounting, the Company assigned this amount to goodwill. Theoperating results

 

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for HealthCore are included in WellPoint’s consolidated income statements for periodsfollowing the completion of the acquisition.

 

OnSeptember 24, 2003, the Company completed its acquisition of Cobalt, theparent company of Blue Cross Blue Shield of Wisconsin. Cobalt servedapproximately 675,000 medical members (excluding BlueCard “host” members) as ofSeptember 30, 2003. The transaction was effective as of September 30,2003 for accounting purposes. The operating results for Cobalt are included inWellPoint’s consolidated income statement for periods following September 30,2003. Under the terms of the transaction, total consideration paid to allholders of Cobalt common stock in the merger was approximately$427.5 million in cash and approximately 7.3 million newly issuedshares of WellPoint Common Stock (which included approximately 2.1 millionshares issued to affiliates). The total purchase price of approximately$884.9 million valued as of September 24, 2003 was used to purchasenet assets with a fair value of approximately $251.3 million. Included inthe total purchase price was $12.1 million used to retire Cobalt’sexisting long-term debt at the time of acquisition. As a result of the acquisitionof Cobalt, the Company incurred $34.0 million in expenses, primarilyrelated to transaction costs. Generally accepted accounting principles requirethat these expenses, which are not associated with the generation of futurerevenues and have no future economic benefit, be reflected as assumedliabilities in the allocation of the purchase price to the net assets acquired.Estimated goodwill and other intangibles totaling $861.6 million includes$96.5 million of deferred tax liabilities relating to identified intangibles.Identified intangibles with definite useful lives are being amortized on astraight-line basis or the timing of related cash flows depending upon theexpected amortization pattern over three to 23 years. The valuationprocess is not yet complete and, therefore, the allocation between goodwill andintangible assets recorded as of March 31, 2004 represents an estimate. As aresult, the useful lives and method of amortization are only preliminaryestimates. The current estimated purchase price allocation between goodwill andidentifiable intangible assets is $620.3 million and $241.3 million,respectively. The entire estimated goodwill amount of $620.3 million isnot deductible for tax purposes.

 

OnJune 30, 2003, the Company completed its acquisition of Golden West HealthPlan, Inc. (“Golden West”) for a purchase price of approximately$30.4 million. Upon completion of the acquisition, Golden West had netassets with a fair value of approximately $0.4 million and served morethan 275,000 dental and vision members. As a result of the acquisition ofGolden West, the Company incurred $0.4 million in expenses primarilyrelated to transaction costs. The estimated purchase price allocation betweengoodwill and identifiable intangible assets was $17.3 million and$13.0 million, respectively. The operating results for Golden West areincluded in WellPoint’s consolidated income statements for periods followingthe completion of the acquisition.

 

**5.****              Goodwilland Other Intangible Assets**

 

In accordancewith SFAS No. 142, the Company completed the annual evaluation of its goodwilland other intangible assets at December 31, 2003, and determined that there wasno impairment loss.

 

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The changes inthe carrying amount of goodwill by reportable segment are as follows:

 
| **(In thousands)**                                                   |   | **Health  Care** |      | **Specialty** |   | **Corporate  and Other** |   | **Consolidated** |   |
|----------------------------------------------------------------------|--------|------------------|-----------|---------------|--------|--------------------------|--------|------------------|--------|
| Balance as of January 1, 2003                                        |   | $                | 1,676,800 |          | $      | 14,971                   |   | $                | — |   | $ | 1,691,771 |   |
| Goodwill acquired during 2003                                        |   | 607,826          |      | 17,248        |   | 2,892                    |   | 627,966          |   |
| Final purchase accounting adjustments  for RightCHOICE goodwill |   | 1,471            |      | —        |   | —                   |   | 1,471            |   |
| Balance as of December 31, 2003                                      |   | 2,286,097        |      | 32,219        |   | 2,892                    |   | 2,321,208        |   |
| Purchase accounting adjustments for Cobalt  goodwill                 |   | 12,440           |      | —        |   | —                   |   | 12,440           |   |
| Other goodwill adjustments                                           |   | —           |      | 39            |   | 15                       |   | 54               |   |
| Balance as of March 31, 2004                                         |   | $                | 2,298,537 |          | $      | 32,258                   |   | $                | 2,907  |   | $ | 2,333,702 |   |

 

OnOctober 31, 2003, WellPoint completed its acquisition of Health Core, asdiscussed in Note 4. As a result of the acquisition of Health Core, theCompany recorded $2.9 million of goodwill as of March 31, 2004.

 

OnSeptember 24, 2003, WellPoint completed its acquisition of Cobalt, asdiscussed in Note 4. As a result of the acquisition of Cobalt, the Companyrecorded $620.3 million of goodwill and $241.3 million ofidentifiable intangible assets as of March 31, 2004. The valuation process isnot yet complete and, therefore, the allocation between goodwill and otherintangible assets recorded as of March 31, 2004 represents an estimate. TheCompany assumes no residual value for its amortizable intangible assets. Thefollowing table presents details of the acquired amortized and non-amortizedintangible assets of Cobalt at cost as of March 31, 2004.

 
| **(In thousands)**                                     |   | **Gross  Carrying  Value** |    | **Useful  Life  (in years)** |     | **Weighted  Average  Useful Life  (in years)** |   |
|--------------------------------------------------------|--------|----------------------------|---------|------------------------------|----------|------------------------------------------------|--------|
| Amortized intangible assets:                           |   |                       |    |                         |     |                                           |   |
| Provider relationships                                 |   | $                          | 3,450   |                         | 11 to 23 |                                           | 16.7   |   |
| Customer contracts and related customer  relationships |   | 70,000                     |    | 3 to 16                      |     | 9.0                                            |   |
| Total amortized intangible assets                      |   | 73,450                     |    |                         |     | 9.4                                            |   |
|                                                   |   |                       |    |                         |     |                                           |   |
| Non-amortized intangible assets:                       |   |                       |    |                         |     |                                           |   |
| Provider relationships                                 |   | 552                        |    | Indefinite                   |     | Indefinite                                     |   |
| Trade names and service marks                          |   | 167,300                    |    | Indefinite                   |     | Indefinite                                     |   |
| Total non-amortized intangible assets                  |   | 167,852                    |    |                         |     |                                           |   |
|                                                   |   |                       |    |                         |     |                                           |   |
| Total other intangible assets                          |   | $                          | 241,302 |                         |     |                                           |   |   |

 

8

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OnJune 30, 2003, WellPoint completed its acquisition of Golden West, asdiscussed in Note 4. As a result of the acquisition of Golden West, theCompany recorded $17.3 million of goodwill and $13.0 million ofidentifiable intangible assets as of March 31, 2004. The valuation process isnot yet complete and, therefore, the allocation between goodwill and other intangibleassets recorded as of March 31, 2004 represents an estimate. The Companyassumes no residual value for its amortizable intangible assets. The followingtable presents details of the acquired amortized and non-amortized intangibleassets of Golden West at cost as of March 31, 2004.

 
| **(In thousands)**                                     |   | **Gross  Carrying  Value** |   | **Useful  Life  (in years)** |   | **Weighted  Average  Useful Life  (in years)** |   |
|--------------------------------------------------------|--------|----------------------------|--------|------------------------------|--------|------------------------------------------------|--------|
| Amortized intangible assets:                           |   |                       |   |                         |   |                                           |   |
| Customer contracts and related customer  relationships |   | $                          | 5,000  |                         | 12     |                                           | 12.0   |   |
| Total amortized intangible assets                      |   | 5,000                      |   |                         |   |                                           |   |
|                                                   |   |                       |   |                         |   |                                           |   |
| Non-amortized intangible assets:                       |   |                       |   |                         |   |                                           |   |
| Trade names and service marks                          |   | 8,000                      |   | Indefinite                   |   | Indefinite                                     |   |
| Total non-amortized intangible assets                  |   | 8,000                      |   |                         |   |                                           |   |
|                                                   |   |                       |   |                         |   |                                           |   |
| Total other intangible assets                          |   | $                          | 13,000 |                         |   |                                           |   |   |

 

The grosscarrying value, accumulated amortization and net carrying value of otherintangible assets of the Company as of March 31, 2004 and December 31, 2003were as follows:

 

 
| **(In thousands)**                                          |   | **Gross  Carrying  Value** |      | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|-------------------------------------------------------------|--------|----------------------------|-----------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| *As of March 31, 2004*                                      |   |                       |      |                          |   |                     |   |                                   |    |
| Amortized  intangible assets:                               |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                      |   | $                          | 33,424    |                          | $      | 5,768                    |   | $                                      | 27,656  |   | 10 to 25 |   |
| Customer contracts and related  customer relationships |   | 427,974                    |      | 122,185                       |   | 305,789                  |   | 1.5 to 20                              |    |
| Other                                                       |   | 21,968                     |      | 10,450                        |   | 11,518                   |   | 5 to 20                                |    |
| Total amortized intangible assets                           |   | 483,366                    |      | 138,403                       |   | 344,963                  |   |                                   |    |
|                                                        |   |                       |      |                          |   |                     |   |                                   |    |
| Non-amortized intangible assets:                            |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                      |   | 17,674                     |      | 98                            |   | 17,576                   |   | Indefinite                             |    |
| Trade names and service marks                               |   | 579,300                    |      | 2,642                         |   | 576,658                  |   | Indefinite                             |    |
| Total non-amortized intangible  assets                 |   | 596,974                    |      | 2,740                         |   | 594,234                  |   |                                   |    |
|                                                        |   |                       |      |                          |   |                     |   |                                   |    |
| Total other intangible assets                               |   | $                          | 1,080,340 |                          | $      | 141,143                  |   | $                                      | 939,197 |   |   |   |

 

9

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| **(In thousands)**                                          |   | **Gross  Carrying  Value** |      | **Accumulated  Amortization** |   | **Net  Carrying  Value** |   | **Amortizat-  ion Period  (in years)** |    |
|-------------------------------------------------------------|--------|----------------------------|-----------|-------------------------------|--------|--------------------------|--------|----------------------------------------|---------|
| *As of December 31, 2003*                                   |   |                       |      |                          |   |                     |   |                                   |    |
| Amortized  intangible assets:                               |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                      |   | $                          | 33,424    |                          | $      | 5,349                    |   | $                                      | 28,075  |   | 10 to 25 |   |
| Customer contracts and related  customer relationships |   | 427,974                    |      | 111,351                       |   | 316,623                  |   | 1.5 to 20                              |    |
| Other                                                       |   | 21,968                     |      | 9,946                         |   | 12,022                   |   | 5 to 20                                |    |
| Total amortized intangible assets                           |   | 483,366                    |      | 126,646                       |   | 356,720                  |   |                                   |    |
|                                                        |   |                       |      |                          |   |                     |   |                                   |    |
| Non-amortized intangible assets:                            |   |                       |      |                          |   |                     |   |                                   |    |
| Provider relationships                                      |   | 17,674                     |      | 98                            |   | 17,576                   |   | Indefinite                             |    |
| Trade names and service marks                               |   | 579,300                    |      | 2,642                         |   | 576,658                  |   | Indefinite                             |    |
| Total non-amortized intangible  assets                 |   | 596,974                    |      | 2,740                         |   | 594,234                  |   |                                   |    |
|                                                        |   |                       |      |                          |   |                     |   |                                   |    |
| Total other intangible assets                               |   | $                          | 1,080,340 |                          | $      | 129,386                  |   | $                                      | 950,954 |   |   |   |

 

For thequarters ended March 31, 2004 and 2003, amortization expense relating tointangible assets was $11.8 million and $9.1 million, respectively. Thefollowing table presents the Company’s estimated annual amortization expensefor amortized intangible assets for each of the years ending December 31, 2004,2005, 2006, 2007 and 2008 (amounts in thousands). These estimates werecalculated based on the gross carrying value of amortized intangible assets asof March 31, 2004 using the applicable amortization period.

 
| For year ending December 31, 2004 |   | $      | 47,028 |   |
|-----------------------------------|--------|--------|--------|--------|
| For year ending December 31, 2005 |   | 43,648 |   |
| For year ending December 31, 2006 |   | 37,102 |   |
| For year ending December 31, 2007 |   | 32,412 |   |
| For year ending December 31, 2008 |   | 28,945 |   |

 

**6.****              PensionBenefits**

 

The Companymaintains three non-contributory defined benefit pension plans. The RestatedEmployees’ Retirement Plan of Blue Cross of California (the “BCC Plan”) coversemployees of a collective bargaining unit. The WellPoint HealthNetworks Inc. Pension Accumulation Plan (the “WellPoint Pension Plan”),which was established on January 1, 1987, covers all eligible employees(employees covered under a collective bargaining agreement participate if theterms of the collective bargaining agreement permits) meeting certain age andservice requirements. In addition, with the completion of the acquisition ofCobalt, WellPoint became the sponsor of Cobalt’s UGS Pension Plan (“UGS Plan”).The UGS Plan provides retirement benefits to covered employees based primarilyon compensation and years of service. Plan assets are invested primarily inpooled income funds. The Company’s policy is to fund its plans according to therequirements of the Employee Retirement Income Security Act of 1974,

 

10

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as amended,and applicable income tax regulations. The Company uses the projected unitcredit method of cost determination. In October 2003, the Company amendedthe WellPoint Pension Plan effective January 1, 2004. BeginningJanuary 1, 2004, employees who are of age 50 and over, with combined ageand service totaling 65 or higher as of December 31, 2003, will continueto earn future contributions under the WellPoint Pension Plan based on eligiblecompensation. For other employees, the funds in their pension account earnedthrough December 31, 2003 will continue to accrue interest. However, therewill be no additional contributions based on the employee’s earnings afterDecember 31, 2003. Once the employee becomes vested (after five years ofservice), the employee will be eligible to receive a benefit from the WellPointPension Plan at retirement or termination based on his or her account balanceas of December 31, 2003 plus accrued interest. Employees hired afterDecember 31, 2003 will not be eligible to participate in the WellPointPension Plan.

 

Estimated netperiodic pension expense for the Company’s defined benefit pension plansincluded the following components:

 
|                                                  |   | **Quarter  Ended March 31,** |       |
|-------------------------------------------------------|--------|------------------------------|------------|
| **(In thousands)**                                    |   | **2004**                     |       | **2003** |   |
|                                                  |   |                         | ** ** |   | ** ** |
| Service cost—benefits earned during the  quarter |   | $                            | 1,893      |   | $ | 4,888 |   |
| Interest cost on projected benefits  obligations      |   | 5,682                        |       | 4,910 |   |
| Expected return on plan assets                        |   | (6,962                       | )          | (4,902 | ) |
| Amortization of prior service cost                    |   | 19                           |       | 24 |   |
| Recognized net actuarial loss                         |   | 1,697                        |       | 2,206 |   |
| Curtailment charge                                    |   | —                       |       | 310 |   |
| Net periodic pension expense                          |   | $                            | 2,329      |   | $ | 7,436 |   |

 

Based on thefunded status of all of WellPoint’s pension plans, during 2004 the Companyexpects to contribute approximately $17.3 million, $0.8 million and $5.9million to the WellPoint Pension Plan, BCC Plan and UGS Plan, respectively. Asof March 31, 2004, $0.2 million in contributions have been made to WellPoint’spension plans.

 

**7.****              Long-TermDebt**

 

The carryingamount of the Company’s long-term indebtedness consisted of the following:

 
| **(In thousands)**       |   | **March 31,  2004** |      | **December  31,  2003** |   |
|--------------------------|--------|---------------------|-----------|-------------------------|--------|
|                     |   |                |      |                    |   |
| 6 3/8% Notes due 2006    |   | $                   | 462,812   |                    | $      | 459,366 |   |
| 6 3/8% Notes due 2012    |   | 349,090             |      | 349,068                 |   |
| Commercial paper program |   | 427,038             |      | 429,833                 |   |
| Total long-term debt     |   | $                   | 1,238,940 |                    | $      | 1,238,267 |   |

 

11

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*6 3/8% Notes due 2012*

 

OnJanuary 16, 2002, the Company issued $350.0 million aggregateprincipal amount at maturity of 6 3/8% Notes due January 15, 2012 (the“2012 Notes”). The net proceeds of this offering totaled approximately$348.9 million. The 2012 Notes bear interest at a rate of 6 3/8% perannum, payable semi-annually in arrears on January 15 and July 15 ofeach year commencing July 15, 2002. Interest is computed on the basis of a360-day year of twelve 30-day months. At March 31, 2004 andDecember 31, 2003, the Company had $349.1 million, (based upon theprincipal amount of $350.0 million less unamortized discount) of 2012Notes outstanding. The related interest expense and amortization of discountand issue costs for each of the quarters ended March 31, 2004 and 2003totaled $5.7 million.

 

The 2012 Notesmay be redeemed, 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 Notesbeing redeemed on the redemption date; or 2) the sum of the present valuesof the remaining scheduled payments of principal and interest on the 2012 Notesbeing redeemed on that redemption date (not including any portion of anypayments of interest accrued to the redemption date) discounted to theredemption date on a semi-annual basis at the Treasury rate as determined bythe Reference Treasury Dealer (J.P. Morgan Securities Inc. or DeutscheBanc Alex Brown or their respective successors), plus 25 basis points. In eachcase, the redemption price will also include accrued and unpaid interest on the2012 Notes to the redemption date.

 

*6 3/8% Notes due 2006*

 

OnJune 15, 2001, the Company issued $450.0 million aggregate principalamount at maturity of 6 3/8% Notes due June 15, 2006 (the “2006 Notes”).The net proceeds of this offering totaled approximately $449.0 million.The net proceeds from the sale of the 2006 Notes were used for repayment ofindebtedness under the Company’s revolving credit facilities. The 2006 Notesbear interest at a rate of 6 3/8% per annum, payable semi-annually in arrearson June 15 and December 15 of each year commencing December 15,2001. Interest is computed on the basis of a 360-day year of twelve 30-daymonths. At March 31, 2004 and December 31, 2003, the Company had$449.5 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, 2004 and 2003 was $7.4 million.

 

The 2006 Notesmay be redeemed, 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 Notesbeing redeemed on the redemption date; or 2) the sum of the present valuesof the remaining scheduled payments of principal and interest on the 2006 Notesbeing redeemed on that redemption date (not including any portion of anypayments of interest accrued to the redemption date) discounted to theredemption date on a semi-annual basis at the Treasury rate as determined bythe designated Reference Treasury Dealer (Salomon Smith Barney Inc. or UBSWarburg LLC or

 

12

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theirrespective successors), plus 25 basis points. In each case, the redemptionprice will also include accrued and unpaid interest on the 2006 Notes to theredemption date.

