<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from ________ to _______
Commission File No. 1-11538
------------
HEALTHSOURCE, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
New Hampshire 02-0387748
------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Two College Park Drive, Hooksett, NH 03106
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (603) 268-7000
--------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
At November 8, 1996, 63,795,517 shares of $.10 par value common stock of
the Registrant were outstanding.
1
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HEALTHSOURCE, INC.
INDEX
Page Number
-----------
Part I. Financial Information
- -----------------------------
Item 1. Financial Statements
--------------------
Condensed Consolidated Balance Sheets as of
September 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Operations
for the Three Months and Nine Months ended
September 30, 1996 and 4 - 5
Condensed Consolidated Statements of Cash Flows
for the Nine Months ended September 30, 1996 and 1995 6
Notes to Condensed Consolidated Financial Statements 7
Independent Accountants' Report 8
Item 2. Management's Discussion and Analysis of
---------------------------------------
Financial Condition and Results of Operations 9 - 14
---------------------------------------------
Part II. Other Information
- ---------------------------
Item 1. Legal Proceedings
-----------------
Not Applicable
Item 2. Changes in Securities
---------------------
Not Applicable
Item 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not Applicable
Item 5. Other Informati 15 - 17
---------------
Item 6. Exhibits and Reports on Form 8-K 17
--------------------------------
Signatures 18
2
<PAGE> 3
HEALTHSOURCE, INC. AND SUBSIDIARIES
- -----------------------------------
<TABLE>
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
- -------------------------------------------------------------------------------
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
(unaudited)
(in thousands)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . $119,553 $121,467
Marketable securities . . . . . . . . . . 22,576 34,301
Premiums and administrative fees
receivable . . . . . . . . . . . . . . . 65,839 66,103
Self-insured claims payments receivable. . 54,497 51,768
Restricted investments . . . . . . . . . . 113,474 123,871
Other current assets . . . . . . . . . . . 47,036 29,986
-------- --------
Total current assets . . . . . . . . . 422,975 427,496
Long-term assets:
Long-term marketable securities . . . . . 114,020 68,357
Property and leasehold improvements - net. 125,753 103,611
Restricted investments . . . . . . . . . . 8,788 8,099
Intangible assets - net. . . . . . . . . . 303,193 254,886
Other assets . . . . . . . . . . . . . . . 21,754 10,590
-------- --------
TOTAL $996,483 $873,039
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable . . . . . . . . . . $170,035 $152,649
Accounts payable and accrued expenses . . 95,113 85,678
Estimated liability under retrospective
refund agreements . . . . . . . . . . . 33,398 35,623
Deferred revenue . . . . . . . . . . . . . 21,055 7,489
Other current liabilities . . . . . . . . 632 1,587
-------- --------
Total current liabilities . . . . . . 320,233 283,026
Long-term liabilities:
Revolving note payable . . . . . . . . . . 15,000 95,000
Convertible subordinated notes . . . . . . 247,250 -
Other liabilities . . . . . . . . . . . . 7,154 6,931
-------- --------
Total liabilities. . . . . . . . . . . 589,637 384,957
-------- --------
Shareholders' equity:
Cumulative preferred stock . . . . . . . . - 100,000
Common stock . . . . . . . . . . . . . . . 6,380 6,358
Additional paid-in capital . . . . . . . . 224,778 221,048
Retained earnings . . . . . . . . . . . . 177,080 159,547
Unrealized gain (loss) on marketable
securities . . . . . . . . . . . . . . . (1,392) 1,129
-------- --------
Total shareholders' equity . . . . . . 406,846 488,082
-------- --------
TOTAL $996,483 $873,039
======== ========
</TABLE>
See notes to condensed consolidated financial statements
3
<PAGE> 4
HEALTHSOURCE, INC. AND SUBSIDIARIES
- -----------------------------------
<TABLE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
- -------------------------------------------------------------------------------
<CAPTION>
Three Months Ended
September 30,
-----------------------
1996 1995
-------- --------
(unaudited)
(in thousands,
except per share data)
<S> <C> <C>
Revenue:
HMO medical premiums .......................... $316,266 $207,843
Other insured medical premiums ................ 54,611 66,259
Administrative and managed care fees .......... 55,537 54,109
-------- --------
Total operating revenue ................... 426,414 328,211
-------- --------
Expenses:
Cost of HMO medical premiums .................. 254,616 159,319
Cost of other insured medical premiums ........ 47,449 53,683
Selling, general and administrative:
HMO and fully insured ....................... 60,724 41,885
Admin. and managed care fees ................ 47,884 47,633
-------- --------
Total selling, general and administrative . 108,608 89,518
Other charges ................................. 12,949 --
Depreciation and amortization ................. 10,045 6,838
-------- --------
Total operating expenses .................. 433,667 309,358
-------- --------
Operating income (loss) ................... (7,253) 18,853
Interest and other income ........................ 6,092 6,077
Interest expense ................................. (3,301) (2,174)
-------- --------
Interest and other income, net ............ 2,791 3,903
Income (loss) before provision for income taxes .. (4,462) 22,756
Income tax benefit (provision) ................... 1,063 (7,733)
-------- --------
Net income (loss) ................................ $ (3,399) $ 15,023
======== ========
Preferred stock dividends ........................ -- (1,563)
-------- --------
Net income (loss)
available to common shareholders ............... $ (3,399) $ 13,460
======== ========
Net income (loss) per common share: .............. $ (0.05) $ 0.21
Weighted average number of common and common
