CompManagement leases a 70,000 square foot office building in Dublin, Ohio, which is used as the Company's principal office facilities. The building is leased for a term of 15 years, provides for annual rent payments, and requires the Company to pay all operating expenses for the building. The lease also provides for, among other things, three renewal options of five years each, an option to purchase the building, and a right of first offer with respect to the sale of such building. The lease restricts CompManagement's ability to distribute funds and/or assets to Health Power, Inc. or another affiliate unless CompManagement meets certain tangible net worth requirements. The Company also leases office space in Akron, Cincinnati, Cleveland, and Toledo, Ohio, which is used as regional offices and service centers for its operations.
Health Power HMO owns two three-story office buildings located in Columbus, Ohio. These buildings contain approximately 14,195 square feet of office space. These buildings are currently for sale in connection with the winding up of Health Power HMO's assets.
The following table sets forth selected consolidated financial data for Health Power, Inc. and its subsidiaries as of and for each of the years in the five-year period ended December 31, 1998. This selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes of Health Power, Inc. and subsidiaries and Management's Discussion and Analysis of Financial Condition and Results of Operation appearing under Items 8 and 7, respectively, of this Form 10-K. All periods in this table have been restated to reflect the operations of Health Power HMO as discontinued operations. See Note 16 of the Notes to Consolidated Financial Statements appearing in Item 8 of this Form 10-K. In addition, all periods in this table have been restated to reflect the acquisition of CompManagement in July 1995. This acquisition was accounted for as a pooling of interests.
The Company is an independent provider of comprehensive cost containment and medical management services designed to minimize the costs of workers' and unemployment compensation benefits for employers. Through CompManagement and M&N Risk Management, the Company serves as a TPA for workers' and unemployment compensation claims and provides claims management, risk management, and medical cost containment services primarily to Ohio employers. The Company is one of the largest workers' compensation TPAs in Ohio, currently serving approximately 19,000 employers located throughout Ohio. Through CompManagement Health Systems, the Company serves as a statewide certified MCO and provides medical management services for workers' compensation claims. The Company began offering its MCO services in March 1997, and currently serves approximately 20,200 employers located throughout Ohio. Because all workers' compensation claims are reimbursed by OBWC, the Company does not assume any risk for the payment of medical or disability benefits to employees with respect to workers' compensation claims.
On December 29, 1998, the Board of Directors of Health Power, Inc. formally approved a plan to discontinue the operations of Health Power HMO. Accordingly, the operating results of Health Power HMO, including provisions for estimated lease costs, employee severance and benefits, write-downs of property, plant, and equipment during the phase-out period, and a loss on the disposal of the assets of Health Power HMO, have been segregated from continuing operations and are reported separately as discontinued operations.
The following discussion should be read in conjunction with the consolidated financial statements, notes, and tables included in Item 8 of this Form 10-K. Readers are cautioned that any forward-looking statements contained in this Form 10-K or any other reports or documents prepared by Health Power, Inc. involve risks and uncertainties and are subject to change based on various factors. Certain of these factors are discussed in greater detail in various parts of this Item 7.
The net loss from discontinued operations was $6.5 million, or basic and diluted earnings per share of $(1.70), for 1998, as compared to a net loss from discontinued operations of $0.8 million, or basic and diluted earnings per share of $(0.21), for 1997. The 1998 results included a $4.9 million loss
from discontinued operations, net of taxes, which included a charge for a valuation allowance on deferred federal income tax assets of $2.8 million, along with a $1.6 million loss on disposal of discontinued operations, net of taxes.
Interest income and other increased $285,000 to $532,000 for 1997, from $247,000 for 1996. This increase resulted primarily from an increase in other income related to the private label managed care product managed by Health Power Management Corporation and an increase in interest income related to increases in the average available investable cash balance.
Income tax expense was $2.3 million in 1997, or an effective tax rate of 38%, as compared to $0.2 million in 1996, or an effective tax rate of 32%. The increase in the effective tax rate resulted from the Company's higher tax bracket due to the significant increase in income from continuing operations before income taxes.
As a result of the foregoing, income from continuing operations was $3.8 million, or basic and diluted earnings per share of $1.00, for 1997, as compared to income from continuing operations of $0.4 million, or basic and diluted earnings per share of $0.10, for 1996.
