The Company has two reportable segments for its continuing operations, TPA services and MCO services, which were determined based upon its method of internal reporting. Each of these segments is managed separately. The Company also has an all other segment which derives its revenues from management fees and interest income. See Note 13 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Form 10-K.
As discussed in Item 3 of the Form 10-K, on January 21, 1999, an administrative hearing was held before ODI regarding ODI's intention to suspend or revoke the certificate of authority issued to Health Power HMO for failing to maintain total admitted assets equal to at least 110% of its liabilities and for failing to meet Ohio's minimum statutory net worth requirements. The hearing officer issued a report recommending that the Superintendent of Insurance issue an order to revoke Health Power HMO's certificate of authority, and on March 18, 1999, ODI issued an order revoking Health Power HMO's certificate of authority effective May 1, 1999. On March 19, 1999, Health Power HMO received notice from ODHS that, due to the issuance of the revocation order, ODHS was commencing the disenrollment of Health Power HMO's Medicaid members effective March 31, 1999. As a result of ODHS's action, Health Power HMO will discontinue its Medicaid operations effective April 1,1999. Health Power HMO will discontinue its commercial operations effective May 1, 1999.
Revenues from continuing operations increased $2.7 million, or 12.1%, to $24.9 million during 1998, from $22.2 million for 1997, primarily as a result of a 15% increase in revenues from MCO services. This increase was primarily the result of the Company's MCO subsidiary being operational for all of 1998 as compared to ten months in 1997. Revenues from TPA services increased by 9% from the prior year primarily as a result of an increase in the number of employers participating in the Company's group rating plans. Revenues from MCO services included one-time incentive payments of approximately $4.0 million related to the acceptance of workers' compensation claims with dates of injury which preceded the commencement date of the Health Partnership Program. The acceptance of these claims, known as beta and gamma claims, occurred during the fourth quarter of 1997. The Company recognized approximately $2.5 million of these one-time incentive payments in 1997 and $1.5 million in 1998.
General and administrative ("G&A") expenses increased to $21.3 million, or 85.6% of revenues, for 1998, as compared to $16.6, or 74.6% of revenues, for 1997. G&A expenses increased in 1998 as a percentage of revenues primarily due to 1997 revenues including significant one-time incentive payments related to the acceptance of beta and gamma claims.
Interest income and other decreased $88,000 to $444,000 for 1998, from $532,000 for 1997. This decrease resulted primarily from a decrease in other income related to the discontinuance of a private label managed care product managed by Health Power Management Corporation.
Income tax expense was $1.6 million in 1998, or an effective tax rate of 39%, as compared to $2.3 million in 1997, or an effective tax rate of 38%.
The Company incurred a net loss of $4.1 million, or basic and diluted earnings per share of $(1.06), for 1998, as compared to net income of $3.0 million, or basic and diluted earnings per share of $0.79, for 1997. There were 3,828,564 and 3,818,465 basic weighted average of shares of common stock and common stock equivalents outstanding at December 31, 1998 and 1997, respectively, and 3,834,858 and 3,832,650 diluted weighted average of shares of common stock and common stock equivalents outstanding at December 31, 1998 and 1997.
The net loss from discontinued operations was $0.8 million, or basic and diluted earnings per share of $(0.21), for 1997, as compared to a net loss from discontinued operations of $9.9 million, or basic and diluted earnings per share of $(2.59), for 1996. The improvement in the loss from discontinued operations primarily resulted from a smaller after-tax loss from Health Power HMO's operations due to the accounting for deferred taxes and the write-off of the entire purchase price of $5.0 million paid by Health Power HMO to acquire certain contract rights from ChoiceCare Health Plans, Inc.
A working capital deficit of $1.1 million from continuing operations existed at December 31, 1998, as compared to working capital from continuing operations of $3.2 million at December 31, 1997. The working capital deficit resulted from incurring $3.5 million in short term debt for the acquisition of M&N Risk Management, including a $3.0 million bank loan due on demand. The Company believes that cash generated from continuing operations should be sufficient to cure the working capital deficit during 1999. In addition, the Company is considering refinancing the bank demand loan for a long-term bank loan once the windup of Health Power HMO is substantially complete. However, there can be no assurance that cash generated from continuing operations will be sufficient to cure the working capital deficit or that the Company will be able to refinance this demand loan for a long-term bank loan. In addition, although the Company believes that the bank does not intend to make demand for payment of such loan in the immediate future, the facts and circumstances surrounding the Company could change at any time such that the bank would demand payment of such loan. Such a demand for payment could have an adverse effect on the Company's financial condition and results of operations.
