<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 SEPTEMBER 30, 2000
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 : 000-22477
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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 October 31, 2000 - 409,602 shares
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CERULEAN COMPANIES, INC.
FORM 10-Q
SEPTEMBER 30, 2000
INDEX
<TABLE>
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PAGE
NUMBER
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2000 and Page 3
December 31, 1999
Consolidated Statements of Income for the Three and Nine Page 4
Months Ended September 30, 2000 and 1999
Consolidated Statements of Comprehensive Income for the Page 4
Three and Nine Months Ended September 30, 2000 and 1999
Consolidated Statements of Cash Flows for the Nine Months Page 5
Ended September 30, 2000 and 1999
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 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings Page 14
Item 2. Changes in Securities Page 14
Item 3. Defaults Upon Senior Securities Page 14
Item 4. Submission of Matters to a Vote of Security Holders Page 14
Item 5. Other Information Page 14
Item 6. Exhibits and Reports on Form 8-K Page 15
Signatures Page 16
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CERULEAN COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
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<S> <C> <C>
ASSETS (UNAUDITED)
Investments:
Fixed maturities:
Available-for-sale, at fair value (amortized cost: $296,514,199;
$265,875,467) $291,423,767 $256,844,521
Equity securities, at fair value (cost: $65,482,583; $55,204,793) 71,077,998 73,036,645
Short-term investments, at fair value (cost: $325,000; $325,000) 325,000 325,000
------------ ------------
Total investments 362,826,765 330,206,166
Cash and cash equivalents 92,691,703 58,522,617
Accounts receivable 93,985,905 76,424,058
Reimbursable portion of estimated benefit liabilities 56,109,000 47,002,000
FEP assets held by agent 27,537,527 26,749,038
Property and equipment 37,145,739 40,063,725
Other assets 37,847,890 33,110,191
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Total assets $708,144,529 $612,077,795
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Estimated benefit liabilities $245,158,544 $201,587,264
Unearned premiums 16,047,259 17,873,115
FEP stabilization reserve 27,537,527 26,749,038
Accounts payable and accrued expenses 70,135,748 50,723,056
Other liabilities 40,632,143 37,472,376
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Total liabilities 399,511,221 334,404,849
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Mandatorily redeemable preferred stock:
Class B Convertible Preferred Stock, no par value
Authorized, issued and outstanding, 49,900 shares at September 30, 2000 and
December 31, 1999; 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 409,602 and 409,597
shares at September 30, 2000 and December 31, 1999,
respectively 4,096 4,096
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) 411,317 7,258,906
Retained earnings 186,416,431 148,608,480
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Total shareholders' equity 261,988,266 231,027,904
Commitments and contingencies (Note 5) -- --
------------ ------------
Total liabilities and shareholders' equity $708,144,529 $612,077,795
============ ============
</TABLE>
See accompanying notes.
3
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CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Revenues:
Premium revenue $ 474,040,525 $373,529,191 $ 1,346,697,234 $1,089,413,073
Management services revenue 39,698,502 35,549,279 115,046,105 106,382,667
Investment and other income 6,971,353 4,619,303 18,315,065 14,799,331
Realized gains 1,193,553 726,954 6,615,932 5,708,592
------------- ------------ --------------- --------------
Total revenues 521,903,933 414,424,727 1,486,674,336 1,216,303,663
Benefits expense 411,719,491 328,437,470 1,172,757,713 957,282,081
Operating expenses 92,777,458 75,895,139 262,190,333 227,760,258
------------- ------------ --------------- --------------
Operating income 17,406,984 10,092,118 51,726,290 31,261,324
Non-operating income -- 63,750 -- 191,250
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Income before income taxes and
minority interests 17,406,984 10,155,868 51,726,290 31,452,574
Income tax expense (Note 3) 3,083,192 3,072,000 10,086,627 8,102,000
Minority interest in (earnings) losses
of joint venture investments (569,988) 895,816 (89,211) 1,002,784
------------- ------------ --------------- --------------
Net income $ 13,753,804 $ 7,979,684 $ 41,550,452 $ 24,353,358
============= ============ =============== ==============
</TABLE>
See accompanying notes.
CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
UNAUDITED
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Net income $ 13,753,804 $ 7,979,684 $ 41,550,452 $ 24,353,358
Other comprehensive income
(loss), net of tax:
Unrealized holding (losses)
gains arising during period,
net of reclassification
adjustment for gains
included in net income of
$954,842, $581,563,
$5,292,746 and $4,566,874,
respectively (1,303,180) (6,377,866) (6,847,589) (12,990,172)
------------- ------------ --------------- --------------
Comprehensive income $ 12,450,624 $ 1,601,818 $ 34,702,863 $ 11,363,186
============= ============ =============== ==============
</TABLE>
See accompanying notes.
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CERULEAN COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
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OPERATING ACTIVITIES
Net income $ 41,550,452 $ 24,353,358
Adjustments to reconcile net income to net cash provided
by operating activities:
Non-cash and non-operating items:
Depreciation 8,625,607 7,330,762
Amortization 192,076 576,674
Uncollectible receivables 3,461,388 263,790
Gain on sale of investments (6,615,932) (5,708,592)
Loss on sale of property and equipment 1,287 491,850
Non-operating income -- (191,250)
(Increase) decrease in certain assets:
Accounts receivable (21,023,235) (11,393,746)
Reimbursable portion of estimated benefit liabilities (9,107,000) 814,000
Other assets (3,291,028) (2,379,974)
Increase (decrease) in certain liabilities:
Estimated benefit liabilities 43,571,280 12,391,306
Unearned premiums (1,825,856) (4,959,812)
Accounts payable and accrued expenses 15,670,191 5,935,980
Other liabilities 3,159,767 (9,271,208)
Minority interest in sale of stock warrants by a
subsidiary -- (183,750)
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Net cash provided by operating activities 74,368,997 18,069,388
INVESTING ACTIVITIES
Investments available-for-sale:
Investments purchased (161,457,969) (128,413,874)
Investments sold or matured 126,966,966 130,136,772
Property and equipment purchased (6,787,239) (11,761,330)
Property and equipment sold 1,078,331 514,506
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Net cash used in investing activities (40,199,911) (9,523,926)
FINANCING ACTIVITIES
Sale of stock warrants by a subsidiary -- 375,000
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Net cash provided by financing activities -- 375,000
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Increase in cash and cash equivalents 34,169,086 8,920,462
Cash and cash equivalents at beginning of period 58,522,617 52,159,196
------------- -------------
Cash and cash equivalents at end of period $ 92,691,703 $ 61,079,658
============= =============
</TABLE>
See accompanying notes.
5
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CERULEAN COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
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 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 consolidated financial statements include the
accounts of the Company, BCBSGA and its wholly-owned life insurance subsidiary,
a health maintenance 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. The Company has
made additional capital contributions to certain CHPNs and may provide
additional capital in the future. 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.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform to the current
year presentation.
