At December 31, 1998, WellCare's executive offices were located in two adjacent buildings, Park West I and Park West II, at Hurley Avenue in Kingston, New York. Park West I provides approximately 27,000 square feet of office space. Park West II, which provides approximately 11,600 square feet of office space, has been used for storage since 1997. The Company also owned four other buildings through its wholly-owned subsidiary, WellCare Development, Inc.("WCD"). Three of the buildings are located in Kingston and, combined, provide approximately 40,000 square feet of office space utilized by the Company's communication, information and member service divisions. The fourth building is located in Saugerties, New York and provides approximately 10,000 square feet of office suites that are leased to three unrelated health care providers and a medical laboratory at annual rental incomes of approximately $45,500, $33,400, $29,300 and $6,000, respectively.
The following selected financial data have been derived from the Company's audited consolidated financial statements and should be read in conjunction with the consolidated financial statements, related notes and other financial information included elsewhere herein.
Balance Sheet Data: (in thousands) December 31, --------------------------------------------- 1998 1997 1996 1995 1994 ----- ----- ----- ----- -----
The results of operations depend in large part on the Company's ability to predict, quantify and manage medical costs. Medical expenses consist of hospital charges, physician fees and related health care costs for its members. Medical expenses also include estimates for medical services incurred but not yet reported ("IBNR") to the Company, based on a number of factors, including hospital admission data and prior claims experience; adjustments, if necessary, are made to medical expenses in the period the actual claims costs are ultimately determined. A daily inventory of hospital days and patient stays by product line is maintained by medical management. Claims are entered and scanned into the claims system and then available for examiners to either process, review and approve for payment, pend for additional information from the provider or deny. All claims are a entered into the system at charges and evaluated.
YEAR ENDED DECEMBER 31, --------------------------- 1998 1997 1996 ---- ---- ---- Statement of Operations Data:
Loss before income taxes (17.6) (15.4) (12.3) Provision/(benefit) for income taxes 3.8 -- (5.0) ----- ----- ----- Net loss (21.4)% (15.4)% (7.3)% ===== ===== =====
Statistical Data: HMO member months enrollment 854,909 901,295 1,077,774 Medical loss ratio(1) 90.7% 88.8% 86.5% General and administrative ratio(2) 22.6% 24.0% 24.4% - ------------------------
(1) Total medical expenses as a percentage of premiums earned; reflects the combined rates of commercial, Medicaid, Full Risk Medicare and Medicare supplemental members. Medical expenses in 1998 include $730,216 of interest expense relating to "Prompt Pay" payments.
Premiums earned in 1997 decreased by 9.6%, or $15.1 million, to $142.1 million from $157.2 million in 1996. Commercial premium revenue decreased 29.6%, or $35.1 million, primarily because of a decrease in member months attributable to the loss in membership. The decline in commercial membership is attributable to WellCare's more stringent application of its credit standards, pursuant to which contracts for non-paying or slow-paying groups were canceled or not renewed, as well as to customers' adverse reaction to the negative publicity received by the Company related to the restatement of its 1994 financial results. The loss of commercial membership in 1997 was also affected by WCNY's non-competitive rates relative to other companies operating within WCNY's marketplace. The rates in effect during 1996 and in the first half of 1997 caused a decline in renewing membership for 1997. During 1997, the Company adjusted its premium rates to be competitive within the principal markets where WCNY operates. Medicaid premium revenue increased 11.3%, or $3 million, primarily as a result of a 10.4% increase in member months. Medicare premium revenue increased 139.8%, or $17 million, due to a 159% increase in member months, partially offset by a reduction in average per member rates of 7.4%, or $2.3 million. Total member months decreased 16.4% in 1997 to 901,295.
Interest and other income decreased by 53.8%, or $2.1 million, to $1.8 million in 1997. This decrease is primarily due to reductions in management fees, insurance reimbursements and interest income.
The 1997 medical expenses include the following accrual items: a $2.5 million charge for adverse development relating to 1996 medical claims and a $1.7 million charge for the estimated liability related to NYSID's audit of the 1993-1995 demographic pool ($1.2 million) and the 1996 demographic pool, and a $435,000 credit relating to the 1994 restatement. The 1996 medical expenses include the recording, as instructed by NYSID, of medical expense of (i) approximately $3.7 million relating to unpaid inpatient hospital claims; and (ii) approximately $2.9 million relating to unpaid claims for the period prior to October 1994. Both of these charges represent obligations which had previously been assumed by the Alliances and for which the Company had no contractual obligation to pay. A percentage of the increase in 1996 medical expenses is also due to a restructuring of the contractual capitation arrangements with the Alliances. As a result of the 1994 prior period restatement, medical expenses in 1996 were reduced approximately $2,423,000 (See Note 3b of "Notes to Consolidated Financial Statements").
