In June 1999, WCD agreed to transfer ownership of all of the Company's real property to the mortgagees of those properties in consideration for the mortgagees relieving the Company of any liability under the mortgages.
The Company leases the following properties for WCNY: approximately 14,100 square feet in Newburgh, New York, approximately 1,800 square feet in Albany, New York, and approximately 1,250 square feet in Binghamton, New York, at an annual expenses of approximately $335,500, $30,300 and $16,800, respectively. In turn, the Company subleases approximately 4,100 square feet in Newburgh, to an unrelated health care provider annual rental of approximately $109,900. The Company also leases 10,000 square feet in Tarrytown, New York, at an annual expense of $191,500, which lease was terminated in June 1999.
The Company leases approximately 5,000 square feet of office space in North Haven, Connecticut, for WCCT, at an annual rental expense of approximately $73,000.
As a result of the Patel and GHI transactions, the Company believes its current and future needs will be significantly reduced. The Company is in the process of consolidating its administrative functions and will be vacating substantially all of the space previously occupied in the owned facilities. The Company continues to evaluate its needs, and believes sufficient space is available for its current and future requirements.
Working capital/(deficiency) $(26,055) $(5,115) $11,172 $12,733 $ 4,776 Total assets 29,939 52,538 71,340 72,011 57,793 Long-term debt 15,078 25,852 26,467 19,209 6,336 Total liabilities 57,647 54,389 51,066 40,207 28,486 (Deficiency in assets)/ Shareholders' equity (27,708) (1,851) 20,274 31,804 29,307
(1) Continuing operating losses during 1998 and 1997 resulted in additional deferred tax benefits of approximately $8.7 and $7.8 million respectively. The Company has provided a 100% valuation allowance, in each year, with respect to these additional deferred tax assets in view of their size and length of the expected recoupment period. In addition, in 1998, the Company provided a 100% valuation allowance with respect to deferred tax assets of $5.4 million relating to periods prior to 1997. (See Note 14 of Notes to Consolidated Financial Statements). (2) Weighted average shares of common stock and common stock equivalents are not shown as the effect on per share would be anti-dilutive.
The Company's financial statements have been prepared assuming that the Company will continue as a going concern. The auditors' report states that "the Company's recurring losses from operations, cash used in operations, deficiency in assets at December 31, 1998, and failure to maintain 100% of the contingent reserve requirement for the New York State Department of Insurance at December 31, 1998, raise substantial doubt about its ability to continue as a going concern." (See Consolidated Financial Statements).
Certain statements in this Annual Report on Form 10-K are forward-looking statements and are not based on historical facts but are management's projections or best estimates. Actual results may differ from these projections due to risks and uncertainties. These risks and uncertainties include a variety of factors, including but not limited to the following: the Company's ability to continue as a going concern; that Dr. Patel will not obtain Connecticut regulatory approval of the change in control of WCCT contemplated by the Patel transaction; the inability to meet HMO statutory net worth requirement for WCNY or WCCT; the absence of a commercial line of business in WCNY for at least one year; that increased regulation will increase health care expenses; that increased competition in the Company's markets or change in product mix will unexpectedly reduce premium revenue; that the Company will not be successful in increasing membership growth; that there may be adverse changes in Medicare and Medicaid premium rates set by federal and state governmental agencies; that health care cost in any given period may be greater than expected due to unexpected incidence of major cases, natural disasters, epidemics, changes in physician practices, and new technologies; that the Company will be unable to successfully expand its operations into New York City, Westchester County and the State of Connecticut; and that major health care providers will be unable to maintain their operations and reduce or eliminate their accumulated deficits.
Legislative and regulatory proposals have been made at the federal and state government levels related to the health care system, including but not limited to limitations on managed care organizations (including benefit mandates) and reform of the Medicare and Medicaid programs. Such legislative or regulatory action could have the effect of reducing the premiums paid to the Company by governmental programs or increasing the Company's medical costs or both. The Company is unable to predict the specific content of any future legislation, action or regulation that may be enacted or when any such future legislation or regulation will be adopted. Therefore, the Company cannot predict the effect of such future legislation, action or regulation on the Company's business.
The Company has sustained operating losses in each of the last three years and, at December 31, 1998, has a working capital deficiency of $26.1 million. At December 31, 1998, WCNY and WCCT are not in compliance with the statutory net worth requirements in New York and Connecticut, respectively. The Company's ability to continue as a going concern is dependent upon the consummation of a transaction or transactions which would provide capital sufficient to meet its financial obligations, including statutory compliance, and its return to profitability.
In March 1998, the Company engaged Bear, Stearns & Co., to assist the Company in exploring its strategic opportunities, which could include joint venture, capital contributions, merger or sale of all or a portion of the Company. In May and June 1999, the Company consummated a number of transactions which are expected to reduce the Company's working capital deficit by approximately $18.0 million; bring WCNY within the 50% to 100% revised contingent reserve requirement, as permitted by NYSID; substantially retire all of the Company's long-term debt; significantly reduce WCNY's obligation to its providers; and change the configuration and focus of the Company ("ongoing WellCare"). Thereafter, ongoing WellCare's operations in New York will consist solely of its governmental programs (Medicare, Medicaid, and Child Health Plus), with WCNY's revised statutory cash reserve decreased to $2.9 million, and its revised statutory contingent reserve decreased to $3.7 million. WCCT will continue its commercial business in Connecticut, subject to a public hearing and regulatory approval of the acquisition of control of WCCT. Management believes the consummation of these transactions will improve ongoing WellCare's ability to continue as a going concern.
WellCare's principal source of revenue is premiums earned from the WellCare HMOs. Other revenue consists principally of interest and rental income. Premiums earned represented 98.8% of the Company's total revenue for the year ended December 31, 1998, and were equal to 1997, after having declined in 1997 by 9.6%. In 1998, the increase in WCCT commercial membership and Child Health Plus membership was offset by the decrease in WCNY commercial membership.
Ongoing studies for the three product lines provide the Company with the tools to estimate the percentage of pended claims to be paid relative to submitted charges. All claims paid, payable and pended are evaluated weekly and a projection of ultimate payables is estimated. Moreover, procedures are in place whereby the actual runoff of claims for each of the last twelve months versus the reserve for IBNR and the paid, pended, payable claims are reviewed for accuracy as compared to the original projections. This procedure is intended to allow the Company to continually estimate its unknown claims reserves and IBNR more effectively.
The Company believes that the process of trending the ultimate resolution of paid, payable, and pended claims allows the Company to analyze trends and changes in payments and utilization patterns and, therefore, react to medical costs on a proactive versus a reactive basis. The Company's recording of IBNR during 1997 and the first three quarters of 1998 has, in retrospect, been for amounts less than subsequently incurred based on the actual settlement of claims. Although the Company continues its efforts to make this estimating process more accurate, and believes the IBNR estimates in the December 31, 1998 consolidated financial statements are adequate, there can be no assurance that IBNR reserve currently recorded will be sufficient to cover medical expenses ultimately incurred.
The Company seeks to control medical expenses through capitation arrangements with the Alliances/IPAs and with non- Alliance/IPA primary care physicians, capitation arrangements with certain specialty providers, and through its quality improvement programs, utilization management and review of hospital inpatient and outpatient services, and educational programs on effective managed care for its providers.
Revenue: Premiums earned 98.8% 98.8% 97.5% Interest and other income 1.2 1.2 2.5 ----- ----- ----- Total revenue 100.0 100.0 100.0
Expenses: Hospital services 29.2 25.1 23.1 Physician services 57.9 58.5 59.5 Other medical services 2.6 4.2 1.7 ----- ----- -----
Total medical expenses 89.7 87.8 84.3 General and administrative 22.6 24.0 24.4 Depreciation and amortization 4.1 2.5 2.0 Interest and other expenses 1.2 1.1 1.6 ----- ----- ----- Total expenses 117.6 115.4 112.3
Interest income remained relatively consistent, and is primarily on amounts due the Company by Primergy, as more fully discussed in Note 5 of "Notes to the Consolidated Financial Statements", which amounts have been fully reserved.
General and administrative ("G&A") expenses decreased 5.3% or $1.9 million, to $32.6 million in 1998 from $34.5 million in 1997, and decreased as a percentage of total revenue (the G&A ratio") to 22.6% in 1998 from 24.0% in 1997. Included in G&A in 1998 is an expense of $2.8 million to reduce Property & Equipment to its net realizable value. The decrease resulted primarily from reductions in the provision for doubtful receivables ($3.1 million), marketing related costs ($1.9 million), and payroll and payroll related costs resulting from staff reductions in January 1998 ($0.6 million), partially offset by increases relating to Y2K compliance ($0.5 million) and broker commissions for WCCT ($0.5 million).
The decision to expand into the Medicare product line recognized that the early stages of expansion would generate a medical loss ratio in excess of 100% until sufficient membership was achieved. As a result of the renegotiation of many provider contracts from a DRG to a per diem basis and the efforts to improve utilization management, it appeared that the third quarter medical loss ratio for Medicare would generate an adequate profit margin before G&A costs. Expected utilization improvements in the fourth quarter were based on the favorable results of the third quarter, and led management to anticipate a fourth quarter Medicare loss ratio in the range of 90-92%. In late January and early February 1998, additional Medicare claims were received for the third quarter of 1997, beyond the time frame within which the Company had been experiencing with its commercial product. The Company had been receiving greater than 90% of its Medicare claims within 12 weeks of the date of service. The receipt of these additional late claims beyond the 12 week period created a situation whereby the updated third quarter medical loss ratio is approximately 5% higher than originally estimated. Additionally, higher than expected fourth quarter Medicare utilization (together with the third quarter adverse development) generated medical costs approximately $2.2 million above projections.
In order to eliminate this deficiency, and to continue as a going concern, the Company is dependent upon the successful consummation of a transaction or transactions which would provide capital sufficient to meet its financial obligations, including statutory compliance, and its achieving a return to profitability. In March 1998, the Company engaged Bear, Stearns & Co., Inc. to assist the Company in exploring its strategic opportunities. In May and June 1999, the Company consummated a number of transaction which are expected to reduce the Company's working capital deficit by approximately $18.1 million. The transactions include: an equity investment of $5 million (the "Patel transaction"); sale of WCNY's commercial business for approximately $5 million (the "GHI transaction"); settlement of provider claims at amounts significantly lower than the estimated liability of approximately $30.5 million; renegotiation and settlement of approximately $5.4 million of mortgage debt; and the conversion of the $15 million subordinated convertible note into senior convertible preferred stock of the Company (see Note 24). After the conclusion of these transaction, the Company's ongoing cash requirements will be less as substantially all long-term debt will have been retired, the Company will no longer provide commercial health care coverage in New York, its space needs will have been reduced substantially, and it will have 105 employees compared to 236 at December 31, 1998. Management believes that the consummation of these transactions will improve WellCare's ability to continue as a going concern.
New York State certified HMOs are required to maintain a cash reserve equal to the greater of 5% of expected annual medical costs or $100,000. Additionally, except as described in the following paragraph, WCNY is required to maintain a contingent reserve which must be increased annually by an amount equal to at least 1% of statutory premiums earned limited, in total, to a maximum of 5% of statutory premiums earned for the most recent calendar year and which may be offset by the cash reserve. The cash reserve is calculated at December 31 of each year and is maintained throughout the following calendar year. At December 31, 1998 and 1997, WellCare had required cash reserves of approximately $5.3 and $5.8 million, respectively, and a contingent reserve of approximately $6.7 and $6.7 million, respectively. In the event the contingent reserve exceeds the required cash reserve, the excess of the contingent reserve over the required cash reserve is required to be maintained.
