The increase in the commercial medical loss ratio has been driven by the Company's entry into new markets, through acquisitions and internal development, with principally traditional fee-for-service delivery systems. Implementing the Company's provider contracting approach, shifting the delivery systems from fee- for-service to capitation and risk-sharing arrangements, and developing the provider network through education in these markets are expected to decrease the commercial medical loss ratio by the end of fiscal 1996. Until health care cost risks are mitigated through contract renewals beginning January 1, 1996 and later, the commercial medical loss ratio may increase slightly in the first and second quarter of fiscal 1996. The decrease in the government medical loss ratio is primarily related to more cost effective physician and hospital contracts. The government medical loss ratio is expected to increase in 1996 as competitive pressures increase health care costs and outpace increases in premium revenue.
Marketing, general and administrative expenses increased $104 million or 26 percent to $498 million for the year ended September 30, 1995 from $395 million for 1994. As a percentage of operating revenue, marketing, general and administrative expenses decreased to 13.4 percent from 13.6 percent. The decrease is primarily attributable to increased operating revenue and efficiencies due to process improvements which have offset infrastructure investments in new markets. Marketing, general and administrative expenses as a percentage of operating revenue in fiscal 1996 are expected to be comparable to, or slightly higher than, fiscal 1995 as mature market process improvements are offset by investments in new markets.
Total operating revenue increased 30 percent or $672 million to $2.9 billion for the year ended September 30, 1994 from $2.2 billion for the same period in 1993. Enrollment gains in both the government and commercial programs provided an increase in total operating revenue of $451 million, while an additional $77 million was derived from higher premium rates in both programs. In addition, approximately $106 million of the increase in total operating revenue represented the incremental operations of acquisitions described in Note 5 of the Notes to Consolidated Financial Statements. The Company's specialty managed care products and services and its joint venture medical groups contributed the remainder of the increase.
Commercial premiums increased $191 million to $1.2 billion for the year ended September 30, 1994 from $1 billion in 1993. Excluding the effects of the acquisitions described above, membership growth provided 46 percent of the increase in the commercial HMO program. An additional 21 percent of the increase was attributable to higher premium rates, which rose an average of three percent. The remainder of the increase in commercial premiums was derived from commercial specialty managed care products and services and joint venture medical groups.
medical loss ratio was primarily attributable to lower inpatient hospital costs. The decrease in the government medical loss ratio was primarily related to lower hospital expenses and increases in net positive reserve adjustments described below.
For the year ended September 30, 1994, before the cumulative effect of a change in accounting principle, earnings per share increased 34 percent to $3.02 compared to $2.25 for 1993. The increase was primarily related to membership growth derived substantially from the government programs. Decreases in health care service expenses were partially offset by increases in marketing, general and administrative expenses. The results for the years ended September 30, 1994 and 1993 include approximately $0.18 and $0.12, respectively, related to the net positive reserve adjustments previously described. Changes in income tax accounting principles (see Note 2j of the Notes to Consolidated Financial Statements) increased earnings per share by approximately $0.20, resulting in earnings per share of $3.22 for the year ended September 30, 1994.
The Company's working capital as of September 30, 1995 was $321 million, an increase of $89 million from September 30, 1994. The increase in working capital is primarily attributable to increases in cash and accounts receivable offset by increases in accounts payable, accrued liabilities and unearned premium revenue resulting from growth in operations. Medical claims and benefits payable decreased from September 30, 1994, reflecting shifting membership, primarily in the Secure Horizons programs, to capitated arrangements, coupled with improvements in claims processing that result in faster payment and fewer claims awaiting adjudication and payment. For the year ended September 30, 1995, payments for physician and hospital capitation represented approximately 68 percent of total health care costs, an increase of four percent over 1994. Redesigned work processes and electronic data interface technologies resulted in more efficient and prompt payment of claims. While the expedited claims payment process is expected to reduce interest income, these operating efficiencies enhance the Company's ability to comply with certain HMO regulations.
The Company made acquisitions using $135 million of cash, decreasing the net purchases of marketable securities. The Company made capital expenditures of $25 million for the year ended September 30, 1995 primarily for computer equipment. The Company anticipates that the level of capital expenditures will increase in 1996 in connection with the Company's ongoing program of updating and enhancing its management information systems.
