<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
{X} Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the period ended MARCH 31, 1999
or
{ } Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from ____________________ to ______________________
Commission File Number : 333-2796
CERULEAN COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Georgia 58-2217138
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3350 Peachtree Road, N.E., Atlanta, Georgia 30326
(Address of principal executive offices) (Zip Code)
(404) 842-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class: Class A Convertible Common Stock, no par value, $0.01 stated value.
Outstanding as of April 30, 1999 - 409,392 shares
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CERULEAN COMPANIES, INC.
FORM 10-Q
MARCH 31, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
NUMBER
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of March 31, 1999 and Page 3
December 31, 1998
Consolidated Statements of Income for the Three Months Ended Page 4
March 31, 1999 and 1998
Consolidated Statements of Comprehensive Income for the Page 4
Three Months Ended March 31, 1999 and 1998
Consolidated Statements of Cash Flows for the Three Months Page 5
Ended March 31, 1999 and 1998
Notes to Consolidated Financial Statements Page 6
Item 2. Management's Discussion and Analysis of Financial Condition Page 10
and Results of Operations
Item 3. Quantitative and Qualitative Disclosure About Market Risk Page 14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Page 15
Item 2. Changes in Securities Page 15
Item 3. Defaults Upon Senior Securities Page 15
Item 4. Submission of Matters to a Vote of Security Holders Page 15
Item 5. Other Information Page 15
Item 6. Exhibits and Reports on Form 8-K Page 15
Signatures Page 17
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CERULEAN COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Investments:
Fixed maturities:
Available-for-sale, at fair value (amortized cost: $239,989,286;
$235,441,231) $240,211,612 $239,548,185
Equity securities, at fair value (cost: $51,756,387; $55,866,571) 72,242,173 76,906,525
Short-term investments, at fair value (cost: $4,613,585; $9,215,878) 4,381,065 9,215,878
------------ ------------
Total investments 316,834,850 325,670,588
Cash and cash equivalents 66,467,856 52,159,196
Accounts receivable 69,700,695 61,777,995
Reimbursable portion of estimated benefit liabilities 51,992,000 47,816,000
FEP assets held by agent 38,786,536 38,786,536
Property and equipment 37,042,428 36,898,538
Other assets 25,663,831 24,232,739
------------ ------------
Total assets $606,488,196 $587,341,592
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Estimated benefit liabilities $193,040,493 $184,075,293
Unearned premiums 10,060,280 16,077,960
FEP stabilization reserve 38,786,536 38,786,536
Accounts payable and accrued expenses 46,835,886 43,893,056
Other liabilities 50,176,655 42,184,663
------------ ------------
Total liabilities 338,899,850 325,017,508
------------ ------------
Mandatorily redeemable preferred stock:
Class B Convertible Preferred Stock, no par value.
Authorized, issued and outstanding, 49,900 shares at March 31,
1999 and December 31, 1998; aggregate liquidation preference
$49,900,000; aggregate mandatory redemption, $44,910,000 46,645,042 46,645,042
------------ ------------
Shareholders' equity:
Blank Preferred Stock, no par value.
Authorized and unissued 100,000,000 shares -- --
Series A Preferred Stock, no par value, $0.01 stated value.
Authorized and unissued 64,000 shares -- --
Class A Convertible Common Stock, no par value, $0.01 stated value.
Authorized 50,000,000 shares; issued and outstanding 409,392 shares
at March 31, 1999 and December 31, 1998 4,094 4,094
Additional paid-in capital 45,188,422 45,188,422
Common Stock, no par value.
Authorized and unissued 100,000,000 shares -- --
Stock warrants exercisable 29,968,000 29,968,000
Accumulated other comprehensive income (unrealized
appreciation on securities, net of taxes) 16,020,592 19,596,908
Retained earnings 129,762,196 120,921,618
------------ ------------
Total shareholders' equity 220,943,304 215,679,042
Commitments and contingencies (Note 5) -- --
------------ ------------
Total liabilities and shareholders' equity $606,488,196 $587,341,592
============ ============
</TABLE>
See accompanying notes.
3
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CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
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Revenues:
Premium revenue $ 349,638,319 $ 280,560,210
Management services revenue 32,661,162 26,895,755
Investment and other income 4,724,347 3,798,597
Realized gains 1,863,462 3,001,846
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Total revenues 388,887,290 314,256,408
Benefits expense 298,626,942 243,422,370
Operating expenses 75,986,289 67,092,603
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Operating income 14,274,059 3,741,435
Non-operating income (Note 3) 63,750 63,750
------------- -------------
Income before income taxes and minority interests 14,337,809 3,805,185
Income tax expense (Note 4) 3,654,000 1,033,000
Minority interest in earnings of joint venture investments (429,398) (498,498)
------------- -------------
Net income $ 10,254,411 $ 2,273,687
============= =============
</TABLE>
See accompanying notes.
CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
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<S> <C> <C>
Net income $ 10,254,411 $ 2,273,687
Other comprehensive income, net of tax:
Unrealized holding (losses) gains arising during period, net of
reclassification adjustment for gains included in net income of
$1,490,769 and $2,401,477, respectively (3,576,316) 3,914,184
------------ ------------
Comprehensive income $ 6,678,095 $ 6,187,871
============ ============
</TABLE>
See accompanying notes.
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CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
------------ ------------
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OPERATING ACTIVITIES
Net income $ 10,254,411 $ 2,273,687
Adjustments to reconcile net income to net cash provided
by operating activities:
Non-cash and non-operating items:
Depreciation 2,602,441 2,561,742
Amortization 178,433 40,355
Uncollectible receivables 1,479,174 1,044,949
Gain on sale of investments (1,863,462) (3,001,846)
Loss (gain) on sale of property and equipment 2,973 (14,579)
Non-operating income (63,750) (63,750)
Increase in certain assets:
Accounts receivable (9,401,873) (6,918,328)
Reimbursable portion of estimated benefit liabilities (4,176,000) --
Other assets (336,093) (1,095,534)
Increase (decrease) in certain liabilities:
Estimated benefit liabilities 8,965,200 13,756,527
Unearned premiums (6,017,680) 421,453
Accounts payable and accrued expenses 2,942,830 1,046,131
Other liabilities 6,578,159 6,984,987
Minority interest in sale of stock warrants by a subsidiary (61,250) (61,250)
------------ ------------
Net cash provided by operating activities 11,083,513 16,974,544
INVESTING ACTIVITIES
Investments available-for-sale:
Investments purchased (69,592,911) (42,145,906)
Investments sold or matured 75,442,362 57,649,394
Property and equipment purchased (2,769,104) (3,225,729)
Property and equipment sold 19,800 43,757
------------ ------------
Net cash provided by investing activities 3,100,147 12,321,516
FINANCING ACTIVITIES
Sale of stock warrants by a subsidiary 125,000 125,000
Repayment of notes payable -- (3,500,000)
------------ ------------
Net cash provided by (used in) financing activities 125,000 (3,375,000)
------------ ------------
Increase in cash and cash equivalents 14,308,660 25,921,060
Cash and cash equivalents at beginning of period 52,159,196 35,001,855
------------ ------------
Cash and cash equivalents at end of period $ 66,467,856 $ 60,922,915
============ ============
</TABLE>
See accompanying notes.
5
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CERULEAN COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
UNAUDITED
1. SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Cerulean Companies, Inc. (the "Company") was incorporated under the laws of the
State of Georgia on February 2, 1996 to act as the holding company for Blue
Cross and Blue Shield of Georgia, Inc. ("BCBSGA") and other subsidiaries, and
for other lawful purposes.
BASIS OF PRESENTATION
The Company's accompanying unaudited consolidated financial statements have been
prepared in conformity with generally accepted accounting principles ("GAAP")
and require the use of management's estimates. As to the Company's managed care,
health and life insurance operations, GAAP varies in some respects from
statutory accounting practices permitted or prescribed by insurance regulatory
authorities. The Company's health care plan subsidiary, its health maintenance
organization and its life insurance subsidiary are subject to regulation by the
Georgia Insurance Department including minimum capital and surplus requirements
and restrictions on payment of dividends. Because of the nature of the Company's
operations, the results for interim periods are not necessarily indicative of
results expected for the entire year. In the opinion of management, all material
adjustments necessary for a fair presentation of the financial position and
results of operations for the interim periods presented have been made. All such
adjustments are of a normal recurring nature.
PRINCIPLES OF CONSOLIDATION
The Company's accompanying unaudited consolidated financial statements include
the accounts of the Company, BCBSGA and its wholly-owned life insurance
subsidiary, a health maintenance organization subsidiary, a non-insurance
subsidiary and community health partnership network joint ventures ("CHPNs").
All significant intercompany transactions and balances have been eliminated in
consolidation.
The Company owns at least 51% of the voting shares of each CHPN. Under certain
circumstances defined in the CHPN shareholder agreements, supermajority votes of
shareholders are required for amendment of the CHPN articles of incorporation;
liquidation of the CHPN; and issuance and repurchase of CHPN equity. The net
effect of supermajority votes in these circumstances results in consensus of the
shareholders, providing minority shareholders protective rights. Only the
Company is required under the CHPN agreements to provide required additional
capital. Future capital requirements of minority shareholders are limited or
prescribed. Profits of CHPNs are allocated to shareholders in accordance with
their respective stock ownership percentages. Losses are allocated in accordance
with ownership interests up to previously contributed capital; losses exceeding
such amounts are absorbed entirely by the Company.
