##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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|x | QUARTER REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | -------------------------------------------------------------------------------------



For the quarterly period ended September 30, 2005



OR



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



For the transition period from 
to.



Commission file number: 0-31014



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HEALTHEXTRAS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 52-2181356                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



800 King Farm
Boulevard, Rockville, Maryland 20850

(Address of principal executive offices, zip code)



(301) 548-2900

(Registrants phone number, including area code)



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Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No ̈



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x



As of November 4, 2005 there were 39,478,745 shares outstanding of the
registrants $0.01 par value common stock.



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##### Table of Contents

HEALTHEXTRAS, INC.

and Subsidiaries



Third Quarter 2005 Form 10-Q



TABLE OF CONTENTS



|           |  |                                                                                                                 |  |     
|---------- |  | --------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                 |  | Page
|PART I     |  | FINANCIAL INFORMATION                                                                                           |  |     
|           |  |                                                                                                                
|Item 1.    |  | Financial Statements (Unaudited)                                                                                |  |     
|           |  |                                                                                                                
|           |  | Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004                                      |  | 1   
|           |  |                                                                                                                
|           |  | Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2004           |  | 2   
|           |  |                                                                                                                
|           |  | Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004                     |  | 3   
|           |  |                                                                                                                
|           |  | Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2005 and 2004 |  | 4   
|           |  |                                                                                                                
|           |  | Notes to Consolidated Financial Statements                                                                      |  | 5   
|           |  |                                                                                                                
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 11  
|           |  |                                                                                                                
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 18  
|           |  |                                                                                                                
|Item 4.    |  | Controls and Procedures                                                                                         |  | 18  
|           |  |                                                                                                                
|PART II    |  | OTHER INFORMATION                                                                                               |  |     
|           |  |                                                                                                                
|Item 1.    |  | Legal Proceedings                                                                                               |  | 20  
|           |  |                                                                                                                
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                     |  | 20  
|           |  |                                                                                                                
|Item 3.    |  | Defaults Upon Senior Securities                                                                                 |  | 20  
|           |  |                                                                                                                
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                             |  | 20  
|           |  |                                                                                                                
|Item 5.    |  | Other Information                                                                                               |  | 20  
|           |  |                                                                                                                
|Item 6.    |  | Exhibits                                                                                                        |  | 20  
|           | 
|SIGNATURES |  |                                                                                                                



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##### Table of Contents

PART I. FINANCIAL INFORMATION



ITEM 1. Financial Statements



HEALTHEXTRAS, INC.

and Subsidiaries



CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)



|                                                                                                                                                                    |  |                    |         |                   |   |        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ----------------- | - | -------
|                                                                                                                                                                    |  | September 30, 2005 |         | December 31, 2004
|ASSETS                                                                                                                                                              |  |                    |         |                   |   |        
|Current assets:                                                                                                                                                     |  |                    |         |                   |   |        
|Cash and cash equivalents                                                                                                                                           |  | $                  | 76,510  |                   | $ | 67,068 
|Short-term investment                                                                                                                                               |  |                    | 1,995   |                   |   |       
|Accounts receivable, net of allowance for doubtful accounts of $830 and $917 at September 30, 2005 and December 31, 2004,
respectively                              |  |                    | 71,531  |                   |   | 68,238 
|Income taxes receivable                                                                                                                                             |  |                    | 114     |                   |   | 2,025  
|Inventory, net of allowance for obsolescence of $25 and $50 at September 30, 2005 and December 31, 2004,
respectively                                               |  |                    | 527     |                   |   | 464    
|Deferred charges                                                                                                                                                    |  |                    | 1,343   |                   |   | 1,871  
|Other current assets                                                                                                                                                |  |                    | 2,090   |                   |   | 2,151  
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total current assets                                                                                                                                                |  |                    | 154,110 |                   |   | 141,817
|                                                                                                                                                                    |  |                   
|Property and equipment, net                                                                                                                                         |  |                    | 9,388   |                   |   | 9,881  
|Intangible assets, net of accumulated amortization of $4,170 and $2,780 at September 30, 2005 and December 31, 2004,
respectively                                   |  |                    | 20,917  |                   |   | 22,307 
|Goodwill                                                                                                                                                            |  |                    | 75,429  |                   |   | 68,947 
|Restricted cash                                                                                                                                                     |  |                    | 1,000   |                   |   | 1,000  
|Other assets                                                                                                                                                        |  |                    | 375     |                   |   | 300    
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total assets                                                                                                                                                        |  | $                  | 261,219 |                   | $ | 244,252
|                                                                                                                                                                    |  |                    |         |                   |   |        
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                |  |                    |         |                   |   |        
|Current liabilities:                                                                                                                                                |  |                    |         |                   |   |        
|Accounts payable                                                                                                                                                    |  | $                  | 57,968  |                   | $ | 55,691 
|Accrued expenses and other current liabilities                                                                                                                      |  |                    | 4,371   |                   |   | 5,321  
|Note payable                                                                                                                                                        |  |                    | 5,000   |                   |   | 5,000  
|Deferred income taxes                                                                                                                                               |  |                    | 967     |                   |   | 967    
|Deferred revenue                                                                                                                                                    |  |                    | 4,287   |                   |   | 4,580  
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total current liabilities                                                                                                                                           |  |                    | 72,593  |                   |   | 71,559 
|                                                                                                                                                                    |  |                   
|Deferred income taxes                                                                                                                                               |  |                    | 5,238   |                   |   | 4,543  
|Notes payable                                                                                                                                                       |  |                    | 8,750   |                   |   | 20,500 
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total liabilities                                                                                                                                                   |  |                    | 86,581  |                   |   | 96,602 
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Commitments and contingencies                                                                                                                                       |  |                    |        |                   |   |       
|                                                                                                                                                                    |  |                   
|Stockholders equity:                                                                                                                                               |  |                    |         |                   |   |        
|Preferred stock, $0.01 par value, 5,000 shares authorized, none issued                                                                                              |  |                    |        |                   |   |       
|Common stock, $0.01 par value, 100,000 shares authorized, 39,409 and 37,714 shares issued and outstanding at September 30, 2005 and
December 31, 2004, respectively |  |                    | 394     |                   |   | 377    
|Additional paid-in capital                                                                                                                                          |  |                    | 141,473 |                   |   | 131,756
|Accumulated other comprehensive income                                                                                                                              |  |                    | 137     |                   |   | 60     
|Retained earnings                                                                                                                                                   |  |                    | 32,634  |                   |   | 15,457 
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total stockholders equity                                                                                                                                          |  |                    | 174,638 |                   |   | 147,650
|                                                                                                                                                                    |  |                    |         |                   |   |        
|Total liabilities and stockholders equity                                                                                                                          |  | $                  | 261,219 |                   | $ | 244,252
|                                                                                                                                                                    |  |                    |         |                   |   |        



The
accompanying notes are an integral part of these consolidated financial statements.



1



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##### Table of Contents

HEALTHEXTRAS, INC.

and Subsidiaries



CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | --------------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                                                       |  | For the three months ended September 30, |         |   | For the nine months ended September 30, |  
|                                                                                                                                                                       |  | 2005                                     |         |   | 2004                                    |   |         | 2005 |  |   | 2004    |  
|Revenue (excludes member co-payments of $69,475, $62,069, $208,970 and $147,724 for the three- and nine-month periods ended September 30,
2005 and 2004, respectively) |  | $                                        | 166,784 |   |                                         | $ | 143,193 |      |  | $ | 513,044 |   |  | $ | 367,915 |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Direct expenses                                                                                                                                                        |  |                                          | 145,856 |   |                                         |   | 126,847 |      |  |   | 453,222 |   |  |   | 325,822 |  
|Selling, general and administrative expenses                                                                                                                           |  |                                          | 11,244  |   |                                         |   | 9,131   |      |  |   | 33,262  |   |  |   | 24,591  |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                                                                                                               |  |                                          | 157,100 |   |                                         |   | 135,978 |      |  |   | 486,484 |   |  |   | 350,413 |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Operating income                                                                                                                                                       |  |                                          | 9,684   |   |                                         |   | 7,215   |      |  |   | 26,560  |   |  |   | 17,502  |  
|Interest income                                                                                                                                                        |  |                                          | 518     |   |                                         |   | 100     |      |  |   | 1,471   |   |  |   | 180     |  
|Interest expense                                                                                                                                                       |  |                                          | (231    | ) |                                         |   | (452    | )    |  |   | (823    | ) |  |   | (704    | )
|Other income                                                                                                                                                           |  |                                          | 26      |   |                                         |   | 41      |      |  |   | 57      |   |  |   | 2,065   |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Income before income taxes                                                                                                                                             |  |                                          | 9,997   |   |                                         |   | 6,904   |      |  |   | 27,265  |   |  |   | 19,043  |  
|Income tax expense                                                                                                                                                     |  |                                          | 3,699   |   |                                         |   | 2,603   |      |  |   | 10,088  |   |  |   | 7,179   |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Net income                                                                                                                                                             |  | $                                        | 6,298   |   |                                         | $ | 4,301   |      |  | $ | 17,177  |   |  | $ | 11,864  |  
|                                                                                                                                                                       |  |                                          |         |   |                                         |   |         |      |  |   |         |   |  |   |         |  
|Net income per share, basic                                                                                                                                            |  | $                                        | 0.16    |   |                                         | $ | 0.13    |      |  | $ | 0.45    |   |  | $ | 0.36    |  
|Net income per share, diluted                                                                                                                                          |  | $                                        | 0.15    |   |                                         | $ | 0.12    |      |  | $ | 0.42    |   |  | $ | 0.32    |  
|Weighted average shares of common stock outstanding, basic                                                                                                             |  |                                          | 38,810  |   |                                         |   | 33,415  |      |  |   | 38,349  |   |  |   | 33,182  |  
|Weighted average shares of common stock outstanding, diluted                                                                                                           |  |                                          | 41,581  |   |                                         |   | 36,869  |      |  |   | 41,174  |   |  |   | 36,712  |  



