As of June 30, 1996, the Company leased approximately 1.75 million aggregate square feet of space primarily for administrative offices, data processing facilities and claims processing in the states in which it is doing business. These leases expire at various dates through December 2003. The Company owns approximately 463,000 aggregate square feet of space for health care centers in California and Arizona and approximately 249,000 square feet of space for the two hospitals in Southern California. The Company also leases approximately 313,000 aggregate square feet of space for health care centers in Arizona, California and Florida, which leases expire at various dates through June 2001.
(2) In connection with certain acquisitions the Company recorded charges for acquisition and restructuring costs. See Note 1 of Notes to the Consolidated Financial Statements.
The Company achieved record revenues and earnings for the fiscal year ended June 30, 1996. The growth in revenues was primarily driven by (i) commercial enrollment gains from the Company's individual, Medicaid, and Medicare risk products, (ii) continued growth in net earned workers' compensation premium due to growth in premiums written and (iii) revenues related to an entire year of health care delivery under the Washington/Oregon Contract and commencement of health care delivery under the Region 6 Contract during the second quarter. Additionally, in September 1995 implementation of the Califiornia/Hawaii Contract commenced and delivery of health care services began in the fourth quarter. These results were offset in part by losses from the Company's Gem Insurance Company ("Gem") PPO operations and HMO operations in Utah. Fiscal year 1995 revenues were primarily driven by commercial enrollment gains, especially from the Company's individual and Medicare risk products, additional Medicaid enrollment as a result of the acquisition of the Florida Medicaid HMO, growth in net earned workers' compensation premium due to sales and recapture of ceded premium and commencement of health care delivery under the Washington/Oregon Contract during the third quarter. This growth was offset by the January 31, 1994 expiration of the CHAMPUS Reform Initiative Contract for California and Hawaii (the "CRI Contract"). Fiscal year 1994 revenues included $431.3 million in revenues related to the CRI Contract. Revenues in fiscal year 1994 exceeded revenues in fiscal year 1993 primarily as a result of increased commercial enrollment and specialty services revenues, including revenues generated from CalComp which was acquired in August 1993.
Investment and other income, included as a component of the Company's revenues, increased in fiscal 1996 over fiscal year 1995 primarily due to investment of excess surplus and reserves generated by operations and to the sale of IPAs in Florida and Arizona which resulted in gains recognized of approximately $10.4 million in the fourth quarter of fiscal year 1996. Increases in each of the other years is due primarily to the investment of excess surplus and reserves generated by operations, a significant part of investments are held by CalComp and its subsidiaries in tax-exempt securities.
The Company's selling, general and administrative ("SG&A") expenses in fiscal year 1996 increased due primarily to the implementation costs of the Region 6 and California/Hawaii Contracts. The Company's SG&A expenses in fiscal year 1995 increased over 1994 primarily due to the implementation costs of the Washington/Oregon and Region 6 Contracts and start-up of the New Jersey Medicaid administrative services only contract. Fiscal year 1994 SG&A expenses were driven primarily by expenses incurred related to the establishment and operation of government claims processing as an internal function and inclusion of SG&A expenses related to Gem, which was acquired January 1, 1994.
Interest expense decreased in fiscal year 1995 from fiscal 1994 as a result of the prepayment of $11.4 million in bank debt by TDMC in November 1994. Interest expense increased in 1996 over 1995 due to increased borrowing under the Company's unsecured revolving line of credit. Fiscal year 1997 interest expense is expected to increase due to increased borrowings under the Company's credit agreement. See "Liquidity and Capital Resources".
In connection with the mergers of CareFlorida, TDMC and Intergroup, the Company recorded a charge for integration, restructuring and pooling costs of $124.8 million in fiscal year 1995. The acquisition and restructuring charge
These costs satisfy the definition of "exit costs" as set forth in Emerging Issues Task Force Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" that are directly related to the mergers.
As a result of the factors described above, fiscal year 1996 income before income taxes and minority interest increased to $240.6 million. In fiscal year 1995, income before income taxes and the minority interest grew to $203.3 million (before acquisition and restructuring costs). After acquisition and restructuring costs, income before income taxes and minority interest was $78.5 million in fiscal year 1995. Fiscal year 1994 income before income taxes and minority interest increased to $165.9 million as compared to $149.4 million (before acquisition and restructuring costs) for fiscal year 1993. After acquisition and restructuring costs, income before income taxes and minority interest was $137.0 million in fiscal year 1993.
