Total operating revenue increased $906 million to $4.6 billion for the fiscal year ended September 30, 1996 from $3.7 billion for the same period in the prior fiscal year. Enrollment gains in both the government (Medicare and Medicaid) and commercial programs, offset slightly by decreases in commercial premium rates, provided an increase in total operating revenue of $787 million. The remaining operating revenue increase was contributed by the incremental operations of acquisitions described in Note 5 of the Notes to Consolidated Financial Statements and the Company's specialty managed care products and services.
Government premiums rose $550 million or 25 percent to $2.7 billion for the fiscal year ended September 30, 1996 from $2.2 billion in 1995. Enrollment gains, predominantly in the Secure Horizons programs, accounted for $430 million or 78 percent of the increase. The remainder of the premium increase is attributable to incremental acquisitions and premium rate increases averaging 4.2 percent.
Marketing, general and administrative expenses increased $78.0 million to $576 million for the fiscal year ended September 30, 1996 from $498 million for fiscal year 1995. However, as a percentage of operating revenue, marketing, general and administrative expenses decreased to 12.4 percent from 13.4 percent. The decrease is primarily attributable to the Company's reduction of performance based employee incentives due to current fiscal year operating results not meeting anticipated fiscal year 1996 targets. Additionally, the Company is realizing the benefit derived from prior investments in the Company's infrastructure which have proven adequate to support the growth in membership.
The Company recognized pretax charges for the fiscal year ended September 30, 1996 totaling $100.8 million ($62.0 million or $1.96 loss per share, net of tax). Included was a fourth quarter charge for the impairment of goodwill associated with the potential disposition of its Florida operations, in addition to third quarter reserves associated with potential government claims with OPM for multiple contract years, the disposition of Pasteur Delivery Systems ("PDS") and certain restructuring charges (See Note 11 of the Notes to the Consolidated Financial Statements).
In the fourth quarter of fiscal year 1996, the Company recognized a $58.7 million ($34.1 million or $1.08 per share, net of tax) impairment of goodwill related to the potential disposition of its Florida operations. The business strategy for PCFL profitability was based on the launching of the Company's Secure Horizons program in Florida. In response to the FHP Transaction and the considerable amount of resources which will be needed to integrate FHP's operations with those of the Company, assuming the FHP Transaction is consummated, the Company decided to explore options with respect to PCFL's operations, including a possible sale. Accordingly, the Company withdrew its HCFA application in September 1996. Consequently, the Company recognized an impairment of the PCFL goodwill and other intangible assets. The Company expects to continue operations in Florida until a sale is consummated or the Company makes alternative arrangements. A comprehensive plan to dispose of PCFL's business may involve a restructuring charge in future periods.
The consolidated effective income tax rate for the fiscal year ended September 30, 1996 was 41.4 percent compared to 40.6 percent for the same period in fiscal year 1995. The increase is attributable to the charges for the disposition of PDS and goodwill impairment described in Note 11 of the Notes to the Consolidated Financial Statements, some of which are not deductible for income tax purposes.
Total operating revenue increased 29 percent or $838 million to $3.7 billion for the fiscal year ended September 30, 1995 from $2.9 billion for the same period in the prior fiscal year. Enrollment gains in both the government and commercial programs, offset slightly by decreases in commercial premium rates, provided an increase in total operating revenue
Commercial premiums increased $275 million or 22 percent to $1.5 billion for the fiscal year ended September 30, 1995 from $1.2 billion in fiscal year 1994. Commercial HMO membership increased by 267,000 or 28 percent to 1,216,000 due to continued growth in California, Oregon, Texas and Washington. The increase in membership includes the effects of acquisitions in California and Washington of 67,000 and 33,000 members, respectively. Commercial HMO membership growth provided $177 million of the increase, more than offsetting average premium rate decreases of two percent, primarily in California. The effects of acquisitions described above and the commercial specialty managed care products and services and joint venture medical groups provided the remainder of the increase in commercial premiums.
Government premiums rose $553 million or 34 percent to $2.2 billion for the fiscal year ended September 30, 1995 from $1.6 billion in fiscal year 1994. Enrollment gains, predominantly in the Secure Horizons programs, accounted for $492 million or 89 percent of the increase. The remainder of the premium increase was attributable to incremental acquisitions and premium rate increases averaging one percent.
For the fiscal year ended September 30, 1995, the Company made net positive reserve adjustments totaling $12 million. These net positive reserve adjustments have historically been made in the third quarter and result primarily from the periodic reconciliation of amounts reserved for physician and hospital incentive programs. For the fiscal year ended September 30, 1995, however, net positive reserve adjustments were made in insignificant amounts throughout the year. For the fiscal year ended September 30, 1994, net positive reserve adjustments of $9 million were made in the third quarter.
