(2) Per share amounts and weighted-average number of common share amounts have been restated to reflect the two-for-one stock split in 1996.
(4) Defined as marketing, general and administrative expense as a percentage of operating revenues.
Results for 2000 were adversely affected by charges related to recapitalization transactions. An extraordinary charge of $20.3 million, net of income tax benefits of $13.9 million, was recorded in connection with the prepayment of the Term Loan and the repurchase or tender of its $200 million Senior Notes. The extraordinary charges include premiums paid, transaction costs and the write-off of unamortized original issuance debt costs. In addition, the Company completed an exchange and repurchase agreement for all of its outstanding Preferred Stock and incurred costs of approximately $41.1 million related to the write-off of unamortized Preferred Stock discount and costs from the original issuance in 1998 and related transaction fees. The Company's results for 1999 and 1998 were adversely affected by significant restructuring charges, and results for 1998 were adversely affected by write-downs of strategic investments. Additionally, 1999 includes a charge of $24 million for the purchase of insurance policies for litigation matters. Net income for 1999 was favorably affected by the reversal of $225 million of deferred tax valuation allowances.
During the first half of 1998, the Company recorded restructuring charges totaling $123.5 million ($114.8 million after income tax benefits, or $1.43 per share). These charges resulted from the Company's actions to better align its organization and cost structure as part of the Company's Turnaround Plan. These charges included estimated costs related to the disposition or closure of noncore businesses; the write-down of certain property and equipment; severance and related costs; and operations consolidation, including long-term lease commitments. The ending reserves for these charges were generally classified in the Company's balance sheet as accounts payable and accrued expenses with the exception of property and equipment, which were written down to their estimated net realizable values.
The tables below present the activity for the restructuring charge reserves established in 1999 and 1998 as part of the Turnaround Plan.
The Company believes that the remaining restructuring reserves as of December 31, 2000 are adequate and that no revisions of estimates are necessary at this time.
As part of its Turnaround Plan, the Company decided to withdraw from noncore markets by selling or closing its HMO and insurance businesses in Pennsylvania, Illinois, Florida and New Hampshire. Total premium revenue for these businesses in 1998 was approximately $170.4 million, with operating losses totaling approximately $37 million. In addition, the Company decided to close its specialty management initiatives and to sell or close certain other health care services operations and investments in noncore businesses. Restructuring reserves were established relating to estimated losses associated with premium deficiencies in the HMO and insurance subsidiaries to be sold or closed, the net book value of noncore investments was reduced to their estimated recoverable value, and accruals were recorded for incremental disposition and closing costs associated with the Turnaround Plan. The Company substantially completed the disposition of all of the property and equipment in 1999. In addition, approximately 250 employees in the noncore businesses were terminated between June 30, 1998 and December 31, 1998.
As of December 31, 2000, the ending reserve of $1.8 million represents a valuation allowance for noncore assets yet to be disposed of and an estimate of remaining legal costs related to the disposition of the related noncore businesses.
The Company's Turnaround Plan contemplated significant changes in the Company's senior management and, in connection therewith, fifteen members of senior management were replaced and certain members of the former management team were granted severance arrangements. As a result, the Company recorded restructuring charges related to severance costs of $24.8 million in 1998. In the third quarter of 1999, the Company recorded an additional $8.8 million for severance and related costs as a result of an additional reduction in force in which approximately 650 employees were terminated. The reduction in the reserve for severance and related costs in 2000 reflects contractual payments of approximately $2.1 million to former employees of the Company in accordance with their respective severance agreements. The December 31, 2000 balance represents contracted amounts payable through 2002 related to individuals who are no longer employed by the Company at year-end.
The remaining costs of operations consolidations reserve is comprised of the following estimated costs associated with the disposition of leased space no longer used in operations:
During the third quarter of 1999, the Company recorded an additional restructuring charge of $10.7 million related to costs associated with the continued consolidation of the Company's office facilities. The majority of these costs were associated with the relocation of its corporate headquarters and the cessation of operations at its Ireland facility. The charges were comprised of the net write-off of $6.4 million in fixed assets (primarily leasehold improvements) and $4.3 million for the write-off of computer equipment no longer used in operations.
During 1998, in connection with the Company's attempts to reduce administrative costs under the Turnaround Plan, the Company decided to consolidate operations and reduce its occupied square footage from approximately 2 million square feet under lease to approximately 1.2 million square feet. The Company has attempted to dispose of property and equipment as it vacated the facilities. The 1998 estimate for write down of property and equipment included provisions for the estimated losses related to vacating certain facilities in connection with the Company's Turnaround Plan. The 1998 charge included an estimated provision for loss related to leasehold improvements ($12.5 million), office furniture ($11.8 million), computers and office equipment ($4 million) and software ($1 million). In determining the estimated fair values, the Company reviewed detailed asset listings for each location to be vacated. Based on the asset classification, acquisition date and anticipated net proceeds, if any, upon disposition, as determined by the Company, the assets were written down to their estimated fair value. The fair values were determined based on the best information available in the circumstances, including prior experience in disposing of similar assets and discussions with potential purchasers of the assets. The Company completed the disposition or sale of these assets during 1999.
The Company's results of operations are dependent, in part, on its ability to predict and control health care costs (through, among other things, appropriate benefit design, utilization review and case management programs, risk-transfer and risk-sharing and payment arrangements with providers) while providing members with coverage for the health care benefits provided under their contracts. However, the Company's ability to contain such costs may be adversely affected by various factors, including, but not limited to: new technologies and health care practices, hospital costs, changes in demographics and trends, changes in laws and regulations, mandated benefits or practices, selection biases, increases in unit costs paid to providers, termination of provider arrangements, termination of, or disputes under risk-transfer or risk-sharing arrangements, major epidemics, catastrophes, inability to establish or maintain acceptable compensation agreements with providers, higher utilization of medical services, including, without limitation, higher out-of-network utilization under point-of-service plans, operational and regulatory issues and numerous other factors may affect the Company's ability to control such costs. The Company attempts to use its medical cost-containment capabilities, such as claim auditing systems, with a view to reducing the rate of growth in health care service expense.
Total commercial premiums earned for the year ended December 31, 2000 were basically unchanged at $3.3 billion compared with the prior year. A 9.8% decrease in member months in the Company's commercial health care programs, primarily due to a 10.3% member month decrease in the Freedom Plan, was offset by average premium yield increases in commercial programs of 10.7% when compared with 1999. The Company experienced attrition of commercial members in its core commercial markets beginning in 1999 through the third quarter of 2000, adversely affecting revenue. The majority of the attrition in commercial members was concentrated in the small group market, where the Company's switch to 4-tier pricing contributed to the decline in membership. Although commercial membership declined 7.5% year over year, overall commercial membership increased from the third to fourth quarter of 2000.
Premiums earned from the Company's Medicare programs decreased 8.2% to $677.5 million in 2000 compared with $737.8 million in 1999. The overall decrease was attributable to a 16.9% decrease in member months of Medicare programs, due to the withdrawal from Suffolk County, New York in January 2000, partially offset by an 8.7% increase in premium yields. The Company expects its Medicare membership to be lower in 2001 as the result of withdrawals from Medicare in certain counties in New Jersey. Reimbursement levels for the Company's 2001 Medicare business are expected to be approximately five percent higher than 2000 (net of the applicable HCFA user fee), reflecting minimum HCFA mandated increases as well as a change in the Company's county-specific mix of business. The Company believes that future Medicare premiums may not keep up with the cost of health care increases. Given current public policy and the fact that Medicare premiums are not scheduled to keep up with the cost of health care, it is possible that the Company may decrease its Medicare membership by, among other things, reducing benefits and exiting additional counties. See "Business - Government Regulations - Federal Regulation".
During the second quarter of 1998, the Company incurred a net loss of $507.6 million. At that time, the Company evaluated the deferred tax assets arising from the net loss and established a valuation allowance pending the results of its Turnaround Plan. During 1998, the Company performed detailed analyses to assess the realizability of the Company's deferred tax assets. These analyses included an evaluation of the results of operations for 1998 and prior periods, the progress to date in its Turnaround Plan and projections of future results of operations, including the estimated impact of the Turnaround Plan. Based on these analyses, management concluded that it was not more likely than not that all of its deferred tax assets would be fully realized. In that regard, the Company established a valuation allowance of $282.6 million as of December 31, 1998.
In light of the Company's progress during 1999 and 2000 in its Turnaround Plan, estimates of future earnings and the expected timing of the reversal of other net tax deductible temporary differences, management concluded that a valuation allowance was no longer necessary for its federal net operating loss carryforwards and certain other temporary differences. The income tax expense (benefit) recorded for the years ended December 31, 2000 and 1999 includes the reversal of $10 million and $225 million, respectively, of deferred tax valuation allowances. The Company adjusted its net deferred tax assets during 2000 to reflect anticipated tax rates relating to the periods when the net deferred tax assets are expected to reverse. The impact was to increase the current year income tax expense by approximately $11.8 million. The remaining valuation allowance at December 31, 2000 of $24.1 million relates primarily to capital loss carryforwards and certain state net operating loss carryforwards. Management believes that the Company will obtain the full benefit of the net deferred tax assets recorded at December 31, 2000.
As of December 31, 2000, the Company has federal net operating loss carryforwards for tax purposes of approximately $202 million, which, if unused, will begin to expire in 2012.
Year Ended December 31, 1999 Compared with Year Ended December 31, 1998
Total commercial premiums earned for the year ended December 31, 1999 decreased 0.2% to $3.3 billion compared with $3.4 billion in the prior year. This decrease is primarily attributable to a 7.9% decrease in member months in the Company's commercial health care programs, primarily due to a 7.2% member months decrease in the Freedom Plan. Average premium yields of commercial programs were 8.4% higher in 1999, when compared with 1998. In response to higher medical costs incurred in 1998 in the Company's core commercial business, the Company increased its premium rates based on estimates of future medical costs. The Company's 1999 commercial revenue as compared to 1998 was adversely affected by the Company's disposition or withdrawal from noncore commercial markets in Pennsylvania, Illinois, Florida and New Hampshire. In addition, the Company experienced attrition of commercial members in its core commercial markets in 1999. The majority of the attrition in commercial members was due to the Company's continued
Premiums earned from government programs decreased 40.3% to $0.7 billion in 1999 compared with $1.26 billion in 1998. The overall decrease was attributable to the complete withdrawal from the Company's New York and Pennsylvania Medicaid markets in January 1999 and a 34.7% decrease in member months of Medicare programs.
Net investment and other income for the year ended December 31, 1999 decreased 7.4% to $82.6 million from $89.2 million in the prior year. Net investment income decreased $17.7 million or 22.2% to $62.1 million in 1999 compared with $79.8 million in 1998. The decline is due primarily to a $22.8 million decline in capital gains realized during the year, partially offset by higher average invested balances. In 1999, other income includes a $13.5 million gain on the sale of the Company's New York Medicaid business and a $7 million gain on the sale of the business and certain assets of the Company's wholly-owned mail order pharmacy subsidiary, Direct Script, Inc. In 1998, other income includes $5.1 million related to the sale of the Company's New Jersey Medicaid business. See "Liquidity and Capital Resources".
Marketing, general and administrative expenses decreased $172.8 million or 22.4% to $599.2 million for 1999 compared with $772.0 million for 1998. Marketing, general and administrative expenses as a percent of operating revenue were 14.6% in 1999 compared with 16.7% in 1998. Significant expense reductions in 1999 compared to 1998 include $66.5 million in payroll and employee related expenses, $24.7 million in occupancy and depreciation costs, $22.2 million in operating costs (primarily telephone and postage expenses) and $18.3 million in marketing and outside services. Substantially all of these cost reductions were a result of the Company's Turnaround Plan. Marketing, general and administrative expenses in 1998 included $35.2 million related to provisions for uncollectible notes and accounts receivable as a result of increases in termination of nonpaying commercial members and groups, the exiting of noncore markets and the exiting and restructuring of Medicaid and Medicare programs, which made it more difficult for the Company to collect amounts due on notes and accounts receivable.
realized. In that regard, the Company established a valuation allowance of $282.6 million as of December 31, 1998.
In light of the Company's progress during 1999 in its Turnaround Plan, estimates of future earnings and the expected timing of the reversal of other net tax deductible temporary differences, management concluded that a valuation allowance was no longer necessary for its federal net operating loss carryforwards and certain other temporary differences. Management believes that the Company will obtain the full benefit of the net deferred tax assets recorded at December 31, 1999. The income tax benefit recorded for 1999 includes the reversal of $225 million of deferred tax valuation allowances. The remaining valuation allowance at December 31, 1999 of $42.5 million relates primarily to capital loss carryforwards and state net operating loss carryforwards.
Although the rate of inflation has remained relatively stable in recent years, health care costs have generally been rising at a significantly higher rate than the consumer price index. Through 1998, the Company experienced significant increases in medical costs in its commercial, Medicare and New York Individual Plans. The Company employs various means to reduce the negative effects of inflation. The Company has increased overall commercial premium rates when practicable in order to attempt to maintain margins. The Company's cost-control measures and risk-sharing and cost-containment arrangements with various health care providers as well as its withdrawal from participation in state Medicaid programs may mitigate the effects of inflation on its operations. There is no assurance that the Company's efforts to reduce the impact of inflation will be successful or that the Company will be able to increase premiums to offset cost increases associated with providing health care.
During 2000, the Company retired its $150 million term loan and its $200 million senior notes, including premiums of approximately $26.4 million. In addition, the Company consummated two transactions, including an exchange and repurchase agreement during the fourth quarter, whereby the Company paid a total of $350 million to repurchase certain of the shares of Preferred Stock and approximately 11.5 million of the outstanding warrants. The Company entered into new senior credit facilities that includes a term loan of $175 million and a revolving credit facility of $75 million, which has not been drawn. Under the terms of the new senior credit facilities, the Company must make scheduled payments and reductions in the revolving credit facility and must prepay the term loan or reduce the revolving credit facility based on Company excess cash flow, as defined, and in certain other circumstances. Additional reductions in indebtedness will depend on the availability of cash at the parent company, which will depend in part on its ability to receive dividends from its subsidiary companies. See "Liquidity and Capital Resources - Financing". The Company paid cash dividends on the then outstanding Preferred Stock of approximately $13.8 million during 2000. Proceeds from the exercise of stock options were approximately $64.6 million during 2000 compared with $18.2 million and $2.7 million in 1999 and 1998, respectively.
restrictions on their ability to make dividend payments, loans or other transfers of cash to the parent company. These restrictions limit the ability of the Company to use cash generated by subsidiary operations to pay the obligations of the parent, including debt service and other financing costs. During 2000, the Company's HMO subsidiaries paid dividends to the parent company of approximately $317.6 million, and the Company made cash contributions to its HMO and insurance subsidiaries of approximately $6 million and $4.5 million during 2000 and 1999, respectively. The capital contributions were made to ensure that each subsidiary had sufficient surplus under applicable regulations after giving effect to operating results and reductions to surplus resulting from the non-admissibility of certain assets. In addition, New York State regulatory authorities authorized the repayment in 2000 of a $38 million surplus note plus $6 million in accrued interest by Oxford NY to the parent company. Although the Company received dividends from its HMO subsidiaries in 2000, there can be no assurances that such dividend payments will be made in future periods.
In September 1998, the National Association of Insurance Commissioners ("NAIC") adopted new minimum capitalization requirements, known as risk-based capital rules, for health care coverage provided by HMOs and other risk-bearing health care entities. Depending on the nature and extent of the new minimum capitalization requirements ultimately adopted by each state, there could be an increase in the capital required for certain of the Company's regulated subsidiaries. The Connecticut Department of Insurance has promulgated regulations based on the NAIC model which are applicable to its 2000 annual financial statements. Neither New York nor New Jersey has enacted similar legislation. In addition, the New Jersey Department of Banking and Insurance ("NJDBI") published solvency regulations in June 1999 that resulted in an additional $1.5 million solvency deposit by Oxford NJ. NYSID has announced an intention to strengthen current solvency regulations to allow NYSID to take over failing health plans without a court order; however, capitalization requirements continue to be subject to state interpretation from time to time. The Company believes that the current capitalization of the subsidiaries is sufficient to meet these requirements.
The New Jersey State legislature has passed legislation that includes a $50 million assessment on HMOs in the state proportionate to market share to be collected over a three-year period. The Company paid $1.8 million in 2000 related to this assessment and is required to pay similar amounts in 2001 and 2002.
The Company's medical costs payable was $612.9 million (including $519.3 million of IBNR) as of December 31, 2000 compared with $699.6 million (including $570.7 million for IBNR) as of December 31, 1999, before netting advance claim payments of $43.6 million in 1999. The Company estimates the amount of its IBNR reserves using standard actuarial methodologies based upon historical data, including the average intervals between the date services are rendered and the date claims are received and paid, denied claims activity, expected medical cost inflation, seasonality patterns and changes in membership. The liability is also affected by shared risk arrangements, including arrangements relating to the Company's Medicare business in certain counties and Physician Groups. In determining the liability for medical costs payable, the Company accounts for the financial impact of the transfer of risk for certain Medicare members and the experience of risk-sharing providers (who may be entitled to credits from Oxford for favorable experience or subject to deductions for accrued deficits). In the case of the North Shore Medicare risk arrangement described below, the Company no longer records a reserve for claims liability since the payment obligation has been transferred to North Shore. The Company has reviewed its Physician Group programs and has terminated most of its arrangements as a result of difficulties and expense associated with administering the program as well as other considerations. The Company believes that its reserves for medical costs payable are adequate to satisfy its ultimate claim liabilities.
renegotiation, Lenox has served notice of termination of the agreement. The failure of these arrangements could have a material adverse effect on the Company's Medicare results of operations.
