10-Q/A 1 d10qa.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2001 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: 001-12617 Trigon Healthcare, Inc. (Exact name of registrant as specified in its charter) Virginia 54-1773225 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2015 Staples Mill Road, Richmond, VA 23230 (Address of principal executive offices) (Zip Code) (Registrant's telephone number, including area code) (804) 354-7000 Not Applicable ------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [x] Yes [ ] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Title of each class Outstanding at November 13, 2001 ------------------- -------------------------------- Class A Common Stock, $0.01 par value 35,786,194 shares TRIGON HEALTHCARE, INC. and SUBSIDIARIES THIRD QUARTER 2001 FORM 10-Q TABLE OF CONTENTS Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000 1 Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2001 and 2000 2 Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income for the Three Months and Nine Months Ended September 30, 2001 and 2000 3 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 and 2000 4 Notes to Consolidated Financial Statements 5 - 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings 20 Item 6. Exhibits and Reports on Form 8-K 21 SIGNATURES PART I. FINANCIAL INFORMATION Item 1. Financial Statements TRIGON HEALTHCARE, INC. and SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands)

See notes to consolidated financial statements 1 TRIGON HEALTHCARE, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the three months and nine months ended September 30, 2001 and 2000 (in thousands, except per share data)

See notes to consolidated financial statements 2 TRIGON HEALTHCARE, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (UNAUDITED) For the three months and nine months ended September 30, 2001 and 2000 (in thousands)

See notes to consolidated financial statements 3 TRIGON HEALTHCARE, INC. and SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the nine months ended September 30, 2001 and 2000 (in thousands)

See notes to consolidated financial statements 4 TRIGON HEALTHCARE, INC. and SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements prepared by Trigon Healthcare, Inc. and its subsidiaries (collectively, Trigon or the Company) are unaudited, except for the balance sheet information as of December 31, 2000, which is derived from the Company's audited consolidated financial statements, pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, the consolidated financial statements do not include all of the information and the footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2000. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such consolidated financial statements have been included. The results of operations for the three months and nine months ended September 30, 2001 are not necessarily indicative of the results for the full year. Certain prior period amounts have been reclassified to conform to the current period presentation. 2. REVOLVING CREDIT FACILITIES AND COMMERCIAL PAPER In November 2001, the Company entered into new revolving credit facilities with a syndicate of lenders, replacing the existing revolving credit facility expiring in February 2002. The new credit facilities consist of a $100 million 364-day revolving credit facility and a $200 million 5-year revolving credit facility. These credit facilities may be used for general corporate purposes and are currently being used to back the commercial paper discussed below. The terms of the credit facilities provide for various borrowing options and rates and require the Company to pay facility and administrative fees on a quarterly basis. The credit facilities contain certain financial covenants and restrictions including minimum net worth requirements and debt to consolidated net worth ratio limitations. There were no amounts borrowed under the former or current credit facilities during 2001. Use of the credit facilities to back the commercial paper reduces the amounts available for borrowing under these facilities. In March 2000, the Company commenced a private placement commercial paper program providing for the issuance of up to $300 million in aggregate maturity value of commercial paper notes. The Company issued an additional $0.2 million in commercial paper during the third quarter of 2001. As of September 30, 2001, outstanding notes under the commercial paper program totaled approximately $299.7 million with an average maturity of 11 days. 5 As of December 31, 2000, outstanding notes totaled approximately $275.4 million with an average maturity of 14 days. The weighted-average discount yield on the outstanding commercial paper notes as of September 30, 2001 and December 31, 2000 was 3.29% and 6.83%, respectively. The commercial paper is currently backed by revolving credit facilities. The Company has the intent to maintain commercial paper borrowings of at least this amount for more than one year. For financial reporting purposes, the commercial paper has been classified as a combination of current and noncurrent liabilities in the accompanying consolidated statements of financial condition based on the terms of the revolving credit facilities backing these notes. 