equivalent shares outstanding: ................. 63,984 63,748
</TABLE>
See notes to condensed consolidated financial statements
4
<PAGE> 5
HEALTHSOURCE, INC. AND SUBSIDIARIES
- -----------------------------------
<TABLE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
- -------------------------------------------------------------------------------
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1996 1995
---------- --------
(unaudited)
(in thousands,
except per share data)
<S> <C> <C>
Revenue:
HMO medical premiums .......................... $ 916,639 $591,236
Other insured medical premiums ................ 185,044 118,632
Administrative and managed care fees .......... 173,943 113,194
---------- --------
Total operating revenue ................... 1,275,626 823,062
---------- --------
Expenses:
Cost of HMO medical premiums .................. 736,112 456,711
Cost of other insured medical premiums ........ 156,888 95,875
Selling, general and administrative:
HMO and fully insured ....................... 177,678 108,225
Admin. and managed care fees ................ 143,720 97,413
---------- --------
Total selling, general and administrative . 321,398 205,638
Other charges ................................. 12,949 --
Depreciation and amortization ................. 27,951 15,986
---------- --------
Total operating expenses .................. 1,255,298 774,210
---------- --------
Operating income .......................... 20,328 48,852
Interest and other income ........................ 18,401 15,878
Interest expense ................................. (9,155) (3,607)
---------- --------
Interest and other income, net ............ 9,246 12,271
---------- --------
Income before provision for income taxes ......... 29,574 61,123
Provision for income taxes ....................... (10,913) (20,707)
---------- --------
Net income ....................................... $ 18,661 $ 40,416
========== ========
Preferred stock dividends ........................ (1,128) (2,605)
---------- --------
Net income available to common shareholders ...... $ 17,533 $ 37,811
========== ========
Net income per common share: ..................... $ 0.27 $ 0.59
Weighted average number of common and common
equivalent shares outstanding: ................. 65,084 63,870
</TABLE>
See notes to condensed consolidated financial statements
5
<PAGE> 6
HEALTHSOURCE, INC. AND SUBSIDIARIES
- -----------------------------------
<TABLE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
- -------------------------------------------------------------------------------
<CAPTION>
Nine Months Ended
September 30,
-----------------------
1996 1995
-------- --------
(unaudited)
(in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income ....................................... $ 18,661 $ 40,416
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization ................ 27,951 15,986
Changes in assets and liabilities,
net of effects of acquisitions:
Premiums and administrative fees receivable .. 2,942 (5,854)
Other current assets ......................... (19,197) (14,645)
Medical claims payable ....................... (4,483) 2,237
Accounts payable and accrued expenses ........ 4,992 (4,113)
Deferred revenue ............................. 13,043 3,853
-------- --------
Net cash provided by operating activities .. 43,909 37,880
-------- --------
Cash flows from investing activities:
Investment in affiliates/intangible assets, net
of cash acquired ............................... (55,558) (153,943)
(Increase) decrease in marketable securities ..... (20,062) 94,268
Additions to property and leasehold improvements . (38,742) (32,356)
(Increase) decrease in other assets and
restricted investments ......................... (707) (6,430)
-------- --------
Net cash used for investing activities ..... (115,069) (98,461)
-------- --------
Cash flows from financing activities:
Issuance of convertible subordinated ............. 247,250 -
Redemption of preferred stock .................... (100,000) -
Net borrowings (repayment) under revolving
note payable ................................... (80,000) 130,000
Issuance of common stock ......................... 2,901 4,508
Preferred stock dividends ........................ (1,128) (2,605)
Increase (decrease) in other liabilit ............ 223 370
-------- --------
Net cash provided by
financing activities ..................... 69,246 132,273
-------- --------
Increase (decrease) in cash and cash equivalents .... (1,914) 71,692
Cash and cash equivalents, beginning of ............. 121,467 67,193
-------- --------
Cash and cash equivalents, end of period ............ $119,553 $138,885
======== ========
Supplemental disclosure of cash flow information:
Income taxes paid ................................ $ 16,653 $ 21,458
Interest paid .................................... 8,239 2,174
</TABLE>
Supplemental disclosure of non-cash transactions:
Effective May 1, 1995, the Company acquired the group health, HMO and
third-party administration business of Provident Life and Accident Insurance
Company of America, Inc. In connection with the agreement, the Company issued
$100 million in 6.25% cumulative preferred stock.
See notes to condensed consolidated financial statements
6
<PAGE> 7
HEALTHSOURCE, INC. AND SUBSIDIARIES
- -----------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- ----------------------------------------------------------------
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Rule 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. These financial statements should be read in conjunction with the
audited consolidated financial statements of Healthsource, Inc. (the Company)
for the year ended December 31, 1995, included in the Company's Annual Report
on Form 10K for the year ended December 31, 1995. In the opinion of
management, all normal recurring adjustments considered necessary for a fair
presentation have been included.
The results of operations for the three month and nine month periods ended
September 30, 1996 are not necessarily indicative of the results of
operations to be expected for the full year.
