UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 1-13248
RIGHTCHOICE MANAGED CARE, INC.
(Exact name of registrant as specified in its charter)
Missouri 43-1674052
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1831 Chestnut Street, St. Louis, Missouri 63103-2275
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (314) 923-4444
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
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 [ ]
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest
practicable date:
Title of each class Outstanding at June 30, 1997
Class A Common Stock, $0.01 par value 3,709,000 shares
Class B Common Stock, $0.01 par value 14,962,500 shares
RIGHTCHOICE MANAGED CARE, INC.
Second Quarter 1997 Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1997
and December 31, 1996 3
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 1997 and 1996 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1997 and 1996 5
Notes to Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 26
ITEM 2. Changes in Securities 26
ITEM 3. Defaults Upon Senior Securities 26
ITEM 4. Submission of Matters to a Vote of Security Holders 26
ITEM 5. Other Information 26
ITEM 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 28
PART I.FINANCIAL INFORMATION
ITEM 1.Financial Statements
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share data)
June 30, December 31,
ASSETS 1997 1996
(unaudited)
Current assets:
Cash and cash equivalents $ 17,427 $ 33,418
Investments available for sale 244,803 262,216
Receivables from members 61,741 54,767
Receivables from related parties 14,199 17,073
Deferred income taxes 5,687 591
Other assets 20,822 13,193
Total current assets 364,679 381,258
Property and equipment, net 53,279 51,248
Deferred income taxes 4,267 6,247
Investments in affiliates 9,221 9,370
Goodwill and intangible assets, net 82,973 84,021
Total assets $514,419 $532,144
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable $ 115,294 $ 111,833
Unearned premiums 50,678 52,699
Accounts payable and accrued expenses 69,635 68,844
Payables to related parties 16,616 17,149
Obligations for employee benefits 3,718 3,864
Income taxes payable 17,048 12,801
Obligations under capital leases 4,728 5,224
Total current liabilities 277,717 272,414
Long-term debt 47,000 62,000
Obligations for employee benefits 20,443 21,244
Obligations under capital leases 2,398 3,532
Total liabilities 347,558 359,190
Shareholders' Equity:
Common Stock:
Class A, $.01 par, 125,000,000
shares authorized, 3,737,500 shares
issued, 3,709,000 and 3,714,400
shares outstanding, respectively 37 37
Class B, $.01 par, 100,000,000
shares authorized, 14,962,500 shares
issued and outstanding 150 150
Additional paid-in capital 132,640 132,640
Retained earnings 34,570 30,687
Treasury stock, 28,500 and 23,100
Class A shares, respectively, at cost (404) (326)
Unrealized net (depreciation)
appreciation of investments
available for sale (132) 9,766
Total shareholders' equity 166,861 172,954
Total liabilities and
shareholders' equity $514,419 $532,144
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except shares and per share data)
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
Revenues:
Premium $161,831 $147,810 $321,988 $291,357
Fees and other income 14,318 13,570 30,475 27,991
Total revenues 176,149 161,380 352,463 319,348
Operating expenses:
Healthcare services 139,301 119,713 268,457 226,600
Commissions 7,072 6,513 14,355 12,819
General and administrative
(excludes depreciation and amor-
tization and excludes net inter-
company charges allocated to Blue
Cross and Blue Shield of Missouri
of $2,491, $3,009, $4,624, and
$6,523, respectively) 34,604 30,969 69,553 62,043
Depreciation and amortization 5,384 3,717 10,402 7,043
Non-recurring charges 834 2,743 2,896 2,743
Total operating expenses 187,195 163,655 365,663 311,248
Operating (loss) income (11,046) (2,275) (13,200) 8,100
Investment income:
Interest and dividends 4,417 3,648 7,746 7,099
Realized gains, net 5,879 1,919 16,060 2,987
Total investment income, net 10,296 5,567 23,806 10,086
Other:
Interest expense (1,056) (1,268) (2,322) (2,597)
Other (expense) income, net (316) 145 (303) 81
Total other, net (1,372) (1,123) (2,625) (2,516)
(Loss) income before provision
for income taxes (2,122) 2,169 7,981 15,670
Provision for income taxes 189 885 4,098 6,161
Net (loss) income $(2,311) $ 1,284 $ 3,883 $ 9,509
Weighted average common
shares outstanding 18,672,000 18,680,000 18,674,000 18,681,000
(Loss) earnings per share $ (0.12) $ .07 $ .21 $ .51
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the six months ended,
June 30,
1997 1996
Cash flows from operating
activities:
Net income $ 3,883 $ 9,509
Adjustments to reconcile net
income to net cash (used in)
provided by operating activities:
Provision for deferred income
tax benefits 2,416 3,332
Depreciation and amortization 10,402 7,043
Undistributed losses (earnings)
of affiliates 149 (115)
Gain on sale of investments (16,060) (2,987)
Amortization of premiums and
accretion of discounts, net (160) 247
Loss on sale of
property and equipment 8 36
(Increase) decrease in certain assets:
Receivables from members (6,974) 6,119
Receivables from related parties 2,874 10,052
Other assets (9,270) (9,020)
Increase (decrease) in certain liabilities:
Medical claims payable 3,462 4,556
Unearned premiums (2,021) (1,136)
Accounts payable and accrued
expenses 791 (6,963)
Payables to related parties (533) (6,419)
Obligations for employee benefits (948) 563
Income taxes payable 4,247 (4,050)
Net cash (used in) provided by
operating activities (7,734) 10,767
Cash flows from investing activities:
Proceeds from matured investments:
Fixed maturities 215 5,025
Proceeds from investments sold:
Fixed maturities 132,317 163,456
Equity securities 40,734 17,690
Other 32,469
Investments purchased:
Fixed maturities (186,280) (161,384)
Equity securities (230) (19,241)
Other (1,023) (941)
Investment in Healthcare InterChange (3,055)
Payment for purchase of HealthLink
HMO, net of cash acquired (198)
Redemption of HealthLink affiliate 500
Property and equipment purchased (8,390) (10,273)
Net cash provided by (used in)
investing activities 9,812 (8,421)
Cash flows from financing activities:
Purchase of Class A Treasury stock (78) (60)
Repayment of borrowings under
revolving credit facility (15,000)
Payments of capital lease
obligations (2,991) (2,386)
Net cash used in financing
activities (18,069) (2,446)
Net (decrease) increase in cash and
cash equivalents (15,991) (100)
Cash and cash equivalents at
beginning of period 33,418 21,132
Cash and cash equivalents at end of
period $ 17,427 $ 21,032
Supplemental Disclosure of Cash Information:
Interest paid $ 2,713 2,655
Income taxes paid (refund
received), net (2,565) 6,562
Supplemental Schedule of Noncash
Investing and Financing Activities:
Equipment acquired through
capital leases $ 1,361
See accompanying Notes to Consolidated Financial Statements.
RightCHOICE Managed Care, Inc.
Notes to Consolidated Financial Statements
(unaudited)
1. Financial Statement Presentation
The interim consolidated financial statements included herein
have been prepared by RightCHOICE Managed Care, Inc. (the
company) without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission (the SEC). Certain
information and footnote disclosures, normally included in the
financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted
pursuant to such SEC rules and regulations; however, the
management of the company believes that the disclosures herein
are adequate to make the information presented not misleading.
In the opinion of management, all adjustments, consisting only
of normal recurring adjustments necessary to present fairly
the consolidated financial position of the company with
respect to the interim consolidated financial statements, and
the consolidated results of its operations and its cash flows
for the interim periods then ended, have been included. The
results of operations for the interim periods are not
necessarily indicative of the results for the full year.
2. Contingencies
OPM audit
The company, through its subsidiary, BlueCHOICE, contracts
with the Office of Personnel Management (OPM) to provide or
arrange health services under the Federal Employees Health
Benefits Program (FEHBP) for federal employees. OPM is the
largest commercial customer of BlueCHOICE. OPM conducts
periodic audits to, among other things, verify that the
premiums established under the OPM contract were established
in compliance with the community rating and other requirements
under the FEHBP.