 

With theintention of reducing the interest expense associated with the 2006 Notes, theCompany, on January 15, 2002, entered into a $200.0 million notionalamount interest rate swap agreement. The swap agreement is a contract toexchange a fixed 6 3/8% rate for a LIBOR-based floating rate. The swap agreementexpires June 15, 2006. As of March 31, 2004 and December 31,2003, the Company recognized a liability adjustment, for the change in the fairvalue of the interest rate swap agreement, of $13.3 million and$9.9 million, respectively, related to the 2006 Notes. The Companyrecognized settlement income of $1.9 million for the each of the quartersended March 31, 2004 and 2003 from this interest rate swap, which offsetthe Company’s interest expense for the respective years (see Note 8).

 

The 2012 and2006 Notes are unsecured obligations and rank equally with all of the Company’sexisting and future senior unsecured indebtedness. All existing and futureliabilities of the Company’s subsidiaries are and will be effectively senior tothe 2012 and 2006 Notes. The indenture governing the 2012 and 2006 Notescontains a covenant that limits the ability of the Company and its subsidiariesto create liens on any of their property or assets to secure certainindebtedness without also securing the indebtedness under the 2012 and 2006Notes.

 

*Revolving Credit Facility*

 

Effective asof March 30, 2001, the Company entered into two unsecured revolving creditfacilities allowing aggregate indebtedness of $1.0 billion in principalamount. Borrowings under these facilities (which are generally referred tocollectively as the Company’s “revolving credit facility”) bear interest atrates determined by reference to the bank’s base rate or London InterBankOffered Rate (“LIBOR”) plus a margin determined by reference to thethen-current rating of the Company’s unsecured long-term debt by specifiedrating agencies. A facility fee based on the facility amount, regardless ofutilization, is payable quarterly. The facility fee rate is also determined bythe senior unsecured long-term debt ratings by specified rating agencies. Onefacility, which provides for borrowings not to exceed $750.0 million atany time outstanding, expires on March 30, 2006, although it may beextended for up to two additional one-year periods under certain circumstances.The other facility, which provides for borrowings not to exceed$250.0 million at any time outstanding, expires on March 25, 2005.Any amount outstanding under this facility as of March 25, 2005 may beconverted into a one-year term loan at the option of the Company and will bearinterest at rates determined by reference to the bank’s base rate or LIBOR plusa margin determined by reference to the then-current rating of the Company’sunsecured long-term debt by specified rating agencies, plus 0.125% until paidin full.

 

Loans underthe $250.0 million facility are made on a committed basis. Loans under the$750.0 million facility are made on a committed basis or pursuant to anauction bid process. The $750.0 million facility also contains sublimitsfor letters of credit and “swingline” loans. Each credit agreement requires theCompany to maintain certain financial ratios and contains

 

13

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restrictivecovenants, including restrictions on the incurrence of additional indebtednessand the granting of certain liens, limitations on acquisitions and investmentsand limitations on changes in control. As of March 31, 2004 andDecember 31, 2003, the Company had no amounts outstanding under therevolving credit facility.

 

*Commercial Paper Program*

 

InApril 2002, the Company commenced a commercial paper program providing forthe issuance of up to $1.0 billion in aggregate maturity value ofshort-term indebtedness (known generally as “commercial paper”). The commercialpaper is being issued by the Company without registration under the SecuritiesAct of 1933, as amended (the “1933 Act”) in reliance upon the exemption fromregistration contained in Section 4(2) of the 1933 Act. The commercialpaper is issued in denominations of $100,000 or integral multiples of $1,000 inexcess thereof and will bear such interest rates, if interest-bearing, or willbe sold at such discount from their face amounts, as agreed upon by the Companyand the dealer or dealers acting in connection with the commercial paperprogram. The commercial paper may be issued with varying maturities up to amaximum of 270 days from the date of issuance. As of March 31, 2004and December 31, 2003, outstanding commercial paper totaled approximately$427.0 million and $429.8 million, respectively. The average maturityfor the commercial paper was 36 days as of March 31, 2004 and 43 daysas of December 31, 2003. The weighted average yield on the outstandingcommercial paper as of March 31, 2004 and December 31, 2003 was 1.16% and1.25%, respectively. The Company intends to maintain commercial paperborrowings of at least the amount outstanding at March 31, 2004 for morethan one year. Accordingly, for financial reporting purposes, the commercialpaper has been classified under non-current liabilities in the accompanyingConsolidated Balance Sheets. Under the Company’s merger agreement withAnthem, Inc., however, the Company has agreed to repurchase, prior to theclosing of the merger with Anthem, any outstanding commercial paper issued bythe Company or any of its subsidiaries. The related interest expense for thequarters ended March 31, 2004 and 2003 was $1.3 million and$1.1 million, respectively.

 

*Debt Covenants*

 

The Company’srevolving credit facility requires the maintenance of certain financial ratiosand contains other restrictive covenants, including restrictions on theincurrence of additional indebtedness by subsidiaries and the granting ofcertain liens, limitations on acquisitions and investments and limitations onchanges in control. As of March 31, 2004 and December 31, 2003, theCompany was in compliance with the requirements in these agreements.

 

**8.****             ****HedgingActivities**

 

The Companymaintains an interest rate risk management strategy that uses derivative instrumentsto minimize 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.

 

14

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By usingderivative financial instruments to hedge exposures to changes in interestrates, the Company exposes itself to credit risk and market risk. Market riskis the adverse effect on the value of a financial instrument that results froma change in interest rates. The Company manages exposure to market riskassociated with interest rate contracts by establishing and monitoringparameters that limit the types and degree of market risk that may beundertaken.

 

The Companyuses interest rate swap agreements to manage interest rate exposures. Theprincipal objective of such contracts is to minimize the risks and/or costsassociated with financial and investing activities. The Company does not usederivative financial instruments for speculative purposes. The counterpartiesto these contractual arrangements are major financial institutions with whichthe Company also has other financial relationships. These counterparties exposethe Company to credit loss in the event of non-performance. However, theCompany does not anticipate non-performance by the other parties. As ofMarch 31, 2004, the Company reported a derivative asset of$13.3 million related to a fair value hedge.

 

*Fair Value Hedges*

 

With theintention of reducing the interest expense associated with the 2006 Notes, theCompany, on January 15, 2002, entered into a $200.0 million notionalamount interest rate swap agreement. The swap agreement is a contract toexchange a fixed 6 3/8% rate for a LIBOR-based floating rate. The swap agreementexpires June 15, 2006. The Company recognized $1.9 million for eachof the quarters ended March 31, 2004 and 2003, in income from this swapagreement, which was recorded as a reduction to interest expense. As of March31, 2004 and December 31, 2003, the Company recognized a derivative asset of$13.3 million and $9.9 million, respectively, related to this swapagreement.

 

*Cash Flow Hedges*

 

The Companyhas entered into interest rate swap agreements to reduce the impact of changesin interest rates on its floating rate debt under its revolving creditfacility. The swap agreements were contracts to exchange variable-rate forfixed-rate interest payments without the exchange of the underlying notionalamounts.

 

InSeptember 2002, the Company terminated and settled its $150.0 millionand $50.0 million notional amount interest rate swap agreements withoriginal expiration dates of October 17, 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 millionrepresented the fair value of the swap agreements at the time of termination.The fair value of the swap agreements was reflected in accumulated othercomprehensive income and will be amortized as a reduction to investment incomeon a straight-line basis over the shorter of the original expiration dates ofthe interest rate swap agreements or the expected cash flows of the commercialpaper program. The fair value of the $150.0 million and $50.0 millionnotional amount swap agreements, at termination, were $8.0 million and$7.8 million, respectively. Amortization of other comprehensive incomerelated to the terminated swaps on a pre-tax basis for the quarters endedMarch 31, 2004 and 2003 totaled $0.5 million, or $0.3 million

 

15

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after-tax, and$2.4 million, or $1.4 million after-tax, respectively. For the yearended December 31, 2003, the fair value of the $150.0 millionnotional amount swap agreement in other comprehensive income was fullyamortized. The unamortized pre-tax amount in other comprehensive income relatedto the $50.0 million notional amount swap agreement as of March 31,2004 and December 31, 2003 totaled $4.9 million and $5.4 million,respectively.

 

**9.****              Stock-Based Compensation**

 

At March 31,2004, 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 related to stock optionsgranted because options granted under those plans had an exercise price equalto the market value of the underlying Common Stock on the date of grant. Inaddition, no compensation expense is recorded for purchases under the EmployeeStock Purchase Plan in accordance with APB No. 25. Employee stock-basedcompensation included in reported net income includes restricted stock awardsbeing amortized over the award’s vesting period.

 

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 ofFinancial Accounting Standards No. 123, “Accounting for Stock-BasedCompensation” as amended by Statement of Financial Accounting Standards No.148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” forthe quarters ended March 31, 2004 and 2003.

 
|                                                                                                                                        |   | **Quarter  Ended  March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
| **(In millions, except per share  amounts)**                                                                                                |   | **2004**                      |   | **2003** |   |
|                                                                                                                                        |   |                          |   |   |   |
| Net income—as reported                                                                                                                 |   | $                             | 295.2  |   | $ | 193.1 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                 |   | 2.6                           |   | 0.4 |   |
| Less: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (29.6                         | )      | (17.2 | ) |
| Net income—pro forma                                                                                                                   |   | $                             | 268.2  |   | $ | 176.3 |   |
|                                                                                                                                        |   |                          |   |   |   |
| Earnings per share—as reported                                                                                                         |   | $                             | 1.92   |   | $ | 1.33 |   |
| Earnings per share—pro forma                                                                                                           |   | $                             | 1.74   |   | $ | 1.21 |   |
| Earnings per share assuming full  dilution-as reported                                                                                      |   | $                             | 1.85   |   | $ | 1.29 |   |
| Earnings per share assuming full  dilution-pro forma                                                                                        |   | $                             | 1.68   |   | $ | 1.18 |   |

 

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

 

**10**.       **Earnings Per Share**

 

The followingis an illustration of the dilutive effect of the Company’s potential CommonStock on earnings per share. Outstanding stock options for which the exerciseprice was greater than the average market per share price of Common Stock wereas follows: 842,000 and 762,000 for the quarters ended March 31, 2004 and 2003,respectively. Since the effect of these options was antidilutive, they havebeen excluded from the computation of the diluted earnings per share below.

 
|                                               |   | **Quarter  Ended  March  31,** |    |
|----------------------------------------------------|--------|-------------------------------------|---------|
| **(In thousands, except per share  data)**         |   | **2004**                            |    | **2003** | ** ** |
| **Numerator**                                      |   |                                |    |   |   |
| Net Income                                         |   | $                                   | 295,221 |   | $ | 193,053 |   |
|                                               |   |                                |    |   |   |
| **Denominator**                                    |   |                                |    |   |   |
| Weighted average shares outstanding                |   | 153,939                             |    | 145,613 |   |
| Net effect of dilutive stock options               |   | 5,459                               |    | 3,558 |   |
| Fully diluted weighted average shares  outstanding |   | 159,398                             |    | 149,171 |   |
|                                               |   |                                |    |   |   |
| Earnings Per  Share                                |   | $                                   | 1.92    |   | $ | 1.33 |   |
| Earnings Per  Share Assuming Full Dilution         |   | $                                   | 1.85    |   | $ | 1.29 |   |

 

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**11**.       **Comprehensive Income**

 

The followingsummarizes comprehensive income (loss) reclassification adjustments for thequarters ended March 31, 2004 and 2003:

 
|                                                                                                                                    |   | **Quarter  Ended  March  31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------|--------|
| **(In  thousands)**                                                                                                                     |   | **2004**                            |   | **2003** |   |
|                                                                                                                                    |   |                                |   |   |   |
| Investment Securities:                                                                                                                  |   |                                |   |   |   |
| Net holding gain (loss) on investment  securities arising during the period, net of tax (expense) benefit of  $(32,797) and $6,794 |   | $                                   | 53,919 |   | $ | (10,635 | ) |
| Reclassification adjustment for realized  gain on investment securities, net of tax expense of $6,627 and $2,455                        |   | 9,939                               |   | 3,737 |   |
| Net gain (loss) recognized in other  comprehensive income, net of tax (expense) benefit of $(39,424) and $4,339                         |   | $                                   | 63,858 |   | $ | (6,898 | ) |

 

**12.****       BusinessSegment Information**

 

The Companymaintains the following two reportable segments: Health Care and Specialty. TheHealth Care segment, prior to the acquisition of Cobalt, was an aggregation offour operating segments: California, Central, Georgia andSenior/State-Sponsored Programs. With the acquisition of Cobalt onSeptember 24, 2003, the Health Care segment increased to five operatingsegments with the addition of the Wisconsin region. These Health Care operatingsegments all have similar characteristics and meet the following fiveaggregation 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)          Alloperating segments provide similar health care products to similar customertypes. WellPoint generally markets the same health care products across thecountry for each of its customer groups.

 

(2)          Theproduction processes are substantially similar for all operating segments asthey support similar customer groups and products.

 

(3)          Eachoperating segment has the same class of customers, primarily large employergroups and individual and small employer groups.

 

(4)          Eachoperating segment has similar distribution channels that are used for each ofthe customer types. Large employer group products are distributed primarilythrough health care consultants and brokers, while individual and small groupproducts are

 

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distributed through agents or through captive sales forces. Thesemethods are similar across geographies.

 

(5)          Thehealth care industry is highly regulated at both the federal and state levels.All of the geographies must comply with the same federal regulations. Whileeach state’s laws are in some respects unique, many states have similar lawsand regulations applicable to 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 composing theHealth Care segment provide a broad spectrum of network-based health plans,including PPOs, HMOs, POS plans, other hybrid plans and traditional indemnityplans, 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, workers’ compensation insurance products and workers’ compensationmanaged care services. Amounts under the heading “Corporate and Other” includenet investment income, general and administrative expense and interest expensenot allocable to the reportable segments. Also included in Corporate and Otherare the operating results from the Company’s captive general insurance agency,which has not met the quantitative thresholds for an operating segment underSFAS No. 131.

 

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, 2004 and 2003.

 

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, 2004, pharmaceutical sales totaled $112.0 million andutilization review fees and claims and rebate processing fees totaled$23.3 million. For the quarter ended March 31, 2003, pharmaceutical salestotaled $93.1 million and utilization review fees and claims and rebateprocessing fees totaled $21.6 million. All intersegment transactions areeliminated in consolidation under the caption “Corporate and Other.”

 

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**Quarter Ended March31, 2004**

 
| **(In thousands)**                    |   | **Health  Care** |      | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|---------------------------------------|--------|------------------|-----------|---------------|------------|--------------------------|------------|------------------|------------|
|                                  |   |             |      |          |       |                     |       |             |       |
| Premium revenue                       |   | $                | 5,072,731 |          | $          | 183,572                  |       | $                | -          |   | $ | 5,256,303 |   |
| Management services and other revenue |   | 254,913          |      | 48,893        |       | 2,370                    |       | 306,176          |       |
| Total revenue from external customers |   | 5,327,644        |      | 232,465       |       | 2,370                    |       | 5,562,479        |       |
| Intersegment revenues                 |   | —           |      | 135,321       |       | (135,321                 | )          | —           |       |
|                                  |   |             |      |          |       |                     |       |             |       |
| Segment net income                    |   | $                | 254,345   |          | $          | 35,000                   |       | $                | 5,876      |   | $ | 295,221 |   |

 

**Quarter Ended March 31, 2003**

 
| **(In thousands)**                    |   | **Health  Care** |      | **Specialty** | ** ** | **Corporate  and Other** | ** ** | **Consolidated** | ** ** |
|---------------------------------------|--------|------------------|-----------|---------------|------------|--------------------------|------------|------------------|------------|
|                                  |   |             |      |          |       |                     |       |             |       |
|                                  |   |             |      |          |       |                     |       |             |       |
| 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 |   |

 

**13.****       RelatedParty 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 Boardof Directors is composed solely of persons who are also officers of theCompany. For the quarters ended March 31, 2004 and 2003, the Company committedand contributed $15.0 million and $10.0 million, respectively, to theFoundation. As of March 31, 2004 and 2003, the Company did not have anyoutstanding commitments payable to the Foundation. The Company currently has nolegal obligations for any future commitments to the Foundation.

 

**14.****       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

 

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a significantpunitive damage award, could have a material adverse effect on the Company. Inaddition, the risk of potential liability under punitive damage theories mayincrease significantly the difficulty of obtaining reasonable settlements ofcoverage claims.

 

InMay 2000, the California Medical Association filed a lawsuit in U.S.district court in San Francisco against BCC. The lawsuit alleges that BCCviolated the Racketeer Influenced and Corrupt Organizations Act (“RICO”)through various misrepresentations to and inappropriate actions against healthcare providers. In late 1999, a number of class-action lawsuits were broughtagainst several of the Company’s competitors alleging, among other things,various misrepresentations regarding their health plans and breaches offiduciary obligations to health plan members. In August 2000, the Companywas added as a party to *Shane v. Humana, et al.*, a class-actionlawsuit brought on behalf of health care providers nationwide. In addition tothe RICO claims brought in the California Medical Association lawsuit, thislawsuit also alleges violations of ERISA, federal and state “prompt pay”regulations and certain common law claims. In October 2000, the federalJudicial Panel on Multidistrict Litigation issued an order consolidating theCalifornia Medical Association lawsuit, the *Shane* lawsuit and various other pendingmanaged care class-action lawsuits against other companies before DistrictCourt Judge Federico Moreno in the Southern District of Florida for purposes ofthe pretrial proceedings. In March 2001, Judge Moreno dismissed theplaintiffs’ claims based on violation of RICO, although the dismissal was madewithout prejudice to the plaintiffs’ ability to subsequently refile theirclaims. Judge Moreno also dismissed, with prejudice, the plaintiffs’ federalprompt pay law claims. On March 26, 2001, the plaintiffs filed an amendedcomplaint in its lawsuit, alleging, among other things, revised RICO claims andviolations of California law. On May 3, 2001, the defendants filed a motion todismiss this amended complaint. On May 9, 2001, Judge Moreno issued anorder requiring that all discovery in the litigation be completed byDecember 2001, with the exception of discovery related to expertwitnesses, which was to be completed by March 15, 2002. In June 2001,the federal Court of Appeals for the 11th Circuit issued a stay of JudgeMoreno’s discovery order, pending a hearing before the Court of Appeals on theCompany’s appeal of its motion to compel arbitration (which had earlier beengranted in part and denied in part by Judge Moreno). The hearing was held inJanuary 2002 and, in March 2002, the Court of Appeals panel issued anopinion affirming Judge Moreno’s earlier action with respect to the motion tocompel arbitration. The Company filed a motion requesting a rehearing of thematter before the entire 11th Circuit Court of Appeals, which motion was deniedby the 11th Circuit Court of Appeals in June 2002. On July 29, 2002,Judge Moreno issued an order providing that discovery in the case would beallowed to re-commence on September 30, 2002. On September 26, 2002,Judge Moreno issued an additional order certifying a nationwide class ofphysicians in the *Shane* matter, setting a trial date in May 2003 andordering the parties to participate in non-binding mediation. In October 2002,the defendants, among other things, moved to compel arbitration of most claims(which motion was granted in part in September 2003). In October 2002, theCompany also filed a motion with the 11th Circuit Court of Appeals seeking toappeal Judge Moreno’s class-certification order. The motion was granted. The11th Circuit heard oral argument on September 11, 2003 on the Company’sappeal. A mediator has been appointed by Judge Moreno and the parties arecurrently conducting court-ordered mediation. On April

 

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30, 2004,Judge Moreno set a new trial date in March 2005 and extended the deadline fordiscovery to September 29, 2004, which may be further extended.