2. SUMMARY OF SIGNIFICANT INCOME STATEMENT POLICIES
Reclassifications - Certain prior year amounts have been reclassified to
conform with the current year presentation.
3. CONVERTIBLE SUBORDINATED NOTES
On March 8, 1996, the Company completed the sale (through a private offering
to institutional investors) of $247 million principal amount of 5%
Convertible Subordinated Notes due 2003. The proceeds of the sale were used
to redeem the outstanding $100 million preferred stock and to repay a portion
of the amount owed under the revolving note payable.
4. OTHER CHARGES
During the third quarter of 1996, the Company has recorded a pre-tax
non-recurring charge of $12.9 million primarily to cover costs of lower than
expected conversion of self-insured lives to HMO membership and estimated
costs of investments in certain long-term strategic alliances to provide
assistance to hospitals for network start-up inefficiencies.
During the fourth quarter of 1996, the Company expects to record additional
non-recurring charges including those for a restructuring and a business
realignment currently being developed.
5. COMMITMENTS AND CONTINGENCIES
In June 1996, the Company announced that it had signed an asset purchase
agreement with Chubb Life to acquire the remaining 85% interest in Chubb
Health. The Company will acquire the stock of Chubb Health for an estimated
purchase price of $25 million, subject to adjustments. The agreement is
subject to regulatory approval.
In June 1996, the Company announced that it had terminated its previously
reported agreement to acquire substantially all of the assets of PACC Health
Plans and PACC HMO (together "PACC") a 113,000 member HMO and managed care
company based in the Portland, Oregon area.
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.
6. SUBSEQUENT EVENT
On October 1, 1996, the $15 million balance on the revolving note payable was
repaid.
7
<PAGE> 8
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors
and Shareholders of
Healthsource, Inc.
Hooksett, New Hampshire
We have reviewed the accompanying condensed consolidated balance sheet of
Healthsource, Inc. and subsidiaries as of September 30, 1996, the related
condensed consolidated statements of operations for the three month and nine
month periods ended September 30, 1996 and 1995, and the condensed consolidated
statements of cash flows for the nine month periods ended September 30, 1996 and
1995. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Healthsource, Inc. and subsidiaries
as of December 31, 1995 and the related consolidated statements of operations,
shareholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 16, 1996, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1995 is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
Boston, Massachusetts
November 8, 1996
8
<PAGE> 9
HEALTHSOURCE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
- -------
The Company has experienced substantial growth since its formation in New
Hampshire in 1985. Revenue growth has been accomplished through increasing
membership and medical premiums per member and administrative and managed care
fees from self-insured employers and through acquisitions. The Company has made
acquisitions of health maintenance organization ("HMO") companies resulting in
wholly-owned subsidiaries in South Carolina, Tennessee, Maine, Indiana, North
Carolina, Syracuse, New York and Massachusetts. The Company has formed strategic
alliances with hospitals and organized HMOs in Arkansas, Georgia, north central
Texas, and southwestern Ohio and has formed additional new HMOs in Connecticut
and Louisville, Kentucky. It also formed a strategic alliance with Chubb Life
Insurance Company to operate an HMO ("ChubbHealth") in the metropolitan New York
City and northern New Jersey areas. Effective May 1, 1995, the Company acquired
the group health, third-party administration and HMO business ("the Provident
Transaction") from Provident Life and Accident Insurance Company of America,
Inc. for $231 million in cash and preferred stock. To conduct the acquired
businesses, the Company organized and capitalized Healthsource Provident
Insurance Company to assume the insured business and Healthsource Provident
Administrators, Inc. to administer the self-insured business.
<TABLE>
The Company has experienced a decline in average premium yield during the first
nine months of 1996 of 5.0% as compared to the same period in 1995. Year-to-date
1996 and 1995 average premium yields were as follows:
<CAPTION>
REGION 9/30/96 9/30/95 % Change
------ ------- ------- --------
<S> <C> <C> <C>
North $138.02 $141.58 (2.5%)
South 117.11 123.29 (5.0%)
Total 125.00 131.61 (5.0%)
</TABLE>
The Company continues to experience very strong resistance to premium increases
by employers and intense price competition from payors, including new entrants.
While the Company expects this pricing environment to continue at least through
the renewal season for January 1997 business (and perhaps longer), the Company
will attempt to increase premium yield on its 1997 business whenever practicable
to reflect higher underlying healthcare costs. In addition, the Company's
overall premium yield will be affected by the mix of business volume between its
higher yielding Northern Plans and the lower yielding Southern Plans that
historically have grown more rapidly. Given the difficult premium pricing
environment, the Company's medical loss ratio, and ultimately its profitability,
will depend upon its ability to control healthcare and administrative costs
commensurate with a more intense premium pricing environment.
Acquisition Developments
- ------------------------
In June, 1996, the Company acquired Security Assurance Company, a Delaware
insurance company licensed in 49 states, at a net cost of $3 million in order to
fulfill commitments made in the Provident Transaction and to enable the Company
to write its national insured business directly rather than through Provident
entities. In February, 1996, the Company acquired Central Massachusetts Health
Care ("CMHC"), an 80,000 member HMO headquartered in Worcester, Massachusetts.