On August 8, 1995, the company received a draft audit report
from the OPM regarding the audit, conducted in 1994, of the
FEHBP operations of BlueCHOICE for the years 1989 through
1994. The audit dealt primarily with a comparison of premium
rates charged to the FEHBP to rates charged by BlueCHOICE to
other similarly sized groups. The OPM draft audit report
indicates that BlueCHOICE has a potential liability of $7.5
million to the FEHBP. The company responded to the draft
report in November of 1995 following an in-depth analysis of
the issues. At this time, management is unable to determine
the final dollar amount which may be required to resolve the
audit findings; however, management believes that it has made
adequate provisions to cover the contingency, and the final
amount will not have a material impact on the financial
position of the company.
Subscriber class action litigation
On March 15, 1996, a suit was filed in the Circuit Court of
the City of St. Louis, Missouri, by Anthony J. Sarkis, Sr. and
James Hacking individually and on behalf of a purported class
of (i) subscribers in individual or group health plans insured
or administered by Blue Cross and Blue Shield of Missouri
(BCBSMo) or the company, and (ii) all persons and/or entities
who benefited from BCBSMo's tax-exempt status. The complaint
names the company, BCBSMo, HealthLink, and certain officers of
the company as defendants.
The plaintiffs' claims relate to an alleged conversion of
BCBSMo from a not-for-profit entity to a for-profit entity and
payment of excessive compensation to management. The complaint
further alleges that certain amendments to BCBSMo's Articles
of Incorporation were improper. The complaint also alleges the
purchase of HealthLink was at an excessive price and that
HealthLink operates under contracts providing for illegal
discounts by health care providers. The plaintiffs seek
restitution, compensatory damages and punitive damages in
unspecified amounts, as well as injunctive and other equitable
relief.
The company and the other defendants removed the case to the
United States District Court for the Eastern District of
Missouri on May 26, 1996, and filed an answer on May 31, 1996.
On August 8, 1996, the district court granted plaintiff's
motion to remand. In May 1997, plaintiffs filed an amended
petition alleging breach of contract by the company. The
company again removed the case to United States District Court
for the Eastern District of Missouri. Plaintiffs are taking
action to again have the case remanded to state court. BCBSMo
and the company believe the claims are without merit and
intend to vigorously defend the action.
Litigation with DOI and Attorney General
In August 1994, BCBSMo transferred certain assets to the
company in connection with an offering to the public of 20% of
the common stock of the company (such events are referred to
collectively as the Reorganization and Public Offering).
Although the Director of the Missouri Department of Insurance
(DOI) formally approved the Reorganization and Public Offering
on April 14, 1994, the Director and DOI subsequently claimed
that the Reorganization and Public Offering violated state
laws and that BCBSMo was obligated to transfer all of its
assets, including all of its RightCHOICE stock, to the State
of Missouri or a charity designated by the State of Missouri.
The Director and DOI threatened to bring legal action, seek a
receivership or terminate BCBSMo's insurance license unless
BCBSMo gave up its assets.
BCBSMo's extensive efforts to settle this dispute were
unsuccessful. On May 13, 1996, BCBSMo filed a declaratory
judgment action in the Circuit Court of Cole County, Missouri
(the Court) against the Director, DOI and the Missouri
Attorney General (the Attorney General was a necessary party
due to his sole authority to enforce nonprofit corporation
laws).
The Director and DOI filed an answer and counterclaims on June
13, 1996. The answer sets forth several affirmative defenses,
including alleged fraud and negligent misrepresentation with
respect to the application filed by BCBSMo seeking approval of
the Reorganization and Public Offering. The counterclaims
allege violations of certain health service corporation and
nonprofit corporation statutes. The Director and DOI's
counterclaims sought among other things: (i) permanent
injunctions against BCBSMo; (ii) imposition of a trust on
BCBSMo's assets for public benefit purposes; (iii) return of
profits from Medigap policies reinsured with a subsidiary; and
(iv) an accounting of all assets transferred by BCBSMo.
The Attorney General filed an answer and counterclaim on June
20, 1996 alleging that the Reorganization and Public Offering,
and the continued operations through the company and its
subsidiaries, exceed BCBSMo's statutory purposes. The Attorney
General requested a declaration that BCBSMo has exceeded its
lawful authority and seeks such relief as the Court determines
to be appropriate under the circumstances based on a statute
which authorizes judicial dissolution or less drastic
alternative relief in the Court's discretion.
On September 9, 1996 (the September 9 Order), the Court
granted BCBSMo's motion for summary judgment against the
Director and DOI, rejected all of the Director and DOI's
affirmative defenses (including allegations of fraud), issued
a permanent injunction against the Director and DOI and
declared that: (i) under Missouri law the Director and DOI
have no authority to demand that BCBSMo make a payment as a
result of the Reorganization and Public Offering; (ii) under
Missouri law the Director and DOI have no jurisdiction to take
any action, the practical effect of which is to amend, modify
or reverse the Director's April 14, 1994 final administrative
approval of the Reorganization and Public Offering; (iii)
under Missouri law the Director and DOI have no jurisdiction
to take any administrative action, including but not limited
to, revoking, suspending or refusing to renew BCBSMo's
Certificate of Authority based in any way on the
Reorganization and Public Offering and the consequences
thereof or BCBSMo's refusal to make a payment as the Director
and DOI have demanded; and (iv) (A) BCBSMo is a mutual benefit
type of nonprofit corporation rather than a public benefit
type of nonprofit corporation; (B) the Reorganization and
Public Offering were authorized under all laws applicable to
nonprofit health services corporations; and (C) BCBSMo does
not owe the State or any person or entity a "toll charge,"
"charitable asset settlement" or any other payment as a result
of the August 1994 Reorganization and Public Offering. On
December 30, 1996, the Court issued orders modifying the
findings and declarations set forth in (iv) above, on the
grounds that it was legally unnecessary to resolve such issues
since the Court had already ruled against the Director and DOI
for other reasons.
The September 9 Order permanently enjoined the Director and
DOI from, among other things, (i) revoking, suspending or
refusing to renew BCBSMo's insurance license based in any part
upon the Reorganization or Public Offering; (ii) commencing a
valuation of BCBSMo's assets and demanding a payment as a
result of the Reorganization and Public Offering; (iii)
commencing any administrative hearing or making any
administrative determination based in any part upon the
Reorganization and Public Offering; (iv) instituting any
seizure, receivership, conservatorship or similar action or
proceeding against BCBSMo based in any part upon the
Reorganization and Public Offering; and (v) taking any other
action however denominated, against BCBSMo based in any part
upon the Reorganization and Public Offering. This injunctive
relief remains in place, but the Court's December 30 orders
clarify that the injunction does not prohibit the Director and
DOI from asserting that the post-Reorganization operations of
BCBSMo may violate the health services corporation laws (even
though such operations may have been affected by the
Reorganization).
On August 28, 1996, the Director and DOI filed an amended
answer asserting a new counterclaim that the Reorganization
and Public Offering were not reasonably designed to serve any
of BCBSMo's purposes as a health services corporation and
seeking a declaration that BCBSMo has exceeded or abused its
authority conferred upon it by law. Under this counterclaim,
the Director and DOI seek an order to rehabilitate BCBSMo or,
in the alternative, injunctive relief.
On October 18, 1996, the Attorney General filed a motion for
leave to file an amended counterclaim against BCBSMo seeking a
declaration that BCBSMo is a public benefit corporation, not a
mutual benefit corporation, and requesting an order that
BCBSMo amend its Articles of Incorporation accordingly. The
Court granted the Attorney General's motion for leave to file
the amended counterclaim, which remains pending.