Marketing, general and administrative expenses increased $104 million or 26 percent to $498 million for the fiscal year ended September 30, 1995 from $395 million for fiscal year 1994. As a percentage of operating revenue, marketing, general and administrative expenses decreased to 13.4 percent from 13.6 percent. The decrease was primarily attributable to increased operating revenue and efficiencies due to process improvements which have offset infrastructure investments in new markets.
The Company's consolidated cash and cash equivalents decreased by $136 million to $143 million at September 30, 1996 from $279 million one year ago. The decrease reflects the impact of timing differences in receipt of HCFA premiums. The Company's September 30, 1995 cash balances included the early receipt of approximately $184 million of premiums from HCFA for Medicare services to be provided to Secure Horizons members in October 1995. The Company's cash balances at September 30, 1996 did not include any early receipt of HCFA premiums. The major source of cash during the fiscal year ended September 30, 1996 was $111 million from operations (excluding the effect of timing differences in receipt of HCFA premiums). The Company's use of cash during fiscal year 1996 included $22.7 million for capital expenditures, $8.6 million for debt payments, and $5.4 million for acquisitions. The
The Company's working capital at September 30, 1996 was $464 million, an increase of $143 million from September 30, 1995. The increase in receivables is primarily attributable to increased provider and government receivables as well as growth in membership. Medical claims and benefits payable decreased from September 30, 1995, reflecting shifting membership to capitated arrangements.
The following forward looking statements, except where specifically noted, exclude the potential impact of the integration of FHP into the Company subsequent to the FHP Transaction (See Note 13 of the Notes to the Consolidated Financial Statements, and "Recent Developments" and "Business Strategy"). The impact of FHP has been excluded because the Company believes that it has insufficient information to make any projections and that disclosure of any potential impact would be premature.
COMMERCIAL MEDICAL LOSS RATIO. The fiscal year 1997 commercial medical loss ratio is expected to decrease as compared to fiscal year 1996. The Company expects commercial premium rates to increase slightly from September 30, 1996 as competitive pressures ease and the Company pursues its strategic focus on product performance, primarily in California, resulting in premium rate stabilization or increases for its HMO and PPO indemnity products. The Company continues to work with certain large employer groups and other purchasers of commercial health care services which continue to demand minimal premium rate increases or reductions in premium rates while limiting the number of choices offered to employees. Increased provider experience in the newer markets, combined with continual renegotiation of current contracts in all markets, should begin to slightly decrease health care costs, improving the commercial medical loss ratio. Additionally, the anticipated divestiture of PCFL, the recent PDS disposition and restructuring plans (See Note 11 of the Notes to the Consolidated Financial Statements), should contribute to a further decrease in the commercial medical loss ratio.
The commercial and government medical loss ratio expectations discussed above could be affected by various uncertainties, including, without limitation: increases in medical costs, including increases in utilization and costs of medical services and the effect of actions by competitors or groups of providers; termination of provider contracts or renegotiation thereof at less cost-effective rates or terms of payment. In addition, price increases in pharmaceuticals, which have been escalating faster than premium increases in recent years, as well as price increases for durable medical equipment and other covered items plus other factors, as discussed below, could also effect expectations.
MARKETING, GENERAL AND ADMINISTRATIVE SUPPORT INVESTMENTS. Marketing, general and administrative expenses as a percentage of operating revenue in fiscal year 1997 are expected to be slightly higher than fiscal year 1996. The Company plans to increase its investment in medical management to improve its medical loss ratios and expects increased investments in information services to maintain and enhance its current competitive advantage in information technology. In addition, employee incentives will be realigned with fiscal year 1997 targets. Marketing, general and administrative expenses as a percentage of operating revenue for fiscal year 1997 are expected to increase from fiscal year 1996 levels as the Company continues to invest in the combined infrastructure and the consolidation of the Company's regional customer service centers. Marketing, general and administrative expenses could be adversely impacted by the need for additional advertising, marketing, administrative, or management information systems expenditures and the inability to carry out marketing and sales plans. The Company anticipates that the FHP Transaction will yield increased operating income partly resulting from a combination of reductions in marketing, general and administrative expenses. There can be no assurances that the anticipated benefits and synergies may be obtained if the FHP Transaction is consummated. The ability of PacifiCare to realize the anticipated benefits and synergies is subject to the following additional uncertainties, among others: the ability to integrate the Company's and FHP's management and information systems, on a timely basis, if at all; the ability to eliminate duplicative functions while maintaining acceptable performance levels; and the possibility that the integration of FHP will result in the loss of providers, employers, members or key employees of PacifiCare, FHP or their subsidiaries.
PAGE ---- Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . 22 Consolidated Statements of Income . . . . . . . . . . . . . . . . . . 23 Consolidated Statements of Shareholders' Equity . . . . . . . . . . . 24 Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . 25 Notes to Consolidated Financial Statements. . . . . . . . . . . . . . 27 Report of Ernst & Young LLP Independent Auditors. . . . . . . . . . . 39 Quarterly Information for Fiscal Years 1996 and 1995 (Unaudited). . . 40
SEPTEMBER 30 (in thousands, except per share data) 1996 1995 - -------------------------------------------------------------------------------- ASSETS Current assets: Cash and equivalents $ 142,818 $ 279,145 Marketable securities 557,275 532,380 Receivables, net 169,545 112,408 Prepaid expenses 8,274 9,469 Deferred income taxes 56,295 28,207 - -------------------------------------------------------------------------------- Total current assets 934,207 961,609 - -------------------------------------------------------------------------------- Property, plant and equipment at cost, net of accumulated depreciation and amortization 93,816 99,276 Marketable securities - restricted 32,406 23,108 Goodwill and intangible assets 228,834 295,794 Other assets 10,199 5,585 - -------------------------------------------------------------------------------- $ 1,299,462 $ 1,385,372 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
b) BASIS OF PRESENTATION. The accompanying consolidated financial statements include the accounts of the Company and all significant subsidiaries which are more than 50 percent owned and controlled. All significant intercompany transactions and balances have been eliminated in consolidation.
a) CASH AND EQUIVALENTS. Cash and equivalents are defined as cash, money market funds and certificates of deposit with a maturity, on acquisition date, of three months or less.
b) MARKETABLE SECURITIES. The Company has determined that all marketable securities (which are comprised of municipal bonds, corporate notes, commercial paper and U.S. Treasury securities) held at September 30, 1996 and 1995, except marketable securities-restricted, are designated available for sale. Accordingly, such securities are carried at fair value and unrealized gains or losses, net of applicable income taxes, are recorded in shareholders' equity. These marketable securities are available for use in current operations and, accordingly, such securities are classified as current assets without regard to the securities' contractual maturity dates. As of October 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" which decreased marketable securities by $6.3 million, decreased shareholders' equity by $3.8 million and increased deferred tax assets by $2.5 million.
relatively short period of time between origination of the instruments and their expected realization. The Company considers that the carrying value of all long-term obligations approximates the fair value of such obligations.
e) PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are recorded at cost; replacements and major improvements are capitalized, while repairs and maintenance are charged to expense as incurred. Upon sale or retirement of property, plant and equipment, the costs and related accumulated depreciation are eliminated from the accounts. Any resulting gains and losses are included in the determination of net income. Property, plant and equipment including assets under capital leases are depreciated using the straight-line method for financial reporting purposes over estimated useful lives ranging from five to twenty-five years. Leasehold improvements are amortized using the straight-line method over the term of the lease or ten years, whichever is shorter.
g) ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. The Company periodically reviews its long-lived assets for impairment based on discounted future cash flows analyses. In the fourth quarter of fiscal year 1996, the Company determined that certain intangibles, primarily goodwill, were no longer recoverable from future operations (See Note 11 - Impairment, Disposition, Restructuring and OPM Charges).
i) PREMIUMS AND REVENUE RECOGNITION. Prepaid health care premiums from the Company's HMOs' enrolled groups are reported as revenue in the month in which enrollees are entitled to receive health care. Premiums received prior to such period are recorded as unearned premium revenue. Funds received under the federal Medicare programs accounted for approximately 57 percent of the Company's premium revenue for each of the fiscal years ended September 30, 1996, 1995 and 1994.
claims related to insolvent medical groups. The Company's HMOs have stop-loss insurance to cover unusually high costs of care when incurred beyond a predetermined annual amount per enrollee.
l) ACCOUNTING FOR STOCK-BASED COMPENSATION. In October 1995, SFAS No. 123, "Accounting for Stock-Based Compensation," was issued which provides an alternative to Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123 encourages, but does not require, recognition of compensation expense for grants of stock, stock options and other equity instruments to employees based on the fair value. SFAS No. 123 also allows companies to continue to measure compensation cost using the intrinsic value method of accounting prescribed by APB Opinion No. 25. While recognition for employee stock-based compensation is not mandatory, SFAS No. 123 requires companies that choose not to adopt the new fair value accounting rules to disclose pro forma net income and earnings per share under the new method. The Company intends to continue with the intrinsic value based method prescribed by APB Opinion No. 25 and make proforma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in SFAS No. 123 had been applied beginning on October 1, 1996.