The Massachusetts market is highly penetrated and competitive and CMHC may lose
significant enrollment in the coming January renewal season and may likely
experience financial losses until it can obtain better health care cost controls
or better premium pricing. In June, 1996, the Company announced an agreement
with Chubb Life Insurance Company of America to acquire the remaining 85%
interest in ChubbHealth, a 50,000 member HMO operating in the metropolitan New
York/New Jersey market. The Company expects to complete this acquisition in the
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<PAGE> 10
near future. Given the competitive market, ChubbHealth may incur substantial
operating losses as it seeks to establish itself in the large metropolitan New
York/New Jersey market.
Recent Reduction in Profitability; Enrollment Levels; Review of Operations
- --------------------------------------------------------------------------
The Company's profitability in the third quarter of 1996, exclusive of the
non-recurring charges discussed below, is lower than the second quarter and
dramatically lower than the similar period in 1995, as a result of the
continuing deterioration in health care costs during a period of premium
contraction. The Company does not expect any improvement in earnings in the
fourth quarter since 1996 premiums are largely fixed. The Company remains
focused on appropriate increases in 1997 premium pricing which may not be
achievable due to market conditions, will significantly reduce its enrollment
growth rate and may reduce its absolute enrollment level. The Company will also
attempt to improve its medical loss ratio through initiatives to reduce
inappropriate or excessive health care costs. Such initiatives (which may
include lower payment levels to providers, new contracting methodologies, and
steerage of members more aggressively to more efficient providers, and other
measures) may cause the Company's relationship with health care providers to be
strained in certain markets. In some markets, however, the Company may have to
increase payments to providers over 1996 levels. The Company is exploring other
methodologies to contain health care costs and reassessing various lines of
business and operating units in a review of operations in an attempt to improve
profitability in 1997. No assurance can be given that such initiatives will be
successful.
<TABLE>
The following table shows membership for the Company's affiliated health plans
as of September 30, 1996 and 1995:
<CAPTION>
9/30/96 9/30/95
--------- ---------
<S> <C> <C>
HMOs(1)
Northern Region:
New Hampshire 136,900 106,500
Massachusetts 78,700 -
Indiana 67,800 61,400
Maine 66,700 59,100
New York City 32,900 29,600
New York (Syracuse) 21,500 22,900
New Jersey 23,400 -
Kentucky 13,300 8,600
Ohio 1,300 -
--------- ---------
Sub-total 442,500 288,100
--------- ---------
Southern Region:
North Carolina 187,500 128,800
South Carolina 150,100 103,000
Tennessee 84,200 41,000
Arkansas 33,800 26,200
Georgia 15,400 6,300
Texas 8,700 -
--------- ---------
Sub-total 479,700 305,300
--------- ---------
Total HMO 922,200 593,400
--------- ---------
MANAGED INDEMNITY (INSURED)(2) 57,300 64,300
SELF AND PARTIALLY INSURED MEDICAL PRODUCTS
- -------------------------------------------
Point of Service 211,900 180,400
Workers' Compensation 101,700 116,900
Other Managed
Care/Administration(3) 2,030,800 2,371,600
--------- ---------
Total Self-Insured 2,344,400 2,668,900
------------------ --------- ---------
TOTAL ADMINISTERED MEDICAL 3,323,900 3,326,600
- -------------------------- --------- ---------
DENTAL PRODUCTS(4)
- ---------------
Fully Insured 343,300 379,900
Self Insured 2,085,000 2,204,100
--------- ---------
TOTAL ADMINISTERED DENTAL 2,428,300 2,584,000
- ------------------------- --------- ---------
</TABLE>
10
<PAGE> 11
(1) Includes membership for HMOs owned, co-owned, and/or managed by the
Company. Managed indemnity lives previously reported in the Company's HMO
membership are now reported separately as managed indemnity lives. At September
30, 1996 and 1995, these lives were 6,300 and 7,300, respectively.
(2) Includes managed indemnity business from the Provident acquisition of
approximately 51,000 and 57,000 at September 30, 1996 and 1995, respectively.
(3) Includes self-insured business from the Provident acquisition of
approximately 1,829,000 and 2,097,000 lives at September 30, 1996 and 1995,
respectively. Included in these totals are approximately 215,000 and 329,000 at
September 30, 1996 and 1995, respectively which were covered by minimum premium
and retrospectively rated premium products where the Company shares risk with
the employers and where the Company receives an insurance premium. Many of these
employer accounts have managed care benefit designs.
(4) Obtained through the Provident acquisition.
Three Months Ended September 30, 1996 Compared to Three Months Ended September
- ------------------------------------------------------------------------------
30, 1995
- --------
operating results for the three months ended september 30, 1996 were adversely
affected by a pre-tax non-recurring charge of $12.9 million primarily to cover
costs of lower than expected conversion of self-insured lives to HMO membership
and estimated costs of investments in certain long-term strategic alliances to
provide assistance to hospitals for network start-up inefficiencies.