The tax provision for fiscal year 1996 decreased to 30.8% as compared to a rate of 34.2% for fiscal year 1995 as a result of the effect of non-deductible acquisition costs in fiscal year 1995 (which caused a higher than normal rate) and the effect of net operating loss carryforwards which became available during fiscal year 1996 (which caused a lower than normal rate) related to Managed Health Network, Inc., which was acquired by the Company in March 1996. Additional net operating loss carryforwards became available in fiscal year 1996 that further decreased the effective tax rate. The tax provision rate for 1995 of 34.2% was lower than the 1994 rate of 39.1% because of the combined effect of the acquisition and restructuring charge of $124.8 million and the resulting increased proportion of tax-exempt interest income as a percentage of pre-tax income. The rate was further reduced by the acquisition of Intergroup, which is not subject to state franchise or income taxes, and the elimination of a duplicate tax for undistributed income from Intergroup to its former parent company. These rate reductions were mitigated by the effects of non-deductible acquisition expenses. The tax rate is anticipated to increase in fiscal year 1997 as the availability of net operating loss carryforwards is not expected to recur.
Minority interest in fiscal years 1994 and 1995 represents the allocation of Intergroup's net income to the holders of the 39.5% portion of Intergroup common stock not held by TDMC (the "Intergroup Minority Interest"), for the periods prior to the Company's acquisition of the Intergroup Minority Interest.
Through the combination of the factors described above, net income grew from $93.6 million or $1.92 per share in fiscal year 1994 to net income of $128.8 million or $2.35 per share in fiscal year 1995 (before the $124.8 million acquisition and restructuring costs net of related tax-effects). After such charge net of related tax effects, net income for fiscal year 1995
The Company operates in a single industry segment, managed health care. The following table presents financial information reflecting the Company's operations by the three primary lines of business: (i) commercial operations; (ii) government contracts; and (iii) specialty services.
Revenues generated by the Company's commercial operations increased in fiscal year 1996 over fiscal year 1995 due in part to a 31% increase in enrollment from existing lines of business and geographic expansion offset by reductions in commercial premium revenue per member due to continued competitive pricing pressures. Revenues generated by commercial operations in fiscal year 1995 increased over fiscal year 1994 due in part to inclusion of revenues from the January 1994 purchase of Gem and the November 1994 purchases of the Colorado HMO and the Florida Medicaid HMO as well as increased enrollment in existing lines of business. Revenues in fiscal year 1994 increased over fiscal year 1993, reflecting increased enrollment growth and as well as the inclusion of revenue from Gem for the last six months of fiscal year 1994. The Company anticipates revenues to increase during fiscal year 1997 primarily as a result of commercial enrollment growth and revenues related to delivery of health care services pursuant to the Medicaid Mainstream program in California anticipated to commence in mid-fiscal year 1997; however, the rate of increase is not expected to be at the same level as in prior years since, to some extent, prior year increases have resulted from businesses acquired and the Company anticipates continued pressure on its ability to increase premium rates.
The improvement in the specialty services ratio in fiscal year 1995 over that of fiscal year 1994 was primarily due to improvement in the workers' compensation operating ratios, through the successful implementation of managed care programs, which has lowered worker's compensation medical costs, and to the addition of the worker's compensation bill review company, which has a lower administrative component than most of the other specialty services companies. The increase in the specialty services ratio in fiscal year 1996 over that of fiscal year 1995 is primarily due to an increase in the combined ratio in the worker's compensation business as described below.
Commencing in fiscal year 1994, several significant reforms to the California workers' compensation laws affected CalComp. The reforms address various aspects of the workers' compensation system, including limitations on certain types of claims, restrictions on vocational rehabilitation benefits, additional penalties for fraud and abuse, and reductions in state-mandated minimum premium rates which culminated in open rating in California effective January 1, 1995. Since the acquisition of CalComp, the Company has taken various actions to mitigate the effects of the reforms and the sharp premium declines as a result of the more competitive pricing environment under open rating. These actions include development and implementation of its managed care approach to workers' compensation, continued use of loss prevention and return to work programs, shifting of the risk profile of CalComp's business, increased use of the Company's PPO and blended case management systems (which have reduced the average severity per claim). In addition, to diversify its underwriting risk as a result of reduced premium levels on policies written in California and to take advantage of perceived opportunities because of favorable national workers' compensation reform, the Company started to write workers' compensation policies in states outside of California through BICO, a subsidiary of CalComp, licensed to write insurance in 49 states. Since being purchased in February 1995, BICO has increased its estimated annual premiums inforce to over $100 million, and recognized direct premiums earned of approximately $42 million during fiscal 1996. BICO utilizes the same managed workers' compensation approach as CalComp to manage its claim costs. The Company believes these strategies should contribute to the continued growth of this part of the specialty services operations and partially offset the impact from the changes in the California workers' compensation marketplace.
