The Company experienced significant changes in its Tennessee and Michigan operations in the fiscal year ended June 30, 2002. OmniCare-TN's membership increased from approximately 55,000 at June 30, 2001 to approximately 120,000 at June 30, 2002, in a markedly changed reimbursement
environment for it and other managed care organizations in Tennessee. OmniCare-MI was placed in court-ordered rehabilitation proceedings on July 31, 2001, which relieved the Company from further funding OmniCare-MI's capital deficiencies and which continued its OmniCare-MI management agreement beyond June 30, 2002, with substantially reduced management fee revenues from OmniCare-MI beginning August 1, 2001. In March 2002, upon the court-appointed Rehabilitator's filing a proposed rehabilitation plan for OmniCare-MI, the Company announced it anticipated eventual termination of the management agreement. Such termination will occur November 1, 2002, after which OmniCare-TN will be the Company's only managed plan. These matters are more fully discussed and analyzed below under the heading "Review of Consolidated Results of Operations - 2002 Compared to 2001."
On April 13, 2000 and June 30, 1998, the Company funded unsecured loans to OmniCare-MI evidenced by surplus notes of $7.7 million and $4.6 million, respectively, to enable OmniCare-MI to meet minimum statutory requirements for net worth and working capital. The $7.7 million loan consisted of $4.0 million cash and conversion of $3.7 million of management fees owed to the Company. Pursuant to the terms of the surplus notes, interest and principal payments required approval by the State of Michigan's Office of Financial and Insurance Services and were repayable only from any statutory surplus earnings of OmniCare-MI. Note interest was payable annually and forfeited if not then paid. Interest income of $0.9 million, $1.1 million and $0.5 million was forfeited for fiscal 2002, 2001 and 2000, respectively. The note principal had no stated maturity or repayment date. The surplus notes were subordinated to all other claimants of OmniCare-MI. Based on an analysis of OmniCare-MI's projected cash flows, the Company recorded impairment losses on the valuation of the surplus notes which resulted in bad debt expense of $6.9 million and $3.1 million for fiscal 2001 and 2000, respectively. On July 29, 2002, claims of all creditors holding OmniCare-MI surplus notes were permanently disallowed by the State circuit court order which approved OmniCare-MI's amended rehabilitation plan.
On July 14, 2000, the State of Michigan notified OmniCare-MI it was a successful bidder in the bid process for increased Medicaid rates and continued eligibility as an HMO providing coverage to enrollees of the State's Comprehensive Health Care Program for Medicaid beneficiaries. OmniCare-MI accordingly was awarded a rate increase and extension of its contract with the State to September 30, 2002, with a potential for three one-year extensions.
Effective July 1, 2000, OmniCare-TN entered into a new 42-month contract with the State of Tennessee's TennCare Program. The contract provided for an approximate 4.5% increase in average premiums effective July 1, 2000 and a further 4% increase effective July 1, 2001, with future increases to be determined by the State of Tennessee. Such increases were in lieu of the quarterly adverse selection payments previously made by TennCare to compensate managed care organizations for substantial adverse costs incurred due to the nature of the services they offer and their treatment of a high risk population.
REVIEW OF CONSOLIDATED RESULTS OF OPERATIONS - 2002 COMPARED TO 2001
TennCare responded to its MCOs' situation generally and in some instances individually. For all its contracted MCOs generally, TennCare changed its reimbursement system to an administrative services only ("ASO") program for an 18-month stabilization period (July 1, 2002 through December 31, 2003), during which the MCOs - including OmniCare-TN - have no medical cost risk (i.e., no risk for medical losses), earn fixed administrative fees, are subject to increased oversight, may earn limited additional administrative fees based on certain performance measures as an incentive to manage medical costs below the targets, and may incur financial penalties for not achieving certain performance requirements. TennCare has stated it intends to return to a full-risk system after the end of the 18-month stabilization period at January 1, 2004.
Pursuant to an agreement between TennCare and OmniCare-TN in early October 2002, TennCare further agreed to pay additional funds to OmniCare-TN if future certified actuarial data confirm they were needed by OmniCare-TN to meet its statutory net worth requirement as of June 30, 2002.