The Company had net income of $3.0 million, or basic and diluted earnings per share of $0.79, for 1997, as compared to a net loss of $9.4 million, or basic and diluted earnings per share of $(2.49), for 1996. There were 3,818,465 and 3,810,331 basic weighted average of shares of common stock and common stock equivalents outstanding at December 31, 1997 and 1996, respectively, and 3,832,650 and 3,810,331 diluted weighted average shares of common stock and common stock equivalents outstanding at December 31, 1997 and 1996.
At December 31, 1998, cash and cash equivalents from continuing operations were $9.1 million, an increase of $6.2 million from $2.9 million at December 31, 1997. This increase was attributable primarily to payments received with respect to the Company's TPA contracts. These payments constitute deferred revenues which are recognized as income on a pro rata basis over the related contract period, which typically ranges from three to twelve months.
Cash provided by continuing operating activities was $8.3 million and $2.8 million for 1998 and 1997, respectively.
Cash used in continuing operations in investing activities was $3.0 million and $1.7 million for 1998 and 1997, respectively. For 1998, this amount included $2.6 million in cash used for the acquisition of M&N Risk Management, net of cash acquired, and $0.9 for the purchase of property and equipment. Property and equipment purchased in 1998 included additional computer software and equipment. For 1997, property and equipment purchase amounted to $1.2 million, which included additional computer software and equipment.
CompManagement leases a 70,000 square foot building in Dublin, Ohio. The lease restricts CompManagement's ability to distribute funds and/or assets to Health Power, Inc. or another affiliate unless CompManagement meets certain tangible net worth requirements.
As previously described, ODI issued an order revoking Health Power HMO's certificate of authority effective May 1, 1999. The revocation order 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
end of the third quarter of 1999. The Company's Year 2000 committee is working with significant third party vendors to verify that they are Year 2000 compliant.
The Company currently believes that the primary costs associated with Year 2000 compliance issues are in-house time costs associated with administration, review and testing of systems. These costs have not been calculated, but the Company believes the costs are not material.
The Company's operations are not significantly affected by inflationary pressures. Although inflation does affect salaries, employee benefits, and other operating expenses, after considering general inflationary trends, total revenues of the Company produced growth in real terms in 1998 and 1997. Revenues increased largely due to increased TPA and MCO services rather than increases in inflation.
As discussed in Note 16 to the financial statements, at December 31, 1998 and 1997, the Company's HMO subsidiary did not meet minimum statutory net worth and admitted asset requirements as established by the Ohio Department of Insurance. Additionally, during the fourth quarter 1998 the Company decided to discontinue operations of its HMO subsidiary.
/s/ PricewaterhouseCoopers LLP ------------------------------ HEALTH POWER, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 - --------------------------------------------------------------------------------
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Basis of presentation. The accompanying consolidated financial statements are presented in accordance with generally accepted accounting principles (GAAP) and reflect the reclassification of the HMO segment as discontinued operations. Assets and liabilities of the discontinued operations are shown separate from the continuing operations in the consolidated balance sheet. Income from discontinued operations has been adjusted for the effect of the allocation of certain general corporate overhead costs associated with continuing operations. All intercompany balances and transactions have been eliminated in consolidation.
Cash equivalents. It is the policy of the Company to classify investments with original maturities of three months or less as cash equivalents. Cash equivalents at December 31, 1998 include $9,381,956 deposited in an overnight sweep account and $96,793 invested in a money market fund.
Expenditures for major betterments are capitalized, and expenditures for repairs and maintenance are charged to operations as incurred. When property and equipment are retired or sold, the cost and related accumulated depreciation and amortization are removed from the accounts, with any gain or loss reflected in operations.
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.
The Company provides a director stock award plan to non-employee directors of Health Power, Inc., Health Power HMO, Inc., and CompManagement, Inc. Under this plan, the directors elect percentages of their directors' fees to be paid in cash or in stock of Health Power, Inc. Payment of the directors' fees is made subsequent to attendance of the respective meetings. In 1998, the Company issued 13,831 shares of common stock with a market value of $64,351 to the directors. The Company records the expense in the year the stock is earned.