General and administrative expenses decreased 11.2%, or $4.4 million, to $34.9 million from $39.3 million in 1996 and decreased as a percent of total revenue (the "G&A ratio") to 24.0% from 24.4% in 1996. The decrease in G&A is the net result of a decrease of $3.2 million in the provision for doubtful trade and other receivables; an increase of $0.3 million in advertising, promotional and communication costs; a decrease of $.9 million in payroll and labor related expenses because of reduced staffing levels; and a decrease of $1.0 million in extraordinary legal and other professional services primarily related to class action litigation.
At December 31, 1998, the Company had a working capital deficiency of $26.1 million, excluding the cash reserve of $5.3 million required by New York State which is classified as a non-current asset, compared to a working capital deficiency of $5.1 million at December 31, 1997, excluding the cash reserve of $5.8 million. The increased deficiency is attributable primarily to the cash operating loss in 1998. The Company's requirements for working capital are principally to meet current obligation, to fund HMO operations and to maintain necessary regulatory reserves.
Net cash provided by operating activities in 1998 was approximately $3.4 million as compared to approximately $4.8 million used in 1997. Cash provided by 1998 operating activities was the net result of increase in medical costs payable of approximately $9.1 million, reductions of advances to providers of $2.8 million and trade and other receivables of $8.1 million, less a cash operating loss of $16.6 million. Cash used for capital expenditures was approximately $.7 million in 1998 as compared to $.3 million in 1997.
In January, 1996, the Company completed a private placement of a subordinated convertible note in the principal amount of $20 million (the "Note"), due December 31, 2002, with The 1818 Fund II, L.P. (the "Fund"), a private equity fund managed by Brown Brothers Harriman & Co. The Company utilized a part of the net proceeds of this private placement to retire a portion of its debt. The Note was amended in February 1997, and subsequently in January 1998, and is convertible into shares of WellCare common stock. In January 1998, the Fund agreed to convert $5 million of the Note into 1,250,000 shares of common stock of the Company at a conversion price of $4 per share, subject to the anti-dilution adjustment. The conversion was completed in May 1998. The Note initially accrued interest at 6.0% per annum, amended to 5.5% per annum in 1997 and amended to 8% per annum in 1998. In June 1999, the Fund converted the remaining $15 million Note, plus accrued and unpaid interest of approximately $0.7 million, into newly authorized senior convertible preferred stock (Series B) of the Company. The preferred stock is non-voting and is subject to mandatory conversion (subject to regulatory approval) into 10,000,000 shares of WellCare's common stock upon the amendment to WellCare's certificate of incorporation to increase the number of authorized shares from 20 million to 75 million (see Note 24).
Legislation by both New York State and Connecticut requires HMOs to pay undisputed claims within 45 days of receipt. WCNY and WCCT continue to pay claims later than required. The Company has recorded as an expense the estimated interest it will be required to pay on these late payments, which management believes is not material to the Company's operations.
Notwithstanding the above, NYSID has the authority to allow an HMO to maintain a net worth of 50% to 100% of the contingent reserve. WCNY executed a Section 1307 loan in March 1998, which retroactively brought WCNY's December 31, 1997 statutory net worth above the permitted 50% contingent reserve requirement. WCNY had been operating within the 50-100% discretionary contingent reserve requirement during 1997, and through the first quarter of 1998, with the full knowledge of NYSID. In 1998, the Company forgave the management fees for WCNY for 1998 in the amount of approximately $1.4 million. In June 1997 and November 1997, the Company loaned $3.1 and $1.3 million, respectively, to WCNY under the provisions of Section 1307. However, after giving effect to the reported results for 1998, at December 31, 1998 WCNY had a negative statutory net worth of approximately ($14.6) million. Failure to come into compliance with the reserve requirement could cause NYSID to take action which could include restriction or revocation of WCNY's license. Management has had ongoing discussions and meetings with NYSID regarding WCNY's operating results and compliance with various statutory requirements and has updated NYSID of the Company's plans to obtain additional funds. This includes a remedial action plan based upon capital to be contributed to WCNY and WCNY's ultimate return to profitability. In April 1999, WCNY agreed to a consent to rehabilitation in which the State of New York has the right to commence court proceedings and have an order entered into that would give the State of New York the right to assume the operations of WCNY. In May and June 1999, the Company consummated the aforementioned transactions, which are intended to bring WCNY within the 50% to 100% revised contingent reserve requirement, as permitted by NYSID. In connection with the Patel and GHI transactions, the Company loaned WCNY $5 million under the provisions of Section 1307. As a result of these transactions, WellCare anticipates that the State of New York would not exercise that right. In addition, as a result of WCNY's sale of its commercial business, the statutory cash reserve required will decrease to $2.9 million, and the statutory contingent reserve will decrease to $3.7 million. Management believes that the consummation of these transactions will improve WellCare's ability to continue as a going concern.