The
accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

HEALTHEXTRAS, INC.

and Subsidiaries



CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                  |  |                                         |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | For the nine months ended September 30, |        
|                                                                                  |  | 2005                                    |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                                         |         |   |      |   |         |  
|Net income                                                                        |  | $                                       | 17,177  |   |      | $ | 11,864  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                         |         |   |      |   |         |  
|Depreciation and amortization expense                                             |  |                                         | 1,521   |   |      |   | 1,022   |  
|Amortization of intangibles and other assets                                      |  |                                         | 1,932   |   |      |   | 1,066   |  
|Provision for inventory obsolescence                                              |  |                                         | (25     | ) |      |   |        |  
|Deferred income taxes                                                             |  |                                         | 215     |   |      |   |        |  
|Loss on disposal of fixed assets                                                  |  |                                         |        |   |      |   | 38      |  
|Other noncash charges                                                             |  |                                         | 340     |   |      |   | 151     |  
|Changes in assets and liabilities:                                                |  |                                         |         |   |      |   |         |  
|Accounts receivable                                                               |  |                                         | (3,293  | ) |      |   | (8,819  | )
|Income tax receivable                                                             |  |                                         | 3,808   |   |      |   |        |  
|Inventory                                                                         |  |                                         | (37     | ) |      |   | 17      |  
|Other assets                                                                      |  |                                         | 61      |   |      |   | (1,891  | )
|Income taxes payable, net                                                         |  |                                         |        |   |      |   | 3,047   |  
|Deferred charges                                                                  |  |                                         | 28      |   |      |   | (171    | )
|Accounts payable, accrued expenses and other liabilities                          |  |                                         | 1,326   |   |      |   | 8,183   |  
|Deferred revenue                                                                  |  |                                         | (294    | ) |      |   | (589    | )
|                                                                                  |  |                                         |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                                         | 22,759  |   |      |   | 13,918  |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                                         |         |   |      |   |         |  
|Business acquisitions, net of cash acquired                                       |  |                                         | (6,482  | ) |      |   | (37,599 | )
|Purchases of property and equipment                                               |  |                                         | (1,042  | ) |      |   | (5,514  | )
|Proceeds from sale of property and equipment                                      |  |                                         | 15      |   |      |   | 1,101   |  
|Purchase of short-term investment                                                 |  |                                         | (1,995  | ) |      |   |        |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Net cash used in investing activities                                             |  |                                         | (9,504  | ) |      |   | (42,012 | )
|                                                                                  |  |                                         |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                                         |         |   |      |   |         |  
|Proceeds from borrowings                                                          |  |                                         |        |   |      |   | 37,338  |  
|Repayments of notes payable                                                       |  |                                         | (11,750 | ) |      |   | (4,250  | )
|Proceeds from exercise of stock options and warrants                              |  |                                         | 7,706   |   |      |   | 976     |  
|Proceeds from issuance of common stock pursuant to Employee Stock Purchase Plan   |  |                                         | 244     |   |      |   |        |  
|Other                                                                             |  |                                         | (13     | ) |      |   |        |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                               |  |                                         | (3,813  | ) |      |   | 34,064  |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                         |  |                                         | 9,442   |   |      |   | 5,970   |  
|Cash and cash equivalents at the beginning of year                                |  |                                         | 67,068  |   |      |   | 28,877  |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Cash and cash equivalents at the end of period                                    |  |                                         | 76,510  |   |      | $ | 34,847  |  
|                                                                                  |  |                                         |         |   |      |   |         |  
|Supplemental disclosure:                                                          |  |                                         |         |   |      |   |         |  
|Cash paid for interest                                                            |  | $                                       | 830     |   |      | $ | 612     |  
|Cash paid for taxes                                                               |  | $                                       | 6,065   |   |      | $ | 4,133   |  



The
accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

HEALTHEXTRAS, INC.

and Subsidiaries



CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)



|                                                         |  |                                  |       |      |                                 |       |      |  |      |        |  |   |        |  
|-------------------------------------------------------- |  | -------------------------------- | ----- | ---- | ------------------------------- | ----- | ---- |  | ---- | ------ |  | - | ------ | -
|                                                         |  | Three months ended September 30, |       |      | Nine months ended September 30, |      
|                                                         |  | 2005                             |       | 2004 |                                 |       | 2005 |  | 2004 |       
|Comprehensive income:                                    |  |                                  |       |      |                                 |       |      |  |      |        |  |   |        |  
|Net income                                               |  | $                                | 6,298 |      | $                               | 4,301 |      |  | $    | 17,177 |  | $ | 11,864 |  
|Other comprehensive income:                              |  |                                  |       |      |                                 |       |      |  |      |        |  |   |        |  
|Unrealized gain (loss) on interest rate swap, net of tax |  |                                  | 42    |      |                                 | (4    | )    |  |      | 77     |  |   | (4     | )
|                                                         |  |                                  |       |      |                                 |       |      |  |      |        |  |   |        |  
|Total comprehensive income                               |  | $                                | 6,340 |      | $                               | 4,297 |      |  | $    | 17,254 |  | $ | 11,860 |  
|                                                         |  |                                  |       |      |                                 |       |      |  |      |        |  |   |        |  



The
accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

HEALTHEXTRAS, INC.

and Subsidiaries



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|1. | BASIS OF PRESENTATION
|-- | ---------------------



The accompanying unaudited consolidated financial statements have been prepared by HealthExtras, Inc. (the Company) pursuant to the rules and
regulations of the Securities and Exchange Commission (the SEC) for interim financial reporting. These consolidated financial statements are unaudited and, in the opinion of management, include all adjustments, consisting of normal
recurring adjustments and accruals, necessary for a fair presentation of the consolidated balance sheets, statements of operations and statements of cash flows for the periods presented. Operating results for the nine months ended September 30,
2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting
principles generally accepted in the United States have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements
and accompanying notes included in the Companys Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 16, 2005.



|2. | RECENT ACCOUNTING PRONOUNCEMENTS
|-- | --------------------------------



In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 123 (revised 2004), Share-Based Payment, (FAS 123(R)). This Statement requires companies to expense the estimated fair value of stock options and similar equity instruments issued to employees. Currently, companies
are required to calculate the estimated fair value of these share-based payments and can elect to either include the estimated cost in earnings or disclose the pro forma effect in the footnotes to their financial statements. We have chosen to
disclose the pro forma effect. The fair value concepts were not changed significantly in FAS 123(R); however, in adopting this Standard, companies must choose among alternative valuation models and amortization assumptions. On April 14, 2005,
the SEC announced a deferral of the effective date of FAS 123(R) for calendar-year companies until the beginning of 2006. The Company intends to take a non-cash charge, estimated to be $.02 per share, in the fourth quarter of 2005 related to the
accelerated vesting of stock options. Additional disclosures related to the charge will be made in our Form 10-K as required by the Securities and Exchange Commission.



On March 29, 2005, the SEC staff issued Staff Accounting Bulletin No. 107 (SAB 107), which expresses
the SEC staffs view on FAS 123R. SAB 107 provides guidance regarding certain matters important to selecting and applying valuation models. We will consider SAB 107 in our implementation of FAS 123(R).



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and
Error Corrections (FAS 154), which replaces Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes In Interim Financial Statements  An Amendment
of APB Opinion No. 28. FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for
reporting a change in accounting principle and the reporting of a correction of an error. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We believe that the adoption
of this statement will not have a material effect on our financial condition or results of operations.



In July 2005, the FASB issued an Exposure Draft of a proposed Interpretation, Accounting for Uncertain Tax Positions. The proposed
Interpretation clarifies the accounting for uncertain tax positions in accordance with FASB Statement No. 109, Accounting for Income Taxes. The proposed Interpretation requires that a tax position meet a probable recognition
threshold for the benefit of the uncertain tax position to be recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either the reduction of a current or deferred tax asset
or receivable, or recording a current or deferred tax liability. The proposed Interpretation also provides guidance on measurement, de-recognition of tax benefits, classification, interim period accounting disclosure, and transition requirements in
accounting for uncertain tax positions. The proposed Interpretation had a 60-day comment period and shall be effective for all companies as of the first fiscal year ending after December 15, 2005. The Company is assessing the impact of adopting
the new pronouncement and is currently unable to estimate its impact on the Companys consolidated financial statements.



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##### Table of Contents

|3. | GOODWILL
|-- | --------



The changes in goodwill for the nine months ended September 30, 2005 are as follows (in thousands):



|                                  |  |      |       
|--------------------------------- |  | ---- | ------
|                                  |  | 2005
|Balance as of January 1           |  | $    | 68,947
|Goodwill acquired in acquisitions |  |      | 6,482 
|                                  |  |      |       
|Balance as of September 30        |  | $    | 75,429
|                                  |  |      |       



Goodwill represents
the excess of the purchase price over the fair value of the net assets of acquired businesses. The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, and discontinued the amortization of goodwill and
indefinite-lived intangible assets, effective January 1, 2002. The Company performed its annual impairment testing at December 31, 2004 and concluded that no impairment of goodwill exists. All goodwill is recorded in the pharmacy benefit
management (PBM) segment. In the nine-month period ended September 30, 2005, the Company increased goodwill by $6.5 million due to additional consideration payments related to the acquisition of Managed Healthcare Systems
(MHS) in June 2004. Of the $6.5 million paid to the seller of MHS, $4.2 million represented amounts due in conjunction with two non-negotiable promissory notes which bore interest at a rate of 3.5% per annum and were subject to
certain revenue and gross profit criteria attributable to MHS for the twelve months ended June 30, 2005; $2.0 million represented the payment of an earn-out provisions which was subject to certain revenue and gross profit criteria attributable
to MHS for the twelve months ended June 30, 2005; and $317,000 represented amounts owed to the seller due to the Company electing to make an IRC 338 election.



|4. | NOTES PAYABLE
|-- | -------------



In June 2004, the Company entered into a $30.0 million revolving credit facility with a commercial bank. The credit facility expires June 2006 and bears
interest at LIBOR plus 2.0%, payable in arrears on the first day of each month. At December 31, 2004, the outstanding balance on the revolving credit facility was $8.0 million. The Company repaid the $8.0 million in the second quarter of 2005.
There is no outstanding balance on the credit facility at September 30, 2005.



In June 2004, the Company entered into a $20.0 million, forty-eight-month term loan facility with a commercial bank. The term loan bears interest at LIBOR plus 2.0%. The outstanding balance on the term loan on
September 30, 2005 and December 31, 2004 was $13.8 million and $17.5 million, respectively.



The table below outlines the Companys outstanding notes payable balances (in thousands):



|                                   |  |                     |        |   |                   |   |        |  
|---------------------------------- |  | ------------------- | ------ | - | ----------------- | - | ------ | -
|                                   |  | Outstanding balance |       
|Description                        |  | September 30, 2005  |        |   | December 31, 2004 |  
|Revolving credit facility          |  | $                   |       |   |                   | $ | 8,000  |  
|Term loan                          |  |                     | 13,750 |   |                   |   | 17,500 |  
|                                   |  |                     |        |   |                   |   |        |  
|Total notes payable                |  |                     | 13,750 |   |                   |   | 25,500 |  
|Less: Current portion of term loan |  |                     | (5,000 | ) |                   |   | (5,000 | )
|                                   |  |                     |        |   |                   |   |        |  
|Long-term notes payable            |  | $                   | 8,750  |   |                   | $ | 20,500 |  
|                                   |  |                     |        |   |                   |   |        |  



The revolving credit
facility and the term loan facility are collateralized by substantially all of the Companys assets. Both facilities contain affirmative and negative covenants related to indebtedness, EBITDA, cash and accounts receivable.



The Company manages its interest rate risk by balancing the amount of fixed
and variable rate debt. In the third quarter of 2004, the Company entered into an interest rate swap for the purpose of converting the interest payable on the term loan from a variable rate to a fixed rate. Under the agreement, the Company has
agreed to receive interest from the counter party on the $15.0 million notional amount at a variable rate of LIBOR plus 2.00% and pay interest at a fixed rate of 5.23%. The interest rate swap met the criteria to qualify for the shortcut method of
accounting for cash flow hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Based on this shortcut method of accounting, no ineffectiveness in the hedging relationship was assumed.
The changes in the fair value of the interest rate swap agreement are exactly offset by changes in the fair value of the underlying long-term debt; therefore, the adjustments are recorded on the balance sheet as comprehensive gain or loss and do not
impact operations.



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Interest expense, to include unused fees on the revolving credit facility, for notes payable for the
three-month periods ended September 30, 2005 and 2004 was $228,000 and $438,000, respectively. Interest expense for notes payable for the nine-month periods ended September 30, 2005 and 2004 was $820,000 and $693,000, respectively.



|5. | CO-PAYMENTS
|-- | -----------



In the PBM segment, member co-payments are not recorded as revenue. The Company incurs no obligations for co-payments to pharmacies and has never made
such payments. Under our pharmacy agreements, the pharmacy is solely obligated to collect the co-payments from the members. Under our client contracts, we do not assume liability for member co-payments in pharmacy transactions. As such, we do not
include member co-payments to pharmacies in revenue or operating expenses.



The following table illustrates the effects on the reported PBM revenue and operating expenses if the Company had included the actual member co-payments as indicated by our claims processing system (in thousands):



|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|------------------------------- |  | -------------------------------- | ------- | ------------------------------- | - | ------- |  | ---- | ------- |  | - | -------
|                                |  | Three months ended September 30, |         | Nine months ended September 30,
|                                |  | 2005                             |         | 2004                            |   | 2005    |  | 2004
|Reported PBM revenue            |  | $                                | 155,932 |                                 | $ | 131,831 |  | $    | 480,490 |  | $ | 333,031
|Member co-payments              |  |                                  | 69,475  |                                 |   | 62,069  |  |      | 208,970 |  |   | 147,724
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Total                           |  | $                                | 225,407 |                                 | $ | 193,900 |  | $    | 689,460 |  | $ | 480,755
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Reported PBM operating expenses |  |                                  | 145,937 |                                 |   | 125,066 |  |      | 453,138 |  |   | 317,325
|Member co-payments              |  |                                  | 69,475  |                                 |   | 62,069  |  |      | 208,970 |  |   | 147,724
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Total                           |  | $                                | 215,412 |                                 | $ | 187,135 |  | $    | 662,108 |  | $ | 465,049
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        



|6. | SEGMENT REPORTING
|-- | -----------------



The Company operates in two business segments, PBM and supplemental benefits.



Segment information for the three months ended September 30, 2005 and 2004 is as follows (in thousands):



|                           |  |     |         |                       |   |        |  |   |        
|-------------------------- |  | --- | ------- | --------------------- | - | ------ |  | - | -------
|September 30, 2005         |  | PBM |         | Supplemental Benefits |   | Total 
|Revenue                    |  | $   | 155,932 |                       | $ | 10,852 |  | $ | 166,784
|Segment operating expenses |  |     | 145,937 |                       |   | 8,448  |  |   | 154,385
|Segment operating income   |  |     | 9,995   |                       |   | 2,404  |  |   | 12,399 
|Total assets               |  |     | 255,377 |                       |   | 5,842  |  |   | 261,219
|Accounts receivable        |  |     | 71,318  |                       |   | 213    |  |   | 71,531 
|Accounts payable           |  |     | 57,293  |                       |   | 675    |  |   | 57,968 
|                           |  |     |        
|September 30, 2004         |  | PBM |         | SupplementalBenefits  |   | Total 
|Revenue                    |  | $   | 131,831 |                       | $ | 11,362 |  | $ | 143,193
|Segment operating expenses |  |     | 125,066 |                       |   | 9,416  |  |   | 134,482
|Segment operating income   |  |     | 6,765   |                       |   | 1,946  |  |   | 8,711  
|Total assets               |  |     | 195,049 |                       |   | 7,785  |  |   | 202,834
|Accounts receivable        |  |     | 61,216  |                       |   | 204    |  |   | 61,420 
|Accounts payable           |  |     | 59,422  |                       |   | 1,474  |  |   | 60,896 



The Company does not
allocate to separate segments certain general and administrative expenses not directly related to the business segments, such as insurance and public company costs. The Company believes this segment disclosure, which excludes corporate overhead,
allows management to more accurately assess each segments operating performance without an arbitrary allocation of non-operating expenses. Operating expenses of the segments exclude $2.7 million and $1.5 million in corporate overhead that was
not allocated by management in assessing segment performance for the three months ended September 30, 2005 and 2004, respectively.