POLICY ACQUISITION COSTS
A substantial portion of the Company's insurance contracts are for group health
and term life insurance for employer groups which are generally billed monthly,
based on the number of lives covered. Related commission costs for these
contracts are incurred as monthly premiums are collected. Certain policy
acquisition costs for individual life insurance contracts are deferred and
amortized over the life of the contracts, generally 25 to 30 years.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
2. EARNINGS PER SHARE
Earnings per share are omitted because such data is not meaningful at the
present time due to the likely dilutive events that will occur prior to the
conversion of the Class A Convertible Common Stock (the "Class A Stock") or the
Class B Convertible Preferred Stock. Presently there is no market for the Class
A Stock or any equity securities of the Company.
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3. INCOME TAXES
The Company's income tax expense consisted primarily of federal alternative
minimum tax. The effective tax rate for the 1999 period was impacted by CHPN
subsidiaries which incurred taxes at a 34% rate and which do not join in the
filing of the Company's consolidated tax return. Additionally, contributing to
the higher rate were state income taxes and other permanent book to tax
differences, including non-deductible expenses.
4. BUSINESS SEGMENT, CUSTOMER AND PRODUCT INFORMATION
The Company operates predominantly in one industry segment, health insurance
products and services, and reports its operations as one business segment. The
Company's products and services are sold principally in the State of Georgia. A
significant portion of its customer base is concentrated with companies that are
located in the metropolitan Atlanta area.
The Company's premium revenue and management services revenue by primary product
groups are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
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<S> <C> <C>
Indemnity and PPO insurance products and services $221,476,649 $188,425,746
HMO and POS insurance products and services 156,320,936 115,165,432
Life insurance and other products and services 4,501,896 3,864,787
------------------------------
Total $382,299,481 $307,455,965
==============================
</TABLE>
5. COMMITMENTS AND CONTINGENCIES
PROPOSED MERGER
On July 9, 1998, the Company entered into an agreement and plan of merger (the
"Merger Agreement") with WellPoint Health Networks Inc. ("WellPoint") and a
subsidiary of WellPoint. Pursuant to the Merger Agreement, the Company will
become a wholly-owned subsidiary of WellPoint. Finalization of the transaction
is subject to, among other things, the approval of the shareholders of the
Company, the approval of the Commissioner of Insurance of the State of Georgia,
the approval of the Blue Cross and Blue Shield Association and certain approvals
of the Health Care Financing Administration. Upon closing the transaction,
shareholders of the Company will exchange their shares for WellPoint shares or
cash in a transaction valued at $500 million.
LEGAL PROCEEDINGS
On December 17, 1998, Plaintiffs Rickey Underhill, Jim Kerscher, Janice Young,
Richard Collins, Greg Lane and Keith Page, individually and on behalf of all
others similarly situated (collectively, the "Bartow County Plaintiffs"), filed
a lawsuit against the Company and BCBSGA in the Superior Court of Bartow County
("the Court of Bartow"), State of Georgia, bearing Civil Action File No.
CV98-2656. The Bartow County Plaintiffs identify themselves as six individuals
who were entitled to receive shares of the Company's stock in connection with
the conversion of BCBSGA from a non-profit corporation to a regular business
corporation. The Bartow County Plaintiffs assert claims for specific
performance, breach of provisions of the Insurance Code of Georgia, and request
declaratory judgment and certification of a class action consisting of all
persons who were "eligible subscribers" of the Company on September 1, 1995, but
who did not become holders of Class A Stock of the Company because their
eligible coverage terminated prior to February 1, 1996. The Bartow County
Plaintiffs allege that they and the members of the purported class are entitled
to receive shares of Class A Stock in the Company. The Bartow County Plaintiffs
allege alternatively that offering materials disseminated by BCBSGA during 1996
relating to Class A Stock of the Company were not disseminated to the Bartow
County Plaintiffs and that the Bartow County Plaintiffs and the purported class
members are entitled to an award of damages in excess of $2.5 million. On
January 28, 1999, the Company and BCBSGA filed answers and a motion to dismiss.
On March 11, 1999, counsel to the Company and BCBSGA argued the motion to
dismiss. No ruling on this motion has been rendered. Management
7
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5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEGAL PROCEEDINGS (CONTINUED)
of the Company believes the case to be without merit and, in any event, believes
that its impact on the assets of the Company, if any, would not be material.
