(1) Represents the historical results of operations of the Predecessor Company. The Company's historical financial statements reflect certain expenses, including expenses attributable to employee benefit programs, retirement and health plans, treasury, and insurance, which were incurred by the Predecessor Company and allocated to the Company on a pro rata basis.
(4) Gives effect to the Acquisition and the Recapitalization as if such transactions had occurred on January 1, 1994.
The unaudited pro forma financial information reflects the following unaudited pro forma adjustments (in thousands):
(c) To reflect the elimination of Predecessor Company one-time severance expenses related to staff reductions, as reflected on the audited statement of income for the nine months ended September 30, 1994, of $3,621.
The Company's profitability depends on its customers' service requirements, its ability to meet these requirements efficiently, and the methods of determining compensation for the Company's services. The factors affecting service requirements and compensation levels vary depending on the business unit.
In the large group and alliance businesses, the Company is typically compensated on a capitated or per member, per month ("PMPM") basis. This rate is usually the result of a competitive bidding process, and pricing is typically fixed for a period of time. Future profitability will be influenced by the Company's ability to create value-added services that allow it to deviate from the commodity pricing inherent in the bidding process.
To understand how the Company books acquisitions of administrators in purchase transactions, an understanding of the unique nature of the business is essential. Because administrators can operate with a minimal amount of capital, acquired companies typically have modest tangible asset bases. As evidenced by the Company's recent experiences at Harrington and Consolidated Group, other than the underlying business, there are no intangible long-lived assets such as work force, customer base, or supplier relationships to which the Company could assign significant value, as these are relationships that routinely turn over and are replaced in the ordinary course of business. Often, no single customer of an acquired business constitutes a significant part of the business, and customers typically have annual contracts which may or may not be renewed. Renewal rates can vary significantly on an annual basis. Accordingly, values cannot be assigned to individual customers or contracts. Thus, goodwill, which is the excess of purchase price over the fair value of net assets acquired, is often a significant portion of the purchase price.
At the time of the DGB acquisition, the Company projected a 10% to 15% growth rate in net cash flows at DGB and paid a purchase price which resulted in $9.8 million of goodwill. Since this acquisition, the DGB business has not achieved, and does not expect to achieve, the revenue and net cash flow projections prepared at the time of the acquisition due to, among other things, higher than originally expected attrition rates resulting in ongoing decreases in net revenues (due in part to increased pricing resulting from a reinsurance carrier's departure from DGB's market) and an inadequate distribution system, as evidenced by an underperforming sales force and greater than anticipated operating costs. The Company's efforts to correct these deficiencies have not enabled it to meet its original projections. The Company has determined that its revised projected cash flows will not fully provide for the recovery of the goodwill balance of $8.8 million. Accordingly, the Company has written off $6.6 million of goodwill associated with the DGB acquisition. Any further significant declines in DGB's projected net cash flows may result in additional write-downs of remaining goodwill.
costs in response to changing conditions and does not believe these operations will create any further materially adverse impact on future results of operations.
Historically, the majority of Consolidated Group's business was written with The Travelers Insurance Company, which recently combined with the health insurance business of Metropolitan Life Insurance Company to form MetraHealth. Subsequently, MetraHealth was acquired by United HealthCare, one of the nation's leading HMO companies. Between July 1, 1996 and December 31, 1996, this business represented approximately 75% of Consolidated Group's revenue, or approximately 13% of the Company's consolidated revenue. The Company is dependent on United HealthCare's commitment to the small group market and on the Company's ultimate success in converting the MetraHealth business to United HealthCare's new products. Should the Company have to move this business to another payor, it could experience higher than normal lapse rates and lower than normal margins.
The abandonment of the small group market by either The New England, Celtic Life Insurance Company, or Ameritas Life Insurance Corporation, indemnity payors' ability to manage medical losses, and the degree to which the Company is successful in the MetraHealth conversion, could have a material adverse effect on the Company. With respect to the business serviced by the Company, a decision by any one of these payors to administer and distribute a significant portion of its products directly to small businesses also could have a material adverse effect on the Company.