3. INCOME TAXES The effective tax rate on income before income taxes and minority interest for the three months ended September 30, 2001 and 2000 was 31.0% and 33.2%, respectively. The effective tax rate on income before income taxes and minority interest for the nine months ended September 30, 2001 and 2000 was 32.9% and 30.5%, respectively. The effective tax rate for the nine months ended September 30, 2000 includes a $2.7 million tax benefit realized during the second quarter of 2000 related to the sale of the Company's Mid-South subsidiary. Excluding this tax benefit, the effective tax rate for the nine months ended September 30, 2000 was 32.6%. The effective tax rates for 2001 and 2000, excluding the $2.7 million tax-exempt benefit in 2000, differ from the statutory tax rate of 35% primarily due to the Company's investments in tax-exempt municipal bonds that reduce the effective tax rate by the effect of the tax-exempt investment income earned. In conjunction with the Demutualization, the Company was required to make a payment of $175 million to the Commonwealth of Virginia (Commonwealth Payment) which was expensed and paid in prior years. The Company claimed the $175 million Commonwealth Payment as a deduction. The Internal Revenue Service denied this deduction during the course of its audit of the Company. The Company continued to pursue the deduction and in April 2001 received a Technical Advice Memorandum from the National Office of the IRS that supports the Company's position that the payment constitutes a normal business expense, and therefore should be deductible. The Company will recognize the financial statement impact of the deduction upon receipt of final approval by the IRS after review by the Congressional Joint Committee on Taxation. Final approval is estimated to take six to twelve months. The Company expects to recover approximately $35 million in cash refunds and $26 million in income tax credit carryovers. In addition, the Company has filed a lawsuit claiming deductions for losses incurred on the termination of certain customer and provider contracts. See note 7. Favorable resolution of these claims is subject to various uncertainties, including whether the deductions will be allowed at all and, in the case of the claim for losses on the termination of customer and provider contracts, the amount of the deductions, if any, that will be allowed. While the Company believes that its claims have merit, it cannot predict the ultimate outcome of the claims. The Company has not recognized the impact of these claims, if any, in the consolidated financial statements. 6 4. CAPITAL STOCK The Company continued its second stock repurchase program during the third quarter of 2001. The Company purchased and retired 115,000 shares of its common stock at a cost of approximately $6.9 million during the third quarter of 2001, bringing the total shares purchased during 2001 to 1,752,830 at a cost of approximately $95.5 million. The excess of the cost of the acquired shares over par value is charged on a pro rata basis to capital in excess of par and retained earnings. In February 2001, the Board of Directors granted 24,052 shares of the Company's common stock as restricted stock awards in accordance with the provisions of the 1997 Stock Incentive Plan (Incentive Plan). The shares vest on a pro rata basis over three years. The recipients of the restricted stock awards generally may not dispose or otherwise transfer the restricted stock until vested. For grants of restricted stock, unearned compensation equivalent to the fair market value of the shares at the date of grant is recorded as a separate component of shareholders' equity and subsequently amortized to compensation expense over the vesting period. A total of 86,327 restricted shares were outstanding as of September 30, 2001. Amortization for the three months ended September 30, 2001 and 2000 was $0.5 million and $0.3 million, respectively, and for the nine months ended September 30, 2001 and 2000 was $1.4 million and $2.3 million, respectively. 5. NET INCOME AND NET INCOME PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the three months and nine months ended September 30, 2001 and 2000 (in thousands, except per share data):

Shares of nonvested restricted stock are not considered outstanding in computing the weighted-average number of common shares for basic earnings per share, but are included in diluted earnings per share using the treasury stock method. 7 6. COMPREHENSIVE INCOME The reclassification entries under SFAS No. 130, Reporting Comprehensive Income, for the three months ended September 30, 2001 and 2000 were as follows (in thousands):

The reclassification entries under SFAS No. 130, Reporting Comprehensive Income, for the nine months ended September 30, 2001 and 2000 were as follows (in thousands):

The components of accumulated other comprehensive income (loss) as of September 30, 2001 and December 31, 2000 were as follows (in thousands):