On September 18, 1998, Plaintiffs Allen Saravuth, Nga Nguyen, Chansamone
Sengsavath and Fatana Pirzad, individually and on behalf of all others similarly
situated (collectively, the "Richmond County Plaintiffs), filed a lawsuit
against the Company, BCBSGA, James L. Laboon, Jr., Fred L. Tolbert, Jr., Richard
D. Shirk, James E. Albright, W. Daniel Barker, Elizabeth W. Camp, Louis H.
Felder, M.D., Edward M. Gillespie, Joseph D. Greene, Mel H. Gregory, Jr., Frank
J. Hanna, III, R. Pierce Head, Jr., Charles H. Keaton, James H. Leigh, Jr.,
M.D., Julia L. Mitchell-Ivey, Charles R. Underwood, M.D., W. Jerry Vereen, A.
Max Walker, Dan H. Willoughby, M.D., Joe M. Young, and John B. Zellars
(collectively, the "Defendant Directors") in the Superior Court of Richmond
County ("the Court of Richmond"), State of Georgia, bearing Civil Action File
No. 98-RCCV-806. In addition, the Richmond County Plaintiffs filed a Motion for
Temporary Restraining Order and Interlocutory Injunctive Relief, which was heard
and denied by the Court of Richmond on September 21, 1998. The Richmond County
Plaintiffs identify themselves as four individuals who were entitled to receive
shares of the Company's stock in connection with the conversion of BCBSGA from a
non-profit corporation to a regular business corporation (the "Conversion"). The
Richmond County Plaintiffs assert claims for specific performance, fraud, breach
of provisions of the Insurance Code of Georgia, breach of fiduciary duty, and
requested declaratory judgment and certification of a class action consisting of
all persons who were "eligible subscribers" of BCBSGA as of February 1, 1996,
and who did not become holders of Class A Stock of the Company. The Richmond
County Plaintiffs allege that they and the members of the purported class are
entitled to receive shares of Class A Stock in the Company. The Richmond County
Plaintiffs allege alternatively that offering materials disseminated by BCBSGA
during 1996 relating to Class A Stock of the Company contained materially
misleading and deceptive statements and omissions and that the Richmond County
Plaintiffs and the purported class members are entitled to an award of damages
in excess of $100 million. The Richmond County Plaintiffs also assert derivative
causes of action against the Defendant Directors alleging that the Defendant
Directors breached fiduciary duties by, among other things, approving the
placement and issuance of Class B Stock in the Company during 1996, the issuance
of Class A Stock in the Company, the settlement of the Let's Get Together, Inc.
et al. v. Insurance Commissioner, et al., Civil Action E-61714 (Superior Court
of Fulton County, Georgia) lawsuit, and certain management compensation. On
October 28, 1998, the Company and BCBSGA filed answers. Defendant Directors need
not file responsive pleadings until later. On December 9 and 10, 1998, a hearing
was held on the plaintiffs' request for declaratory ruling on the issue of
whether plaintiffs are properly shareholders of the Company and on December 17,
1998, the Superior Court ruled in favor of the plaintiffs. The Company filed an
appeal with the Georgia Supreme Court which accepted jurisdiction and granted
expedited treatment to the appeal. Oral argument was heard on March 8, 1999. On
May 3, 1999, the Georgia Supreme Court reversed the ruling of the Richmond
County Superior Court, holding that the Richmond County Superior Court erred in
considering and ruling upon the plaintiffs' claims. The Georgia Supreme Court
found that the Commissioner of Insurance of the State of Georgia (the "Georgia
Commissioner") had properly exercised his broad power of review over the
Conversion and that sufficient administrative remedies with the Georgia
Commissioner had been available to the plaintiffs during and following the
Conversion. The ruling confirms that only those eligible subscribers who
returned the necessary election form to become holders of Class A Stock in
connection with the Conversion are properly holders of Class A Stock as a result
of the Conversion. The plaintiffs may file with the Georgia Supreme Court a
motion for reconsideration of this decision any time through May 13, 1999.
Thereafter, if no motion is filed, or if filed and denied, the Georgia Supreme
Court's order will be remitted to the Richmond County Court, the injunction will
be lifted and the Company will then be free to complete and mail the Proxy
Statement/Prospectus to its Class A shareholders. If such a motion for
reconsideration is filed and granted, the Company anticipates that there would
be a further hearing by the Georgia Supreme Court on this matter, with an
additional decision.
The Company's Board of Directors has appointed a Special Litigation Committee to
review the derivative claims. On April 14, 1999, the Special Litigation
Committee reported to the Board of Directors that it had concluded that the
derivative claims were without substance. On May 5, 1999, the Company also filed
motions with the Richmond
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5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEGAL PROCEEDINGS (CONTINUED)
County Court to dismiss the remaining fraud claims of the named plantiffs.
Management of the Company believes the case to be without merit and, in any
event, believes that its impact, if any, on the assets of the Company would not
be material.
In the normal course of business, the Company is involved in and subject to
claims, contractual disputes and other uncertainties. Management, after
reviewing with legal counsel all of these actions and proceedings, believes that
the aggregate losses, if any, will not have a material effect on the Company's
financial position or results of operations.