m) TAXES BASED ON PREMIUMS AND INCOME. Certain states in which the Company does business require the remittance of excise, per capita or premium taxes based upon a specified rate for enrolled members or a percentage of billed premiums. Such taxes may be levied in lieu of a state income tax. These amounts are recorded in marketing, general and administrative expenses and totaled $6.0 million, $4.3 million and $4.0 million for the fiscal years ended September 30, 1996, 1995 and 1994.
The following table summarizes marketable securities as of September 30, 1996:
The total purchase price for the Acquisitions, including contingent purchase payments, is expected to be approximately $131 million. Based on the fair values of the assets and liabilities of the acquired companies, the preliminary estimate of excess purchase price is approximately $126 million. A final allocation of purchase price will be determined when appraisals and other studies are completed and contingent purchase payments are determined. The Acquisitions have been accounted for as purchases and the operating results of each completed acquisition are included in the consolidated financial statements from the date of purchase. Amortization of excess purchase price is made over a period not to exceed forty years. Proforma results of operations have not been presented because the effects of these acquisitions were not significant.
SEPTEMBER 30 (in thousands) 1996 1995 - -------------------------------------------------------------------------------- 8.80% privately placed senior debt, due in annual installments of $3,750 through November 1997 $ 7,500 $ 11,250 Capitalized lease obligations 2,280 5,655 Other long-term debt 1,726 3,022 - -------------------------------------------------------------------------------- 11,506 19,927 Less amounts due within one year 6,323 7,978 - -------------------------------------------------------------------------------- Long-term debt due after one year $ 5,183 $ 11,949 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
In November 1994, the Company established a $250.0 million revolving line of credit with Bank of America National Trust and Saving Association and a syndicate of banks (the "B of A Credit Line"). At that time, the Company borrowed $82.3 million under the B of A Credit Line to pay the balance owed under a syndicated $130.0 million credit line with The Chase Manhattan Bank. The amount outstanding under the B of A Credit Line was repaid in March 1995 from the proceeds of the sale of the Company's Class B Common Stock (See Note 7 - - "Shareholders' Equity"). At September 30, 1996, the Company did not owe any amounts under the B of A Credit Line.
YEARS ENDING SEPTEMBER 30 (in thousands) - -------------------------------------------------------------------------------- 1997 $ 6,323 1998 3,953 1999 85 2000 76 2001 40 Thereafter 1,029 - -------------------------------------------------------------------------------- $ 11,506 - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Common Stock and Class B Common Stock are entitled to equal amounts per share of cash distributions and stock dividends, if any, upon liquidation of the Company and consideration in a merger or consolidation of the Company.
Joseph S. Konowiecki, the Secretary and General Counsel of the Company, is the sole shareholder of Joseph S. Konowiecki, Inc., a California professional corporation, which is a partner of the law firm of Konowiecki & Rank. The Company purchased legal services from Konowiecki & Rank in the amounts of $4.0 million, $3.2 million and $3.1 million for the fiscal years ended September 30, 1996, 1995 and 1994, respectively.
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
The provision for income taxes for the fiscal years ended September 30, 1996, 1995 and 1994, consists of the following components:
The following table summarizes significant differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to income before income taxes:
b) Stock Option Plans. The Company has granted stock options for employees and directors under various plans including the Stock Option Plan for Executive and Key Employees, as amended (the "1985 Plan"), the Second Amended and Restated 1989 Stock Option Plan for Officers and Key Employees, as amended (the "1989 Employee Plan"), the 1989 Non-Officer Directors Stock Option Plan (the "1989 Director Plan") and the amended 1992 Non-Officer Directors Stock Option Plan (the "1992 Director Plan").
The 1992 Director Plan provides for a maximum of 140,000 shares of Class B Common Stock issuable upon the exercise of NQSOs granted to eligible non-officer Directors of the Company. Non-officer Directors of the Company who are not eligible to receive options under the 1989 Employee Plan are eligible to receive NQSOs under the 1992 Director Plan. The Company's Board of Directors has amended the 1992 Directors Plan, subject to shareholder approval, to: increase the number of shares available under the plan; increase the number of shares underlying the NQSOs automatically granted to eligible directors of the Company each year; and provide for the automatic grant of NQSOs to each eligible director of the Company upon being elected the Company's Board of Directors.
The following table summarizes the activity in NQSOs under the 1985 Plan, the 1989 Employee Plan, the 1989 Director Plan and the 1992 Director Plan for the fiscal years ended September 30, 1996 and 1995:
At September 30, 1996, approximately 1,955,955 shares were reserved for issuance upon the exercise of outstanding options. As of that date, options were exercisable for 308,834 shares of Class A Common Stock at exercise prices of $1.63 - $19.75 per share and 434,411 shares of Class B Common Stock at exercise prices of $1.63 - $66.75. No SARs have been awarded under the 1989 Employee Plan.
c) Performance Incentive Programs. The Company has a long-term performance incentive program, under which all executive officers of the Company and certain officers and key employees of the Company and its subsidiaries are eligible to participate. Incentive compensation is based on the achievement of objectives established by the Compensation Committee (the "Committee") of the Board of Directors and approved by the shareholders of the Company. For fiscal years ended September 30, 1996, 1995 and 1994, the incentive compensation expense for this program was $3.6 million, $3.0 million and $2.5 million, respectively.
The Company also has an annual incentive compensation program. All executive officers of the Company or any subsidiary of the Company are eligible to participate and any officer or full-time employee of the Company or any subsidiary of the Company, determined by the Committee to have a direct, significant and measurable impact on the attainment of the Company's or subsidiary's annual growth and profitability objectives is eligible to participate. Amounts charged to expense for the annual compensation program were $5.1 million, $2.7 million and $7.0 million for the fiscal years ended September 30, 1996, 1995 and 1994, respectively.
resulted in a pretax loss of $9.3 million ($8.3 million or $0.26 loss per share, net of tax), primarily attributable to the write off of goodwill and certain other assets, the majority of which is not deductible for income tax purposes. PrimeCare assumed the daily operations of the PDS clinics on June 1, 1996, delivering primary and specialty health care services to certain members under capitated contracts with PCFL.
c) LITIGATION. The Company is involved in legal actions in the normal course of business, some of which seek substantial monetary damages, including claims for punitive damages which are not covered by insurance. Additionally, the Company's programs, including services provided to government employees, in the normal course of its business, are subject to retrospective audits by the respective regulating agencies. After review, including consultation with counsel, management believes any ultimate liability in excess of amounts accrued which could arise from the actions would not materially affect the Company's consolidated financial position, results of operations or cash flows.
On August 5, 1996, the Company announced that it had entered into a definitive agreement and plan of reorganization with FHP International Corporation, the Fountain Valley-based health care services company("FHP"), in which the Company will acquire FHP for a total purchase price expected to be approximately $2.1 billion (the "FHP Transaction"). FHP is a diversified health care services company which, through its HMO subsidiaries, serves approximately 1.9 million members in 11 states and Guam. FHP reported revenues of $4.2 billion and net income of $44.2 million for the fiscal year ended June 30, 1996. FHP also operates a health indemnity insurer, a workers' compensation insurer, and a national preferred provider organization. FHP operates one of the largest providers of health care services for Medicare beneficiaries in the United States. As a result of the FHP Transaction, the Company and FHP will become wholly-owned subsidiaries of N-T Holdings, Inc., a corporation formed to effect the FHP Transaction ("PacifiCare Holding"). In addition, the FHP Transaction will result in the current operations of the Company in California, Florida, Oklahoma, Oregon, Texas and Washington being expanded to include operations in Arizona, Colorado, Illinois, Indiana, Kentucky, New Mexico, Nevada, Ohio, Utah and Guam. The FHP Transaction will be accounted for as a purchase and is designed to qualify as a tax-free exchange for the stock portion.
In October 1996, PacifiCare Holding entered into a credit agreement, dated as of October 31, 1996 (the "Credit Agreement") with Bank of America as Agent, and a syndicate of financial institutions (collectively, the "Banks") whereby the Banks are obligated to provide a five-year unsecured, revolving credit facility in an aggregate amount of $1.5 billion (the "Credit Facility"). The Company and FHP will provide guarantees under the Credit Facility. PacifiCare Holding may borrow the full amount of the Credit Facility to fund the cash portion of the consideration being paid to FHP shareholders and to pay a portion of the fees and expenses incurred in the connection with the FHP transaction. Thereafter, the Credit Facility will remain available for general corporate purposes. Interest on the borrowing under the Credit Facility will be based on any of the London Interbank Offering Rate, a base rate or competitive bid. Funding under the Credit Facility is subject to the satisfaction of a variety of customary borrowing conditions.