On December 30, 1996, the court issued three orders (the
December 30 Orders): (i) denying BCBSMo's motion for summary
judgment against the Attorney General; (ii) granting the
Attorney General's motion for partial summary judgment against
BCBSMo; (iii) denying BCBSMo's supplemental motion for summary
judgment against the Director and DOI on their amended
counterclaim; (iv) granting the Director and DOI's motion for
summary judgment against BCBSMo on their amended counterclaim;
and (v) modifying, in part, the Court's previous September 9
Order as described above. The December 30 Orders declared
that (i) BCBSMo has continued to exceed or abuse its
statutorily permissible purposes and the authority conferred
on it by law; and (ii) BCBSMo is subject to judicial
dissolution proceedings, but that prior to ordering
dissolution, the Court is required to consider whether there
are alternatives to dissolution and whether dissolution is in
the public interest or is the best way of protecting the
interests of its members.
The Court also (i) certified the December 30 Orders and the
September 9 Order, as modified, for immediate appeal; (ii)
held in abeyance further proceedings on the Attorney General's
counterclaim pending appeal; and (iii) stayed the legal effect
of the order granting the Director and DOI summary judgment
pending the filing of an appeal bond (which BCBSMo promptly
filed). On January 9, 1997, BCBSMo filed a notice of appeal of
the December 30 Orders. On January 21, 1997, the Director and
DOI filed a notice of appeal of the September 9 Order, as
modified. Both appeals are pending; briefing will continue
through the summer and early fall and an appellate hearing is
not likely to be scheduled before October.
Notwithstanding the December 30 Orders, the company still
believes that the counterclaims of the Director, DOI and the
Attorney General are without merit and that BCBSMo's legal
position is strong. If, however, BCBSMo does not prevail on
appeal in overturning the summary judgment in favor of the
Attorney General, it may be subject to dissolution proceedings
if the Court determines that no reasonable alternatives to
dissolution exist. Likewise, BCBSMo could be unsuccessful on
the appeal of the relief already granted against the Director
and DOI or in its defense of the Attorney General's amended
counterclaim. Any of the foregoing could have a material
adverse effect on the company and the market for the company's
stock. See "Contingencies - Status of Blue Cross and Blue
Shield trademark licenses."
Status of Blue Cross and Blue Shield trademark licenses
BCBSMo has an exclusive trademark license (the Primary
License), and the company, Healthy Alliance Life Insurance
Company (HALIC) and BlueCHOICE have exclusive controlled
affiliate licenses (the Affiliate Licenses), with the national
Blue Cross and Blue Shield Association (BCBSA) giving them the
right to use the "Blue Cross" and "Blue Shield" names,
trademarks and service marks in connection with health
insurance products marketed and sold in BCBSMo's licensed
operating area (consisting of 85 counties in eastern and
central Missouri). The trademark licenses require BCBSMo, the
company and its controlled affiliates to pay license fees to
BCBSA for the use of the trademarks. The company believes that
the exclusive right to use the "Blue Cross" and "Blue Shield"
trademarks provides it and its controlled affiliates with a
significant marketing advantage in BCBSMo's licensed operating
area, the loss of which would have a material adverse effect
on the company and the market for the company's stock.
The Affiliate Licenses are derivative of the Primary License
and automatically terminate if the Primary License is
terminated. According to their terms, the trademark licenses
also automatically terminate if, among other things: (i)
BCBSMo controls less than 51% of the total voting power of the
company; (ii) BCBSMo, the company or its controlled affiliates
do not maintain certain quality control standards; (iii) DOI
assumes control of BCBSMo, the company or its controlled
affiliates; or (iv) an action is instituted against BCBSMo,
the company or its controlled affiliates seeking dissolution
or liquidation or seeking the appointment of a trustee,
receiver or custodian, which is not dismissed within 60 days
of being instituted. According to their terms, if the
trademark licenses are terminated, BCBSMo, the company and its
controlled affiliates are jointly liable to BCBSA for payment
of a termination fee in an amount equal to $25 times the
number of licensed enrollees of the terminated entity and its
controlled affiliates, and must give written notice of such
termination to their enrollees.
Although the 60-day period contemplated by (iv) in the
immediately preceding paragraph would have expired on August
20, 1996, ongoing discussion with BCBSA did not give any
indication that BCBSMo's pending litigation against the
Attorney General, the Director and DOI described above (the
Litigation) would have any impact on the retention of the
licenses. On or about January 9, 1997, however, BCBSA notified
BCBSMo that the Primary License and the Affiliate Licenses had
automatically terminated because a counterclaim in the
Litigation seeking dissolution of BCBSMo had been pending for
60 days. BCBSMo believes that the Litigation did not trigger
the automatic termination provisions of the licenses and that
such licenses remain in full force and effect, and has
strongly stated this position to BCBSA. BCBSMo based its
legal position upon, among other things: (i) the fact that the
Attorney General's claim against BCBSMo seeks alternatives to
dissolution, not the dissolution of BCBSMo; (ii) the fact that
the trial court stayed the legal effect of the rulings adverse
to BCBSMo in the Litigation pending their appeal and that
there is no threat of the type contemplated by the licenses
until the appeal is decided; (iii) Missouri franchise laws
that mandate 90 days prior written notice of termination of
the trademark licenses; and (iv) based upon the prior
statements, actions and inaction of BCBSA, equitable
principles of waiver, estoppel and laches prevent termination
of the licenses. BCBSA decided to resolve the issue without
litigation and to give BCBSMo, the company and its controlled
affiliates the uninterrupted right to use the "Blue Cross" and
"Blue Shield" names, trademarks and service marks by granting
them new interim and temporary licenses, (thereby placing them
in substantially the same position as if no termination had
taken place). BCBSMo, the company and its controlled
affiliates agreed to accept the benefits and rights under such
new licenses, while reserving and in no manner waiving their
rights under the Primary License and the Affiliate Licenses.
The interim licenses gave BCBSMo, the company and its
previously licensed controlled affiliates the right to
continue to use the trademarks from the effective date of the
purported automatic termination of the Primary License and the
Affiliate Licenses until the date the temporary licenses were
approved by the board of BCBSA. On January 20, 1997, the board
of BCBSA granted new temporary licenses to BCBSMo, the company
and its previously licensed controlled affiliates to continue
to use the "Blue Cross" and "Blue Shield" names, trademarks
and service marks. The temporary licenses will automatically
terminate upon the expiration or termination of the stay of
the Litigation entered on December 30, 1996. Pursuant to the
temporary licenses, BCBSMo agreed not to bring any action
against BCBSA arising out of the purported automatic
termination or the granting of the interim and temporary
licenses for so long as BCBSMo remains a licensee, whether
temporary or permanent, of BCBSA. BCBSA also agreed that the
provisions of the Primary License and the Affiliate Licenses
requiring payment of the $25 per enrollee termination fee and
notice of termination to each enrollee shall not apply so long
as BCBSMo remains a licensee, whether temporary or permanent,
of BCBSA.
BCBSA agreed to grant to BCBSMo, the company and its
previously licensed controlled affiliates full trademark
licenses if and when (i) the Litigation is resolved in a
manner that is in the best interests of BCBSA, the trademarks
and the other Blue plans, and (ii) BCBSMo, the company and its
previously licensed controlled affiliates are then in
compliance with the terms of such full licenses and with BCBSA
rules and regulations. BCBSMo is working closely with BCBSA
to amend the terms of the temporary license to give BCBSMo
greater flexibility in pursuing its appeal of the litigation
with the DOI and Attorney General.
As a result of the issuance of the temporary licenses, BCBSMo,
the company, HALIC and BlueCHOICE currently have the right to
continue to use the "Blue Cross" and "Blue Shield" names,
trademarks and service marks pending the appeal of the
Litigation. However, if BCBSMo is not successful in its appeal
of the December 30 Orders issued in the Litigation, the
company may lose the right to use such names, trademarks and
service marks, which would have a material adverse effect on
the company and the market for the company's stock. See
"Contingencies - Litigation with DOI and Attorney General."
Other contingencies
The company and BCBSMo received a market conduct report from
the DOI in April 1996. The company has formally responded to
the report. Certain of the criticisms made by the examiners
involve compliance issues, which the company is currently
addressing. The company believes, and has so alleged in the
action described under "Litigation with DOI and Attorney
General," that the market conduct study was not conducted for
legitimate purposes of regulatory oversight but rather as a
pretext to either revoke or refuse to renew BCBSMo's license
to operate as a health services corporation and thus to
improperly pressure and coerce BCBSMo into making the payment
in the nature and amount described above under "Litigation
with DOI and Attorney General." The company is in the process
of discussing outstanding issues on the market conduct report.