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The reconciliation of segment operating income to income before income taxes as disclosed in the
financial statements is as follows (amounts in thousands):



|                                  |  |                                          |        |   |      |   |       |  
|--------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ----- | -
|                                  |  | For the three months ended September 30, |       
|                                  |  | 2005                                     |        |   | 2004 |  
|Segment operating income          |  | $                                        | 12,399 |   |      | $ | 8,711 |  
|Less: Corporate overhead expenses |  |                                          | 2,715  |   |      |   | 1,496 |  
|                                  |  |                                          |        |   |      |   |       |  
|Operating income                  |  |                                          | 9,684  |   |      |   | 7,215 |  
|Interest income                   |  |                                          | 518    |   |      |   | 100   |  
|Interest expense                  |  |                                          | (231   | ) |      |   | (452  | )
|Other income                      |  |                                          | 26     |   |      |   | 41    |  
|                                  |  |                                          |        |   |      |   |       |  
|Income before income taxes        |  | $                                        | 9,997  |   |      | $ | 6,904 |  
|                                  |  |                                          |        |   |      |   |       |  



Segment information
for the nine months ended September 30, 2005 and 2004 is as follows (in thousands):



|                           |  |     |         |                       |   |        |  |   |        
|-------------------------- |  | --- | ------- | --------------------- | - | ------ |  | - | -------
|September 30, 2005         |  | PBM |         | Supplemental Benefits |   | Total 
|Revenue                    |  | $   | 480,490 |                       | $ | 32,554 |  | $ | 513,044
|Segment operating expenses |  |     | 453,138 |                       |   | 25,954 |  |   | 479,092
|Segment operating income   |  |     | 27,352  |                       |   | 6,600  |  |   | 33,952 
|                           |  |     |        
|September 30, 2004         |  | PBM |         | Supplemental Benefits |   | Total 
|Revenue                    |  | $   | 333,031 |                       | $ | 34,884 |  | $ | 367,915
|Segment operating expenses |  |     | 317,325 |                       |   | 28,988 |  |   | 346,313
|Segment operating income   |  |     | 15,706  |                       |   | 5,896  |  |   | 21,602 



The Company does not
allocate to separate segments certain general and administrative expenses not directly related to the business segments, such as insurance and public company costs. The Company believes this segment disclosure, which excludes corporate overhead,
allows management to more accurately assess each segments operating performance without an arbitrary allocation of non-operating expenses. Operating expenses of the segments exclude $7.4 million and $4.1 million in corporate overhead that was
not allocated by management in assessing segment performance for the nine months ended September 30, 2005 and 2004, respectively.



The reconciliation of segment operating income to income before income taxes as disclosed in the financial statements is as follows (amounts in
thousands):



|                                  |  |                                         |        |   |      |   |        |  
|--------------------------------- |  | --------------------------------------- | ------ | - | ---- | - | ------ | -
|                                  |  | For the nine months ended September 30, |       
|                                  |  | 2005                                    |        |   | 2004 |  
|Segment operating income          |  | $                                       | 33,952 |   |      | $ | 21,602 |  
|Less: Corporate overhead expenses |  |                                         | 7,392  |   |      |   | 4,100  |  
|                                  |  |                                         |        |   |      |   |        |  
|Operating income                  |  |                                         | 26,560 |   |      |   | 17,502 |  
|Interest income                   |  |                                         | 1,471  |   |      |   | 180    |  
|Interest expense                  |  |                                         | (823   | ) |      |   | (704   | )
|Other income                      |  |                                         | 57     |   |      |   | 2,065  |  
|                                  |  |                                         |        |   |      |   |        |  
|Income before income taxes        |  | $                                       | 27,265 |   |      | $ | 19,043 |  
|                                  |  |                                         |        |   |      |   |        |  



|7. | NET INCOME PER SHARE
|-- | --------------------



Basic net income per common share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number
of common shares outstanding for the period. Diluted net income per common share reflects the potential dilution that could occur (using the treasury stock method) if options and warrants to issue common stock were exercised.



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##### Table of Contents

The following represents a reconciliation of the number of shares used in the basic and diluted net
income per share computations (amounts in thousands, except per share data):



|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|--------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                    |  | Three months endedSeptember 30, |        | Nine months endedSeptember 30,
|                                                    |  | 2005                            |        | 2004                           |   | 2005   |  | 2004
|Net income                                          |  | $                               | 6,298  |                                | $ | 4,301  |  | $    | 17,177 |  | $ | 11,864
|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Calculation of shares:                              |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Weighted average common shares outstanding, basic   |  |                                 | 38,810 |                                |   | 33,415 |  |      | 38,349 |  |   | 33,182
|Dilutive effect of stock options and warrants       |  |                                 | 2,771  |                                |   | 3,454  |  |      | 2,825  |  |   | 3,530 
|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Weighted average common shares outstanding, diluted |  |                                 | 41,581 |                                |   | 36,869 |  |      | 41,174 |  |   | 36,712
|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income per common share, basic                  |  | $                               | 0.16   |                                | $ | 0.13   |  | $    | 0.45   |  | $ | 0.36  
|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income per common share, diluted                |  | $                               | 0.15   |                                | $ | 0.12   |  | $    | 0.42   |  | $ | 0.32  
|                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       



The following options
and warrants were not included in the computation of diluted net income per share because the exercise prices were greater than the average market price of the common shares:



|                                                                       |  |                                  |  |                                 |  |      |  |     
|---------------------------------------------------------------------- |  | -------------------------------- |  | ------------------------------- |  | ---- |  | ----
|                                                                       |  | Three months ended September 30, |  | Nine months ended September 30,
|                                                                       |  | 2005                             |  | 2004                            |  | 2005 |  | 2004
|Options and warrants to purchase shares of common stock (in thousands) |  |                                 |  | 335                             |  |     |  | 340 



|8. | STOCK-BASED COMPENSATION
|-- | ------------------------



The Company accounts for stock-based compensation in accordance with FASB Statement No. 123, Accounting for Stock-Based
Compensation, as amended by FASB Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an Amendment of FASB No. 123. These statements establish financial accounting and reporting
standards for stock-based compensation, including employee stock option plans.



As allowed by FASB Statement No. 123, the Company continues to measure compensation expense under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25), and related interpretations. Accordingly, no compensation cost has been recognized for the Companys employee and director stock option plans. Had compensation cost for the Companys stock-based compensation plans been
determined under a fair value method included in FASB Statement No. 123, as amended by FASB Statement No. 148, the Companys net income and earnings per share would have been reduced to the pro forma amounts as indicated below.
Amounts in thousands, except per share data.



|                                                                                                                                                      |  |                                         |       |                                         |   |       |  |      |        |  |   |       
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ----- | --------------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                                                                                                                                                      |  | For the three months endedSeptember 30, |       | For the nine months ended September 30,
|                                                                                                                                                      |  | 2005                                    |       | 2004                                    |   | 2005  |  | 2004
|Net income, as reported                                                                                                                               |  | $                                       | 6,298 |                                         | $ | 4,301 |  | $    | 17,177 |  | $ | 11,864
|Add: Stock-based compensation expense included in net income (net of related taxes in 2005 and 2004)                                                  |  |                                         | 6     |                                         |   | 6     |  |      | 19     |  |   | 19    
|Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards (net of related taxes in 2005
and 2004) |  |                                         | 707   |                                         |   | 712   |  |      | 2,274  |  |   | 2,148 
|                                                                                                                                                      |  |                                         |       |                                         |   |       |  |      |        |  |   |       
|Pro forma net income                                                                                                                                  |  | $                                       | 5,597 |                                         | $ | 3,595 |  | $    | 14,922 |  | $ | 9,735 
|                                                                                                                                                      |  |                                         |       |                                         |   |       |  |      |        |  |   |       
|Net income per share:                                                                                                                                 |  |                                         |       |                                         |   |       |  |      |        |  |   |       
|Basic - as reported                                                                                                                                   |  | $                                       | 0.16  |                                         | $ | 0.13  |  | $    | 0.45   |  | $ | 0.36  
|Basic - pro forma                                                                                                                                     |  | $                                       | 0.14  |                                         | $ | 0.11  |  | $    | 0.39   |  | $ | 0.29  
|Diluted - as reported                                                                                                                                 |  | $                                       | 0.15  |                                         | $ | 0.12  |  | $    | 0.42   |  | $ | 0.32  
|Diluted - pro forma                                                                                                                                   |  | $                                       | 0.13  |                                         | $ | 0.10  |  | $    | 0.36   |  | $ | 0.27  



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##### Table of Contents

The fair value of these options was estimated at the date of the grants using the binomial lattice
option-pricing model with the following assumptions for the three and nine-month periods ended September 30, 2005 and 2004:



|                        |  |                                         |  |      |                                         |   |      |   |             |      |  |   |             |  
|----------------------- |  | --------------------------------------- |  | ---- | --------------------------------------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                        |  | For the three months endedSeptember 30, |  |      | For the nine months ended September 30, |  
|                        |  | 2005 (a)                                |  | 2004 |                                         |   | 2005 |   |             | 2004 | 
|Expected term           |  |                                        |  |      | 5 years                                 |   |      |   | 5 years     |      |  |   | 5 years     |  
|Volatility factor       |  |                                        |  |      | 76.02-76.96                             | % |      |   | 71.81-74.65 | %    |  |   | 76.02-79.87 | %
|Risk free interest rate |  |                                        |  |      | 3.46-3.85                               | % |      |   | 3.57-4.09   | %    |  |   | 2.76-4.04   | %
|Dividend yield          |  |                                        |  |      |                                        |   |      |   |            |      |  |   |            |  
|Fair value              |  |                                        |  | $    | 8.62                                    |   |      | $ | 10.31       |      |  | $ | 8.09        |  

---

|(a) | The Company did not issue any stock option grants in the third quarter of 2005.
|--- | -------------------------------------------------------------------------------



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##### Table of Contents

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



This Form 10-Q may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking
statements involve a number of risks and uncertainties. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully
review and consider the various disclosures made in this report and in our other filings with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.