In March 1995, the Company completed a public offering of 5,175,000 shares of its Class B Common Stock, of which 3,000,000 shares were sold by the Company and 2,175,000 share were sold by UniHealth. The Company received net proceeds of approximately $198 million for the sale of the 3,000,000 shares of Class B Common Stock after deducting underwriting discounts and commissions and expenses of the offering payable by the Company. The Company used approximately $186 million of the net proceeds to repay the amount outstanding under its line of credit (see Note 6 -
"Long Term Debt") and to replenish working capital used to pay for certain of the acquisitions (see Note 5 - "Acquisitions").
The Company believes that its current capital resources, which includes the $250 million line of credit with B of A, are adequate to fund existing HMO operations, the introduction of new products and services and the continued development of its health-care related businesses (see Note 6 - "Long Term Debt" for a summary of the terms of the B of A Credit Line).
a) Organization and Operations. PacifiCare Health Systems, Inc. (the "Company") owns and operates federally qualified health maintenance organizations ("HMOs"), which arrange health care services principally for a predetermined, prepaid periodic fee to enrolled subscriber groups through independent health care organizations under contract. The Company also offers certain specialty products and services to group purchasers and to other managed care organizations and their beneficiaries, including pharmacy benefit management, life and health insurance, behavioral health, Medicare risk management services and vision services, coordination of managed care products for multi-region employers, military health care management, workers' compensation managed care and health promotion. UniHealth, a California non- profit public benefit corporation owned approximately 44 percent and two percent of the Company's outstanding shares of Class A and Class B Common Stock, respectively, at September 30, 1995.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. The statement also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt SFAS No. 121 on October 1, 1996 and, based on current circumstances, does not believe the effect of the adoption will be material.
e) Software Costs. Direct costs associated with the development of computer software are expensed as incurred. These costs totaled $12.1 million, $9.6 million and $7.0 million in 1995, 1994 and 1993, respectively.
f) 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 years ended September 30, 1995 and 1994 and 52 percent for the year ended September 30, 1993.
The Company's HMOs have various programs that provide incentives to participating medical groups through the use of risk-sharing agreements and other programs. Payments are made to medical groups based on their performance in controlling health care costs while providing quality health care. Expenses related to these programs, which are based in part on estimates, are recorded in the period in which the related services are dispensed.
The cost of health care provided is accrued in the period it is dispensed to the enrolled members, based in part on estimates for hospital services and other health care costs which have been incurred but not yet reported. The Company has also recorded reserves, based in part on estimates, to indemnify its members against potential referral 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.
i) Earnings Per Share. Earnings per share are computed on the weighted average number of common shares outstanding each year. Outstanding stock options are common stock equivalents and are included in earnings per share computations.
The following table summarizes marketable securities as of September 30, 1995:
As of September 30, 1995, the contractual maturities of the Company's marketable securities were as follows:
During the year ended September 30, 1995, proceeds from sales and maturities of marketable securities were $2.7 billion, resulting in gross realized gains of $6.0 million and realized losses of $6.8 million. Realized gains and losses are included in investment income under the specific identification method.
The following table summarizes the components of property, plant and equipment:
During fiscal 1994, the Company made the following acquisitions (the "1994 Acquisitions"): (i) Freedom Plan, Inc., a Santa Barbara, California-based HMO, with approximately 14,000 members in October 1993; (ii) California Dental Health Plan, Inc., a southern California-based dental HMO and its affiliate, Dental Plan Administrators, a third party administrator, in November 1993; (iii) Advantage Health Plans, Inc., a southern Florida-based HMO, with approximately 20,000 members in December 1993; (iv) Network Health Plan, Inc., a Washington- based health care service contractor, with approximately 28,000 members in February 1994; and (v) Pasteur Health Plans, Inc., a southern Florida-based HMO, with approximately 50,000 members in August 1994. The 1994 and the 1995 Acquisitions shall together be referred to herein as the "Acquisitions" and the companies acquired through the Acquisitions shall be referred to as the "Acquired Companies."
The following table summarizes the unaudited pro forma consolidated results of the Company as though the Acquisitions had occurred at the beginning of the periods presented giving effect to the interest income foregone, the costs associated with the integration of the operations into those of the Company and the amortization of the excess of the purchase price over the fair value of the assets acquired. The unaudited pro forma information is not necessarily indicative of the actual consolidated results of operations that would have occurred had the Acquisitions occurred at the beginning of the period and is not intended to be indicative of results which may occur in the future.
