Healthsource's principal executive offices are located at Two College Park Drive, Hooksett, New Hampshire 03106, where Healthsource owns a large tract of land. Healthsource currently occupies a 97,600 square foot office building on this site and has announced plans to ultimately construct two additional buildings on the same site with approximately 200,000 square feet to replace other leased facilities in New Hampshire.
The cost of other insured medical premiums increased to $149 million from $14 million as a result of the acquisition of Provident's fully-insured managed indemnity products and experience rated refundable premium products.
Total selling, general and administrative ("SG&A") expenses increased to $300 million from $123 million due to acquisitions and the development of existing and new businesses. As a percent of total revenue, SG&A increased to 25.7% from 21.0% as a result of the self-funded business acquired in the Provident Transaction which has inherently higher levels of SG&A expense.
SG&A expenses related to HMO, fully-insured medical business and corporate administration increased 86% to $153 million from $83 million. This increase was primarily due to the effect of the acquisition of the remaining interests in HSNC and HSNY and the Provident Transaction, the membership increases at Existing Plans and start up of operations at HSSV and HSKY, and other business development activities. SG&A expenses related to administrative and managed care fees increased 265% to $146 million from $40 million due to the Provident Transaction, the effect of the acquisition of the remaining interest in HSNCA and increases in the Company's administrative service businesses serving self-insured POS and managed workers' compensation membership.
Depreciation and amortization expense increased 114% to $24 million from $11 million due to amortization expense associated with the acquisitions of Provident and the remaining interests in HSNC and HSNY and depreciation associated with increased capital purchases.
interest in the parent companies of HSME, HSNC, and HSNY; (2) the combined effect of an 11% increase in average membership and a 4% increase in average medical premium yield to $145 PMPM from $140 PMPM at its wholly-owned subsidiaries HSNH, HSIN, and HSTN; and (3) $12 million in medical premiums from the commencement of operations of HSAR. The remaining revenue increase was due to a 72% increase in administrative and managed care fees to $52 million from $30 million resulting primarily from continued growth of the Company's self-funded POS business in New Hampshire and Maine, managed workers' compensation healthcare administration fees in New Hampshire, administrative fees generated by the acquisition of a TPA business in Arkansas and the acquisition of the remaining interest in HSNCA.
The Company's MLR increased to 76.4% from 74.4% because the 4% increase in the average premium yield was less than the 6% increase in average cost of medical premiums at HSNH, HSTN, and HSIN and because of the acquisition of the remaining interest in HSME which had a higher MLR than the Company's 1993 MLR.
Depreciation and amortization expense increased 87% to $11 million from $6 million primarily due to the amortization expense associated with the Company's acquisitions of the remaining interests in HSNC, HSME, and HSNY.
Interest and other income increased 96% to $13 million from $6.6 million. This increase resulted primarily from the increased funds available for investment from the Company's $73 million public offering in August 1993, the acquisition of the remaining interests in HSSC, HSME, HSNC, and HSNY and continued increases in cash available from operations.
At December 31, 1995, cash, cash equivalents and marketable securities totaled approximately $224 million, of which $203 million was held by regulated operating subsidiaries and was largely restricted to use in those subsidiaries.
During 1995, the Company generated $51 million of cash from operations. The Company liquidated approximately $118 million in marketable securities and invested $55 million in property and equipment. The Provident Transaction resulted in a net cash expenditure of approximately $154 million.
On February 22, 1996, the Company announced its intention to privately offer to institutional investors $215 million principal amount of convertible subordinated notes (the "Notes"). The Company intends to use $100 million of the net proceeds of the Note offering to redeem the $100 million face amount of the Company's outstanding 6.25% Class A Cumulative Preferred Stock. The Company intends to use the balance of the net proceeds of the offering to repay a portion of the outstanding principal balance under the Chase Facility.
The Company's Chase Facility is a $300 million unsecured revolving line of credit, which is committed through March 15, 2000. At December 31, 1995, the Company had $95 million outstanding. Subsequent to year end, the Company borrowed an additional $50 million under the Chase Facility to fund the CMHC Transaction in February 1996. Additionally, the Company has signed a definitive agreement to purchase substantially all of the operating assets of PACC for approximately $80 million in cash subject to significant adjustments. The Company intends to fund the PACC Transaction from borrowings under the Chase Facility or other financial resources.
Historically, medical premiums and the cost of medical premiums generally have risen at a rate higher than that for consumer goods as a whole. Nationally, the rate of inflation of premiums and costs of medical premiums slowed substantially during 1995. The Company experienced a decrease of 3.7% in the average cost of medical premiums during 1995 over 1994. There is no assurance that the Company's cost of medical premiums will continue to decline.