Specifically, the company is discussing the premiums charged
to groups of less than 25 members in 1994, the first year of
the Missouri Small Group Reform Law. The DOI believes the
company should refund excess premium payments to the groups.
In addition, the DOI is investigating the way in which BCBSMo
and the company calculated co-payment amounts prior to January
1996. This issue was the subject of a class action suit,
titled Kelly versus Blue Cross and Blue Shield of Missouri,
and subsequent settlement. BCBSMo settled the case in 1995
and paid the majority of the total settlement amount of five
million dollars. The company believes it has resolved this
issue through the Kelly settlement; however, it cannot
anticipate the actions the DOI may take on this issue.
Management believes that it has made adequate provisions to
cover the contingency and that the final amount should not
have a material impact on the financial position of the
company; however, the company cannot anticipate the potential
actions of the DOI.
In addition to the matters described above, the company is a
party to litigation in the normal course of business,
including professional liability.
3. Transfer of Service Functions
In the first half of 1997, the company moved its St. Louis-
based claims, customer service, billing and provider services
functions to its Springfield, Missouri facility and a new
facility in Cape Girardeau, Missouri. Approximately 200 jobs
were relocated to Cape Girardeau with an additional 100
relocated to Springfield. The move is expected to result in
annual salary and benefit cost savings of approximately $3.0
million, with approximately $1.4 million expected in 1997.
However, the expected 1997 savings will be offset in part by
higher than expected staffing levels and additional resources
needed to reduce claims backlog resulting in an anticipated
delay of $1.3 million of the savings from the relocation. In
1996, beginning in the second quarter, the company incurred
charges to earnings of $4.5 million. The company expects to
incur a total of $3.0 million to $3.5 million in 1997 for
costs associated with finalizing this relocation. A charge of
$2.9 million was incurred in the first half of 1997 for this
relocation and is reflected in the non-recurring charges
caption on the 1997 Consolidated Statement of Income.
4. Recently Issued Accounting Standards
During March 1997, the Financial Accounting Standards Board
(FASB) released Statement of Financial Accounting Standards
No. 128, "Earnings per Share" (SFAS No. 128), which changes
the computation and disclosure of earnings per share. SFAS
No. 128 is effective for both interim and annual periods
ending after December 15, 1997 and earlier application is not
permitted. Under the company's current capital structure, the
adoption of SFAS No. 128 will not have a material impact on
the company's determination of earnings per share.
In addition, the FASB recently released SFAS No. 129,
"Disclosure of Information about Capital Structure," SFAS No.
130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 129 establishes standards for
disclosing information about an entity's capital structure and
is effective for periods ending after December 15, 1997. SFAS
No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of
general-purpose financial statements. This statement is
effective for fiscal years beginning after December 15, 1997.
SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating
segments in annual financial statements and requires that
those enterprises report selected information about operating
segments in interim financial reports issued to shareholders.
It also establishes standards for related disclosures about
products and services, geographic areas, and major customers.
This statement is effective for financial statements for
periods beginning after December 15, 1997. Management of the
company has not determined the effect that these three new
standards will have on the company's current financial
statement and footnote disclosures.
5. Provision for Income Taxes
The company's effective income tax rates for the 1997 interim
periods presented in the Consolidated Statements of Income
were affected by gains from the liquidation of company-owned
life insurance policies as well as non-deductible goodwill
amortization. The effective rates for the 1996 interim
periods presented were also affected by non-deductible
goodwill amortization.
6. Reclassifications
Certain reclassifications have been made to the consolidated
financial statements for 1996 to conform with the 1997
presentation.
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Results of Operations
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH
THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO.
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL
RESULTS, FINANCIAL CONDITION OR BUSINESS COULD DIFFER
MATERIALLY FROM ITS HISTORICAL RESULTS, FINANCIAL CONDITION OR
BUSINESS, OR THE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR
BUSINESS CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS.
FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE
SECTION ENTITLED "FACTORS THAT MAY AFFECT FUTURE RESULTS OF
OPERATIONS, FINANCIAL CONDITION OR BUSINESS."
The following table sets forth premium revenue by product
group for the three and six month periods ended June 30, 1997
and 1996 (unaudited):
Three Months Ended Six Months Ended
June 30, June 30,
Product Group 1997 1996 1997 1996
(in thousands) (in thousands)
PPO:
Alliance PPO $ 50,106 $ 60,595 $102,064 $121,477
AllianceChoice POS 30,367 17,013 57,830 31,531
HMO (includes other POS) 43,431 33,638 86,762 66,011
Medicare supplement 24,798 24,755 49,458 49,752
Managed indemnity 3,667 4,413 7,267 8,505
Other specialty services 9,462 7,396 18,607 14,081
Total premium revenue 161,831 147,810 321,988 291,357
ASO/Self-funded and other income 14,318 13,570 30,475 27,991
Total revenues $176,149 $161,380 $352,463 $319,348
The following table sets forth selected operating ratios. The
medical loss ratio is shown as a percentage of healthcare
services expense over premium revenue. All other ratios are
shown as a percentage of premium revenue and fees and other
income combined:
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
Operating revenues:
Premium revenue 91.9% 91.6% 91.4% 91.2%
Fees and other income 8.1% 8.4% 8.6% 8.8%
100.0% 100.0% 100.0% 100.0%
Operating expenses:
Medical loss ratio 86.1% 81.0% 83.4% 77.8%
Commission expense 4.0% 4.0% 4.1% 4.0%
General and administrative
expense (includes
depreciation
and amortization) 22.7% 21.5% 22.7% 21.6%
Membership
The following table sets forth membership data and the percent
change in membership:
June 30,
Product Group 1997 1996 %
Underwritten:
PPO:
Alliance PPO 167,858 210,332 (20.2)%
AllianceChoice POS 124,568 74,962 66.2
HMO:
Commercial (includes other POS) 118,641 92,510 28.2
BlueCHOICE Senior 5,825 5,058 15.2
BlueCHOICE Medicaid (MC+) 4,831 5,120 (5.6)
Medicare supplement 64,991 70,649 (8.0)
Managed indemnity 8,984 12,373 (27.4)
495,698 471,004 5.2
Self-funded:
PPO 89,737 111,680 (19.6)
HMO 16,326 16,157 1.0
ASO (includes HealthLink):
Workers' Compensation 326,061 248,460 31.2
Other ASO* 970,230 885,185 9.6
Total Membership 1,898,052 1,732,486 9.6%
* does not include 565,521 and 439,073 as of June 30, 1997
and June 30, 1996, respectively, relating to additional
third-party administrator members that are part of The
EPOCH Group, L.C., a joint venture with Blue Cross and Blue
Shield of Kansas City formed in December 1995.
Comparison of Results for Second Quarter 1997 to Second Quarter 1996
Revenues
Premium revenue increased 9.5% in the second quarter of 1997
in comparison to the second quarter of 1996. As described
below, components of premium revenue were affected by shifts
in product mix, rate increases, and other factors; and as a
result, such changes may not be indicative of future periods.
The company will continue to strive to establish its
commercial premium rates based on anticipated health care
costs. Depending on the level of future competition, customer
acceptance of the company's premium increases, future health
care cost trends or other factors, there can be no assurance
that the company will be able to price its products consistent
with health care cost trends.
PPO revenues increased $2.9 million - - $0.7 million due to a
2.6% increase in member months and $2.2 million resulting from
a marginal increase in net premium rates. Net rates increased
due in part to the company's targeted general rate increases
averaging 7% to 9% during enrollment periods in the first half
of 1997. Net rate increases are significantly below the
targeted levels due in part to changes in deductibles, the
timing of group renewals throughout the year, and product mix
changes such as the continued shift in membership to
AllianceChoice, a lower cost, non-gatekeeper point-of-service
(POS) product. Alliance PPO membership decreased by 42,474
members from June 30, 1996 to June 30, 1997 while
AllianceChoice POS membership increased by 49,606 over the
same time period. The company also began offering its PPO
product in Illinois at the end of the first quarter of 1997.
