Beginning July 1, 2002, TennCare implemented an 18-month stabilization program which entailed changes to TennCare's contracts with MCOs, including UAHC-TN. During that period, MCOs were generally compensated for administrative services only (commonly called "ASO"), earned fixed administrative fees, were not at risk for medical costs in excess of targets established based on various factors, were subject to increased oversight, and could incur financial penalties for not achieving certain performance requirements. Through successive contractual amendments, TennCare extended the ASO reimbursement system applicable to UAHC-TN first through June 30, 2004, then through December 31, 2004, and then through June 30, 2005. These matters are more fully discussed and analyzed below under the heading "Review of Consolidated Results of Operations - 2005 Compared to 2004."
(i.e., no risk for medical losses), earn fixed administrative fees and are subject to increased oversight. Through successive contractual amendments, TennCare extended the ASO reimbursement system applicable to UAHC-TN, first through June 30, 2004, then through December 31, 2004, and then through June 30, 2005. Through an amendment with an effective date of July 1, 2005, TennCare has implemented a modified risk arrangement with all its contracted MCOs, including UAHC-TN, which are at risk for losing up to 10% of administrative fee revenue and may receive up to 15% incentive bonus revenue based on performance relative to benchmarks. TennCare has also announced plans to disenroll non-medically needy adults who are not eligible for Medicaid from TennCare coverage statewide, and to impose benefit limits on the 396,000 adults left in the program who are eligible for Medicaid. The announced plans would preserve full coverage for the 612,000 children on the program. As a result, UAHC-TN expects to lose only approximately 12,000 of its present 132,258 members over a 12-month period beginning in the first quarter of fiscal year 2006, being its only working uninsured and uninsurable adult members.
The administrative supervision notice asserted a number of findings of fact, which the Commissioner stated formed the basis for her order. UAHC-TN and the Company do not agree with many of those findings. The notice also asserted that its findings of fact described potential grounds for termination of UAHC-TN's TennCare contract. Although we acknowledge that any such termination would have a material adverse effect on UAHC-TN and the Company, we do not agree that those findings are accurate. Moreover, the State of Tennessee in August 2005 extended UAHC-TN's TennCare contract through June 30, 2006, by an amendment to the contract effective as of July 1, 2005.
On May 25, 2004, and effective as of January 1, 2004, the Company's wholly owned subsidiary, United American of Tennessee, Inc. ("UA-TN"), which already owned 75% of the outstanding stock of UAHC-TN, purchased the remaining 25% of the outstanding common stock of UAHC-
TN. UAHC-TN thereby became a wholly owned subsidiary of UA-TN and a wholly owned second-tier subsidiary of the Company. The 25% minority interest was purchased under a longstanding option agreement for $500,000 evidenced by a Company promissory note that was paid by December 31, 2004.
As of June 30, 2005, UAHC-TN's total enrollment was 131,247 members, compared to 129,484 at June 30, 2004.
Because of its resulting workforce reduction, the Company made plans to sublease all of its then principal office premises in Detroit, Michigan, to OmniCare-MI, retroactive to November 1, 2002, and expiring at the lease end in May 2005, and to sell to OmniCare-MI furniture, a telephone system and certain computer hardware and software that the Company chose to leave there. OmniCare-MI commenced its occupancy of the premises on November 1, 2002 and the Company remained in a portion of the premises until it moved its principal offices to new leased premises in Detroit on February 3, 2003. Management had expected both parties to finalize and sign the sublease, and close the sale of such assets, in the fourth quarter of fiscal 2003, but was delayed as a result of the appointment by the Governor of Michigan of Linda A. Watters as the new Commissioner of the Office of Financial and Insurance Services on April 11, 2003. Ms. Watters had served on the Company's Board of Directors continually since 2000 and resigned that office on the same date she became the new Commissioner (as required to avoid any possible appearance of a conflict of interest and not as the result of any disagreement with the Company). Because of the new Commissioner's prior association with the Company, the State circuit court judge who retained jurisdiction over OmniCare-MI's rehabilitation proceedings then
required that a designated independent person replace the Rehabilitator's (i.e., Commissioner's) special deputy who had been dealing with the sublease and assets purchase. Meanwhile, due to the subsequent sale of OmniCare-MI members to Coventry of Michigan approved on May 10, 2004 and effective October 1, 2004, the sale of assets did not occur and the Company accordingly recorded a loss from discontinued operations of $0.7 million in the fourth quarter of fiscal year 2004. The Company renegotiated sublease terms with Michigan HMO (formerly doing business as OmniCare Health Plan in Michigan), which continued to occupy and pay rent for reduced space in such premises. Michigan HMO's occupancy and rent obligation for the subleased premises ceased on February 28, 2005 sooner than the primary lease end in May 2005. The Company recorded a liability in the first quarter of fiscal year 2005 as it relates to the sublease obligation.
Medical premiums revenues were $0.02 million for the fiscal year ended June 30, 2005, a decrease of $0.5 million (96%) from medical premiums revenues of $0.5 million for the fiscal year ended June 30, 2004. The decrease came from UAHC-TN as the result of TennCare's changing its reimbursement system to an ASO program for an initially declared 18-month stabilization period beginning July 1, 2002, subsequently extended through June 30, 2005.
Fixed administrative fees related to the ASO program were $20.9 million for the fiscal year ended June 30, 2005, an increase of $0.5 million (3%) from fixed administrative fees of $20.4 million for the fiscal year ended June 30, 2004. The increase in fixed administrative fees is principally due to a slight increase in members of UAHC-TN.
Total expenses were $16.0 million for the fiscal year ended June 30, 2005, compared to $15.3 million for the fiscal year ended June 30, 2004, an increase of $0.7 million (4%). The increase was principally due to an increase in costs associated with the Administrative Supervision Order for UAHC-TN discussed above, and an increase in claims processing costs.