The following table sets forth, for the periods indicated, the percentages which certain items of income and expense bear to the Company's revenues for such periods.
Revenues for the year ended December 31, 1996 increased $93.5 million, or 93.2%, to $193.8 million from $100.3 million in 1995. This increase resulted primarily from additional revenues of $5.9 million, $6.7 million, $32.1 million, and $42.0 million from the Company's acquisitions of TPCM (effective 9/1/95), DGB (effective 10/1/95), Consolidated Group (effective 7/1/96), and Harrington (effective 7/1/96), respectively. Revenues from HealthPlan Services, Inc. ("HPSI") large group and alliance customers increased $2.1 million and $5.7 million, respectively, over 1995.
Agent commissions expense for the year ended December 31, 1996 increased $12.4 million, or 34.3%, to $48.5 million from $36.1 million in 1995. This increase resulted primarily from $12.6 million of additional commissions related to the Company's acquisitions of TPCM, DGB, Consolidated Group, and Harrington. HPSI's commissions as a percentage of operating revenues declined from 36.8% in 1995 to 34.2% in 1996, as large group revenues represented a greater percentage of total HPSI revenues. Large group commissions (11.9% of 1996 HPSI revenues) represent a lower percentage of revenues than small group commissions (44.9% of 1996 HPSI revenues). If large group revenues continue to represent an increasingly greater percentage of overall consolidated revenues, agent commissions as a percentage of revenues are expected to continue to decline.
Personnel expenses for the year ended December 31, 1996 increased $46.8 million to $72.2 million, or 184.3%, from $25.4 million in 1996. Of this increase, $41.3 million is attributable to the Company's acquisitions of TPCM, DGB, Consolidated Group, and Harrington. Personnel expenses for HPSI increased $5.5 million and are primarily related to additional salaries and wages, overtime, and temporary services related to new activity in HPSI's alliance and large group business units, which are more labor-intensive than the small group business unit. Assuming the mix of activity in the Company's business units is consistent with that of 1996, ongoing personnel expenses as a percentage of revenues are not expected to change significantly.
General and administrative expenses for the year ended December 31, 1996 increased $24.6 million, or 144.7%, to $41.6 million from $17.0 million in 1995. Of this increase, $17.1 million is attributable to costs associated with the Company's acquisitions of TPCM, DGB, Consolidated Group, and Harrington. Costs for HPSI increased by $7.6 million and are primarily attributable to telephone, postage, printing, and professional services related to HPSI's new business activities in the alliance and large group business units.
Contract commitment expenses relate to the recognition of losses on adverse contracts entered into by the Company in previous periods with state-sponsored health care purchasing alliances in Florida and North Carolina. These losses are the result of lower than anticipated growth in lives per case and the resulting excess of cost of service over revenue to be earned over the balance of the applicable contract periods. Discussions have been ongoing with the related sponsors (Florida and North Carolina) to obtain revisions in contract terms sufficient to generate additional revenue or reduced costs. During 1996, the Company was unable to obtain concessions sufficient to offset the adverse results expected on the Florida and North Carolina contracts, resulting in the recognition of a loss of $2.7 million.
Restructure charges result primarily from the Company's closure of its Memphis facility and downsizing of its corporate offices subsequent to the acquisitions of Consolidated Group and Harrington.
The loss on partial impairment of goodwill reflects the write-down of the carrying value of goodwill originally recorded upon the Company's acquisition of TPCM and DGB, which reflects their expected future discounted cash flows (see Item 1, "Business - Recent Transactions and Company Reorganization" for related discussion).
