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 quarterly period ended March 31, 1998
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 No. 0-21684
THE WELLCARE MANAGEMENT GROUP, INC.
(Exact Name of Registrant as specified in its charter)
NEW YORK 14-1647239
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization Identification Number)
PARK WEST/HURLEY AVENUE EXTENSION, KINGSTON, NY 12401
(Address of principal executive offices) (Zip Code)
(914) 338-4110
(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
requiring to file such report(s), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
The number of Registrant's shares outstanding on May 1, 1998 was 5,295,367
shares of Common Stock, $.01 per value, and 1,004,025 shares of Class A Common
Stock, $.01 par value.
Page 1 of 32 Pages
Exhibit Index on Page 29
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
INDEX TO FORM 10-Q
Page
----
PART 1 - CONSOLIDATED FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets at March 31, 1998
and December 31, 1997 3
Consolidated Statements of Operations for the
Three Months Ended March 31, 1998 and 1997 5
Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 1998 and 1997 6
Consolidated Statements of Shareholders' Equity
for the Three Months Ended March 31, 1998 8
Notes to Consolidated Financial Statements 9
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 20
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 25
Item 2 Changes in Securities 26
Item 3 Defaults Upon Senior Securities 27
Item 4 Submission of Matters to a
Vote of Security Holders 27
Item 5 Other Information 27
Item 6 Exhibits and Reports on Form 8-K 27
Signatures 28
Index to Exhibits 29
2
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
MARCH 31, DECEMBER 31,
1998 1997
--------- -----------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents $ 1,970 $ 3,368
Short-term investments -
available for sale 103 103
Accounts receivable (net
of allowance for doubtful
accounts of $2,753 in 1998
and $2,422 in 1997) 7,068 6,802
Notes receivable (net of
allowance for doubtful
accounts of $5,761 in 1998
and $5,441 in 1997) 774 679
Advances to participating providers 3,462 2,860
Other receivables (net of allowances
for doubtful accounts of $1,342 in
1998 and $1,137 in 1997) 4,453 4,873
Taxes receivable 284 284
Deferred tax asset 3,927 3,927
Prepaid expenses and other
current assets 662 522
------- -------
TOTAL CURRENT ASSETS 22,703 23,418
------- -------
PROPERTY AND EQUIPMENT (net of
accumulated depreciation and
amortization of $6,857 in 1998
and $6,528 in 1997) 11,108 11,094
OTHER ASSETS:
Restricted cash 5,771 5,771
Notes receivable (net of allowance
for doubtful accounts of $2,358
in 1998 and $2,655 in 1997) 28 122
Preoperational costs (net of
accumulated amortization of
$2,886 in 1998 and $2,562 in 1997) 1,115 1,440
Other non-current assets (net of
allowance for doubtful accounts
of $1,010 in 1998 and $1,133 in
1997 and accumulated amortization
of $963 in 1998 and $869 in 1997) 3,438 3,302
Goodwill (net of accumulated
amortization of $2,504 in 1998
and $2,339 in 1997) 7,226 7,391
------- -------
TOTAL $51,389 $52,538
======= =======
3
<PAGE>
MARCH 31, DECEMBER 31,
1998 1997
--------- -----------
(unaudited)
LIABILITIES AND SHAREHOLDERS'
EQUITY/(DEFICIENCY IN ASSETS)
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,319 $ 618
Medical costs payable 17,406 16,199
New York State demographic pool 150 1,122
Accounts payable 1,144 1,188
Accrued expenses 2,843 3,722
Unearned income 6,614 5,684
------- -------
TOTAL CURRENT LIABILITIES 29,476 28,533
LONG-TERM LIABILITIES:
Long-term debt 24,982 25,856
------- -------
TOTAL LIABILITIES 54,458 54,389
------- -------
COMMITMENTS AND CONTINGENCIES -- --
SHAREHOLDERS' EQUITY/(DEFICIENCY
IN ASSETS)
Class A Common Stock ($.01 par
value; 1,119,015 and 1,199,015
shares authorized; 1,004,025
and 1,084,025 shares issued
and outstanding at March 31, 1998
and December 31, 1997, respectively) 10 11
Common Stock ($.01 par value;
20,000,000 shares authorized,
5,308,217 and 5,228,217 shares
issued at March 31, 1998 and
December 31, 1997, respectively) 53 52
Additional paid-in capital 26,624 26,624
Accumulated deficit (36,205) (34,987)
Statutory reserve 6,656 6,656
------- -------
2,138 (1,644)
Unrealized gain/(loss) on
short-term investments -- --
Less:
Notes receivable from shareholders 5 5
Treasury stock (at cost; 12,850
shares of Common Stock at
March 31, 1998 and December 31,
1997, respectively) 202 202
------- -------
TOTAL SHAREHOLDERS' EQUITY/(DEFICIENCY
IN ASSETS) (3,069) (1,851)
------- -------
TOTAL $51,389 $52,538
======= =======
See accompanying notes to consolidated financial statements.
4
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
---- ----
REVENUE:
Premiums earned $ 35,019 $ 33,830
Interest and investment income 268 326
Other income - net 277 122
-------- --------
TOTAL REVENUE 35,564 34,278
-------- --------
EXPENSES:
Medical expense 28,509 36,524
General and administrative
expenses 6,929 9,374
Depreciation and amortization
expense 912 945
Interest expense 432 437
-------- --------
TOTAL EXPENSES 36,782 47,280
-------- --------
LOSS BEFORE INCOME TAXES (1,218) (13,002)
BENEFIT FOR INCOME TAXES -- --
-------- --------
NET LOSS $ (1,218) $(13,002)
======== ========
LOSS PER SHARE - BASIC $ (0.19) $ (2.06)
======== ========
Weighted average shares of
Common Stock outstanding 6,299 6,298
======== ========
LOSS PER SHARE - DILUTED $ (0.19) $ (2.06)
======== ========
Weighted average shares of Common
Stock and Common Stock equivalents Not Not
outstanding Applicable Applicable
See accompanying notes to consolidated financial statements.