Revenue increased 30% to $426 million from $328 million. This increase was
largely the result of a 52% increase in HMO medical premium revenue to $316
million from $208 million. The change in HMO medical premium revenue was
attributable to: (1) the combined effect of a 41% increase in average membership
and a 3.2% decrease in average medical premium yield to $125 per member per
month (pmpm) from $129 pmpm at Healthsource New Hampshire (HSNH), Healthsource
Tennessee (HSTN), Healthsource Indiana (HSIN), Healthsource South Carolina
(HSSC), Healthsource Maine (HSME), Healthsource North Carolina (HSNC),
Healthsource Arkansas (HSAR), Healthsource Savannah (HSSV), Healthsource New
York (HSNY) and Healthsource Kentucky (HSKY)(collectively "Existing Plans"); (2)
a $30 million increase due to the acquisition of Healthsource CMHC ("HSCMHC");
and (3) the commencement of operations of Healthsource North Texas (HSNTX) and
Healthsource Ohio (HSOH).
Other insured medical premium decreased 18% to $55 million from $66 million as a
result of both lapses and a conscious effort to reduce or convert the Company's
non-HMO insured book of business.
Cost of HMO medical premiums (health care costs) increased 60% to $255 million
from $159 million. This increase was due to: (1) the combined effect of the 41%
increase in average membership with a 1.8% increase in the average cost of
medical premiums to $101 pmpm from $99 pmpm at Existing Plans; (2) a $26 million
increase due to the acquisition of HSCMHC; and (3) the commencement of
operations at HSNTX and HSOH. This 1.8% increase in costs resulted principally
from higher outpatient hospital, diagnostic and pharmaceutical costs.
The cost of HMO medical premiums as a percent of HMO medical premiums (the
"medical loss ratio") increased to 80.5% from 76.7% primarily because of the
3.2% decrease in average medical premium yield and the 1.8% increase in average
cost of medical premiums at Existing Plans. The divergence between premium
pricing (which significantly declined) and health care costs (which increased)
was primarily responsible for the Company's significant reduction in
profitability. While the difficult premium pricing environment is expected to
continue, the Company will attempt to reverse the premium yield decline in 1997,
although there can be no assurance that the Company will be successful. Failure
to achieve an increase in premium yield will most likely increase the Company's
medical loss ratio and reduce net income.
11
<PAGE> 12
The cost of other insured medical premiums decreased to $47 million from $54
million as a result of a decrease in the fully-insured managed indemnity
products and minimum premium and retrospectively rated premium products, but is
higher as a percentage of premiums due to an unusually high level of large
claims.
Total selling, general and administrative (SG&A) expenses increased to $109
million from $90 million due to acquisitions and the development of existing
operations and new businesses. As a percent of total operating revenue, SG&A
expenses decreased to 25.5% from 27.3% as a result of a number of factors
including change in mix of business where SG&A levels as a percentage of revenue
are far lower in fully-insured business than self-insured business where revenue
does not include health care expenses.
SG&A expenses related to HMO, fully-insured medical business and corporate
administration increased 45% to $61 million from $42 million. This increase
resulted primarily from the SG&A expense associated with the acquisition of
HSCMHC, the membership increases at existing HMOs, the commencement of
operations at HSNTX and HSOH, development expenses at start-up HMOs and other
business development activities. SG&A expenses related to administration and
managed care fees remained level at $48 million.
Depreciation and amortization expense increased 47% to $10 million from $7
million primarily due to the amortization expense associated with HSCMHC which
was acquired in the first quarter of 1996 and depreciation associated with
increased capital purchases.
Interest expense increased 52% to $3.3 from $2.2 million as a result of the
convertible subordinated notes issued in March 1996.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
- ----------------------------------------------------------------------------
30, 1995
- --------
Revenue increased 55% to $1.3 billion from $823 million. The majority of the
difference was the result of a 55% increase in HMO medical premium revenue to
$917 million from $591 million. The change in HMO medical premium revenue was
attributable to: (1) the combined effect of a 45% increase in average membership
and a 5.0% decrease in average medical premium yield to $125 pmpm from $132 pmpm
at its wholly-owned subsidiaries HSNH, HSTN, HSME, HSSC, HSNC, HSAR, HSIN, HSSV,
and HSNY ("Existing Plans"); (2) an $83 million increase due to the acquisition
of HSCMHC; and (3) from the commencement of operations of HSNTX and HSOH.
In addition, there was a significant increase in revenue resulting from an
increase in other insured medical premiums to $185 million from $119 million
which resulted from the inclusion of the Provident transaction for a full nine
months in 1996.
The remaining revenue increase was due to a 54% increase in administrative and
managed care fee revenue to $174 million from $113 million which resulted from
the inclusion of the Provident acquisition for a full nine months in 1996.
Cost of HMO medical premiums increased 61% to $736 million from $457 million.
This increase was due to the combined effect of the 45% increase in average
membership, with a 1.0% decrease in the average cost of medical premiums to $100
pmpm from $101 pmpm at Existing Plans, the acquisition of HSCMHC and the
commencement of operations at HSNTX, HSKY, and HSOH. This 1.0% decrease was due
principally to lower inpatient hospital costs offset by higher outpatient
hospital, diagnostic and pharmaceutical costs.
The Company's HMO medical loss ratio increased to 80.3% from 77.2% because the
5.0% decrease in the average premium yield was higher than the 1.0% decrease in
cost of medical premiums at Existing Plans coupled with HSNTX, HSOH, and HSKY
which combined had higher medical loss ratios than the Existing Plans. The
divergence between premium pricing (which declined 5%) and health care costs
(which declined 1%) was primarily responsible for the Company's significant
reduction in profitability. While the difficult premium pricing environment is
12
<PAGE> 13
expected to continue, the Company will attempt to reverse the premium yield
decline in 1997, although there can be no assurance that the Company will be
successful. Failure to achieve an increase in premium yield will most likely
increase the Company's medical loss ratio and reduce net income.