We have audited the accompanying consolidated balance sheets of Healthsource, Inc. and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 1995. 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 1995, the Company issued $100 million in 6.25% cumulative preferred stock in connection with the Provident Transaction (as defined in Note 1) (See Note 4).
In 1994, the Company issued 1,242,000 shares of common stock, which were valued at $39.2 million in connection with the Healthsource Health Plans, Inc. acquisition (See Note 4).
Healthsource, Inc. and its subsidiaries (together referred to as the "Company") operate in a single business segment, managed healthcare, and provide a broad range of managed healthcare products and services through various subsidiaries. The Company owns health maintenance organizations (HMOs) in New England, upstate New York, and the Central, Southeastern and South Central United States and acquired the group health, HMO and third-party administration business of Provident Life and Accident Insurance Company of America ("Provident") of Chattanooga, Tennessee in May 1995 (the "Provident Transaction") (see Note 4). The Company also provides managed care and administration services directly to other healthcare payors.
Cash and Cash Equivalents The Company considers all money market deposits and instruments, repurchase agreements, remarketed preferred stock, certificates of deposit and U.S. Government obligations with original maturities of three months or less to be cash equivalents.
Intangible Assets Intangible assets consist of costs in excess of net assets acquired, covenants not to compete, hospital services agreements, physician networks and acquired membership lists. The costs in excess of net assets acquired are amortized over various periods not exceeding forty years using a straight-line method. The other intangible assets are amortized using a straight-line method over their estimated useful lives ranging from three to fifteen years. The Company continually evaluates the recoverability of goodwill using various methods and believes that no material impairment of goodwill existed at December 31, 1995.
Physician Risk Withholding The cost of medical premiums (including the portion of the physicians' fees withheld) are charged to expense as incurred, and amounts withheld from physicians are recorded as liabilities. Amounts to be returned to physicians are reviewed periodically, and any amounts not returned under the risk-sharing arrangement are recorded as reductions of the cost of medical premiums and corresponding reductions of the related liability for physician risk withholding.
Revenue HMO medical premium revenue and other insured medical premium revenue are recognized in the month in which members are entitled to receive healthcare services and are reported net of retrospective refunds. Medical premiums collected in advance are recorded as deferred revenue. Administrative and managed care fees are recognized in the period that claims processing and other managed care services are provided to self-funded clients. Revenue from management service agreements is recognized in the period for which the Company performs the services.
Selling, General & Administrative ("SG&A") Expense HMO and other insured SG&A expense includes the costs recognized by the Company and its majority-owned entities: (1) to market and administer the delivery of medical services for which the Company is at risk and (2) to develop and administer its management services agreements. Administrative and managed care fees SG&A expense includes the costs recognized by the Company and its majority-owned entities to market and administer the delivery of medical services for self-insured clients. Corporate SG&A is included within HMO and other insured SG&A expense.
Income Taxes The Company and its majority-owned subsidiaries file consolidated federal, New Hampshire, and Maine income tax returns. All other state income tax returns are filed on a separate company basis.
The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
Net Income Per Common Share Net income per common share for all periods presented was computed by dividing net income less preferred dividends by the weighted average number of shares outstanding during each respective period after giving effect to a two-for-one stock split effected in the form of a 100% stock dividend payable to shareholders, December 15, 1995. Preferred stock dividends amounted to $4,167,000 in 1995. Stock options, which do not materially dilute net income per common share, are included as common stock equivalents.
Risks and Uncertainties The Company's business could be impacted by continuing price pressure on new and renewal business, the Company's ability to effectively control healthcare costs, additional competitors entering the Company's markets, federal and state legislation in the area of healthcare reform and governmental licensing regulations of HMOs and insurance companies. Changes in these areas could adversely impact the Company's operations in the future.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Reclassifications Acquisitions in all years presented affect the comparability of amounts. Other insured medical premiums, cost of other insured medical premiums and a significant portion of SG&A are impacted and relate primarily to the Provident Transaction. Accordingly, certain prior year amounts have been reclassified to conform with the current year presentation.
The Company's investment portfolio consisted of the following securities which were classified as "available-for-sale" at December 31, 1995:
Proceeds from sales of "available-for-sale" securities during 1995 were $27.5 million. Realized gains on these sales totalled $.4 million.
Non-current restricted investments at December 31, 1994 consisted primarily of US Government Agencies and Municipal Tax Exempt Bonds.