In January 1997, WCNY received the final report on its biennial statutory examination for the years ended December 31, 1994 and 1995 from NYSID. In 1996, during the course of the audit, the Company had recorded two non-recurring medical charges (See Note 3g of "Notes to Consolidated Financial Statements") based on the interim findings and instructions of NYSID. Additionally, the examiners determined that WCNY was not in compliance with all pertinent New York State regulation sections relating to WCNY's underwriting and rating procedures and referred the matter to NYSID's Office of General Counsel for disciplinary action. In December 1997, WCNY entered into a Stipulation Agreement whereby it agreed to pay a penalty of $91,000 and to correct past violations. An additional penalty of $66,000 may be assessed if NYSID, subsequently determines that WCNY has not made a good faith effort to recoup undercharges from incorrectly rated groups. WCNY believes it has directed its best efforts at recouping these undercharges, and believes it will not be assessed any additional penalty.
As a result of the examination, WCNY's statutory net worth at December 31, 1995, was deficient by approximately $1.1 million. In March 1996, the Company made a capital contribution of $3 million to WCNY, and in October 1996, the Company loaned WCNY $3 million under the provisions of Section 1307 of the New York State Insurance Law. Under Section 1307, the principal and interest are treated as equity capital for regulatory purposes and are repayable out of the free and divisible surplus, subject to the prior approval of the Superintendent of Insurance of the State of New York. These two cash infusions more than offset the examination's adjustment to WCNY's net worth.
In June 1999, the Company reached a settlement with Key Bank (the "Bank"), whereby the Company will execute deeds in favor of the Bank on the real property securing two mortgages, in lieu of foreclosure. The net book value of the real property was approximately $6.5 million compared to the outstanding mortgage balances of approximately $4.4 million. In June 1999, the Company reached a settlement with Premier National Bank ("Premier"), whereby the Company will execute deeds in favor of Premier on the real property securing two mortgages, in lieu of foreclosure. The net book value of the real property was approximately $1.8 million compared to the outstanding mortgage balances of approximately $1 million.
In May 1999, the Company entered into a settlement agreement for $2.5 million, all of which is being funded by the insurance carrier which provided coverage to the individual defendants. The settlement agreement is subject to Federal Court approval. The Company expects related to fees it paid to the attorneys representing the individual defendants, less the Company's insurance deductible.
CEO $ 188 $ 163 $ 360 $ 711 CFO 151 190 159 500 ------ ------ ------ ------ $ 339 $ 353 $ 519 $1,211 ====== ====== ====== ======
With respect to the efforts undertaken to date by Comprehensive and affiliates to address the Y2K issues, Comprehensive has upgraded its computer hardware and software systems, and has expended approximately $430,000 in software related costs and $235,000 in hardware related costs.
Prior to the Patel and GHI transaction, the Company had assessed the requirements of modifying its computer systems to accommodate the Year 2000 and anticipated that required modifications would be completed in advance of the Year 2000 so as to not adversely affect its operations. In most cases, the Company was dependent on outside vendors whose software the Company uses. These vendors had advised the Company that the required modifications were being made, and would be available to the Company in the form of software release upgrades. The Company had developed plans for implementing these release upgrades in a timely fashion, and estimated that the hardware and software costs would approximate $1.6 million. The Company expensed noncapital associated costs incurred to make these modifications. The core processing system, AMISYS, was upgraded to the Y2K compliant version in February 1999. The MAS90 system, the Company's financial software, was upgraded in March 1999. Both of these systems are now Y2K compliant. The Company had incurred costs of approximately $550,000 in 1998 and $410,000 in 1999. Except for hardware costs of approximately $60,000, the Company has expensed these costs as incurred.