The cost of other insured medical premiums increased to $157 million from $96
million as a result of the inclusion of Provident's fully-insured managed
indemnity products and minimum premium and retrospectively rated premium
products for a full nine months in 1996.
Total SG&A expenses increased to $321 million from $206 million due to
acquisitions and the development of existing and new businesses. As a percent of
total revenue, SG&A increased to 25.2% from 25.0%.
SG&A expenses related to HMO, fully-insured medical business and corporate
administration increased 64% to $178 million from $108 million. This increase
was primarily due to the SG&A associated with the fully-insured Provident
business being included for a full nine months, the acquisition of HSCMHC, the
membership increases at Existing Plans, the commencement of operations at HSOH,
HSNTX, and HSKY, development expenses at start-up HMOs and other business
development activities. SG&A expenses related to administrative and managed care
fees increased 48% to $144 million from $97 million due to the SG&A associated
with the Provident business being included for a full nine months in 1996.
Depreciation and amortization expense increased 75% to $28 million from $16
million primarily due to amortization expense associated with the Provident and
HSCMHC acquisitions and depreciation associated with increased capital
purchases.
Interest and other income increased 16% to $18.4 million from $15.9 million.
This increase resulted primarily from the increase in cash, cash equivalents and
marketable securities associated with the Provident acquisition. Interest
expense increased 154% to $9.2 million from $3.6 million as a result of interest
associated with the convertible subordinated notes.
Liquidity and Capital Resources
- -------------------------------
At September 30, 1996, cash, cash equivalents and marketable securities totaled
approximately $256 million, of which $252 million were held by regulated
operating companies and, except for permissable dividends, were largely
restricted to use in those companies.
During the first nine months of 1996, the Company generated $44 million of cash
from operations and invested approximately $39 million in additional facilities
and information technology. The acquisition of HSCMHC resulted in a net cash
expenditure of $46 million which was funded from borrowings under the Chase
Facility described below.
On March 8, 1996, the Company completed the sale (through a private offering to
institutional investors) of $247 million principal amount of 5% Convertible
Subordinated Notes (the "Notes") due 2003. The Notes are convertible into Common
Stock of the Company at a price of $46.965 per share. The Company used the net
proceeds of the offering to redeem the $100 million face amount of the Company's
outstanding 6.25% Class A Cumulative Preferred Stock. The balance of the net
proceeds of the offering was used to repay a portion of the outstanding
principal balance under the Company's $200 million unsecured revolving credit
agreement with Chase Manhattan Bank N.A. as agent ("Chase Facility").
The Chase Facility is committed through March 15, 2000. At September 30, 1996,
the Company had $15 million outstanding which it repaid on October 1, 1996. Due
to certain covenants taking effect in March 1998, the effective availability of
the Chase Facility is limited to $100 million; current earnings tests would
substantially further restrict permanent loan levels, but the Company is
negotiating for additional flexibility through March 1998.
13
<PAGE> 14
The principal and interest on the Notes is by their terms subordinated in right
of payment to principal and interest on substantially all existing and future
debt (including debt under the Chase Facility) incurred by the Company ("Senior
Debt"). As of September 30, 1996, the Company had $15 million in Senior Debt. As
of such date, the Company's subsidiaries had aggregate liabilities of
approximately $311 million, to which the Notes are also structurally
subordinated.
The Company has signed an asset purchase agreement with Chubb Life to acquire
the remaining 85% interest in ChubbHealth for an estimated purchase price of $25
million, subject to adjustments. The agreement is subject to regulatory
approval. The Company intends to fund the ChubbHealth transaction from
borrowings under the Chase Facility or other financial resources.
The Company believes that its existing cash balances and cash flow generated by
its wholly-owned plans coupled with the amounts available for borrowing under
the Chase Facility are adequate to fund its existing operations and commitments.
During the fourth quarter of 1996, the Company expects to record additional
non-recurring charges including those for a restructuring and a business
realignment currently being developed.
Effects of Inflation
- --------------------
Medical premiums and the costs of medical premiums (healthcare costs) generally
increase at higher rates than the overall rates of inflation in the economy.
Accordingly, the Company must use strong utilization management techniques and
tight provider contracting strategies to counteract inflationary trends in
healthcare costs and, given the current phenomenon of declining premium levels,
any failure to adequately control healthcare costs can substantially increase
the Company's medical loss ratio and decrease the Company's net income.
* * * * * *
Risks associated with any forward looking statements contained in Management's
Discussion and Analysis of Financial Condition and Results of Operations are
discussed in Item 5, Other Information.
14
<PAGE> 15
PART II - OTHER INFORMATION
Items 1, 2, 3, & 4. Not Applicable.
---------------
Item 5. Other Information.