OVERVIEW



The Company



HealthExtras provides pharmacy benefit management (PBM) services and supplemental benefit programs. Our PBM segment, which operates under the brand name
Catalyst Rx, accounted for 94% and 91% of our revenue in the first nine months of 2005 and 2004, respectively, and is expected to be the primary source of our growth and profits in the future. Our PBM clients include more than 1,000
self-insured employers, including state and local governments, third-party administrators (TPAs), and managed care organizations, who contract with us to administer the prescription drug component of their overall health benefit
programs. Total claims processed increased to over 12.8 million in the nine-month period ended September 30, 2005 from 8.7 million in the nine-month period ended September 30, 2004 and our PBM segment revenue increased by 44% for
the nine-month period ended September 30, 2005 compared to 38% in the comparable 2004 nine-month period.



We also offer supplemental benefit programs developed by us under the brand name HealthExtras, which include lump sum accidental disability benefits, accidental death and dismemberment benefits, and
emergency accident and sickness medical benefits. We contract with insurance companies to underwrite the insurance components of these programs. As a result, the financial responsibility for the payment of claims resulting from a qualifying event
covered by the insurance features of our programs is borne by the third-party insurers. Our supplemental benefits segment accounted for 6% and 9% of our revenue in the first nine months of 2005 and 2004, respectively. Individuals are the major
purchasers of these programs.



PHARMACY BENEFIT MANAGEMENT



Catalyst Rx



Catalyst Rx provides its clients access to a contracted, non-exclusive national network of
more than 55,000 pharmacies. Catalyst Rxs services provide our clients members with timely and accurate benefit adjudication, while controlling pharmacy spending trends through customized plan designs, physician orientation programs, and
member education. Catalyst Rx uses an electronic point-of-sale system of eligibility verification and plan design information, and offers access to rebate arrangements for certain branded pharmaceuticals. When a member of one of our clients presents
a prescription or health plan identification card to a retail pharmacist in our network, the system provides the pharmacist with access to online information regarding eligibility, patient history, health plan formulary listings, and contractual
reimbursement rates. The member generally pays a co-payment to the retail pharmacy and the pharmacist fills the prescription. We electronically aggregate pharmacy benefit claims, which include prescription costs plus our claims processing fees for
consolidated billing and payment. We receive payments from clients, make payments of amounts owed to the retail pharmacies pursuant to our negotiated rates, and retain the difference, including claims processing fees.



Pharmacy benefit claim payments from our clients are recorded as revenue, and prescription
costs to be paid to pharmacies are recorded as direct expenses. Under our network contracts, we generally have an independent obligation to pay pharmacies for the drugs dispensed and, accordingly, have assumed that risk independent of our clients.
When we administer pharmacy reimbursement contracts and do not assume a credit risk, we record only our administrative or processing fees as revenue. Rebates earned under arrangements with manufacturers are recorded as a reduction of direct
expenses. The portion of manufacturer rebates due to clients is recorded as a reduction of revenue.



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##### Table of Contents

Member co-payments are not recorded as revenue. We incur no obligations for co-payments to pharmacies and have never made
such payments. Under our pharmacy agreements, the pharmacy is solely obligated to collect the co-payments from the members. Under our client contracts, we do not assume liability for member co-payments in pharmacy transactions. As such, we do not
include member co-payments to pharmacies in revenue or operating expenses.



To
provide additional information to investors, we have disclosed the specific amounts of member co-payments which we exclude from both revenue and operating expenses. If we had included co-payments in both reported revenue and operating expenses, it
would have resulted in an increase in reported PBM revenue and operating expenses for the three months ended September 30, 2005 and 2004 of $69.5 million and $62.1 million, respectively. Revenue and operating expenses for the nine months ended
September 30, 2005 and 2004 would have increased by $209.0 million and $147.7 million, respectively. Our operating and net income, consolidated balance sheets and statements of cash flows would not be affected by the inclusion of co-payments.



The following tables illustrate the effects on the reported PBM revenue and
operating expenses if Catalyst Rx had included the actual member co-payments as indicated by our claims processing system (in thousands):



|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|------------------------------- |  | -------------------------------- | ------- | ------------------------------- | - | ------- |  | ---- | ------- |  | - | -------
|                                |  | Three months ended September 30, |         | Nine months ended September 30,
|                                |  | 2005                             |         | 2004                            |   | 2005    |  | 2004
|Reported PBM revenue            |  | $                                | 155,932 |                                 | $ | 131,831 |  | $    | 480,490 |  | $ | 333,031
|Member co-payments              |  |                                  | 69,475  |                                 |   | 62,069  |  |      | 208,970 |  |   | 147,724
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Total                           |  | $                                | 225,407 |                                 | $ | 193,900 |  | $    | 689,460 |  | $ | 480,755
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Reported PBM operating expenses |  |                                  | 145,937 |                                 |   | 125,066 |  |      | 453,138 |  |   | 317,324
|Member co-payments              |  |                                  | 69,475  |                                 |   | 62,069  |  |      | 208,970 |  |   | 147,724
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        
|Total                           |  | $                                | 215,412 |                                 | $ | 187,135 |  | $    | 662,108 |  | $ | 465,049
|                                |  |                                  |         |                                 |   |         |  |      |         |  |   |        



SUPPLEMENTAL
BENEFITS



Our supplemental benefits segment generates revenue from the sale
of supplemental benefit programs, which include lump sum accidental disability benefits, accidental death and dismemberment benefits, and emergency accident and sickness medical benefits. In recent periods, our supplemental benefits programs have
been marketed and sold to individuals primarily by three nationally-recognized companies, which incur the marketing expenses. Accordingly, our supplemental benefit revenue from new members is primarily dependent on the extent and timing of marketing
campaigns funded by these three companies and the success they achieve. Correspondingly, these companies are compensated with an increasing percentage of total program revenue, which is accounted for as direct expenses by HealthExtras. All of the
insurance and service features included in our programs are supplied by third-party insurance companies or other vendors, and the programs are distributed through an independent, licensed and non-affiliated insurance agency.



The primary determinant of revenue recognition for the supplemental benefits segment is
monthly program enrollment. In general, program revenue is recognized based on the number of members enrolled in each reporting period multiplied by the applicable monthly fee for their specific membership program. The program revenue we recognize
includes the cost of membership features supplied by others, including the insurance components. Revenue from program payments received and related direct expenses are deferred to the extent that they are applicable to future periods or to any
refund guarantee we offer.



Direct program expenses consist of the costs that
are a direct function of a period of membership and a specific set of program features. The coverage obligations of our benefit suppliers and the related expense are determined monthly, as are the remaining direct expenses.



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RECENT ACCOUNTING PRONOUNCEMENTS



In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 123 (revised 2004), Share-Based Payment, (FAS 123(R)). This Statement requires companies to expense the estimated fair value of stock options and similar equity instruments issued to employees.
Currently, companies are required to calculate the estimated fair value of these share-based payments and can elect to either include the estimated cost in earnings or disclose the pro forma effect in the footnotes to their financial statements. We
have chosen to disclose the pro forma effect. The fair value concepts were not changed significantly in FAS 123(R); however, in adopting this Standard, companies must choose among alternative valuation models and amortization assumptions. On
April 14, 2005, the SEC announced a deferral of the effective date of FAS 123(R) for calendar-year companies until the beginning of 2006. The Company intends to take a non-cash charge, estimated to be $.02 per share, in the fourth quarter of
2005 related to the accelerated vesting of stock options. Additional disclosures related to the charge will be made in our Form 10-K as required by the Securities and Exchange Commission.



On March 29, 2005, the SEC staff issued Staff Accounting Bulletin No. 107 (SAB 107), which expresses the SEC
staffs view on FAS 123R. SAB 107 provides guidance regarding certain matters important to selecting and applying valuation models. We will consider SAB 107 in our implementation of FAS 123R.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections (FAS 154), which replaces Accounting Principles Board Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes In Interim Financial Statements  An Amendment of
APB Opinion No. 28. FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting
a change in accounting principle and the reporting of a correction of an error. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We believe that the adoption of this
statement will not have a material effect on our financial condition or results of operations.



In July 2005, the FASB issued an Exposure Draft of a proposed Interpretation, Accounting for Uncertain Tax Positions. The proposed Interpretation clarifies the accounting for uncertain tax positions in
accordance with FASB Statement No. 109, Accounting for Income Taxes. The proposed Interpretation requires that a tax position meet a probable recognition threshold for the benefit of the uncertain tax position to be
recognized in the financial statements. A tax position that fails to meet the probable recognition threshold will result in either reduction of current or deferred tax asset or receivable, or recording a current or deferred tax liability. The
proposed Interpretation also provides guidance on measurement, de-recognition of tax benefits, classification, interim period accounting disclosure, and transition requirements in accounting for uncertain tax positions. The proposed Interpretation
has a 60-day comment period and shall be effective for all companies as of the first fiscal year ending after December 15, 2005. The Company is assessing the impact of adopting the new pronouncement and is currently unable to estimate its
impact on the Companys consolidated financial statements.



RESULTS OF OPERATIONS



Three Months Ended September 30,
2005 Compared to Three Months Ended September 30, 2004



Revenue. Revenue from operations for the three months ended September 30, 2005 was $166.8 million, consisting of $155.9 million generated from the PBM segment and $10.9 million from the supplemental benefits segment. The PBM
segment continues to produce significant earnings and revenue growth driven by new client additions and improved operating margins resulting from higher generic and preferred brand utilization. Compared to the prior year third quarter period, PBM
segment revenues increased $24.1 million, of which $2.5 million resulted from increased prescription volume at Catalyst Rx, $6.7 million was attributable to the acquisition of MHS, and $1.9 million was due to greater generic utilization resulting in
decreased member co-payments at Catalyst Rx, and unit price increases of $13.0 million. Total claims processed increased to over 4.1 million in the third quarter of 2005 from 3.6 million in the third quarter of 2004. A significant
contributor to the increase in revenue and prescription volume was a new contract with the State of Louisiana, now covering about 145,000 members, which commenced on July 1, 2004. In the third quarter of 2005, this contract generated 18.8% and
17.5% of the Companys PBM and total revenue, respectively, while in the third quarter of 2004, the contract generated 22.4% and 20.7% of the Companys PBM and total revenue, respectively. The supplemental benefits revenue decreased by
$500,000, largely as a result of lower levels of coverage purchased and decreased membership. Revenue for the three months ended September 30, 2004 was $143.2 million, consisting of $131.8 million and $11.4 million attributable to the PBM and
supplemental benefits segments, respectively.



Direct Expenses.Direct
expenses for the three months ended September 30, 2005 were $145.9 million, consisting of $138.2 million in direct expenses from the PBM segment and $7.7 million in direct expenses from the supplemental benefits



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segment. PBM segment direct expenses increased by $19.8 million, while the supplemental benefits segment direct expenses
decreased by $700,000. The PBM segments $19.8 million increase in direct expenses was a direct function of the $24.1 million increase in PBM revenue. The resulting gross margin, calculated as segment revenue less segment direct expenses,
increased by $4.3 million and was consistent with our anticipated gross margin contribution from increased prescription volume and the acquisition of MHS, decreased member co-payments, and increased unit prices. The decrease in direct expenses in
the supplemental benefits segment largely resulted from the negotiation of lower costs for certain of the benefits in our programs.



Direct expenses for the three months ended September 30, 2004 were $126.8 million, consisting of $118.4 million and $8.4 million attributable to the PBM and
supplemental benefit segments, respectively. The direct expenses of $145.9 million and $126.8 million for the three-month periods ended September 30, 2005 and 2004, respectively, represented 92.8% and 93.3% of operating expenses for the
respective periods.



Gross margins in the PBM segment for the three months
ended September 30, 2005 were 11.4%, or $17.8 million, compared to 10.2%, or $13.4 million, for the three months ended September 30, 2004. Gross margins for the supplemental benefits segment for the three months ended September 30,
2005 were 28.7%, or $3.1 million, compared to 26.3%, or $3.0 million for the three months ended September 30, 2004.



Gross margins in the PBM segment are generally predictable based on client contract terms and vendor/supplier contracts. Factors that can result in changes in gross
margins include generic substitution rates, changes in the utilization of preferred drugs with higher discounts and changes in the volume of prescription dispensing at lower cost network pharmacies. None of these factors materially changed in the
third quarter of 2005 in a manner that would meaningfully affect current or anticipated results. In the current quarter, gross margins were improved by an increased volume of higher margin workers compensation business resulting from the acquisition
of the MHS business. This increase was largely offset in percentage terms by the addition of the State of Louisiana contract that has lower percentage margin contributions than our historical averages. Excluding these changes, there were no other
significant factors that influenced reported gross margins in the third quarter of 2005 or indicate likely changes in the near future.



Gross margins in the supplemental benefits segment are generally consistent on a per transaction basis. Gross dollar margins have been declining as new enrollments, with
lower gross dollar margins, offset attrition in membership under more profitable prior marketing arrangements. This gradual shift in business mix is likely to continue in the future but is not anticipated to accelerate.



Selling, General and Administrative.For the three-month period ended
September 30, 2005, selling, general and administrative expenses increased by $2.1 million over the prior year to $11.2 million or 7.2% of operating expenses. This increase was primarily associated with PBM segment growth, increased sales and
marketing efforts, and new client implementations.



Of the $11.2 million in
selling, general and administrative expenses for the three months ended September 30, 2005, $7.8 million related to the PBM segment, $711,000 related to the supplemental benefits segment, and $2.7 million related to corporate overhead. These
expenses included $6.1 million in compensation and benefits, $2.0 million in commissions, other professional fees, insurance and taxes, $733,000 in other expenses, $947,000 in depreciation and amortization, $53,000 for creative development, product
endorsement and market research, $805,000 in facility costs, and $569,000 in travel expenses.



Of the $9.1 million in selling, general and administrative expenses for the three-month period ended September 30, 2004, $6.6 million related to the PBM segment, $1.0 million related to the supplemental benefits
segment, and $1.5 million related to corporate overhead. Selling, general and administrative expenses included $4.5 million in compensation and benefits, $1.4 million in commissions, other professional services, insurance and taxes, $952,000 in
other expenses, $722,000 in depreciation and amortization, $462,000 for creative development, product endorsement and market research, $612,000 in facility costs, and $423,000 in travel expenses and a $38,000 loss on the disposal of fixed assets.



Interest Income. Interest income increased to $518,000 in the three
months ended September 30, 2005 from $100,000 in the three months ended September 30, 2004. The increase was primarily due to our higher average cash and cash equivalents balance during 2005 due to our sale of common stock in the fourth
quarter of 2004.



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Interest Expense.Interest expense decreased to $231,000 in the three months ended September 30, 2005 from
$452,000 in the three months ended September 30, 2004. With our acquisition of MHS on June 18, 2004, we entered into a $20.0 million term loan and increased our line of credit. As a result, the decrease in interest expense was attributable
to significant larger amounts of outstanding debt in the three months ended September 30, 2004 compared to the three months ended September 30, 2005.



Income Tax Expense.In the third quarters of 2005 and 2004, the Company recorded income tax expense of $3.7 million and $2.6 million, respectively. The
effective income tax rate of 37.0% and 37.7% in the third quarters of 2005 and 2004, respectively, represent the combined federal and state income tax rates adjusted as necessary based on the particular jurisdictions where we operate.



Net Income.Net income for the three months ended September 30, 2005 increased
$2.0 million over the same period in 2004. The increase in net income was primarily a function of increased gross margins in the PBM segment. PBM segment gross margins increased to $17.8 million in the third quarter of 2005 from $13.3 million in the
third quarter of 2004, largely attributable to the $24.1 million increase in PBM revenues from the third quarter of 2004 to the third quarter of 2005. Segment operating information for 2005 and 2004 is as follows (in thousands):



|                           |  |     |         |                      |   |        |  |   |        
|-------------------------- |  | --- | ------- | -------------------- | - | ------ |  | - | -------
|September 30, 2005         |  | PBM |         | SupplementalBenefits |   | Total 
|Revenue                    |  | $   | 155,932 |                      | $ | 10,852 |  | $ | 166,784
|Segment operating expenses |  |     | 145,937 |                      |   | 8,448  |  |   | 154,385
|Segment operating income   |  |     | 9,995   |                      |   | 2,404  |  |   | 12,399 
|Total assets               |  |     | 255,377 |                      |   | 5,842  |  |   | 261,219
|Accounts receivable        |  |     | 71,318  |                      |   | 213    |  |   | 71,531 
|Accounts payable           |  |     | 57,293  |                      |   | 675    |  |   | 57,968 
|                           |  |     |        
|September 30, 2004         |  | PBM |         | SupplementalBenefits |   | Total 
|Revenue                    |  | $   | 131,831 |                      | $ | 11,362 |  | $ | 143,193
|Segment operating expenses |  |     | 125,066 |                      |   | 9,416  |  |   | 134,482
|Segment operating income   |  |     | 6,765   |                      |   | 1,946  |  |   | 8,711  
|Total assets               |  |     | 195,049 |                      |   | 7,785  |  |   | 202,834
|Accounts receivable        |  |     | 61,216  |                      |   | 204    |  |   | 61,420 
|Accounts payable           |  |     | 59,422  |                      |   | 1,474  |  |   | 60,896 



The Company does not allocate to
separate segments certain general expenses not directly related to the business segment, such as insurance and public company costs. The Company believes this segment disclosure, which excludes corporate overhead, allows management to more
accurately assess each segments operating performance without an arbitrary allocation of non-operating expenses. Operating expenses of the segments exclude $2.7 million and $1.5 million in corporate overhead that was not allocated by
management in assessing segment performance for the three months ended September 30, 2005 and 2004, respectively.