5
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
---- ----
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net loss $ (1,218) $(13,002)
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 912 945
Loss on sale of assets and others -- 1
Changes in assets and liabilities:
(Increase)/decrease in accounts
receivable - net (266) 2,708
Increase in medical costs payable 1,207 2,583
(Decrease)/increase in New York State
demographic pool (972) 3,426
Decrease in accounts receivable -
non-current - net 9 754
Decrease in other receivables 276 1,266
Decrease in accounts payable,
accrued expenses and other
current liabilities (924) (174)
Decrease in taxes receivable -- 1,186
(Increase)/decrease in prepaid
expenses and other (141) 91
Increase in unearned income 930 707
(Increase)/decrease in advances to
participating providers (602) 195
Decrease in other non-current
assets - excluding preoperational
costs and account and other
receivables -- 69
Other - net (94) (65)
-------- --------
NET CASH USED IN OPERATING
ACTIVITIES $ (883) $ (2,736)
-------- --------
6
<PAGE>
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
---- ----
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of equipment $ (342) $ (61)
Decrease in notes receivable -- 44
Sale of investments -- 385
Other investing activities -- 11
------- -------
NET CASH (USED IN)/PROVIDED BY
INVESTING ACTIVITIES: (342) 379
------- -------
CASH FLOW FROM FINANCING
ACTIVITIES:
Repayment of notes payable and
long-term debt (173) (202)
------- -------
NET CASH USED IN
FINANCING ACTIVITIES (173) (202)
NET DECREASE IN CASH AND
CASH EQUIVALENTS (1,398) (2,559)
CASH AND CASH EQUIVALENTS,
BEGINNING OF PERIOD 3,368 7,869
------- -------
CASH AND CASH EQUIVALENTS,
END OF PERIOD $ 1,970 $ 5,310
======= =======
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Income taxes paid $ -- $ --
Interest paid 388 418
See accompanying notes to consolidated financial statements.
7
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the Three Months Ended March 31, 1998
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Class A Additional
Common Common Paid-In (Accumulated Statutory
Stock Stock Capital Deficit) Reserve
------- ------ ------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE,
DEC 31, 1997 $ 11 $ 52 $26,624 $(34,987) $ 6,656
Net change of
valuation allowance
of short-term
investments
Conversion of Class
A Common to Common
Shares (1) 1
Net loss $ (1,218)
BALANCE,
MARCH 31, 1998 $ 10 $ 53 $26,624 $(36,205) $ 6,656
</TABLE>
<TABLE>
<CAPTION>
Total
Unrealized Shareholders'
Gain/(Loss) Notes Equity/
On Short-term Receivables- Treasury (Deficiency
Investments Shareholders' Stock in Assets)
------------- ------------- -------- ----------
<S> <C> <C> <C> <C>
BALANCE,
DEC 31, 1997 $ -- $ (5) $ (202) $(1,851)
Net change of
valuation allowance
on short-term
investments -- --
Conversion of Class
A Common to Common
Shares
Net loss (1,218)
BALANCE,
MARCH 31, 1998 $ -- $ (5) $ (202) $(3,069)
</TABLE>
See accompanying notes to consolidated financial statements.
8
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with the instructions to Form 10-Q and, accordingly, do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements and should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1997. In the opinion of management, the accompanying unaudited interim
financial statements contain all adjustments necessary to present fairly the
financial position at March 31, 1998, and the results of operations and cash
flows for the interim periods presented. Operating results for the interim
period are not necessarily indicative of results that may be expected for the
year ended December 31, 1998. Certain amounts in the 1997 financial statements
have been reclassified to conform to the 1998 presentation.
2. MEDICAL EXPENSE
a. During the 1997 year, the Company charged to medical expense approximately
$1.7 million relating to the New York State Insurance Department ("NYSID") audit
of the New York State market stabilization pool for the audit years 1993, 1994
and 1995, and for additional amounts due for the year 1996. The quarterly charge
or credit to medical expense was calculated based on NYSID's preliminary
assessment and the Company's ongoing discussions with NYSID. Subsequently, it
was determined that the final expense was $1.7 million. The recording of this
expense, by quarter in 1997, is as follows:
Q1 1997 $ 4.3 million
Q2 1997 (1.1) million
Q3 1997 (1.5) million
Q4 1997 --
Net 1997 $ 1.7 million
b. In April 1998, NYSID announced the distribution of approximately $110
million in accumulated pool funds to Health Plans to help offset losses
resulting from adverse selection of its products by high cost enrollees. These
pools had been established five years ago to reimburse Health Plans that covered
a higher than average number of sick people. The surplus relates to the years
1993 to 1996.
Based on verbal notification from NYSID, WCNY has recorded an $800,000 reduction
in medical expenses in the quarter ended March 31, 1998, with a corresponding
reduction in liability to the New York State demographic pool. As part of this
distribution, NYSID has limited 1998 individual and small group rate increases
to less than ten percent (10%).
9
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
c. In 1994, two entities which were predecessors to the regional health care
delivery networks (the "Alliances"/"IPAs") with which WellCare of New York, Inc.
("WCNY") contracted to provide health care services to WCNY's members, made
payments of approximately $2,879,000 to providers in connection with the close
out of the 1993 group risk accounts and to resolve certain disputed amounts
between the Company and certain providers, which payments might otherwise have
been made by the Company. Additionally, these entities paid approximately
$1,833,000 directly to the Company in payment of 1993 provider deficits which
would otherwise have been due to the Company directly from the providers. As
originally reported in its 1994 consolidated financial statements, the Company
recorded the $1,833,000 received as a reduction of medical expense, and the
Company did not record as medical expense, the $2,879,000 paid directly to the
providers by these entities.
Subsequently, in 1996, the Company's accounting personnel were informed that
Edward A. Ullmann, then Chairman of the Board, Chief Executive Officer and
President of the Company, had guaranteed, in his individual capacity, two loans
each in the amount of $2,700,000, made by banks to these two entities, the
proceeds of which were used to fund the aggregate payments of $4,712,000
referred to above.
The Company subsequently restated its 1994 consolidated financial statements to
reflect the higher medical expenses, and established a medical expense accrual.
As there were no specific accounts payable by the Company, this accrual is being
reduced concurrently with the pay down of the bank loans, with a simultaneous
reduction in medical expense. A reduction of medical expense of approximately
$435,000 was recorded in the first quarter of 1997. The remaining principal
balance, which is in default, is approximately $116,000 at May 11, 1998. The
Company's ability to reduce future medical expense by the remaining $116,000 is
contingent on this amount being paid.
d. WCNY had arrangements with several medical practices owned by the principal
shareholder of the Buyer (see Note 3) for the promotion of WCNY's access to
primary care medical services at these sites. As explained in Note 2e of Notes
to Consolidated Financial Statements in the 1997 Annual Report on Form 10-K,
WCNY has made advances to the practices ($150,000 in 1997, $2,388,763 in 1996
and $710,000 in 1995), and as a result of operating losses at the practices and
the uncertainty of their ability to repay these advances, WCNY had previously
reserved these receivables.
During the second half of 1997, the principal shareholder of the Buyer entered
negotiations to sell these medical practices to unrelated third parties. Due to
the continuing losses at these medical practices and their importance in
providing medical services to a significant number of WCNY members, WellCare
determined that it was in the best interests of WCNY's members and WellCare to
continue to subsidize the practices to avoid service disruptions to WCNY's
members. During the second half of 1997, approximately $583,000 was advanced by
WellCare to these practices
10
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
to meet operating expenses, which amounts have been expensed in 1997 as bad debt
expense. WellCare has advanced to the practices and expensed as bad debts an
additional $166,000 in the first quarter of 1998. Three of the practices have
been sold in 1998 and it is anticipated that the remaining medical practices
will be sold in the first half of 1998.
3. SALE OF WELLCARE MEDICAL MANAGEMENT, INC.
In June 1995, the Company contributed approximately $5.1 million to its then
wholly-owned subsidiary, WellCare Medical Management, Inc. ("WCMM"), which was
engaged in managing physician practices, and then sold the assets of WCMM for
cash of $.6 million and note receivable of $5.1 million. The buyer (the
"Buyer"), which had been newly formed to acquire WCMM, is in the business of
managing medical practices and providing related consultative services, and
entered into agreements to manage the Alliances. The Company also received a
five-year option to acquire the Buyer, which option was canceled in 1996. The
note receivable bears interest at a rate equal to prime plus 2% (10.5% at March
31, 1998), with interest payable monthly through July 31, 2000. The Buyer has
paid only interest through January 1996.
The Company has also advanced $3.4 million to the Buyer ($.6 million in 1997,
$2.1 million in 1996 and $.7 million in 1995) for operating expenses and unpaid
interest, which obligations are documented by notes of $215,000 and $2.1 million
and interest receivable of $1.1 million. The note for $215,000, which is dated
February 26, 1996, bears interest at a rate equal to prime plus 2% (10.5% at
March 31, 1998) and was due December 31, 1996. No payments of principal have
been made on this note, nor payments of interest beyond May 1996.
In February 1997, the Buyer executed the promissory note for $2.1 million,
bearing interest at the rate of prime plus 2% (10.5% at March 31, 1998), with
repayment of the principal over 36 months, starting upon the occurrence of
certain events explained below (no interest has been paid on this obligation).
Subsequently, in February 1997, the Buyer entered into an Option Agreement with
a potential investor (the "Investor"), whereby the Investor loaned the Buyer
$4,000,000 and received an option to merge with the Buyer, exercisable through
June 30, 1998. Concurrently, WellCare entered into an agreement with the Buyer
whereby WellCare agreed to forebear on the collection of principal and interest
on the note for $5.1 million, and on the collection of principal of the $2.1
million note, in exchange for the right to convert the $5.1 million note into
43% of the Common Stock of the company resulting from the merger of the Investor
and the Buyer. If the Investor merges with the Buyer, the $2.1 million note
would be payable immediately, and the Company would have a 43% equity interest
in the company resulting from the merger of the Investor and the Buyer.
The Investor has removed the contractual restriction limiting the Buyer's
ability to explore other options and the Buyer has
11
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
identified strategies and is exploring other alternatives should the Investor
not exercise its option. At the earlier of the Buyer relinquishing its option to
merge (which would include expiration of the option), or March 14, 1999, the
forebearance will be rescinded and the original payment terms of the $5.1
million note reinstated. The Buyer would be obligated to continue paying monthly
interest on the $2.1 million note, with principal payments over a thirty-six
month period to commence upon recession of the forbearance. The Buyer has not
made any of the interest payments due under the $2.1 million note. The notes are
subordinated to the Investor's security interest.
In view of the Buyer's operating losses and advances to the Alliances, the
Company had obtained from certain of the Buyer's equity holders personal
guarantees of the original note and pledges of collateral to secure these
guarantees. In April 1997, the Company's Board of Directors agreed to release
these guarantees and related collateral pledged by the guarantors to secure the
guarantees in exchange for the Buyer's stock options that such guarantors
originally received from the Buyer and a release from the guarantors for any
potential claims against WellCare associated with the transactions. In view of
the Buyer's financial condition and difficulties inherent in the collection of
personal guarantees and realization of collateral, and the Buyer's default on
the payments of the notes, the Company had fully reserved in 1995 the original
$5.1 million note receivable, plus the $.7 million advanced in 1995. In 1996,
the Company established an additional net reserve of $1.9 million for the
$215,000 note, interest accrued on the notes, and advances receivable, net of
the deferred gain of $144,000 on the original sale. In 1997, the Company
established a reserve of $.8 million for 1997 accrued interest not paid by the
Buyer and for advances made in 1997. In 1998, the Company established a reserve
of $0.2 million for 1998 accrued interest not paid.
