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

(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

OVERVIEW

The Company provides managed behavioral healthcare services through full and shared risk arrangements with employers, health plans and managed care organizations to perform behavioral health services on a capitated per member per month basis. In addition, the Company provides an array of managed behavioral health services including employee assistance programs, third party clinical case management and claims administration. Integra's contract service areas are principally concentrated in Connecticut, Delaware, Maryland, New Jersey, New York, Pennsylvania, Rhode Island, Virginia and Tennessee.

SALE AND DIVESTITURE OF PATIENT SERVICE AND PROVIDER SEGMENT

In December 1997, the Company announced its plans to sell and divest its outpatient behavioral health group practice operations. The Company entered into an agreement to sell substantially all of the assets of the outpatient behavioral practice business (the "Sale"), except for practices located in the Western region of the United States which the Company sold or shut down. The Sale was completed effective May 18, 1998 and resulted in the divestiture by the Company of substantially all the assets and business of the Company's outpatient behavioral health practices. As of December 31, 1997, the outpatient behavioral health practice business accounted for approximately eight-four percent (84%) of the assets of the Company (before the impact of the write down of assets held for sale and the impact of the restructuring charge); and for the year ended December 31, 1997, approximately eighty-three percent (83%) of the Company's net revenues. As a result of the Sale, the Company is significantly smaller in terms of revenues and assets. Patient service revenues and patient service costs pertained solely to the outpatient business and as a result of the exit of this segment, the Company no longer performs direct patient service and hence has no patient service revenues or patient service costs.

RESULTS OF OPERATIONS

PREMIUM REVENUE
Premium revenue pertains to the Company's managed behavioral healthcare business which maintains a portfolio of agreements with managed care organizations and corporations to provide inpatient and outpatient behavioral health services. Revenues are primarily generated by capitated managed behavioral healthcare and employee assistance programs. The fees are defined by contract and are primarily calculated on a fixed per member per month fee. Revenues under these contracts are recorded in the month for which the member is entitled to services. Generally, these contracts are on a one to three year basis subject to cancellation by either party without cause at any time with thirty to ninety days written notice.

Premium revenue for the three and six month periods ended June 30, 1999 increased from the corresponding periods of the prior year primarily due to one new contract in New York State for which the Company implemented coverage on a capitated basis effective January 1, 1999.

PREMIUM SERVICE COSTS

Premium service costs are primarily comprised of medical claims and personnel costs associated with the Company's service delivery, support and management of its portfolio of behavioral healthcare contracts. The Company estimates the medical claims cost of providing services under these agreements, including a reserve for services incurred, but not reported, based upon authorized healthcare services, past claim payment experience for member groups, patient census data and other factors. The Company typically does not subcapitate the risk of providing services under these contracts, but the Company arranges discounted fee-for-service rates with independent inpatient and outpatient behavioral health providers.

Under capitated contracts, the Company is responsible for ensuring appropriate access to care and bears the risk for utilization levels and pricing of the cost of services performed under these contracts. The Company believes the future revenues under these contracts will exceed the costs of services it will be required to provide under the terms of the contracts. An underestimation in the utilization or price of services for these contracts could result in material losses to the Company. Historically, Integra has managed these capitated contracts profitably. The Company maintains no re-insurance against the risk of loss under these contracts.

Premium service costs increased for the three and six month periods ended June 30, 1999 from the corresponding periods in the prior year. This increase is primarily a result of the coverage implemented on new contracts.

SELLING AND ADMINISTRATIVE EXPENSES

Selling and administrative expenses are primarily comprised of corporate office, sales and administration. Selling and administrative expenses increased to $1,462 for the three months ended June 30, 1999 from $1,221 for the same period in 1998. The increase is essentially a result of increased investment in sales and marketing personnel. Selling and administrative expenses for the six month period ended June 30, 1999 decreased to $2,749 from $4,286 for the same period in 1998. This decrease is essentially the result of the impact of the operations sold and the downsizing of the corporate office in connection with the Sale.

PROVISION FOR DOUBTFUL ACCOUNTS

There was no provision for doubtful accounts for the three or six month periods ended June 30, 1999 as compared to $419 for the three months ended June 30, 1999 and $1,189 for the six months ended June 30, 1999. This decrease is a result of the Sale and exit of the outpatient provider operations. The Company's managed behavioral healthcare business has historically had minimal provision for doubtful accounts.