Four ratios are traditionally used to measure underwriting performance of workers' compensation companies: the loss and loss adjustment expense ratio, the underwriting expense ratio and the policyholder dividend ratio, which when added together constitute the combined ratio. A combined ratio of greater than 100% reflects an underwriting loss, while a combined ratio of less than 100% indicates an underwriting profit.
the claims frequency rate decreased by 8% during fiscal year 1996 compared to 1995. In addition to frequency as a percent of payroll decreasing, the average cost of new reported claims was 7% lower than new claims reported during fiscal 1995. This reduction in costs is due to the effective use of managed care techniques, which reduces the medical components of loss costs, lower allocated loss adjustment expenses by utilizing more cost efficient hearing representatives, emphasizing returning the injured worker to some form of modified work, and closing claims more quickly. The reductions in claim incidence and cost, and reductions in estimates for prior accident year claims did not fully offset the impact of reductions in premium revenue due to competitive rating, thereby producing a loss and loss adjustment expense ratio that increased by 1.4% from fiscal 1995.
The policyholder dividend ratio for the fiscal year 1996 was 1.1%. In fiscal year 1996, CalComp issued less than 6% of its California policies on a participating basis. This resulted in minimal policyholder dividends accrued. Currently, California policyholders receive the benefit of lower workers' compensation premiums at the inception of their respective policies, as compared to policyholder dividends which were paid after policy expiration. Though CalComp writes participating policies through BICO in states outside of California, the portion of earned premiums represented by this group is relatively small in fiscal year 1996.
CalComp was able to maintain a consistent loss and loss adjustment expense ratio in fiscal year 1995 through the successful implementation of managed care programs, and the increased use of internal staff to support fair hearing representatives in the settlement of claims, despite the 16% decrease in the minimum rates in California effective October 1, 1994, and the abolishment of minimum rates and the commencement of open rating effective January 1, 1995. The decrease in the combined ratio from fiscal year 1994 to fiscal year 1995 was primarily due to the 6.0% decrease in the policyholder dividend ratio and the 1.3% reduction in the underwriting expense ratio. The underwriting expense ratio decrease is primarily due to the decrease in employee salaries and benefits to 9.7% of premiums in fiscal year 1995 from 11.0% in fiscal year 1994. CalComp was able to achieve this decrease during a period when net premiums earned increased by 20%; however, approximately one-half of such increase was the result of cancellation of CalComp's quota share reinsurance arrangement effective July 1, 1994. Workers' compensation reforms and increased price competition have also resulted in lower policyholder dividends incurred as policyholders now receive the benefit of lower workers' compensation costs in the form of reduced premiums at the inception of the policy versus policyholder dividends paid after the policy expires.
The following table presents unaudited consolidated operating results for the last twelve fiscal quarters. The Company believes that all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the following quarterly results when read in conjunction with the Company's consolidated financial statements included elsewhere herein. Results of operations for any particular quarter are not necessarily indicative of results of operations for a full fiscal year.
Cash provided by operating activities was $156.8 million for the year ended June 30, 1996 as compared to $201.8 million for the prior year. The change is principally due to timing of the receipt or payment of amounts under government contracts as revenues are received monthly in arrears under the current CHAMPUS contracts, while previously some contracts were prepaid. The Company's cash and investments increased from $795.3 million at June 30, 1995 to $939.8 million at June 30, 1996. The Company invests its cash in investment grade securities.
In January 1996, the Company sold its affiliated California IPAs to FPA for a purchase price consisting of cash and a promissory note payable over 10 years, see notes 1 and 11 to the Consolidated Financial Statements. The notes receivable under the revolving credit agreements with the IPAs in the amount of $10 million were repaid to the Company and terminated in connection with the transaction.
On June 28, 1996, the Company and the sole shareholder of the Foundation Health Medical Group, Inc. and Thomas-Davis Medical Centers, P.C. (collectively referred to as the "Medical Groups") entered into a Stock and Note Purchase Agreement whereby the Company will sell all the outstanding stock of Foundation Health Medical Services ("FHMS"), its management services organization, and the shareholder will sell all the outstanding stock of the holding company for the Medical Groups to FPA. The aggregate consideration consists of $2 million cash, $75 million of FPA common stock, $22 million bridge note due five months after closing and bearing a floating interest rate and a $12 million note to be consolidated with the assumption of the intercompany indebtedness of FHMS, the holding company and the Medical Groups to FHC by FPA (estimated to be $80 million as of June 30, 1996, which amount will be adjusted for liabilities incurred, up to $12 million, between June 30, 1996 and the closing of the transaction, currently anticipated for October 1, 1996). The consolidated note will bear interest at a floating rate with amortization of principal on a 15 year schedule with the remaining principal and accrued interest due 84 months after close. FPA will also assume other liabilities owed by FHMS, the Holding Company and the Medical Groups to third parties (estimated to be $41 million as of June 30, 1996). The promissory notes will be secured by the assets and stock of the FPA, the purchasing company, FHMS, the holding company and the Medical Groups. The promissory notes will be guaranteed by FPA. The Company's affiliated health plans in Arizona, California and Florida will have agreed to pay to FPA an aggregate of $55 million during the period commencing August 1996 through December 1998 for continued and uninterrupted access as defined in the Purchase Agreement to the professional providers of the IPAs and the Medical Groups for the Company's affiliated health plan enrollees.
In December 1994, the Company established a $300 million unsecured revolving credit agreement with Citicorp USA, Inc. as Administrative Agent (the "Credit Agreement") for the lenders parties thereto. As of August 15, 1996, the Company has drawn $230 million under the Credit Agreement. In June 1993, the Company issued $125 million of Senior Notes due June 1, 2003, which bear interest at 7.75% due semiannually (the "Senior Notes"). See Notes 7 and 13 to the Consolidated Financial Statements for a more detailed description of the TROL financing, the Credit Agreement and the Senior Notes.
In April 1993, the Company established a stock repurchase program (as amended) to acquire from time to time up to 5.7 million shares of the Company's common stock in the open market at prices deemed appropriate by management and subject to market conditions and other relevant factors. As of June 30, 1996, the Company had repurchased 1,795,500 shares under the program, 250,000 of which were repurchased in fiscal year 1996.
Certain of the Company's subsidiaries are required to maintain reserves to cover their estimated ultimate liability for claims, losses and loss adjustment expenses with respect to reported and unreported claims incurred. These reserves are estimates of future costs based on various assumptions. Establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience, which in the past has resulted and in the future could result in loss reserves being too high or too low. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicial administration of claims, medical costs and other factors. Future loss development or governmental regulators could require reserves for prior periods to be increased, which would adversely impact earnings in future periods.
The Company currently believes its available cash resources will be sufficient to meet its current operating requirements and internal development and integration activities. However, external financing sources may be required to
In October 1995, the Financial Accounting Standards Board issued Statement No. 123, "Accounting for Stock-Based Compensation". The new standard defines a fair value method of accounting for stock options and other equity instruments, such as stock purchase plans. Under this method, compensation cost is measured on the fair value of the stock award when granted and is recognized as expense over the service period, which is usually the vesting period. This standard will be effective for the Company beginning in fiscal 1997, and requires measurement of awards made on or after December 15, 1995. The new standard permits companies to continue to account for equity transactions with employees under existing accounting rules, but requires disclosure in a note to the financial statements of the pro forma net income and earnings per share as if the Company had applied the new method of accounting. The Company intends to follow the disclosure requirements for its employee stock plans. The new standard will also require that all stock-based transactions with non-employees be measured in accordance with the fair value method and recorded as expense. The Company has not determined the effect, if any, of implementing this standard on its results of operations.
In March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of ("FAS No. 121"). The Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Statement also requires that long-lived assets and certain identifiable intangibles to be disposed of be reported at the lower of carrying amounts or fair value less cost to sell. This Statement will be effective for the Company beginning in fiscal 1997. Adoption of FAS No. 121 is not expected to have a significant effect on the Company's consolidated financial Statements.