On January 12, 1998, as a result of significant operating losses, negative working capital and a reduction in net worth, the Company announced a major financial restructuring program which was designed to cut the Company's cash losses and position the Company for profitable operations. To oversee the Company's restructuring efforts, the Company named a new Chairman of the Board to serve in a non-executive capacity, with the day to day operations of the Company continuing to be managed by its then current Chief Executive Officer and then current President and Chief Operating Officer. The Company engaged Arthur Andersen LLP to assist in the development and implementation of the financial restructuring program and named as Interim Chief Financial Officer of the Company, the individual who was also the head of Arthur Andersen LLP's Chicago-based Corporate Recovery Services Group.
The restructuring program encompassed Company plans to discontinue some expansion projects, reduce non-core spending activities, reduce corporate overhead, renegotiate its bank credit facilities, re-evaluate its investment in affiliates and other assets and sell CHF.
On May 12, 1998, the Company announced three changes in management: (1) the retirement of the then current Chief Executive Officer of the Company effective August 6, 1998, including his immediate relinquishment of his operational responsibilities, (2) the resignation of the then current President and Chief Operating Officer of the Company and (3) the election of Gregory H. Moses, Jr. as the new President and Chief Operating Officer of the Company. In August 1998, Mr. Moses additionally became the Chief Executive Officer of the Company, the Company's Corporate Controller became its new Treasurer and Interim Chief Financial Officer and the Company appointed a new Senior Director of Management Information Systems.
In June 1998, the Company funded a $4.6 million unsecured loan to OmniCare-MI, evidenced by a surplus note, to enable OmniCare-MI to meet its minimum
YEAR ENDED JUNE 30, 1998 COMPARED TO YEAR ENDED JUNE 30, 1997
Medical premium revenues were $78.6 million in fiscal 1998, an increase of $8.2 million (12%) over medical premium revenues of $70.4 million in fiscal 1997. Medical premiums for OmniCare-TN increased $7.0 million (12%), from $56.5 million in 1997 to $63.5 million in fiscal 1998. Of the increase, $1.1 million relates to the TennCare Bureau's 1998 annual settlement to managed care organizations for high cost chronic conditions of their membership and new medical technologies. The remaining OmniCare-TN increase of $5.9 million is due to rate and enrollment increases. The per member per month ("PMPM") premium rate - based on an average membership of 44,000 compared to 43,000 for the prior year excluding the effects of the adverse selection and medical technologies settlement - was $119 in fiscal 1998, compared to $110 in fiscal 1997, an increase of 8% or $4.7 million. The rate increase included changes in the enrollment mix. A 2% increase in enrollment accounted for the remaining $1.2 million increase.
Depreciation and amortization in fiscal 1998 was $9.7 million, compared to $4.1 million in fiscal 1997, an increase of $5.6 million (137%). Of this increase, $3.5 million was due to the write-off of the remaining goodwill related to the Company's purchase of UltraMedix due to the liquidation order as to UltraMedix in fiscal 1998. Also see Notes 4 and 7 to the audited Consolidated Financial Statements. Additional increases included $.3 million due to the change in estimate of the remaining useful life of the Company's managed care software, and the write-off of certain property and equipment of approximately $.8 million.
Bad debt expense increased $5.0 million (278%), from $1.8 million in fiscal 1997 to $6.8 million in fiscal 1998. The increase related to impairment losses established on certain of the Company's investments and surplus note receivable.
The loss from discontinued operation, net of income taxes, was $2.6 million for fiscal 1998, compared to earnings of $1.9 million for 1997, a change of $4.5 million. This is due primarily to increased contract servicing costs and the reduction in the net carrying value of net assets to the net realizable value of $2.5 million.
YEAR ENDED JUNE 30, 1997 COMPARED TO YEAR ENDED JUNE 30, 1996
Total revenues from continuing operations increased $20.1 million (22%), from $92.4 million in fiscal 1996 to $112.5 million in fiscal 1997.