The reconciliation of segment operating income to income before income taxes as disclosed in the financial statements is as follows (amounts in thousands):



|                                  |  |                                          |        |   |      |   |       |  
|--------------------------------- |  | ---------------------------------------- | ------ | - | ---- | - | ----- | -
|                                  |  | For the three months ended September 30, |       
|                                  |  | 2005                                     |        |   | 2004 |  
|Segment operating income          |  | $                                        | 12,399 |   |      | $ | 8,711 |  
|Less: Corporate overhead expenses |  |                                          | 2,715  |   |      |   | 1,496 |  
|                                  |  |                                          |        |   |      |   |       |  
|Operating income                  |  |                                          | 9,684  |   |      |   | 7,215 |  
|Interest income                   |  |                                          | 518    |   |      |   | 100   |  
|Interest expense                  |  |                                          | (231   | ) |      |   | (452  | )
|Other income                      |  |                                          | 26     |   |      |   | 41    |  
|                                  |  |                                          |        |   |      |   |       |  
|Income before income taxes        |  | $                                        | 9,997  |   |      | $ | 6,904 |  
|                                  |  |                                          |        |   |      |   |       |  



Nine Months Ended
September 30, 2005 Compared to Nine Months Ended September 30, 2004



Revenue. Revenue from operations for the nine months ended September 30, 2005 was $513.0 million, consisting of $480.5 million generated from the PBM segment and $32.6 million from the supplemental benefits segment. The PBM
segment continues to produce significant earnings and revenue growth driven by new client additions and improved operating margins resulting from higher generic and preferred brand utilization. Compared to the prior year nine-month period, PBM
segment



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revenues increased $147.5 million of which $127.2 million resulted from increased prescription volume at Catalyst Rx,
$18.3 million was attributable to the acquisition of MHS, and $8.2 million was due to greater generic utilization resulting in decreased member co-payments at Catalyst Rx, offset by a decrease in revenue of $6.2 million reflecting a decrease in
average unit prices due to an increase in the relative number of generic prescriptions versus brand drug prescriptions. Total claims processed increased to 12.8 million in the first nine months of 2005 from 8.7 million in the first nine
months of 2004. A significant contributor to the increase in revenue and prescription volume was a new contract with the State of Louisiana now covering about 145,000 members, which commenced on July 1, 2004. In the first nine months of 2005,
this contract generated 22.2% and 20.8% of the Companys PBM and total revenue, respectively, while in the first nine months of 2004, this contract generated 8.9% and 8.0% of the Companys PBM and total revenue, respectively. The
supplemental benefits revenue decreased by $2.3 million, largely as a result of lower levels of coverage purchased and decreased membership. Revenue for the nine months ended September 30, 2004 was $367.9 million, consisting of $333.0 million
and $34.9 million attributable to the PBM and supplemental benefits segments, respectively.



Direct Expenses.Direct expenses for the nine months ended September 30, 2005 were $453.2 million, consisting of $429.9 million in direct expenses from the PBM segment and $23.3 million in direct expenses
from the supplemental benefits segment. PBM segment direct expenses increased by $129.6 million, while the supplemental benefits segment direct expenses decreased by $2.2 million. The PBM segments $129.6 million increase in direct expenses was
a direct function of the $147.5 million increase in PBM revenue. The resulting PBM segment gross margin increase of $17.9 million was consistent with our anticipated gross margin contribution from increased prescription volume and the acquisition of
MHS, decreased member co-payments, and decreased unit prices. The decrease in direct expenses in the supplemental benefits segment largely resulted from the negotiation of lower costs for certain of the benefits in our programs.



Direct expenses for the nine months ended September 30, 2004 were $325.8 million,
consisting of $300.3 million and $25.5 million attributable to the PBM and supplemental benefit segments, respectively. The direct expenses of $453.2 million and $325.8 million for the nine-month periods ended September 30, 2005 and 2004,
respectively, represented 93.2% and 93.0% of operating expenses for the respective periods.



Gross margins in the PBM segment for the nine months ended September 30, 2005 were 10.5%, or $50.6 million, compared to 9.8%, or $32.7 million, for the nine months ended September 30, 2004. Gross margins for
the supplemental benefits segment for the nine months ended September 30, 2005 were 28.3%, or $9.2 million, compared to 26.9%, or $9.4 million for the nine months ended September 30, 2004.



Gross margins in the PBM segment are generally predictable based on client contract terms and
vendor/supplier contracts. Factors that can result in changes in gross margins include generic substitution rates, changes in the utilization of preferred drugs with higher discounts and changes in the volume of prescription dispensing at lower cost
network pharmacies. None of these factors have materially changed in the first nine months of 2005 in a manner that would meaningfully affect current or anticipated results. In the current year, gross margins were improved by an increased volume of
higher margin workers compensation business resulting from the acquisition of the MHS business. This increase was largely offset in percentage terms by the addition of the State of Louisiana contract that has lower percentage margin contributions
than our historical averages. Excluding these changes, there were no other significant factors that influenced reported gross margins in the first nine months of 2005 or indicate likely changes in the near future.



Gross margins in the supplemental benefits segment are generally consistent on a per
transaction basis. Gross dollar margins have been declining as new enrollments, with lower gross dollar margins, offset attrition in membership under more profitable prior marketing arrangements. This gradual shift in business mix is likely to
continue in the future but is not anticipated to accelerate.



Selling,
General and Administrative.For the nine-month period ended September 30, 2005, selling, general and administrative expenses increased by $8.7 million over the prior year to $33.3 million or 6.8% of operating expenses. This increase was
primarily associated with PBM segment growth, increased sales and marketing efforts, and new client implementations.



Of the $33.3 million in selling, general and administrative expenses for the nine-month period ended September 30, 2005, $23.3 million related to the PBM segment,
$2.6 million related to the supplemental benefits segment, and $7.4 million related to corporate overhead. Selling, general and administrative expenses included $17.1 million in compensation and benefits, $5.6 million in commissions, other
professional services, insurance and taxes, $2.7 million in other expenses, $2.9 million in depreciation and amortization, $788,000 for creative development, product endorsement and market research, $2.4 million in facility costs, and $1.8 million
in travel expenses.



Selling, general and administrative expenses for the nine
months ended September 30, 2004 totaled $24.6 million or 7.0% of total operating expenses, $17.3 million of which related to the PBM segment, $3.2 million related to the supplemental



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benefits segment, while the remaining $4.1 million related to corporate overhead. These expenses included $11.7 million
in compensation and benefits, $3.6 million in commissions, other professional fees, insurance and taxes, $3.0 million in other expenses, $2.0 million in depreciation and amortization, $1.5 million for creative development, product endorsement and
market research, $1.6 million in facility costs, and $1.1 million in travel expenses and $38,000 in loss on disposal of fixed assets.



Interest Income. Interest income increased to $1.5 million in the nine months ended September 30, 2005 from $180,000 in the nine months ended
September 30, 2004. The increase was primarily due to our higher average cash and cash equivalents balance during 2005 due to our sale of common stock in the fourth quarter of 2004.



Interest Expense.Interest expense increased to $823,000 in the nine months ended September 30, 2005 from $704,000 in the nine
months ended September 30 2004. With our acquisition of MHS on June 18, 2004, we entered into a $20.0 million term loan and increased our line of credit. As a result, the increase in interest expense was attributable to significantly
larger amounts of outstanding debt in the nine months ended September 30, 2005 compared to 2004.



Other Income. In the second quarter of 2004, the Company reached a legal settlement related to litigation initiated by the Company on December 3, 2002. The terms of the settlement are confidential;
however, the net proceeds from the settlement constitute the significant portion of the $2.0 million of other income reported in the 2004 income statement.



Income Tax Expense.In the first nine months of 2005 and 2004, the Company recorded income tax expense of $10.1 million and $7.2 million, respectively. The
effective income tax rate of 37.0% and 37.7% for the first nine months of 2005 and 2004, respectively, represent the combined federal and state income tax rates adjusted as necessary based on the particular jurisdictions where we operate.



Net Income.Net income for the nine months ended September 30,
2005 increased by $5.3 million over the same period in 2004. The increase in net income was primarily a function of increased gross margins in the PBM segment. PBM segment gross margins increased to $50.6 million in the first nine months of 2005
from $32.7 million in the first nine months of 2004, largely attributable to the $147.5 million increase in PBM revenues from the first nine months of 2004 to the first nine months of 2005.