4. LONG-TERM DEBT
Although the Company was current on all its mortgage obligations, in July 1997,
Key Bank (the "Bank") notified the Company that it considered the Company not in
compliance with the Target Loan to Value Ratio provided for in two of its
mortgages, with outstanding balances of approximately $4.9 million. According to
the Bank's calculations, the outstanding Loan Amount exceeded the corresponding
Lendable Property Value, as defined, based on appraisals prepared for the Bank,
by approximately $1.7 million. The Bank had requested that the Company either
reduce the outstanding obligation, or provide additional collateral for $1.7
million, otherwise the Bank would consider the Company in default of the
mortgage notes. A default would require the Company to pay a higher interest
rate on the outstanding obligations, among other potential penalties. The
Company disagreed with the Bank's valuation methodology and has informed the
Bank in writing of this disagreement. The Company continues to classify the
debts in accordance with their original terms.
12
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
5. SUBORDINATED CONVERTIBLE NOTE
In January 1996, the Company completed a private placement of a subordinated
convertible note in the principal amount of $20 million (the "Note"), with The
1818 Fund II, L.P. (the "Fund"), a private equity fund managed by Brown Brothers
Harriman & Co. ("BBH & Co"). The Note and underlying terms were amended in
February 1997 (the "1997 Amendment") by the Company and the Fund. In January
1998, The Fund agreed to convert $5 million of the Note into Common Stock of the
Company, at a conversion price of $4 per share (the "1998 Amendment"), subject
to approval by the New York State Department of Health ("DOH"). In May 1998, the
DOH advised the Company that such approval was not required. As of May 15, 1998,
the conversion is in the process of being completed.
The Company's Consolidated Balance Sheet at March 31, 1998, after giving pro
forma effect to reflect the conversion in the first quarter of 1998 is as
follows:
March 31, 1998
-----------------
(in thousands)
Actual Proforma
------ --------
Current Assets $22,703 $22,703
------- -------
Total Assets $51,389 $51,389
======= =======
Total Liabilities $54,458 $49,458
(Deficiency in Assets)/
Shareholders' Equity $(3,069) $ 1,931
------- -------
Total Liabilities and
Shareholders' Equity $51,389 $51,389
======= =======
The remaining $15 million principal is payable in December 2002. Interest was
initially at the rate of 6% per annum, amended in 1997 to 5.5% per annum, and
amended in 1998 to 8% per annum, and is payable quarterly, The Note is
subordinated to all senior indebtedness.
The Note is subject to certain mandatory redemption at the option of the Fund
upon certain changes in control (as defined) of the Company. The redemption
price was initially equal to 115% of the principal amount of the Note, amended
to 130% by the 1997 Amendment and to 150% by the 1998 Amendment, together with
all accrued and unpaid interest. If a change of control occurs within 24 months
of a redemption of the Note, the Company may also be required to pay the Fund an
amount equal to 30% of the principal amount of the redeemed Note. Under certain
conditions, the Note is redeemable at the option of the Company after the fourth
anniversary of the date of the Note.
13
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
After the 1998 Amendment, The Fund has the right to convert the outstanding
principal into shares of Common Stock of the Company at a conversion price of $8
per share, subject to an anti- dilution adjustment. Previously the conversion
price was equal to 115% of the average price of the Company's Common Stock
through February 1997, subject to adjustments for certain dilutive events, with
a floor of $9 per share and a ceiling of $15 per share. Initially, the
conversion price was $29 per share. The conversion price granted to the holder
of the Note is adjusted, if the Company issues shares of its Common Stock or
options, warrants or other rights to acquire shares of Common Stock of the
Company at a price per share less than the current market price, or the
conversion price at the time.
As part of the 1998 Amendment, the Fund agreed to waive any existing defaults
known to it. The Company will also have the right to purchase one half of the
shares of the Common Stock and the debt held by the Fund, for $12 million plus
accrued interest, if consolidated earnings before taxes are positive for either
the second or third quarter of 1998. This right is exercisable after filing the
relevant Form 10-Q's, and prior to December 31, 1998.
6. INCOME TAXES
In 1996, the Company recorded a deferred tax asset of approximately $5.4 million
giving recognition to the future tax benefit of reversing temporary differences
and state net operating loss carryovers ("NOL"). No valuation allowance was
established for the deferred tax asset since realization was determined by
management to be more likely than not based upon the Company's internal budget.
Continuing operating losses in the first quarter of 1998 and for the year 1997,
resulted in additional deferred tax benefits of approximately $0.5 million and
$7.8 million, respectively, against which a 100% valuation allowance was
provided. The maximum utilization period for the NOL's are fifteen (15) and five
(5) years for New York and Connecticut, respectively.
The ability to realize the tax benefits associated with these losses is
dependent upon the Company's ability to generate future taxable income from
operations and/or to effectuate successful tax planning strategies. Although
management believes that profitable operations will be achieved in 1998, the
Company has provided a 100% valuation allowance with respect to the additional
1997 and 1998 deferred tax assets in view of their size and length of the
expected recoupment period. Management will continue to closely monitor the need
for future adjustments to this valuation allowance.
The Company has also engaged Bear, Stearns Co. Inc., to review available
strategic alternatives. The successful completion of a transaction could be a
source of future taxable income. The Company also is a party to other pending
transactions, the successful completion of which would generate taxable income
in 1998. The realization of the tax benefits would be achieved upon the
completion of any of these transactions.
14
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
7. STOCK OPTIONS
The Company's 1993 Incentive and Non-Incentive stock option plan (the "Plan"),
as amended, has 820,904 shares reserved for issuance, as of March 31, 1998, upon
exercise of options granted or to be granted.
Options to purchase 727,479 shares of Common Stock at exercise prices ranging
from $3.01 to $24.50 per share were outstanding under the Plan on March 31,
1998. Of the total options outstanding at March 31, 1998, options to purchase
402,988 shares were exercisable.
Effective February, 1, 1998, the exercise price of the CEO's options to purchase
30,000 shares at $15.00 per share granted in September 1997 was reduced from
$15.00 per share to $4.51 per share. Additionally, the Company granted the CEO,
effective February 1, 1998, five-year options to purchase 100,000 shares at an
exercise price equal to $5.02 per share.
The Company has adopted the disclosure-only provisions of the FASB's SFAS No.
123, "Accounting for Stock Based Compensation" (SPAS 123"). Accordingly, no
compensation cost has been recognized for grants of stock options.
8. STATUTORY REQUIREMENTS
New York State certified HMOs are required to maintain a cash reserve equal to
the greater of 5% of expected annual medical costs or $100,000. Additionally,
except as described in the following paragraph, WCNY is required to maintain a
contingent reserve which must be increased annually by an amount equal to at
least 1% of statutory premiums earned limited, in total, to a maximum of 5% of
statutory premiums earned for the most recent calendar year and which may be
offset by the cash reserve. The cash reserve is calculated at December 31 of
each year and is maintained throughout the following calendar year. At March 31,
1998, WellCare had required cash reserves of $5.8 million and a contingent
reserve of $6.7 million. In the event the contingent reserve exceeds the
required cash reserve, the excess of the contingent reserve over the required
cash reserve is required to be maintained.
Notwithstanding the above, NYSID has the authority to allow an HMO to maintain a
net worth of 50% to 100% of the contingent reserve. WCNY executed a Section 1307
loan in March 1998, which has brought WCNY's statutory net worth above the
permitted 50% contingent reserve requirement. WCNY has been operating within the
50-100% discretionary contingent reserve requirement during 1997 and 1998 with
the full knowledge of NYSID. In June 1997 and November 1997, the Company loaned
$3.1 and $1.3 million, respectively, to WCNY under the provisions of Section
1307. Management has had ongoing discussions and meetings with NYSID and has
updated NYSID of the Company's plans to obtain additional funds during 1998,
which the Company's Board has authorized to be contributed to WCNY's
15
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
capital. Management expects that WCNY's 1998 budgeted return to profitability,
together with a capital contribution and additional Section 1307 loans, if
required, will fully fund the contingent reserve requirement in 1998.
In June and November 1997, the Company made capital contributions of $350,000
and $425,000, respectively, to WCCT to bring its statutory net worth to the
required $1 million. On March 2, 1998, the Company made an additional capital
contribution of $368,000 to WCCT to bring its statutory net worth above the $1
million requirement. WCCT was in compliance with the statutory net worth
requirement at March 31, 1998.
9. OTHER
In March 1998, the Company engaged Bear, Stearns and Co., Inc. to assist the
Company in exploring its strategic opportunities. This could include joint
venture, merger or sale of all or a portion of the Company.
10. COMMITMENTS AND CONTINGENCIES
a. In October 1994, WCNY changed its capitation arrangements with the majority
of its providers from capitating primary care physicians with attendant
risk-sharing to capitating the Alliances comprised of the specialists and
previously-capitated primary care physicians. The Alliances have operated at an
accumulated deficit since inception but have instituted measures designed to
reduce this deficit and achieve profitability. The Alliance could request
additional funding beyond the contractual increases from the Company, which
management does not believe should be required and, if requested, by the
Alliances does not intend to provide. During 1997, the Alliances received a $4.0
million cash infusion from an unrelated third-party.
In an effort to improve profitability of the Company and the Alliances,
effective September 1996, WCNY entered into a letter of understanding with the
Alliances to restructure the capitation arrangements. In April 1998, formal
contracts were finalized and executed. WCNY reassumed risk for certain
previously capitated services, with a corresponding reduction in rates. WCNY
capitated the Alliances for all physician services, both primary care and
specialty services, on a PMPM basis for each HMO member associated with an
Alliance except for physician services for certain diagnostics and mental
health, which are capitated through regional integrated delivery systems.
Management of the Alliances and WCNY believe that the these measures will enable
the Alliances to maintain their operations and reduce their accumulated
deficits.
The Company has been advised by counsel that it would have no financial
liability to providers with whom the Alliances/IPAs had contracted for services
rendered in the event the Alliances/IPAs were unable to maintain their
operations. Further, the Company has direct contracts with providers which would
require the
16
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THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
providers to continue medical care to members on the financial terms similar to
those in the Alliances'/IPAs' agreement with providers, in the event that the
Alliances/IPAs were unable to maintain their operations.
Nevertheless, in the event of continuing losses or increasing deficits by the
Alliances/IPAs, the Alliances could request increased capitation rates from the
Company.
Management of the Company does not believe that such additional financial or
increased contractual capitation rates should be required by the Alliances/IPAs
and has no intention to agree to such terms if requested by the Alliances/IPAs
beyond the negotiated contractual increases. However, as described in Note 2d of
Notes to Consolidated Financial Statements in the 1997 Annual Report, the
Company agreed to record charges to medical expense based on the instructions of
NYSID. Effective September 1996, the Company entered into a letter of
understanding with the Alliances/IPAs to restructure its capitation arrangement.