 

InMarch 2002, the American Dental Association and three individual dentistsfiled a lawsuit in U.S. district court in Chicago against the Company and BCC.This lawsuit alleges that WellPoint and BCC engaged in conduct that constituteda breach of contract under ERISA, trade libel and tortious interference withcontractual relations and existing and prospective business expectancies. Thelawsuit seeks class-action status. The Company filed a motion (which wasgranted in July 2002) with the federal Judicial Panel on MultidistrictLitigation requesting that the proceedings in this case be consolidated with asimilar action brought against other managed care companies that has beenconsolidated with the *Shane* lawsuit. The case is currentlystayed.

 

InMay 2003, a lawsuit entitled *Thomas, et al. v. Blue Cross and Blue ShieldAssociation, et al*. was filed in the U.S. District Court in the SouthernDistrict of Florida. The attorneys representing the plaintiffs in the lawsuitare primarily the attorneys representing the plaintiffs in the *Shane*litigation described above. The defendants in *Thomas* are the Company’sBlue Cross and Blue Shield-licensed subsidiaries, the BCBSA and all of theother current Blue Cross and Blue Shield licensees. The lawsuit alleges thateach of the defendants engaged in similar activities and conduct as thatalleged in the *Shane* litigation. The case has been assigned to JudgeMoreno. The defendants have moved to compel arbitration and to dismiss thecomplaint.

 

OnMarch 26, 2003, a lawsuit entitled *Irwin v. AdvancePCS, et al*. was filed inthe California Superior Court in Alameda County, California. WellPoint andcertain of its wholly owned subsidiaries are named as defendants in thelawsuit. The complaint alleges that the defendants violated California Businessand Professions Code Section 17200 by engaging in unfair, fraudulent andunlawful business practices. The complaint alleges, among other things, thatpharmacy benefit management companies (such as the Company’s subsidiary thatdoes business under the tradename WellPoint Pharmacy Management) engage inunfair practices such as negotiating discounts in prices of drugs frompharmacies and negotiating rebates from drug manufacturers and retaining suchdiscounts and rebates for their own benefit. The complaint also alleges thatdrugs are included in formularies in exchange for rebates and that thedefendants charge patient co-payments that exceed the actual cost of genericdrugs.

 

In early 2003,a lawsuit entitled *Knecht v. Cigna, et al.* was filed in U.S.District Court in Oregon. This litigation has subsequently been transferred toJudge Moreno of the U.S. District Court for the Southern District of Florida.This litigation is a putative class action lawsuit on behalf of chiropractorsin the western United States. The Company is a named defendant in the lawsuit.The lawsuit alleges that each of the defendants engaged in similar activitiesand conduct as that alleged in the *Shane* litigation. The case is currentlystayed.

 

InOctober 2003, a lawsuit entitled *Solomon, et al. v. Cigna, et al.* was filedin the U.S. District Court in the Southern District in Florida. The Company isa named defendant in this lawsuit, although the Company has not yet beenserved. This lawsuit is also a putative class action

 

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brought onbehalf of chiropractors, podiatrists and certain other types of health carepractitioners nationwide. This lawsuit also alleges that the defendants engagedin similar activities and conduct as that alleged in the *Shane* litigation. OnDecember 15, 2003, this lawsuit was transferred to Judge Moreno, and the casewas consolidated with the *Knecht* lawsuit for pre-trial purposes.Both of these cases are currently stayed. In December 2003, the plaintiffsin *Solomon,et al. v. Cigna, et al.* filed a similar lawsuit against the Company,the Company’s Blue Cross and Blue Shield-licensed subsidiaries, the BCBSA andall of the other current Blue Cross and Blue Shield licensees. The lawsuit isentitled *Solomon,et al. v. Blue Cross and Blue Shield Association, et al.* and wasfiled in the U.S. District Court in the Southern District in Florida. OnJanuary 7, 2004, this lawsuit was transferred to Judge Moreno.  On March 9, 2004, Judge Moreno issued anorder restoring this case to the active docket and placing it on a coordinatedtrack with the *Thomas* lawsuit.

 

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.

 

Prior to theCompany’s acquisition of the GBO, John Hancock Mutual Life Insurance Company(“John Hancock”) entered into a number of reinsurance arrangements with respectto personal accident insurance and the occupational accident component ofworkers’ compensation insurance, a portion of which was originated through apool managed by Unicover Managers, Inc. Under these arrangements, JohnHancock assumed risks as a reinsurer and transferred certain of such risks toother companies. These arrangements have become the subject of disputes,including a number of legal proceedings to which John Hancock is a party. TheCompany is currently in arbitration with John Hancock regarding thesearrangements. The Company believes that it has a number of defenses to avoidany ultimate liability with respect to these matters and believes that suchliabilities were not transferred to the Company as part of the GBO acquisition.However, if the Company were to become subject to such liabilities, the Companycould suffer losses that might have a material adverse effect on its financialcondition, results of operations or cash flows.

 

A stockholderclass action lawsuit was filed in the Superior Court of Ventura County,California on October 28, 2003 against the Company and its board ofdirectors. The lawsuit, which is entitled *Abrams v. WellPoint Health Networks Inc.,et al.*, alleges that the Company’s directors breached theirfiduciary duties to stockholders by approving an Agreement and Plan of Mergerwith Anthem while in possession of non-public information regarding theCompany’s financial results for the third quarter of 2003. The lawsuit seeks toenjoin the Company from consummating the merger with Anthem, unless the Companyadopts and implements a process for obtaining the highest possible price forstockholders, and to rescind any terms of the Agreement and Plan of Merger thathave already been implemented.  On May7, 2004, WellPoint and the plaintiff signed a memorandum of understandingregarding a potential settlement of the action.  The potential settlement contemplated by the memorandum ofunderstanding would involve WellPoint agreeing to provide certain additionaldisclosures on several matters in the joint proxy statement/prospectus to besent to WellPoint’s stockholders beyond those contained in the preliminaryproxy statement/prospectus.  Thesettlement would also provide for the payment by WellPoint of $2.25 million tothe plaintiff’s counsel for fees and costs (subject to court approval).  No part of the settlement costs will be paidby the WellPoint directors individually. The settlement would not involve any admissions of breaches of fiduciaryduty or other wrongdoing by WellPoint or any of its directors.  The settlement and payment of theplaintiff’s counsel fees would be conditioned upon, among other things, completionof the merger.  Any final settlementagreement signed by the parties must be approved by the Superior Court judgeassigned to the matter.  While WellPointexpects to diligently negotiate the terms of a final settlement agreement,there can be no assurances that a settlement agreement will be signed.

 

Certain ofsuch legal proceedings are or may be covered under insurance policies orindemnification agreements. Based upon information presently available, theCompany

 

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believes thatthe final outcome of all such proceedings should not have a material adverseeffect on the Company’s results of operations, cash flows or financialcondition.

 

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 forother services, such as custodial arrangements with respect to certain of theCompany’s assets. 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 inthe entity’s capital and the entity does not then have capital sufficient tomeet the increased requirement or (ii) the entity’s medical care ratio is100% or greater during any 180-day period and the entity does not then meetstatutory capital requirements under the Puerto Rico Insurance Code. The amountof this guarantee will not exceed 80% of the amount necessary to provide theentity with a 12 to 1 premium-to-capital ratio. As of March 31, 2004, theCompany’s maximum potential liability pursuant to this guarantee was $27.3million. 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.

 

**15.  PendingMerger with Anthem**

 

OnOctober 26, 2003, WellPoint entered into a merger agreement withAnthem, Inc. (“Anthem”). The consideration to be received by the stockholdersof WellPoint will be composed of $23.80 in cash and one share of Anthem commonstock per share of WellPoint Common Stock. Based on the closing price ofAnthem’s common stock on October 24, 2003, the transaction was valued atapproximately $16.4 billion. Upon completion of this transaction,WellPoint will merge into a wholly owned subsidiary of Anthem and Anthem willchange its name to WellPoint, Inc. Anthem, a publicly traded company, isan independent licensee of the Blue Cross and Blue Shield Association and holdsthe exclusive right to use the Blue Cross and Blue Shield names and marks inthe states of Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Colorado,Nevada, Maine and Virginia, excluding the immediate suburbs of Washington D.C. Asof March 31, 2004, Anthem provided health care benefits to more than12.5 million members, which includes BlueCard “host” members.Headquartered in Indianapolis, Indiana, Anthem, along with its subsidiaries,offers a diverse portfolio of complementary health and group life insurance,managed care products, pharmacy benefit management and government healthprogram administration.

 

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Thetransaction is subject to customary closing conditions, including, among otherthings, approval of WellPoint’s and Anthem’s shareholders and variousregulatory agencies. The Company currently expects the transaction to close bymid-2004.

 

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Report ofIndependent Accountants

 

To the Stockholders and Board of Directors of

WellPoint Health Networks Inc.

 

We have reviewed the accompanyingconsolidated balance sheet of WellPoint Health Networks Inc. and itssubsidiaries (the “Company”) as of March 31, 2004, and the relatedconsolidated income statements for each of the three-month periods endedMarch 31, 2004 and 2003 and the related consolidated statement of changesin stockholders’ equity for the three-month period ended March 31, 2004and the consolidated statements of cash flows for the three-month periods endedMarch 31, 2004 and 2003.  Theseinterim financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance withstandards established by the American Institute of Certified PublicAccountants.  A review of interimfinancial information consists principally of applying analytical proceduresand making inquiries of persons responsible for financial and accountingmatters.  It is substantially less inscope than an audit conducted in accordance with generally accepted auditingstandards, the objective of which is the expression of an opinion regarding thefinancial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of anymaterial modifications that should be made to the accompanying consolidatedinterim financial statements for them to be in conformity with accountingprinciples generally accepted in the United States of America.

 

We previously audited in accordance withauditing standards generally accepted in the United States of America, theconsolidated balance sheet as of December 31, 2003, and the relatedconsolidated income statement and consolidated changes in stockholders’ equity,and cash flows for the year then ended (not presented herein), and in ourreport dated January 27, 2004  weexpressed an unqualified opinion on those consolidated financial statements.  Our report included an explanatoryparagraph, that effective January 1, 2002, the Company adopted Statementof Financial Accounting Standards No. 142, *Goodwilland Other Intangible Assets*. Accordingly, the Company ceased amortizing goodwill and indefinite-livedintangible assets as of January 1, 2002. Additionally, effective January 1, 2003, the Company adoptedStatement of Financial Accounting Standards No. 145, *Rescission of FASB No. 4, 44, and 64, Amendment of FASB Statement No.13, and Technical Corrections*. In our opinion, the information setforth in the accompanying consolidated balance sheet as of December 31,2003, 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 19, 2004, except Note 14 as to which the date is May 7,  2004 |

 

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ITEM 2.          Management’s Discussion and Analysis ofFinancial Condition and Results of Operations

 

This discussion contains forward-looking statements, which involverisks and uncertainties.  The Company’sactual results may differ materially from those anticipated in theseforward-looking statements as a result of certain factors including, but notlimited to, those set forth under “Factors That May Affect Future Results ofOperations.”

 

***General***

 

The Company is one of the nation’s largest publicly traded managedhealth care companies. As of March 31, 2004, WellPoint had approximately15.4 million medical members (including approximately 1.2 millionBlueCard “host” members) and approximately 45.9 million specialty members.Through its subsidiaries, the Company offers a broad spectrum of network-basedmanaged care plans to the large and small employer, individual, Medicaid and seniormarkets. The Company’s managed care plans include PPOs, HMOs, POS plans, otherhybrid plans and traditional indemnity plans. In addition, the Company offersmanaged care services, including underwriting, actuarial services, networkaccess, medical management and claims processing. The Company also provides abroad array of specialty and other products and services, including pharmacybenefits management, dental, vision, life insurance, preventive care,disability insurance, behavioral health, COBRA and flexible benefits accountadministration. With its recent acquisition of Cobalt Corporation (“Cobalt”),the Company now also offers workers’ compensation insurance products and iscurrently the largest Medicare Part A fiscal intermediary in the nation,processing claims for providers in all 50 states. The Company markets itsproducts in California primarily under the name Blue Cross of California, inGeorgia primarily under the name Blue Cross Blue Shield of Georgia, in variousparts of Missouri (including the greater St. Louis area) primarily under thename Blue Cross Blue Shield of Missouri, in Wisconsin primarily under the namesBlue Cross Blue Shield of Wisconsin and CompcareBlue and in various parts ofthe country under the names UNICARE and HealthLink.

 

*Acquisition ofCobalt*

 

On September 24, 2003, the Company completed its acquisition ofCobalt (see Note 4 to the Consolidated Financial Statements). At closing,the acquisition was valued at approximately $884.9 million, which was paidwith $439.6 million in cash and approximately 7.3 million shares ofWellPoint Common Stock, of which approximately 2.1 million shares wereissued to affiliates of WellPoint. As of September 30, 2003, Cobalt servedapproximately 675,000 medical members and offered a diverse portfolio ofcomplementary insurance, managed care products and administrative services toemployer, individual, insurer and government customers. The Cobalt merger waseffective as of September 30, 2003 for accounting purposes.

 

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*Acquisition ofGolden West*

 

On June 30, 2003, the Company completed its acquisition of GoldenWest (see Note 4 to the Consolidated Financial Statements), which servedover 275,000 dental and vision members, primarily in California, at the time ofacquisition.

 

*Pending Merger withAnthem*

 

OnOctober 26, 2003, WellPoint entered into a merger agreement withAnthem, Inc. (“Anthem”). The consideration to be received by thestockholders of WellPoint will be composed of $23.80 in cash and one share ofAnthem common stock per share of WellPoint Common Stock. Based on the closingprice of Anthem’s common stock on October 24, 2003, the transaction wasvalued at approximately $16.4 billion. Upon completion of thistransaction, WellPoint will merge into a wholly owned subsidiary of Anthem andAnthem will change its name to WellPoint, Inc. Anthem, a publicly tradedcompany, is an independent licensee of the Blue Cross and Blue ShieldAssociation and holds the exclusive right to use the Blue Cross and Blue Shieldnames and marks in the states of Indiana, Kentucky, Ohio, Connecticut, NewHampshire, Colorado, Nevada, Maine and Virginia, excluding the immediatesuburbs of Washington D.C. As of March 31, 2004, Anthem provided healthcare benefits to more than 12.5 million medical members, which includesBlueCard “host” members. Headquartered in Indianapolis, Indiana, Anthem, alongwith its subsidiaries, offers a diverse portfolio of complementary health andgroup life insurance, managed care products, pharmacy benefit management andgovernment health program administration.

 

Thetransaction is subject to customary closing conditions, including, among otherthings, approval of WellPoint’s and Anthem’s shareholders, various regulatoryagencies and the Blue Cross and Blue Shield Association.

 

Inconnection with obtaining the approval of WellPoint’s and Anthem’s shareholdersfor the proposed merger, Anthem filed a preliminary registration statement onForm S-4, including the preliminary joint proxy statement/prospectusconstituting a part thereof, with the Securities and Exchange Commission onNovember 26, 2003. Anthem will file a final registration statement,including a definitive joint proxy statement/prospectus constituting a partthereof, and other documents with the Securities and Exchange Commission. Thefinal joint proxy statement/prospectus will be mailed to holders of WellPointand Anthem common stock.

 

WellPointand Anthem have made appropriate filings and applications with insurance andHMO regulators in California, Delaware, Georgia, Illinois, Missouri, Oklahoma,Puerto Rico, Texas, Virginia, West Virginia and Wisconsin. Pursuant toapplicable insurance and HMO laws and regulations, and before the merger may beconsummated, the insurance commissioner and, where applicable, HMO regulator,must review and approve the acquisition of control of the insurance company orHMO subsidiary domiciled in its respective jurisdiction. In addition to thefilings with and approvals from the domiciliary insurance and HMO regulators,pre-acquisition notifications of the merger under state insurance antitrustlaws and regulations will be required in certain states in which insurancecompany or HMO subsidiaries of both WellPoint and Anthem operate.

 

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TheBlue Cross and Blue Shield Association must approve the transfer to Anthem ofWellPoint’s licenses to use the Blue Cross and Blue Shield names and marks inWellPoint’s geographical territories. Anthem and WellPoint have submitted ajoint application requesting that, in connection with the completion of themerger, the Blue Cross and Blue Shield Association grant to Anthem the licensesfor the WellPoint service area. The Blue Cross and Blue Shield Associationunanimously approved this application on March 18, 2004.

 

TheHart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the rulesand regulations thereunder provide that the merger may not be completed untilpre-merger notification filings have been made with the Federal TradeCommission, and the Antitrust Division of the U.S. Department of Justice, andthe specified waiting period thereunder has expired or is terminated. Evenafter the waiting period expires or is terminated, the Department of Justice andthe Federal Trade Commission will have the authority to challenge the merger onantitrust grounds before or after the merger is completed. Each of Anthem andWellPoint filed a notification and report form for the merger with the FederalTrade Commission and the Department of Justice in January 2004 and thewaiting period expired on February 26, 2004.

 

Followingthe merger, WellPoint stockholders will become shareholders of Anthem. Inaddition, in the merger agreement, among other things, WellPoint has agreedthat Anthem will have its corporate headquarters and principal executiveoffices in Indianapolis, Indiana and that Anthem’s name will be changed toWellPoint, Inc. WellPoint and Anthem have also agreed to file anapplication to have the common stock of Anthem listed on the New York StockExchange under the ticker symbol “WLP.”