The OmniCare-MI management agreement was amended on December 14, 2001, effective August 1, 2001 (the second month of fiscal 2002). Pursuant to the amendment, OmniCare-MI has paid all of its own expenses commencing as of August 1, 2002, except for personnel, rent and depreciation, which the Company has continued to pay. The amendment reduced the Company's management fee revenues from OmniCare-MI beginning August 1, 2001, by changing the methodology for determining the management fee from a fixed percentage (14%) of premiums earned by OmniCare-MI to a cost-based fee, which was equivalent to approximately 10% beginning in August 2001, subject to adjustment to reflect the Company's actual costs of performing the management agreement.
Total revenues increased $48.4 million (37%) to $180.1 million in the fiscal year ended June 30, 2002 from $131.7 million in the fiscal year ended June 30, 2001.
Medical premium revenues for OmniCare-TN increased $67.3 million (72%), to $160.6 million in the fiscal year ended June 30, 2002, from $93.3 million in the fiscal year ended June 30, 2001. This was attributable in part to an increase in member months, and in part to a decrease in the OmniCare-TN per member per month revenue rate as described in the following paragraph. Member months increased 524,000 (86%) to 1,130,000 in the fiscal year ended June 30, 2002 from 606,000 in the fiscal year ended June 30, 2001, and accounted for a $74.4 million increase in OmniCare-TN's medical premium revenues.
Premium revenues from the County Care program totaled $2.5 million for the fiscal year ended June 30, 2002, compared to $9.7 million for the fiscal year ended June 30, 2001. The program operated for three months through its expiration on September 30, 2001.
As a result of other MCOs which had contracts with TennCare ceasing to serve their enrollees or being unable to take on new enrollees, OmniCare-TN was assigned approximately 9,000 members
by TennCare in the first half of fiscal 2002 and an additional 40,000 members in February 2002. Medical services expenses for such new OmniCare-TN members disproportionately exceeded OmniCare-TN's normal PMPM experience and adversely affected its earnings for the remainder of fiscal 2002. See "2002 Compared to 2001 -- OmniCare-TN Developments" above regarding TennCare's favorable response to OmniCare-TN's requests for risk adjustments and reimbursements to compensate it for such medical expenses.
Marketing, general and administrative expenses decreased $1.7 million (5%) to $30.7 million in the fiscal year ended June 30, 2002 from $32.4 million in the fiscal year ended June 30, 2001. This included, however, for OmniCare-TN, $2.0 million of increased claims costs and $1.3 million of increased premium taxes due to OmniCare-TN's significant membership increases. Salaries and wages decreased $1.4 million and promotion and advertising decreased $1.2 million as part of OmniCare-MI's changed operations during its rehabilitation proceedings. General and administrative costs decreased an additional $2.4 million after OmniCare-MI began paying directly most of its general and administrative expenses in the fourth quarter of fiscal year 2002.
Interest expense decreased $0.2 million (46%) to $0.2 million in the fiscal year ended June 30, 2002 from $0.4 million in the fiscal year ended June 30, 2001, due to bank debt reduction of $0.6 million and a two percentage point decrease in the prime rate for the majority of the fiscal year.
The Company recorded an impairment loss equal to the $2.4 million remaining carrying value of the patient care software system which it had purchased to fulfill a requirement of the State of Michigan's Office of Financial and Insurance Services to implement such a system for OmniCare-MI. The system was not in use at June 30, 2002 and will not be used by OmniCare-MI because its management agreement with the Company will terminate November 1, 2002.
ended June 30, 2000. The County Care MLR for the fiscal year ended June 30, 2001 was 88%. County Care operations began with inception of the contract in April 1999 and ceased, at the Company's election, after the contract's expiration on September 30, 2001.
Marketing, general and administrative expenses increased $2.2 million (7%), to $32.4 million in the fiscal year ended June 30, 2001, from $30.2 million in the fiscal year ended June 30, 2000. The increase was due primarily to increases in wages, benefits and temporary labor costs.
Bad debt expense in the fiscal year ended June 30, 2001 totaled $11.5 million as a result of writing off the $2.0 million advance and $2.6 million of management fee receivable owed by OmniCare-MI and the remaining carrying value of surplus notes of $6.9 million. Bad debt expense in the fiscal year ended June 30, 2000 totaled $3.1 million as a result of recording an impairment loss on the valuation of the unsecured loan made to OmniCare-MI.
At June 30, 2002, the Company had (i) cash and cash equivalents and short-term marketable securities of $18.8 million, compared to $24.8 million at June 30, 2001; (ii) negative working capital of $3.7 million, compared to positive working capital of $3.6 million at June 30, 2001; and (iii) a current assets-to-current liabilities ratio of 0.87-to-1, compared to 1.14-to-1 at June 30, 2001.
Medical claims payable increased by $4.6 million over at June 30, 2002 compared to June 30, 2001, which is directly related to the increased membership of OmniCare-TN. Other accounts payable and accruals actually decreased by $1.5 million during fiscal 2002 as OmniCare-MI expenses were being paid.
On September 20, 2000, the Company made an additional cash contribution of $0.9 million to OmniCare-TN in exchange for additional preferred stock of OmniCare-TN issued to the Company. The cash contribution was made to enable OmniCare-TN to meet minimum statutory requirements for net worth, while allowing OmniCare-TN to utilize the funds for working capital.
certain performance measures as an incentive to manage medical costs below the targets, and may incur financial penalties for not achieving certain performance requirements. The limited variable administrative fees could reward certain measurable MCO performance in the following areas; third party liability recovery rates; early and periodic screening, diagnosis and treatment (EPSDT) of children; multi-source prescription drug utilization; reduced appeals related to provider access; and successful collaboration on an EPSDT initiative.
OmniCare-TN received a permitted practice letter from the State of Tennessee to include such $7.5 million receivable in its statutory net worth at June 30, 2002. Under generally accepted accounting principles, such $7.5 million is not recorded in the Company's fiscal 2002 financial statements but will be recorded in its fiscal 2003 financial statements.
OmniCare-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 OmniCare-TN's substantially increased enrollment from members TennCare assigned from defunct other plans, together with adapting to TennCare's 18-month stabilization program.
As a Michigan HMO, OmniCare-MI is subject to oversight by the Commissioner of the Office of Financial & Insurance Services of the State of Michigan (the "Commissioner"). On July 31, 2001, pursuant to a motion by the Commissioner, a State circuit court judge entered an order of rehabilitation of OmniCare-MI (the "Order") and appointed the Commissioner to serve as Rehabilitator of OmniCare-MI. The Order directed the Rehabilitator to administer all of OmniCare-MI's assets and business while attempting to reform or revitalize OmniCare-MI to effectuate its rehabilitation, preserve its provider network and maintain uninterrupted health care
services to the greatest extent possible. Pursuant to and since the Order, the Rehabilitator's appointed special deputy has acted as the Chief Executive Officer of OmniCare-MI.
The management agreement was amended on December 14, 2001, effective August 1, 2001. The amendment reduced the Company's management fee revenues from OmniCare-MI beginning August 1, 2001, by changing the methodology for determining the Company's management fee from a fixed percentage (14%) of premiums earned by OmniCare-MI to a cost-based fee, which was equivalent to approximately 10% beginning in August 2001, subject to adjustment to appropriately reflect the Company's actual costs of performing the management agreement.
The Company currently has a $2.9 million term loan with Standard Federal Bank, repayable in monthly installments of principal and interest of $0.1 million, with an interest rate equal to the bank's prime rate (4.75% at June 30, 2002) plus one percent per annum, and a maturity date of September 30, 2004. The loan agreement is collateralized by a security interest in all of the Company's personal property. The bank has waived the Company's compliance with certain financial covenants for the fiscal quarter ended June 30, 2002, and the bank and the Company have agreed to modify the loan agreement's debt service coverage and net worth covenants for succeeding fiscal quarters.
The Company's ability to generate adequate amounts of cash to meet its future cash needs depends on a number of factors, particularly including its ability to control administrative costs related to managing medical costs for the TennCare program and controlling corporate overhead costs. On the basis of the matters discussed above, management believes at this time that the Company has the ability to generate sufficient cash to adequately support its financial requirements through June 30, 2003.