Segment reporting. The Company adopted Statement of Financial Accounting Standard 131, "Disclosure about Segment of an Enterprise and Related Information" (FAS 131). This statement requires a "management" segment approach in identifying reportable segments which focuses on financial information that the Company's decision makers use to make decisions and performance about the operating segments. FAS 131 also requires disclosures about certain related disclosures about products and services, geographic areas and major customers. The adoption of FAS 131 did not affect results of operations or financial position but did affect the disclosure of segment information (see Note 13).
management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
On December 31, 1998, the Company's subsidiary CompManagement acquired M&N Risk Management, Inc. and M&N Enterprise, Inc., collectively referred to as "M&N" in a transaction accounted for under the purchase method of accounting for business combinations. CompManagement purchased 100% of the issued and outstanding shares of capital stock of M&N for a purchase price of $6,000,000 with the provision for adjustment based on the closing net equity of M&N. Funding for the acquisition was provided by a $3,000,000 demand note with a financial institution and $2,526,736 in a promissory note payable to the seller of M&N. At the time of acquisition, M&N had $5,451,165 in total assets and $5,924,429 in total liabilities, which have been included in the accompanying consolidated financial statements. The Company has recorded a reduction in the promissory note due the seller of M&N of $473,264 as a result of an adjustment to the purchase price. The Company also recorded goodwill of $5,526,736 as a result of the application of purchase accounting.
The following summarizes the pro-forma results of continuing operations for the years ended December 31, 1997 and 1998 as if M&N had been acquired at the beginning of each period presented:
Notes payable represents the amounts payable for the acquisition of M&N at December 31, 1998 and consists of $3,000,000 demand note payable to a financial institution with interest payable monthly at prime rate. At December 31, 1998, the prime rate was 7.75%. In addition, the Company recorded a $2,526,736 promissory note payable to the parent company of M&N with a stated interest rate of 7% due quarterly. The scheduled principal payments of the promissory note are as follows:
CompManagement is party to employment agreements with certain employees. The agreements call for certain levels of commission expense to be paid by CompManagement to these individuals for selected contract revenue earned over the terms of their agreements. In 1997, CompManagement and CompManagement Health Systems amended the above employee agreements to include certain commissions to be paid to these employees. These agreements expire on December 31, 1999. Total commission expense paid in 1998, 1997 and 1996 in connection with these agreements was approximately $668,000 and $2,050,000 and $74,000, respectively.
The significant components of the deferred tax (expense) benefit for the years ended December 31, 1998, 1997 and 1996 were as follows:
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The components of the net deferred tax (liability) asset as of December 31, 1998 and 1997 were as follows:
The Company has various operating leases for office space and equipment. The leases have initial terms of up to fifteen years, contain certain escalation clauses, and provide for renewal options for up to 10 years.
As of December 31, 1998, future minimum rental payments under the leases are as follows:
Rental expense was approximately $1,579,786, $876,813, and $470,350, for 1998, 1997 and 1996, respectively.
Stock-based compensation plans. The Company sponsors various stock-based incentive compensation plans (the Plans) for directors and eligible employees. The Company applies APB Opinion 25 and related interpretations in accounting for the Plans. Pro forma disclosures as if the Company adopted the cost recognition provisions of SFAS 123 are required by SFAS 123 and are presented below.
Employee and director stock options. The Company granted market price stock options in 1998, 1997 and 1996 to employees and directors. The stock options granted in 1998, 1997 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 first four anniversaries of the date of grant. Options granted to various executives vest 100% at the end of six years (subject to acceleration to a two-year period depending on the performance of the Company or at the discretion of the Compensation Committee). In accordance with APB 25, the Company has not recognized any compensation cost for these stock options granted in 1998, 1997 and 1996.
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A summary of the status of the Company's director and employee stock options, and the changes during the years 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 1998, 1997 and 1996, respectively: no dividend yield for all years; risk-free interest rates are different for each grant and range from 5.06% to 6.73%; the expected lives of options are estimated to be five years; and a volatility of 50.20% for 1998 grants, 41.97% for 1997 grants, and 54.73% for 1996.
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The following table summarizes information about director and employee stock options outstanding at December 31, 1998
ProForma net income and net income per common share. Had the compensation cost for the Company's stock-based compensation plans been determined in accordance with SFAS 123, the Company's net income and net income per common share for 1998 and 1997 would approximate the pro forma amounts below:
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 had an exercise price of $6.50 per share and various vesting provisions. No expense has been recognized for these options. The agreement was terminated as of February 1998 and all options were forfeited.
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The Company has two reportable segments for its continuing operations: consulting services and managed care services, which were determined based upon its method of internal reporting. Each segment of the Company is managed separately. The consulting services segment offers workers' and unemployment compensation consulting services. The managed care services administer workers' compensation claims for the OBWC and began operations March 1, 1997. The Company also has an all other segment which derives its revenues from management fees and interest income. Segment assets of the all other segment includes those assets of the discontinued operations of the HMO.