RESTRUCTURING AND OTHER CHARGES

In prior years, the Company established reserves in connection with its restructurings and the exit of long-term care and outpatient operations. As part of its ongoing evaluation of these reserves, at June 30, 1999, the Company determined, based on its assessment of all remaining open matters, that the Company was over accrued for these matters by $700. This change in estimate is separately reflected in the Statement

of Operations under "Restructuring and Other Charges." The Company believes the remaining reserves for these matters are adequate at June 30, 1999, however, as the Company continues to pursue resolution of open matters, actual results could differ from such estimates.

INTEREST EXPENSE - RELATED PARTIES

In 1998, as a contingency plan in the event the Sale had not been not completed, the Company entered into an agreement with certain investment partnerships (the "Investment Partnerships") which are significant stockholders of the Company and are managed by Foster Management Company, an affiliated party, to obtain their commitment to guarantee an additional $7,000 of financing. This amount represented the Company's estimated additional cash needs during 1998 for contingent payments, seller notes and for restructure related activities. Under the terms of the agreement, the Investment Partnerships were to receive the following: (i) a commitment fee of 2% of the guaranteed amount;
(ii) a draw down fee of 2% on borrowings in excess of $5,000; (iii) an unused commitment fee of 1/2% per annum; and (iv) warrants to purchase 400,000 shares of common stock of the Company at a price of $0.05 per share (the "Integra Warrants") or, in the event the Sale was not consummated, a transaction fee of $3,500 payable on April 30, 1999. With the Sale completed in 1998, the cost to the Company of this guarantee was $140 in cash paid to the Investment Partnerships and a non-cash charge of approximately $880 which represents the difference between the exercise price of the Integra Warrants and the fair market value of the underlying Company Common Stock on the closing date of the Sale. These charges, which are non-recurring in nature, have been recorded in the Company's results of operations for the quarter ending June 30, 1998.

INTEREST EXPENSE - NET

Interest expense, net, decreased for the three and six month periods ended June 30, 1999 from the corresponding periods in the prior year. This decrease is primarily due to the pay down of bank debt in May 1998 with proceeds from the Sale to PsychPartners.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operations was $1,553 for the six months ended June 30, 1999, compared to net cash used in operations of ($2,322) for the same period in the prior year. Unrestricted cash and cash equivalents decreased to $1,384 at June 30, 1999 from $2,452 at December 31, 1998. At June 30, 1999, the Company also had $400 in cash which is contractually restricted as a reserve for medical claims payable.

At June 30, 1999, the Company had a working capital deficit of $4,939. The deficit is primarily attributable to accrued liabilities of $2,967 which pertain to the exit of the outpatient provider behavioral group practice business and reserves established for long-term care and other provider billing matters. Although these amounts are classified as current due to their nature, the Company does not expect that all of these amounts will require payment in the next year. The remainder of the Company's accrued liabilities are operating in nature.

The Company has established a Credit Facility with PNC Bank. At June 30, 1999, borrowing availability under this Credit Facility was approximately $9,000. The Credit Facility is secured by substantially all of the assets of the Company. If necessary, the Company will use its Credit Facility to fund working capital requirements.

The Company believes that the cash flow generated by the Company's operations together with its existing cash and availability of additional borrowings under its Credit Facility will be sufficient to meet the Company's cash requirements in 1999.

The Company's current ratio, working capital and debt to equity ratio are set forth below for the dates indicated:

                                                    June 30, 1999          December 31, 1998
                                                    -------------          -----------------
Current Ratio...............................             .41:1                    .42:1
Working Capital Deficit.....................           $(4,939)                 $(5,448)
Debt to Equity..............................                --                    .34:1

INFLATION

A significant portion of the Company's operating expenses have been subject to inflationary increases, including clinical and administrative salaries and rent expense. Based on management's assessment, the Company has historically been unable to substantially offset inflationary increases through price increases. The Company believes it has somewhat mitigated the effect of inflation by expanding services and increasing operating efficiencies. There can be no assurance that the Company will be able to offset future inflationary increases in expenses, if any, which would result in a dilutive impact on the Company's future earnings.

NEW CONTRACT

Effective January 1, 1999, the Company implemented coverage of a full-risk capitated contract with a health plan covering over 350,000 members. The Company expects that this contract will generate over $11,000 in annual revenues and it is currently the Company's largest contract. Profitability under this contract will depend upon the Company's ability to manage the utilization of services within the premiums received. An underestimation in the expected utilization of services for this contract could result in a material loss to the Company.