As previously described, CompManagement acquired all of the outstanding capital stock of M&N Risk Management and a related entity on December 31, 1998. The purchase price for this acquisition, after an adjustment based upon the closing net equity of M&N Risk Management and the related entity, was $5,526,736. The purchase price was financed by a $3,000,000 promissory note from National City Bank (the "Bank") and by a $2,526,736 promissory note payable to the seller. The promissory note from the Bank is due on demand, accrues interest at the Bank's prime rate (currently 7.8%), and is secured by a lien on all business assets of CompManagement, CompManagement Health Systems, and M&N Risk Management. The seller's promissory note is a three-year note maturing on December 31, 2001. This note provides for principal payments in the amounts of $526,736, $1,000,000, and $1,000,000 due on December 31, 1999, 2000, and 2001, respectively, and interest payments at the rate of 7% per annum due quarterly over the term of the note. The payment of the seller's promissory note is guaranteed by M&N Risk Management and is secured by a lien on all business assets of CompManagement, CompManagement Health Systems, and M&N Risk Management. The seller's promissory note and all liens granted with respect to such note are subordinated in all respects to the Bank's promissory note.
involvement. Health Power HMO has commenced the immediate windup of its business and is in the process of collecting all of its receivables and other assets and attempting to sell or otherwise dispose of all of its properties on the most favorable terms and conditions under the circumstances. Once this process has been completed, Health Power HMO will pay, or make provision for payment of, claims against it, to the extent funds are available. Health Power HMO intends to pay its creditors in a fair and equitable manner, in order of priority, and on a pro rata basis. Health Power HMO anticipates that its windup will be completed by the end of 1999. Health Power HMO expects that its liabilities will exceed its assets by a significant amount. Accordingly, it is not anticipated that the creditors of Health Power HMO will receive payment in full for their claims against Health Power HMO. Health Power, Inc. believes that neither it nor any of its other subsidiaries are liable for any claims against Health Power HMO. Furthermore, Health Power, Inc. does not intend to fund, or cause any other subsidiary to fund, any deficits of Health Power HMO.
The Year 2000 issue is the result of computer programs having been written using two digits rather than four to define the applicable year. Any information technology ("IT") systems used by the Company that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of uncertain duration in the Company's operations, including, among other things, an inability to process transactions or engage in normal business activities. The Company uses IT systems which are essential to its operations, such as computer software and hardware in the mainframe, midrange and desktop environments, as well as telecommunications. Additionally, the impact of the problem extends to non-IT systems, such as automated building systems and instrumentation.
The timetable provides for the Company's completion of its remediation of any Year 2000 issues by the end of the third quarter of 1999. During the first quarter of 1999, the Company substantially completed an inventory of its IT systems. According to the compliance plan, the testing phase is expected to be complete by the end of the second quarter of 1999. In that phase, the Company will perform a system-wide test on all of its proprietary and non-proprietary IT systems and applications for Year 2000 compliance. The Company believes that all proprietary and non-proprietary IT systems and applications utilized by the Company are either Year 2000 compliant or will be Year 2000 compliant upon installation of available patches and upgrades. The Company currently believes that all of its IT systems will be Year 2000 compliant by the end of the third quarter 1999. The Company also performed a Year 2000 readiness review of M&N Risk Management in connection with the acquisition of that company, and the Company currently believes that all of M&N Risk Management's IT systems will be Year 2000 compliant by the
The Company currently believes that all Year 2000 issues will be resolved in a timely manner and that costs associated with Year 2000 compliance issues will not be material to the Company's financial position or results of operations. However, there is a risk that third parties will not achieve Year 2000 compliance in a timely manner, which could have an adverse effect on the Company's operations. The Company's Year 2000 committee intends to develop appropriate contingency plans as necessary to address Year 2000 compliance issues as they arise.
Statements contained in this Form 10-K or any other reports or documents prepared by Health Power, Inc. or made by management of Health Power, Inc. may be "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause Health Power, Inc.'s operating results to differ materially from those projected. The following factors, among others, in some cases have affected and in the future could affect Health Power, Inc.'s actual financial performance.