Medical premium revenues were $70.4 million in fiscal 1997, an increase of $35.9 million (104%) over medical premium revenues of $34.5 million in fiscal 1996. Medical premiums for OmniCare-TN increased $27.8 million (97%), from $28.7 million in fiscal 1996 to $56.5 million in fiscal 1997. The net increase is due to 12 months of activity in fiscal 1997 compared to 5 months in fiscal 1996, offset by a net decrease in member months. The enrollment for OmniCare-TN was approximately 40,100 at June 30, 1997, compared to approximately 48,200 at June 30, 1996, a decrease of 8,100 members or 17%. The State of Tennessee's disenrollment of approximately 7,000 members in the quarter ending December 1996 was the primary reason for the decrease. This action was taken by the State based upon the return of undeliverable questionnaires mailed to members, which the State requested for continued participation.
Operating revenues of OmniCare-MI decreased in fiscal 1997 due primarily to a net decrease in enrollment rates of approximately 2%, which resulted in decreased management fees to the Company of approximately $1.4 million. These decreases were offset by a $2.0 million increase in management fees from PPC, attributable primarily to increased PPC enrollment of approximately 52%, offset by a decrease in premium rates of approximately 15% and 11 months of management fees in fiscal 1997 compared to 12 months in fiscal 1996.
OmniCare-MI was notified in May 1997 that it had been selected to participate in the State of Michigan's initiative to mandate Medicaid enrollment into managed care organizations. Similar to the initiative in Florida, the State's initiative was legally challenged by unsuccessful bidders responding to the State's request for proposal. Because of these legal challenges, the State did not assign the Medicaid eligibles to plans that were awarded contracts in the bid process, but did, however, institute the rate reduction component of this new program effective July 1997.
Of the total medical service expenses of $57.8 million in fiscal 1997, $45.4 million relates to OmniCare-TN and $12.4 million to UltraMedix, an increase of $27.9 million (93%) over medical service expenses of $29.9 million in fiscal 1996. The MLR was 80% for OmniCare-TN and 88% for UltraMedix in fiscal 1997. The OmniCare-TN MLR for fiscal 1997 was positively affected by the State of Tennessee's $2.4 million settlement to adjust the amount of claims saving paid and/or
accrued to the State of Tennessee prior to OmniCare-TN obtaining its TennCare HMO license and the recognition of duplicate claims paid to providers.
Marketing, general and administrative expenses (MG&A) increased $2.7 million (5%), from $50.1 million in fiscal 1996 to $52.8 million in fiscal 1997, due to the following: (i) MG&A for the Company's operation of PPC increased $1.0 million, but PPC-related MG&A as a percentage of management fee revenues decreased 9% from 95% in fiscal 1996 to 86% in fiscal 1997, due primarily to the mandated Medicaid initiative that increased enrollment without a corresponding marketing effort; (ii) MG&A for corporate headquarters, including the cost to operate OmniCare-MI, increased $1.9 million, and MG&A as a percentage of management fee revenues increased 9%, from 93% in 1996 to 102% in fiscal 1997, due to several factors, including: (a) a $1.4 million decrease in management fees from OmniCare-MI; (b) an average 5% salary rate increase, and (c) a $.3 million adjustment to increase rent expense in fiscal 1997 calculated as the difference between the lease obligations of the Company and the estimated rental income from sub-tenants for the remaining life of the Company's lease in Pennsylvania; and (iii) a net decrease of approximately $.2 million related to the Company's Florida and Tennessee operations.
Equity in net losses of unconsolidated affiliates decreased approximately $.7 million, from $.7 million in fiscal 1996 to zero in fiscal 1997, due to the Company's acquisition of a majority interest in OmniCare-TN and UltraMedix in January 1996.
Depreciation and amortization in fiscal 1997 was $4.1 million, compared to $3.4 million in fiscal 1996, an increase of $.7 million (21%). The increase was due primarily to the amortization of goodwill related to acquisitions and computer software.