2. EARNINGS PER SHARE
Earnings per share is omitted because such data is not meaningful at the present
time due to 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 in all periods. The effective tax rates for the periods are impacted
by CHPN subsidiaries which incur taxes at a 34% rate and which do not join in
the filing of the Company's consolidated tax return, 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
2000 1999 2000 1999
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<S> <C> <C> <C> <C>
Indemnity and PPO insurance products
and services $277,768,719 $229,343,363 $ 806,543,759 $ 686,314,206
HMO and POS insurance products
and services 230,918,224 175,304,530 640,709,187 496,034,818
Life insurance and other products
and services 5,052,084 4,430,577 14,490,393 13,446,716
------------ ------------ -------------- --------------
Total $513,739,027 $409,078,470 $1,461,743,339 $1,195,795,740
============ ============ ============== ==============
</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. As of July 9, 1999, the parties agreed upon an
extension of the Merger Agreement until October 15, 1999 and, under certain
circumstances, December 31, 1999. Effective October 15, 1999, the parties agreed
to extend the Merger Agreement through December 31, 1999. On December 30, 1999,
the parties agreed to further extend the Merger Agreement through December 31,
2000. Pursuant to the Merger Agreement, the Company will become a wholly-owned
subsidiary of WellPoint in consideration for a combination of WellPoint common
stock and cash valued at $500 million. On June 25, 1999, the shareholders of the
Company approved the transaction. However, the merger with WellPoint has not
been completed. Because of the intervening time period since the prior approval,
the Company's Board of Directors resolicited proxies for the approval of the
merger. The shareholders reconfirmed their approval of the transaction at a
special meeting in lieu of an annual meeting held on October 10, 2000.
Finalization of the transaction is subject to, among other things, the approval
of the Commissioner of Insurance of the State of Georgia (the "Georgia
Commissioner"), the approval of the Blue Cross and Blue Shield Association and
certain approvals of the Health Care Financing Administration. The Blue Cross
and Blue Shield Association has already approved the merger. The Company expects
that the Georgia Commissioner will schedule a public hearing in connection with
the approval of the merger in December.
LEGAL PROCEEDINGS
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,
7
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5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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, State of Georgia, bearing Civil Action File
No. 98-RCCV-806 (the "Richmond County Lawsuit"). In addition, the Richmond
County Plaintiffs filed a Motion for Temporary Restraining Order and
Interlocutory Injunctive Relief, which was heard and denied by the Superior
Court of Richmond County 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
request 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 asserted
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 November 9, 1998, Harrell Tiller, Charlie Deal and Olean Lokey
joined the case as additional named plaintiffs. 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 of the appeal. The Company's Board of Directors 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 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 Georgia
Commissioner had 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 Richmond County Plaintiffs did not file a motion for reconsideration of the
Georgia Supreme Court's decision. On May 5, 1999, BCBSGA and the Company filed
motions for summary judgment on the Richmond County Plaintiffs' fraud claims. On
May 20, 1999, the Company and BCBSGA filed a motion for entry of judgment on all
remaining counts of the Richmond County Plaintiffs' Complaint. On May 28, 1999,
the Richmond County Plaintiffs filed a Second Amended and Restated Class Action
Complaint against the Company, BCBSGA and the Defendant Directors. In addition
to the factual allegations contained in the initial complaint, the Richmond
County Plaintiffs assert that certain persons, including Charlie Deal and Olean
Lokey, were entitled to be offered shares of stock in the Company but never
received an offer. The Richmond County Plaintiffs have asserted claims for
specific performance, deprivation of possession of personal property, fraud,
constructive fraud, direct and derivative claims based on breach of fiduciary
duty, and request declaratory and injunctive relief, damages, punitive damages,
and certification of a class action on behalf of all persons who were "eligible
subscribers" of BCBSGA as of February 1, 1996 who did not become holders of
Class A Stock of the Company. On July 29, 1999, the Superior Court of Richmond
County entered an order dismissing all claims against the Defendant Directors
without prejudice. On September 21, 1999, the Superior Court of Richmond County
entered orders denying the motions for summary judgment and the motion for entry
of judgment. On October 27, 1999, the Company and BCBSGA filed a motion for
reconsideration of the motion for entry of judgment.