Segment operating information for the first nine months of
2005 and 2004 is as follows (in thousands):



|                           |  |     |         |                       |   |        |  |   |        
|-------------------------- |  | --- | ------- | --------------------- | - | ------ |  | - | -------
|September 30, 2005         |  | PBM |         | Supplemental Benefits |   | Total 
|Revenue                    |  | $   | 480,490 |                       | $ | 32,554 |  | $ | 513,044
|Segment operating expenses |  |     | 453,138 |                       |   | 25,954 |  |   | 479,092
|Segment operating income   |  |     | 27,352  |                       |   | 6,600  |  |   | 33,952 
|                           |  |     |        
|September 30, 2004         |  | PBM |         | Supplemental Benefits |   | Total 
|Revenue                    |  | $   | 333,031 |                       | $ | 34,884 |  | $ | 367,915
|Segment operating expenses |  |     | 317,325 |                       |   | 28,988 |  |   | 346,313
|Segment operating income   |  |     | 15,706  |                       |   | 5,896  |  |   | 21,602 



The Company does not allocate to
separate segments certain general expenses not directly related to the business segment, such as insurance and public company costs. The Company believes this segment disclosure, which excludes corporate overhead, allows management to more
accurately assess each segments operating performance without an arbitrary allocation of non-operating expenses. Operating expenses of the segments exclude $7.4 million and $4.1 million in corporate overhead that was not allocated by
management in assessing segment performance for the nine months ended September 30, 2005 and 2004, respectively.



17



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The reconciliation of segment operating income to income before income taxes as disclosed in the financial statements is
as follows (amounts in thousands):



|                                  |  |                                         |        |   |      |   |        |  
|--------------------------------- |  | --------------------------------------- | ------ | - | ---- | - | ------ | -
|                                  |  | For the nine months ended September 30, |       
|                                  |  | 2005                                    |        |   | 2004 |  
|Segment operating income          |  | $                                       | 33,952 |   |      | $ | 21,602 |  
|Less: Corporate overhead expenses |  |                                         | 7,392  |   |      |   | 4,100  |  
|                                  |  |                                         |        |   |      |   |        |  
|Operating income                  |  |                                         | 26,560 |   |      |   | 17,502 |  
|Interest income                   |  |                                         | 1,471  |   |      |   | 180    |  
|Interest expense                  |  |                                         | (823   | ) |      |   | (704   | )
|Other income                      |  |                                         | 57     |   |      |   | 2,065  |  
|                                  |  |                                         |        |   |      |   |        |  
|Income before income taxes        |  | $                                       | 27,265 |   |      | $ | 19,043 |  
|                                  |  |                                         |        |   |      |   |        |  



LIQUIDITY AND
CAPITAL RESOURCES



Our sources of funds are usually the capital markets
through the sale of equity, bank debt, and cash flows from operations. During the first nine months of 2005 and 2004, we generated positive cash flow from operations and anticipate similar results throughout 2005 and thereafter. Cash and cash
equivalents and short-term investments at September 30, 2005 were $78.5 million, an increase of $11.4 million from December 31, 2004.



Net Cash Provided by Operating Activities.Our operating activities generated $22.8 million of cash from operations during the first nine months of 2005, a $8.9
million increase from the $13.9 million of net cash provided in the first nine months of 2004. The increase was primarily due to a $5.3 million increase in net income and the net impact of the timing of payments to vendors included in accounts
payable and the timing of receipts from clients against accounts receivable.



Net Cash Used in Investing Activities.Net cash used in investing activities for the nine-month period ended September 30, 2005 was $9.5 compared to $42.0 million in the same period in 2004. This net decrease in cash used
reflects the $37.6 million in consideration paid in 2004 for the acquisition of MHS and the $5.5 million used to purchase property and equipment for our new headquarters in Rockville, Maryland.



Net Cash Provided by (Used in) Financing Activities.Net cash used by financing
activities for the nine-month period ended September 30, 2005 was $3.8 million compared to cash provided by financing activities of $34.1 million in the same period in 2004. In the first nine months of 2005, we repaid $11.8 million on our
credit facility compared to payments of $4.3 million in the first nine months of 2004. Also, in 2004, we borrowed $37.3 million to finance the purchase of MHS. In 2005, we received $3.4 million from the exercise of 625,000 warrants associated with a
September 2001 private placement of the Companys common stock with an exercise price of $5.37, which were due to expire on September 26, 2005, $3.0 million from the exercise of employee stock options and $1.3 million from the exercise of
250,000 common stock warrants issued in 2002 at an exercise price of $5.22 per share.



We anticipate continuing to generate positive operating cash flow which, combined with available cash resources, should be sufficient to meet our planned working capital, capital expenditures and operating expenses. However, there can be no
assurance that we will not require additional capital. Even if such funds are not required, we may seek additional equity or debt financing. We cannot be assured that such financing will be available on acceptable terms, if at all, or that such
financing will not be dilutive to our stockholders.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



There have been no significant changes in our market risk from that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2004.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



Based on
their most recent review, which was made as of the end of the Companys third quarter ended September 30, 2005, the Companys chief executive officer and chief financial officer have concluded that the Companys disclosure
controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and
communicated to



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the Companys management, including its chief executive officer and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions
rules and forms.



Changes in Internal Controls



There have been no changes in the Companys internal control over financial reporting
for the Companys quarter ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



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##### Table of Contents

PART II. OTHER INFORMATION



ITEM 1. Legal Proceedings



In the ordinary course of business, the Company may become subject to legal proceedings and claims. The Company is not aware of any legal proceedings or claims, which, in the opinion of management, will have a material effect on the
financial condition, results of operations or cash flows of the Company.



ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds



On August 17, 2005, the Company issued 25,000 shares of its common stock to a non-employee in exchange for consulting services. The shares were
issued without registration under the Securities Act of 1933 (the Securities Act) in reliance on Section 4(2) of the Securities Act.



Between August 30, 2005 and September 15, 2005, the Company issued 250,000 shares of its common stock upon the exercise of warrants issued in
2002 at an exercise price of $5.22. The shares were issued without registration under the Securities Act in reliance on Section 4(2) of the Securities Act.



ITEM 3. Defaults Upon Senior Securities



None



ITEM 4. Submission of Matters to a Vote of Security Holders



The Annual Meeting of Stockholders of the Company was held on June 7, 2005. The following matters were submitted to a vote of the Stockholders:



1. The following individuals were elected to the Board of Directors for a three-year term with the indicated votes:



|                    |  |            |  |               
|------------------- |  | ---------- |  | --------------
|                    |  | Votes For  |  | Votes Withheld
|David T. Blair      |  | 36,101,969 |  | 461,782       
|Frederick H. Graefe |  | 36,290,215 |  | 273,536       
|Thomas J. Graf      |  | 36,070,516 |  | 493,235       



2. The ratification of
PricewaterhouseCoopers LLP as independent accountants for the Company for the fiscal year ending December 31, 2005:



For 36,528,300             Against 32,622
            Abstain 2,829



ITEM 5. Other Information



None



ITEM 6. Exhibits



|           |  |                                                                                                                             
|---------- |  | ----------------------------------------------------------------------------------------------------------------------------
|Exhibit No |  | Description                                                                                                                 
|3.1        |  | Amended and Restated Certificate of Incorporation of HealthExtras, Inc.(1)                                                  
|           | 
|3.2        |  | Bylaws of HealthExtras, Inc.(1)                                                                                             
|           | 
|4.1        |  | Specimen Stock Certificate of HealthExtras, Inc.(1)                                                                         
|           | 
|10.1       |  | Form of Employment Agreements between HealthExtras, Inc. and David T. Blair and HealthExtras, Inc.
and Michael P. Donovan(2)
|           | 
|10.2       |  | Form of Employment Agreement between HealthExtras, Inc. and Nick J. Grujich(2)                                              
|           | 
|31.1       |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer                                                           
|           | 
|31.2       |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                           
|           | 
|32.0       |  | Certifications pursuant to 18 U.S.C. Section 1350, as Added By Section 906 of the Sarbanes Oxley Act of 2002                

---

|(1) | Incorporated herein by reference into this document from the Exhibits to the Form S-1
Registration Statement, as amended, Registration No. 333-83761, initially filed on July 26, 1999.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Management contract or compensation plan or arrangement.
|--- | --------------------------------------------------------



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SIGNATURES



Pursuant to the
requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                 |  |                                     
|---------------- |  | ------------------------------------
|                 |  | HEALTHEXTRAS, INC.                  
|                 | 
|November 9, 2005 |  | /s/ David T. Blair                  
|                 |  | David T. Blair                      
|                 |  | Chief Executive Officer and Director
|                 | 
|November 9, 2005 |  | /s/ Michael P. Donovan              
|                 |  | Michael P. Donovan                  
|                 |  | Chief Financial Officer and         
|                 |  | Chief Accounting Officer