6. SUBSEQUENT EVENTS
As described above at Note 5, on May 3, 1999, the Georgia Supreme Court rejected
the claims of the Richmond County Plaintiffs, ruling that they had ample
opportunity in the administrative process to challenge offering of shares in the
conversion and did not do so.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto. The Company's actual future
results could differ materially from its historical results, depending on, among
other factors, changing rates of utilization of medical services by its
enrollees and changing rates of medical service costs.
OVERVIEW
Cerulean Companies, Inc. (the "Company") was incorporated under the laws of the
State of Georgia on February 2, 1996 to act as the holding company for Blue
Cross and Blue Shield of Georgia, Inc. ("BCBSGA") and other subsidiaries, and
for other lawful purposes.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998
Premium revenues increased 25% to $349.6 million for the three months ended
March 31, 1999 from $280.6 million for the three months ended March 31, 1998.
HMO and POS premiums increased $40.2 million to $151.9 million for the three
months ended March 31, 1999 primarily as a result of a 21% increase in
membership and rate increases in the 1999 period. New sales, in-group growth,
and to a lesser extent, migrations from traditional indemnity products into HMO
and POS products, continued to drive HMO and POS insured membership growth to
375,000 members at March 31, 1999 from 310,000 members at March 31, 1998. HMO
and POS products accounted for 43% of premium revenues at March 31, 1999,
compared to 40% of premium revenues at March 31, 1998. Premium revenues for
indemnity and PPO products increased $28.3 million to $193.3 million for the
three months ended March 31, 1999 as a result of rate increases in 1999 and a
5% growth in the members served.
Management services revenue increased 21% to $32.7 million for the three months
ended March 31, 1999 compared to $26.9 million for the three months ended March
31, 1998, due primarily to increased administrative fee revenue from services
provided to self-funded employer groups, other third parties and network access
fees from other Blue Cross Blue Shield plans. Self-funded employer group
membership was 852,000 at March 31, 1999 compared to 890,000 at March 31, 1998
due to self-funded employer groups shifting to the national Interplan
Teleprocessing System for Blue Cross Blue Shield plans.
Realized gains on the sale of marketable securities of $1.9 million for the
three months ended March 31, 1999 were $1.1 million lower than gains realized
for the three months ended March 31, 1998. The magnitude of realized gains in
any period can fluctuate due to fixed income and equity market performance, as
well as timing of individual sale transactions, which are subject to decisions
made by the Finance Committee of the Company's Board of Directors or by
individual investment portfolio managers. Results in one period are not
necessarily indicative of results to be expected in the future.
The Company's medical loss ratio (benefits expense as a percentage of premium
revenue) improved to 85.4% for the three months ended March 31, 1999 from 86.8%
for the three months ended March 31, 1998. The loss ratio for HMO and POS
products improved to 84.3% for the first quarter of 1999 from 85.2% for the
first quarter of 1998; the loss ratio for indemnity and PPO products improved to
87.0% for the first quarter of 1999 from 88.5% for the comparable period of
1998. Loss ratios for the Company's products in 1999 improved over the same
period a year ago as a result of 1999 rate increases, medical cost improvement
actions and hospital contracting changes implemented in the last half of 1998.
Operating expenses increased 13% to $76.0 million for the first quarter of 1999
compared to the same period a year ago, while premium revenues increased 25%.
Operating expenses included $1.0 million and $1.1 million for Year 2000
Readiness costs for the first quarter 1999 and 1998, respectively. Additionally,
the 1999 period includes approximately $2.4 million in legal and other
professional expenses related to the pending merger with WellPoint and the
litigation referred to in Notes 5 and 6 of the Notes to Consolidated Financial
Statements (Unaudited).
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Operating expenses as a percentage of premium and management services revenue
improved to 19.9% for the three months ended March 31, 1999 compared to 21.8%
for the first quarter of 1998, due to a positive impact from premium increases
in the first quarter 1999 being realized at a rate higher than operating expense
increases.
The Company recorded tax expense of $3.7 million for the three months ended
March 31, 1999 compared to a tax expense of $1.0 million for the three months
ended March 31, 1998. The Company's effective tax rate in both periods consists
primarily of federal alternative minimum tax and state income taxes, adjusted
for the effect of other permanent book to tax differences, including non
deductible expenses and losses from CHPN subsidiaries that are not expected to
generate a tax benefit currently or in the foreseeable future.