7. LITIGATION On June 9, 2000, the Company's subsidiary, Trigon Insurance Company, filed a lawsuit against the federal government for the recovery of federal income tax overpayments for the years 1989 through 1995. If successful, the Company expects to recover approximately $35 million in cash refunds plus interest of about $20 million and to receive tax refunds for the years 1996 through 1999 of about $65 million. In addition, if the Company is successful it could receive substantial additional tax credits that could lower federal income tax liability in future years. The lawsuit, filed in the United States District Court for the Eastern District of Virginia, relates to the initial valuation and deductibility of the Company's assets when, along with other Blue Cross or Blue Shield organizations, it became subject to federal income taxation in 1987. As 8 part of this change in tax status, Congress provided that if a Blue Cross or Blue Shield organization disposed of an asset that it had acquired while tax-exempt, its taxable gain or loss would be computed by reference to the asset's fair market value at the time the organization became subject to tax. The Company is seeking deductions for losses incurred on the termination of certain customer and provider contracts that were held by it on January 1, 1987, based on the fair market value of the contracts on that date. The Internal Revenue Service asserts that the Company is not entitled to deduct losses incurred on the termination of these contracts. The resolution of the Company's refund claim is subject to uncertainties, including whether the court will allow the deductions and, if so, the amount of the deductions that will be allowed. While the Company believes that its claim is meritorious, it cannot predict the ultimate outcome of the claim. The case is scheduled for trial in November 2001. If the Company wins this lawsuit and has previously collected refunds for the Demutualization payment deduction discussed in note 3, the tax recoveries for the years 1996 through 1999 would most likely be realized in the form of income tax credit carryovers rather than cash. The Company and certain of its subsidiaries are involved in various other legal actions occurring in the normal course of their business. While the ultimate outcome of such litigation cannot be predicted with certainty, in the opinion of Company management, after consultation with counsel responsible for such litigation, the outcome of those actions is not expected to have a material adverse effect on the financial condition or results of operations of the Company. 8. MID-SOUTH EXIT OF HEALTH INSURANCE MARKET AND SALE OF TRIGON ADMINISTRATORS During the nine months ended September 30, 2001, the Company made payments of $7.7 million against the claim reserves for future losses related to the third quarter 1999 Mid-South exit accrual. There have been no payments made against the accrual for certain other costs during 2001. No other payments or adjustments were made to the exit accruals in the third quarter of 2001. The remaining accrual is expected to be sufficient to satisfy any potential payments related to the 1999 exit. In March 2001, the Company sold Trigon Administrators, Inc. and its Property and Casualty Division, which provides workers compensation, liability and short-term disability services, and recognized a gain of $3.5 million on the sale. The gain is included as a component of net realized losses in the accompanying consolidated statements of operations. 9 9. SEGMENT INFORMATION The following table presents information by reportable segment for the three months and nine months ended September 30, 2001 and 2000 (in thousands):

10 A reconciliation of reportable segment total revenues, income before income taxes and minority interest and depreciation and amortization expense to the corresponding amounts included in the consolidated statements of operations for the three and nine months ended September 30, 2001 and 2000 is as follows (in thousands):

10. ACCOUNTING FOR DERIVATIVE INSTRUMENTS The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS Nos. 137 and 138, effective January 1, 2001. The Company enters into foreign currency forward contracts (forward contracts) to minimize exposure to fluctuations in foreign currency exchange rates. Company policy only permits utilization of these instruments in its foreign denominated bond and equity portfolios. The counterparties to these transactions are major financial institutions. The Company may incur a loss with respect to these transactions to the extent that the counterparty fails to perform under a contract and exchange rates have changed unfavorably since the inception of the contract. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. The forward contracts involve the exchange of one currency for another at a future date and typically have maturities of one year or less. The forward contracts do not qualify for hedge accounting under SFAS No. 133, as amended. Accordingly, upon adoption, the forward contracts were recorded at fair value with changes in fair value recorded as realized gains or losses in the consolidated statements of operations. The fair value of forward contracts held by the Company as of January 1, 2001 was not material. 11 The Company also enters into financial futures contracts for portfolio strategies such as minimizing interest rate risk and managing portfolio duration. The notional amount of the futures contracts is limited to that of the market value of the underlying portfolios. Should this limitation be exceeded, futures contracts are immediately terminated in order to comply with this restriction. Initial margins in the form of securities are maintained with the counterparties for these transactions. Changes in fair value of financial futures, determined and settled with the counterparties on a daily basis, are recorded as realized gains or losses in the consolidated statements of operations. Terminations of contracts are accounted for in the same manner. The adoption of SFAS No. 133, as amended, did not change the accounting for these contracts. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL Substantially all of the revenues of Trigon Healthcare, Inc. and subsidiaries (collectively, Trigon or the Company) are generated from premiums and fees received for health care services provided to its members and from investment income. Trigon's expenses are primarily related to health care services provided which consist of payments to physicians, hospitals and other providers. A portion of medical cost expenses for each period consists of an actuarial estimate of claims incurred but not reported to the Company during the period. The Company's results of operations depend in large part on its ability to accurately predict and effectively manage health care costs. The Company divides its business into four reportable segments: health insurance, government programs, investments and all other. Its health insurance segment offers several network products, including health maintenance organizations (HMO), preferred provider organizations (PPO) and traditional indemnity products with access to the Company's participating provider network (PAR) as well as Medicare supplement plans. Within the Company's health insurance network product offerings, employer groups may choose various funding options ranging from fully-insured to partially or fully self-funded financial arrangements. While self-funded customers participate in Trigon's networks, the customers bear all or portions of the claims risk. The government programs segment includes the Federal Employee Program (FEP). Through its participation in the national contract between the Blue Cross and Blue Shield Association and the U.S. Office of Personnel Management (OPM), the Company provides health benefits to federal employees in Virginia. FEP revenues represent the reimbursement by OPM of medical costs incurred including the actual cost of administering the program, as well as a performance-based share of the national program's overall profit. 12 All of the investment portfolios of the consolidated subsidiaries are managed and evaluated collectively within the investment segment. The Company's other health-related business, including disease management programs, benefits administration, health promotion and similar products, is reflected in an "all other" category. ENROLLMENT The following table sets forth the Company's enrollment data by network: As of September 30, --------------------------- 2001 2000 ---------------------------------------------------------------------- Health Insurance Commercial HMO 292,795 268,112 PPO 525,595 467,529 PAR 123,534 140,008 Medicaid HMO 58,771 55,054 Medicare supplement 119,744 119,773 ---------------------------------------------------------------------- Total commercial 1,120,439 1,050,476 Self-funded 772,148 715,052 Processed for other Blue Cross and Blue Shield Plans (ASO) - 5,314 ---------------------------------------------------------------------- Total health insurance 1,892,587 1,770,842 ---------------------------------------------------------------------- Government Federal Employee Program (PPO) 222,182 221,196 ---------------------------------------------------------------------- Total government 222,182 221,196 ---------------------------------------------------------------------- Total 2,114,769 1,992,038 ====================================================================== PREMIUM AND PREMIUM EQUIVALENTS BY NETWORK SYSTEM The following table sets forth the Company's premium and premium equivalents by network (in thousands):

13 THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 Premium and fee revenues increased 16.8% to $739.5 million in the third quarter of 2001 from $633.1 million in the third quarter of 2000. The $106.4 million increase is due to a combination of enrollment growth and rate increases in the Company's health insurance segment's HMO and PPO networks, offset by expected declines in the segment's PAR network enrollment. Commercial revenue increased 16.3% to $551.0 million in the third quarter of 2001 from $473.6 million in the third quarter of 2000, driven by a 6.7% increase in members and rate increases. Premium revenues on a per member per month basis for the Company's commercial business increased 8.9% to $164.97 in the third quarter of 2001 from $151.53 in the third quarter of 2000. Self-funded margins increased $10.4 million or 24.3%. The improvement is a result of 8.0% higher enrollment and a 16.1% increase in margin per member per month. The government segment's FEP revenues increased 16.1% to $135.4 million the third quarter of 2001 from $116.7 million in the third quarter of 2000 due to increased medical costs to be reimbursed by OPM. Total enrollment increased to 2,114,769 as of September 30, 2001 from 1,992,038 as of September 30, 2000. The increase of 122,731 was a result of a 121,745 increase in the Company's health insurance segment and a 986 increase in the government segment. The health insurance enrollment increase was primarily the result of a 69,963 increase in commercial enrollment, a 6.7% increase, and a 57,096 increase in self-funded enrollment, an 8.0% increase. Enrollment in the HMO network, which accounts for 31.4% of the total commercial enrollment, increased by 8.8% over the prior year. Enrollment in the PPO network as of September 30, 2001 increased 12.4% over September 30, 2000 and accounts for 46.9% of the Company's commercial enrollment. Growth in PPO was offset by an expected decline of 11.8% in the Company's PAR network as members continue to migrate into more tightly managed networks. The PAR network enrollment represents 11.0% of the Company's commercial