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5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
On May 17, 1999, Harrell Tiller, Charlie Deal and Olean Lokey, who were among
the Richmond County Plaintiffs, filed two separate Petitions for Declaratory
Ruling (the "Petitions") before the Georgia Commissioner, seeking a declaration
from the Georgia Commissioner that they, and others similarly situated, should
have been issued shares of Class A Stock. On June 22, 1999, the Georgia
Commissioner entered orders on the Petitions denying the relief sought. On June
24, 1999, Harrell Tiller, Charlie Deal and Olean Lokey filed two separate
Petitions for Judicial Review in the Superior Court of Richmond County. In these
cases, styled In Re: Harrell Tiller, individually and on behalf of all others
similarly situated v. Commissioner of Insurance of the State of Georgia, Civil
Action No. 1999-RCCV-471 and In Re: Charlie Deal and Olean Lokey, individually
and on behalf of all others similarly situated v. Commissioner of Insurance of
the State of Georgia, Civil Action No. 1999-RCCV-470, the Petitioners sought
judicial review of the decisions of the Georgia Commissioner of June 22, 1999
(the "Judicial Review Proceedings"). On September 21, 1999, the Superior Court
of Richmond County entered orders reversing the Georgia Commissioner's orders.
On October 12, 1999, the Company and BCBSGA filed Applications for Discretionary
Appeal (the "Applications") with the Supreme Court of Georgia, seeking to have
that court reverse the Superior Court of Richmond County's decisions. These
Applications were transferred to the Court of Appeals of the State of Georgia on
November 12, 1999. On October 21, 1999, the Georgia Commissioner filed two
separate applications for appellate relief from the Superior Court's decisions
with the Court of Appeals of the State of Georgia, seeking to have that court
overturn the Superior Court's decisions. On November 22, 1999, the Georgia Court
of Appeals granted the Applications for Discretionary Appeal of all parties. The
cases were docketed on December 15, 1999, and the parties fully briefed the
cases. On June 29, 2000, the Court of Appeals entered a decision affirming the
earlier decision by the Georgia Commissioner which had held that the Petitioners
were not entitled to relief. On July 19, 2000, the Petitioners filed a Petition
for Writ of Certiorari in the Georgia Supreme Court, which remains pending. On
August 1, 2000, the plaintiffs filed a motion in the Richmond County Superior
Court seeking to enforce a purported settlement of the litigation with the
Company. The Company notified the plaintiffs in writing that the Company
considers the claims in this motion to be frivolous and to constitute abusive
litigation under Georgia law and that the Company intends to seek damages and
attorneys' fees against the plaintiffs, and their counsel, if they do not
withdraw the motion.
On October 6, 2000, the Company announced the settlement of the Richmond County
Lawsuit and the Judicial Review Proceedings. The settlement agreement provides
for payment of certain expenses by WellPoint, along with a payment of $5 million
by WellPoint, which will be payable after the closing of the merger between
WellPoint and the Company. The settlement payment will be distributed to class
members and their attorneys pursuant to the terms of an order of the Superior
Court of Richmond County. On November 2, 2000, the Superior Court of Richmond
County held a fairness hearing and approved the settlement and entered a final
judgment. A hearing to approve the plaintiffs' request for attorneys' fees out
of the settlement proceeds has been scheduled for November 7, 2000. The
settlement agreement may be terminated by the Company if the closing of the
merger with WellPoint does not occur. The terms of the merger are unaffected by
the settlement.
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.
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 September 30, 2000 Compared to Three Months Ended September
30, 1999
Premium revenues increased $100.5 million to $474.0 million for the three months
ended September 30, 2000 from $373.5 million for the three months ended
September 30, 1999. HMO and POS premiums increased $54.9 million to $225.3
million for the three months ended September 30, 2000 primarily as a result of a
15% increase in members served during each quarter and rate increases in the
2000 period. Premium revenues for indemnity and PPO products increased $44.9
million to $243.7 million for the three months ended September 30, 2000 as a
result of rate increases in 2000 and a 12% growth in the members served.
Management services revenue increased 12% to $39.7 million for the three months
ended September 30, 2000 compared to $35.5 million for the three months ended
September 30, 1999, due primarily to increased administrative fee revenue from
services provided to self-funded employer groups and other third parties and
network access fees from other Blue Cross Blue Shield plans.