Year Ended December 31, 1995 Compared to Pro Forma Year Ended December 31, 1994
Revenues for the year ended December 31, 1995 decreased $6.9 million, or 6.4%, to $100.3 million from $107.2 million in 1994. This decrease resulted primarily from a decline of $14.2 million in revenues generated from services provided through the small group business unit. Declines in revenue from two of the Company's payors accounted for $8.3 million of this decrease, as such payors deemphasized their small group indemnity products and developed managed care products. Additionally, the loss of one payor relationship, the Centennial Life Insurance Company relationship (which terminated effective January 31, 1995), resulted in a reduction in revenue of $5.2 million. The decline in small group revenue was partially offset by an increase in large group revenue of $6.1 million resulting from the Company's 1995
Agent commissions expense for the year ended December 31, 1995 decreased $7.2 million, or 16.6%, to $36.1 million from $43.3 million in 1994. This decrease resulted principally from the decline in revenues for the period. Agent commissions expense represented approximately 36.8% of operating revenues for the year ended December 31, 1995 (40.4% in 1994). As a percentage of revenues, small group agent commissions are significantly greater than large group agent commissions. Small group agent commissions represented approximately 45.6% of related customer revenues in 1995 (46.7% in 1994), and large group agent commissions represented approximately 10.8% of related customer revenues in 1995 (8.1% in 1994).
Personnel expenses for the year ended December 31, 1995 decreased $2.0 million, or 7.3%, to $25.4 million from $27.4 million in 1994. This decrease was primarily related to the termination of 125 employees of the Predecessor Company on September 30, 1994, offset by $2.4 million of additional personnel costs related to the Company's 1995 acquisitions.
Other operating expenses for the year ended December 31, 1995 decreased $0.2 million, or 1.2%, to $17.0 million from $17.2 million in 1994. The Company realized savings in telephone, rent, leased equipment, and consulting fees in 1995, which were offset by $1.4 million of additional expenses related to the Company's 1995 acquisitions.
Contract commitment expense of $3.6 million for the year ended December 31, 1994 represented the excess of expected future costs over future revenues for the CHPA contract term expiring in April 1997.
On May 19, 1995, the Company completed an initial public offering which generated net proceeds of approximately $51.0 million. On August 31, 1995, HPS used approximately $7.5 million of the offering proceeds to acquire all of the outstanding capital stock of TPCM. On October 12, 1995, HPS used approximately $5.1 million of the offering proceeds to acquire substantially all of the assets of the third party administration business of DGB. The Company placed an additional $5.0 million of the proceeds in an escrow account to guarantee the availability of funds for semi-monthly payments due with respect to the DGB acquisition. On January 13, 1996, using offering proceeds, the Company acquired $2.0 million of preferred stock of Medirisk, representing a 9% ownership interest in Medirisk, and on March 15, 1996, Medirisk exercised its option to issue $6.9 million of debt with detachable warrants to the Company. To date, the Company has not elected to convert the detachable warrants into common stock of Medirisk. On January 29, 1997, Medirisk completed an initial public offering of 2.3 million shares of its common stock at a purchase price of $11.00 per share, and Medirisk subsequently fully satisfied its debt obligation to the Company (see "Notes to Consolidated Financial Statements Investments").
stock without the consent of First Union. During the third quarter of 1996, the Company amended the terms of its credit facility to allow it to spread the effects of the restructuring and integration costs recorded (see "Notes to Consolidated Financial Statements - Restructure and Integration") over three years for purposes of calculating funds availability on its Line of Credit. Similar treatment is in place for calculating compliance with financial covenants. The outstanding draw against the Line of Credit was $55.0 million at December 31, 1996.
The Company expects that the decline in cash flows which resulted in the recording of a $13.7 million charge for the impairment of goodwill will not result in the Company's inability to meet future operating, investing, and financing requirements for the near future, especially given that TPCM and DGB revenues represent approximately 5% of total Company revenue in the fourth quarter of 1996. Cash flow, as measured by earnings before interest, taxes, depreciation, and amortization, approximated $225,000 and $1.7 million for the year ended December 31, 1996 for TPCM and DGB, respectively. In addition, other than the decline in cash flow that led to the impairment of goodwill in the third quarter of 1996, the Company knows of no other effects or expected effects on the Company's results of future operations or financial position. The Company believes that additional revenue will be provided by new products and sales generated by other initiatives of the Company, which will offset the impact on its future operations and cash flows. This statement is forward-looking in nature, however, and actual results may differ if the Company's initiatives are unsuccessful.
Based on current expectations, the Company believes that all consolidated operating, investing, and financing activities for the foreseeable future will be met from internally generated cash flow from operations, available cash, or its existing Line of Credit.