As a result of the foregoing factors, net income increased to $10.3 million for
the three months ended March 31, 1999 from $2.3 million for the three months
ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The Company has both short-term and long-term liquidity needs and has structured
its investment portfolios accordingly. Short-term liquidity needs to fund
operating costs, as well as payment obligations to its customers, are met from
funds invested primarily in institutional money market accounts and short-term
government agency notes. Assets not required for short-term liquidity needs are
transferred to a portfolio of investments in the fixed income and equity
markets. This portfolio, which provides reserves for future payment obligations
and funds for long-term liquidity needs is managed by several independent
advisory firms. The Company's investment policies are designed to provide
liquidity to meet anticipated payment obligations, to preserve capital and to
maximize yield in conformance with all regulatory requirements. Over $309.0
million of the Company's investment portfolio is held at its insurance
subsidiaries and is invested subject to limitations prescribed by Georgia
insurance statutes.
Net cash provided by operating activities amounted to $11.1 million for the
three months ended March 31, 1999 compared to net cash provided by operating
activities of $17.0 million for the same period in 1998. Because of the nature
of the Company's business, current cash flows from operations for interim
periods are not necessarily indicative of cash flows from operations expected
for the entire year. The Company believes its future cash resources will be
adequate to meet its operating requirements.
Capital Resources
The Company has analyzed its information technology assets and is executing a
comprehensive plan to either modify or replace portions of its software and
hardware so that those systems will properly function when processing
information involving dates after 1999. Total year 2000 computer software
readiness costs are estimated at $15.6 million and are being funded through
operating cash flows. Through March 31, 1999, the Company has incurred $5.1
million in capital expenditures and has expensed $7.8 million as renovation
expenses when incurred, with $1.0 million expensed in the 1999 period. Remaining
Year 2000 capital expenditures and renovation expenses are estimated at $1.9
million and $0.8 million, respectively.
The Company anticipates that the principal elements of its future capital
requirements are information technology needs, product development, development
of potential medical access points, equity contributions to its CHPN joint
ventures and other subsidiaries and strategic acquisitions. The Company believes
future capital requirements can be met with a combination of (i) the Company's
current resources, (ii) cash flows from operations, (iii) borrowings and (iv)
potential debt or equity offerings. Management believes that the consummation of
the Merger will provide the Company with significant additional capital
alternatives.
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Year 2000 Computer Software Readiness
All companies that operate on mature computer software programs face the
difficult task of how to reprogram or replace their existing systems, which have
protocols that address dates in terms of two digits rather than four to define
the applicable year. Date sensitive software may recognize a date using "00" as
the year 1900 instead of the year 2000 (the "Year 2000 Issue"). The Company has
analyzed its systems and is executing a comprehensive plan to either modify or
replace portions of its software and hardware so that those systems will
properly function when processing information involving dates beyond December
31, 1999. The Company's plans to resolve the Year 2000 Issue involve the
following phases: (1) awareness and assessment, which includes identification of
significant business processes, facilities and third party dependencies
requiring a Year 2000 solution; (2) renovation, which includes updating and
modifying critical systems and business processes; (3) validation, which
includes testing of systems that have been updated or modified; (4)
implementation, which includes placing systems into production and comprehensive
testing to identify and resolve any remaining Year 2000 issues and (5)
contingency planning.
During 1997, the Company began its assessment of all systems that could be
significantly affected by the Year 2000 Issue. Detailed plans for renovation
were finalized in early 1998. The Company is scheduled to complete its
certification of Year 2000 renovation efforts by November 1, 1999 based on
mandated testing requirements from the Health Care Financing Administration
("HCFA"), Federal Employees Program ("FEP"), and the Blue Cross Blue Shield
Association. A more detailed description and status of Year 2000 activities as
of April 30, 1999 follows:
- - The Company's data center is already Year 2000 compliant; the Company
anticipates that all client server, desk top computers and software,
telephone and voice mail systems will be compliant by the end of June
1999.
- - The Company's claims processing, membership billing and primary payment
system, which currently handles over 70% of the Company's membership,
is renovated; certification testing and production implementation is
scheduled for completion by the end of June 1999.
- - The claims processing system for approximately 27% of the Company's
membership (representing the non-HMO membership for one of its largest
customers) is in the process of renovation and is scheduled for
production implementation by the end of August 1999. Certification
testing will be complete by November 1, 1999.
- - Expanded certification testing for the Company's other large customers,
including the FEP and for the national Interplan Teleprocessing System
(ITS) for BCBS plans will continue through November 1, 1999.
- - Medicare Part A processing system is renovated. Final certification
testing with HCFA will continue through November 1, 1999.
- - Electronic data interchange testing and implementation is scheduled for
completion during the third quarter.
- - During April 1999, the Company assessed certain other applications that
were initially identified as systems which did not require a Year 2000
solution to determine if circumstances have changed such that a Year
2000 solution would now be required. All identified systems will be
renovated and tested by the end of the third quarter.
- - Security systems and elevators in leased and owned facilities have been
certified by outside parties as Year 2000 compliant.
The Company utilizes both internal and external resources to renovate, replace,
test and implement the software and equipment to satisfy Year 2000 requirements.