Included in the Alliance PPO member count are 500 PPO Illinois
members at June 30, 1997. The company anticipates future
enrollment gains in the central and southern regions of
Illinois throughout 1997.
HMO premium revenue increased $9.8 million or 29.1% - - $9.0
million due to a 27.8% increase in member months and $0.8
million resulting from a marginal increase in net premium
rates. Net premium rates have increased only slightly,
despite the company's targeted renewal rate increases of 7% to
9% during enrollment periods in the first half of 1997, due to
HMO competition in the company's HMO service areas, the status
of one large group with which the company is currently
involved in rate discussions, shifts in chosen benefit levels,
changes in the geographic mix of the HMO business, and product
mix shifts due to various new products. Membership increases
were driven primarily by the company's BlueCHOICE Senior and
HealthNet Blue POS products as well as the company's efforts
to expand geographically within the State of Missouri.
BlueCHOICE Senior gained 800 members (15.2%) from June 30,
1996 to June 30, 1997. HealthNet Blue POS gained 6,800
members (57.5%) over the same time period. Through an
arrangement with Freeman Hospitals and Health System,
beginning in July 1995, the BlueCHOICE HMO and POS products
are offered in the six-county area surrounding Joplin,
Missouri. As of June 30, 1997, there were approximately
12,500 members enrolled in products sold through this
arrangement with Freeman, representing an increase of 6,600
members over June 30, 1996. In addition, the BlueCHOICE and
BlueCHOICE POS programs became available beginning in October
1996 in the southwest Missouri area surrounding Springfield
through an arrangement with Primrose Health Care Services, a
physician hospital organization jointly owned by physicians
and Cox Hospitals, one of the leading tertiary care centers in
the area. There were 7,600 members enrolled in these programs
at June 30, 1997, an increase of 5,900 over December 31, 1996.
The company expects future enrollment growth in these
relatively new products as well as in these geographic regions
of Missouri.
Premium revenue from Medicare supplement increased by less
than $0.1 million in the second quarter of 1997. Premium
rates increased 9.0% partially offset by an 8.1% decrease in
member months. Membership declines are partially attributable
to members shifting to BlueCHOICE Senior, a Medicare-risk
program, which provides medical benefits at least as
comprehensive as Medicare benefits for persons eligible to
receive Medicare (parts A and B) at no or minimal additional
cost to the member. The company markets its BlueCHOICE Senior
product as part of its strategy to direct existing customers
to more intensely managed health care products.
Managed indemnity premium revenue decreased by $0.7 million
due to a 24.4% decline in member months in keeping with the
company's strategy to move towards more highly managed care
products.
Revenue from other specialty services increased $2.1 million
due primarily to a 17.0% increase in member months. The
company's drug product, AllianceRx, continued to gain momentum
with revenues increasing $1.9 million due to a 19.2% increase
in member months in the second quarter of 1997 as compared to
the second quarter of 1996. This product was introduced in
November 1994 and is sold to members on a separate product
basis; prior to this, the drug benefit was typically included
as part of the basic PPO medical program.
Fees and other income from administrative services only/self-
funded and network services increased by $0.7 million. This
increase is due to increased 1997 revenues from HealthLink,
Inc. (HealthLink), the company's network rental and managed
care service subsidiary, of $2.9 million. HealthLink's 1997
and 1996 revenues include $1.8 million and $0.4 million of
revenues, respectively from HealthLink HMO, Inc. (HealthLink
HMO), which was only 50% owned by HealthLink (and not
consolidated with the company's operations) prior to its May
31, 1996 acquisition from a subsidiary of Blue Cross and Blue
Shield of Kansas City. HealthLink's increases to fees and
other income were offset by decreases to revenue caused by
higher stop loss claims expenses for the company's self-
insured groups in 1997.
Operating Expenses
The overall medical loss ratio increased from 81.0% in the
second quarter of 1996 to 86.1% in the second quarter of 1997.
The overall medical loss ratio increased primarily as a result
of 1) growth of lower margin products, 2) aggressive pricing
in 1996 in order to retain and increase membership, 3) higher
drug and outpatient utilization, 4) growth in regions outside
of the metropolitan St. Louis area that have less cost
efficient networks, and 5) an increase to claims reserves of
$1.8 million in the second quarter of 1997 for the estimate of
claims which had been incurred but not reported in 1996.
There can be no assurance that the company's initiatives to
control future increases in medical cost trends to improve the
medical loss ratio will be effective.
Commission expense increased by $0.6 million or 8.6% in the
second quarter of 1997 primarily related to increased
membership growth. The commission expense ratio was unchanged
at 4.0% for both the second quarter of 1997 and the second
quarter of 1996.
General and administrative expenses (excluding depreciation
and amortization) increased by $3.6 million, or 11.7% in the
second quarter of 1997 as compared to the second quarter of
1996. Approximately $1.8 million of this increase relates to
an increase in HealthLink expenses of which $1.2 million
relates to HealthLink HMO due to its inclusion in the
consolidated results of the company beginning in June of 1996.
Management previously announced its plans to improve the
company's overhead cost structure by streamlining operations,
focusing on the core business, reviewing investment
priorities, and reducing legal, consulting, and non-essential
vendor expenses. The achievement of overhead reduction goals
was delayed, in part, by higher-than-expected staffing levels
and additional resources needed to reduce claims backlog that
occurred as claims processing relocated to the new customer
service centers. The staffing resources required to resolve
the claims backlog delayed the realization of $1.3 million of
anticipated overhead savings. Excluding the $1.3 million for
staffing resources related to the claims backlog, the
company's general and administrative ratio (excluding
depreciation and amortization) was 18.9% for the second
quarter of 1997 compared to 19.2% for the second quarter of
1996.
Depreciation and amortization expenses increased by $1.7
million in the second quarter of 1997 as compared to the
second quarter of 1996 primarily due to $1.2 million of
amortization expenses for completed components of the
company's information and operations strategy (IOS) project.
See "Outlook - Information Strategies" for more information
related to this project.
Non-recurring charges in the second quarter of 1997 and 1996
include $0.8 million and $2.7 million, respectively, related
to costs associated with the relocation of the company's St.
Louis-based claims, customer service, billing, and provider
services functions to its Springfield, Missouri facility and a
new facility in Cape Girardeau, Missouri.
Operating Income
Operating income, excluding non-recurring charges, decreased
$10.7 million in the second quarter of 1997 in comparison to
the second quarter of 1996.
Net Investment Income
The second quarter 1997 net investment income of $10.3 million
represents a $4.7 million increase over the second quarter of
1996, inclusive of a $4.0 million increase in net realized
gains. Second quarter 1997 includes a $5.7 million realized
gain from the sale of company-owned life insurance policies,
the proceeds of which have been reinvested in fixed income
securities.
Provision for Income Taxes
The company's effective income tax rate was (8.9)% and 40.8%
for the second quarters of 1997 and 1996, respectively. The
company's effective income tax rate for 1997 was affected by
gains from the liquidation of company-owned life insurance
policies as well as non-deductible goodwill amortization. The
1996 effective rate was also affected by non-deductible
goodwill amortization.
Net Income
Excluding non-recurring charges, the company's net loss for
the second quarter of 1997 was $1.8 million, or $0.10 per
share, compared to net income of $3.0 million, or $0.16 per
share for the second quarter of 1996. Inclusive of the non-
recurring charges, the company's net loss for the second
quarter of 1997 was $2.3 million, or $0.12 per share compared
to net income of $1.3 million, or $0.07 per share for the
second quarter of 1996.