In February 2000, the Company commenced a capital restructuring with the repurchase of (i) $130 million of Series E Preferred Stock and Series D Preferred Stock and (ii) $19 million of loans outstanding under its existing Term Loan. In May 2000, the Company prepaid the remaining $131 million balance of the Term Loan, including pre-payment premiums, for a total amount of $134.3 million. During the second half of 2000, the Company repurchased or tendered all of its $200 million Senior Notes and paid $22.4 million in tender and consent premiums. The purchase price for each $1,000 principal amount of the remaining Senior Notes validly tendered and accepted was determined based on a fixed spread of 0.5% over the yield to maturity of the 7.5% U.S. Treasury Note due May 15, 2002. All of the outstanding Senior Notes were tendered with consent. The total purchase price, including tender and consent premiums, was approximately $215.9 million, or $1,115.50 per $1,000 principal amount. In addition, in December 2000, the Company consummated an exchange and repurchase agreement pursuant to which, among other things, (i) the Company paid $220 million to TPG Investors to repurchase certain of the shares of Preferred Stock and certain of the warrants and (ii) TPG Investors exchanged their remaining shares of Preferred Stock and remaining warrants for 10,986,455 newly issued shares of common stock (the "Recapitalization"). The TPG Investors agreed not to sell the newly issued shares of common stock prior to February 15, 2001. In connection with the Recapitalization in the fourth quarter of 2000, the Company incurred costs of approximately $38.5 million related to the write-off of unamortized Preferred Stock discount and costs from the original issuance in 1998 and related transaction fees. Accordingly, as of the end of 2000, the Company had no warrants, Preferred Stock or Senior Notes remaining outstanding.
Simultaneously with the consummation of the Recapitalization and the tender offer for the Senior Notes, the Company entered into new senior bank facilities totaling $250 million, $175 million of which is a 5 -1/2 year term loan (the "New Term Loan") and $75 million of which is a 5 year revolving credit facility (the "Revolver", together with the New Term Loan, the "Senior Credit Facilities"). The proceeds of the New Term Loan were used, along with available Company cash, to fund the Recapitalization. The Company has not drawn on the Revolver. The only Company debt outstanding as of December 31, 2000 was the $175 million New Term Loan and $5.7 million of capital leases.
The agreement governing the Senior Credit Facilities (the "Credit Agreement"), provides for scheduled quarterly repayments of principal of the New Term Loan in annual amounts with a final maturity of June 2006. The Credit Agreement provides for voluntary prepayments of principal and voluntary reductions in commitments under the Revolver without penalty of a minimum amount of $5 million and mandatory prepayments of principal from proceeds upon the occurrence of certain events. Mandatory prepayments of principal and/or reductions in the Revolver are required from (1) the net proceeds from the sale of assets, subject to certain exceptions; (2) 50% of the net proceeds from certain equity issuances; (3) the net proceeds from the issuance of debt securities; and (4) 50% of excess cash flow, as defined, beginning with the quarter ending June 30, 2001. The Credit Agreement also provides for mandatory prepayment of the entire amount
outstanding under the Senior Credit Facilities at a 1% premium upon the occurrence of a change in control (as defined). Based on financial projections for 2001 and 2002, including anticipated dividends from the regulated subsidiaries, subsequent mandatory prepayments of principal primarily from excess cash flow, as well as scheduled repayments, the Company expects to repay the New Term Loan prior to its scheduled maturity.
Borrowings under the Senior Credit Facilities bear interest, subject to periodic resets, at either a base rate ("Base Rate Borrowings") or LIBOR plus an applicable margin based on the Company's credit ratings. Interest on Base Rate Borrowings is calculated as the higher of (a) the prime rate or (b) the federal funds effective rate plus 0.5% and is payable quarterly. As of December 31, 2000, the interest rate on the New Term Loan, utilizing the Base Rate Borrowing option, was 12%. As a result of a decline in the prime rate, the Base Rate option applicable to borrowings under the Senior Credit Facilities decreased to 11.5% on January 4, 2001. On January 12, 2001, the New Term Loan was converted to a LIBOR basis. Currently interest is being calculated based on an $87 million tranche at a rate of 9.26125% through March 12, 2001 and an $88 million tranche at a rate of 8.96875% through July 12, 2001. The average interest rate is approximately 9.1% through March 12, 2001. Commitment fees of 0.5% per annum are payable on the unused portion of the Revolver.
See Index to Consolidated Financial Statements and Schedule on page 43.