Realized gains on the sale of marketable securities were $1.2 million and $0.7
million for the three months ended September 30, 2000 and 1999, respectively.
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 86.9% for the three months ended September 30, 2000 from
87.9% for the three months ended September 30, 1999. The improved loss ratios
for the Company's products for the quarter ended September 30, 2000 is primarily
attributable to pricing increases and changes in benefit designs implemented
since September 1999 and increased membership in products with lower cost
benefit designs.
Operating expenses increased 22% to $92.8 million for the third quarter of 2000
compared to the same period a year ago, while premium and management services
revenues increased 26%. As a result, operating expenses as a percentage of
premium and management services revenue improved to 18.1% for the three months
ended September 30, 2000 compared to 18.6% for the third quarter of 1999.
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, operating income increased to $17.4
million for the three months ended September 30, 2000 from $10.2 million for the
three months ended September 30, 1999. The Company recognized
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net income of $13.8 million for the quarter ended September 30, 2000 compared to
net income of $8.0 million for the quarter ended September 30, 1999.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30,
1999
Premium revenues increased 24% to $1,346.7 million for the nine months ended
September 30, 2000 from $1,089.4 million for the nine months ended September 30,
1999. HMO and POS premiums increased 30% to $624.4 million for the nine months
ended September 30, 2000 primarily as a result of a 17% increase in members
served and rate increases effective during the 2000 period. New sales, in-group
growth, and a low cancellation rate, drove HMO and POS insured membership to
473,000 members at September 30, 2000 from 400,000 members at September 30,
1999. Premium revenues for indemnity and PPO products increased 19% to $707.8
million, for the nine months ended September 30, 2000 as a result of rate
increases in 2000 and a 13% growth in the members served.
Management services revenue increased 8% to $115.0 million for the nine months
ended September 30, 2000 compared to $106.4 million for the nine months ended
September 30, 1999, due primarily to increased administrative fee revenue from a
higher number of members administered under self-funded employer groups and
other third parties and network access fees from other Blue Cross Blue Shield
plans. Self-funded employer group membership was 886,000 at September 30, 2000,
compared to 857,000 members at September 30, 1999 principally due to a 19%
increase in commercial self-funded employer group members served offset by a 8%
decline in members serviced under state government programs and national service
accounts for other Blue Cross Blue Shield plans.
Membership served under insurance products and management services arrangements
totaled 1,843,000 at September 30, 2000 compared to 1,677,000 members at
September 30, 1999.
Realized gains on the sale of marketable securities were $6.6 million and $5.7
million for the nine months ended September 30, 2000 and 1999, respectively. 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 87.1% for the nine months ended September 30, 2000 down
from 87.9% for the nine months ended September 30, 1999. The improvement in the
loss ratios for the Company's products for the nine months ended September 30,
2000 is primarily attributable to pricing increases implemented in 2000, changes
in benefit designs such as increased co-pays, improvement in claims trends from
prior year's claims estimates and increased membership in products with lower
cost benefit designs offset by medical cost trend increases for hospital
services and prescription drugs.
Operating expenses increased 15% to $262.2 million for the nine months ended
September 30, 2000 compared to the same period a year ago, while premium and
management services revenues increased 22%. Due to the positive impact from
revenue increases in 2000 being realized at a rate higher than operating expense
increases, operating expenses as a percentage of premium and management services
revenue improved to 17.9% for the nine months ended September 30, 2000 compared
to 19.0% for the nine months ended September 30, 1999. Operating expenses
included $1.1 million and $7.8 million in legal and other professional expenses
related to the pending merger with WellPoint and the litigation referred to in
Note 5 of the Notes to Consolidated Financial Statements (Unaudited) for the
nine months ended September 30, 2000 and 1999, respectively. Additionally, the
1999 period included approximately $3.6 million for Year 2000 readiness costs.
The Company recorded tax expense of $10.1 million for the nine months ended
September 30, 2000 compared to a tax expense of $8.1 million for the nine months
ended September 30, 1999. 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.