Comparison of Results for the Six Months Ended June 30, 1997 to
the Six Months Ended June 30, 1996
Revenues
Premium revenue increased $30.6 million or 10.5% in the first
half of 1997 in comparison to the first half of 1996. As
described below, components of premium revenue were affected
by shifts in product mix, rate increases, and other factors;
and as a result, such changes may not be indicative of future
periods. The company will continue to strive to establish its
commercial premium rates based on anticipated health care
costs. Depending on the level of future competition, customer
acceptance of the company's premium increases, future health
care cost trends or other factors, there can be no assurance
that the company will be able to price its products consistent
with health care cost trends.
PPO revenues increased $6.9 million - - $2.7 million due to a
3.5% increase in member months and $4.2 million due to a
slight increase in net premium rates. Net rates increased due
in part to the company's targeted general rate increases
averaging 7% to 9% during enrollment periods in the first half
of 1997. Net rate increases are significantly below the
targeted levels due in part to changes in deductibles, the
timing of group renewals throughout the year, and product mix
changes such as the continued shift in membership to
AllianceChoice. Alliance PPO membership decreased by 42,474
members from June 30, 1996 to June 30, 1997 while
AllianceChoice POS membership increased by 49,606 over the
same time period. The company also began offering its PPO
product in Illinois at the end of the first quarter of 1997.
Included in the Alliance PPO member count are 500 PPO Illinois
members at June 30, 1997. The company anticipates future
enrollment gains in the central and southern regions of
Illinois throughout 1997.
HMO premium revenue increased $20.8 million or 31.4% - - $20.7
million due to a 32.9% increase in member months and $0.1
million due to a slight increase in net premium rates. Net
premium rates have increased only slightly, despite the
company's targeted renewal rate increases of 7% to 9% during
enrollment periods in the first half of 1997, due to HMO
competition in the company's HMO service areas, the status of
one large group with which the company is currently involved
in rate discussions, shifts in chosen benefit levels, changes
in the geographic mix of the HMO business, and product mix
shifts due to various new products. Membership increases were
driven primarily by the company's BlueCHOICE Senior and
HealthNet Blue POS products as well as the company's efforts
to expand geographically within the State of Missouri.
BlueCHOICE Senior gained 800 members (15.2%) from June 30,
1996 to June 30, 1997. HealthNet Blue POS gained 6,800
members (57.5%) over the same time period. As of June 30,
1997, there were approximately 12,500 members enrolled in
BlueCHOICE HMO and POS products in the six-county area
surrounding Joplin, Missouri, representing an increase of
6,600 members over June 30, 1996. In addition, as of June 30,
1997, there were 7,600 members enrolled in BlueCHOICE HMO and
POS products in the southwest Missouri area surrounding
Springfield, an increase of 5,900 over December 31, 1996. The
company expects future enrollment growth in these relatively
new products as well as in these geographic regions of
Missouri.
Premium revenue from Medicare supplement decreased by $0.3
million in the first half of 1997. Member months decreased by
8.2% partially offset by an 8.3% increase in premium rates.
Membership declines are partially attributable to members
shifting to BlueCHOICE Senior.
Managed indemnity premium revenue decreased by $1.2 million
due to a 21.8% decline in member months in keeping with the
company's strategy to move towards more highly managed care
products.
Revenue from other specialty services increased $4.5 million
due primarily to a 20.7% increase in member months. The
company's drug product, AllianceRx, continued to gain momentum
with revenues increasing $3.9 million due to a 21.7% increase
in member months in the first half of 1997 as compared to the
first half of 1996.
Fees and other income from administrative services only/self-
insured and network services increased by $2.5 million. ASO
revenues from HealthLink increased by $5.1 million in the
first half of 1997 as compared to the first half of 1996
primarily due to the aforementioned inclusion of HealthLink
HMO's results beginning in June 1996. HealthLink HMO revenues
were thus $2.9 million greater in the first half of 1997 as
compared to the first half of 1996. HealthLink's revenues
also increased due to membership gains in its PPO products of
approximately 11% or 70,200 members from June 30, 1996 to June
30, 1997. HealthLink's increases to fees and other income
were offset by decreases to revenue caused by higher stop loss
claims expenses for the company's self-insured groups in 1997.
Operating Expenses
The overall medical loss ratio increased by 5.6% to 83.4% in
the first half of 1997 in comparison to 77.8% in the first
half of 1996 primarily as a result of 1) growth of lower
margin products, 2) aggressive pricing in 1996 in order to
retain and increase membership, 3) higher drug and outpatient
utilization, 4) growth in regions outside of the metropolitan
St. Louis area that have less cost efficient networks, and 5)
an increase to claims reserves of $3.0 million in 1997 for the
estimate of claims which had been incurred but not reported in
1996. There can be no assurance that the company's
initiatives to control future increases in medical cost trends
to improve the medical loss ratio will be effective.
Commission expense increased by $1.5 million or 12.0% in the
first half of 1997 primarily related to increased membership
growth. The commission expense ratio remained relatively flat
at 4.1% for the first half of 1997 compared to 4.0% for the
first half of 1996.
General and administrative expenses (excluding depreciation
and amortization) increased by $7.5 million, or 12.1%.
HealthLink general and administrative expenses increased by
$3.5 million in the first half of 1997 as compared to the
first half of 1996 inclusive of a $2.5 million increase in
HealthLink HMO expenses. Excluding the aforementioned $1.3
million of expenses for staffing resources in 1997 related to
the company's claims backlog, the general and administrative
ratio (excluding depreciation and amortization) for the six
months ended June 30, 1997 was 19.4% and 19.4% as well for the
six months ended June 30, 1996.
Depreciation and amortization expenses increased to $10.4
million for the first half of 1997 compared to $7.0 million
for the first half of 1996. The primary cause for this $3.4
million increase is an additional $2.2 million of IOS
amortization expense incurred in the first half of 1997 as
compared to the first half of 1996. See "Outlook -
Information Strategies" for more information related to the
IOS project.
Non-recurring charges in the first half of 1997 and 1996
include $2.9 million and $2.7 million, respectively, related
to costs associated with the relocation of the company's St.
Louis-based claims, customer service, billing, and provider
services functions to its Springfield, Missouri facility and a
new facility in Cape Girardeau, Missouri.
Operating Income
Operating income decreased $21.3 million in the first half of
1997 in comparison to the first half of 1996. Excluding the
non-recurring relocation charges, operating income decreased
by $21.1 million.
Net Investment Income
The first half 1997 net investment income of $23.8 million
represents a $13.7 million increase over the first half 1996,
inclusive of a $13.1 million increase in net realized gains.
Realized gains in the first half of 1997 include a $5.7
million gain on the sale of company-owned life insurance
policies as well as additional 1997 net realized gains from
the liquidation of equity securities due to the company's
intent to increase its holdings of fixed income securities and
the company's decision to repay $15.0 million of its debt.
Provision for Income Taxes
The company's effective income tax rate was 51.3% and 39.3%
for the first half of 1997 and the first half of 1996,
respectively. The company's effective income tax rate for
1997 was affected by gains from the liquidation of company-
owned life insurance policies as well as non-deductible
goodwill amortization. The 1996 effective rate was also
affected by non-deductible goodwill amortization.
Net Income
The company's net income for the first half of 1997 was $3.9
million ($0.21 per share). Excluding the non-recurring
relocation charges, net income was $5.7 million ($0.31 per
share), representing a decrease of $5.5 million compared to
the net income of $11.2 million ($0.60 per share) for the
first half of 1996.
Liquidity and Capital Resources
The company's working capital as of June 30, 1997 was $87.0
million, a decrease of $21.9 million from December 31, 1996.
The decrease is primarily attributable to a $15.0 million
repayment of a portion of the $62.0 million of funds that were
borrowed in August 1995 from the company's reducing revolving
credit facility in conjunction with the company's acquisition
of HealthLink. In addition, the company capitalized $8.4
million of costs for property and equipment purchases, $7.6
million of which relates to capitalized IOS development costs.
The company's unrealized net appreciation (depreciation) of
investments available for sale decreased by $9.9 million in
1997 as most of the unrealized gains existing at December 31,
1996 were realized in 1997 as the company liquidated equity
securities and company-owned life insurance policies. These
working capital decreases are partially offset by the $14.3
million of 1997 earnings before depreciation and amortization.