POTENTIAL IMPACT OF YEAR 2000 COMPUTER ISSUES

The Year 2000 problem is primarily the result of two potential malfunctions that could have an impact on the Company's systems and equipment. The first problem arises due to computers being programmed to use two rather than four digits to define the applicable year. The second problem arises in embedded chips where microchips and microcontrollers have been designed using two rather than four digits to define the applicable year. Certain of the Company's computers, programs, and building infrastructure components (e.g. alarm systems and HVAC systems) are date sensitive and may recognize a date using "00" as the Year 1900 rather than the Year 2000.

The Company relies on information technology ("IT") systems and other systems and facilities such as telephones, building access control systems and heating and ventilation equipment ("Embedded Systems") to conduct its business. These systems are potentially vulnerable to Year 2000 problems due to their use of date information. The Company also has business relationships with customers and healthcare providers and other critical vendors who are themselves reliant on IT and Embedded Systems to conduct their businesses.

State of Readiness

The Company's internal IT systems are largely centralized and consist primarily of purchased software. The Company's IT hardware infrastructure is built mainly around IBM PC compatible servers and desktop systems. The Company's IT software primarily utilizes Microsoft systems including SQL Server, Windows NT, Internet Information Server, Exchange and Office. The Company believes these systems are either compliant or, with soon to be released "service packs" from Microsoft, will be compliant by September 30, 1999. The Company's clinical and claims administration software has been certified by the vendor as being Year 2000 compliant. The Company intends to complete testing of this system during the third quarter of 1999. Year 2000 remediation costs incurred in 1998 were approximately $100 and are estimated at under $250 in 1999.

External Relationship

The Company also faces the risk that one or more of its critical suppliers or customers ("External Relationships") will not be able to interact with the Company due to the third party's inability to resolve its own Year 2000 issues, including those associated with its own External Relationships. The Company has been assessing its External Relationships and risk rating each External Relationship based upon the potential business impact, available alternatives and cost of substitution. The Company is attempting to determine the overall Year 2000 readiness of its External Relationships. In the case of significant customers and mission critical suppliers such as banks, telecommunications providers and other utilities and IT vendors, the Company is engaged in discussions with the third parties and is attempting to obtain detailed information as to those parties' Year 2000 plans and state of readiness. The Company, however, does not have sufficient information at the current time to predict whether its External Relationships will be Year 2000 ready.

Risks and Contingency/Recovery Planning

If the Company's Year 2000 issues were unresolved, it is possible the Company would not have the ability to accurately and timely authorize and process benefits and claims, accurately bill customers, assess claims exposure, determine liquidity requirements, report accurate data to management, stockholders, customers, regulators and others, and would be subject to business interruptions or shutdowns, financial losses, reputational harm, loss of significant customers, increased scrutiny by regulators and litigation related to Year 2000 issues. The Company is attempting to limit the potential impact of the Year 2000 by monitoring the progress of its own Year 2000 project and those of its critical External Relationships and by developing contingency/recovery plans. The Company cannot guarantee that it will be able to resolve all of its Year 2000 issues. Any critical unresolved Year 2000 issues of the Company or its External Relationships could have a material adverse effect on the Company's results of operations, liquidity or financial condition.

The Company is developing contingency/recovery plans aimed at maintaining the continuity of critical business functions before and after December 31, 1999. As part of that process, the Company is developing manual work alternatives to automated processes which will be designed to maintain business continuity. These manual alternatives presume, however, that basic infrastructure such as electrical power and telephone service, as well as purchased systems which are advertised to be Year 2000 compliant by their manufacturers (primarily IT hardware and software) will remain unaffected by the Year 2000 problem.

CAUTIONARY STATEMENT

Matters discussed above contained forward-looking statements that are based on the Company's estimates, assumptions and projections. Major factors which could cause results to differ materially from those expected by management include the timing and nature of reimbursement changes, the nature of changes in laws and regulations that govern various aspects of the Company's business, new criteria adopted to determine medical necessity for behavioral health services, the outcome of post-payment reviews of the Company's billings to Medicare patients in long-term care facilities, Year 2000 issues, pricing of managed care and other third party contracts, the utilization and cost of services under the Company's capitated contracts, the direction and success of competitors, management retention and unanticipated market changes.

INTEGRA, INC.

FORM 10-Q - QUARTER ENDED JUNE 30, 1999