The total cost of the Year 2000 changes is estimated at $15.6 million and is
being funded through operating cash flows. Through March 31, 1999, the Company
has incurred $5.1 million in capital expenditures and has expensed $7.8 million
with $1.0 million expensed in the 1999 period. Remaining Year 2000 costs are
estimated at $2.7 million and include $0.8 million of renovation expense. The
increase from $13.0 million, as reported in the Company's Form 10-K for the year
ended December 31, 1998, to $15.6 million relates to more complete cost
estimates for the renovation of the Company's largest customer and recently
identified incremental benefit design changes for a major customer that require
a Year 2000 solution. Costs of new software and hardware are included in capital
expenditures and will be amortized over three to five years.
The Company conducts business electronically with certain external parties,
including suppliers, customers, physicians, hospitals, financial infrastructures
and communications service companies. The Company has contacted
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substantially all of the external parties with which it interacts to determine
Year 2000 compliance issues. Certification testing with external parties began
in January 1999. Over 50% of the physicians and hospitals that provide health
care services to the Company's 1.6 million members reported that they were Year
2000 ready at the end of March 1999. Certification testing of interfaces with
vendors, suppliers, physicians and hospitals will continue through October. The
Company is also dependent on interfaces with several government agencies,
including HCFA and FEP. Although the Company continues to monitor the Year 2000
readiness of significant external parties, it cannot guarantee that the systems
of external parties upon which the Company depends will be Year 2000 ready.
Additionally, the Company uses external money managers to manage its investment
portfolio of publicly traded bonds and equity securities. Historically, the
Company has been dependent on its investment advisors to timely monitor
performance of its investment portfolio against predetermined benchmarks. The
effect of Year 2000 non-compliance by its investment advisors, any of the
national securities exchanges, certain financial institutions or the
corporations in which the Company has either a bond or stock investment is not
determinable. Non-compliance by these entities could have a material impact on
the Company's investment earnings which have accounted for a significant portion
of operating income over the last five years.
The Company has received independent reviews from third parties of all its Year
2000 compliance activities. At this time, neither the third party reviews nor
the Company's reviews have identified any business function which would suffer
from Year 2000 problems, if the Year 2000 plan is successfully implemented.
However, failure by the Company or a critical third party business partner to
correct a material Year 2000 problem could result in an interruption in the
Company's business activities and operations. Due to the general uncertainty
inherent in Year 2000 Issues, especially as the uncertainty relates to the
readiness of third parties, there can be no assurances that all potential
problems will be mitigated by the Company's Year 2000 readiness program. The
Company cannot determine the level of financial exposure relating to the
possibility of the inability of the Company or third party business partners to
address all pertinent Year 2000 issues.
In late 1998, the Company began contingency planning with a third party
consulting group in the event that all phases of its Year 2000 plan are not
completed. Risk mitigation actions will be identified by mid 1999. For those
risks which cannot be mitigated, the Company expects to identify specific
contingency actions by September 1999. Due to increased requirements for
contingency planning as required by HCFA, testing of the contingency plan has
been scheduled for completion during third quarter 1999.
The projected cost of the Year 2000 program and the expected completion dates
are based on management's best estimates, using numerous assumptions about
future events. The estimates may be updated as additional information becomes
available. There can be no guarantee that these estimates will be achieved;
actual results could differ materially from expected results.
COMMITMENTS AND CONTINGENCIES
See the description under the same caption in Note 5 to the Notes to
Consolidated Financial Statements (Unaudited), which description is incorporated
herein by reference.