 

Afterthe merger, the board of directors of Anthem will have 19 members, consistingof 11 current members of Anthem’s board of directors designated by Anthem(including Larry C. Glasscock) and eight current members of WellPoint’s boardof directors designated by WellPoint (including Leonard D. Schaeffer). Alsoafter the merger, Leonard D. Schaeffer of WellPoint will be Chairman of theBoard of Directors of Anthem and Larry C. Glasscock of Anthem will be thePresident and Chief Executive Officer and a director of Anthem. By the secondanniversary of the completion of the merger, Leonard D. Schaeffer will retireas Chairman and as a director of Anthem and Larry C. Glasscock will succeed himas Chairman.

 

EitherWellPoint or Anthem may terminate the merger agreement, even after therequisite shareholder approvals have been received, if the merger has not beencompleted by November 30, 2004, and either of them may also terminate themerger agreement in certain other circumstances specified in the mergeragreement. The Company currently expects the transaction to close by mid-2004.

 

*CareFirst Merger Agreement*

 

InNovember 2001, WellPoint entered into a merger agreement withCareFirst, Inc. (“CareFirst”), which agreement was amended inJanuary 2003. CareFirst has the exclusive right to use the Blue Cross andBlue Shield names and marks in Maryland, Delaware, the District of Columbia andcertain counties in Northern Virginia. Under the amended merger agreement,CareFirst would have become a subsidiary of WellPoint. The consummation of theCareFirst transaction was subject to a number of conditions, including theapproval of the insurance regulators in Maryland, Delaware and the District ofColumbia for the conversion of

 

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CareFirstfrom a non-profit corporation to a for-profit entity. On March 5, 2003,the Maryland insurance commissioner issued an order disapproving thisconversion. In August 2003, the Company received a notice from CareFirstelecting to terminate the amended merger agreement in accordance with itsterms.

 

InAugust 2003, the Company received a Grand Jury subpoena from the UnitedStates Attorney’s office in the District of Maryland requesting variousdocuments relating to the CareFirst transaction. The Company has responded tothe request and intends to cooperate fully with the United States Attorney’soffice. The Company has no reason to believe it is a target of the proceedings.

 

*National Expansionand Other Recent Developments*

 

In an effort to pursue the expansion of the Company’s business outsidethe state of California, the Company acquired two businesses in 1996 and 1997,the Life and Health Benefits Management Division of Massachusetts Mutual LifeInsurance Company and the Group Benefits Operations (the “GBO”) of John HancockMutual Life Insurance Company. The acquisitions of Rush Prudential Health Plansand a mail-order pharmacy, which now does business as PrecisionRx, in 2000, theacquisition of Cerulean Companies, Inc. in 2001, the acquisitions ofRightCHOICE and MethodistCare in 2002 and the acquisition of Cobalt in 2003were also components of this expansion strategy.

 

As a result of these acquisitions, the Company has significantlyexpanded its operations outside of California. In order to integrate itsacquired businesses and implement its regional expansion strategy, the Companywill need to develop satisfactory networks of hospitals, physicians and otherhealth care service providers, develop distribution channels for its productsand successfully convert acquired books of business to the Company’s existinginformation systems, which will require continued investments by the Company.

 

In response to rising medical and pharmacy costs, the Company has fromtime to time implemented premium increases with respect to certain of itsproducts. The Company will continue to evaluate the need for further premiumincreases, plan design changes and other appropriate actions in the future inorder to maintain or restore profit margins. There can be no assurances,however, that the Company will be able to take subsequent pricing or otheractions or that any actions previously taken or implemented in the future willbe successful in addressing any concerns that may arise with respect to theperformance of certain businesses.

 

## *Legislation*

## * *

Federal legislation enacted during the last several years seeks, amongother things, to ensure the portability of health coverage and mandates minimummaternity hospital stays. California legislation enacted since 1999, amongother things, establishes an explicit duty on managed care entities to exerciseordinary care in arranging for the provision of medically necessary health careservices and establishes a system of independent medical review. In 1997, Texasadopted legislation purporting to make managed care organizations such as theCompany liable for their failure to exercise ordinary care when making healthcare treatment decisions. Similar legislation has also been enacted in Georgia.These and other proposed measures may have the effect of dramatically alteringthe regulation of health care and of increasing the

 

30

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Company’s medical care ratio and administrative costs or decreasing theaffordability of the Company’s products.

 

***Consolidated Resultsof Operations***

 

The Company’s revenues are primarily generated from premiums earned forrisk-based health care and specialty services provided to its members; fees foradministrative services, including claims processing and access to providernetworks for self-insured employers; and investment income. Operating expensesinclude health care services and other benefits expenses, consisting primarilyof payments for physicians, hospitals and other providers for health care andspecialty products claims; selling expenses for broker and agent commissions;general and administrative expenses; interest expense; depreciation andamortization expense; and income taxes.

 

The Company’s consolidated results of operations for the quarter endedMarch 31, 2004 include its acquired operations of Cobalt for the entirethree months, while operating results for the quarter ended March 31, 2003do not include any acquired operations of Cobalt. On September 24, 2003,the Company completed its acquisition of Cobalt. The Cobalt merger waseffective as of September 30, 2003 for accounting purposes.

 

The following table sets forth selected operating ratios.  The medical care ratio for health careservices and other benefits is shown as a percentage of premium revenue.  All other ratios are shown as a percentageof premium revenue and management services and other revenue combined.

 
|                                  |   | **Quarter  Ended  March 31,** |   |
|---------------------------------------|--------|------------------------------------|--------|
|                                  |   | **2004**                           |   | **2003** | ** ** |
| Operating Revenues:                   |   |                               |   |   |   |
| Premium revenue                       |   | 94.5                               | %      | 95.3 | % |
| Management services and other revenue |   | 5.5                                | %      | 4.7 | % |
|                                  |   | 100.0                              | %      | 100.0 | % |
| Operating Expenses:                   |   |                               |   |   |   |
| Health care services and other        |   |                               |   |   |   |
| benefits (medical care ratio)         |   | 79.7                               | %      | 81.7 | % |
| Selling expense                       |   | 3.9                                | %      | 4.0 | % |
| General and administrative expense    |   | 13.0                               | %      | 12.4 | % |

 

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***Membership***

 

The following table sets forth membership data and the percent changein membership:

 
|                                                          |   | **March 31,** |   | **Percent********Change** |   |
|---------------------------------------------------------------|--------|--------------------|--------|---------------------------|--------|
|                                                          |   | **2004**           |   | **2003 (e)**              |   |   |
| ***Medical Membership  (a)(b)(c)(d)***                        |   |               |   |                      |   |   |   |
| **California**                                                |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 4,772,760          |   | 4,810,834                 |   | -0.8 | % |
| Individual and Small Group                                    |   | 1,656,153          |   | 1,653,001                 |   | 0.2 | % |
| Senior                                                        |   | 244,031            |   | 246,605                   |   | -1.0 | % |
| Total California                                              |   | 6,672,944          |   | 6,710,440                 |   | -0.6 | % |
| **Georgia**                                                   |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 1,659,351          |   | 1,645,702                 |   | 0.8 | % |
| Individual and Small Group                                    |   | 511,588            |   | 449,054                   |   | 13.9 | % |
| Senior                                                        |   | 55,722             |   | 69,191                    |   | -19.5 | % |
| Total Georgia                                                 |   | 2,226,661          |   | 2,163,947                 |   | 2.9 | % |
|                                                          |   |               |   |                      |   |   |   |
| **Central Region (f)**                                        |   |               |   |                      |   |   |   |
| **Missouri**                                                  |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 1,177,183          |   | 1,281,694                 |   | -8.2 | % |
| Individual and Small Group                                    |   | 240,543            |   | 235,779                   |   | 2.0 | % |
| Senior                                                        |   | 40,465             |   | 41,726                    |   | -3.0 | % |
| Total Missouri                                                |   | 1,458,191          |   | 1,559,199                 |   | -6.5 | % |
| **Illinois**                                                  |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 590,948            |   | 606,727                   |   | -2.6 | % |
| Individual and Small Group                                    |   | 128,241            |   | 113,759                   |   | 12.7 | % |
| Senior                                                        |   | 13,460             |   | 12,497                    |   | 7.7 | % |
| Total Illinois                                                |   | 732,649            |   | 732,983                   |   | 0.0 | % |
| **Texas**                                                     |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 278,878            |   | 313,931                   |   | -11.2 | % |
| Individual and Small Group                                    |   | 202,583            |   | 187,456                   |   | 8.1 | % |
| Senior                                                        |   | 8,244              |   | 1,260                     |   | N/A |   |
| Total Texas                                                   |   | 489,705            |   | 502,647                   |   | -2.6 | % |
| **Other****States**                                           |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 1,892,135          |   | 1,633,468                 |   | 15.8 | % |
| Individual and Small Group                                    |   | 104,637            |   | 97,870                    |   | 6.9 | % |
| Senior                                                        |   | 32,639             |   | 24,849                    |   | 31.3 | % |
| Total Other States                                            |   | 2,029,411          |   | 1,756,187                 |   | 15.6 | % |
| **Wisconsin**                                                 |   |               |   |                      |   |   |   |
| Large Group                                                   |   | 413,243            |   | 24,816                    |   | N/A |   |
| Individual and Small Group                                    |   | 104,832            |   | 944                       |   | N/A |   |
| Senior                                                        |   | 53,209             |   | 68                        |   | N/A |   |
| Total Wisconsin                                               |   | 571,284            |   | 25,828                    |   | N/A |   |
|                                                          |   |               |   |                      |   |   |   |
| **Total Medical Members Excluding BlueCard Host Members (g)** |   | 14,180,845         |   | 13,451,231                |   | 5.4 | % |
| **Total BlueCard Host Members (h)**                           |   | 1,196,000          |   | 748,490                   |   | 59.8 | % |
| **Total Medical Members**                                     |   | 15,376,845         |   | 14,199,721                |   | 8.3 | % |

 

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|                      |   | **March 31,** |       | **Percent  Change** | ** ** |
|---------------------------|--------|--------------------|------------|---------------------|------------|
|                      |   | **2004**           | ** ** | **2003 (e)**        |       | ** ** |
| ***ASO Membership (i)***  |   |               |       |                |       |   |   |
| California                |   | 1,609,412          |       | 1,578,546           |       | 2.0 | % |
| Georgia                   |   | 871,220            |       | 864,946             |       | 0.7 | % |
| Central Region (f)        |   | 2,839,187          |       | 2,695,656           |       | 5.3 | % |
| Wisconsin                 |   | 183,987            |       | 16,427              |       | N/A |   |
| BlueCard Host Members     |   | 1,196,000          |       | 748,490             |       | 59.8 | % |
| Total ASO Membership      |   | 6,699,806          |       | 5,904,065           |       | 13.5 | % |
| ***Risk Membership***     |   |               |       |                |       |   |   |
| California                |   | 5,063,532          |       | 5,131,894           |       | -1.3 | % |
| Georgia                   |   | 1,355,441          |       | 1,299,001           |       | 4.3 | % |
| Central Region            |   | 1,870,769          |       | 1,855,360           |       | 0.8 | % |
| Wisconsin                 |   | 387,297            |       | 9,401               |       | N/A |   |
| Total Risk Membership     |   | 8,677,039          |       | 8,295,656           |       | 4.6 | % |
| Total  Medical Membership |   | 15,376,845         |       | 14,199,721          |       | 8.3 | % |

 
|                                |   | **March 31,** | ** ** | **Percent  Change** |       |
|-------------------------------------|--------|--------------------|------------|---------------------|------------|
|                                |   | **2004**           |       | **2003**            | ** ** |   |
| ***State-Sponsored  Programs (j)*** |   |               |       |                |       |   |   |
| Medi-Cal/Medicaid                   |   |               |       |                |       |   |   |
| California                          |   | 847,156            |       | 835,273             |       | 1.4 | % |
| Virginia                            |   | 52,025             |       | 41,893              |       | 24.2 | % |
| Puerto Rico                         |   | 260,749            |       | 274,723             |       | -5.1 | % |
| Other                               |   | 43,819             |       | 80,776              |       | -45.8 | % |
| Total                               |   | 1,203,749          |       | 1,232,665           |       | -2.3 | % |
|                                |   |               |       |                |       |   |   |
| Healthy Families                    |   | 270,413            |       | 264,102             |       | 2.4 | % |
| MRMIP / AIM / IHRP                  |   | 13,676             |       | 18,190              |       | -24.8 | % |
| California Kids                     |   | 13,587             |       | 19,114              |       | -28.9 | % |
| Total                               |   | 1,501,425          |       | 1,534,071           |       | -2.1 | % |

 

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(a)   Membership numbers are approximate and include someestimates based upon the number of contracts at the relevant date and anactuarial estimate of the number of members represented by the contract.

(b)   Classification between states for employer groups isdetermined by the zip code of the subscriber.

(c)   Medical membership includes management services andnetwork services members, who are primarily included in the Large Group foreach respective state.

(d)   Senior membership includes members covered underboth Medicare risk and Medicare supplement products.

(e)   Membership numbers as of March 31, 2003 havebeen reclassified to reflect the zip code of the subscriber of HealthLink’scommercial insurer accounts. These members were previously included in thecommercial insurers’ state of domicile. As of March 31, 2003, Missouri andIllinois members would have been higher by 84,612 and 32,361, respectively,while California, Georgia, Texas and Other States would have been lower by1,876, 495, 9,572 and 105,030, respectively.

(f)    Central Region - Large Group membership includesnetwork access services members, primarily from HealthLink, of 1,277,580 and1,429,847 as of March 31, 2004 and March 31, 2003, respectively. Asof December 31, 2003, the Company revised its methodology of calculatingthe number of medical members represented by each subscriber contract withinthe Company’s rental networks and a Missouri joint venture. The weightedaverage factor changed from approximately 2.4 members to 2.1 members persubscriber. The impact of this change as of quarter end for the year endedDecember 31, 2003 is to reduce membership as follows:

 
| **As of**               |   | **Illinois** |   | **Missouri** |   | **Other  States** |   | **Total** |   |
|-------------------------|--------|--------------|--------|--------------|--------|-------------------|--------|-----------|--------|
|                    |   |         |   |         |   |              |   |      |   |
| March 31, 2003     |   | 35,999       |   | 111,008      |   | 15,314            |   | 162,321   |   |
| June 30, 2003      |   | 35,083       |   | 108,097      |   | 14,925            |   | 158,105   |   |
| September 30, 2003 |   | 34,990       |   | 104,614      |   | 14,885            |   | 154,489   |   |
| December 31, 2003  |   | 34,377       |   | 103,013      |   | 14,624            |   | 152,014   |   |

 

Membership data as of March 31, 2003 shown in the above table havenot been revised to reflect this change in methodology.

 

(g)   Total medical members as of March 31, 2004include 663,274 medical members from the Cobalt acquisition.

 

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(h)   The Company has revised its medical membershipcounting methodology to include estimated “host” members using the nationalBlueCard program. Host members are generally members who reside in a state inwhich a WellPoint subsidiary is the Blue Cross and/or Blue Shield licensee andwho are covered under an employer-sponsored health plan issued by anon-WellPoint controlled Blue Cross and/or Blue Shield licensee. Host membersare computed using, among other things, an estimate of the average number ofBlueCard claims received per member per month. Total BlueCard host members asof each calendar quarter end during the year ended December 31, 2003 wereas follows:

 
| **As of**               |   | **BlueCard  Members** |   |
|-------------------------|--------|-----------------------|--------|
|                    |   |                  |   |
| March 31, 2003     |   | 748,490               |   |
| June 30, 2003      |   | 743,897               |   |
| September 30, 2003 |   | 1,009,900             |   |
| December 31, 2003  |   | 1,002,113             |   |

 

(i)    ASO Membership represents members for which theCompany provides administrative services only and does not assume fullinsurance risk.

 

(j)    Medi-Cal (the California Medicaid program)membership 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 membership are included in California – Large Group.

 

***Specialty Membership***

 
|                          |   | **March 31,** |   | **Percent  Change** |   |
|-------------------------------|--------|--------------------|--------|---------------------|--------|
|                          |   | **2004 (A)**       |   | **2003**            |   |   |
| Pharmacy  Benefits Management |   | 31,020,178         |   | 35,998,130          |   | -13.8 | % |
| Dental                        |   | 3,218,669          |   | 2,655,528           |   | 21.2 | % |
| Life                          |   | 3,082,286          |   | 2,732,911           |   | 12.8 | % |
| Disability                    |   | 573,297            |   | 511,002             |   | 12.2 | % |
| Behavioral  Health (B)        |   | 7,962,848          |   | 7,307,468           |   | 9.0 | % |
| Total                         |   | 45,857,278         |   | 49,205,039          |   | -6.8 | % |

 

----

(A) Specialty membership as of March 31,2004 includes 644,006 specialty members, from the Cobalt acquisition.

 

(B) Effective as of January 1, 2004, theCompany began including HealthLink members who receive certain behavioralhealth services in its behavioral health membership. As of March 31, 2004,the Company had approximately 482,000 such members.

 

34

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***Comparisonof Results of Operations for the Quarter Ended March 31, 2004 to theQuarter Ended March 31, 2003***

 

The Company maintains the following two reportable segments: HealthCare and Specialty. (See Note 12 to the Consolidated Financial Statementsfor further discussion.) The Health Care segment provides a broad spectrum ofnetwork-based health plans, including PPOs, HMOs, POS plans, other hybrid plansand traditional indemnity plans, to large and small employers and individualsas well as other health care-related products, such as vision, preventive care,COBRA and flexible benefits account administration. The Specialty business ismaintained as a separate segment providing an array of specialty products,including pharmacy benefits management, dental, life insurance, disabilityinsurance, behavioral health, workers’ compensation insurance products andworkers’ compensation managed care services.

 

The operating results for the quarter ended March 31, 2004compared to the quarter ended March 31, 2003 were impacted by the Cobaltacquisition, which was effective as of September 30, 2003 for accountingpurposes. Specifically, the Company’s operating results for the quarter endedMarch 31, 2004 included three months of operating results from the Cobaltacquisition whereas the Company’s operating results for the quarter endedMarch 31, 2003 did not include any operating results from the acquired Cobaltbusiness. In order to provide a more meaningful comparison of the Company’sresults of operations for the quarter ended March 31, 2004 versus thequarter ended March 31, 2003, the following discussion presents financialmeasures that exclude operating results attributable to the acquired Cobaltbusiness for the quarter ended March 31, 2004, which we refer to as“Same-Store.” The Company also uses Same-Store measures for purposes ofreporting comparative financial results to its Board of Directors.