The Company's intangible assets were acquired as the result of various acquisitions. At December 31, 1995 and 1994, the Company's intangible assets consisted of the following:
1994 Acquisitions On January 13, 1994, the Company acquired the remaining 60.2% interest in Healthsource Maine, Inc. (HSME). Under the terms of the agreement, the Company made a cash payment of $11.5 million in exchange for all of the shares of HSME which it did not already own. The transaction was accounted for as a purchase.
On March 31, 1994, the Company acquired the remaining 69.9% of Healthsource Health Plans, Inc. (HSHP), the parent company of Healthsource North Carolina, Inc. (HSNC). Under the terms of the agreement, HSHP shareholders received approximately 1.24 million shares of the Company's common stock. In addition, certain existing options held by HSHP management were converted at the same ratio to options to purchase approximately 153,000 shares of Healthsource common stock with an exercise price of approximately $4.60 per share. The transaction was accounted for as a purchase. The number of shares and option price per share have not been adjusted for subsequent stock splits.
1993 Acquisitions On March 31, 1993, the Company acquired the remaining 69.6% of PHS, the parent company of Healthsource South Carolina (HSSC). Under the terms of the agreement, Healthsource, Inc. issued 737,775 shares of common stock in exchange for all of the shares of PHS which it did not own. Additionally, the Company cashed out the rights to future share grants and options for approximately $1.2 million. The transaction was accounted for as a purchase. The number of shares has not been adjusted for subsequent stock splits.
The following unaudited pro forma consolidated statement of operations information assumes the Provident Transaction and the HSME, HSHP and HSNY acquisitions had occurred on January 1 of each year.
Property and leasehold improvements at December 31, 1995 and 1994 consisted of the following:
Depreciation and amortization expense for the years ended December 31, 1995, 1994 and 1993 was $14.9 million, $6.5 million and $2.9 million, respectively.
Acquisitions In February 1996, the Company acquired substantially all of the HMO assets of CMHC for approximately $46.5 million, subject to post closing purchase price adjustments. The purchase price was funded with proceeds from its revolving line of credit.
In January 1996, the Company announced that it had signed a definitive agreement to purchase substantially all of the operating assets of PACC HMO and PACC Health Plans for an estimated net price of $80 million in cash, subject to certain adjustments. The definitive agreement is subject to regulatory and other approvals.
Legal Proceedings The Company is involved in legal actions in the ordinary course of business. Although the outcome of any such legal actions cannot be predicted, in the opinion of management there are
no legal proceedings pending against or involving the Company, the outcome of which is likely to have a material adverse effect upon the consolidated financial position or results of operations of the Company.
Employee Benefit Plans The Company sponsors defined contribution retirement plans covering substantially all full-time employees. The Company matches employee contributions to a maximum of 3% of compensation. Expense related to this plan amounted to $1.7 million, $.4 million and $.2 million in 1995, 1994 and 1993, respectively.
At December 31, 1995, future minimum annual lease payments under noncancellable operating leases are as follows:
Under the terms of various management services agreements, the Company provided services to previously unconsolidated affiliates. Additionally, several members of the Board of Directors are also physicians who provide services to a wholly-owned subsidiary under a standard agreement used for all physicians, and three hospitals who are minority shareholders of each of three of the Company's consolidated subsidiaries also provide services under standard provider agreements.
The Company, with the approval of the shareholders, has three Non-Qualified Stock Option Plans for employees and one Non-Qualified Stock Option Plan for non-employee directors (the "Plans"). Options granted to employees may be designated by the Company as qualified or non-qualified at the date of grant. Under the provisions of the Plans, the Company is currently entitled to grant up to approximately 7 million options, plus annually an amount equal to 1 1/2% of the number of outstanding shares on the preceeding December 31. Each option is convertible into one share of common stock of the Company and may be awarded to employees of the Company and its subsidiaries and non-employee directors of the Company at a purchase price of at least 110% of the fair market value of the stock as of the date of grant. Options may be
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of investments in marketable securities, premiums receivable and hospital settlement receivables. The Company's investments in marketable securities are managed by internal and external investment managers within the guidelines established by the Board of Directors, which, as a matter of policy, limit the amounts which may be invested in any one issuer. Concentrations of credit risk with respect to premiums receivable and hospital settlement receivables are limited due to the large number of employer groups and hospital providers comprising the Company's customer base and provider networks, respectively. Additionally, the Company has a right of offset with respect to amounts due from and to the hospitals. As of December 31, 1995, management believes that the Company had no significant concentrations of credit risk.
The following table presents selected quarterly financial information for each of the four quarters of 1995 and 1994. Such information includes all adjustments the Company considers necessary for a fair presentation thereof.