CompManagement currently leases approximately 39,000 square feet of office space at 5777 Frantz Road, Dublin, Ohio. This lease will expire in December 1997. CompManagement has entered into a lease for a building under construction located in Dublin, Ohio, which it expects to occupy in October 1997. CompManagement will initially lease approximately 50,000 square feet of office space in this new building. CompManagement also leases office space in Akron, Cleveland, and Toledo, Ohio, which is used as service centers for its operations.
The following table sets forth selected consolidated financial data, operating statistics, and membership data for the Company as of and for each of the years in the five-year period ended December 31, 1996. All periods in the table have been restated to reflect the acquisition of CompManagement, which was accounted for as a pooling of interests.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
We have audited the accompanying consolidated balance sheets of Health Power, Inc., and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
f. PROPERTY, EQUIPMENT AND SOFTWARE: Depreciation and amortization of property, equipment and software is computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 25 years.
Depreciation expense amounted to $359,855, $202,242 and $111,101 in 1996, 1995 and 1994, respectively.
Effective January 1, 1997, the HMO entered into an agreement to outsource the claims adjudication and payment process and other administrative functions related to the HMO's Medicaid and commercial members with a third-party administrator. The administrative and claim processing fees are subject to change on January 1 of each year, beginning January 1, 1998.
i. INCOME TAXES: Deferred income tax assets and liabilities are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
k. STOCK-BASED COMPENSATION: Compensation cost is measured under the intrinsic value method. Pro forma disclosures of net income and earnings per share are presented as if the fair value based method has been applied (see Note 11).
Separate results of the combined entities for the six months ended June 30, 1995 are as follows:
Certificates of deposit represent amounts held on deposit under the terms of the HMO's Certificate of Authority with the Ohio Department of Insurance and the Ohio Department of Human Services.
The Company's HMO maintains stop-loss insurance coverage for 85% of inpatient hospital costs in excess of $50,000 ($40,000 prior to April 1, 1996 and $30,000 prior to April 1, 1995) per Medicaid member, per contract year. The HMO also maintains stop-loss insurance coverage for varying percentages (generally 80%) of inpatient hospital costs in excess of $75,000 per commercial member, per contract year, subject to certain limitations. These reinsurance contracts do not relieve the Company from its obligations to commercial members, and failure of reinsurers to honor their obligations could result in losses to the Company.
Stop-loss insurance premiums of $1,848,274, $1,500,957 and $1,507,576 are included in health care costs for 1996, 1995 and 1994, respectively. Stop-loss recoveries of $1,897,806, $1,248,179 and $1,294,189 are deducted from health care costs for 1996, 1995 and 1994, respectively.
The significant components of the deferred tax benefit (expense) for the years ended December 31, 1996, 1995 and 1994 were as follows:
The components of the net deferred benefit (tax) asset as of December 31, 1996 and 1995 were as follows:
Due to the uncertain nature of their ultimate realization based upon past levels of taxable income, the Company has established a full valuation allowance on the net deferred tax asset at December 31, 1996. While the need for this valuation allowance is subject to periodic review, if the allowance is reduced, the tax benefits of these tax assets will be recorded in future operations as a reduction of the Company's income tax expense.
The Company's Medicaid revenue is derived from a contract with the ODHS. The Company's current contract with ODHS is for a one-year term through June 30, 1997.
As of December 31, 1996, future minimum rental payments under the leases are as follows:
b. COMMERCIAL REVENUE: Certain affiliated providers have contracted with the Company's HMO to provide health care services to their employees and dependents. The Company recognized commercial premiums from these affiliated providers in the amounts of $137,223, $152,774 and $115,985 in 1996, 1995 and 1994, respectively.
Under the Plans, the Company is authorized to issue shares of common stock pursuant to "awards" granted in various forms, including incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended), nonqualified stock options, and other similar stock-based awards to directors and eligible employees of the Company for up to 340,000 common shares of the Company. The Company granted stock options in 1995 and 1996 under the Plans in the form of incentive stock options and nonqualified stock options. In January 1997, the Company registered 35,000 shares of common stock for the 1996 directors stock award plan.
b. EMPLOYEE AND DIRECTOR STOCK OPTIONS: The Company granted market price stock options in 1995 and 1996 to employees and directors. The stock options granted in 1995 and 1996 have terms of 10 years. The options granted to directors were vested immediately on the grant date. The options granted to employees vest at the rate of 25% per year on each of the
A summary of the status of the Company's stock options as of December 31, 1996 and 1995, and the changes during the years ended on those dates is presented below:
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1995 and 1996, respectively: no dividend yield for all years; risk-free interest rates are different for each grant and range from 5.44% to 7.06%; the expected lives of options are estimated to be five years; and a volatility of 54.73% for all grants.
d. MEDOHIO STOCK OPTIONS: During 1996, the Company entered into a management agreement with Med Ohio Health, Inc. and Med Ohio Health Plan, Inc. to offer a managed care product. In connection with this agreement, MedOhio was granted the option to purchase 25,000 shares of common stock of the Company. Each option has an exercise price of $6.50 per share. This option vests based on performance over the four-year period beginning with the year closing on June 30, 1997 and ending with the year closing on June 30, 2000. At the end of each year within this period, 6,250 options will vest if a predetermined number of new members are added by MedOhio for the year (otherwise, the 6,250 options are forfeited).
Each of the 25,000 options has a fair value of $3.36 for purposes of SFAS 123. The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; a risk-free interest rate of 6.64%; an expected life of five years; and a volatility of 54.73%. Based on the current status of the Company and Med Ohio's performance (number of new members added) to date, the Company has made no determination that it is likely that the 1996 options will vest. As a consequence and in accordance with SFAS 123, the Company has not yet recognized any expense for these options. All these options are outstanding at December 31, 1996 (the first vesting has not yet ended) and have a remaining contractual life of five and one-half years and an exercise price of $6.50 per share.
On December 5, 1996, due to the Company's HMO's statutory deficit, the Department issued an order placing the HMO under supervision. The order also placed certain financial and other restrictions on the HMO and required the HMO to submit to the Department a corrective action plan, by January 17, 1997, describing management's proposed actions to improve the HMO's financial position.
Payment of dividends by HMOs is subject to prior approval by the Department when the fair market value of the divided or distribution, inclusive of any other dividends or distributions made within the preceding 12 months, is in excess of 15% of the HMO's total statutory net worth as of the preceding December 31. At December 31, 1996, no dividends can be paid by the HMO to the Company.
In connection with the initial public offering, the Company issued warrants to its underwriters to purchase 30,000 shares of common stock at an exercise price of $13.20. None of the warrants has been exercised as of December 31, 1996. The warrants expire on March 3, 1999.
The Health Power HMO subsidiary was declared to be exempt from Ohio Franchise and Net Income Tax due to its status as an insurance company as determined under the regulations of the Department. Therefore, the Company was able to file refund claims with the Ohio Department of Treasury resulting in additional income tax income of $684,455.
There were no cash dividends paid by the Company's consolidated subsidiaries to the Company in 1996, 1995, or 1994.