Under this understanding, the Company reassumed risk for certain previously
capitated services with a corresponding reduction in rates.
b. Between April and June 1996, the Company, its former President and Chief
Executive Officer, and its former Vice President of Finance and Chief Financial
Officer were named as defendants in twelve separate actions filed in Federal
Court (the "Securities Litigations"). An additional three directors were also
named in one of these actions. Plaintiffs sought to recover damages allegedly
caused by the Company's defendants' violations of federal securities laws with
regard to the preparation and dissemination to the investing public of false and
misleading information concerning the Company's financial condition.
In July 1996, the Securities Litigations were consolidated in the United States
District Court for the Northern District of New York, and an amended
consolidating complaint (the "Complaint") was served in August 1996. The
Complaint did not name the three additional directors. The Company's auditor,
however, was named as an additional defendant. In October 1996, the Company
filed a motion to dismiss the consolidated amended complaint against the Company
as well as the individual defendants. The Company's auditor likewise filed its
own motion to dismiss. By Memorandum Decision and Order (the "Order"), entered
in April 1997, the court (i) granted the auditor's motion to dismiss and ordered
that the claims against the auditors be dismissed with prejudice; and (ii)
denied the motion to dismiss brought by the individual defendants. Because the
Order did not specifically address the Company's motion to dismiss, in May 1997,
the Company moved for reconsideration of its motion to dismiss and dismissal of
all claims asserted against it. On reconsideration, the judge clarified his
previous ruling expanding it to include a denial of the Company's motion as
well. Following the Court's decision, the Company filed its answer and defense
to the Complaint. In September 1997, the plaintiff's class was certified and the
parties are currently actively engaged in the discovery process of the
litigation.
17
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Although management is unable to predict the likelihood of success on the merits
of the consolidated class action, it has instructed its counsel to vigorously
defend its interests. To date, the Company has indemnified both former officers
who are defendants for costs incurred in defending the Securities Litigations.
The Company has insurance in effect which may, at least in part, offset any
costs to be incurred in these litigations.
c. The Company and certain of its subsidiaries, including WellCare of New
York, Inc. have responded to subpoenas issued in April and August 1997 from the
United States District Court for the Northern District of New York through the
office of the United States Attorney for that District. These subpoenas sought
the production of various documents concerning financial and accounting systems,
corporate records, press releases and other external communications. While the
United States Attorney has not disclosed the purpose of its inquiry, the Company
has reason to believe that neither its current management nor its current
directors are subjects or targets of the investigation. The Company has,
however, informed the government that it will continue to cooperate fully in any
way that it can in connection with the ongoing investigation.
d. On July 31, 1996 and October 3, 1996 the Securities and Exchange Commission
issued subpoenas to the Company for the production of various financial and
medical claims information. The Company fully complied with both of these
subpoenas on August 21, 1996 and October 31, 1996. It is management'
understanding that the Securities and Exchange Commission investigation is
continuing.
e. Other - The Company is involved in litigation and claims which are
considered normal to the Company's business. In the opinion of management, the
amount of loss that might be sustained, if any, would not have a material effect
on the Company's consolidated financial statements.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including short-term investments,
advances to participating providers, other receivables - net, restricted cash,
other non-current assets - net, accounts payable and accrued expenses
approximate their fair values.
The fair value of notes receivable consisting primarily of advances to medical
practices, is not materially different from the carrying value for financial
statement purposes. In making this determination, the Company used interest
rates based on an estimate of the credit worthiness of each medical practice.
The Subordinated Convertible Note was issued in a private placement in January
1996, and amended with the holder in February 1997 and January 1998, as
described in Note 5. There is no public market for this instrument or other debt
of the Company and management believes it is not practicable to estimate its
fair
18
<PAGE>
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
value at this time. The carrying amount of other long-term debt, the majority of
which bears interest at floating rates, are assumed to approximate their fair
value.
12. EARNINGS/(LOSS) PER SHARE
Earnings/(loss) per share - Basic calculations are based on a weighted average
number of shares outstanding for the applicable period. Earnings/(loss) per
share - Diluted calculations are based on a weighted average number of shares
plus equivalent shares outstanding, except if the effect on the per share
amounts of including equivalents would be anti-dilutive.
19
<PAGE>
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto, included in the quarterly
report and with the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. The auditors' report on the Company's 1997
financial statements states that "the Company's recurring losses from
operations, cash used in operations, deficiency in assets at December 31, 1997
and failure to maintain 100% of the contingent reserve requirement for the New
York State Department of Insurance ("NYSID") at December 31, 1997 raise
substantial doubt about its ability to continue as a going concern."
Certain statements in this Form 10-Q are forward-looking statements and are not
based on historical facts but are management's projections or best estimates.
Actual results may differ from these projections due to risks and uncertainties.
These risks and uncertainties include a variety of factors. The Company's
results of operations and projections of future earnings depend in large part on
accurately predicting and effectively managing medical costs and other operating
expenses. A variety of factors, including competition, changes in health care
practices, changes in federal or state laws and regulations or the
interpretations thereof, inflation, provider contract changes, new technologies,
government-imposed surcharges, taxes or assessments, reductions in provider
payments by governmental payors (including Medicare, whereby such reductions may
cause providers to seek high payments from private payor), major epidemics,
disasters and numerous other factors affecting the delivery and cost of health
care, such as major health care providers' inability to maintain their
operations and reduce or eliminate their accumulated deficits, may in the future
affect the Company's ability to control its medical costs and other operating
expenses. Governmental action (including downward adjustments to premium rates
requested by the Company, which could result in adjusted rates lower than
premium rates then in effect) or business conditions (including intensification
of competition and the other factors described above) could result in premium
revenues not increasing to thus offset any increases in medical costs and other
operating expenses. Once set, premiums are generally fixed for one year periods
and, accordingly, unanticipated costs during such periods cannot be recovered
through higher premiums. The expiration, suspension or termination of contracts
to provide health coverage for governmental entities or other significant
customers would also negatively impact the Company. Due to these factors and
risks, no assurance can be given with respect to the Company's premium levels or
its ability to control its medical costs.