------------------
(i) SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995. The statements contained in the Management's Discussion and Analysis of
Financial Condition and Results of Operations and those contained in the
Company's Annual Report on Form 10-K concerning future profitability, premium
pricing levels, future levels of medical-loss ratios, the Company's ability to
control healthcare and SG&A costs and all other statements that are not
historical facts are forward looking statements. Because such statements involve
risks and uncertainties, the following factors, among others, could affect the
Company's actual results and could cause actual future results to differ
materially from those expressed in any forward looking statements made by the
Company or its representatives including those made herein or in SEC filings,
press releases, presentations to securities analysts or investors or other
communications by the Company:
CONTROL AND PREDICTABILITY OF HEALTH CARE COSTS. The Company's profitability
depends in large part on predicting and maintaining effective control of the
healthcare costs of its HMOs. The future profitability of the Company's HMOs is
dependent upon controlling future healthcare costs in part through appropriate
benefit design, utilization control and negotiation of favorable provider
contracts, including global capitation arrangements with hospitals which
generally link healthcare costs for assigned members to the premiums received
for such members. The Company may be unable to predict accurately or to control
health care costs because of many factors, including the inherent
unpredictability of rates of utilization of services in any given period and the
volatility of such use particularly in quarterly periods; major epidemics;
undetected increases in costs of units of services (in some cases implemented by
providers without prior notice); changes in risk profile of a rapidly increasing
membership due to pre-existing medical conditions, changing demographics and
other factors; and increased utilization driven by changes in physician practice
patterns and new techniques (e.g., use of bone marrow transplants for an
increasing number of diagnostic categories)and by consumer demand for new drugs.
There can be no assurance that the Company will be successful in predicting or
mitigating the effect of any of these factors nor that its global capitation
agreements will be able to totally buffer these factors or costs for assigned
members, especially since the Company expects that certain provider disputes
will require it to pay higher than anticipated costs for health care services in
1997 and beyond.
COMPETITION AND PREMIUM PRICING. The managed healthcare industry is highly
competitive at both the local HMO level and in the regional and national
employer markets. The principal competitive factors affecting the Company's
products are premium rates and fees, plan design and flexibility, and
physician/hospital network and reputation. The Company competes in all of its
markets with Blue Cross plans, indemnity insurers, HMOs, TPAs, PPOs and other
managed care companies. The Company also faces competition in many of its
markets from hospitals and other provider groups who have organized their own
networks to contract directly with employer groups.
The price charged for providing benefits is in many instances the controlling
factor in obtaining and retaining employer groups, and in certain markets some
competitors are underpricing the Company's products. In many historically under-
penetrated markets such as the Carolinas and upper New England, many new HMOs
have been recently licensed which is reflected in premium pressure for new and
renewal business. Partially as a result of this competition, the Company
experienced a 5.0% decline in average premium yield per member during the first
nine months of 1996. The Company expects the difficult premium pricing
environment to continue and the Company's attempts to reverse the 1996 premium
decline may not be successful.
15
<PAGE> 16
ACCOUNTING; MIS; NETWORK DISRUPTION ISSUES. Reserves for incurred but not
reported claims ("IBNR") are a large component of the Company's medical claims
payable reserve and are based upon an estimation of future claims using
traditional actuarial techniques heavily influenced by historical claims
experience; rapid growth and changing risk profiles could render the Company's
IBNR estimates inaccurate and there can be no assurance as to the ultimate
accuracy of such estimates or that subsequent adjustments will not cause
fluctuations in the Company's operating results. The ability to predict IBNR,
control costs in general and to manage increasingly complicated global
capitation arrangements depends upon the use of sophisticated customized MIS
systems; there can be no assurance that such systems can be developed quickly
enough to effectively manage the increasing complexity of the Company's
contractual arrangements nor that facility or equipment problems will not
disrupt the Company's ability to effectively provide such MIS support. The
increasing complexity of contractual arrangements and adverse experience in
periods of premium contraction and increasing costs, create the potential for
disagreements with major hospital providers over the reimbursement under such
contracts, which disagreements (if not resolved) could disrupt relations with
affiliated hospital or physician providers, could potentially affect the
perception of the Company's plans in the affected markets and has resulted in
the Company's election to invest in certain of these long-term arrangements to
smooth the affiliated providers' transition to global risk.
ACQUISITIONS AND NEW PRODUCTS. A significant part of the Company's business
strategy is to diversify into new geographic markets through acquisitions or
start-up plans and to develop new products although existing credit lines limit
its current ability to do so. Identifying and pursuing acquisition
opportunities, integrating acquired businesses and managing growth requires a
significant amount of management time and skill. The Company may be unable to
(i) negotiate acceptable terms with suitable acquisition candidates or ensure
that, if negotiated, such acquisitions will be either approved by all relevant
regulatory authorities or concluded, (ii) assimilate such acquired companies
free from hidden risks undetected at the time of closing or (iii) manage future
growth effectively. Until start-up HMOs reach a critical mass of membership,
they generally produce operating losses (despite capitated provider contracts)
and failure to generate sufficient membership in start-up markets could
adversely affect operating results. The Company is expanding its product
offerings, most notably by developing and seeking a license for Medicare risk
products in several of its markets. The Company will expend approximately $5
million in 1996 and 1997 in developing such Medicare products which will still
require a substantial marketing program before the Company generates revenues
from such products in any market; the failure to achieve Medicare membership
quickly in various markets may further impact operating results as such
development expenses are relatively fixed. There can be no assurance that the
Company will successfully mitigate any of the foregoing risks.