Net cash used in operations totaled $7.7 million for the six
months ended June 30, 1997. Net income was $3.9 million while
depreciation and amortization expenses were $10.4 million.
Net income also included realized gains from the sale of
investments of $16.1 million. In addition, other assets,
medical claims payable, receivables from members, and net
intercompany receivables were affected by the timing of
operating cash payments and receipts, as well as changes in
membership and utilization and claims payment trends.
Recent Developments
Information Strategies
In 1995, the company implemented a comprehensive information
and operations strategy (IOS) to assist in implementing the
company's managed care strategy of delivering the lowest cost
medical care consistent with quality outcomes. The company
believes that controlling medical costs in the future will be
highly dependent on readily accessing both member and provider
medical information at a detail level which provides real-time
analytical support. The company receives capital expenditure
authorizations from the Board of Directors to expend funds for
the project subject to periodic review by an ad-hoc committee
of the Board. In the first six months of 1997, the company
incurred capitalized expenditures of $7.6 million on this
project. Cumulatively, since 1995, the company has incurred
capitalized expenditures of $29.4 million. While management
believes that the IOS project will be initially dilutive to
earnings per share, it is believed that opportunities exist
for significant medical and administrative savings which will
begin to provide a payback possibly during 1997. There can be
no assurance that the ultimate impact of this IOS project will
contribute to earnings per share or reduce medical costs.
Recently Issued Accounting Standards
During March 1997, the Financial Accounting Standards Board
(FASB) released Statement of Financial Accounting Standards
No. 128, "Earnings per Share" (SFAS No. 128), which changes
the computation and disclosure of earnings per share. SFAS
No. 128 is effective for both interim and annual periods
ending after December 15, 1997 and earlier application is not
permitted. Under the company's current capital structure, the
adoption of SFAS No. 128 will not have a material impact on
the company's determination of earnings per share.
In addition, the FASB recently released SFAS No. 129,
"Disclosure of Information about Capital Structure," SFAS No.
130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 129 establishes standards for
disclosing information about an entity's capital structure and
is effective for periods ending after December 15, 1997. SFAS
No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of
general-purpose financial statements. This statement is
effective for fiscal years beginning after December 15, 1997.
SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating
segments in annual financial statements and requires that
those enterprises report selected information about operating
segments in interim financial reports issued to shareholders.
It also establishes standards for related disclosures about
products and services, geographic areas, and major customers.
This statement is effective for financial statements for
periods beginning after December 15, 1997. Management of the
company has not determined the effect that these three new
standards will have on the company's current financial
statement and footnote disclosures.
Operating Outlook
The following statements are based on year-to-date 1997
activity and short-term expectations. The statements are
forward-looking and actual results may differ materially.
The company's anticipated return to marginal operating
profitability in the fourth quarter of 1997 is dependent on
achieving member recruitment and retention at targeted price
levels as well as realizing overhead and medical cost savings.
The company currently is continuing discussions with a large
HMO group to achieve a mutually acceptable rate and risk
structure. The result of those discussions as well as the
result of future discussions could materially affect the
profitability of the HMO and change the company's expected
timeline for returning to operating profitability.
Premium revenue growth will be driven primarily by repricing
opportunities through the remainder of the year. As of
September 30, 1997, the small group rate restrictions in the
St. Louis market imposed by the Missouri Department of
Insurance as a condition of RightCHOICE's 1995 acquisition of
HealthLink will expire. RightCHOICE's small group business
comprises approximately 60% of the company's revenues. While
the market has shown acceptance of more rational pricing
strategies, the results of small group renewal and repricing
activities will not be reflected in the company's operating
revenues until early next year.
The company's medical management strategies focus on re-
contracting for both inpatient and outpatient services, a new
pharmacy benefits program, and the use of information and
incentives to control the increases of medical costs without
sacrificing quality and health outcomes.
Contingencies
See the description under the same caption in Note 2 of the
Notes to Consolidated Financial Statements, which description
is incorporated herein by reference.
Factors that May Affect Future Results of Operations, Financial
Condition or Business
In order to take advantage of the safe harbor provisions for
forward-looking statements contained in Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, added to those
Acts by the Private Securities Litigation Reform Act of 1995,
the company is identifying important risks and uncertainties
that could cause the company's actual results of operations,
financial condition or business to differ materially from its
historical results of operations, financial condition or
business, or the results of operations, financial condition or
business contemplated by forward-looking statements made
herein or elsewhere orally or in writing. Factors that could
cause or contribute to such differences include, but are not
limited to, those factors described below.
Litigation with DOI and Attorney General
BCBSMo has filed an action against the Missouri Department of
Insurance (DOI), the Director of the DOI, and the Attorney
General seeking a declaratory judgment and other relief with
respect to the Reorganization and Public Offering, as
described under the same caption in Note 2 "Contingencies"
which is incorporated herein by reference. While BCBSMo has
prevailed on most issues, the Court has ruled that BCBSMo has
continued to exceed or abuse its statutorily permissible
purposes and is subject to judicial dissolution proceedings or
alternative remedies that are in the public interest and
consistent with the protection of its members. This issue and
the prior rulings favorable to BCBSMo are on appeal and
additional claims are pending at the trial court.
While the company believes, after reviewing these matters with
legal counsel, that BCBSMo's legal position is strong, the
risks and uncertainties of litigation are such that there can
be no assurance that BCBSMo will prevail on all remaining
claims, that the appellate court will affirm all the rulings
of the trial court favorable to BCBSMo and will reverse the
ruling of the trial court adverse to BCBSMo, that the DOI and
Attorney General will not pursue administrative action during
or after these proceedings, or that any such action would not
have a material adverse impact on the company or the market
for the company's stock.
Status of Blue Cross and Blue Shield Trademark Licenses
The company and certain of its subsidiaries have temporary
licenses to use the "Blue Cross" and "Blue Shield" names,
trademarks and service marks as described under the same
caption in Note 2 "Contingencies" which is incorporated herein
by reference. The company believes that the right to use the
Blue Cross and Blue Shield names and marks provide it with a
significant marketing advantage in its licensed service area.
As explained in Note 2, if BCBSMo's litigation against the DOI
and the Attorney General is not resolved in a manner that is
in the best interests of the BCBSA, the marks and the other
Blue plans, then the company's temporary license to use such
names and marks may be terminated (and a permanent license may
not be issued). The loss of such licenses would have a
material adverse effect on the company and the market for the
company's stock. See "Factors that May Affect Future Results
of Operations, Financial Condition or Business - Litigation
with DOI and Attorney General."
Government Regulations and Health Care Reform
The company operates its managed health care business
principally through wholly owned subsidiaries whose business
is subject to extensive federal, state and local laws and
regulations. To date, these laws and regulations have not had
a significant negative impact on the growth of the company's
business. However, there can be no assurance that the company
will be able to obtain or maintain required governmental
approvals or licenses or that any regulatory reform such as
the recently adopted mandatory length of stay for maternity
patients will not have a material adverse effect on the
company's business or results of operations in the future.
Competition and Consolidation
The health care industry is highly competitive. The company
has numerous types of competitors in its PPO, POS and HMO
operations, many of which have substantially greater financial
and other resources than the company. The company believes
that price competition among PPO, POS and HMO benefits plans
in the company's markets, particularly the St. Louis
metropolitan area, has recently intensified. Because the
company's existing business operations are confined to markets
within or contiguous to the state of Missouri, the company
currently is unable to subsidize losses in these markets with
profits from other markets. The company believes that certain
larger, national competitors are able to subsidize losses in
the Missouri market with profits from other markets in which
they operate and may pursue such a strategy in the company's
markets in an effort to increase their market share. Health
care providers are consolidating into larger health care
delivery enterprises and their increased bargaining power may
lead to a reduction in the gross margins of the company's
products and services. The company also faces competition in
its markets from a trend among some health care providers to
combine and form their own networks in order to contract
directly with employer groups and other prospective customers
for the delivery of health care services.
Escalating Health Care Costs
The company's profitability depends in large part on
predicting and effectively managing medical costs under its
managed care plans. A variety of external factors affecting
the delivery and cost of health care, including increased
costs and utilization of high-technology diagnostic testing
and treatments, the rising costs of malpractice insurance,
efforts in the medical community to avoid malpractice claims,
higher operating costs of hospitals and physicians, the aging
of the population and other demographic characteristics,
changes in federal and state health care regulations and major
epidemics may adversely affect the company's ability to
predict and control health care costs and claims. Other
relevant factors affecting the company's ability to control
health care costs include higher outpatient and drug
utilization and growth of business in regions with less cost
efficient networks.
Dependence on Sales to Individuals
Sales of the company's health care benefit products to
individuals comprise a substantial portion of the company's
business. The medical loss ratio attributable to some
components of the company's individual business is
significantly lower than that of the company's insured group
business. As a result, individual business accounts for a
proportionately greater percent of the company's operating
income. The company's overall margins would be adversely
impacted by a reduction in the relative percent of its
business represented by certain individual products or by an
increase in the medical loss ratio for individuals enrolled in
those products. The company believes that the success of the
individual business is more dependent than that of its group
business on the management of health care costs through
product design, pricing decisions and the application of
appropriate underwriting standards. There can be no assurance
that the profitability of this business will be sustained or
that the company will not experience unanticipated increases
in claims.
Potential Nonrenewal of Subscriber and Provider Agreements
The company's profitability is dependent upon its ability to
obtain and maintain contracts with employee groups and
individual consumers which generally are renewable annually.
The company's profitability is also dependent, in large part,
on its ability to contract on favorable terms with hospitals,
physicians and other health care providers. There can be no
assurance that the subscribers or providers will renew their
contracts or enter into new contracts with the company or, in
the case of provider contracts, will not seek terms that are
less profitable to the company in connection with any such
renewal.
Control by BCBSMo
BCBSMo has voting control on all stockholder actions,
including the sale or merger of the company, a sale of
substantially all of its assets and the election of all of the
company's directors. BCBSMo may have interests with respect
to its ownership of the company which diverge from those of
the company's public shareholders. There can be no assurance
that the company will not be adversely impacted by the control
which BCBSMo has with respect to matters affecting the
company.
Dependence on Key Management
The company depends to a significant extent on key management
members. The loss of these management members could have a
material adverse effect on the company's results of
operations, financial condition and business.
Variability of Quarterly Operating Results and Stock Price
The company's quarterly results of operations could be
adversely affected by the timing of new product and service
introductions, competitive pricing pressures, contract
renegotiations with customers and providers, fluctuations in
the medical loss ratio (due to changes in utilization, timing
of submission of claims presented for payment in the period
and the unpredictability of unusually large claims), increases
in commission expenses and general and administrative
expenses, changes in interest rates, acquisitions,
governmental and regulatory actions, overall market
conditions, and other factors. The company's stock price may
experience significant price and volume fluctuations in
response to these and other internal and external factors
which cause variations in its quarterly results of operations
and the stock markets.
Credit Agreement Restrictions
The company's revolving credit agreement with its existing
lenders contains certain restrictions on the company,
including requirements as to the maintenance of net worth and
certain financial ratios, restrictions on payment of cash
dividends or purchases of stock, restrictions on acquisitions,
dispositions and mergers and restrictions on additional
indebtedness and liens and certain other matters. There can
be no assurance that the company will be able to achieve and
maintain compliance with the prescribed financial ratio tests
or other requirements of the revolving credit agreement. The
failure to obtain any waivers or amendments that might be
needed to remain in compliance with such requirements would
reduce the company's flexibility to respond to adverse
industry conditions and could have a material adverse effect
on the company's results of operations, financial condition or
business.
Large Group Impact
The company currently is continuing discussions with a large
HMO group to achieve a mutually acceptable rate and risk
structure. The result of those discussions as well as the
result of future discussions could materially affect the
profitability of the HMO and change the company's expected
timeline for returning to operating profitability.
Additional Factors
Additional risk and uncertainties that may affect future
results of operations, financial condition or business of the
company include, but are not limited to: demand for and
market acceptance of the company's products and services; the
effect of economic and industry conditions on prices for the
company's products and services and its cost structure; the
ability to develop and deliver new products and services and
adapt existing products and services to meet customer needs
and expectations; the ability to keep pace with technological
change including developing and implementing technological
advances timely and cost effectively in order to lower its
cost structure, to provide better service and remain
competitive; adverse publicity, news coverage by the media, or
negative reports by brokerage firms, industry and financial
analysts regarding the company, its parent or BCBSA or their
products or services which may have the effect of reducing the
reputation, goodwill or customer demand for, or confidence in,
the company's products or services; the ability to attract and
retain capital for growth and operations on competitive terms;
and changes in accounting policies and practices.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Note 2 to the Consolidated Financial Statements in Part I,
Item 1 contains a description of various pending and
threatened claims, including a description of the
subscriber class action lawsuit filed on March 15, 1996
and litigation with the Missouri Department of Insurance
(DOI), the Director of the DOI, and the Missouri
Attorney General, which descriptions are incorporated by
reference herein. Also, see "Management's Discussion
and Analysis of Financial Condition and Results of
Operations - Factors that May Affect Future Results of
Operations, Financial Condition or Business."
ITEM 2. Changes in Securities
a) Not applicable
b) Not applicable
ITEM 3. Defaults Upon Senior Securities
a) Not applicable
b) Not applicable
ITEM 4. Submission of Matters to a Vote of Security Holders
a) The Annual Meeting of Shareholders of the company was
held on May 13, 1997.
b) Three class III directors of the company were elected for
three year terms by the shareholders at the annual meeting.
The three newly elected directors are:
Nominee Number of Votes
William H.T. Bush 153,141,122
John A. O'Rourke 153,140,220
Norman J. Tice 153,141,322
The following directors' terms continued in effect after the
meeting:
Frederic C. Brussee
Ronald G. Evens, M.D.
Edward C. Gomes, Jr.
Earle H. Harbison, Jr.
Roger B. Porter
Gloria W. White
ITEM 5. Other Information
None.
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit
Number Exhibit
3.1 Articles of Incorporation of the Registrant - Incorporated
by reference - previously filed as Exhibit 3.1 to
Registration Statement on Form S-1 under the
Securities Act of 1933 filed by the Registrant.
Registration Statement No. 33-77798.*
3.1.1 Amendment to Articles of Incorporation of the Registrant
- Incorporated by reference - previously filed as
Exhibit 3.1.1 to Registration Statement on Form S-1
under the Securities Act of 1933 filed by the
Registrant. Registration Statement No. 33-77798.*
3.2 Amended and Restated Bylaws of the Registrant -
Incorporated by reference - previously filed as
Exhibit 3.2 to the company's Form 10-K for the
period ending December 31, 1995.*
27 Financial Data Schedule (Electronic Filing Only).
* Document has previously been filed with the Securities and
Exchange Commission and is incorporated by reference and made
a part hereof.
b) Reports on Form 8-K:
The company filed a report on Form 8-K dated June 23, 1997.
This filing was made in connection with the changes in the
company's certifying accountant.
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.
RIGHTCHOICE MANAGED CARE, INC.
Registrant
Date: August 12, 1997 By: [s] JANICE FORSYTH
Janice C. Forsyth
Senior Vice President,
Secretary and General Counsel
Date: August 12, 1997 By: [s] SANDRA VAN TREASE
Sandra Van Trease
Senior Vice President and
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements in the RightCHOICE Managed Care, Inc. Form 10-Q for the
quarterly period ended June 30, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
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<SECURITIES> 244,803
<RECEIVABLES> 61,741
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<CURRENT-ASSETS> 364,679
<PP&E> 91,279
<DEPRECIATION> 38,000
<TOTAL-ASSETS> 514,419
<CURRENT-LIABILITIES> 277,717
<BONDS> 54,126
0
0
<COMMON> 187
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<TOTAL-LIABILITY-AND-EQUITY> 514,419
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