Legislative and regulatory proposals have been made at the federal and state
government levels related to the health care system, including but not limited
to limitations on managed care organizations (including benefit mandates) and
reform of the Medicare and Medicaid programs. Such legislative or regulatory
action could have the effect of reducing the premiums paid to the
20
<PAGE>
Company by governmental programs or increasing the Company's medical costs.
Specifically, pending federal budgetary action could reduce the premiums payable
to the Company under the Medicare program as compared to previously announced
levels. The Company is unable to predict the specific content of any future
legislation, action or regulation that may be enacted or when any such future
legislation or regulation will be adopted. Therefore, the Company cannot predict
the effect of such future legislation, action or regulation on the Company's
business.
The following table provides certain statement of operations data expressed as a
percentage of total revenue and other statistical data for the periods
indicated:
THREE MONTHS ENDED MARCH 31,
---------------------------
1998 1997
---- ----
Revenue:
Premiums earned 98.5% 98.7%
Interest and other income 1.5 1.3
----- -----
Total revenue 100.0 100.0
Expenses:
Hospital services 25.9 28.9
Physician services 54.5 62.4
Other medical services (0.3) 15.2
----- -----
Total medical expenses 80.1 106.5
General and administrative 19.5 27.3
Depreciation and amortization 2.6 2.7
Interest and other expenses 1.2 1.3
----- -----
Total expenses 103.4 137.8
Loss before income taxes (3.4) (37.8)
Provision for income taxes 0.0 0.0
----- -----
Net loss (3.4)% (37.8)%
----- -----
STATISTICAL DATA:
HMO member months enrollment 208,221 233,791
Medical loss ratio (1) 81.4% 108.0%
General and administrative
ratio (2) 19.5% 27.3%
- ------------------------
(1) Total medical expenses as a percentage of premiums earned; reflects the
combined rates of commercial, Medicaid, Full- Risk Medicare and Medicare
supplemental members.
(2) General and administrative expenses as a percentage of total revenue.
21
<PAGE>
THREE MONTHS ENDED MARCH 31, 1998
COMPARED TO THREE MONTHS ENDED MARCH 31, 1997
Premiums earned in the first quarter of 1998 increased by 3.5%, or $1.2 million,
to $35.0 million from $33.8 million in the first quarter of 1997. Premium
revenue in the first quarter of 1997, after a pro forma adjustment to reflect
the net impact of Medicaid rate changes during 1997, was $34.4 million. Medicaid
premium revenue, after giving effect in 1997 to the rate changes discussed
above, increased 43.2%, or $2.5 million, primarily as a result of an increase in
average per member rates of 23.3%, or $1.6 million, plus a 16.2% increase, or
$0.9 million, in member months. Medicare premium revenue increased 111.8%, or
$5.5 million, as a result of a 99.8% increase in member months, accompanied by
an increase in average per member rates of 6.0%, or $0.6 million. Commercial
premium revenue decreased 31.4%, or $7.4 million, as a result of a 30.1%, or
$7.1 million, decrease in member months and a 1.8% decrease in average member
rates. The decline in Commercial membership is attributable to WellCare's more
stringent application of its credit standards, pursuant to which contracts for
non-paying or slow-paying groups were canceled or not renewed, as well as to
customers' adverse reaction to the negative publicity received by the Company
related to the restatement of its 1994 financial results in 1996. The loss of
commercial membership in 1997 was also affected by WCNY's non-competitive rates
relative to other companies operating within WCNY's marketplace. The rates in
effect during 1996 and in the first half of 1997 caused a decline in renewing
membership for 1997. During 1997, the Company adjusted its premium rates to be
competitive within the principal markets where WCNY operates. The Company
believes it is positioned to increase 1998 premium rates and remain competitive
in the marketplace. Total member months in the quarter ended March 31, 1998
decreased 10.9% to 208,221 as compared to 233,791 for the quarter ended March
31, 1997.
Interest and other income increased 21.7%, or $0.1 million, to $0.5 million in
the first quarter of 1998, primarily due to an increase in third party
reimbursements.
Medical expenses decreased 21.9% or $8.0 million, to $28.5 million in the first
quarter of 1998, from $36.5 million in 1997. There was a 12.4% decrease on a per
member per month ("PMPM") basis and decrease as a percentage of premiums earned
(the "medical loss ratio") from 108.0% in 1997 to 81.4% in 1998. The decrease in
medical expenses from 1997 is primarily due to decreased commercial membership
and the Company's efforts to improve the medical cost economics of the business,
partially offset by increases attributable to a change in product mix. Beginning
in the third quarter of 1996 and throughout 1997, the Company made a major
effort to improve the medical cost economics of the business. These initiatives
principally revolved around renegotiated provider contracts and an improved
effort in utilization management. The shift in the percentage of member months
attributable to Medicare versus commercial has also affected medical costs.
The first quarter 1998 medical expenses include the following accrual items: a
$0.5 million charge for adverse development relating to medical claims for the
second half of 1997; a $0.8 million credit relating to the accumulated pool
funds distribution announced by NYSID; and a $0.2 million credit to adjust the
1997
22
<PAGE>
New York demographic pool liability downward to the actual liability. In the
absence of such additional items, medical expenses would have been $29.0 million
and the medical loss ratio would have been approximately 82.8%. The 1997 medical
expenses include the following accrual items: a $2.3 million charge for adverse
development relating to 1996 medical claims, a $4.3 million charge for the
estimated liability related to NYSID's audit of the 1993-1995 demographic pool
and the 1996 demographic pool, and a $0.4 million credit relating to the 1994
restatement. In the absence of such additional items, medical expenses would
have been $30.3 million and the medical loss ratio, after also taking into
account the pro forma premium adjustments, would have been approximately 88.3%.