IMPACT OF HEALTHCARE REFORM. Many federal and state proposals have been made in
the past to reform the healthcare system. Federal legislation covering minimum
maternity stay and enhanced mental health benefits has been recently passed. The
Company anticipates that federal and state legislatures will continue to assess
alternative healthcare systems and payment methodologies as well as other
mandated coverages, capitation limits, underwriting constraints and other
measures that could affect the Company's business. The Company is unable to
predict which, if any, of these healthcare reform proposals may be adopted.
While the Company does not believe it would be materially adversely impacted by
most of the recent or proposed reforms, certain proposals could have such an
impact; for example the imposition of a single-payor system in any state could
potentially eliminate the Company's business in that state. See "Business --
Governmental Regulation" in the Company's Form 10-K.
GOVERNMENTAL REGULATION. The Company's HMOs, insurance companies and certain of
its other subsidiaries are licensed by and subject to periodic examination and
extensive regulation by the states in which they operate and by the federal
government. Such state and federal statutes and regulations are subject to
change and such changes could adversely impact the Company's operations in the
16
<PAGE> 17
future. There can be no assurance that the Company will be able to obtain any
regulatory approvals required to enter new markets or to offer new products. See
"Business - Governmental Regulation" in the Company's Form 10-K.
VOLATILITY OF THE COMPANY'S STOCK. The market price for the Company's stock may
be affected by investor perception of the Company, by general economic and
market conditions, by fluctuations in quarterly earnings, by general trends in
the healthcare market, by adverse news coverage of the HMO industry and by
regulatory developments especially at the federal level; accordingly, the market
price of the Company's stock may be volatile.
Item 6. Exhibits and Reports on Form 8-K
---------------------------------
(a) Exhibits
11. Statement re: Computation of Net Income Per Share
27. Financial Data Schedule
(b) Reports on Form 8-K
The following reports on Form 8-K were filed with the Securities and
Exchange Commission during the quarter ended September 30, 1996:
1. On August 2, 1996, the Company reported preliminary operating
results and the adoption of a Rights Agreement pursuant to which
each shareholder of record as of August 12, 1996 and subsequently
(subject to certain exceptions) will receive one right per share of
outstanding Common Stock. The rights will entitle the holders,
upon any person or group acquiring ownership of 20% or greater of
the outstanding Common Stock, to purchase additional shares of
Common Stock at half the market price, except the 20% or greater
holder.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEALTHSOURCE, INC.
Dated: November 12, 1996 By /S/ Norman C. Payson
---------------------------------
Norman C. Payson, M.D.
President and
Chief Executive Officer
By /S/ Joseph M. Zubretsky
----------------------------------
Joseph M. Zubretsky
Chief Financial Officer/Principal
Accounting Officer
18
<PAGE> 1
HEALTHSOURCE, INC. EXHIBIT 11
<TABLE>
COMPUTATION OF NET INCOME PER SHARE
(UNAUDITED)
<CAPTION>
Three Months Ended
September 30,
-----------------------
1996 1995
------- -------
(in thousands
except per share data)
<S> <C> <C>
Net income (loss) .............................. $(3,399) $15,023
Preferred dividend ............................. - (1,563)
------- -------
Net income (loss) available
to common stockholder ........................ $(3,399) $13,460
======= =======
COMPUTATION OF SHARES OUTSTANDING:
- ---------------------------------
Average weighted common shares
outstanding ................................ 63,984 63,054
Dilutive effect of stock options issued ........ - 694
------- -------
Average weighted common shares and share
equivalents outstanding .................... 63,984 63,748
======= =======
NET INCOME PER COMMON SHARE: $ (0.05) $ .21
- ---------------------------
<CAPTION>
Nine Months Ended
September 30,
-----------------------
1996 1995
------- -------
(in thousands
except per share data)
<S> <C> <C>
Net Income ..................................... $18,661 $40,416
Preferred dividend ............................. (1,128) (2,605)
------- -------
Net income available to
common stockholders ........................... $17,533 $37,811
======= =======
COMPUTATION OF SHARES OUTSTANDING:
- ----------------------------------
Average weighted common shares
outstanding ................................ 63,702 62,806
Dilutive effect of stock options issued ........ 1,382 1,064
------- -------
Average weighted common shares and share
equivalents outstanding .................... 65,084 63,870
======= =======
NET INCOME PER COMMON SHARE: $ 0.27 $ 0.59
- ---------------------------
</TABLE>
20
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 119,553
<SECURITIES> 136,596
<RECEIVABLES> 120,336
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 422,975
<PP&E> 125,753
<DEPRECIATION> 0
<TOTAL-ASSETS> 996,483
<CURRENT-LIABILITIES> 320,233
<BONDS> 262,250
<COMMON> 6,380
0
0
<OTHER-SE> 400,466
<TOTAL-LIABILITY-AND-EQUITY> 996,483
<SALES> 1,275,626
<TOTAL-REVENUES> 1,294,027
<CGS> 893,000
<TOTAL-COSTS> 1,255,298
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,155
<INCOME-PRETAX> 29,574
<INCOME-TAX> 10,913
<INCOME-CONTINUING> 18,661
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,661
<EPS-PRIMARY> .27
<EPS-DILUTED> 0
</TABLE>