FORWARD-LOOKING STATEMENTS
The matters discussed in this Form 10-Q contain certain forward-looking
statements made pursuant to the safe harbor provisions of Section 27A of the
Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934,
that represent the Company's expectations or beliefs including, without
limitation, statements concerning future revenue, future investment earnings and
value and certain Year 2000 information. Such statements involve risk and
uncertainties that may cause actual results to differ materially from those
implied in this Form 10-Q. Among other things, these risks and uncertainties
include: the need to accurately predict health care costs and the ability to
control future health care costs through product and benefit design,
underwriting criteria, utilization management and negotiation of favorable
provider and hospital contracts; changes in mandated benefits, utilization
rates, demographic characteristics, health care practices, inflation, new
pharmaceuticals and technologies, clusters of high-cost cases, response to the
regulatory environment and numerous other factors that are beyond the Company's
13
<PAGE> 14
control and may adversely affect its ability to predict and control health care
costs and claims; periodic renegotiation of hospital and other provider
contracts coupled with continued consolidation of physician, hospital and other
provider groups which may result in increased health care costs, limit the
Company's ability to negotiate favorable rates and control costs and subject the
Company to increased credit risk or risks of network stability related to
provider groups; competitive pressure to contain premium prices; fiscal concerns
regarding the continued viability of government-sponsored programs such as
Medicare and the potential of decreasing reimbursement rates for these programs;
and any other limitations on the Company's ability to increase or maintain its
premium levels, design products, select underwriting criteria or negotiate
competitive provider contracts. Other risk factors are described in the
Company's other Securities and Exchange Commission reports and filings.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
With a primary emphasis on protection of capital, the Board of
Directors-approved investment guidelines seek appropriate asset distribution,
diversification of risk, and use of professional external money managers to
manage levels of risk. The Company maintains two investment portfolios. The
Company does not hold derivative financial instruments or derivative commodity
instruments in either portfolio and has no foreign currency exposure. The
Company is subject to market risk exposure associated with changes in interest
rates and equity prices in its investment portfolios. A sensitivity analysis to
measure potential losses in the market value of the Company's fixed income and
equity investments in both portfolios (both portfolios are classified as other
than trading) indicates the following market risk exposures:
As of March 31, 1999, approximately 75.8% of the value ($240.2 million)
of the consolidated portfolios was held in financial instruments with
fixed maturities. The primary market risk exposure is to changes in
interest rates. An immediate one percentage point decrease in interest
rates would increase the net aggregate market value of the fixed income
portfolio by $9.0 million. An immediate one percentage point increase
in interest rates would decrease the net aggregate market value of the
fixed income portfolio by $9.0 million. Corporate Treasury manages
interest rate exposure by maintaining a short duration in its fixed
income portfolio. The modeling technique used by the Company considers
the net present value of cash flows (including duration estimates).
Short-term debt instruments, approximately 1.4% of the value ($4.4
million) of the consolidated portfolios, with a fair value equal to
their cost are excluded from the aggregate net market value market risk
exposure analysis.
The fair value of the common equity portfolio, excluding investments in
affiliated entities (2.1% of the common equity portfolio), was $70.7
million as of March 31, 1999. The equity portfolio is highly
diversified and limited to high quality domestic dividend paying
stocks. The primary market risk exposure is therefore an overall
decline in market prices for balanced portfolios composed of the equity
securities of seasoned domestic companies. Assuming an immediate 10%
decrease in each equity security price, the hypothetical pre-tax loss
in fair value is $7.3 million. Likewise, assuming an immediate 10%
increase in each equity security price, the hypothetical pre-tax gain
in fair value is $7.3 million. The Company's unrealized net gains and
losses are recorded net of taxes as accumulated other comprehensive
income in the Shareholders' equity section of the accompanying
Consolidated Financial Statements at Item 1 of this Form 10-Q.
The Company does not anticipate any material change in primary market risk
exposure during the remainder of 1999.
14
<PAGE> 15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Note 5 of the Notes to Consolidated Financial Statements (Unaudited) in Part I,
Item 1 regarding the lawsuit filed on December 17, 1998 in the Superior Court of
Bartow County by six plaintiffs on behalf of themselves and all others similarly
situated is incorporated herein by reference.
Notes 5 and 6 of the Notes to Consolidated Financial Statements (Unaudited) in
Part I, Item 1 regarding the lawsuit filed on September 18, 1998 in the Superior
Court of Richmond County is incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
2.1 Agreement and Plan of Merger, dated July 9, 1998, by and among Cerulean
Companies, Inc., WellPoint Health Networks, Inc. and Water Polo
Acquisition Corp.1
3.1 Amended Articles of Incorporation of Cerulean Companies, Inc.2
3.2 Bylaws of Cerulean Companies, Inc. 3
4.1 Stock Escrow Agreement among Cerulean Companies, Inc., Blue Cross and
Blue Shield of Georgia, Inc. and SunTrust Bank, Atlanta.3
4.2 Specimen form of Class A Convertible Common Stock certificate.3
27 Financial Data Schedule.*
</TABLE>
- -------------
*This exhibit is filed herewith.
(1) The Appendix A of Form S-4, Registration No. 333-64955, filed by WellPoint
Health Networks, Inc. on September 30, 1998 is incorporated herein by
reference.
(2) This exhibit to Form 10-Q filed on November 13, 1998 is incorporated herein
by reference.
(3) This exhibit to Form S-1, Registration No. 333-2796, filed on March 27,
1996 and subsequent amendments is incorporated herein by reference.
15
<PAGE> 16
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended March 31, 1999.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CERULEAN COMPANIES, INC.
Registrant
Date: May 13, 1999 By: /s/ Richard D. Shirk
-----------------------------------------
Richard D. Shirk, President and
Chief Executive Officer
Date: May 13, 1999 By: /s/ John A. Harris
-----------------------------------------
John A. Harris, Treasurer
17
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CERULEAN
COMPANIES, INC. ON FORM 10-Q FOR THE QUARTER ENDED AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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