POTENTIAL LEGAL ACTIONS RELATED TO HEALTH POWER HMO AND ITS DISCONTINUED OPERATIONS
Due to the revocation of its certificate of authority effective May 1, 1999, and the disenrollment of its Medicaid members effective March 31, 1999, Health Power HMO has commenced the immediate windup of its business. The revocation order issued by ODI permits Health Power HMO to conclude its affairs and to windup its business on its own, subject to ODI's continuing supervision, but without judicial involvement. Health Power HMO expects that its liabilities will exceed its assets by a significant amount. Accordingly, it is not anticipated that the creditors of Health Power HMO will receive payment in full for their claims against Health Power HMO. Health Power, Inc. believes that neither it nor any of its other subsidiaries are liable for any claims against Health Power HMO. Furthermore, Health Power, Inc. does not intend to fund, or cause any other subsidiary to fund, any deficits of Health Power HMO. However, there can be no assurance that creditors of Health Power HMO will not initiate legal actions against Health Power, Inc. or any of its other subsidiaries seeking satisfaction of their unpaid claims against Health Power HMO. The legal fees and other costs of defending such legal actions could be significant. Furthermore, due to the fact-intensive nature of these actions and the unpredictability of courts in this area of the law, there can be no assurance that Health Power, Inc. or its other subsidiaries will be successful in defending any such legal actions. Any such legal actions having an unfavorable outcome to Health Power, Inc. or any of its other subsidiaries could have a material adverse affect on their financial condition and results of operations. Any such legal actions could also cause Health Power HMO or ODI to seek regulatory or court protection and oversight of the liquidation process.
The Company participates in Ohio's Health Partnership Program through its contract with OBWC. This contract is for a two-year term expiring on December 31, 2000. There can be no assurance that OBWC will renew this contract when it expires. In addition, there can be no assurance that OBWC will not modify this contract in the future in a manner unfavorable to the Company. Furthermore, OBWC may at any time initiate proceedings to decertify the Company as an MCO if it fails to substantially perform its duties under the contract, and if such decertification occurs, the contract will automatically terminate. Finally, approximately 43% of the fees payable under this contract are subject to the attainment of certain return to work measurements established in the contract. There can be no assurance that the Company will be able to meet any or a significant portion of these performance measurements. This contract accounts for all of the revenues associated with MCO services, which revenues were $13.0 million and $11.3 million in 1998 and 1997, respectively. For 1998 and 1997, the Company's MCO revenues represented approximately 52% and 51%, respectively, of the Company's consolidated revenues. The loss or unfavorable modification of this contract or the failure to significantly satisfy the performance measurements under the contract would have a material adverse effect on the Company's business, financial condition, and results of operations.
The Company provides TPA services for group rating plans for approximately 100 trade associations, which include approximately 17,600 employers. Each association and employer administrative agreement is typically for a one-year service period. Revenues from one group rating plan represented approximately 28% of the Company's 1998 revenues. There can be no assurance that the agreement with this trade association or any other associations or employers will be renewed upon their expiration, or if renewed, upon terms favorable to the Company. The failure to renew the contract with this trade association could have a material adverse effect on the Company's financial condition and results of operations.
The Company is actively assessing its Year 2000 readiness, including the extent to which third parties with whom the Company has significant relationships may be vulnerable to Year 2000 issues and what impact, if any, these Year 2000 issues will have on the Company. As part of these assessments, the Company has created a task force which has developed a timetable for identifying, evaluating, resolving and testing its Year 2000 issues. The Company anticipates timely completion of its Year 2000 remediation by the end of the third quarter of 1999. However, the failure to become Year 2000 compliant on a timely basis could have a material adverse affect on the Company's business, financial condition, and results of operations. Currently, the Company does not have a contingency plan in place if it fails to become Year 2000 compliant on a timely basis. However, the Year 2000 task force is continuously reviewing the status of the Company's remediation efforts and intends to develop appropriate contingency plans as necessary to address Year 2000 compliance issues as they arise.
During the past year the Company has invested, and for the foreseeable future the Company anticipates investing, a substantial amount of capital in acquisitions. Acquisitions involve numerous risks, including the failure to retain key employees and contracts and the inability to integrate businesses without material disruption. In addition, some competitors of the Company have similar acquisition strategies. There can be no assurance that any future acquisitions will be successfully integrated into the Company's operations, that competition for acquisitions will not intensify, or that the Company will be able to complete such acquisitions on acceptable terms and conditions. In addition, the costs of unsuccessful acquisition efforts may adversely affect the Company's results of operations.
The workers' compensation cost containment and medical management industry is highly fragmented and competitive, and the intensity of competition can be expected to increase. In Ohio, the market share in this industry is concentrated among a few companies, including the Company. The Company's primary competitors in Ohio are several TPAs and/or MCOs owned by large insurance carriers which offer one or more services similar to those offered by the Company and numerous independent companies, typically on a regional basis. Some of the Company's competitors are significantly larger and have greater financial and marketing resources than the Company. Although the Company believes its specialization in the workers' compensation area, breadth of services, outstanding service, and independence from insurance carriers will enable it to compete successfully, there can be no assurance that the Company will be able to compete effectively against existing competitors or that additional competitors will not enter the Company's areas of operations in the future.
REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 REPORT OF INDEPENDENT ACCOUNTANTS
We have audited the accompanying consolidated balance sheets of Health Power, Inc., and Subsidiaries (the Company) as of December 31, 1998 and 1997,and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Health Power, Inc., and Subsidiaries as of December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
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Health Power, Inc. (the Company) is a Delaware holding company that provides full-service workers' and unemployment compensation consulting services through its CompManagement, Inc. (CompManagement) subsidiary to employers in the State of Ohio. Effective March 1, 1997, CompManagement Health Systems, Inc., a subsidiary of CompManagement, began operations as a managed care organization for the Ohio Bureau of Workers' Compensation (OBWC). Effective December 31, 1998, CompManagement purchased M&N Risk Management, Inc., and M&N Enterprise, Inc., companies providing compensation consulting services. It also operates Health Power HMO, Inc., a health maintenance organization (HMO) in and around the Columbus, Cincinnati, Dayton, Ohio, areas for Medicaid recipients primarily enrolled in the Ohio Works First/Healthy Start (OWF) programs, as well as for commercial members. On December 29, 1998, the Company's Board of Directors formally approved a plan to discontinue operations of the HMO.
The following is a summary of significant accounting policies followed in preparation of these consolidated financial statements:
Unless otherwise stated, the notes to the financial statements disclose information related to continuing operations. See note 16 for disclosure of discontinued operations and related notes.
Leaseholds and equipment. Depreciation of leasehold improvements and equipment is computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 25 years.
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Goodwill. The Company records goodwill for the excess of cost over fair value of net assets acquired. Goodwill is amortized on a straight-line basis over a twenty year period. Goodwill will be evaluated periodically as events or circumstances indicate a possible inability to recover their carrying amount.
Revenues. Contract revenues are derived from claims management, administrative, consulting services, and managed care administration services which are recorded as earned based on the requirements and duration of the related contract. Revenue from the managed care administration services are recognized on a monthly basis based on the contracted administrative fee with the OBWC. In addition, contract revenue earned is recorded for some incentive awards when the claims are processed to which the incentive is related and a bonus award is recorded in the year earned. Revenue on certain contracts has been deferred and is recognized in income on a pro rata basis over the related contract periods, which typically range between 3 and 12 months. Commission expense associated with these contracts is also deferred and recognized as an expense on a pro rata basis over the related contract periods. For services related to group rating contracts, fees are paid to the group's sponsor and netted against contract revenues. For the year ended December 31, 1998, contract revenue from a major client approximated 28% of the Company's contract revenue. Contract revenues received in advance are included in deferred revenues.
Stock-based compensation. The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and related interpretations in accounting for its stock-based compensation plans in the accompanying financial statements. The Company applies the disclosure requirements of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation (see Note 10).
Use of estimates. The preparation of financial statements in conformity with GAAP requires
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Effective January 1, 1998, the Company adopted SFAS 130, Reporting Comprehensive Income. This statement establishes standards for reporting of comprehensive income and its components in a full set of general-purpose financial statements. The impact of the statement on Health Power, Inc.'s financial statement was not included, as the Company had no other comprehensive income items.
Investment in subsidiary (Parent Company Only). The Parent's investment in its wholly-owned subsidiaries, is recorded using the equity method of accounting. The investment represents the underlying net book value of the subsidiaries on a generally accepted accounting principles basis (see Note 15).
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Contract receivables primarily represent amounts due from the OBWC for incentive and bonus earned of approximately $1,200,000 and $2,558,000 in the fourth quarter of 1998 and 1997, respectively. In addition, due to the acquisition of M&N at December 31, 1998 contract receivables increased by $3,254,842. The Company maintains an allowance for doubtful accounts when the receivable is deemed uncollectible.
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In 1997, the certificate of deposit represented amounts pledged for the HMO's Certificate of Authority with the Ohio Department of Insurance. During 1998, cash in an equal amount was transferred to the HMO and the pledge of the certificate of deposit was released.
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The (provision) benefit for income taxes in 1998, 1997 and 1996 for continuing operations consists of the following:
A reconciliation of the Company's effective income tax rate for continuing operations, as reflected in the consolidated statement of operations, to the statutory federal, state and local tax rate is as follows:
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The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995.
The Company maintains 401(k) plans for its employees meeting certain age requirements and completing six months to one year of employment and may contribute a percentage of their compensation to this plan. The Company matches a portion of the employee contributions based on the terms of the plan agreement. The Company's matching contributions to the 401(k) plans were approximately $79,803, $50,332, and $34,497 for 1998, 1997 and 1996, respectively, for employees of the continuing operations and approximately $3,438, $5,976 and $7,334 for 1998, 1997 and 1996, respectively, for employees of the discontinued operations.
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 have been exercised as of December 31, 1998. The warrants expired on March 3, 1999.
The accounting policies of the segments are the same as those described in Note 2 "Summary of Significant Accounting Policies". Segment data includes intercompany revenues, as well as a charge to allocating corporate expenses to each of its segments. Such amounts have been included in the elimination column to reconcile to consolidated totals.
The following tables present this information by segment as it is reported internally to management:
Condensed balance sheets of Health Power, Inc. (parent company only) as of December 31, 1998 and 1997 and the condensed statements of operations and cash flows for the years ended December 31, 1998, 1997 and 1996 are as follows:
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The Company has restated its prior financial statements to present the operating results of the HMO as discontinued operations. The assets and liabilities of such operations at December 31, 1998 and 1997, respectively, have been reflected as a separate line item on the balance sheet based substantially on the original classification of such assets and liabilities.
Revenues. Revenues consist primarily of amounts earned under contracts with commercial groups and the Ohio Department of Human Services (ODHS) for Medicaid recipients. Such amounts are recognized when earned. Amounts received prior to the month of service are recorded as deferred revenues. Effective February 24, 1997, the Company gave notice to cancel its contract to provide services for the State of Ohio group in the Dayton area; therefore, health care coverage for that group ceased on March 1, 1997. In addition, effective December 1, 1997, the State of Ohio commercial group coverage for the remaining Columbus and Cincinnati areas were canceled. For the year ended December 31, 1997, commercial group premiums from the State of Ohio approximated 63% of the Company's commercial revenues.
Property and equipment. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 25 years. A valuation
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allowance has been recorded to reflect property and equipment at estimated fair value and the resulting loss included in loss on disposal.
Health care costs. Health care costs include primary care and physician-related costs and hospital costs. Primary care and physician-related costs represent expenses incurred under contracts and arrangements with health care providers in rendering services to enrollees. Such costs include fee-for-service amounts and capitation (a monthly fixed fee per enrollee) recognized in providing medical, vision, pharmacy and other health care services. Hospital costs are recognized when hospital services are provided to enrollees and include stop-loss insurance coverage premiums, net of recoveries (see Note 23). Such expenses are recognized as incurred, except as noted below.
Due to the plan to discontinue the operations of the HMO, management has recorded an estimate of all health care costs for the period January 1, 1999 through April 30,1999 and included them in loss on disposal.
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 recognized as income or expense in the period that includes the enactment date. Due to the uncertainty regarding the method of disposal of the HMO, a full valuation allowance has been provided for the net deferred tax assets.
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The HMO engages in transactions with medical centers and companies controlled by certain shareholders and directors of the Company and its subsidiaries, which are herein, referred to as affiliates or affiliated providers as follows:
Health care providers. During 1998, 1997 and 1996, primary care and physician-related costs of $564,123, $1,485,107 and $2,854,159, respectively, resulted from transactions between the HMO and affiliated providers. Such transactions resulted in receivables from related primary care providers of $12,830 and $31,570, as of December 31, 1998 and 1997.
Commercial revenue. Certain affiliated providers have contracted with the HMO to provide health care services to their employees and dependents. The HMO recognized commercial premiums from these affiliated providers in the amounts of $53,674, $65,793, and $137,223 in 1998, 1997 and 1996, respectively.
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In addition, the HMO recorded an experience refund receivable of approximately $135,000 due from a reinsurer based on the terms of the contract.
The benefit for income taxes of the discontinued operations of the HMO in 1998, 1997 and 1996 consists of the following:
The significant components of the deferred tax benefit of the discontinued operations of the HMO for the years ended December 31 were as follows:
The components of the net deferred tax asset as of December 31, 1998 and 1997 were as follows: