SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Date of Report: October 11, 1995
(Date of Earliest Event Reported)
HUMANA INC.
(Exact name of Registrant as specified in its Charter)
Delaware 1-5975 61-0647538
(State of Incorporation) (Commission (I.R.S. Employer
File Number) Identification No.)
500 West Main Street, Louisville, Kentucky 40202
(Address of principal executive offices) (Zip Code)
(502) 580-1000
(Registrant's telephone number, including area code)
1 of 43
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
Upon the terms and subject to the conditions set forth in the Offer to
Purchase, dated August 16, 1995, (the "Offer"), HEW, Inc., a Delaware
corporation (the "Offeror") and a wholly owned subsidiary of Humana Inc.,
a Delaware corporation (the "Company"), offered to purchase all outstanding
shares of common stock, par value $0.01 per share (the "Shares"), of
EMPHESYS Financial Group, Inc., a Delaware corporation ("EMPHESYS"), at a
purchase price of $37.50 per Share, net to the seller in cash, without
interest (the "Offer Price"). The Offer Price was determined by the
Company and its investment advisor, Smith Barney Inc., through a valuation
of EMPHESYS based upon public information and information provided to the
Company. EMPHESYS received an opinion dated August 8, 1995, from Morgan
Stanley & Co. Incorporated (EMPHESYS' investment advisor) to the effect
that the Offer Price was fair to EMPHESYS' stockholders from a financial
point of view.
The Offer was made pursuant to the Agreement and Plan of Merger, dated as
of August 9, 1995 (the "Merger Agreement"), among the Company, the Offeror
and EMPHESYS. The Merger Agreement provided, among other things, that as
soon as practicable after the purchase of Shares pursuant to the Offer and
the satisfaction of the other conditions set forth in the Merger Agreement
and in accordance with the relevant provisions of the General Corporation
Law of the State of Delaware (the "DGCL"), the Offeror would be merged with
and into EMPHESYS (the "Merger"). Other than as described in the Merger
Agreement, there were no material relationships between the Company, the
Offeror and EMPHESYS.
As a result of all conditions of the tender offer being met, including
obtaining all necessary regulatory approvals and the attainment by EMPHESYS
of certain specified financial and operational targets, the tender offer was
closed and all shares tendered were acquired on October 11, 1995.
At the close of the tender, 16,890,756 or 99 percent of the Shares were
acquired. Under the DGCL, if 90 percent or more of the shares are acquired,
the Merger can be consummated without the vote of the remaining stockholders.
The Merger was consummated on October 13, 1995. At the effective time of the
Merger, each remaining issued and outstanding Share not purchased in the
tender offer was converted into and represented the right to receive the
Offer Price. Following consummation of the Merger, EMPHESYS continued as
the surviving corporation and became a wholly owned subsidiary of the
Company.
The aggregate purchase price of approximately $650 million was funded by
the Company through available cash, the sale of selected marketable
securities and bank borrowings. The bank borrowings of approximately $250
million were pursuant to a credit agreement, as amended and restated,
dated as of September 26, 1995, among the Company, Chemical Bank, as agent,
and several other banks.
2
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
Page
(a) Financial Statements of Business Acquired
EMPHESYS Financial Group, Inc. and Subsidiaries
Index to Consolidated Financial Statements
Consolidated Balance Sheets as of June 30, 1995
(unaudited) and December 31, 1994 4-5
Consolidated Statements of Income for the three and six
month periods ended June 30, 1995 and 1994 (unaudited) 6
Consolidated Statements of Cash Flows for the six
months ended June 30, 1995 and 1994 (unaudited) 7
Notes to Consolidated Financial Statements (unaudited) 8-10
Report of Independent Accountants 11
Consolidated Balance Sheets as of December 31, 1994
and 1993 12-13
Consolidated Statements of Income for the years
ended December 31, 1994, 1993 and 1992 14
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 1994, 1993 and 1992 15
Consolidated Statements of Cash Flows for the years
ended December 31, 1994, 1993 and 1992 16
Notes to Consolidated Financial Statements 17-34
(b) Pro forma Financial Information (Unaudited)
Introduction to Pro forma Condensed Consolidated
Financial Statements 35-36
Pro forma Condensed Consolidated Balance Sheet as
of June 30, 1995 37
Pro forma Condensed Consolidated Statement of Income
for the six months ended June 30, 1995 38
Notes to Pro forma Condensed Consolidated Financial
Statements as of and for the six months
ended June 30, 1995 39
Pro forma Condensed Consolidated Statement of Income
for the year ended December 31, 1994 40
Notes to Pro forma Condensed Consolidated Statement
of Income for the year ended December 31, 1994 41
(c) Exhibit Index 42
3
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
June 30, December 31,
1995 1994
(unaudited)
ASSETS
Investments:
Securities available for sale, at
fair value:
Fixed income (amortized cost:
1995--$556,851; 1994--$562,366) $ 580,584 $ 542,150
Equity (cost: 1995--$6,940 and
1994--$7,170) 7,725 7,337
Commercial mortgages 59,478 60,203
Real estate 1,142 1,107
Short-term investments 47,317 34,823
Other investments 4,023 5,200
Total investments 700,269 650,820
Property and equipment:
Land 2,071 2,071
Land improvements 3,857 3,857
Building and improvements 25,145 24,820
Office equipment 56,476 51,655
87,549 82,403
Less accumulated depreciation (39,397) (37,646)
Net property and equipment 48,152 44,757
Receivables and other assets:
Premiums receivable, less allowance
for doubtful accounts
(1995 and 1994-- $464) 16,675 15,179
Accrued investment income 11,104 12,686
Due from reinsurers 1,767 1,293
Deferred income taxes 22,652 30,012
Other assets 5,884 6,052
Total receivables and
other assets 58,082 65,222
Intangible assets:
Excess of purchase price over fair
value of net assets acquired, less
accumulated amortization (1995--
$19,649; 1994--$17,434) 55,504 48,886
Present value of insurance in force
and other intangible assets, less
accumulated amortization (1995 --
$6,188; 1994 -- $5,171) 7,139 4,304
62,643 53,190
Separate account assets 10,431 12,397
$ 879,577 $ 826,386
See notes to consolidated financial statements.
4
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(In thousands, except per share amounts)
June 30, December 31,
1995 1994
(unaudited)
RESERVES, LIABILITIES AND
STOCKHOLDERS' EQUITY
Insurance reserves and liabilities:
Claim liabilities:
Accident and health $ 304,527 $ 296,048
Group life and other 5,932 5,579
Future policy benefits 9,715 9,536
Total insurance reserves
and liabilities 320,174 311,163
Other liabilities:
Premiums paid in advance 29,628 26,279
Other policyholders' funds 3,683 7,533
Amounts due reinsurers 792 4,072
Accrued expenses and other
liabilities 85,104 97,639
Federal income taxes 9,492 10,233
Notes payable 56,380 55,947
Total other liabilities 185,079 201,703
Separate account liabilities 10,431 12,397
Stockholders' equity:
Preferred stock ($0.01 par value,
1,000,000 shares authorized, 1995
and 1994 - none outstanding) - -
Common stock ($0.01 par value,
50,000,000 shares authorized,
June 30, 1995 - 17,063,997 out-
standing; December 31, 1994 -
17,025,840 outstanding) 171 170
Additional paid-in capital 170,719 169,279
Retained earnings 179,142 153,653
Unearned compensation - restricted
stock awards (2,075) (1,930)
Net unrealized gain (loss) on
securities available for sale 15,936 (20,049)
Total stockholders' equity 363,893 301,123
$ 879,577 $ 826,386
See notes to consolidated financial statements.
5
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
1995 1994 1995 1994
Premium revenues $ 398,039 $ 341,226 $ 781,933 $ 677,981
Net investment income 13,551 11,749 26,681 23,942
Realized gain on
investments 1,212 148 777 647
Administrative fees
and other 7,958 5,446 16,512 10,298
Total revenue 420,760 358,569 825,903 712,868
Policy benefits paid
or provided 302,643 248,413 587,044 494,419
Salaries and other
operating expenses 62,296 54,552 122,498 107,670
Commissions 31,176 26,335 62,512 54,587
Amortization of
intangible assets 1,745 1,290 3,233 2,378
Interest expense 1,041 713 2,036 926
Total benefits
and expenses 398,901 331,303 777,323 659,980
Income before federal
income taxes 21,859 27,266 48,580 52,888
Federal income taxes 8,086 10,114 17,972 19,594
Net income $ 13,773 $ 17,152 $ 30,608 $ 33,294
Net income per common
and common equiva-
lent share $ 0.81 $ 1.01 $ 1.79 $ 1.96
Net income per common
share-assuming full
dilution $ 0.81 $ 1.00 $ 1.79 $ 1.95
Dividends declared
per share $ 0.15 $ 0.15 $ 0.15 $ 0.15
See notes to consolidated financial statements.
6
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
June 30,
1995 1994
Operating activities
Net income $ 30,608 $ 33,294
Adjustments to reconcile net income to
net cash provided by operating
activities:
Decrease (increase) in receivables
and other assets 26 (2,852)
Increase (decrease) in insurance
reserves and liabilities 8,681 4,530
Increase (decrease) in other
liabilities (13,811) 6,645
Amortization of intangible assets
and restricted stock awards 4,527 2,735
Provision for depreciation 5,085 4,261
Provision (credit) for deferred
federal income taxes (1,049) 27
Realized gain on investments (777) (647)
Net amortization of investment
premium (discount) (659) 222
Net cash provided by operating
activities 32,631 48,215
Investing activities
Purchase of fixed income securities (22,059) (62,501)
Purchase of equity securities (12,699) (6,740)
Purchase of commercial mortgages - -
Proceeds from the sale of fixed
income securities 14,978 4,275
Proceeds from the sale of equity
securities - 4
Proceeds from maturities, redemptions
and principal repayments of fixed
income securities 17,012 21,710
Purchase of property and equipment (7,668) (3,879)
Carrying value of property and
equipment sold 78 37
Other (153) 59
Net cash used in
investing activities (10,511) (47,035)
Financing activities
Dividends paid to stockholders (5,119) (7,687)
Repayment of notes payable (275) (914)
Decrease in cash overdraft (4,232) (579)
Net cash used in
financing activities (9,626) (9,180)
Increase (decrease) in cash and cash
equivalents 12,494 (8,000)
Cash and cash equivalents at beginning
of period 34,823 8,000
Cash and cash equivalents at end
of period $ 47,317 $ -
See notes to consolidated financial statements.
7
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1995
(Unaudited)
1. Business
EMPHESYS Financial Group, Inc. ("EMPHESYS"), through its
subsidiary, Employers Health Insurance ("EHI"), is a
leading provider of a broad range of employee benefit
products to small businesses, including managed care group
medical, group life, group dental and group disability
income insurance. The Company also provides administrative
and managed care services to medium and large employers,
flexible benefits services to employers of all sizes,
purchasing pool marketing and administration for
governmental and private organizations, and distribution of
group health insurance products. EMPHESYS operates in one
segment - the employer-based, managed care medical and
insurance services segment of the insurance industry.
2. Basis of Presentation
The consolidated financial statements include the accounts
of EMPHESYS and its subsidiaries, collectively referred to
as the Company. All significant intercompany transactions
have been eliminated.
The accompanying financial statements have been prepared in
accordance with generally accepted accounting principles
for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Certain
information and footnote disclosures normally included in
complete financial statements prepared in accordance with
generally accepted accounting principles have been
condensed or omitted. The interim financial data is
unaudited; however, in the opinion of management, the
interim data includes all adjustments (consisting only of
normal recurring accruals) necessary for a fair
presentation of the results for interim periods. The
results of operations for the three and six month periods
ended June 30, 1995 is not necessarily indicative of the
results to be expected for the year ended December 31,
1995.
The accompanying financial statements should be read in
conjunction with the consolidated financial statements and
footnotes for the year ended December 31, 1994,
incorporated by reference in the Company's Annual Report on
Form 10-K filed in March 1995 with the Securities and
Exchange Commission.
3. Investments
The Company's fixed income securities and equity securities
(common and non-redeemable preferred stock) are classified
as "available for sale" and, accordingly, are carried at
fair value. The cost of fixed income securities is
adjusted for amortization of premiums and discounts.
Unrealized gains and losses associated with available for
sale securities are excluded from net income and are
recorded as a component of stockholders' equity, net of
deferred income taxes. Fixed income securities and equity
securities deemed to have declines in value that are other
than temporary are written down through the statement of
income to carrying values equal to their estimated fair
values. Realized gains (losses) on investments are
recognized in net income using the specific identification
method.
8
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
For the mortgage-backed securities portion of the fixed
income securities portfolio, including collateralized
mortgage obligations, the Company recognizes income using
a constant effective yield based on anticipated prepayments
and the estimated economic life of the securities. When
actual prepayments differ significantly from anticipated
prepayments, the effective yield is recalculated to reflect
actual payments to date and anticipated future payments.
The net investment in each security is adjusted to the
amount that would have existed had the new effective yield
been applied since the acquisition of the security. This
adjustment is reflected in net investment income.
Commercial mortgages are carried at their outstanding
principal balances less unaccrued discounts and allowances
for loan losses. Real estate, acquired principally through
foreclosure, is carried at the lower of depreciated cost or
fair value. Short-term and other investments are carried
at cost, which approximates fair value.
4. Notes Payable
Notes payable consist principally of a $50 million term
note payable to Lincoln National Corporation or its
subsidiaries issued on March 4, 1994. The principal amount
of the term note is payable in full on or before December
31, 1996. The term note bears interest at a variable rate
equal to .75% over the three-month LIBOR rate, adjusted
quarterly. The rate of interest in effect for the three
months ended June 30, 1995 and 1994 was 7% and 4.8%,
respectively. For the six months ended June 30, 1995 and
1994, the interest rate was 7.1% and 4.8%, respectively.
Interest is payable quarterly through the end of the loan
term.
The term note is secured by a pledge of 20% of the
outstanding common stock of EHI. In addition, the term
note contains restrictive covenants which, among other
things, limit the acquisition or disposition of assets or
business units by EMPHESYS and the repurchase or redemption
of EMPHESYS' common stock. The term note contains
covenants which impose borrowing limits on the Company and
EHI and requires the maintenance of a $200,000,000 minimum
level of surplus for EHI.
5. Federal Income Taxes
The Company provides for income taxes using the liability
method of accounting, whereby deferred income tax assets or
liabilities are recognized on the differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax
purposes. These differences relate primarily to
accelerated depreciation on property and equipment,
unrealized gains and losses on investment securities,
discounting of accident and health claims liabilities for
tax purposes, premiums paid in advance, the deferral of
certain policy acquisition costs for tax purposes,
differences in claims liability reserves calculated for
book and tax purposes and the accrual of estimated salvage
and subrogation receivable for tax purposes. Such tax
assets or liabilities are adjusted regularly to amounts
estimated to be receivable or payable based on enacted
future tax laws and rates. Valuation allowances are
provided for those deferred tax assets whose realization is
uncertain. Changes in the valuation allowance related to
deferred tax assets provided on unrealized losses on
available for sale securities are charged directly to
stockholders' equity.
9
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Contingent Liabilities
The Company is involved in various pending or threatened
legal proceedings arising from the normal conduct of
business. It is management's opinion that these
proceedings ultimately will be resolved without materially
affecting the financial position of the Company.
7. Earnings per Share
Earnings per share are calculated based on the weighted
average shares of common stock and common stock equivalents
outstanding during the periods presented. Common stock
equivalents arising from dilutive stock options are
computed using the treasury stock method.
8. Dividends
On August 2, 1995, the Company's Board of Directors
declared a quarterly dividend of $0.15 per share, payable
on September 15, 1995 to shareholders of record on
September 1, 1995.
9. Reclassifications
Certain 1994 amounts have been reclassified to conform to
the 1995 presentation.
10
Report of Ernst & Young, LLP, Independent Auditors
The Board of Directors and Stockholders
EMPHESYS Financial Group, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets
of EMPHESYS Financial Group, Inc. and Subsidiaries (the
"Company") as of December 31, 1994 and 1993, and the related
consolidated statements of income, stockholders' equity and
cash flows for each of the three years in the period ended
December 31, 1994. These financial statements are the
responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting
principles used and significant estimates made by management,
as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of EMPHESYS Financial Group,
Inc. and Subsidiaries at December 31, 1994 and 1993, and the
consolidated results of its operations and its cash flows for
each of the three years in the period ended December 31, 1994,
in conformity with generally accepted accounting principles.
As discussed in Notes 2 and 3 to the consolidated financial
statements, in 1993 the Company changed its method of
accounting for post-retirement benefits other than pensions,
income taxes and certain investments in debt and equity
securities.
Milwaukee, Wisconsin
January 27, 1995
11
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
December 31,
1993 1994
ASSETS
Investments:
Securities available for sale, at
fair value:
Fixed income (amortized cost: 1993--
$522,716; 1994--$562,366) $ 563,719 $ 542,150
Equity (cost: 1993--$3,045; and
1994--$7,170) 3,489 7,337
Commercial mortgages, less allowance
for losses (1993 - $2,120) 64,027 60,203
Real estate 1,100 1,107
Short-term investments 8,000 34,823
Other investments 3,398 5,200
Total investments 643,733 650,820
Property and equipment:
Land 2,071 2,071
Land improvements 3,848 3,857
Building and improvements 24,373 24,820
Office equipment 41,757 51,655
72,049 82,403
Less accumulated depreciation (29,757) (37,646)
Net property and equipment 42,292 44,757
Receivables and other assets:
Premiums receivable, less allowance
for doubtful accounts (1993 - $428;
1994- $464) 8,933 15,179
Accrued investment income 9,686 12,686
Due from reinsurers 2,983 1,293
Deferred income taxes 15,519 30,012
Other assets 4,201 6,052
Total receivables and
other assets 41,322 65,222
Intangible assets:
Excess of purchase price over fair
value of net assets acquired, less
accumulated amortization (1993-
$13,100; 1994--$17,434) 49,447 48,886
Present value of insurance inforce
and other intangible assets, less
accumulated amortization (1993 -
$4,150; 1994 - $5,171) 2,850 4,304
Total intangible assets 52,297 53,190
Separate account assets 13,899 12,397
$ 793,543 $ 826,386
12
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(in thousands, except share amounts)
December 31,
1993 1994
RESERVES, LIABILITIES AND
STOCKHOLDERS' EQUITY
Insurance reserves and liabilities:
Claim liabilities:
Accident and health $ 293,217 $ 296,048
Group life and other 5,538 5,579
Future policy benefits 8,507 9,536
Total insurance reserves
and liabilities 307,262 311,163
Other liabilities:
Premiums paid in advance 21,053 26,279
Other policyholders' funds 4,039 7,533
Amounts due reinsurers 4,530 4,072
Accrued expenses and other liabilities 80,449 97,639
Dividends payable 5,156 -
Federal income taxes 10,541 10,233
Notes payable 6,459 55,947
Total other liabilities 132,227 201,703
Separate account liabilities 13,899 12,397
Commitments and contingent liabilities
(Notes 7 and 12)
Stockholders' equity:
Preferred stock (1994 - $0.01 par value,
1,000,000 shares authorized, none out-
standing) - -
Common stock (1994 - $0.01 par value,
50,000,000 shares authorized, 17,025,840
outstanding; 1993 - $8 par value,
15,000,000 shares authorized, 1,104,167
outstanding) (Note 1) 8,893 170
Additional paid-in capital 207,228 169,279
Retained earnings 97,032 153,653
Unearned compensation - restricted
stock awards - (1,930)
Net unrealized gain (loss) on securities
available for sale 27,002 (20,049)
Total stockholders' equity 340,155 301,123
$ 793,543 $ 826,386
See notes to consolidated financial statements.
13
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
For the Year Ended December 31,
1992 1993 1994
Revenues:
Premiums $ 1,191,470 $ 1,239,782 $ 1,386,814
Net investment income 43,453 47,378 48,619
Realized gain on investments 1,293 2,068 1,539
Administrative fees and other 11,384 15,445 25,299
Total revenues 1,247,600 1,304,673 1,462,271
Policy benefits and expenses:
Policy benefits paid or provided 900,115 919,255 1,020,283
Salaries and other operating
expenses 177,179 192,691 222,544
Commissions 97,751 98,595 109,217
Amortization of intangible assets 2,407 3,980 5,354
Interest expense - - 2,807
Total benefits and
expenses 1,177,452 1,214,521 1,360,205
Income before federal income
taxes and cumulative effect of
changes in accounting principle 70,148 90,152 102,066
Federal income taxes 26,275 32,099 37,786
Income before cumulative effect
of changes in accounting principle 43,873 58,053 64,280
Cumulative effect of changes in
accounting principle, net of
income taxes - (2,815) -
Net income $ 43,873 $ 55,238 $ 64,280
Per common and common equivalent share:
Income before cumulative effect
of changes in accounting
principle $ 2.58 $ 3.42 $ 3.77
Cumulative effect of changes
in accounting principle - (0.17) -
Net income $ 2.58 $ 3.25 $ 3.77
See notes to consolidated financial statements.
14
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
Unrealized
Unearned Gain (Loss) Total
Common Stock Additional Compensation on Securities Stock-
Paid-In Retained -Restricted Available holders'
Shares Amount Capital Earnings Stock Awards For Sale Equity
Balance at
January 1, 1992 1,104,167 $ 8,893 $ 207,228 $ 44,163 $ - $ 1,663 $ 261,947
1992 net income 43,873 43,873
Dividends declared (25,617) (25,617)
Change in unrealized
gain (loss) 55 55
Balance at
December 31, 1992 1,104,167 8,893 207,228 62,419 - 1,718 280,258
1993 net income 55,238 55,238
Dividends declared (20,625) (20,625)
Change in unrealized
gain (loss) 25,284 25,284
Balance at
December 31, 1993 1,104,167 8,893 207,228 97,032 - 27,002 340,155
Reclassification to
recognize effect
of the reorgani-
zation 15,773,102 (8,724) 8,724 -
Distribution to
parent pursuant
to the reorgani-
zation (50,000) (50,000)
Restricted stock
issued pursuant
to the initial
public offering 122,731 1 2,757 (2,758) -
1994 net income 64,280 64,280
Dividends declared (7,659) (7,659)
Change in unrealized
gain (loss) (47,051) (47,051)
Issuance of restricted
stock pursuant to
benefit plans 25,840 570 570
Amortization of
restricted stock
grants 828 828
Balance at
December 31, 1994 17,025,840 $ 170 $ 169,279 $ 153,653 $ (1,930) $ (20,049) $ 301,123
See notes to consolidated financial statements.
15
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the year ended December 31,
1992 1993 1994
Operating activities:
Net income $ 43,873 $ 55,238 $ 64,280
Adjustments to reconcile net
income to net cash provided by
operating activities:
Decrease (increase) in
receivables and other assets 1,600 (6,582) (9,020)
Increase in insurance reserves
and liabilities 19,663 46,452 3,901
Increase (decrease) in
other liabilities (1,046) 11,758 24,303
Amortization of intangible
assets and restricted
stock awards 2,407 3,980 6,182
Provision for depreciation 5,061 7,877 9,291
Provision (credit) for deferred
federal income taxes (11,501) (7,691) 198
Proceeds from sale of trading
account securities 1,954 2,015 -
Realized gain on investments (1,293) (2,068) (1,539)
Net amortization of investment
premium or discount (1,065) (2,398) 782
Cumulative effect of changes
in accounting principle - 2,815 -
Net cash provided by
operating activities 59,653 111,396 98,378
Investing activities:
Purchase of fixed income
securities (114,793) (146,919) (95,346)
Purchase of equity securities - (1,625) (8,096)
Purchase of commercial mortgages (15,050) (34,420) (143)
Proceeds from sale of fixed
income securities 54,495 20,212 20,839
Proceeds from sale of equity
securities - 108 6
Proceeds from maturities,
redemptions and principal repay-
ments of fixed income securities 47,904 79,185 37,719
Purchase of property and equipment (7,131) (13,634) (11,682)
Carrying value of property and
equipment sold 439 128 150
Other 957 (16) (903)
Net cash used in
investing activities (33,179) (96,981) (57,456)
Financing activities:
Dividends paid to stockholders (25,474) (21,874) (12,815)
Proceeds from (repayment of)
notes payable - 6,459 (1,284)
Net cash used in
financing activities (25,474) (15,415) (14,099)
Increase (decrease) in cash and
cash equivalents 1,000 (1,000) 26,823
Cash and cash equivalents at
beginning of year 8,000 9,000 8,000
Cash and cash equivalents at
end of year $ 9,000 $ 8,000 $ 34,823
Supplementary data:
Interest paid $ - $ - $ 2,807
Income taxes paid 39,846 45,619 38,177
Distribution to Lincoln Life
in the form of note payable - - 50,000
Insurance reserves assumed from
Lincoln Life 41,168 7,373 -
See notes to consolidated financial statements.
16
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1994
1. BASIS OF PRESENTATION
BUSINESS
EMPHESYS Financial Group, Inc. ("EMPHESYS"), through its
subsidiary, Employers Health Insurance ("EHI"), is a leading provider
of a broad range of employee benefit products to small businesses,
including managed care group health, group life, dental and disability
income insurance. The Company also provides administrative and
managed care services to medium and large employers, flexible
benefits services to employers of all sizes, purchasing pool marketing
and administration for governmental and private organizations, and
distribution of group health insurance products. Wisconsin Employers
Group, Inc.'s ("WEG") operations are limited to leasing certain office
equipment to EHI. EMPHESYS operates in one segment - the
employer-based, managed care medical and insurance services segment
of the insurance industry.
BASIS OF CONSOLIDATION
The consolidated financial statements as of and for the year ended
December 31, 1994, include the accounts of EMPHESYS and its
subsidiaries, EHI and WEG, collectively referred to as the Company.
All significant intercompany transactions have been eliminated.
Financial statements as of December 31, 1993, and for the years ended
December 31, 1993 and 1992, prior to the reorganization described
below, reflect the combined financial position and results of operations
and cash flows of EHI and WEG. Amounts relating to EHI and WEG
at December 31, 1993 are summarized as follows:
Total Stockholders'
Assets Equity
(in thousands)
EHI $ 793,702 $ 340,315
WEG (159) (160)
$ 793,543 $ 340,155
REORGANIZATION
EMPHESYS was formed on December 15, 1993 by the Lincoln
National Life Insurance Company ("Lincoln Life") to act as a holding
company for EHI and WEG. Under a preorganization subscription
agreement dated December 15, 1993, Lincoln Life, upon receiving
required regulatory approvals, transferred its 100% stock ownership in
EHI and WEG to EMPHESYS in exchange for 17,000,000 shares of
EMPHESYS' common stock and a $50,000,000, three-year term note.
The reorganization was completed on March 4, 1994. The
reorganization transaction was a transfer among entities under
common control and, therefore, was accounted for using historical
values similar to pooling-of-interests accounting.
On December 16, 1993, the Company filed a Registration Statement on
Form S-1 with the Securities and Exchange Commission for the initial
public offering of 10,500,000 shares of its common stock. The closing
of the transaction occurred on March 21, 1994. All shares in the public
offering were offered for sale by Lincoln Life, with all proceeds from
the offering being retained by Lincoln Life. In connection with the
public offering, Lincoln Life also sold 200,000 shares of the Company's
Common Stock to EHI, which EHI subsequently contributed to its
profit sharing 401(k) plan and trust. Lincoln Life also contributed
127,293 shares of the Company's Common Stock to the Company of
which 122,731
17
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
shares were awarded to certain members of the Company's
management in the form of restricted stock awards. In addition, the
underwriters, on April 13, 1994, notified the Company and Lincoln Life
of the exercise of their over-allotment option to purchase an additional
1,186,200 shares of Common Stock from Lincoln Life. On April 19,
1994, Lincoln Life transferred its retained stock ownership in the
Company to Lincoln National Corporation ("LNC"). At December 31,
1994, and after consideration of the transactions described above, LNC
held 4,986,507 shares or approximately 29.3% of the issued and
outstanding Common Stock of the Company.
2. SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS
As of December 31, 1993, in accordance with Statement of Financial
Accounting Standards No. 115, fixed income securities and equity
securities (common and nonredeemable preferred stocks) are classified
as "available for sale" and, accordingly, are carried at fair value. The
cost of fixed income securities is adjusted for amortization of premiums
and discounts. Unrealized gains and losses associated with available
for sale securities are excluded from net income and are recorded as
a component of stockholders' equity, net of deferred income taxes.
Fixed income securities and equity securities deemed to have declines
in value that are other than temporary are written down through the
statement of income to carrying values equal to their estimated fair
values. Realized gains (losses) on investments are recognized in net
income using the specific identification method.
Prior to December 31, 1993, the Company classified fixed income
securities in accordance with existing accounting standards and,
accordingly, identified those fixed income securities that were not
intended to be held to maturity as either "trading" or "held for sale."
Trading securities were carried at fair value, with unrealized gains or
losses excluded from net income and recorded as a separate
component of stockholders' equity, net of deferred income taxes. Held
for sale securities were carried at the lower of aggregate amortized cost
or fair value.
For the mortgage-backed securities portion of the fixed income
securities portfolio, including collateralized mortgage obligations, the
Company recognizes income using a constant effective yield based on
anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from
anticipated prepayments, the effective yield is recalculated to reflect
actual payments to date and anticipated future payments. The net
investment in each security is adjusted to the amount that would have
existed had the new effective yield been applied since the acquisition of
the security. This adjustment is reflected in net investment income.
Commercial mortgages are carried at their outstanding principal
balances less unaccrued discounts and allowances for loan losses. Real
estate, acquired principally through foreclosure, is carried at the lower
of depreciated cost or fair value. Short-term and other investments are
carried at cost, which approximates fair value.
18
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Provisions for
depreciation are computed principally by the straight-line method at
rates based on estimated useful lives of 3 to 7 years for equipment and
40 years for buildings.
INTANGIBLE ASSETS
The excess purchase price over fair value of net assets acquired consists
primarily of goodwill associated with Lincoln Life's 1986 acquisition of
EHI ("Lincoln goodwill"). Prior to January 1, 1993, Lincoln goodwill
was being amortized and charged to income over 40 years. Effective
January 1, 1993, the remaining amortization period for the
unamortized balance of Lincoln goodwill was reduced to 14 years based
on management's estimate of the remaining life of this asset. The
effect of this change was to reduce net income for the years ended
December 31, 1993 and 1994 by approximately $2,237,000. Other
goodwill consists of the excess purchase price over the fair value of net
assets of acquired subsidiaries and divisions of EHI. These amounts
are being amortized over their estimated lives of three to five years.
The estimated present values of acquired group accident and health
insurance blocks of business are being amortized in relation to
estimated future profits associated with the acquired policies and
charged to income as the estimated profits are recognized. Other
intangible assets, consisting of trademarks, customer lists and
agreements not to compete, are being amortized over their estimated
useful lives of approximately three years.
The Company periodically reviews goodwill and other intangible assets
to assess permanent impairment. Impairment is recognized in income
when the expected, undiscounted future operating cash flows from the
underlying asset or business unit are less than the carrying value of the
related intangible asset.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits principally related to annuity
policies are based on cash values of the related policies including
interest additions at current rates.
CLAIM LIABILITIES
The liabilities for insurance claims are determined using statistical
analyses and represent estimates of the ultimate net cost of all reported
and unreported claims which are unpaid at year end. The Company's
year-end claim liabilities are substantially satisfied through claim
payments in the subsequent year. Although it is not possible to
measure the degree of variability inherent in such estimates,
management believes that the liabilities for insurance claims are
adequate. In recent years, the ultimate settlement of claims has
resulted in claims liabilities in excess of subsequent payments by
amounts less than 5% of annual benefit costs. The estimates are
reviewed periodically and as adjustments to these liabilities become
necessary, these adjustments are reflected in current operations.
ACCRUED EXPENSES AND OTHER LIABILITIES
Included in accrued expenses and other liabilities are cash credit
balances totalling $26,284,000 and $37,659,000 at December 31, 1993
and 1994, respectively.
19
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
SEPARATE ACCOUNT
The separate account assets and liabilities reflected in the balance
sheets represent the assets (principally certificates of deposit) and
liabilities for group annuity contracts issued through financial
institutions. The assets of the separate accounts are segregated from
the Company's other assets both for investment and administrative
purposes. Investment income on the specific certificates of deposit
purchased with the annuitants' premium payments is utilized to fund
the annuity benefits and to pay the Company a contractually
predetermined administrative fee which is recognized over the life of
the contract.
RECOGNITION OF PREMIUM REVENUE AND RELATED
BENEFITS AND EXPENSES
Premiums for group life and accident and health policies are
recognized ratably over the period of insurance coverage. Benefits and
expenses are recorded on a basis consistent with the recognition of
premium revenue.
REINSURANCE ASSUMED AND CEDED
The Company assumes and cedes reinsurance to provide for greater
diversification of business and to reduce its exposure to potential losses
arising from large risks. Premiums paid for reinsurance ceded are
recognized during the period coverage is in effect. Amounts
recoverable from reinsurance are estimated in a manner consistent
with the claim liability associated with the reinsured policies.
FEDERAL INCOME TAXES
Prior to January 1, 1993, deferred federal income taxes were provided
for timing differences between financial statement income and income
reported for tax purposes. Subsequent to December 31, 1992, deferred
income tax assets or liabilities are recognized on the differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
Valuation allowances are provided for those deferred tax assets whose
realization is uncertain. Changes in the valuation allowance related to
deferred tax assets provided on unrealized losses on available for sale
securities are charged directly to stockholders' equity.
CASH FLOWS
For purposes of the statements of cash flows, the Company considers
highly liquid, short-term investments with an original maturity of three
months or less and investments in money market funds to be cash
equivalents.
EARNINGS PER SHARE
Earnings per share are calculated based on the weighted average
shares of common stock and common stock equivalents outstanding
during the periods presented. Common stock equivalents arising from
dilutive stock options are computed using the treasury stock method.
For periods prior to March 4, 1994 (the date of the Company's
reorganization), earnings per share is computed assuming 17,000,000
shares of common stock are outstanding.
20
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
1994 presentation.
3. ACCOUNTING CHANGES
POST-RETIREMENT BENEFITS
The Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 106, "Employers' Accounting for
Post-Retirement Benefits Other Than Pensions," effective January 1,
1993, by electing the immediate recognition of the transition obligation
as defined in the statement. The cumulative effect of adopting this
statement was a one-time charge to income of $3,876,000 (net of the
applicable tax benefit of $1,997,000).
INCOME TAXES
The Company adopted SFAS No. 109, "Accounting for Income Taxes,"
on January 1, 1993. The cumulative effect of adopting this statement
was to increase net income by $1,061,000. Financial statements for
1992 were not restated to reflect this new accounting principle.
4. INVESTMENTS
The amortized cost and estimated fair values of fixed income securities,
by category, are as follows:
December 31, 1993
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
(in thousands)
U.S. Government $ 35,671 $ 3,664 $ - $ 39,335
Corporate securi-
ties 339,420 27,940 1,418 365,942
Foreign bonds 998 66 - 1,064
Mortgage-backed
securities 146,627 11,293 542 157,378
$ 522,716 $ 42,963 $ 1,960 $ 563,719
December 31, 1994
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
(in thousands)
U.S. Government $ 35,324 $ 664 $ 380 $ 35,608
States and munici-
pals 13,469 130 1 13,598
Corporate securi-
ties 384,411 3,209 21,000 366,620
Foreign bonds 999 - 102 897
Mortgage-backed
securities 128,163 2,373 5,109 125,427
$ 562,366 $ 6,376 $ 26,592 $ 542,150
21
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
Fair values of fixed income securities are based on quoted market
prices, where available. For fixed income securities not actively traded,
fair values are estimated using values obtained from independent
pricing services, or, in the case of private placements, are estimated by
discounting expected future cash flows using a current market rate
applicable to the coupon rate, credit quality and maturity of the
investments.
The amortized cost and estimated fair value of fixed income securities
at December 31, 1994, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or repay obligations with or
without call or prepayment penalties.
Amortized Estimated
Cost Fair Value
(in thousands)
Due in one year or less $ 11,754 $ 11,724
Due after one year through five years 101,864 100,994
Due after five years through ten years 175,149 166,903
Due after ten years 145,436 137,102
434,203 416,723
Mortgage-backed securities 128,163 125,427
$ 562,366 $ 542,150
Proceeds from sales of investments in fixed income securities
(excluding maturities and redemptions) were as follows:
Gross Gross
Proceeds Realized Realized
From Sales Gains Losses
(in thousands)
Year ended December 31, 1992:
Held for sale securities $ 54,495 $ 4,144 $ 593
Trading account securities 1,954 - 1
$ 56,449 $ 4,144 $ 594
Year ended December 31, 1993:
Held for sale securities $ 20,212 $ 782 $ 168
Trading account securities 2,015 8 -
$ 22,227 $ 790 $ 168
Year ended December 31, 1994:
Available for sale securities $ 20,839 $ 599 $ 691
22
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Realized and unrealized gains and losses on investments, including gains and
losses on securities called in advance of their maturity by the issuer, are as
follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Net realized gains (losses):
Fixed income securities $ 3,551 $ 2,514 $ 7
Equity securities 82 (12) 2
Trading account securities (1) - -
Recoveries (provisions and
writedowns):
Commercial mortgages (1,572) (121) 1,480
Real estate - (313) 40
Fixed income securities (767) - 10
$ 1,293 $ 2,068 $ 1,539
December 31,
1992 1993 1994
(in thousands)
Unrealized gains (losses):
Equity securities:
Gross unrealized gains $ 710 $ 682 $ 627
Gross unrealized losses (278) (238) (460)
Deferred income tax
expense (benefit) (132) (135) -
Fixed income securities:
Gross unrealized gains 2,148 42,963 6,376
Gross unrealized losses - (1,960) (26,592)
Deferred income tax
expense (benefit) (730) (14,310) -
$ 1,718 $ 27,002 $(20,049)
The net change in net unrealized gains (losses) on investment securities is as follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Increase (decrease) in net
unrealized gains (losses):
Equity securities $ 153 $ 12 $ (277)
Fixed income securities (71) 38,855 (61,219)
Applicable income taxes (27) (13,583) 14,445
Net increase (decrease) $ 55 $ 25,284 $(47,051)
Net investment income is comprised of the following:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Fixed income securities $ 40,683 $ 42,664 $ 42,868
Equity securities 139 121 118
Commercial mortgages 1,946 3,573 5,158
Short-term, real estate and
other investments 1,371 1,464 1,346
Gross investment income $ 44,139 $ 47,822 $ 49,490
Investment expenses (686) (444) (871)
$ 43,453 $ 47,378 $ 48,619
23
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
The carrying value of investments which are non-income producing and commercial
mortgages considered to be impaired under SFAS No. 114 are as follows:
December 31,
1993 1994
(in thousands)
Fixed income securities $ 1,759 $ 1,815
Real estate 1,100 1,107
Commercial mortgages 5,000 -
Valuation allowances of $2,120,000 were provided on $5,000,000 of impaired
commercial mortgages at December 31, 1993.
All impaired commercial mortgage loans are on a non-accrual basis. Interest income recognized on
impaired loans was as follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Impaired commercial mortgages,
average balance $ 7,000 $ 5,500 $ 4,566
Interest income
contractually due 673 515 422
Interest income recognized - - 51
Interest income received -
cash basis - - 51
A summary of activity in the allowance for loan losses is as follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Balance at beginning of year $ 1,000 $ 2,572 $ 2,120
Provisions (recoveries) 1,572 121 (1,480)
Charge-offs - (573) (640)
Balance at end of year $ 2,572 $ 2,120 $ -
The Company has estimated the fair value of its investment in
commercial mortgages using a discounted cash flow method based on
rating, maturity and future income when compared to the expected
yield for mortgages having similar characteristics. The ratings for
mortgages in good standing are based on property type, location,
market conditions, occupancy, debt service coverage, loan to value
ratio, caliber of tenancy, borrower and payment record. The fair value
of impaired mortgages considers such factors as the degree of default,
whether or not payments are still being made, interest rate, maturity
and operating performance of the underlying collateral.
24
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
A summary of the fair values of the Company's financial assets
(liabilities) follows:
December 31,
1993 1994
Fair Carrying Fair Carrying
Value Value Value Value
(in thousands)
Securities avail-
able for sale:
Fixed income $ 563,719 $ 563,719 $ 542,150 $ 542,150
Equity 3,489 3,489 7,337 7,337
Commercial mortgages 65,400 64,027 56,805 60,203
Short-term invest-
ments 8,000 8,000 34,823 34,823
Other investments 3,398 3,398 5,200 5,200
Notes payable (6,459) (6,459) (55,947) (55,947)
The Company does not have a material concentration of financial instruments
in a single investee, industry or geographic location or off-balance sheet
risks which would expose the Company to credit risk.
5. FEDERAL INCOME TAXES
The components of federal income tax expense are as follows:
For the Year Ended December 31,
1992 1993 1994
Deferred
Method Liability Method
(in thousands)
Current $ 37,776 $ 39,790 $ 37,588
Deferred (credit) (11,501) (7,691) 198
$ 26,275 $ 32,099 $ 37,786
A reconciliation of the differences between income tax expense
determined using the statutory federal income tax rate and the
Company's effective income tax rate is as follows:
For the Year Ended December 31,
1992 1993 1994
Deferred
Method Liability Method
(in thousands)
Income tax at statutory
rate applied to income
before taxes $ 23,851 $ 31,553 $ 35,721
Add (deduct) tax effect of:
Tax-exempt interest and
dividends received
deduction (86) (27) (33)
Intangible asset amorti-
zation 532 1,331 1,487
Other non-deductible
expenses 57 563 717
Increase in statutory
tax rates - (555) -
Other 1,921 (766) (106)
$ 26,275 $ 32,099 $ 37,786
25
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Significant components of the Company's deferred federal
tax liabilities and assets are as follows:
December 31,
1993 1994
(in thousands)
Deferred tax liabilities:
Accelerated depreciation $ 2,854 $ 3,064
Discount on bonds 431 680
Unrealized gains on available
for sale securities 14,492 -
Total deferred tax liabilities 17,777 3,744
Deferred tax assets:
Post-retirement benefits other
than pensions 2,526 3,153
Advance premium discounting 1,474 1,833
Deferred acquisition costs 558 692
Medical reserves discounting 2,802 2,865
Claim liability reserves 18,451 16,671
Salvage and subrogation 5,165 5,588
Accrual differences 1,391 2,785
Investment write-downs 929 169
Unrealized losses on available
for sale securities - 7,017
Total deferred tax assets 33,296 40,773
Less: valuation allowance - (7,017)
Net deferred tax assets $ 15,519 $ 30,012
The components of the deferred income tax expense (credit) are as follows:
For the Year Ended December 31,
1992 1993 1994
Deferred
Method Liability Method
(in thousands)
Financial accounting increase
in claim liabilities less
than (greater than) the
increase for tax purposes $ (11,958) $ (6,926) $ 1,717
Post-retirement benefits
other than pensions - (529) (627)
Premiums recognized as
income for tax purposes
and prepaid for financial
accounting purposes 503 (20) (359)
Estimated salvage and
subrogation recognized as
income for tax purposes (408) 59 (423)
Provision for losses on real
estate, loans and fixed
income securities (795) 206 760
Other 1,157 (481) (870)
$ (11,501) $ (7,691) $ 198
Prior to March 4, 1994, the Company filed a consolidated federal
income tax return with LNC. Under an agreement with LNC, the
Company provided for income taxes as though a separate return was
being filed and the taxes computed were remitted to or collected from
LNC.
26
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
6. NOTES PAYABLE
In connection with the reorganization (see Note 1), the Company
issued, on March 4, 1994, a $50,000,000 term note payable to Lincoln
Life. The principal amount of the term note is payable in full on or
before December 31, 1996. The term note bears interest at a variable
rate equal to .75% over the three-month LIBOR rate, adjusted
quarterly. The average rate of interest in effect during the year ended
December 31, 1994 was 5.36%. Interest is payable quarterly through
the end of the loan term.
The term note is secured by a pledge of 20.0% of the outstanding
common stock of EHI. In addition, the term note contains restrictive
covenants, which, among other things, limit the acquisition or
disposition of assets or business units by EMPHESYS and the
repurchase or redemption of EMPHESYS' common stock. The term
note also contains covenants which impose borrowing limits on the
Company based on the achievement of certain financial targets and
requires the maintenance of minimum levels of capital and surplus for
EHI.
The Company has also borrowed to finance the acquisition of
computer equipment. This note payable has an outstanding balance of
$5,321,000 at December 31, 1994 and bears interest at 6.17%. This
note is due in equal monthly installments of $125,000, including
accrued interest, through January 1, 1999. The note payable is secured
by a security interest in the underlying equipment. In connection with
the acquisition of certain businesses, the Company assumed liabilities,
principally to the former owners of the acquired businesses. These
notes total $627,000 at December 31, 1994 and bear interest at rates
from 8.5% to 10.0%. The notes are due in monthly installments of
principal and interest through July 1999. The Company believes the
carrying value of all notes payable approximates their fair value.
Annual principal amounts due under all notes for the years following
December 31, 1994 are as follows (in thousands):
1995 $ 1,433
1996 51,496
1997 1,449
1998 1,536
1999 33
$ 55,947
EHI has an unsecured line of credit agreement with a commercial bank
with maximum borrowings of $20,000,000 which expires November 14,
1995. Borrowings under the agreement bear interest at 1% below the
bank's prime rate. The agreement contains certain conditions
including, but not limited to, restrictions on additional indebtedness of
EHI and guarantees of the debt of others. In addition, the agreement
requires EHI to maintain a minimum statutory capital and surplus of
$200,000,000. At December 31, 1994, the Company had no borrowings
under this agreement.
27
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
7. LEASES
The Company leases certain office space, automobiles and computer
equipment under operating leases. Rent expense was $7,247,000,
$7,060,000 and $5,540,000 in 1992, 1993 and 1994, respectively. Future
minimum lease payments under noncancellable operating leases for the
years following December 31, 1994 are as follows (in thousands):
1995 $ 4,498
1996 3,485
1997 2,504
1998 985
1999 897
Thereafter 1,712
Total minimum
lease payments $ 14,081
8. REINSURANCE
The Company reinsures portions of its business through various
reinsurance treaties. Under terms of the agreements, the Company
generally retained $250,000, $350,000 and $500,000 of each accident
and health insurance risk written in 1992, 1993 and 1994, respectively.
Premiums paid for reinsurance ceded totalled $19,022,000, $14,994,000
and $13,161,000 during 1992, 1993 and 1994, respectively. Included in
these amounts are premiums paid to Lincoln Life for reinsurance
ceded of $1,116,000, $1,468,000 and $7,258,000 for 1992, 1993 and 1994,
respectively. Although the reinsurer in each case is primarily liable for
the insurance ceded, the Company remains liable to the insured
whether or not the reinsurer meets its contractual obligations.
In addition, the Company assumes certain accident and health
and life business, principally from Lincoln Life. Amounts
related to reinsurance assumed are as follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Premiums assumed from
Lincoln Life $ 319,668 $ 322,158 $ 339,712
Premiums assumed from others - - 8,101
Service charges to Lincoln
Life 5,027 2,787 2,564
Premium taxes to Lincoln Life 6,997 7,068 7,157
Commissions to Lincoln Life 31,226 30,710 31,773
Amounts payable to Lincoln Life in connection with these contracts at
December 31, 1993 and 1994 totalled $1,706,000.
28
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
Effective January 1, 1995, the Company entered into an escrow
agreement which provides Lincoln Life with a security interest in a
portion of the Company's investment securities in an amount based on
the claims liabilities associated with the group health, accident,
disability and life business assumed from Lincoln Life. The escrow
agreement does not affect the Company's ability to collect income or
principal payments, dispose of or substitute investment securities which
are pledged, subject to certain requirements relating to the credit
quality, issuer and maturity of the pledged securities. On January 1,
1995, securities with a cost and fair value of $62,419,000 and
$61,763,000, respectively, were pledged under the escrow agreement.
9. EMPLOYEE BENEFIT PLANS
PROFIT SHARING 401(K) PLAN AND TRUST
The Company's employees are included in a defined contribution plan
(the "Plan") with profit-sharing and discretionary savings provisions
covering all eligible salaried and hourly employees. Employees become
eligible on the semi-annual entry date (January 1 or July 1). Prior to
August 1, 1994, participant contributions up to 5% of the participant's
compensation were matched by the Company on a scale between 20%
and 50% based on the participant's length of service. Subsequent to
August 1, 1994, the matching scale was amended to 100% of the first
2% of a participant's compensation and between 50% and 100% of the
next 4% of a participant's compensation based on achievement of
certain Company growth and profitability criteria. Matching
contributions are made in the form of Company stock. The expense
related to the matching provision of the Company's discretionary
savings plan was $729,000, $900,000 and $1,913,000 for 1992, 1993 and
1994, respectively.
Profit-sharing contributions to the Plan are determined annually by the
Company's Board of Directors. Profit-sharing contributions may be
made in the form of cash or Company stock or any combination
thereof. The expense associated with the Company's profit-sharing
contribution was $5,210,000, $6,805,000 and $6,240,000 in 1992, 1993
and 1994, respectively.
POST-RETIREMENT HEALTH PLAN
The Company sponsors an unfunded, post-retirement defined benefit
health and life insurance plan for all full-time employees who are at
least 55 years old and their eligible dependents. Coverage is
coordinated with Medicare when an employee reaches age 65. The
Company's contribution to the retiree's health insurance premium is
50% of premium upon completion of 15 years of credited service and
increases ratably to 100% after 40 years of credited service. The
Company has the ability to change these benefits at any time.
29
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
The following table presents the funded status of the post-retirement
benefit plans, reconciled with the liability recognized on the Company's
balance sheet at the dates indicated:
December 31,
1993 1994
(in thousands)
Accumulated post-retirement benefit
obligation:
Retirees and dependents $ 261 $ 256
Active plan participants:
Fully eligible 497 813
Other 6,602 7,904
7,360 8,973
Plan assets - -
Accumulated post-retirement benefit
obligation in excess of plan assets 7,360 8,973
Unrecognized net loss due to change
in assumptions (193) (207)
Accrued liability for post-retirement
benefits other than pensions, included
in accrued expenses and other liabilities $ 7,167 $ 8,766
The components of net periodic post-retirement benefit cost, excluding
the cumulative effect of initially adopting SFAS No. 106 in 1993,
is comprised of the following:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Service cost $ 51 $ 905 $ 1,090
Interest cost - 440 551
Amortization of net loss from
change in assumptions - - 9
Net periodic post-retirement
benefit cost $ 51 $ 1,345 $ 1,650
The cost for post-retirement benefits for the year ended December 31,
1992 is prior to the adoption of SFAS No. 106 and, therefore,
represents the total amount of benefits actually paid. The weighted
average discount rate used in determining the accumulated post-
retirement benefit obligation was 7.5% at December 31, 1993 and 8.0%
at December 31, 1994 and the assumed rate of compensation increase
was 5.0% at December 31, 1993 and 5.5% at December 31, 1994. The
healthcare cost trend rate at December 31, 1993 was 11.5% graded
down over ten years to 5.5% and at December 31, 1994, 11.5% graded
down over ten years to 6.0%. A one percentage point increase in the
assumed healthcare cost trend rate would have increased the
accumulated benefit obligation by $2,683,000 at December 31, 1994 and
the aggregate service and interest cost components of projected net
periodic post-retirement benefits cost for 1994 by $492,000. The
Company amortizes experience gains and losses straight line over the
estimated average future service periods of the active participants
expected to receive benefits.
Excluding the cumulative effect of initial adoption, the impact of
adopting the statement was to increase net periodic post-retirement
benefit cost by $1,294,000 and $1,599,000 in 1993 and 1994, respectively,
and to decrease income before cumulative effect of changes in
accounting principle by $841,000 in 1993 and $1,007,000 in 1994. Net
income for 1992 has not been restated for the accounting change.
30
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
STOCK INCENTIVE PLAN
The Company maintains a stock incentive plan for key employees
which provides for the issuance of stock options, stock appreciation
rights, restricted stock awards and stock incentive awards. Stock
options granted under the plan may be designated as either non-
qualified or incentive stock options and have an exercise price at least
equal to the market value of the Company's stock on the date of grant.
The options generally vest over a four-year period and, subject to
termination of employment, expire ten years from the date of grant.
Information with respect to the stock incentive plan is as follows:
Options Outstanding
Shares
Available Average
For Grant Shares Option Price
Balance at March 21, 1994
(inception of plan) 819,693 -
Options granted (188,600) 188,600 $ 22.06
Options exercised -
Options expired -
Restricted stock awarded (148,571)
Balance at December 31, 1994 482,522 188,600 $ 22.06
Shares under option agreements which become exercisable on January 1, 1995 totalled 47,150.
10. RELATED-PARTY TRANSACTIONS
Short-term investments aggregating $8,000,000 at December 31, 1993
were invested in LNC's short-term investment pool. Interest earned on
these investments totalled $416,000, $771,000 and $127,000 during 1992,
1993 and 1994, respectively. The Company's investment in commercial
mortgages consists principally of participating interests in loans
originated and serviced by LNC.
The Company pays amounts to LNC for management, administrative
and other services. The Company believes that amounts paid to LNC
are, in the aggregate, comparable to amounts which would have been
paid to independent third parties for similar services. These amounts
are summarized as follows:
For the Year Ended December 31,
1992 1993 1994
(in thousands)
Investment management fees $ 266 $ 444 $ 670
Agent compensation 1,512 1,822 1,735
Management services 3,152 3,507 1,923
Corporate insurance premiums 5,027 2,274 441
$ 9,957 $ 8,047 $ 4,769
31
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
11. RESTRICTIONS ON STOCKHOLDERS' EQUITY
In connection with requirements prescribed by the Insurance Department
of the State of Wisconsin ("OCI"), EHI is required to maintain minimum
levels of statutory capital and surplus. A reconciliation of EHI's
statutory capital and surplus to amounts reported under generally accepted
accounting principles is as follows:
December 31,
1993 1994
(in thousands)
Amounts reported on a statutory basis $ 235,642 $286,174
Adjustments:
Intangible assets 52,297 47,946
Unrealized gain (loss) on investments 41,144 (20,090)
Deferred income taxes 15,837 29,777
Receivables from affiliates 1,219 6,358
Non-admitted assets 10,404 12,601
Post-retirement benefit obligation (6,602) (7,904)
Statutory investment valuation reserves 5,788 6,704
Other (15,414) (13,648)
Amounts as reported under generally
accepted accounting principles $ 340,315 $ 347,918
At December 31, 1994, EHI's statutory security surplus requirement
was $151,571,000 and EHI's statutory capital and surplus was
$286,174,000 which exceeded the security surplus requirement by
$134,603,000. Statutory net income was $41,238,000, $58,295,000 and
$71,771,000 in 1992, 1993 and 1994, respectively.
EHI is required to prepare its statutory financial statements in
accordance with accounting practices prescribed or permitted by the
OCI. Prescribed statutory accounting practices include those set forth
in a variety of publications of the National Association of Insurance
Commissioners ("NAIC") as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices
encompass all accounting practices accepted by the OCI in statutory-
basis filings not so prescribed. The Company prepares its statutory
financial statements solely on the basis of prescribed accounting
practices.
Wisconsin insurance laws and regulations require that, with respect to
EHI, any dividend, together with other dividends paid in the preceding
12 months, that exceeds the lesser of (1) 10% of statutory surplus at the
end of the prior year or (2) the total net gain from operations of the
insurer for the preceding calendar year, less realized capital gains for
such year, is deemed "extraordinary" and must receive the written prior
approval of the OCI. After taking into account dividends paid through
December 31, 1994, EHI would be able to pay approximately
$16,516,000 in dividends without being subject to the restrictions
governing payment of extraordinary dividends. The Wisconsin statutes
require a report of all other distributions to stockholders other than a
stock dividend at least thirty days prior to payment.
12. CONTINGENT LIABILITIES
The Company is involved in various pending or threatened legal
proceedings arising from the normal conduct of business. It is
management's opinion that these proceedings ultimately will be
resolved without materially affecting the financial position of the
Company.
32
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
continued
13. QUARTERLY RESULTS OF OPERATIONS (Unaudited)
The following is a summary of the quarterly results of operations
for the years ended December 31, 1994 and 1993:
Quarter Ended
MAR 31 JUN 30 SEP 30 DEC 31
(in millions, except per share data)
1994
Revenues:
Premiums $ 336.8 $ 341.2 $ 346.8 $ 362.0
Net investment income 12.1 11.8 12.2 12.5
Realized gain on
investments 0.5 0.1 - 0.9
Administrative fees
and other 4.9 5.5 7.3 7.7
Total revenues 354.3 358.6 366.3 383.1
Policy benefits and
expenses:
Policy benefits paid
or provided 246.0 248.4 253.2 272.7
Salaries and other
operating expenses 53.1 54.6 56.3 58.5
Commissions 28.3 26.3 27.1 27.5
Amortization of
intangible assets 1.1 1.3 1.5 1.5
Interest expense 0.2 0.7 0.9 1.0
Total benefits
and expenses 328.7 331.3 339.0 361.2
Income before federal
income taxes 25.6 27.3 27.3 21.9
Federal income taxes 9.5 10.1 10.0 8.2
Net income $ 16.1 $ 17.2 $ 17.3 $ 13.7
Net income per common
and common equiva-
lent share $ 0.95 $ 1.01 $ 1.01 $ 0.80
33
EMPHESYS FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Quarter Ended
MAR 31 JUN 30 SEP 30 DEC 31
(in millions, except per share data)
1993
Revenues:
Premiums $ 300.8 $ 302.8 $ 311.9 $ 324.3
Net investment income 11.0 11.5 11.8 13.1
Realized gain on
investments 0.1 0.5 0.6 0.9
Administrative fees
and other 4.0 2.9 4.6 3.9
Total revenues 315.9 317.7 328.9 342.2
Policy benefits and
expenses:
Policy benefits paid
or provided 229.1 224.5 216.7 249.0
Salaries and other
operating expenses 44.8 47.1 50.4 50.4
Commissions 25.0 23.2 24.8 25.6
Amortization of
intangible assets 0.4 1.6 1.0 1.0
Total benefits
and expenses 299.3 296.4 292.9 326.0
Income before taxes and
cumulative effect of
changes in accounting
principle 16.6 21.3 36.0 16.2
Federal income taxes 5.5 7.3 13.0 6.3
Income before cumulative
effect of changes in
accounting principle 11.1 14.0 23.0 9.9
Cumulative effect of
changes in accounting
principle (1) (2.8) - - -
Net income $ 8.3 $ 14.0 $ 23.0 $ 9.9
Net income per common
and common equivalent
share (2) $ 0.49 $ 0.83 $ 1.35 $ 0.58
(1) Reflects the cumulative effect of the adoption of SFAS No. 106,
"Employers' Accounting for Post-Retirement Benefits Other Than
Pensions" of $(3.9) million and SFAS No. 109, "Accounting for
Income Taxes" of $1.1 million.
(2) Determined assuming 17,000,000 shares of common stock are
outstanding.
34
INTRODUCTION TO PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Upon the terms and subject to the conditions set forth in the Offer to
Purchase, dated August 16, 1995, (the "Offer"), HEW, Inc., a Delaware
corporation (the "Offeror") and a wholly owned subsidiary of Humana Inc.,
a Delaware corporation (the "Company"), offered to purchase all
outstanding shares of common stock, par value $0.01 per share (the
"Shares"), of EMPHESYS Financial Group, Inc., a Delaware corporation
("EMPHESYS"), at a purchase price of $37.50 per Share, net to the seller
in cash, without interest (the "Offer Price").
The Offer was made pursuant to the Agreement and Plan of Merger, dated as
of August 9, 1995 (the "Merger Agreement"), among the Company, the Offeror
and EMPHESYS. The Merger Agreement provided, among other things, that as
soon as practicable after the purchase of Shares pursuant to the Offer and
the satisfaction of the other conditions set forth in the Merger Agreement
and in accordance with the relevant provisions of the General Corporation
Law of the State of Delaware (the "DGCL"), the Offeror would be merged
with and into EMPHESYS (the "Merger").
As a result of all conditions of the tender offer being met, including
obtaining all necessary regulatory approvals and the attainment by EMPHESYS
of certain specified financial and operational targets, the tender offer was
closed and all shares tendered were acquired on October 11, 1995. At the
close of the tender offer, 16,890,756 or 99 percent of the Shares were
acquired. Under the DGCL, if 90 percent or more of the Shares are acquired,
the Merger can be consummated without the vote of the remaining stockholders.
The Merger was consummated on October 13, 1995. At the effective time of the
Merger, each remaining issued and outstanding Share not purchased in the
tender offer was converted into and represented the right to receive the
Offer Price. Following consummation of the Merger, EMPHESYS continued as
the surviving corporation and became a wholly owned subsidiary of the Company.
The aggregate purchase price of approximately $650 million was funded by
the Company through available cash, the sale of selected marketable
securities and bank borrowings. The bank borrowings of approximately $250
million were pursuant to a credit agreement as amended and restated dated
as of September 26, 1995, among the Company, Chemical Bank, as agent, and
several other banks (the "Credit Agreement"). The Credit Agreement, which
expires September 25, 2000, provides for a $600 million revolving line of
credit. Principal amounts outstanding under the Credit Agreement bear
interest based upon the consolidated capitalization ratio (defined as total
debt divided by total debt plus net worth) at rates ranging from LIBOR plus
16 basis points to LIBOR plus 40 basis points, although the facility also
provides for an auction process which could result in lower rates. The
Credit Agreement contains customary covenants and events of default.
The unaudited pro forma condensed consolidated balance sheet of the
Company and EMPHESYS (collectively the "Combined Entities") as of June 30,
1995, presents the financial position of the Combined Entities assuming
the Merger had occurred on June 30, 1995. Prior to June 30, 1995,
EMPHESYS' historical balance sheet had been presented on an unclassified
basis. As a result of the Merger, EMPHESYS' balance sheet was classified
between short-term and long-term assets and liabilities to conform with
the Company's presentation. The unaudited pro forma condensed
consolidated statements of income of the Combined Entities for the six
months ended June 30, 1995, and for the year ended December 31, 1994,
present the results of operations of the Combined Entities assuming the
Merger and related transactions had occurred on January 1, 1994. All
material adjustments required to reflect the Merger and related
transactions are set forth in the "Pro Forma Adjustments" column. The pro
forma adjustments are based on preliminary assumptions of the allocation
of the purchase price and are subject to substantial revision once
appraisals, evaluations and other studies of the fair value of EMPHESYS'
assets and liabilities are completed. Actual purchase accounting
adjustments may differ from the pro forma adjustments presented herein.
35
INTRODUCTION TO PRO FORMA
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The unaudited pro forma condensed consolidated financial statements should
be read in conjunction with the historical consolidated financial
statements of the Company and EMPHESYS. The pro forma data is for
informational purposes only and may not necessarily reflect future results
of operations and financial position or what the results of operations or
financial position would have been had the Company and EMPHESYS merged at
the beginning of the periods presented.
36
Humana Inc.
Pro forma Condensed Consolidated Balance Sheet
June 30, 1995
(Unaudited)
(Dollars in millions except per share amounts)
Humana
Historical Pro forma Pro forma
Humana EMPHESYS Adjustments Combined
Assets
Current assets:
Cash and cash
equivalents $ 447 $ 14 $ (155)(a) $ 306
Marketable securities 528 586 1,114
Premiums receivable,
net 80 17 97
Deferred income taxes 42 21 8 (b) 71
Other 64 18 82
Total current
assets 1,161 656 (147) 1,670
Property and equip-
ment, net 320 48 15 (c) 383
Long-term marketable
securities 388 67 (250)(a) 205
Cost in excess of
net assets acquired 159 56 251 (d) 466
Deferred income taxes 50 2 (33)(b) 19
Other 85 7 70 (e) 162
Total Assets $ 2,163 $ 836 $ (94) $ 2,905
Liabilities and Common
Stockholders' Equity
Current liabilities:
Medical costs payable $ 554 $ 263 $ 10 (f) $ 827
Trade accounts payable
and accrued expenses 166 46 10 (g) 222
Unearned premium
revenues 127 30 157
Income taxes payable 52 9 61
Total current
liabilities 899 348 20 1,267
Long-term debt 1 56 250 (h) 307
Professional liability
and other obligations 87 68 155
Total liabilities 987 472 270 1,729
Contingencies
Common stockholders' equity:
Common stock,$.16 2/3
par; authorized
300,000,000 shares;
issued and outstanding
161,820,165 shares 27 1 (1)(i) 27
Other 1,149 363 (363)(i) 1,149
Total common stock-
holders' equity 1,176 364 (364) 1,176
Total Liabilities and
Common Stockholders'
Equity $ 2,163 $ 836 $ (94) $ 2,905
See notes to pro forma condensed consolidated financial statements.
37
Humana Inc.
Pro forma Condensed Consolidated Statement of Income
For the six months ended June 30, 1995
(Unaudited)
(Dollars in millions except per share results)
Humana
Historical Pro forma Pro forma
Humana EMPHESYS Adjustments Combined
Revenues:
Premiums $ 2,073 $ 782 $ 2,855
Interest 38 27 $ (10)(j) 55
Other income 7 17 - 24
Total revenues 2,118 826 (10) 2,934
Operating expenses:
Medical costs 1,686 587 - 2,273
Selling, general and
administrative 250 180 430
Depreciation and
amortization 30 8 9 (k) 47
Total operating
expenses 1,966 775 9 2,750
Income from operations 152 51 (19) 184
Interest expense 4 2 8 (l) 14
Income before income
taxes 148 49 (27) 170
Provision for income
taxes 50 18 (9)(m) 59
Net income $ 98 $ 31 $ (18) $ 111
Earnings per common
share $ 0.60 $ 0.19 $ (0.11) $ 0.68
Weighted average
common shares
outstanding (000's) 162,148 162,148 162,148 162,148
See notes to pro forma condensed consolidated financial statements.
38
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
As of and for the six months ended June 30, 1995
(Unaudited)
Note 1: Pro forma Adjustments - Condensed Consolidated Balance Sheet as
of June 30, 1995
(a) To record the use of existing cash and cash equivalents and long-
term marketable securities necessary to finance a portion of the
acquisition costs.
(b) To record deferred taxes associated with the identifiable
intangibles, the revaluation of property and equipment and
additional medical claims and accrued liabilities.
(c) To record the revaluation of property and equipment acquired to
estimated fair market value.
(d) To record the purchase price in excess of net tangible and
identifiable intangible assets acquired.
(e) To record the fair value of identifiable intangible assets
acquired.
(f) To record additional medical costs payable, necessary to conform
EMPHESYS' actuarial method used to determine medical costs payable
with the Company's actuarial method.
(g) To record estimated liabilities associated with the acquisition
transaction including severance, lease terminations and the
discontinuance of certain non-core businesses.
(h) To record bank borrowings necessary to finance the remaining
portion of the acquisition cost.
(i) To eliminate the acquired equity of EMPHESYS as of June 30, 1995.
Note 2: Pro forma Adjustments - Condensed Consolidated Statement of
Income for the six months ended June 30, 1995.
(j) To reduce interest income for the estimated forgone interest
income resulting from the use of cash and cash equivalents and
marketable securities to finance the acquisition. The
calculation is based upon the nominal monthly portfolio yield for
investments held by the Company (at the parent level) over the
six-month period.
(k) To record depreciation and amortization related to property and
equipment, identifiable intangible assets and the excess of
purchase price over net tangible assets acquired. Identifiable
intangible assets will be amortized over 10 years and the excess
of purchase price over net assets acquired will be amortized over
40 years. Acquired property and equipment (primarily buildings)
will be depreciated over 30 years, the estimated remaining useful
life.
(l) To recognize estimated interest expense related to bank
borrowings necessary to finance the acquisition. The bank
borrowings have an assumed interest rate of LIBOR plus 3/8
percent over the six month period.
Note 3: Income Taxes
(m) Estimated pro forma income taxes were recorded at an assumed
combined federal and state income tax rate of 34.6 percent.
39
Humana Inc.
Pro forma Condensed Consolidated Statement of Income
For the year ended December 31, 1994
(Unaudited)
(Dollars in millions except per share results)
Humana
Historical Pro forma Pro forma
Humana EMPHESYS Adjustments Combined
Revenues:
Premiums $ 3,576 $ 1,387 $ 4,963
Interest 62 50 $ (16)(a) 96
Other income 16 25 - 41
Total revenues 3,654 1,462 (16) 5,100
Operating expenses:
Medical costs 2,918 1,020 - 3,938
Selling, general and
administrative 436 323 759
Depreciation and
amortization 50 14 17 (b) 81
Restructuring and
unusual charges 18 - 18
Total operating
expenses 3,422 1,357 17 4,796
Income from operations 232 105 (33) 304
Interest expense
(recovery) (25) 3 12 (c) (10)
Income before income
taxes 257 102 (45) 314
Provision for income
taxes 81 38 (15)(d) 104
Net income $ 176 $ 64 $ (30) $ 210
Earnings per common
share $ 1.10 $ 0.40 $ (0.19) $ 1.31
Weighted average
common shares
outstanding (000's) 160,911 160,911 160,911 160,911
See notes to pro forma condensed consolidated statement of income.
40
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF INCOME
For the year ended December 31, 1994
(Unaudited)
Note 1: Pro forma Adjustments
(a) To reduce interest income for the estimated forgone interest
income resulting from the use of cash and cash equivalents and
marketable securities to finance the acquisition. The
calculation is based upon the nominal monthly portfolio yield for
investments held by the Company (at the parent level) over the
twelve-month period.
(b) To record depreciation and amortization related to property and
equipment, identifiable intangible assets and the excess of
purchase price over net tangible assets acquired. Identifiable
intangible assets will be amortized over 10 years and the excess
of purchase price over net assets acquired will be amortized over
40 years. Acquired property and equipment (primarily buildings)
will be depreciated over 30 years, the estimated remaining useful
life.
(c) To recognize estimated interest expense related to bank
borrowings necessary to finance the acquisition. The bank
borrowings have an assumed interest rate of LIBOR plus 3/8
percent over the twelve month period.
Note 2: Income Taxes
(d) Estimated pro forma income taxes were recorded at an assumed
combined federal and state income tax rate of 33 percent.
41
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(c) Exhibits
2.1 Offer to Purchase, dated August 16, 1995. Exhibit (a)(1)
to the Company's Schedule 14D-1 and 13D dated August 16,
1995, is incorporated by reference herein.
2.2 Agreement and Plan of Merger, dated August 9, 1995 among
the Company, EMPHESYS and HEW, Inc. Exhibit (a)(10) to the
Company's Schedule 14D-1 and 13D is incorporated by
reference herein.
2.3 Stock Option and Tender Agreement, dated as of August 9,
1995, among the Company, Lincoln National Corporation and
American States Insurance Company. Exhibit (c)(1) to the
Company's Schedule 14D-1 and 13D is incorporated by
reference herein.
2.4 Amendment No. 1 dated August 24, 1995, to the Company's
Schedule 14D-1 and 13D is incorporated by reference
herein.
2.5 Amendment No. 2 dated August 30, 1995, to the Company's
Schedule 14D-1 and 13D is incorporated by reference
herein.
2.6 Amendment No. 3, dated September 15, 1995, to the
Company's Schedule 14D-1 and 13D is incorporated by
reference herein.
2.7 Amendment No. 4, dated September 28, 1995, to the
Company's Schedule 14D-1 and 13D is incorporated by
reference herein.
2.8 Amendment No. 5, dated October 3, 1995, to the Company's
Schedule 14D-1 and 13D is incorporated by reference
herein.
2.9 Amendment No. 6, dated October 10, 1995, to the Company's
Schedule 14D-1 and 13D is incorporated by reference
herein.
2.10 Amendment No. 7, dated October 12, 1995, to the Company's
Schedule 14D-1 and 13D is incorporated by reference
herein.
20.1 Credit Agreement, dated as of January 12, 1994, as amended
by an Agreement and Amendment dated as of October 27,
1994, an Amendment dated as of August 1, 1995, and an
Amendment and Restatement dated as of September 26, 1995
among Chemical Bank as Agent, the Banks party thereto, and
the Company. Exhibit (b)(2) to Amendment No. 4 of the
Company's Schedule 14D-1 and 13D is incorporated by
reference herein.
23.1 Consent of Ernst and Young LLP, Independent Auditors.
42
SIGNATURE
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 hereunto duly authorized.
Humana Inc.
Date: October 25, 1995
/s/James E. Murray
James E. Murray
Vice President and
Controller (Principal
Accounting Officer)
43
Exhibit 23.1
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the
registration statements of Humana Inc. (Form S-8 No. 2-
39061, No. 2-79239, No. 2-96154, No. 33-33072, No. 33-49305,
No. 33-52593 and No. 33-54455), of our report dated January
27, 1995, included in the 1994 Annual Report to Stockholders
of EMPHESYS Financial Group, Inc.
Ernst & Young LLP
Milwaukee, Wisconsin
October 20, 1995