(1) The unaudited pro forma income before cumulative effect of a change in accounting principle for the year ended September 30, 1994 was $73.2 million or $2.62 per share. The unaudited pro forma cumulative effect on prior years of a change in accounting principle for the year ended September 30, 1994 is $5.7 million or $0.20 per share (see Note 2j of the Notes to Consolidated Financial Statements).
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"). The B of A Credit Line has a five year term with interest payable at a rate per annum equal to the London Interbank Offered Rate plus a margin. The B of A Credit Line is subject to, among other things, certain financial covenants, including a fixed charge ratio and a leverage ratio. The B of A Credit Line may be extended beyond its five year term but not beyond November 30, 2001. In November 1994, the Company borrowed $82.3 million under the B of A Credit Line to pay the balance owed on the syndicated $130.0 million credit line with The Chase Manhattan Bank, N.A. 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, par value $0.01 per share (the "Class B Common Stock") (see Note 7 - "Shareholders' Equity").
As of September 30, 1995, the maturities of long-term debt for the years following 1995 are as follows:
In March 1995, the Company completed a public offering of 5,175,000 shares of its Class B Common Stock, of which 3,000,000 shares were issued and sold by the Company and 2,175,000 shares were sold by UniHealth. The sale of 4,500,000 shares of the Class B Common Stock closed on March 23, 1995 with the sale of the additional 675,000 shares of the Class B Common Stock occurring on March 29, 1995 pursuant to the exercise of the underwriters' over-allotment option.
On December 13, 1993, UniHealth completed a public offering of 575,000 shares of the Company's Class A Common Stock. The Company did not receive any of the proceeds from this offering.
In November 1992, the Company completed a public offering of 3,200,000 shares of Class B Common Stock, of which 1,600,000 shares were sold by the Company and 1,600,000 shares were sold by UniHealth. The net proceeds received by the Company were approximately $59 million after deducting underwriting discounts and commissions, and expenses of the offering.
The Company purchased health care services from hospitals owned and managed by UniHealth totaling $70.6 million, $61.5 million and $55.5 million for the years ended September 30, 1995, 1994 and 1993, respectively. Under the terms of a management arrangement with UniHealth, the Company paid $0.7 million, $0.8 million and $1.2 million for management fees, payroll processing services and other services in the years ended September 30, 1995, 1994 and 1993, respectively.
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 $3.2 million, $3.1 million and $2.3 million for the years ended September 30, 1995, 1994 and 1993, respectively. The amount payable to Konowiecki & Rank was $0.2 million at September 30, 1995 and 1994.
a) Savings and Profit-Sharing Plan. The Company has an employee profit- sharing plan (the "Plan") covering substantially all full-time employees, which provides for annual contributions by the Company of two percent of the annual compensation of employees and additional amounts determined by the Board of Directors which are generally based upon a percentage of pretax income. Employees may defer up to twelve percent of their annual compensation under the Plan, with the Company matching one-half of the deferred amount, up to a maximum of three percent of annual compensation. Amounts charged to expense applicable to the Plan were $14.3 million, $10.3 million and $7.8 million for the years ended September 30, 1995, 1994 and 1993, respectively.
The following table summarizes the activity in NQSQs under the 1985 Plan, the 1989 Employee Plan, the 1989 Director Plan and the 1992 Director Plan for the years ended September 30, 1995 and 1994:
a) Lease Commitments. The Company leases office space and equipment under various non-cancelable operating leases. Rental expense for the years ended September 30, 1995, 1994 and 1993 totaled $18.3 million, $10.2 million and $8.1 million, respectively. Future minimum lease payments under operating leases at September 30, 1995 are as follows:
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. 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.
Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of investments in marketable securities, interest rate swap agreements and commercial premiums receivable. The Company's short-term investments in marketable securities are managed by professional investment managers within guidelines established by the Board of Directors, which, as a matter of policy, limit the amounts which may be invested in any one issuer. Concentrations of credit risk with respect to commercial premiums receivable are limited due to the large number of employer groups comprising the Company's customer base. The interest rate swap agreements contain an element of risk that the counter parties may be unable to meet the terms of the agreement. However, the Company minimizes such risk exposure for interest rate swap agreements by limiting the counterparties to major financial institutions. As of September 30, 1995, in Management's opinion, the Company had no significant concentrations of credit risk.