Because of TennCare's ASO reimbursement system, medical services expenses were $0.02 million in the fiscal year ended June 30, 2005, a decrease of $0.5 million (96%), as compared with medical services expenses of $0.5 million in the fiscal year ended June 30, 2004. The $0.02 million of medical services expenses represent fiscal 2002 claims processed and reimbursed by TennCare in fiscal 2005 as explained in item 1 under the heading "Managed Plans - Managed Plan Owned by the Company."
Depreciation and amortization expense decreased $0.2 million (22%), to $0.05 million for the fiscal year ended June 30, 2005 from $0.23 million for the fiscal year ended June 30, 2004.
Interest expense decreased $0.06 million (88%), to $0.06 million for the fiscal year ended June 30, 2005 from $0.07 million for the fiscal year ended June 30, 2004, principally due to debt reduction.
million for the fiscal year ended June 30, 2003. The increase in fixed administrative fees is principally due to an increase in members and an increase in reimbursement rates effective July 1, 2003.
Because of TennCare's ASO reimbursement system, medical services expenses were $0.5 million in the fiscal year ended June 30, 2004, an increase of $0.1 million (23%) as compared with medical services expenses of $0.4 million in the fiscal year ended June 30, 2003. The $0.5 million of medical services expenses represent fiscal 2002 claims processed and reimbursed by TennCare in fiscal 2004 as explained above.
Income tax expense decreased $1.7 million (269%), to $(1.1) million in the fiscal year ended June 30, 2004 from $0.6 million in the fiscal year ended June 30, 2003. The Company's effective tax rate for the fiscal year ended June 30, 2003 was (16)% and differs from the statutory rate of 34%. This difference is primarily a result of the utilization of net operating loss carryforwards.
At June 30, 2005, the Company had (i) cash and cash equivalents and short-term marketable securities of $13.5 million, compared to $8.8 million at June 30, 2004; (ii) working capital of $13.7 million, compared to working capital of $8.1 million at June 30, 2004; and (iii) a current assets-to-current liabilities ratio of 4.70-to-1, compared to 2.56-to-1 at June 30, 2004.
Property, plant and equipment decreased by $0.1 million at June 30, 2005 compared to June 30, 2004, due to the recording of depreciation of $0.2 million.
Medical claims payable decreased by $0.2 million at June 30, 2005 compared to June 30, 2004, which is directly related to the payment of outstanding medical claims.
UAHC-TN's application for a commercial HMO license was approved on September 7, 2001. Management is not yet actively pursuing that commercial business, however, due to UAHC-TN's substantially increased enrollment from members TennCare assigned from defunct other plans, together with adapting to TennCare's stabilization program.
The Company and the Department of Finance and Administration of the State of Tennessee, Bureau of TennCare ("TennCare") are parties to two escrow agreements under which the Company has funded, on August 5, 2005, two escrow accounts held by TennCare at the State Treasury. One, in the amount of $2,300,000, is security for repayment to TennCare of any overpayments to UAHC-TN that may be determined by a pending audit of all UAHC-TN process claims since 2002; and the other, in the amount of $420,500, is security for any money damages that may be awarded to TennCare in the event of any future litigation between the parties in connection with certain pending investigations by state and federal authorities. The escrow accounts bear interest at a rate no lower than the prevailing commercial interest rates for savings accounts at financial institutions in Nashville, Tennessee. The escrow accounts will terminate August 5, 2007 or sooner in certain events, except if litigation is pursued by either party, in which event the escrow accounts will continue until the end of such litigation. All amounts (including interest earnings) credited to the escrow accounts will belong to the Company, except to the extent, if any, they are paid to TennCare to satisfy amounts determined to be owed to TennCare as provided in the escrow agreements. Both escrow agreements recite that TennCare does not at this time assert there has been any breach of UAHC-TN's TennCare contract and that the Company has funded the escrow accounts as a show of goodwill and good faith in working with TennCare.
The administrative supervision notice asserted a number of findings of fact which the Commissioner stated formed the basis for her order. UAHC-TN and the Company do not agree with many of those findings. The notice also asserted that its findings of fact described potential grounds for termination of UAHC-TN's TennCare contract. Although we acknowledge that any such termination would have a material adverse effect on UAHC-TN and the Company, we do not agree that those findings are accurate. Moreover, the State of Tennessee in August 2005 extended UAHC-TN's TennCare contract through June 30, 2006, by an amendment to the contract effective as of July 1, 2005.
SFAS No. 123(R), "Share-Based Payment", which is a replacement to SFAS No. 123 "Accounting for Stock Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees", was issued in December 2004. The revisions are intended to provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No. 123, as originally issued in 1995, established a preferable fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in APB Opinion No. 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Publicly traded entities (other than those filing as small business issuers) will be required to apply SFAS No. 123(R) as of the first annual reporting period that begins after June 15, 2005. The Company is currently evaluating the financial statement impact of the adoption of SFAS No. 123(R).
SFAS No. 151, "Inventory Costs," which amends ARB No. 43 Chapter 4, "Inventory Pricing," was issued in November 2004. The amendments made by SFAS No. 151 provide clarity relating to abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage), which should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of this standard is expected to have no effect on the Company's financial condition or results of operations.
SFAS No. 154, "Accounting Changes and Error Corrections - replacement of APB Opinion No. 20 and FASB Statement No. 3," (SFAS No. 154) was issued in May 2005. SFAS No. 154 changes the accounting for and reporting of a change in accounting principle by requiring retrospective application to prior periods' financial statements of changes in accounting principle unless impracticable. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not expect the adoption of SFAS No. 154 to have a material impact on our results of operations, financial position or cash flows.