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There were no cash dividends paid by the Company's consolidated subsidiaries to the Company in 1998, 1997, or 1996.
The Company's HMO is subject to regulation by the Ohio Department of Insurance (the Department) and is required to file separate financial statements with the Department prepared in accordance with prescribed or permitted statutory accounting practices. Such practices differ in certain respects from GAAP. In addition, Ohio law requires HMOs to maintain statutory net worth in an amount such that admitted assets are equal to at least one hundred ten percent of liabilities, but in no event less than $1,700,000 and requires cash deposits to be maintained with the Department of $400,000. The Company's HMO did not meet the statutory net worth requirements at December 31, 1998 and 1997. In addition, the Department placed the HMO under supervision on July 13, 1998 and subsequently had a hearing on January 21, 1999 to determine whether to suspend or revoke the license of the HMO. On February 25, 1999, the hearing officer issued a report recommending that the Superintendent of Insurance revoke the license of the HMO. The HMO has filed an objection to the hearing officer report. It is management's intention to cease operations of HMO by April 30, 1999 if it is not disposed of prior to that date.
Primary care and physician-related costs and hospital costs include management's estimate of services provided but not reported at year-end and expected future losses on contracts in effect at year-end. The Company recognizes expected future contract losses when it is probable that expected future health care costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums and stop-loss insurance recoveries on those contracts. The reserve for expected future contract losses is $0 and $11,853 as of December 31, 1998 and 1997, respectively, and is included with health care costs payable. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated based on current circumstances, and any adjustments resulting therefrom will be reflected in discontinued operations during the claim run-off period. It is reasonably possible that circumstances impacting these estimates may change in the near term.
Management Services: The Company has a management service agreement between Health Power Management Company (HPMC), a subsidiary of the Company, and its affiliate, Health Power HMO, to provide administrative services. Services provided include finance and accounting functions, data processing, office of the president, marketing and membership services, corporate planning, legal and regulatory services. The affiliates of HPMC pay a management fee on a monthly basis. In 1998, 1997 and 1996, the HMO paid approximately $2,257,000, $2,970,000 and $4,465,000 to HPMC for these administrative services. In addition, beginning in 1997, the HMO was reimbursed approximately $14,000 and $7,000 in 1998 and 1997, respectively, per month by its affiliates CompManagement, Inc., and CompManagement Health Systems, for the portion of management services that related to their organization's activities.
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The HMO maintains stop-loss insurance coverage for 85% of inpatient hospital costs in excess of $50,000 per Medicaid member, per contract year and varying percentages (generally 80%) of inpatient hospital costs in excess of $81,000 per commercial member, per contract year. These stop-loss insurance contracts do not relieve the HMO of its obligations to members, and failure of reinsurers to honor their obligations could result in losses to the HMO.
Stop-loss insurance premiums of $1,261,535, $1,872,282, and $1,848,274 are included in health care costs for 1998, 1997 and 1996, respectively. Stop-loss recoveries of $1,624,502, $1,178,104, and $1,897,806 are deducted from health care costs for 1998, 1997 and 1996, respectively.
In 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. In September 1997, the HMO terminated the original agreement and contracted with a new third-party administrator in 1998. The HMO incurred approximately $1,358,000 of operating expenses under this agreement as of December 31, 1997 and $1,764,000 under a new administrative agreement (began May 1, 1998) as of December 31, 1998. The HMO expects to incur approximately $520,000 in the period January through April 1999, under this agreement. In addition, the HMO accrued a termination fee of $135,000, as specified in the contract as a loss on disposal of discontinued operations in 1998.
The HMO has various operating leases for office equipment. Rental expense was approximately $58,057, $103,273, and $119,255 for 1998, 1997 and 1996, respectively. The HMO expects to incur approximately $42,424 in the period January through April 1999, and has accrued future rental payments for the remaining lease terms of approximately $98,000, as a loss on disposal of discontinued operations in 1998.
During 1998 the Company's HMO subsidiary commenced a legal action seeking compensation for damages alleged under a prior administrative agreement with a claims processing organization. A counterclaim was filed against the HMO alleging breach of contract and other items and seeks compensatory and punitive damages totaling approximately $8 million. The lawsuits are in the formative stage, however, management does not believe the outcome of the counterclaim will have a material adverse impact in the earnings, cash flows or financial position on the HMO.
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At December 31, 1998 the Company had the following net federal investment credits and tax credit carryforwards available: