(2) The Company expects that the square footage of these properties will be increased slightly in 1999 as a result of consolidations with respect to other properties pursuant to the Company's Turnaround Plan.
The operating data and balance sheet information set forth below for each year in the five-year period ended December 31, 1998 have been derived from the consolidated financial statements of the Company. The information below is qualified by reference to and should be read in conjunction with the audited consolidated financial statements and related notes and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein.
(2) Defined as health care services expense as a percentage of premiums earned.
In 1998, the Company's revenues consisted primarily of commercial premiums derived from its Freedom Plan and Liberty Plan, health maintenance organization ("HMO"), preferred provider organizations ("PPOs") and dental plan products, reimbursements under government contracts relating to its Medicare+Choice ("Medicare") and Medicaid programs, third-party administration fee revenue for its self-funded plan services (which is stated net of direct expenses such as third-party reinsurance premiums) and investment income.
Health care services expense primarily comprises payments to physicians, hospitals and other health care providers under fully insured health care business and includes an estimated amount for incurred but not reported or paid claims ("IBNR"). The Company estimates IBNR expense based on a number of factors, including prior claims experience. The actual expense for claims attributable to any period may be more or less than the amount of IBNR reported. The Company's results for the year ended December 31, 1998 were adversely affected by additions to the Company's reserves for IBNR in the second and fourth quarters. See "Liquidity and Capital Resources". The Company's results for the year ended December 31, 1998 were also adversely affected by significant restructuring and unusual charges, as described below.
The Company experienced substantial growth in membership and revenues since it began operations in 1986 through 1997. The membership and revenue growth has been accompanied by increases in the cost of providing health care in the Company's service areas. The Company experienced declines in membership and revenue through 1998 and such declines may continue through 1999 and beyond. The Company does not intend to promote significant membership or revenue growth in 1999 because the Company has redirected its strategic initiatives to attempt to establish profitability. See "Business - Recent Developments - Turnaround Plan". Since the Company provides services on a prepaid basis, with premium levels fixed for one-year periods, unexpected cost increases during the annual contract period cannot be passed on to employer groups or members.
The changes in estimate totaling $29.0 million were recognized as a credit to restructuring charges in the fourth quarter of 1998 and reduced the net loss by $.36 per share.
As part of its Turnaround Plan, the Company decided to restructure its current Medicare arrangements and/or withdraw from Medicare in certain counties and to withdraw from Medicaid business entirely. Premium deficiency reserves totaling $51.0 million were established in the second quarter of 1998. This amount represented an estimate of the deficiency for the remainder of 1998 pending implementation of the plan to restructure or withdraw from these businesses.
reserves against losses in these programs amounted to $31.8 million in the second half of 1998. As a result of the Company's early completion of this portion of its Turnaround Plan, the remaining reserve balance of $19.2 million was reversed as a reduction of restructuring charges in the fourth quarter of 1998.
In connection with the consolidating of operations to reduce its occupied square footage, restructuring charges totaling approximately $13.7 million were recorded in the first half of 1998 for estimated costs associated with future rental obligations (net of estimated sublease revenues), commissions, legal costs, penalties and other expenses relating to disposition of excess space. The Company recorded an additional restructuring charge of approximately $4.5 million in the fourth quarter as a change in estimate as the Company's experience in negotiating subleases and lease cancellations through the fourth quarter indicates that costs will exceed previous estimates. The Company's relevant lease obligations extend to July 2005, but the Company expects that a significant portion of the expense will be incurred prior to January 1, 2000, including termination fees aggregating approximately $2.4 million.
The Company disposed of its 47% interest in Health Partners, Inc. ("Health Partners") in October 1997, and received 2,090,109 shares of common stock of FPA Medical Management, Inc. ("FPAM") stock with a market value of approximately $76.4. million, resulting in a pretax gain of approximately $63.1 million. As of December 31, 1997, the market value of the FPAM stock had dropped to approximately $38.4 million. At year-end 1997, the Company wrote down its investment in FPAM by $38.0 million, thereby reducing the 1997 pretax gain on the sale of Health Partners to approximately $25.2 million ($20.5 million after taxes, or $.26 per share).
During the second quarter of 1998, the Company sold 540,000 shares of FPAM and recognized a loss of $8.1 million. In July 1998, FPAM filed for protection under Chapter 11 of the U.S. Bankruptcy Code and the market value per share of its common stock fell below one dollar. The Company wrote down its remaining investment in FPAM to nominal value and recognized a loss in the second quarter of 1998 of $30.2 million. The total 1998 recognized loss and write-down of $38.3 million, or $.49 per share, has been recognized as an unusual charge in the accompanying financial statements.
The 1997 charges resulted from a reduction in the level of future investment in expansion markets and, accordingly, the Company wrote down its investments in its Florida and Illinois subsidiaries and one affiliate.
In connection with the completion of the Company's year-end closing, certain nonrecurring items that were previously classified as unusual charges and restructuring charges in the second quarter of 1998 were reclassified to operating and income tax captions in the 1998 statement of operations. A reclassification of unusual charges aggregating approximately $73.5 million was made related to charges taken in the second quarter for strengthening medical claim reserves, establishing reserves for losses on provider advances, and certain other asset impairment losses. A reclassification of restructuring charges aggregating $18.8 million was made related to the write-down of government program account receivables and accruals of certain litigation defense costs and other expenses. These reclassifications do not affect the reported net loss for the second quarter or for the full year, but do have the effect of increasing the second quarter medical loss ratio and administrative loss ratio from the levels previously reported and full year ratios are also slightly higher. In addition, a reclassification of restructuring charges approximating $6.0 million was made related to certain deferred tax assets, which charges are now included in the 1998 statement of operations as income tax expense. This reclassification has no effect on the reported net loss for the second quarter or the full year of 1998.
Software and hardware problems experienced in the conversion of a portion of the Company's computer system in September 1996 resulted in significant delays in the Company's billing of group and individual customers and have adversely affected the Company's premium billing. The Company's revenues were adversely affected by adjustments of approximately $173.5 million in 1997 and $218.2 million in 1998 related to estimates for terminations of group and individual members and for nonpaying group and individual members. The Company has taken steps to attempt to improve billing timeliness, reduce billing errors, reduce lags in recording enrollment and disenrollment notifications, and improve the Company's collection processes and is attempting to make requisite improvements in management information systems concerning the value and aging of outstanding accounts receivable. The Company continues to experience significant levels of retroactive member and group terminations impacting revenue and believes it has made adequate provision in its estimates for group and individual member terminations and for nonpaying group and individual members as of December 31, 1998. Adjustments to the estimates may be necessary, however, and any such adjustments would be included in the results of operations for the period in which such adjustments were made.
As a consequence of the charges described in the previous paragraphs, comparisons of operating results for 1996, 1997 and 1998 may not be meaningful.
The Company may continue to report losses in 1999 as the result of high medical costs and high administrative costs. The Company's Turnaround Plan contemplates steps to better control medical and administrative spending and increase premium rates and discontinue unprofitable businesses, but there can be no assurance that it will be successful. Results of operations will be adversely affected if such steps cannot be successfully implemented or if there are delays in such implementation. In addition, the Company may decide to increase certain administrative costs to attempt to improve service levels. The Company's ability to control administrative costs could be adversely affected by a continuation of the high level of employee attrition that the Company has experienced over the last several quarters.
Total commercial premiums earned for the year ended December 31, 1998 increased 14.5% to $3.4 billion compared with $2.9 billion in the prior year. This increase is primarily attributable to a 11.2% increase in member months in the Company's commercial health care programs, including a 10.8% member months increase in the Freedom Plan. Commercial premium revenue was adversely affected by adjustments of $173.5 million in 1997 and $218.2 million in 1998 related to estimates for termination of group and individual members and for nonpaying group and individual members. See "Overview". Average premium yields of commercial programs were 2.9% higher in 1998, net of such adjustments, when compared with 1997. Medical costs incurred in 1998 in the Company's core commercial business were higher than estimates used in establishing rates for groups sold and renewing in late 1997 and early 1998. As a consequence, premium rates were insufficient and the Company
Premiums earned from government programs increased 1.6% to $1.26 billion in 1998 compared with $1.24 billion in 1997. The overall increase was attributable to an 8.3% increase in member months of Medicare programs offset, in part, by a 28.0% decline in member months of Medicaid programs due primarily to the withdrawal from the Connecticut and New Jersey Medicaid markets during 1998. Additionally, the Company's New York Medicaid contract was assigned to a third party in January 1999, and the Company's Pennsylvania subsidiary, including its Pennsylvania Medicaid business, was sold in January 1999. As of February 1, 1999, the Company had no Medicaid members and will have limited Medicaid revenue in 1999. The Company expects its Medicare revenue to be significantly lower in 1999 as the result of withdrawals from Medicare in certain counties as well as net losses in membership due to changes in provider arrangements and benefit plans in other counties. Reimbursement levels for the Company's 1999 Medicare business are expected to be 1.6% higher than 1998 (net of the applicable HCFA user fee). The Company believes that future Medicare premiums may be adversely affected by the implementation of risk adjustment mechanisms recently announced by HCFA. See "Business - Government Regulations - Recent Regulatory Developments".
Moreover, the Company's claims payment and accuracy still require improvement to meet acceptable standards. Additions to reserves could also result as a consequence of regulatory examinations, and such additions also would be included in the results of operations for the period in which such adjustments are made. See "Liquidity and Capital Resources".
Effective January 1, 1997, the New York Health Care Reform Act of 1996 (the "New York Act") requires that the Company make payments to state funding pools to finance hospital bad debt and charity care, graduate medical education and other state programs under the New York Act. Previously, hospital bad debt and charity care and graduate medical education were financed by surcharges on payments to hospitals for inpatient services. The Company's costs have increased as these payment obligations have not been offset by corresponding reductions in payments to hospitals and others.
The Company incurred interest and other financing charges of $41.6 million in 1998 related to the issuance of $200 million in bridge financing in the first quarter of 1998 and $350 million of long-term debt in May 1998. Interest expense on capital leases entered into in 1998 aggregated $1.4 million. No such interest was incurred in 1997. Interest expense on delayed claims totaled $14.1 million in 1998, compared with $11.1 million in 1997. Interest payments have been made in accordance with the Company's interest payment policy and applicable law. The Company's future results will continue to reflect interest payments by the Company on delayed claims as well as interest expense on outstanding indebtedness incurred in 1998. See "Business - Recent Developments - Financings".
The Company has established a tax valuation allowance related to certain net operating losses and the effect of the Company's net tax deductible temporary differences. Based on the results of operations, management does not currently believe that such tax benefits relating to losses incurred subsequent to the first quarter of 1998 are more likely than not to be realized in the foreseeable future. Accordingly, the Company discontinued providing tax benefits beginning in the second quarter of 1998. Based on management's assessment of the progress to date in its Turnaround Plan, together with projections of future performance, management currently believes that it is more likely than not that deferred tax benefits recorded prior to April 1998 will be realized. However, the Company will continue to monitor its tax position throughout the implementation of its Turnaround Plan to determine whether such deferred tax benefits will require an additional valuation allowance or adjustment. The amounts of future taxable income necessary during the carryforward period to utilize the unreserved net deferred tax assets is approximately $320 million.
As of December 31, 1998, the Company has federal net operating loss carryforwards of approximately $600 million, which will begin to expire in 2012.
The following tables show plan revenues earned and membership by product:
Commercial premium revenues increased 35% to $2.9 billion in 1997 from $2.2 billion in 1996. Membership growth accounted for substantially all of the change as member months of the Freedom Plan increased 37.2% when compared with 1996, and member months of Oxford's traditional HMOs increased 43.2% over the prior year. Premium yields of commercial programs were about the same in 1997 as in 1996. Software and hardware problems experienced in the conversion of a portion of the Company's computer system in September 1996 resulted in significant delays in the Company's billing of group and individual customers and in 1997 adversely affected the Company's premium billing. The Company's revenues in 1997 were adversely affected by adjustments of approximately $173.5 million related to estimates for terminations of group and individual members and for nonpaying group and individual members.
Third-party administration revenues for the year ended December 31, 1997 increased to $12.6 million from $10.4 million in 1996, attributable to a 27.1% increase in member months due to the acquisition of Compass PPA, Incorporated, partially offset by a 4.7% decrease in per member per month revenue.
Net investment and other income for the year ended December 31, 1997 increased to $71.4 million from $42.6 million in 1996. This was principally due to significantly greater realized capital gains in 1997 when compared with 1996.
The Company's paid and received claims data and revised estimates show significant increases in medical costs in 1996 and 1997 in the Company's Medicare, Medicaid and New York Mandated Plans. The Company estimates that its per member per month medical costs increased 13.1% in 1996 and 21.4% in 1997 in its Medicare programs. In its New York Mandated Plans and its Medicaid programs the Company's per member per month medical costs increased 49.1% and 17.3%, respectively, in 1997. These increases resulted primarily from higher expenses for hospital and specialist physician services and increases in per member per month pharmacy costs of 20.7% and 18.5% in 1996 and 1997, respectively. The Company reviews its ultimate claims liability in light of its claims payment history and other factors, and any resulting adjustments are included in the results of operations for the period in which such adjustments are made.
Marketing, general and administrative expenses increased 54.5% to $737.4 million in 1997 from $477.4 million in 1996 which, as a percentage of operating revenues, was 17.6% in 1997 compared with 15.7% in 1996. The increase in marketing, general and administrative expenses was attributable to the Company's membership growth, costs associated with expansion into new markets in Florida and Illinois and expenses attributable to strengthening the Company's operations, including costs for independent consultants, additional staff and information system enhancements. Principal areas of increased expense were payroll and benefits expense, broker commissions, marketing expenses and depreciation. Payroll and benefits expense increased $87.5 million in 1997 primarily due to an increase in the size of the Company's work force to approximately 7,200 employees at the end of 1997 from approximately 5,000 employees at the end of 1996. The additional employees were hired primarily in the areas of health services, member services, management information systems and marketing. Broker commissions increased by $47.8 million in 1997 due to the increase in premiums. Marketing expenses other than payroll and benefits increased by $15.7 million in 1997 as the Company implemented programs to market its products in a highly competitive environment in several markets. Depreciation expense was $17.1 million higher than in 1996 as a result of $101.9 million of capital expenditures during 1997.
these expansion markets. The Company believes that such reduction in future investments will adversely impact the value of these companies and, accordingly, the Company reduced the value of its investment in these companies by writing off $27.3 million in goodwill arising from the acquisitions and subsequent investment. The Company also reduced the carrying value of its minority investment in the capital stock and subordinated surplus notes of St. Augustine Health Care, Inc., a Florida-based HMO by $14.3 million.
Cash used by operations during 1998 aggregated $46.5 million compared with $152.6 million in 1997. The improvement is primarily attributable to the receipt in 1998 of federal and state tax refunds totaling $121 million. During 1998, the Company significantly strengthened its balance sheet and enhanced short-term liquidity through the infusion of $710 million in cash in the Financing described below.
Premiums receivable at December 31, 1998 decreased to $110.3 million from $275.6 million at December 31, 1997 primarily due to improved collections and continued clean-up efforts for nonpaying groups and reconcilliations and increased reserves for doubtful accounts.
As a result of the previously discussed delays in claims payments, the Company experienced a significant increase in medical claims payable during the fourth quarter of 1996 and the first quarter of 1997, but the increase in medical costs payable was mitigated by progress in paying backlogged claims and by making advance payments to providers and reductions in IBNR relating to the Company's exit from certain businesses during the first quarter of 1998 and thereafter. Outstanding advances, net of a $35 million valuation reserve, aggregated approximately $139.5 million at December 31, 1998 and have been netted against medical costs payable in the Company's consolidated balance sheet. The Company believes that it will be able to recover outstanding advance payments, either through repayment by the provider or application against future claims, but any failure to recover funds advanced in excess of the reserve would adversely affect the Company's results of operations. There can be no assurance that insurance regulators will continue to recognize such advances as admissible assets and the New Jersey Department of Banking and Insurance is requiring the Company to provide collateral for repayment of the advances by setting aside in trust at the parent company funds equal to the admitted portion of the advances on the New Jersey subsidiary's statutory financial statement (currently not expected to exceed $30 million). If the Company fails to provide such collateral or if all or a portion of the advances were deemed nonadmitted, the capital of the Company's operating subsidiaries would be impaired and additional capital contributions would be required for the subsidiaries to meet statutory requirements.
The Company's medical costs payable was $989.7 million as of December 31, 1998, before netting advance claim payments of $139.5 million (including $864.5 million for IBNR) compared with $965.9 million as of December 31, 1997, before netting advance claim payments of $203.4 million (including $936.7 million for IBNR). 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 paid and between the date services are rendered and the date claims are received by the Company, 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 Private Practice Partnerships ("Partnerships"). 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 Partnership providers (who may be entitled to credits from Oxford for favorable experience or subject to deductions for accrued deficits). In the case of the Medicare risk arrangements, the Company no longer records a reserve for claims liability since the payment obligation has been transferred to third parties. In the case of Partnership providers subject to deficits, the Company has established reserves to account for delays or other impediments to recovery of those deficits. The Company has reviewed its partnership program and has terminated most of its partnership arrangements as a result of difficulties and expense associated with administering the program as well as other considerations. The Company recognized estimated costs in taking these actions in the second quarter of 1998. The Company believes that its reserves for IBNR are adequate to satisfy its ultimate claim liabilities. However, the Company's prior rapid growth, delays in paying claims, paying or denying claims in error and changing speed of payment may affect the Company's ability to rely on historical information in making IBNR reserve estimates.
On February 6, 1998, the Company issued a $100 million senior secured increasing rate note due February 6, 1999 ("Bridge Note") and on March 30, 1998, issued an additional $100 million Bridge Note, pursuant to a Bridge Securities Purchase Agreement, dated as of February 6, 1998, between the Company and an affiliate of Donaldson Lufkin & Jenrette Securities Corporation, as amended on March 30, 1998. The Company used the proceeds of the Bridge Notes to make a portion of the above described contributions to its HMO subsidiaries, to pay expenses in connection with the issuance of the Bridge Notes and for general corporate purposes. The Bridge Notes were redeemed as part of the financing described below.
Pursuant to an Investment Agreement, dated as of February 23, 1998 (the "Investment Agreement"), between the Company and TPG Oxford LLC ("TPG", together with the investors thereunder, the "Investors"), the Investors, on May 13, 1998, purchased $350 million in redeemable Preferred Stock with Warrants to acquire up to 22,530,000 shares of common stock. The Preferred Stock and Warrants were issued without registration under the Securities Act in reliance on Section 4(2) of the Securities Act, which provides an exemption for transactions not involving any public offering. In determining that such exemption was available, the Company relied on, among other things, the facts that the Preferred Stock and Warrants were being issued through direct communication only to a limited number of sophisticated investors having knowledge and access to information regarding the Company and that the certificates evidencing such Preferred Stock and Warrants bear a legend restricting transfer in nonregistered transactions. Dividends on the Preferred Stock may be paid in kind for the first two years. The Warrants have an exercise price of $17.75, which represents a 5% premium over the average trading price of Oxford shares for the 30 trading days ended February 20, 1998. The exercise price will become 115% of the average trading price of Oxford common stock for the 20 trading days following the filing of the Company's annual report on Form 10-K for the year ended December 31, 1998, if such adjustment would reduce the exercise price.
The Preferred Stock was originally issued as 245,000 shares of Series A and 105,000 shares of Series B. The Series A Preferred Stock carried a cash dividend of 8% per annum, payable quarterly, provided that prior to May 13, 2000, the Series A Preferred Stock accumulated dividends at a rate of 8.243216% per annum, payable annually in cash or additional shares of Series A Preferred Stock, at the option of the Company. The Series A Preferred Stock was issued with Series A Warrants to purchase 15,800,000 shares of common stock, or approximately 19.9% of the then outstanding voting power of Oxford's common stock. The Series A Preferred Stock had approximately 16.6% of the combined voting power of Oxford's then outstanding common stock and the Series A Preferred Stock. The Series B Preferred Stock, which was originally issued with Series B Warrants to purchase nonvoting junior participating preferred stock, was nonvoting and carried a cash dividend of 9% per annum, payable quarterly, provided that prior to May 13, 2000, the Series B Preferred Stock accumulated dividends at a rate of 9.308332% per annum, payable annually in cash or additional shares of Series B Preferred Stock, at the option of the Company. The Preferred Stock was not redeemable by the Company prior to May 13, 2003. Thereafter, subject to certain conditions, the Series A and Series B Preferred Stock were each redeemable at the option of the Company at a redemption price of $1,000 per share (in each case, plus accrued and unpaid dividends), and were subject to mandatory redemption at the same price on May 13, 2008. The Series A Warrants and the Series B Warrants expire on the earlier May 13, 2008 or redemption of the related series of Preferred Stock. The Warrants are detachable from the Preferred Stock. With respect to dividend rights, the Series A and Series B Preferred Stock rank on a parity with each other and prior to the Company's common stock. On August 28, 1998, the Company held its annual shareholders meeting at which its shareholders approved the vesting of voting rights in respect of the Series B Preferred Stock and the issuance, subject to adjustment, of up to 6,730,000 shares of common stock upon exercise of the Series B Warrants. This approval resulted in the reduction of the dividend on the Series B Preferred Stock to 8% (8.243216% prior to May 13, 2000) and an increase in the voting rights of TPG to 22.1% of the combined voting power of the Company's outstanding common stock and Series A and Series B Preferred Stock.