 

The following table depicts premium revenue by reportable segment:

 

 
| **(In  thousands)** |   | **Quarter Ended****March 31, 2004** |      | **Less: Acquired  Cobalt Business for  the Quarter Ended  March 31, 2004** |   | **Quarter Ended****March 31, 2004  (Same-Store)** |   | **Quarter Ended****March 31, 2003** |      |
|---------------------|--------|------------------------------------------|-----------|---------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|------------------------------------------|-----------|
| Health Care         |   | $                                        | 5,072,731 |                                                                            | $      | 298,243                                                |   | $                                        | 4,774,488 |   | $ | 4,417,465 |   |
| Specialty           |   | 183,572                                  |      | 38,910                                                                          |   | 144,662                                                |   | 130,840                                  |      |
| Consolidated        |   | $                                        | 5,256,303 |                                                                            | $      | 337,153                                                |   | $                                        | 4,919,150 |   | $ | 4,548,305 |   |

 

Premium revenue increased 15.6%, or $708.0 million, to $5,256.3 millionfor the quarter ended March 31, 2004 from $4,548.3 million for thequarter ended March 31, 2003. Excluding premium revenue attributable to the acquired Cobalt businessof $337.2 million for the quarter ended March 31, 2004, premium revenueincreased $370.8 million or 8.2% on a Same-Store basis from the quarter endedMarch 31, 2003. Excluding insured member months attributable to theacquired Cobalt business for the quarter ended March 31, 2004, insuredmember months decreased slightly by approximately 0.4% for the quarter endedMarch 31, 2004 compared to the quarter ended March 31, 2003. Thisgrowth in premium revenue occurred across all regions of the Health Caresegment, but was more pronounced in the California and Georgia regions and wasmainly attributable to the implementation of premium increases.

 

35

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The following table depicts management services and other revenue byreportable segment:

 
| **(In  thousands)**  |   | **Quarter Ended****March 31, 2004** |    | **Less: Acquired  Cobalt Business for  the Quarter Ended  March 31, 2004** |   | **Quarter Ended****March 31, 2004  (Same-Store)** |   | **Quarter Ended****March 31, 2003** |    |
|----------------------|--------|------------------------------------------|---------|---------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|------------------------------------------|---------|
| Health Care          |   | $                                        | 254,913 |                                                                            | $      | 48,835                                                 |   | $                                        | 206,078 |   | $ | 188,534 |   |
| Specialty            |   | 48,893                                   |    | 2,377                                                                           |   | 46,516                                                 |   | 36,967                                   |    |
| Corporate and  Other |   | 2,370                                    |    | —                                                                          |   | 2,370                                                  |   | 670                                      |    |
| Consolidated         |   | $                                        | 306,176 |                                                                            | $      | 51,212                                                 |   | $                                        | 254,964 |   | $ | 226,171 |   |

 

Management services and other revenue increased 35.4%, or$80.0 million, to $306.2 million for the quarter ended March 31,2004 from $226.2 million for the quarter March 31, 2003. Excludingmanagement services and other revenue attributable to the acquired Cobaltbusiness of $51.2 million for the quarter ended March 31, 2004, managementservices and other revenue increased $28.8 million or 12.7% from the quarterended March 31, 2003. The increase was primarily due to an increase inmanagement services revenue from the California and Georgia regions of theHealth Care segment of $7.0 million and $12.9 million, respectively. Theincrease in the California region resulted from an increase in administrativeservices member months of 5.7% and an increase of 5.2% in the administrativeservices per member per month rate. The increase in the Georgia region resultedprimarily from an increase in administrative services member months of 14.9%and an increase of 8.0% in the administrative services per member per monthrate. The increase in administrative services revenue also resulted fromincreased sales in large self-insured accounts. In addition, managementservices revenue in the Specialty segment increased by $9.5 million, which wasprimarily attributable to an increase in pharmacy benefit management servicesrevenues from non-affiliated clients. These increases were offset by a decrease in the Central Region of $2.3million. The decrease in the Central Region resulted primarily from a decreasein management services revenue from the UNICARE Large Group division of $3.3million due to lower administrative services membership, slightly offset by anincrease in the administrative services per member per month rate.

 

Investment income was $83.7 million for the quarter endedMarch 31, 2004, compared to $66.3 million for the quarter endedMarch 31, 2003, an increase of $17.4 million or 26.2%. The increase wasprimarily due to net realized gains for the quarter ended March 31, 2004of $16.6 million as compared to net realized gains for the quarter endedMarch 31, 2003 of $6.2 million. Additionally, gross investment income, netof investment expenses increased by $6.9 million due primarily to higheraverage investment balances.

 

36

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The following table depicts health care services and other benefitsexpense by reportable segment:

 
| **(In  thousands)** |   | **Quarter Ended****March 31, 2004** |      | **Less: Acquired  Cobalt Business for  the Quarter Ended  March 31, 2004** |   | **Quarter Ended****March 31, 2004  (Same-Store)** |   | **Quarter Ended****March 31, 2003** |      |
|---------------------|--------|------------------------------------------|-----------|---------------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|------------------------------------------|-----------|
| Health Care         |   | $                                        | 4,061,352 |                                                                            | $      | 255,830                                                |   | $                                        | 3,805,522 |   | $ | 3,634,857 |   |
| Specialty           |   | 125,999                                  |      | 29,459                                                                          |   | 96,540                                                 |   | 82,643                                   |      |
| Consolidated        |   | $                                        | 4,187,351 |                                                                            | $      | 285,289                                                |   | $                                        | 3,902,062 |   | $ | 3,717,500 |   |

 

Health care services and other benefits expense increased 12.6%, or$469.9 million, to $4,187.4 million for the quarter endedMarch 31, 2004 from $3,717.5 million for the quarter endedMarch 31, 2003. The Company’s medical care ratio was 79.7% for the quarterended March 31, 2004, compared to 81.7% for the quarter endedMarch 31, 2003. The medical care ratio attributable to the Health Caresegment was 80.1% for the quarter ended March 31, 2004, compared to 82.3%for the quarter ended March 31, 2003. The medical care ratio attributable to the Specialty segment was 68.6%for the quarter ended March 31, 2004, compared to 63.2% for the quarterended March 31, 2003. Health care services and other benefits expense andmedical care ratio information is provided for each segment so investors cancompare the performance of each segment to the other segment and to the Companyas a whole.

 

The Company’s medical care ratio attributable to the Health Caresegment decreased from 82.3% for the quarter ended March 31, 2003 to 80.1%for the quarter ended March 31, 2004, primarily due to price increases inall regions, lower claims trends and lapses in accounts withhigher-than-average medical care ratios. The medical care ratio for the Specialty segment increased to 68.6% forthe quarter ended March 31, 2004 from 63.2% for the same quarter in 2003.The increase in the Specialty medical ratio was attributable to higher claimstrends for life insurance products. The health care services and other benefitsexpense included 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 item andits potential effect on the Company’s reported results of operations.

 

Selling expense consists of commissions paid to outside brokers andagents representing the Company.  Theselling expense ratio decreased from 4.0% for the quarter ended March 31,2003 to 3.9% for the quarter ended March 31, 2004. The acquired Cobaltbusiness experienced a lower selling expense ratio due primarily to its higherpercentage of large employer group business that maintained a selling expenseratio of less than 1%. Excluding selling expense of $6.4 million and combinedpremium revenue and management services and other revenue of $388.4 millionattributable to the acquired Cobalt business for the quarter endedMarch 31, 2004, the selling

 

37

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expense ratio increased from 4.0% for the quarter ended March 31,2003 to 4.1% for the quarter ended March 31, 2004.

 

The general and administrative expense ratio increased to 13.0% for thequarter ended March 31, 2004 from 12.4% for the quarter endedMarch 31, 2003. The increase in the general and administrative expenseratio resulted from costs associated with the pending Anthem mergerintegration, which added $10.2 million to general and administrative expensefor the quarter ended March 31, 2004. The acquired Cobalt business had ahigher general and administrative expense ratio of 21.6% during the quarterended March 31, 2004. The acquired Cobalt business has had an historicallyhigher administrative expense ratio due to its Medicare processing business,which has a general and administrative expense ratio of approximately 98%, andthe balance of its business is weighted more towards non-insured business,which tends to have a higher general and administrative expense ratio thaninsured business. Excluding general and administrative expense of $84.0 millionand combined premium revenue and management services and other revenue of$388.4 million attributable to the acquired Cobalt business for the quarterended March 31, 2004, general and administrative expense remained constantat 12.4% for each of the quarters ended March 31, 2003 and 2004.

 

Interest expense decreased $0.6 million to $12.2 million forthe quarter ended March 31, 2004, compared to $12.8 million for thequarter ended March 31, 2003.  Thedecrease in interest expense was primarily due to the reduction in the weightedaverage interest rate (which includes fees associated with the Company’sborrowings and interest rate swap agreements) for the quarter endedMarch 31, 2004 of 4.2%, compared to 4.4% for the quarter endedMarch 31, 2003.

 

Other expense, net increased $4.7 million to $11.7 millionfor the quarter ended March 31, 2004, compared to $7.0 million for thequarter ended March 31, 2003. The increase was primarily due to additionalamortization of intangibles attributable to the Cobalt and Golden Westacquisitions of $3.3 million during the quarter ended March 31, 2004.

 

The Company’s net income for the quarter ended March 31, 2004 was$295.2 million, compared to $193.1 million for the quarter endedMarch 31, 2003.  Net income for thequarter ended March 31, 2004 included after-tax net realized investmentgains of $9.9 million, compared to $3.7 million for the quarter endedMarch 31, 2003.  Earnings per sharetotaled $1.92 and $1.33 for the quarters ended March 31, 2004 and 2003,respectively.  Earnings per shareassuming full dilution totaled $1.85 and $1.29 for the quarters endedMarch 31, 2004 and 2003, respectively.

 

Earnings per share for the quarter ended March 31, 2004 is basedupon weighted average shares outstanding of 153.9 million shares, excludingpotential common stock, and 159.4 million shares, assuming fulldilution.  Earnings per share for thequarter ended March 31, 2003 is based upon 145.6 million shares, excludingpotential common stock, and 149.2 million shares, assuming fulldilution.  The increase in weightedaverage shares outstanding assuming full dilution primarily resulted from theissuance of shares related to the Cobalt acquisition and the Company’s stockoption and stock purchase plans.

 

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*Financial Condition*

 

The Company’s consolidated assets increased by $1,168.4 million, or7.9%, to $15,957.1 million as of March 31, 2004 from $14,788.7 million asof December 31, 2003. The increase in total assets was primarily due togrowth in cash and investments of $931.4 million as a result of an increase insecurity trades pending of $581.8 million and $305.9 million in operating cashflows attributable to net income. Also contributing to the increase inconsolidated assets was an increase in receivables, net of $205.2 million. Cashand investments totaled $8.9 billion as of March 31, 2004, or 55.5% oftotal assets.

 

Overall claims liabilities, which is composed of medical claims payableand reserves for future policy benefits, decreased $95.7 million, or 3.0%, to$3,068.7 million as of March 31, 2004 from $3,164.4 million as ofDecember 31, 2003. The decrease was due primarily to the timing ofpharmacy benefits management payments. See “Critical Accounting Policies” for adiscussion of medical claims payable and reserves for future policy benefits.As of March 31, 2004, the Company’s long-term indebtedness was $1,238.9million, of which $462.8 million was related to the Company’s 6 3/8%Notes due 2006 (which includes a fair value adjustment of $13.3 million),$349.1 million was related to the Company’s 6 3/8% Notesdue 2012 and $427.0 million was related to the commercial 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. Duringthe year ended December 31, 2003, the Company issued an additional $104.7million in commercial paper (net of repayments made during the year) torepurchase Common Stock of the Company. In the third quarter of 2003, theCompany also issued an additional $125.1 million in commercial paper primarilyto partially finance the acquisition of Cobalt (see “Liquidity and CapitalResources” below for a discussion of the potential repurchase of the Company’scommercial paper as a result of the Company’s pending merger with Anthem,Inc.).

 

Stockholders’ equity totaled $5,948.2 million as of March 31,2004, an increase of $518.3 million from $5,429.9 million as ofDecember 31, 2003. The increase was primarily due to net income of $295.2million for the quarter ended March 31, 2004; a net increase of $194.1million from the issuance of new Common Stock and the reissuance of treasurystock related to stock grants; the Company’s employee 401(k) plan, stock optionand stock purchase plans; and an increase in net unrealized gains frominvestment securities of $63.9 million, net of taxes. Partially offsettingthese increases were net losses from the reissuance of treasury stock of $34.9million.

 

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***Liquidity andCapital Resources***

 

As of March 31, 2004, consolidated cash and investments were $8.9billion, of which $1.1 billion were in cash and cash equivalents. The Company’sprimary sources of cash are premium and management services revenues andinvestment income.  The Company’sprimary uses of cash include health care claims and other benefits, capitationpayments, income taxes, repayment of long-term debt, interest expense, brokerand agent commissions, administrative expenses, Common Stock repurchases andcapital expenditures.  In addition tothe foregoing, other uses of cash include provider network and systemsdevelopment costs and costs associated with the integration of acquired businesses.

 

The Company generally receives premium revenue in advance ofanticipated claims for related health care services and other benefits.  The Company’s investment policies aredesigned to provide safety and preservation of capital, sufficient liquidity tomeet cash flow needs, the integration of investment strategy with the businessoperations and objectives of the Company, and attainment of a competitiveafter-tax total return.

 

The Company’s strategy for achieving its investment goals is broaddiversification of its investments, both across and within asset classes.  As of March 31, 2004, the Company’sinvestment portfolio consisted primarily of investment grade fixed-incomesecurities.  The Company’s portfolioalso included large capitalization and small capitalization domestic equities,foreign equities, tax-exempt municipal bonds and a small amount ofnon-investment grade debt securities. The fixed-income assets include both short and long-duration securitieswith an attempt to match the Company’s funding needs.  The Company’s investment policy contains limitations regardingconcentration in individual securities and industries and generally prohibitsspeculative and leveraged investments. Cash and investment balances maintained by the Company are sufficient tomeet applicable regulatory financial stability and net worth requirements,including license requirements of the Blue Cross and Blue Shield Association.

 

Net cash provided by operating activities was $305.9 million forthe quarter ended March 31, 2004, compared with $313.6 million for thequarter ended March 31, 2003.  Netcash provided by operations for the quarter ended March 31, 2004 was dueprimarily to net income of $295.2 million and an increase in income taxespayable of $176.0 million attributable to business growth and the absence ofestimated tax payments during the first quarter of 2004.  Partially offsetting these increases was adecrease in medical claims payable of $107.6 million primarily due to thetiming of pharmacy benefits management payments and an increase in“receivables, net” of $99.4 million due to timing of cash receipts of certainreceivables.

 

Net cash used in investing activities for the quarter endedMarch 31, 2004 totaled $284.6 million, compared with$24.6 million for the quarter ended March 31, 2003.  The cash used in the first quarter of 2004was primarily attributable to the purchase of investments of $1,462.7 millionand the purchase of property and equipment, net of sales proceeds, of $44.4million, which were partially offset by proceeds from investments sold of$1,231.9 million.

 

Net cash provided by financing activities totaled $85.0 millionfor the quarter ended March 31, 2004 compared with $34.8 million for thequarter ended March 31, 2003.  Thenet cash provided

 

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in the quarter ended March 31, 2004 was primarily attributable toadditional advances on securities lending deposits of $46.5 million and thereceipt of proceeds from the issuance of Common Stock related to the Company’semployee stock option plans of $41.3 million, partially offset by netrepayments of commercial paper of $2.8 million.

 

Effective March 30, 2001, the Company entered into two unsecuredrevolving credit facilities allowing aggregate indebtedness of $1.0 billion inprincipal amount. Borrowings under these facilities (which are generallyreferred to collectively as the Company’s “revolving credit facility”) bearinterest at rates determined by reference to the bank’s base rate or to theLondon InterBank Offered Rate (“LIBOR”) plus a margin determined by referenceto the then-current rating of the Company’s senior unsecured long-term debt byspecified rating agencies. One facility, which provides for borrowings not toexceed $750.0 million at any time outstanding, expires as of March 30,2006, although it may be extended for up to two additional one-year periodsunder certain circumstances. The other facility, which provides for borrowingsnot to exceed $250.0 million at any time outstanding, expires on March 25,2005. Any amount outstanding under this facility as of March 25, 2005 maybe converted into a one-year term loan at the option of the Company and willbear interest at rates determined by reference to the bank’s base rate or LIBORplus a margin determined by reference to the then-current rating of theCompany’s unsecured long-term debt by specified rating agencies, plus 0.125%until paid in full. Loans under the $250.0 million facility are made on acommitted basis. Loans under the $750.0 million facility are made on acommitted basis or pursuant to an auction bid process. The $750.0 millionfacility also contains sublimits for letters of credit and “swingline” loans.Each credit agreement requires the Company to maintain certain financial ratiosand contains restrictive covenants, including restrictions on the incurrence ofadditional indebtedness and the granting of certain liens, limitations onacquisitions and investments and limitations on changes in control (see Note 7to the Consolidated Financial Statements). As of March 31, 2004 andDecember 31, 2003, there were no amounts outstanding under the revolvingcredit facility.

 

In April 2002, the Company commenced a commercial paper programproviding for the issuance of up to $1.0 billion in aggregate maturity value ofshort-term indebtedness (known generally as “commercial paper”). The commercialpaper is being issued by the Company without registration under the SecuritiesAct of 1933, as amended (the “1933 Act”) in reliance upon the exemption fromregistration contained in Section 4(2) of the 1933 Act. The commercialpaper is issued in denominations of $100,000 or integral multiples of $1,000 inexcess thereof and will bear such interest rates, if interest-bearing, or willbe sold at such discount from their face amounts, as agreed upon by the Companyand the dealer or dealers acting in connection with the commercial paperprogram. The commercial paper may be issued with varying maturities up to amaximum of 270 days from the date of issuance. The commercial paper ranksequally with all other unsecured and unsubordinated indebtedness of theCompany. As of March 31, 2004 and December 31, 2003, the outstandingcommercial paper borrowings totaled $427.0 million and $429.8 million, respectively,with various maturity dates and had interest rates ranging from 1.12% to 1.20%as of March 31, 2004 and interest rates ranging from 1.10% to 1.27% as ofDecember 31, 2003. The weighted average yield on the outstandingcommercial paper as of March 31, 2004 and December 31, 2003 was 1.16%and 1.25%, respectively. The Company intends to maintain commercial paper

 

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borrowings of at least the amount outstanding at March 31, 2004for more than one year. Accordingly, for financial reporting purposes, thecommercial paper has been classified under non-current liabilities in theConsolidated Balance Sheets. Under the Company’s merger agreement with Anthem,Inc., however, the Company has agreed to repurchase, prior to the closing ofthe merger with Anthem, any outstanding commercial paper issued by the Companyor any of its subsidiaries.

 

In anticipation of the completion of the RightCHOICE acquisition onJanuary 31, 2002, the Company on January 16, 2002 issued $350.0million aggregate principal amount at maturity of 6 3/8*%* Notes due January 15, 2012 (the“2012 Notes”). 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-annually inarrears on January 15 and July 15 of each year commencingJuly 15, 2002. Interest is computed on the basis of a 360-day year oftwelve 30-day months.

 

The 2012 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2012 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principal amountof the 2012 Notes being redeemed on the redemption date; or 2) the sum of thepresent values of the remaining scheduled payments of principal and interest onthe 2012 Notes being redeemed on that redemption date (not including anyportion of any payments of interest accrued to the redemption date) discountedto the redemption date on a semi-annual basis at the Treasury rate asdetermined by the Reference Treasury Dealer (J.P. Morgan Securities Inc. orDeutsche Banc Alex Brown or their respective successors), plus 25 basis points.In each case, the redemption price will also include accrued and unpaidinterest on the 2012 Notes to the redemption date.

 

On June 15, 2001, the Company issued $450.0 million aggregateprincipal 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 inarrears on June 15 and December 15 of each year commencingDecember 15, 2001. Interest is computed on the basis of a 360-day year oftwelve 30-day months.

 

The 2006 Notes may be redeemed, in whole or in part, at the Company’soption at any time. The redemption price for any 2006 Notes redeemed will beequal to the greater of the following amounts: 1) 100% of the principal amountof the 2006 Notes being redeemed on the redemption date; or 2) the sum of thepresent values of the remaining scheduled payments of principal and interest onthe 2006 Notes being redeemed on that redemption date (not including anyportion of any payments of interest accrued to the redemption date) discountedto the redemption date on a semi-annual basis at the Treasury rate asdetermined by the designated Reference Treasury Dealer (Salomon Smith BarneyInc. or UBS Warburg LLC or their respective successors), plus 25 basis points.In each case, the redemption price will also include accrued and unpaidinterest on the 2006 Notes to the redemption date.

 

The 2006 and 2012 Notes are unsecured obligations and rank equally withall of the Company’s existing and future senior unsecured indebtedness. Allexisting and future

 

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liabilities of the Company’s subsidiaries are and will be effectivelysenior to the 2006 and 2012 Notes. The indenture governing the 2006 and 2012Notes contains a covenant that limits the ability of the Company and itssubsidiaries to create liens on any of their property or assets to securecertain indebtedness without also securing the indebtedness under the 2006 and2012 Notes.

 

As a part of a hedging strategy to limit its exposure to variableinterest rate increases, the Company has from time to time entered intointerest rate swap agreements in order to reduce the volatility of interestexpense resulting from changes in interest rates on its variable rate debt. Theswap agreements were 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 endedDecember 31, 2002 of 7.08%) without the exchange of the underlyingnotional amounts. The Company had entered into $200.0 million of fixed-rateswap agreements, which consisted of a $150.0 million notional amount swapagreement at 6.99% maturing on October 17, 2003 and a $50.0 millionnotional amount swap agreement at 7.06% maturing on October 17, 2006. InSeptember 2002, the Company terminated these two fixed-rate swap agreementswith an aggregate cash settlement of $17.6 million, of which $1.8 million wasaccrued interest and the remaining $15.8 million represented the fair value ofthe swap agreements at the time of termination and is being amortized over theterm of the original swap agreements. As of March 31, 2004, the remainingbalance of the swap agreements was $4.9 million. (See Note 8 to theConsolidated Financial Statements.)

 

In order to reduce the interest expense associated with the 2006 Notes,the Company, on January 15, 2002, entered into a $200.0 million notionalamount interest rate swap agreement, which matures on June 15, 2006. Theswap agreement is a contract to exchange a fixed 6 3/8%rate for a LIBOR-based floating rate (weighted average variable rate of 2.57%and 2.45% for the quarter ended March 31, 2004 and 2003, respectively).

 

Certain of the Company’s subsidiaries are required to maintain minimumcapital requirements prescribed by various regulatory agencies, including theCalifornia Department of Managed Health Care and the Departments of Insurancein various states, including Georgia, Missouri, Wisconsin and Delaware. As ofMarch 31, 2004 (or the most recent date with respect to which complianceis required), those subsidiaries of the Company were in compliance with allminimum capital requirements.

 

The Company believes that cash flow generated by operations and itscash and investment balances, supplemented by the Company’s ability to borrowunder its existing revolving credit facility, commercial paper program or throughpublic or private financing sources, will be sufficient to fund continuingoperations and expected capital requirements for the foreseeable future.

 

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# ***Critical Accounting Policies***

# * *

The preparation of financial statements in conformity with generallyaccepted accounting principles requires the Company’s management to make avariety of estimates and assumptions. These estimates and assumptions affect,among other things, the reported amounts of assets and liabilities, thedisclosure of contingent liabilities and the reported amounts of revenues andexpenses. Actual results could differ from the amounts previously estimated,which were based on the information available at the time the estimates weremade.

 

The critical accounting policies described below are those that theCompany believes are important to the portrayal of the Company’s financialcondition and results of operations, and which require management to makedifficult, subjective or complex judgments. Critical accounting policies coveraccounting matters that are inherently uncertain because the future resolutionof such matters is unknown. The Company believes that critical accountingpolicies include medical claims payable, reserves for future policy benefits,goodwill and other intangible assets and investments.

 

## *Medical ClaimsPayable*

## * *

Medical claims payable includes claims in process as well as provisionsfor the estimate of incurred but not reported claims (“IBNR”) and provisionsfor disputed claims obligations.  As ofMarch 31, 2004, approximately 90% of the Company’s medical claims payableconsisted of IBNR and claims in process. Such estimates are developed usingactuarial principles and assumptions that consider, among other things, contractualrequirements, historical utilization trends and payment patterns, benefitschanges, medical inflation, product mix, seasonality, membership and otherrelevant factors.  In developing IBNR,the Company applies different estimation methods depending on the period forwhich incurred claims are being estimated. For the most recent four months, the incurred claims are estimated fromthe trend analysis based on per member per month claims trends developed fromthe experience in preceding months.  Forperiods prior to the most recent four months, the key assumption used indeveloping the Company’s IBNR is that the completion factor pattern remainsconsistent over a rolling 12-month period. The completion factor is an actuarial estimate, based upon historicalexperience, of the percentage of claims incurred during a given period thathave been adjudicated by the Company as of the date of estimation.  This approach is consistently applied toeach period presented.

 

The completion factors and claims per member per month trend factor arethe most significant factors used in estimating the Company’s IBNR.  The following table illustrates thesensitivity of these factors using March 31, 2004 data and the estimatedpotential impact on the Company’s operating results caused by these factors:

 

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| **Completion  Factor (a):**         |   | **Claims  Trend Factor (b):**                        |        |
|-------------------------------------|--------|------------------------------------------------------|-------------|
| **(Decrease)  Increase in  Factor** |   | **Increase  (Decrease) in  Medical Claims  Payable** |        | **(Decrease)  Increase in  Factor** |   | **Increase  (Decrease) in  Medical Claims  Payable** |   |
|                                |   |                                                 |        |   |   |   |   |
| (3                                  | )%     | $                                                    | 327,000,000 |   | (3 | )% | $ | (12,000,000 | ) |
| (2                                  | )%     | 212,000,000                                          |        | (2 | )% | (8,000,000 | ) |
| (1                                  | )%     | 103,000,000                                          |        | (1 | )% | (4,000,000 | ) |
| 1                                   | %      | (98,000,000                                          | )           | 1 | % | 4,000,000 |   |
| 2                                   | %      | (191,000,000                                         | )           | 2 | % | 8,000,000 |   |
| 3                                   | %      | (279,000,000                                         | )           | 3 | % | 12,000,000 |   |
|                                     |        |                                                      |             |  |  |  |  |  |  |

 

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(a)   Reflects estimated potential changes in medicalclaims payable caused by changes in completion factors in each of the mostrecent four months.

 

(b)   Reflects estimated potential changes in medicalclaims payable caused by changes in annualized claims trend used for theestimation of per member per month claims for the most recent four months.

 

In addition, assuming a hypothetical 1% difference between theCompany’s March 31, 2004 estimated claims liability and the actual claimsincurred, net income for the quarter ended March 31, 2004 would increaseor decrease by $15.8 million, while diluted net income per share would increaseor decrease by $0.10 per share.

 

Other relevant factors include exceptional situations that might requirejudgmental adjustments in setting the outstanding reserves, such as systemconversions, processing interruptions, environmental changes or otherfactors.  None of these factors had amaterial impact on the development of the Company’s claims payable estimatesduring any of the periods presented in this quarterly report on Form 10-Q. Allof these factors are used in estimating IBNR and are important to the Company’sreserve methodology in trending the claims per member per month for purposes ofestimating the reserves for the most recent four months.

 

In developing its best estimate of medical claims payable, the Companyconsistently applies the principles and assumptions listed above from year toyear, while also giving due consideration to the potential variability of thesefactors. Because medical claims payable includes various actuarially developedestimates, the Company’s actual health care services expense may be more orless than the Company’s previously developed estimates. Claim processing expensesare also accrued based on an estimate of expenses necessary to process suchclaims. Such reserves are continually monitored and reviewed, with anyadjustments reflected in current operations.

 

Health care claims are usually described as having a “short tail,”which means that they are generally paid within a few months of the memberreceiving service from the physician or other health care provider.  Based on the Company’s historical claim payment patterns, less than 5%of the medical claims payable as of the end of any given year is outstanding atthe end

 

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ofthe following year. Management expects that substantially all of thedevelopment of the estimate of medical claims payable as of December 31,2003 will be known by the end of 2004.

 

Capitation costs represent monthly fees paid one month in advance tophysicians, certain other medical service providers and hospitals in theCompany’s HMO networks as retainers for providing continuing medical care. The Companymaintains various programs that provide incentives to physicians, certain othermedical service providers and hospitals participating in its HMO networksthrough the use of risk-sharing agreements and other programs. Payments undersuch agreements are made based on the providers’ performance in managing healthcare costs while providing quality health care. Expenses related to theseprograms, which are based in part on estimates, are recorded in the period inwhich the related services are rendered. The Company believes that its reservesfor medical claims payable are adequate to satisfy its ultimate claimliability. However, these estimates are inherently subject to a number ofhighly variable circumstances. Consequently, the actual results could differmaterially from the amount recorded in the Consolidated Financial Statements.

 

Health care services and other benefits expense includes the costs ofhealth care services, capitation expenses and expenses related to risk-sharingagreements with participating physicians, medical groups and hospitals andincurred losses on the Company’s disability and life products. The costs ofhealth care services are accrued as services are rendered, including anestimate for claims incurred but not yet reported.

 

For many of the Company’s HMO plans (including substantially all of itsCalifornia HMO plans), the Company contracts with physicians, hospitals andother health care providers through capitation fee arrangements as a means tomanage health care costs. The Company has two general types of capitationarrangements. The predominant type is the so-called “professional” capitationarrangement. Under professional capitation arrangements, the Company pays thehealth care provider, such as a participating medical group, a fixed amount permember per month, and the health care provider assumes the risk of the member’sutilization of certain specified health care services. Typically, underprofessional capitation arrangements, the health care provider does not assumethe risk of the member’s utilization of any hospital-based services. The secondtype is the so-called “global” capitation arrangement. Under global capitationarrangements, the Company also pays the health care provider, such as aparticipating medical group, a fixed amount per member per month. However,under global capitation arrangements, the health care provider generallyassumes the risk of the member’s utilization of all health care services(subject to certain limited exceptions and state regulatory requirements). TheCompany had approximately eight global capitation arrangements as ofMarch 31, 2004 and December 31, 2003, covering approximately 190,000and 161,000 members, respectively. In addition, one of the Company’ssubsidiaries owns a 51% equity interest in a community health partnershipnetwork (the “CHPN”) operating in the greater Atlanta area. The CHPN is alocally based equity venture between the Company’s subsidiary and a localphysician group. The Company’s subsidiary has entered into a global capitationarrangement with the CHPN. As of March 31, 2004 and December 31,2003, approximately 544,000 and 560,000 members, respectively, were covered bythis arrangement.

 

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For the quarters ended March 31, 2004 and 2003, the Company’scapitation expenses of $428.2 million and $393.7 million, represented 10.2% and10.6%, respectively, of the Company’s total health care services and otherbenefits expense. As of March 31, 2004 and December 31, 2003, the Company’scapitation expenses payable of $159.2 million and $145.9 million represented6.0% and 5.3%, respectively, of the Company’s total medical claims payable.

 

The Company’s future results of operations will depend in part on itsability to predict and manage health care costs through underwriting criteria,medical management, product design and negotiation of favorable provider andhospital contracts. The Company’s ability to contain such costs may beadversely affected by changes in utilization rates, demographiccharacteristics, the regulatory environment, health care practices, inflation,new technologies, clusters of high-cost cases, continued consolidation ofphysician, hospital and other provider groups, acts of terrorism andbioterrorism or other catastrophes, including war and numerous other factors.The Company’s inability to mitigate any or all of the above-listed or otherfactors may adversely affect the Company’s future profitability.

 

## *Reserves forFuture Policy Benefits*

## * *

The estimate of reserves for future policy benefits relates to life anddisability insurance policies written in connection with health care contracts.Reserves for future life benefit coverage are based on projections of pastexperience. Reserves for future policy and contract benefits for certainlong-term disability products and group paid-up life products are based uponinterest, mortality and morbidity assumptions from published actuarial tables,modified based upon the Company’s experience. Reserves are continually monitoredand reviewed, and as settlements are made or reserves adjusted, differences arereflected in current operations. The current portion of reserves for futurepolicy benefits relates to the portion of such reserves that the Companyexpects to pay within one year. The Company believes that its reserves forfuture policy benefits are adequate to satisfy its ultimate benefit liability.However, these estimates are inherently subject to a number of highly variablecircumstances. Consequently, the actual results could differ materially fromthe amount recorded in the consolidated financial statements. As ofMarch 31, 2004 and December 31, 2003, the reserves for future policybenefits were $429.2 million and $417.3 million, respectively.

 

## *IntangibleAssets and Goodwill*

## * *

The Company has made several acquisitions in the past several yearsthat included a significant amount of goodwill and other intangible assets.Under generally accepted accounting principles in effect throughDecember 31, 2001, these assets were amortized over their useful lives andwere tested periodically to determine if they were recoverable from operatingearnings on an undiscounted basis over their useful lives.

 

The Company is required to make estimates of fair value and applycertain assumptions, such as a discount factor in applying these annualimpairment tests. Such estimates could produce significantly different resultsif other assumptions, which could also be considered reasonable, were to beused. Intangible assets with definite useful lives are being amortized using astraight-line basis or the timing of related cash flows over periods rangingfrom 1.5 to

 

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25 years. An intangible asset subject to amortization must bereviewed for impairment pursuant to Statement of Financial Accounting StandardsNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

In accordance with SFAS No. 142, the Company completed the annualevaluation of its goodwill and other intangible assets at December 31,2003 and determined that there was no impairment loss. Goodwill and otherintangible assets totaled $3.3 billion as of March 31, 2004 and as ofDecember 31, 2003. (See Note 5 to the Consolidated Financial Statementsfor further discussion of the Company’s goodwill and other intangible assets.)

 

## *Investments*

## * *

As of March 31, 2004, the Company’s current investment securitiesat fair value, totaled $7.6 billion, of which 88.3% was invested infixed-income securities and the remaining 11.7% was invested in equitysecurities. As of December 31, 2003, the Company’s current investmentsecurities at fair value totaled $6.7 billion, of which 87.6% was invested infixed-income securities and the remaining 12.4% 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, 2004 and December 31,2003 were $148.1 million and $161.8 million, respectively, and consistedprimarily of restricted assets, certain equities and other investments. Totalcurrent and long-term investments at fair value, comprised 48.3% and 46.6% oftotal assets as of March 31, 2004 and December 31, 2003, respectively.

 

With the majority of investments in fixed-income securities, theCompany maintains an investment portfolio that is primarily structured tomaximize total return while preserving the principal asset base and provide asource of liquidity for operating needs. The Company records investment incomewhen earned, and realized gains or losses when sold, as determined using thefirst-in-first-out method.

 

The Company regularly evaluates the appropriateness of investmentsrelative to its internal investment guidelines. The Company operates withinthese guidelines by maintaining a well-diversified portfolio, both across andwithin asset classes. The Company has from time to time retained an independentconsultant to advise the Company on the appropriateness of its investmentpolicy. The Company performs a quarterly evaluation of its investmentsecurities, using both quantitative and qualitative factors to determinewhether a decline in investment value is other-than-temporary. When a declinein an investment’s fair value is determined to be other-than-temporary, a lossis recorded against investment income. When determining whether a decline in aninvestment’s fair value is other-than-temporary, the Company considers theextent and duration to which a security’s market value has been less than itscost, the financial condition and future earnings potential of the issuer,recommendations and opinions from outside investment managers and the currenteconomic environment. For the quarters ended March 31, 2004 and 2003, the Companyrecorded investment losses that the Company believed to be other-than-temporaryof less than $0.1 million and $23.9 million,

 

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respectively. The Company believes that it has performed an adequatereview for impairment of the investment portfolio and that investments arecarried at fair value. Changing economic and market conditions in the future,however, may cause the Company to reassess its judgment regarding impairment,which could result in realized losses relating to other-than-temporary declinesbeing charged against future income.

 

As of March 31, 2004 and December 31, 2003, net unrealizedgains from the Company’s fixed-income securities totaled $190.1 million and$131.6 million, respectively, primarily resulting from a general decrease ininterest rates. The Company had a net unrealized gain in its equity securitiesportfolio as of March 31, 2004 and December 31, 2003 of $202.7million and $157.2 million, respectively. The Company believes that thesefluctuations are temporary as a result of current market conditions.

 

The following table illustrates the gross unrealized losses included inthe Company’s investment portfolio aggregated by investment category. The tablealso illustrates the length of time the securities have been in an unrealizedloss position as of March 31, 2004.

 
|                                |   | **March 31,  2004  Gross Unrealized Losses** |       |
|-------------------------------------|--------|---------------------------------------------------|------------|
|                                |   | **Months in  Unrealized  Loss Position**          |       |
|                                |   | **Less than  12 months**                          |       | **12 months  or more** | ** ** | **Total** | ** ** |
|                                |   | **(In  thousands)**                               | ** ** |
|                                |   |                                              |       |   |   |   |   |
| U.S. Treasury and agency securities |   | $                                                 | 602        |   | $ | 10 |   | $ | 612 |   |
| Municipal securities                |   | 1,430                                             |       | — |   | 1,430 |   |
| Mortgage-backed securities          |   | 3,599                                             |       | 100 |   | 3,699 |   |
| Corporate and other securities      |   | 1,704                                             |       | 111 |   | 1,815 |   |
| Total debt securities               |   | 7,335                                             |       | 221 |   | 7,556 |   |
| Equity and other investments        |   | 12,288                                            |       | 251 |   | 12,539 |   |
| Total investment securities         |   | $                                                 | 19,623     |   | $ | 472 |   | $ | 20,095 |   |

 

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***Factors That MayAffect Future Results of Operations***

 

Certain statements contained in “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” such as statementsconcerning the Company’s geographic expansion and other business strategies,the effect of recent health care reform legislation, changes in the competitiveenvironment and small group membership growth and other statements containedherein regarding matters that are not historical facts, are forward-lookingstatements (as such term is defined in the Securities Exchange Act of 1934, asamended). Such statements involve a number of risks and uncertainties that maycause actual results to differ from those projected. Factors that could causeactual results to differ materially include, but are not limited to, thosediscussed below. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof.

 

Completion of the Company’s pending merger with Anthem is contingent upon,among other things, receipt of necessary approvals from certain federal andstate agencies and from the stockholders of both companies on or beforeNovember 30, 2004. Broad latitude in administering the applicableregulations is given to the federal and state agencies from which WellPoint andAnthem must seek approvals. There can be no assurance that the companies willobtain these approvals. As a condition to approval of the transaction,regulatory agencies may seek to impose requirements or limitations or costs onthe way that the combined company conducts business after consummation of thetransaction. If the Company or Anthem were to agree to any materialrequirements or limitations in order to obtain any necessary approvals, suchrequirements or limitations or additional costs could adversely affect thecombined company’s ability to integrate the operations of the Company withthose of Anthem, and could result in a material adverse effect on the combinedcompany’s revenues or results of operations. In addition, achieving theanticipated benefits of the merger will depend in part upon whether the twocompanies integrate their businesses in an efficient and effective manner.Because of the complex nature of the integration process, WellPoint cannot provideany assurances regarding the ultimate success of these integration activities.

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors. The lawsuit, which is entitled *Abrams v. WellPoint HealthNetworks Inc., et al.*, alleges that the Company’s directorsbreached their fiduciary duties to stockholders by approving an Agreement andPlan of Merger with Anthem while in possession of non-public informationregarding the Company’s financial results for the third quarter of 2003. Thelawsuit seeks to enjoin the Company from consummating the merger with Anthem,unless the Company adopts and implements a process for obtaining the highestpossible price for stockholders, and to rescind any terms of the Agreement andPlan of Merger that have already been implemented.  On May 7, 2004, WellPoint and the plaintiff signed a memorandumof understanding regarding a potential settlement of the action.  The potential settlement contemplated by thememorandum of understanding would involve WellPoint agreeing to provide certainadditional disclosures on several matters in the joint proxystatement/prospectus to be sent to WellPoint’s stockholders beyond thosecontained in the preliminary proxy statement/prospectus.  The settlement would also provide for thepayment by WellPoint of $2.25 million to the plaintiff’s counsel for fees andcosts (subject to court approval).  Nopart of the settlement costs will be paid by the WellPoint directorsindividually.  The settlement would notinvolve any admissions of breaches of fiduciary duty or other wrongdoing byWellPoint or any of its directors.  Thesettlement and payment of the plaintiff’s counsel fees would be conditioned upon,among other things, completion of the merger. Any final settlement agreement signed by the parties must be approved bythe Superior Court judge assigned to the matter.  While WellPoint expects to diligently negotiate the terms of afinal settlement agreement, there can be no assurances that a settlementagreement will be signed.

 

The Company’s operations are subject to substantial regulation byfederal, state and local agencies in all jurisdictions in which the Companyoperates. Many of these agencies have increased their scrutiny of managedhealth care companies in recent periods or are expected to increase theirscrutiny as newly passed legislation becomes effective. From time to time, theCompany and its subsidiaries receive requests for information from regulatoryagencies or are

 

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notified that such agencies are conducting reviews, investigations orother proceedings with respect to certain of the Company’s activities. TheCompany also provides insurance products to Medicare and Medicaid beneficiariesin various states, including to Medi-Cal beneficiaries in various Californiacounties under contracts with the California Department of Health Services (ordelegated local agencies), and provides administrative services to the Centersfor Medicare and Medicaid Services in various capacities (including serving asthe largest Medicare Part A fiscal intermediary). There can be noassurance that acting as a government contractor in these circumstances will notincrease the risk of heightened scrutiny by such government agencies or thatsuch scrutiny will not have a material adverse effect on the Company, eitherthrough negative publicity about the Company or through an adverse impact onthe Company’s results of operations. In addition, profitability from thisbusiness may be adversely affected by inadequate premium rate increases due togovernmental budgetary issues. Future actions by any regulatory agencies mayhave a material adverse effect on the Company’s business.

 

In connection with the RightCHOICE, Cerulean, and Cobalt transactions,the Company incurred significant additional indebtedness to fund the cashpayments made to the acquired companies’ stockholders. In addition, the Companymay incur additional indebtedness to fund potential future acquisitions. Thisexisting or new indebtedness may result in a significant percentage of theCompany’s cash flow being applied to the payment of interest, and there can beno assurance that the Company’s operations will generate sufficient future cashflow to service this indebtedness. The Company’s current indebtedness, as wellas any indebtedness that the Company may incur in the future (such asindebtedness incurred to fund repurchases of its Common Stock or to fundpotential future acquisitions), may adversely affect the Company’s ability tofinance its operations 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’s business strategy, the Company has acquiredsubstantial operations in new geographic markets over the last seven years.These businesses, some of which include substantial indemnity-based insuranceoperations, have experienced varying profitability or losses in recent periods.Since the relevant dates of acquisition of Cerulean, RightCHOICE, MethodistCareand Cobalt, the Company has continued to work extensively on the integration ofthese businesses. However, there can be no assurances regarding the ultimatesuccess of the Company’s integration efforts or regarding the ability of theCompany to maintain or improve the results of operations of the acquiredbusinesses. The Company has incurred and will, among other things, need tocontinue to incur considerable expenditures for provider networks, distributionchannels and information systems in addition to the costs associated with theintegration of these acquisitions. The integration of these complex businessesmay result in, among other things, temporary increases in claims inventory orother service-related issues that may negatively affect the Company’srelationship with its customers and contribute to increased attrition of suchcustomers. The Company’s results of operations could be adversely affected inthe event that the Company experiences such problems or is otherwise unable toimplement fully its expansion strategy.

 

The Company and certain of its subsidiaries are subject to capitalsurplus requirements by the California Department of Managed Health Care, theCalifornia, Delaware, Georgia, Missouri

 

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and Wisconsin Departments of Insurance, various other state Departmentsof Insurance and the Blue Cross and Blue Shield Association. Although theCompany believes that it is currently in compliance in all material respectswith all applicable requirements, there can be no assurances that applicablerequirements will not be increased in the future.

 

From time to time, the Company and certain of its subsidiaries areparties to various legal proceedings, many of which involve claims for coverageencountered in the ordinary course of business. The Company, like HMOs andhealth insurers generally, excludes certain health care services from coverageunder its HMO, PPO and other plans. The Company is, in its ordinary course ofbusiness, subject to the claims of its enrollees arising out of decisions torestrict treatment or reimbursement for certain services. The loss of even onesuch claim, 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 May 2000, the California Medical Association filed a lawsuit inU.S. district court in San Francisco against BCC. The lawsuit alleges that BCCviolated the Racketeer Influenced and Corrupt Organizations Act (“RICO”)through various misrepresentations to and inappropriate actions against healthcare providers. In late 1999, a number of class-action lawsuits were broughtagainst several of the Company’s competitors alleging, among other things,various misrepresentations regarding their health plans and breaches offiduciary obligations to health plan members. In August 2000, the Companywas added as a party to *Shane v. Humana, et al.*, a class-actionlawsuit brought on behalf of health care providers nationwide. In addition tothe RICO claims brought in the California Medical Association lawsuit, thislawsuit also alleges violations of ERISA, federal and state “prompt pay”regulations and certain common law claims. In October 2000, the federalJudicial Panel on Multidistrict Litigation issued an order consolidating theCalifornia Medical Association lawsuit, the *Shane* lawsuit and various other pendingmanaged care class-action lawsuits against other companies before DistrictCourt Judge Federico Moreno in the Southern District of Florida for purposes ofthe pretrial proceedings. In March 2001, Judge Moreno dismissed theplaintiffs’ claims based on violation of RICO, although the dismissal was madewithout prejudice to the plaintiffs’ ability to subsequently refile theirclaims. Judge Moreno also dismissed, with prejudice, the plaintiffs’ federalprompt pay law claims. On March 26, 2001, the plaintiffs filed an amendedcomplaint in its lawsuit, alleging, among other things, revised RICO claims andviolations of California law. On May 3, 2001, the defendants filed amotion to dismiss this amended complaint. On May 9, 2001, Judge Morenoissued an order requiring that all discovery in the litigation be completed byDecember 2001, with the exception of discovery related to expert witnesses,which was to be completed by March 15, 2002. In June 2001, thefederal Court of Appeals for the 11th Circuit issued a stay of Judge Moreno’sdiscovery order, pending a hearing before the Court of Appeals on the Company’sappeal of its motion to compel arbitration (which had earlier been granted inpart and denied in part by Judge Moreno). The hearing was held inJanuary 2002 and, in March 2002, the Court of Appeals panel issued anopinion affirming Judge Moreno’s earlier action with respect to the motion tocompel arbitration. The Company filed a motion requesting a rehearing of thematter before the entire 11th Circuit Court of Appeals, which motion was deniedby the 11th Circuit Court of Appeals in June 2002. On July 29, 2002,Judge Moreno issued an order providing that discovery in the case would be

 

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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 inMay 2003 and ordering the parties to participate in non-binding mediation.In October 2002, the defendants, among other things, moved to compelarbitration of most claims (which motion was granted in part in September 2003).In October 2002, the Company also filed a motion with the 11th CircuitCourt of Appeals seeking to appeal Judge Moreno’s class-certification order.The motion was granted. The 11th Circuit heard oral argument onSeptember 11, 2003 on the Company’s appeal. A mediator has been appointedby Judge Moreno and the parties are currently conducting court-orderedmediation. On April 30, 2004, Judge Moreno set a new trial date inMarch 2005 and extended the deadline for discovery to September 29,2004, which may be further extended.

 

In March 2002, the American Dental Association and threeindividual dentists filed a lawsuit in U.S. district court in Chicago againstthe Company and BCC. This lawsuit alleges that WellPoint and BCC engaged inconduct that constituted a breach of contract under ERISA, trade libel andtortious interference with contractual relations and existing and prospectivebusiness expectancies. The lawsuit seeks class-action status. The Company fileda motion (which was granted in July 2002) with the federal Judicial Panelon Multidistrict Litigation requesting that the proceedings in this case beconsolidated with a similar action brought against other managed care companiesthat has been consolidated with the *Shane* lawsuit. The case is currentlystayed.

 

In May 2003, a lawsuit entitled *Thomas, et al. v. Blue Cross and BlueShield Association, et al.* was filed in the U.S. District Court inthe Southern District of Florida. The attorneys representing the plaintiffs inthe lawsuit are primarily the attorneys representing the plaintiffs in the *Shane*litigation described above. The defendants in *Thomas* are the Company’sBlue Cross and Blue Shield-licensed subsidiaries, the BCBSA and all of theother current Blue Cross and Blue Shield licensees. The lawsuit alleges thateach of the defendants engaged in similar activities and conduct as thatalleged in the *Shane* litigation. The case has been assigned to JudgeMoreno. The defendants have moved to compel arbitration and to dismiss thecomplaint.

 

On March 26, 2003, a lawsuit entitled *Irwin v. AdvancePCS, et al.*was filed in the California Superior Court in Alameda County, California.WellPoint and certain of its wholly owned subsidiaries are named as defendantsin the lawsuit. The complaint alleges that the defendants violated CaliforniaBusiness and Professions Code Section 17200 by engaging in unfair,fraudulent and unlawful business practices. The complaint alleges, among otherthings, that pharmacy benefit management companies (such as the Company’s subsidiarythat does business under the tradename WellPoint Pharmacy Management) engage inunfair practices such as negotiating discounts in prices of drugs frompharmacies and negotiating rebates from drug manufacturers and retaining suchdiscounts and rebates for their own benefit. The complaint also alleges thatdrugs are included in formularies in exchange for rebates and that thedefendants charge patient co-payments that exceed the actual cost of genericdrugs.

 

In early 2003, a lawsuit entitled *Knecht v. Cigna, et al.* was filed in U.S.District Court in Oregon. This litigation has subsequently been transferred toJudge Moreno of the U.S. District

 

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Court for the Southern District of Florida. This litigation is aputative class action lawsuit on behalf of chiropractors in the western UnitedStates. The Company is a named defendant in the lawsuit. The lawsuit allegesthat each of the defendants engaged in similar activities and conduct as thatalleged in the *Shane* litigation. The case is currently stayed.

 

In October 2003, a lawsuit entitled *Solomon, et al. v. Cigna, et al.*was filed in the U.S. District Court in the Southern District in Florida. TheCompany is a named defendant in this lawsuit, although the Company has not yetbeen served. This lawsuit is also a putative class action brought on behalf ofchiropractors, podiatrists and certain other types of health care practitionersnationwide. This lawsuit also alleges that the defendants engaged in similaractivities and conduct as that alleged in the *Shane* litigation. OnDecember 15, 2003, this lawsuit was transferred to Judge Moreno, and thecase was consolidated with the *Knecht* lawsuit for pre-trial purposes.Both of these cases are currently stayed. In December 2003, the plaintiffsin *Solomon,et al. v. Cigna, et al.* filed a similar lawsuit against the Company,the Company’s Blue Cross and Blue Shield-licensed subsidiaries, the BCBSA andall of the other current Blue Cross and Blue Shield licensees. The lawsuit isentitled *Solomon,et al. v. Blue Cross and Blue Shield Association, et al.* and wasfiled in the U.S. District Court in the Southern District in Florida. OnJanuary 7, 2004, this lawsuit was transferred to Judge Moreno. OnMarch 9, 2004, Judge Moreno issued an order restoring this case to theactive docket and placing it on a coordinated track with the *Thomas*lawsuit.

 

The financial and operational impact that these and other evolvingtheories of recovery will have on the managed care industry generally, or theCompany in particular, is at present unknown.

 

The Company’s future results will depend in part on its ability toaccurately predict health care costs and to manage future health care coststhrough product and benefit design, underwriting criteria, medical managementand negotiation of favorable provider contracts. Changes in utilization rates,demographic characteristics, the regulatory environment and health carepractices, inflation, new pharmaceuticals/technologies, clusters of high-cost casesand numerous other factors are beyond the control of any health plan providerand may adversely affect the Company’s ability to predict and control healthcare costs and claims, as well as the Company’s financial condition, results ofoperations or cash flows. Periodic renegotiations of hospital and otherprovider contracts, coupled with continued consolidation of physician, hospitaland other provider groups, may result in increased health care costs and limitthe Company’s ability to negotiate favorable rates. In recent years, largephysician practice management companies have experienced extreme financialdifficulties, including bankruptcy, which may subject the Company to increasedcredit risk related to provider groups and cause the Company to incurduplicative health care services expense. Additionally, the Company facescompetitive pressure to contain premium prices. Fiscal concerns regarding thecontinued viability of government-sponsored programs such as Medicare andMedicaid may cause decreasing reimbursement rates for these programs. Anylimitation on the Company’s ability to increase or maintain its premium levels,design products, implement underwriting criteria or negotiate competitiveprovider contracts may adversely affect the Company’s financial condition orresults of operations.

 

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Managed care organizations, both inside and outside California, operatein a highly competitive environment that has undergone significant change inrecent years as a result of business consolidations, new strategic alliances,aggressive marketing practices by competitors and other market pressures.Additional increases in competition (including competition from market entrantsoffering Internet-based products and services) could adversely affect theCompany’s financial condition, cash flows or results of operations.

 

The Company is dependent on the services of independent agents andbrokers in the marketing of its health care plans, particularly with respect toindividuals, seniors and small employer group members. Such independent agentsand brokers are typically not exclusively dedicated to the Company and mayfrequently also market health care plans of the Company’s competitors. TheCompany faces intense competition for the services and allegiance ofindependent agents and brokers.

 

As a result of the Company’s acquisitions, the Company operates on aselect geographic basis nationally and offers a spectrum of health care andspecialty products through various risk-sharing arrangements. The Company’shealth care products include a variety of managed care offerings as well astraditional fee-for-service coverage. With respect to product type,fee-for-service products are generally less profitable than managed careproducts. A component of the Company’s expansion strategy is to transition overtime the traditional insurance members of the Company’s acquired businesses tomore managed care products.

 

With respect to the risk-sharing nature of products, managed careproducts that involve greater potential risk to the Company generally tend tobe more profitable than management services products and those managed careproducts where the Company is able to shift risks to employer groups.Individuals and small employer groups are more likely to purchase the Company’shigher-risk managed care products because such purchasers are generally unableor unwilling to bear greater liability for health care expenditures. Typically,government-sponsored programs involve the Company’s higher-risk managed careproducts. Over the past few years, the Company has experienced a slight declinein margins in its higher-risk managed care products and to a lesser extent onits lower-risk managed care and management services products. This decline isprimarily attributable to product mix change, product design, competitivepressure and greater regulatory restrictions applicable to the small employergroup market. From time to time, the Company has implemented price increases incertain of its managed care businesses. While these price increases areintended to improve profitability, there can be no assurance that this willoccur. Subsequent unfavorable changes in the relative profitability between theCompany’s various products could have a material adverse effect on theCompany’s results of operations and on the continued merits of the Company’sgeographic expansion strategy.

 

One of the Company’s wholly owned subsidiaries operates as a pharmacybenefit manager (“PBM”) under the trade name WellPoint Pharmacy Management. ThePBM industry faces a number of risks and uncertainties in addition to thosefacing the Company’s core health plan business. Such risks and uncertaintiesinclude the application of federal and state anti-remuneration laws (generallyknown as “anti-kickback” laws), whether PBMs operate as fiduciaries underthe Employee Retirement Income Security Act of 1974 (“ERISA”) and are in

 

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compliance with their fiduciary obligations under ERISA in connectionwith the development and implementation of items such as formularies, preferreddrug listings and therapeutic intervention programs, and potential liabilityregarding the use of patient-identifiable medical information. In addition, anumber of federal and state legislative proposals are being considered thatcould affect a variety of PBM industry practices, such as the receipt ofrebates from pharmaceutical manufacturers. The Company believes that its PBMbusiness is currently being conducted in compliance in all material respectswith applicable legal requirements. However, there can be no assurance that theCompany’s PBM business will not be subject to challenge under various laws andregulations, or that any such challenge will not have a material adverse effectupon the Company’s results of operations or financial condition. In addition,future legislative enactments affecting the PBM industry could have a materialadverse effect upon the Company’s results of operations and financialcondition.

 

Substantially all of the Company’s investment assets are ininterest-yielding debt securities of varying maturities or equity securities.The value of fixed-income securities is highly sensitive to fluctuations inshort- and long-term interest rates, with the value decreasing as such ratesincrease and increasing as such rates decrease. In addition, the value ofequity securities can fluctuate significantly with changes in marketconditions. Changes in the value of the Company’s investment assets, as aresult of interest rate fluctuations, can affect the Company’s results ofoperations and stockholders’ equity. There can be no assurances that interestrate fluctuations will not have a material adverse effect on the results ofoperations or financial condition of the Company.

 

The Company’s operations are dependent on retaining existing employees,attracting additional qualified employees and achieving productivity gains fromthe Company’s investment in technology. The Company faces intense competitionfor qualified information technology personnel and other skilled professionals.There can be no assurances that an inability to retain existing employees orattract additional employees will not have a material adverse effect on theCompany’s results of operations.

 

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Prior to the Company’s acquisition of the GBO, John Hancock Mutual LifeInsurance Company (“John Hancock”) entered into a number of reinsurancearrangements with respect to personal accident insurance and the occupationalaccident component of workers’ compensation insurance, a portion of which wasoriginated through a pool managed by Unicover Managers, Inc. Under thesearrangements, John Hancock assumed risks as a reinsurer and transferred certainof such risks to other companies. These arrangements have become the subject ofdisputes, including a number of legal proceedings to which John Hancock is aparty. The Company is currently in arbitration with John Hancock regardingthese arrangements. 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.

 

In December 2000, a wholly owned subsidiary of the Companycompleted its acquisition of certain mail order pharmaceutical service assetsand now conducts business as a mail order pharmacy. The pharmacy business issubject to extensive federal, state and local regulations that 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 currently maintains and intends to continue tomaintain professional liability and errors and omissions liability insurance,there can be no assurances that the coverage limits under such insuranceprograms will be adequate to protect against future claims or that the Companywill be able to maintain insurance on acceptable terms in the future.

 

Following the terrorist attacks of September 11, 2001, there havebeen various incidents of suspected bioterrorist activity in the United States.To date, these incidents have resulted in related isolated incidents of illnessand death. However, federal and state law enforcement officials have issuedpublic warnings about additional potential terrorist activity involvingbiological and other weapons. If the United States were to experience morewidespread bioterrorist or other attacks, the Company’s covered medicalexpenses could rise and the Company could experience a material adverse effecton its results of operations, financial condition and cash flow.

 

In April and May 2002, one of the Company’s wholly ownedsubsidiaries acting as a pharmacy benefit management business under the tradename WellPoint Pharmacy Management received two administrative subpoenas ducestecum issued by the U.S. Attorney’s Office in Boston Massachusetts. The Companydoes not believe that its pharmacy benefit management business is presently atarget of investigation by the U.S. Attorney. The subpoenas appear to focus

 

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primarily on WellPoint Pharmacy Management’s relationship with TAPPharmaceuticals, including TAP’s drugs Lupron and Prevacid. The Company hasresponded to the subpoenas by producing certain requested documents. TheCompany believes that it is in compliance in all material respects with alllaws and regulations applicable to the pharmacy benefit management business.

 

As a result of the general nationwide economic downturn, many statesare currently experiencing budget deficits. State legislators are exploring avariety of alternatives to address this situation. In order to address thebudget shortfalls, various states may propose reductions in payments receivedby Medicaid managed care providers such as the Company. For instance, theCalifornia Legislature in 2003 enacted legislation reducing rates paid forMedi-Cal (California’s Medicaid program) coverage. Alternatively, statelegislators may seek to impose greater state taxes. Any significant reductionin payments received by the Company in connection with its Medicaid managedcare business could have a material adverse effect on the Company’s results ofoperations or financial condition. Additionally, any increase in state taxescould prolong or exacerbate the current economic downturn, which could in turnhave a material adverse effect on the Company’s results of operations orfinancial condition. Budget cutbacks could also result in reduced employmentlevels in public sector accounts for which the Company provides insured oradministrative services products or could result in public sector accountsswitching from insured products to administrative services products.

 

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***Review byIndependent Accountants***

 

With respect to the unaudited consolidated financial information ofWellPoint Health Networks Inc. for the three-month periods ended March 31,2004 and 2003, PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”) reportedthat they have applied limited procedures in accordance with professionalstandards for a review of such information. However, their separate report dated April 19, 2004, except Note 14as to which the date is May 7, 2004, appearing herein states that they did notaudit and they do not express an opinion on that unaudited consolidatedfinancial information.  Accordingly, thedegree of reliance on their report on such information should be restricted inlight of the limited nature of the review procedures applied.  PricewaterhouseCoopers is not subject to theliability 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.          Quantitative and Qualitative DisclosuresAbout Market Risk

 

The Company regularly evaluates its asset and liability interest raterisks, as well as the appropriateness of investments, relative to its internalinvestment guidelines. The Company operates within these guidelines bymaintaining a well-diversified portfolio, both across and within asset classes.The Company has from time to time retained an independent consultant to advisethe Company on the appropriateness of its investment policy.

 

Asset interest rate risk is managed within a duration band tied to theCompany’s liability interest rate risk. Credit risk is managed by maintaininghigh average quality ratings and a well-diversified portfolio.

 

The Company’s use of derivative instruments is generally limited tohedging purposes and has principally consisted of forward exchange contractsand interest rate swaps. The Company’s investment policy prohibits the use ofderivatives for leveraging purposes as well as the creation of risk exposuresnot otherwise allowed within the policy.

 

From time to time, the Company has entered into interest rate swapagreements primarily to minimize significant, unanticipated earningsfluctuations caused by interest rate volatility. The Company’s goal is tomaintain a balance between fixed and floating interest rates on its long-termdebt. The Company believes that this allows it to better anticipate itsinterest payments while helping to manage the asset-liability relationship.

 

# *Interest Rate Risk*

# * *

The Company is exposed to market rate risks associated with itsinvestments and borrowings. Market risk represents the risk of loss in value ofa financial instrument resulting from changes in interest rates and equityprices.

 

As of March 31, 2004, the Company’s current investment securitiesat fair value, totaled $7.6 billion, of which 88.3% was invested infixed-income securities and the remaining 11.7% was invested in equitysecurities. The Company has evaluated the pre-tax net impact to the fair valueof its fixed-income investments over a 12-month period from a hypotheticalchange in all interest rates of 100, 200 and 300 basis points (“bp”). In doingso, optionality was addressed through Monte Carlo simulation of the pricebehavior of 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, 2004 are shown in the table below. The tablealso shows the change in valuation of the $200.0 million notional amount 6 3/8*%* fixed for LIBOR-based floating interestrate swap agreement as of March 31, 2004.

 

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|                                      |   | **Decrease  in fair value  given an interest rate increase of:** |       |
|-------------------------------------------|--------|------------------------------------------------------------------|------------|
|                                      |   | **100 bp**                                                       |       | **200 bp** |   | **300 bp** |   |
|                                      |   | **(In  millions)**                                               | ** ** |
|                                      |   |                                                             |       |   |   |   |   |
| Fixed Income Portfolio                    |   | $                                                                | (201.5     | ) | $ | (413.4 | ) | $ | (627.5 | ) |
| Valuation of Interest Rate Swap Agreement |   | (3.9                                                             | )          | (7.8 | ) | (11.5 | ) |
|                                      |   | $                                                                | (205.4     | ) | $ | (421.2 | ) | $ | (639.0 | ) |

 

The Company believes that an interest rate shift in a 12-month periodof 100 bp represents a moderately adverse outcome, while a 200 bp shift issignificantly adverse and a 300 bp shift is unlikely given historicalprecedents. Although the Company holds its bonds as “available for sale” forpurposes of Statement of Financial Accounting Standards No. 115, “Accountingfor Certain Investments in Debt and Equity Securities,” the Company’s cashflows and the short duration of its investment portfolio should allow it tohold securities to maturity, thereby avoiding the recognition of losses shouldinterest rates rise significantly.

 

# *Interest Rate Swap Agreements*

# * *

On January 15, 2002, the Company entered into a $200.0 millionnotional amount interest rate swap agreement with respect to its 2006 Notes.The swap agreement is a contract to exchange a fixed 6 3/8*%* rate for a LIBOR-based floating rate.The Company recognized settlement income of $1.9 million for each of thequarters ended March 31, 2004 and 2003 made from this swap agreement. (SeeNote 8 to the Consolidated Financial Statements.)

 

The Company has from time to time entered into additional interest rateswap agreements in order to reduce the volatility of interest expense resultingfrom changes in interest rates. As of December 31, 2001, the Company hadentered into $200.0 million of floating to fixed-rate swap agreements, whichconsisted of a $150.0 million notional amount swap agreement at 6.99% and a$50.0 million notional amount swap agreement at 7.06%. As of December 31,2001, the Company also had $235.0 million of LIBOR-based floating rate debtoutstanding. In September 2002, the Company terminated these twofixed-rate swap agreements with an aggregate cash settlement of $17.6 million,of which $1.8 million was accrued interest and the remaining $15.8 millionrepresented the fair value of the swap agreements at the time of terminationand is being amortized over the term of the original swap agreements. As ofMarch 31, 2004, the remaining balance of the swap agreements was $4.9million. (See Note 8 to the Consolidated Financial Statements for furtherdiscussion.)

 

# *Equity Price Risk*

# * *

As of March 31, 2004, the Company’s equity securities werecomprised primarily of domestic stocks. Assuming an immediate decrease of 10%in market value, as of March 31, 2004, the hypothetical pre-tax loss in fairvalue of stockholders’ equity is estimated to be approximately $88.8 million.

 

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ITEM 4.          Controls andProcedures

 

The Company maintains “disclosure controls and procedures,” as suchterm is defined under Rule 13a-14(c) of the rules and regulations under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”).  These disclosure controls and procedures aredesigned to ensure that information required to be disclosed in the Company’sExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the rules and forms of the Securities and ExchangeCommission (the “SEC”), and that such information is accumulated andcommunicated to the Company’s management, including its Chief Executive Officerand Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosures.  As ofMarch 31, 2004, the Company has carried out an evaluation under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures. Based upon their evaluation, the Chief Executive Officer andChief Financial Officer concluded that the Company’s disclosure controls andprocedures were effective in ensuring that material information relating to theCompany is made known to the Chief Executive Officer and Chief FinancialOfficer by others within the Company during the period in which this quarterlyreport on Form 10-Q was being prepared.

 

There has been no change in the Company’s internal control overfinancial reporting during the period covered by this quarterly report on Form10-Q that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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PART II.        OTHER INFORMATION

 

ITEM 1.          Legal Proceedings

 

A stockholder class action lawsuit was filed in the Superior Court ofVentura County, California on October 28, 2003 against the Company and itsboard of directors. The lawsuit, which is entitled *Abrams v. WellPoint HealthNetworks Inc., et al.*, alleges that the Company’s directorsbreached their fiduciary duties to stockholders by approving an Agreement andPlan of Merger with Anthem while in possession of non-public informationregarding the Company’s financial results for the third quarter of 2003. Thelawsuit seeks to enjoin the Company from consummating the merger with Anthem,unless the Company adopts and implements a process for obtaining the highestpossible price for stockholders, and to rescind any terms of the Agreement andPlan of Merger that have already been implemented.  On May 7, 2004, WellPoint and the plaintiff signed a memorandumof understanding regarding a potential settlement of the action.  The potential settlement contemplated by thememorandum of understanding would involve WellPoint agreeing to provide certainadditional disclosures on several matters in the joint proxystatement/prospectus to be sent to WellPoint’s stockholders beyond thosecontained in the preliminary proxy statement/prospectus.  The settlement would also provide for thepayment by WellPoint of $2.25 million to the plaintiff’s counsel for fees andcosts (subject to court approval).  Nopart of the settlement costs will be paid by the WellPoint directorsindividually.  The settlement would notinvolve any admissions of breaches of fiduciary duty or other wrongdoing byWellPoint or any of its directors.  Thesettlement and payment of the plaintiff’s counsel fees would be conditionedupon, among other things, completion of the merger.  Any final settlement agreement signed by the parties must beapproved by the Superior Court judge assigned to the matter.  While WellPoint expects to diligentlynegotiate the terms of a final settlement agreement, there can be no assurancesthat a settlement agreement will be signed.

 

See “Factors That May Affect Future Results of Operations” for adiscussion of additional various pending legal matters involving the Companyand its subsidiaries. The Company’s annual report on Form 10-K for the yearended December 31, 2003, as amended by Amendment No. 1 on Form 10-K/A alsocontains a discussion of various pending legal matters.

 

ITEM 2.          Changes in Securities,Use of Proceeds and Issuer Purchases of Equity Securities

 

During the three months ended March 31, 2004, the Company had oneoutstanding stock repurchase program. The Company's stock repurchase program is primarily intended to reducethe dilutive effect of its employee stock option and stock purchase plans.  The amount the Company spends and the numberof shares repurchased varies based on a variety of factors, including employeestock option grants and the stock price.

 

A summary of the Company's repurchase activity for the three monthsended March 31, 2004 is as follows:

 
|                     |   | **Total  Number of Shares Purchased (1)** |   | **Average   Price Paid   per Share** |   | **Total  Number   of Shares   Purchased as Part   of Publicly Announced Program** |   | **Maximum  Number of Shares that May Yet Be   Purchased Under the Program (2)** |      |
|--------------------------|--------|-------------------------------------------|--------|--------------------------------------|--------|-----------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------|-----------|
| January 1 - January 31   |   | —                                    |   | $                                    | — |                                                                              | — |                                                                            | 6,198,400 |   |
| February 1 - February 29 |   | 1,670                                     |   | 106.91                               |   | —                                                                            |   | 6,198,400                                                                       |      |
| March 1 - March 31       |   |  843,948                             |   | 108.87                               |   | —                                                                            |   | 6,198,400                                                                       |      |
| Total                    |   | 845,618                                   | (3)    |                                 | 108.86 |                                                                              |   |                                                                            |      |   |
|                          |        |                                           |        |                                      |        |                                                                                   |        |                                                                                 |           |  |  |

 

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(1)   The total number of sharespurchased is due to shares delivered to or withheld by the Company inconnection with stock-for-stock stock option exercises and employee payroll taxwithholding upon exercise of stock options and vesting of restricted stock.

 

(2)   The board of directors ofthe Company has previously authorized the Company to repurchase up to 35.5million shares of the Company's Common Stock.

 

(3)   Shares purchased for thepurposes described in footnote 1 above are reported net of actual stock grantsin the Consolidated Statement of Changes in Stockholders' Equity.

 

ITEM 6.          Exhibits and Reportson Form 8-K

 

(a)   Exhibits

 

See Exhibit Index.

 

(b)   Reportson Form 8-K

 

On January 9, 2004, the Company furnished a current report onForm 8-K dated January 6, 2004, which attached a copy of theCompany’s press release dated January 6, 2004 and portions of a transcriptof a conference call held by the Company on January 7, 2004 relating toadditional anticipated financial results for the year ended December 31,2003.

 

On January 29, 2004, the Company furnished a current report onForm 8-K dated January 28, 2004, which attached a copy of theCompany’s press release dated January 28, 2004 regarding the Company’searnings for the quarter and year ended December 31, 2003.

 

On February 3, 2004, the Company furnished a current report onForm 8-K dated February 3, 2004, which attached the text of certaininformation provided and to be provided by the Company during various investorconferences.

 

Theinformation furnished pursuant to the current reports on Form 8-K describedabove was intended to be furnished under Item 12 of the Form 8-K and is not tobe considered “filed” under the Securities Exchange Act of 1934, as amended,nor shall it be incorporated by reference into this filing or future filings bythe Company under the Securities Act of 1933, as amended or under theSecurities Exchange Act of 1934, as amended, unless the

 

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Companyexpressly sets forth in such future filing that such information is to beconsidered “filed” or incorporated by reference therein.

 

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**SIGNATURES**

 

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

 
|               | **WELLPOINT HEALTH  NETWORKS INC.**                            |
|--------------------|----------------------------------------------------------------|
|               | Registrant                                                     |
|               |                                                           |   |
| Date: May 10, 2004 | By:                                                            | /s/ LEONARD D. SCHAEFFER |   |
|               | Leonard D. Schaeffer                                           |
|               | Chairman of the Board of Directors and Chief Executive Officer |
|               |                                                           |   |
|               |                                                           |   |
| Date: May 10, 2004 | By:                                                            | /s/ DAVID C. COLBY |   |
|               | David C. Colby                                                 |
|               | Executive Vice President and Chief Financial Officer           |
|               |                                                           |   |
| Date: May 10, 2004 | By:                                                            | /s/ KENNETH C. ZUREK |   |
|               | Kenneth C. Zurek                                               |
|               | Senior Vice President, Controller and Taxation                 |
|                    |                                                                |  |  |  |  |

 

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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                |   | 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).                                                          |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 2.03                |   | Amended and Restated  Agreement and Plan of Merger effective as of October 26, 2003 among  Anthem, Inc., Anthem Holding Corp. and the Registrant, incorporated by  reference to Appendix A to the Registration Statement on Form S-4  (Registration No. 333-110830) filed by Anthem, Inc.                                                             |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 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. 333-112933).                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 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               |   | Amendment  to the WellPoint 401(k) Retirement Savings Plan effective as of  February 28, 2004.                                                                                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 10.02               |   | Amendment  to the WellPoint 401(k) Retirement Savings Plan effective as of  April 23, 2004.                                                                                                                                                                                                                                                           |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 15.01               |   | Letter on unaudited  interim financial information.                                                                                                                                                                                                                                                                                                        |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 31.01               |   | Certifications.                                                                                                                                                                                                                                                                                                                                            |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 32.01               |   | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                         |
|                |   |                                                                                                                                                                                                                                                                                                                                                       |
| 32.02               |   | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                         |

 

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