Of the bad debt expense of $1.8 million in fiscal 1997, $1.1 million relates to a valuation reserve established to estimate the net recovery of $1.2 million in refundable advances made by OmniCare-TN to a third party administrator. The third party administrator has denied the obligation and, as a result, the Company is pursuing legal action to collect the receivable. The balance of the fiscal 1997 bad debt expense is due to an additional write-down of approximately $.7 million recorded to reduce the Company's $4.0 million investment in Advica. Prior year Advica reserves totaled $1.1 million. As the investment was capital in nature, no tax credits have been taken against the cumulative reserve of $1.8 million.
retroactive to January 1994. Despite the fact that OmniCare-TN agreed to reimburse the Company approximately $8.7 million in June 1996 for the start-up and other costs incurred by the Company between January 1994 and September 1995, the transaction was not sufficiently documented to allow recognition of the same on the Company's financial statements in December 1995.
For fiscal 1997, the estimated Company expense related to the then proposed shareholder class action lawsuit settlement, net of insurance coverage, was $1.15 million. The proposed settlement was subject to federal court approval. See also "Legal Proceedings".
As a result of the foregoing, the Company recognized a loss from continuing operations before income taxes of $6.5 million in fiscal 1997, compared to a loss from continuing operations before income taxes of $3.4 million in fiscal 1996, a $3.1 million change. The federal statutory tax rate for continuing operations for fiscal 1997 and fiscal 1996 was approximately 34%. Goodwill amortization related to equity investments, equity losses from unconsolidated affliates, losses related to capital investments not deductible for tax purposes and state income taxes resulted in an effective tax rate of approximately 19% in fiscal 1997. These differences resulted in tax expense on the fiscal 1996 loss. The net loss from continuing operations in fiscal 1997 was $5.3 million, compared to a net loss from continuing operations of $3.7 million in fiscal 1996, a change of $1.6 million.
\ PhilCare. The foregoing funds were provided by the Company from its line of credit arrangement. Due to the cessation of its Louisiana operations, the Company withdrew the $1.0 million capital contribution and is in the process of cancelling its letter of credit commitments. The Company's Board of Directors has determined to withdraw from all of its involvement in Pennsylvania and to pursue recouping its investment in PhilCare.
On March 12, 1998, effective as of February 1, 1998, the Company entered into an amended loan agreement and promissory note for a $22.9 million line of credit facility with its current bank lender. On September 1, 1998, the Company and the bank amended the loan agreement and promissory note to decrease the line of credit amount to $20.94 million and modify other terms. The purposes of the line of credit facility as of February 1, 1998 were to (i) renew and increase the existing line of credit to pay off outstanding term loans with the same bank and (ii) guarantee the payment of an existing $.5 million letter of credit. The agreement requires the permanent reduction of the outstanding balance and the line of credit facility (a) at October 15, 1998 to $20.44 million, (b) at November 15, 1998 to $19.94 million, (c) at December 15, 1998 to $19.44 million, (d) at January 15, 1999 to $18.44 million, (e) at February 15, 1999 to $17.94 million and (f) at April 15, 1999 to the lesser of the then outstanding principal balance or $8 million, and the cancellation of the $.5 million letter of credit by January 1, 1999. The maturity date of the line of credit facility is October 1, 1999.
The Company's restructuring efforts significantly contributed to the $22.9 million loss from continuing operations in fiscal 1998. However, after adjusting for non-cash activities and changes in assets and liabilities, the Company generated positive cash flows from operations in fiscal 1998. The Company's ability to generate adequate amounts of cash to meet its future cash needs will depend on a number of factors, including the stabilization of OmniCare-MI, continuation of its restructuring efforts, achieving increased operational efficiencies at its Tennessee operation and the collection of the CHF sale proceeds.
Management believes that the negative working capital, excluding the $6.3 million in medical claims liability established for UltraMedix and including long term debt at June 30, 1998 of $15.8 million, can be funded from the CHF sale proceeds and operations in fiscal 1999. Management further expects that the OmniCare-MI corrective action plan, which is in the process of implementation, will stabilize that Plan and eliminate the need for future cash infusions from the Company. Omnicare-MI has successfully renegotiated certain major hospital provider contracts,including its most significant hospital contract, which was one of the major components of the corrective action plan, the effects of which will reduce medical costs.