On February 13, 1999, the Company entered into a Share Exchange Agreement (the "Exchange Agreement") with TPG, its affiliates and others to make an adjustment of the dividends payable among the shares of Series A Preferred Stock and Series B Preferred Stock in connection with the possible sale of shares of Preferred Stock by the holders thereof to institutional holders. Pursuant to the Exchange Agreement, the 245,000 shares of Series A Preferred Stock were exchanged for 260,146.909 shares of a new Series D Preferred Stock (the "Series D Preferred Stock"), and the 105,000 shares of Series B Preferred Stock were exchanged for 111,820.831 shares of a new Series E Preferred Stock (the "Series E Preferred Stock"). In the exchange, (1) a holder received in exchange for each share of Series A Preferred Stock, one share of Series D Preferred Stock, plus 0.061824118367 share of Series D Preferred Stock representing dividends on the Series
A Preferred Stock accrued and unpaid through February 13, 1999, and (2) a holder received in exchange for each share of Series B Preferred Stock, one share of Series E Preferred Stock, plus 0.064960295238 share of Series E Preferred Stock representing dividends on the Series B Preferred Stock accrued and unpaid through February 13, 1999. As a result of the exchange, the holders hold only Series D Preferred Stock and Series E Preferred Stock. On March 9, 1999, the Company filed Certificates of Elimination for the Series A Preferred Stock and the Series B Preferred Stock that have the effect of eliminating from the Certificate of Incorporation all matters with respect to the Series A Preferred Stock and the Series B Preferred Stock. The terms of the shares of the Series D Preferred Stock are identical to the terms of the Series A Preferred Stock, except that the Series D Preferred Stock accumulates cash dividends at the rate of 5.12981% per annum, payable quarterly, provided that prior to May 13, 2000, the Series D Preferred Stock accumulates dividends at a rate of 5.319521% per annum, payable annually in cash or additional shares of Series D Preferred Stock, at the option of the Company. The terms of the shares of the Series E Preferred Stock are identical to the terms of the shares of the Series B Preferred Stock except that the Series E Preferred Stock accumulates cash dividends at a rate of 14.00% per annum, payable quarterly, provided that prior to May 13, 2000, the Series E Preferred Stock accumulates dividends at a rate of 14.589214% per annum, payable annually in cash or additional shares of Series E Preferred Stock, at the option of the Company. In addition, prior to May 13, 2000, the holders of the Series D Preferred Stock may only use to pay the exercise price of the Warrants a percentage of the total amount of Series D Preferred Stock issued on February 13, 1999 that does not exceed the percentage of the total number of shares of Series E Preferred Stock issued on February 13, 1999 that have been redeemed, repurchased or retired by the Company, or used as consideration for the Warrants by the holders. With respect to dividend rights, the Series D and Series E Preferred Stock rank on a parity with each other and prior to the Company's common stock.
The aggregate cost to the Company of dividends on the Series D Preferred Stock and Series E Preferred Stock is the same as the aggregate cost to the Company of dividends on the Series A Preferred Stock and Series B Preferred Stock. The respective voting rights of the holders of the Series A Preferred Stock and Series B Preferred Stock have not changed as the result of the exchange of such shares for shares of Series D Preferred Stock and Series E Preferred Stock.