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As a result of the foregoing factors, net income increased to $41.6 million for
the nine months ended September 30, 2000 from $24.4 million for the nine months
ended September 30, 1999.
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 $351.8 million of the Company's
investment portfolio is held at its insurance subsidiaries and is invested
subject to limitations prescribed by Georgia insurance statutes.
The Company generated positive cash flow from operations of $74.4 million for
the nine months ended September 30, 2000 and $18.1 million for the same period
in 1999 due primarily to profitability in both periods and to increased levels
of operating liabilities such as estimated benefit liabilities and accounts
payable. Investment purchases exceeded investments sold by $40.2 million during
the nine months ended September 30, 2000. Cash and cash equivalents increased
$34.2 million for the period. 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 anticipates that the principal elements of its future capital
requirements are information technology needs, product development, 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 with WellPoint will
provide the Company with significant additional capital alternatives.
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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
With a primary emphasis on adherence to statutory compliance and 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 September 30, 2000, approximately 80% of the value ($291.4 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 $8.9 million. Comparatively, at December 31, 1999, 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 $9.1
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 0.1% of the
value ($0.3 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 (less than 1% of the common equity portfolio), was
$70.5 million as of September 30, 2000. The equity portfolio is highly
diversified and limited by Georgia statute 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 $7.1 million. Likewise, assuming an immediate 10% increase in
each equity security price, the hypothetical pre-tax gain in fair value is
$7.1 million. Comparatively, at December 31, 1999, 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 2000.
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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 September 18, 1999 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
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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, 1999, by and among Cerulean
Companies, Inc., WellPoint Health Networks Inc. and Water Polo
Acquisition Corp.(1)
2.2 First Amendment to Agreement and Plan of Merger, dated July 9, 1999, by
and among Cerulean Companies, Inc., WellPoint Health Networks Inc. and
Water Polo Acquisition Corp.(2)
2.3 Second Amendment to Agreement and Plan of Merger, dated December 31,
1999, by and among Cerulean Companies, Inc., WellPoint Health Networks
Inc. and Water Polo Acquisition Corp.(3)
3.1 Amended Articles of Incorporation of Cerulean Companies, Inc.(4)
3.2 Bylaws of Cerulean Companies, Inc.(5)
4.1 Stock Escrow Agreement among Cerulean Companies, Inc., Blue Cross and
Blue Shield of Georgia, Inc. and SunTrust Bank, Atlanta.(5)
4.2 Specimen form of Class A Convertible Common Stock certificate.(5)
27 Financial Data Schedule (for SEC use only).*
</TABLE>
---------------
* This exhibit is filed herewith.
(1) The Appendix A of the Form S-4 Registration Statement, Registration No.
333-64955, filed by WellPoint Health Networks Inc. on September 30,
1999 is incorporated herein by reference.
(2) This exhibit to the Company's Form 10-Q filed on August 16, 1999 is
incorporated herein by reference.
(3) This exhibit to the Company's Form 10-K for the fiscal year ended
December 31, 1999, filed on March 29, 2000 is incorporated herein by
reference.
(4) This exhibit to the Company's Form 10-Q for the quarterly period ended
September 30, 1999, filed on November 13, 1999, is incorporated herein
by reference.
(5) This exhibit to the Company's Form S-1 Registration Statement,
Registration No. 333-2796, filed on March 27, 1996 and subsequent
amendments is incorporated herein by reference.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K dated July 27, 2000. This filing was made
in connection with the lawsuit described in Note 5 to the Consolidated Financial
Statements in Part I, Item 1 which is incorporated herein by reference.
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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: November 10, 2000 By: /s/ Richard D. Shirk
--------------------------------
Richard D. Shirk, President and
Chief Executive Officer
Date: November 10, 2000 By: /s/ John A. Harris
--------------------------------
John A. Harris, Treasurer
16