enrollment. Investment income decreased 13.6% to $25.6 million in the third quarter of 2001 from $29.7 million in the third quarter of 2000. The decline is due to continued purchases under the stock repurchase program affecting the amount available for investment and the impact of declining interest rates. Net realized losses increased to $37.0 million in the third quarter of 2001 from $2.5 million in the third quarter of 2000. The increase in realized losses was primarily from equity-indexed investment (futures contracts) losses reflecting the impact of various market factors, including the events of September 11. Medical costs increased 18.3% to $577.5 million in the third quarter of 2001 from $488.1 million in the third quarter of 2000. The $89.4 million increase is a result of growth in the health insurance segment's commercial enrollment, continued increased medical costs and an increase in the government segment's FEP medical costs reimbursed by OPM. The medical cost per member per month for the Company's commercial business increased 11.4 % to $134.12 in the third quarter of 2001 from $120.37 in the third quarter of 2000. The medical cost ratio on commercial business increased to 81.3% in the third quarter of 2001 from the unusually low level of 79.4% in the third quarter of 2000. Medical cost increases have been slightly higher than expected driven primarily by 14 overall increases in the use of physician services, hospital services and the move toward higher-priced medications that are heavily advertised to the consumer. Selling, general and administrative expenses (SG&A) increased $7.7 million to $128.9 million in the third quarter of 2001 from $121.2 million in the third quarter of 2000. This increase is attributed to the incremental commissions and operating costs resulting from the enrollment increase and continuing investments in technology. The SG&A ratio decreased to 11.7% in the third quarter of 2001 from 12.8% in the third quarter of 2000. The reduced SG&A ratio demonstrates the leveraging impact of revenue growth. Increased revenue growth has allowed the Company to cover inflation and volume growth and make investments in the business while simultaneously improving the SG&A ratio. Interest expense in the third quarter of 2001 was $3.0 million compared to $4.3 million in the third quarter of 2000. The decrease in interest expense is due to declining interest rates on short-term borrowings in 2001 that more than offset the impact of the increase in commercial paper issued between the end of the third quarters of 2000 and 2001. Income before income taxes and minority interest decreased $29.3 million to $23.6 million in the third quarter of 2001 from $52.9 million in the third quarter of 2000. The decrease is a result of an increase in net realized losses of $34.5 million and decreased investment income of $4.0 million offset by a $7.9 million increase in operating income and lower interest expense of $1.3 million. Operating income is calculated as the sum of premium and fee revenues and other revenues less the sum of medical and other benefit costs and selling, general and administrative expenses. It differs from income before income taxes and minority interest because it excludes both income and realized gains or losses from investment securities and interest expense on debt. Operating income is intended to be used as a measure of operating performance of the Company's health care business and does not capture the Company's performance of its investment portfolio and the interest incurred on debt. The Company's definition of operating income may not be comparable to similarly titled measures reported by other companies and should not be construed as a substitute for, or a better indicator of, pretax profitability than income before income taxes and minority interest, which is determined in accordance with GAAP. The effective tax rate on income before income taxes and minority interest for the third quarter of 2001 and third quarter of 2000 was 31.0% and 33.2%, respectively. The effective tax rates for 2001 and 2000 differ from the statutory tax rate of 35% primarily due to the Company's investments in tax- exempt municipal bonds that reduce the effective tax rate by the effect of the tax-exempt investment income earned. NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 Premium and fee revenues increased 16.4% to $2.1 billion in the first nine months of 2001 from $1.8 billion in the first nine months of 2000. The $302.4 million increase is due to a combination of enrollment growth and rate increases in the Company's health insurance segment's HMO and PPO networks, offset by expected declines in the segment's PAR network enrollment. Commercial 15 revenue increased 15.6% to $1.6 billion in the first nine months of 2001 from $1.4 billion in the first nine months of 2000, driven by a 6.7% increase in members and rate increases. Premium revenues on a per member per month basis for the Company's commercial business increased 8.4% to $161.48 in the first nine months of 2001 from $148.94 in the first nine months of 2000. Self-funded margins increased $36.5 million or 29.8%. The improvement is a result of 8.0% higher enrollment, a 20.5% increase in margin per member per month and the elimination of a $3.0 million allowance established in 2000 to cover possible claims run-out for a self-funded group that previously declared bankruptcy. During the first quarter of 2001, the group pre-funded this amount making the allowance no longer