Simultaneously with the consummation of the Investment Agreement, the Company issued $200 million principal amount of 11% Senior Notes due May 15, 2005. The Senior Notes were issued in a private placement to Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ"), the initial purchasers, who agreed to sell the Senior Notes only to "qualified institutional buyers", as defined in Rule 144A under the Securities Act in reliance upon the exemption from the registration requirements of the Securities Act provided by Rule 144A, or outside the United States in accordance with Regulation S under the Securities Act. DLJ received $6,000,000 in discounts and commissions in connection with the initial purchase of the Senior Notes. The Senior Notes are senior unsecured obligations of the Company and rank pari passu in right of payment with all current and future senior indebtedness of the Company. The Company's obligations under the Senior Notes are effectively subordinated to all existing and future secured indebtedness of the Company to the extent of the value of the assets securing such indebtedness and are structurally subordinated to all existing and future indebtedness, if any, of the Company's subsidiaries. Interest is payable semi-annually on May 15 and November 15 of each year commencing November 15, 1998. At any time on or before May 15, 2001, the Company may redeem for cash up to 33 1/3% of the original aggregate principal amount of the Senior Notes at a redemption price of 111% of the principal amount thereof, in each case, plus any accrued and unpaid interest thereon to the redemption date, with the net proceeds of a public equity offering provided that at least 66 2/3% of the original aggregate principal amount of the Senior Notes remains outstanding immediately after the occurrence of such redemption. After May 15, 2002, the Senior Notes will be subject to redemption for cash at the option of the Company, in whole or in part, at a redemption prices ranging from 105.5% of face amount beginning May 15, 2002 to 100% on and after May 15, 2004.
The aggregate proceeds of the above Financing of $710 million were utilized, in part, to retire the Bridge Notes, make capital contributions to certain regulated subsidiaries and pay fees and expenses approximating $39 million related to the transactions. The balance has been and will be used for future subsidiary capital contributions, as necessary, and for general corporate purposes. The Company believes that the above described proceeds will be sufficient to finance the capital needs referred to previously and to provide additional capital for losses or contingencies in excess of the Company's current expectations. However, there can be no assurance that such proceeds will be sufficient to finance such capital needs and to provide additional capital for losses or contingencies in excess of the Company's current expectations.
The Company is required to submit periodic reports regarding Year 2000 compliance to certain of the regulatory authorities which regulate its business. The Company is in compliance with such Year 2000 reporting requirements. Such regulatory authorities have also asked the Company to submit to certain audits regarding its Year 2000 compliance.
The Company is in the process of completing the modifications of its computer systems to accommodate the Year 2000 and will undertake testing to ensure its systems and applications will function properly after December 31, 1999. The Company currently expects this modification and testing to be completed in a time frame to avoid any material adverse effect on operations. The Company has deferred certain other information technology initiatives to concentrate on its Year 2000 compliance efforts but the Company believes that such deferral is not reasonably likely to have a material adverse effect on the Company's financial condition or results of operations. The Company's inability to complete Year 2000 modifications on a timely basis or the inability of other companies with which the Company does business to complete their Year 2000 modifications on a timely basis could adversely affect the Company's operations.
The Company expects to incur associated expenses of approximately $5 million in 1999 to complete this effort. As of December 31, 1998, the Company had incurred approximately $9.8 million of expenses in connection with its Year 2000 compliance efforts. The costs of the project and the date on which the Company
plans to complete the necessary Year 2000 modifications are based on management's best estimate, which include assumptions of future events including the continued availability of certain resources. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those plans.
The Company has contracted with an external consulting firm to assist in the generation of a Year 2000 contingency plan in the event compliance is not achieved. In connection therewith, the Company has begun to identify reasonably likely scenarios which could arise in the event of the Company's Year 2000 noncompliance. The Company has completed a contingency strategy and will develop detailed plans to support this strategy. The Company expects to be substantially complete with these detailed plans by the second quarter of 1999. However, there can be no assurance that this contingency plan will be completed on a timely basis or that such a plan will protect the Company from experiencing a material adverse effect on its financial condition or results of operations.