WCCT is subject to similar regulatory requirements with respect to its HMO operations in Connecticut. The Connecticut Department of Insurance requires that WCCT maintain a statutory reserve of $1 million. In June and November 1997, the Company made capital contributions of $350,000 and $425,000, respectively, to WCCT to bring its statutory net worth to the required minimum of $1 million. In March 1998, the Company made an additional capital contribution of $368,000 to WCCT to bring its statutory net worth above the $1 million requirement. At December 31, 1998, WCCT is not in compliance with the statutory net worth requirement having a statutory net worth of approximately $.6 million, including an account receivable from the Company of approximately $.9 million. As a result, on June 2, 1999 the State of Connecticut Insurance Department issued an order requiring WCCT to submit to administrative supervision by the State's Insurance Commissioner until WCCT meets its statutory net worth (without including the account receivable from the Company) and other requirements. Management has been meeting with the Connecticut Department of Insurance regarding the statutory net worth deficiency to develop a mutually agreeable plan to bring WCCT into compliance with the statutory net worth requirement.
At December 31, 1998, the Company had total mortgage indebtedness of $5.5 million outstanding on five of its office buildings, of which approximately $0.7 million is due February 1, 1999, approximately $3.8 million is due January 1, 2000, approximately $0.7 million is due March 1, 2000, and approximately $0.3 million is due March 1, 2001. At December 31, 1998, the Company has classified the entire mortgage debt as current, to reflect the June 1999 settlements with the Bank and Premier.
Between April and June 1996, the Company, its former President and Chief Executive Officer (Edward A. Ullmann), and its former Vice President of Finance and Chief Financial Officer (Marystephanie Corsones) were named as defendants in twelve separate actions filed in Federal Court (the "Securities Litigations"). An additional three directors were also named in one of these actions. Plaintiffs sought to recover damages allegedly caused by the Company's defendant's violations of federal securities laws with regard to the preparation and dissemination to the investing public of false and misleading information concerning the Company's financial condition. (See Item 3, Legal Proceedings, for additional detail).
The amount of legal fees incurred with respect to the defense of the former President and Chief Executive Officer and Chief Financial Officer in the Securities Litigations, and included in G&A expenses, is as follows:
In connection with the "Patel" and "GHI" transactions, the Company sold or assigned substantially all of its computer hardware and software to GHI. The plan is for all data processing/MIS requirements to ultimately be provided under the terms of the newly executed management agreements with Comprehensive Health Management, Inc. ("Comprehensive"), an affiliate of Dr. Patel. Under the terms of the GHI transaction, the Company will continue to use the existing computer systems and software a transition period. The computer hardware and software that was not sold or assigned to GHI is in the process of being upgraded so that it will be Y2K compliant. The Company anticipates these modifications will be completed by September 1999.
The inability of Comprehensive or the Company to complete timely any of its Year 2000 modifications, or the inability of other companies with which Comprehensive or the Company does business to complete timely their Year 2000 modifications, could potentially have a material adverse effect on the Company's operations.
The Company is exposed to interest rate risk primarily through its borrowing activities and minimally through its short-term investments. All of the Company's borrowings are in US dollar debt and, at December 31, 1998, approximately 77% of its debt is at fixed rates. In June 1999, the Company retired its long-term debt. This includes conversion into equity by The 1818 Fund II, L.P., and the settlement by the Company of its mortgages with Key Bank and Premier National Bank, whereby the Company will transfer ownership of real property securing the mortgages to the banks in lieu of foreclosure. There were no fluctuations in interest rates for these obligations between December 31, 1998 and the date of retirement. Although there is inherent risk for any replacement borrowings, the extent of this is not quantifiable or predictable because of the restructuring of the Company as a result of the June transactions, as more fully discussed under Recent Events in Item 1.