necessary. The government segment's FEP revenues increased 14.8% to $395.4 million the first nine months of 2001 from $344.6 million in the first nine months of 2000 due to increased medical costs to be reimbursed by OPM. Investment income decreased 6.4% to $80.2 million in the first nine months of 2001 from $85.7 million in the first nine months of 2000. The decline is due to continued purchases under the stock repurchase program affecting the amount available for investment and the impact of declining interest rates. Net realized losses increased to $59.8 million in the first nine months of 2001 from $7.9 million in the first nine months of 2000. The net realized losses for the first nine months of 2001 consist of $63.3 million of net realized losses on investments and a $3.5 million gain on the sale of Trigon Administrators. The increase in realized losses was primarily from equity-indexed investment losses reflecting the impact of various market factors, the repositioning of the underperforming medium-quality bond portion of the portfolio during the second quarter of 2001 and normal portfolio turnover during a period of declining prices for equities. In March 2001, the Company sold Trigon Administrators, Inc. and its Property and Casualty Division, which provides workers compensation, liability and short-term disability services, and recognized a gain of $3.5 million on the sale. Medical costs increased 15.8% to $1.7 billion in the first nine months of 2001 from $1.4 billion in the first nine months of 2000. The $228.6 million increase is a result of growth in the health insurance segment's commercial enrollment, continued increased medical costs and an increase in the government segment's FEP medical costs reimbursed by OPM. The medical cost per member per month for the Company's commercial business increased 8.9 % to $131.39 in the first nine months of 2001 from $120.63 in the first nine months of 2000. The medical cost ratio on commercial business increased to 81.4% in the first nine months of 2001 from 81.0% in the first nine months of 2000. Medical cost increases have been slightly higher than expected driven primarily by overall increases in the use of physician services, hospital services and the move toward higher-priced medications that are heavily advertised to the consumer. SG&A expenses increased $39.1 million to $386.8 million in the first nine months of 2001 from $347.7 million in the first nine months of 2000. This increase is attributed to the incremental commissions and operating costs resulting from the enrollment increase and continuing investments in technology. Administrative expenses for the first nine months of 2001 also included a $3.2 million write- off in the first quarter of previously capitalized software related to the Company's e-distribution initiative. The SG&A ratio decreased to 12.1 % in the first nine months of 2001 from 12.5% in the first nine months of 2000. The reduced SG&A ratio demonstrates the leveraging impact of revenue growth. Increased revenue growth has allowed the Company to cover inflation 16 and volume growth, as well as make investments in the business while simultaneously improving the SG&A ratio. Interest expense in the first nine months of 2001 was $10.8 million compared to $12.4 million in the first nine months of 2000. The decrease in interest expense is due to declining interest rates on short-term borrowings in 2001 that more than offset the impact of the increase in commercial paper issued between the end of the first nine months of 2000 and 2001. Income before income taxes and minority interest decreased $23.1 million to $112.1 million in the first nine months of 2001 from $135.2 million in the first nine months of 2000. The decrease is a result of an increase in net realized losses on investment securities of $55.4 million and decreased investment income of $5.5 million offset by a $32.7 million increase in operating income, lower interest expense of $1.6 million, and the $3.5 million realized gain on sale of Trigon Administrators, Inc. The effective tax rate on income before income taxes and minority interest for the first nine months of 2001 and first nine months of 2000 was 32.9% and 30.5%, respectively. The effective tax rate for the nine months ended September 30, 2000 includes a $2.7 million tax benefit realized during the second quarter of 2000 related to the sale of the Company's Mid-South subsidiary. Excluding this tax benefit, the effective tax rate for the nine months ended September 30, 2000 was 32.6%. The effective tax rates for 2001 and 2000, excluding the $2.7 million tax benefit in 2000, differ from the statutory tax rate of 35% primarily due to the Company's investments in tax-exempt municipal bonds that reduce the effective tax rate by the effect of the tax-exempt investment income earned. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of cash are premiums and fees received and investment income. The primary uses of cash include health care benefit expenses and capitation payments, brokers' and agents' commissions, administrative expenses, income taxes and repayment of debt. Trigon generally receives premium revenues in advance of anticipated claims for related health care services. The Company's investment policies are designed to provide liquidity to meet anticipated payment obligations and preserve capital. Trigon fundamentally believes that concentrations of investments in any one asset class are unwise due to constantly changing interest rates as well as market and economic conditions. Accordingly, the Company maintains a diversified investment portfolio consisting both of fixed income and equity securities, with the objective of producing a consistently growing income stream and maximizing risk- adjusted total return. The fixed income portfolio includes government and corporate securities, both domestic and international, with an average quality rating of "A1" as of September 30, 2001. The portfolio had an average contractual maturity of 7.0 years as of September 30, 2001. A portion of the fixed income portfolio is designated as a short-term fixed income portfolio and is intended to cover near-term cash flow needs and to serve as a buffer for unanticipated business needs. The equity portfolios contain readily marketable securities ranging from small growth to well-established Fortune 500 companies. The international 17 portfolio is diversified by industry, country and currency-related exposure. As of September 30, 2001, the Company's equity exposure, comprised of direct equity as well as equity-indexed investments, was 13.5% of the total portfolio, as compared to 14% as of December 31, 2000. In November 2001, the Company entered into new revolving credit facilities with a syndicate of lenders, replacing the existing revolving credit facility expiring in February 2002. The new credit facilities consist of a $100 million 364-day revolving credit facility and a $200 million 5-year revolving credit facility. These credit facilities may be used for general corporate purposes and are currently being used to back the commercial paper discussed below. The terms of the credit facilities provide for various borrowing options and rates and require the Company to pay facility and administrative fees on a quarterly basis. The credit facilities contain certain financial covenants and restrictions including minimum net worth requirements and debt to consolidated net worth ratio limitations. There were no amounts borrowed under the former or current credit facilities during 2001. Use of the credit facilities to back the commercial paper reduces the amounts available for borrowing under these facilities. In March 2000, the Company commenced a private placement commercial paper program providing for the issuance of up to $300 million in aggregate maturity value of commercial paper notes. The Company issued an additional $0.2 million in commercial paper during the third quarter of 2001. As of September 30, 2001, outstanding notes under the commercial paper program totaled approximately $299.7 million with an average maturity of 11 days. The commercial paper is currently backed by revolving credit facilities. The Company has the intent to maintain commercial paper borrowings of at least this amount for more than one year. For financial reporting purposes, the commercial paper has been classified as a combination of current and noncurrent liabilities in the accompanying consolidated statements of financial condition based on the terms of the revolving credit facilities backing these notes. The Company continued its second stock repurchase program during the third quarter of 2001. The Company purchased and retired 115,000 shares of its common stock at a cost of approximately $6.9 million during the third quarter of 2001, bringing the total shares purchased during 2001 to 1,752,830 at a cost of approximately $95.5 million. The Company believes that cash flow generated by operations and its cash and investment balances will be sufficient to fund continuing operations, capital expenditures and debt repayment costs for the foreseeable future. The nature of the Company's operations is such that cash receipts are principally premium revenues typically received up to three months prior to the expected cash payment for related health care services. The Company's operations are not capital intensive. The Company announced in April 2001 a four-year, $84 million building project to expand its headquarters in Richmond, Virginia. The expansion plan includes construction of a four- story, 308,000-square-foot building to house the operations center and major renovation to the existing headquarters building. Construction of the new building should begin early next year, with completion scheduled for mid-2003. Renovations will begin once the new building is completed with a scheduled completion date in 2005. The project will be 18 funded using internal cash and investments. There are currently no other commitments for major capital expenditures to support existing business. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also specifies the criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 addresses the accounting and financial reporting for goodwill and other intangible assets upon acquisition and in the periods following acquisition. Under Statement 142, goodwill and intangible assets determined to have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. Intangible assets that have definite useful lives will be amortized over their useful lives to their estimated residual values. In connection with the transitional goodwill impairment evaluation, Statement 142 will require the Company to perform an assessment of whether there is an indication that goodwill is impaired as of the date of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company's statement of earnings The Company is required to adopt the provisions of Statement 141 immediately and Statement 142 effective January 1, 2002. Goodwill acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement 142. As of the date of adoption, the Company expects to have unamortized goodwill in the amount of $13.7 million that will be subject to the transition provisions of Statements 141 and 142. Because of the extensive effort needed to comply with adopting Statements 141 and 142, the Company will be evaluating the impact of adoption on existing goodwill during 2001 but expects no material impact on the consolidated financial position or results of operations. FORWARD-LOOKING INFORMATION This Item, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and this Form 10-Q contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, among other things, statements concerning future earnings, premium rates, enrollment and medical and administrative costs. Such forward- looking statements are subject to inherent risks and uncertainties, many of which are beyond the control of the Company, that may cause actual results to differ materially from those contemplated by such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, rising health care costs, business conditions and competition in the managed care industry, government action and other regulatory issues. Additional information concerning factors that could cause actual results to differ materially from those in forward-looking statements is contained in the Company's Annual Report on Form 10-K under the caption "Forward-Looking Information." 19 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a result of its investing and borrowing activities, the Company is exposed to financial market risks, specifically those resulting from changes in interest rates, foreign currency exchange rates and marketable equity security prices. No material changes have occurred in the Company's exposure to financial market risks since December 31, 2000. A discussion of the Company's market risk is incorporated by reference in Part II, Item 7A of the Company's Annual Report on Form 10-K. PART II. OTHER INFORMATION Item 1. Legal Proceedings (a) On June 9, 2000, the Company's subsidiary, Trigon Insurance Company, filed a lawsuit against the federal government for the recovery of federal income tax overpayments for the years 1989 through 1995. If successful, the Company expects to recover approximately $35 million in cash refunds plus interest of about $20 million and to receive tax refunds for the years 1996 through 1999 of about $65 million. In addition, if the Company is successful it could receive substantial additional tax credits that could lower federal income tax liability in future years. The lawsuit, filed in the United States District Court for the Eastern District of Virginia, relates to the initial valuation and deductibility of the Company's assets when, along with other Blue Cross or Blue Shield organizations, it became subject to federal income taxation in 1987. As part of this change in tax status, Congress provided that if a Blue Cross or Blue Shield organization disposed of an asset that it had acquired while tax- exempt, its taxable gain or loss would be computed by reference to the asset's fair market value at the time the organization became subject to tax. The Company is seeking deductions for losses incurred on the termination of certain customer and provider contracts that were held by it on January 1, 1987, based on the fair market value of the contracts on that date. The Internal Revenue Service asserts that the Company is not entitled to deduct losses incurred on the termination of these contracts. The resolution of the Company's refund claim is subject to uncertainties, including whether the court will allow the deductions and, if so, the amount of the deductions that will be allowed. While the Company believes that its claim is meritorious, it cannot predict the ultimate outcome of the claim. The case is scheduled for trial in November 2001. If the Company wins this lawsuit and has previously collected refunds for the Demutualization payment deduction discussed in note 3, the tax recoveries for the years 1996 through 1999 would most likely be realized in the form of income tax credit carryovers rather than cash. The Company and certain of its subsidiaries are involved in various other legal actions occurring in the normal course of their business. While the ultimate outcome of such litigation cannot be predicted with certainty, in the opinion of Company management, after consultation with counsel responsible for such litigation, the outcome of those actions is not expected to have a material adverse effect on the financial condition or results of operations of the Company. 20 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following is a list of exhibits filed with the Form 10-Q: Exhibit Number Description ------ ----------- 11 -- Computation of per share earnings for the three months and nine months ended September 30, 2001. Exhibit has been omitted as the detail necessary to determine the computation of per share earnings can be clearly determined from the material contained in Part I of this Form 10-Q. All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (b) Reports on Form 8-K: None filed during the three months ended September 30, 2001. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TRIGON HEALTHCARE, INC. Registrant Dated: November 14, 2001 By: /s/ Thomas R. Byrd ------------------------------- THOMAS R. BYRD SENIOR VICE PRESIDENT & CHIEF FINANCIAL OFFICER (PRINCIPAL ACCOUNTING AND FINANCIAL OFFICER)

TRIGON HEALTHCARE INC 10-Q/A