General and administrative (G&A) expenses decreased 26.1%, or $2.5 million, to
$6.9 million in the first quarter of 1998 and decreased as a percentage of total
revenue (the "G&A ratio") to 19.5% in the first quarter of 1998 from 27.3% in
the first quarter of 1997. The decrease in G&A expenses resulted primarily from
a decrease in bad debt expense and a decrease in payroll and payroll-related
expenses resulting from staff reductions in January 1998.
Depreciation and amortization remained constant at $0.9 million, as there were
no significant acquisitions or dispositions in 1997 and 1998.
Interest expense remained constant at $0.4 million. The 1998 Amendment (see Note
5) will result in an increase to annual interest expense on the Note of $0.1
million.
LIQUIDITY AND CAPITAL RESOURCES
In January, 1996, the Company completed a private placement of a subordinated
convertible note in the principal amount of $20,000,000 (the "Note") due
December 31, 2002, with The 1818 Fund II, L.P., a private equity fund managed by
Brown Brothers Harriman & Co. The Company utilized a part of the net proceeds of
this private placement to retire a portion of its debt. The Note, was amended in
February 1997, and subsequently in January 1998, and is convertible into shares
of WellCare Common Stock. In January 1998, the Fund agreed to convert $5 million
of the Note into 1,250,000 shares of Common Stock of the Company at a conversion
price of $4 per share, subject to an anti-dilution adjustment. The agreement to
convert was subject to the approval of the DOH. In May 1998, the DOH advised the
Company that such approval was not required. As of May 15, 1998, the conversion
is in the process of being completed. The Note initially accrued interest at
6.0% per annum, amended to 5.5% per annum in 1997 and amended to 8% per annum in
1998. The conversion price after the 1998 amendment is $8 per share for the
remaining $15 million debt, and the mandatory redemption percentage is 150%. The
Company will also have the right to purchase one half of the shares of the
Common Stock and the debt held by the Fund, for $12 million plus accrued
interest, if consolidated earnings before taxes are positive for either the
second or third quarter of 1998. This right is exercisable after filing the
relevant Form 10-Q, and prior to December 31, 1998.
The Company's requirements for working capital are principally to meet current
obligations, fund geographic and product expansion for HMO operations, maintain
necessary regulatory reserves, and marketing and product expansion.
23
<PAGE>
Net cash used by operating activities was $0.9 million during the first quarter
of 1998 as compared to $2.7 million for the first quarter of 1997. The cash used
in the first quarter of 1998 was to fund the cash operating loss and the net
decrease in payables, partially offset by an increase in unearned income. The
cash used in operations in the first quarter of 1997 resulted primarily from the
operating loss and the decrease in medical costs payable, partially offset by
the impact of a decrease in accounts and other receivables and an increase in
accounts payable. Cash used for capital expenditures was approximately $0.3
million during the first quarter of 1998 as compared to $.1 million for the same
period in 1997.
Recent legislation by New York State ("Prompt Pay" legislation) requires HMOs,
effective with claims submitted for services provided after January 22, 1998, to
pay undisputed ("clean") claims within 45 days of date of receipt. It is too
early to determine if the prompt pay rule will require the Company to accelerate
the payment pattern of its claims.
New York State certified HMOs are required to maintain a cash reserve equal to
the greater of 5% of expected annual medical costs or $100,000. Additionally,
WCNY is required to maintain a contingent reserve which must be increased
annually by an amount equal to at least 1% of statutory premiums earned limited,
in total, to a maximum of 5% of statutory premiums earned for the most recent
calendar year and which may be offset by the cash reserve. The cash reserve is
calculated at December 31 of each year and is maintained throughout the
following calendar year. At March 31, 1998, WellCare had required cash reserves
of $5.8 million and a contingent reserve of $6.7 million. In the event the
contingent reserve exceeds the required cash reserve, the excess of the
contingent reserve over the required cash reserve is required to be maintained.
NYSID has the authority to allow an HMO to maintain a net worth of 50% to 100%
of the contingent reserve. WCNY executed a Section 1307 loan in March 1998,
which has brought WCNY's December 31, 1997, statutory net worth above the
permitted 50% contingent reserve requirement. WCNY has been operating within the
50% discretionary contingent reserve requirement during 1997 and 1998 with the
full knowledge of NYSID. In June 1997 and November 1997, the Company loaned $3.1
and $1.3 million, respectively, to WCNY under the provisions of Section 1307.
Management has had ongoing discussions and meetings with NYSID and has updated
NYSID of the Company's plans to obtain additional funds during 1998, which the
Company's Board has authorized to be contributed, as needed, to WCNY's capital.
Management expects that WCNY's 1998 budgeted return to profitability, together
with the capital contribution and additional Section 1307 loans, if required,
will fully fund the contingent reserve requirement in 1998.
WCCT is subject to similar regulatory requirements with respect to its HMO
operations in Connecticut. In June and November 1997, the Company made capital
contributions of $350,000 and $425,000, respectively, to WCCT to bring its
statutory net worth to the required $1 million. The Company, on March 2, 1998,
made an additional capital contribution of $368,000 to WCCT to bring its
statutory net worth above the $1 million requirement. At March 31, 1998, WCCT
was in compliance with the statutory net worth requirement.
24
<PAGE>
At March 31, 1998, the Company had working capital deficiency of $6.8 million,
excluding the $5.8 million cash reserve required by New York State which is
classified as a non-current asset, compared to a working capital deficiency of
$5.1 million at December 31, 1997; the increased deficiency is attributable
primarily to the operating loss for the first quarter of 1998. The Company
intends to finance its current and future operations from the positive cash flow
from its projected return to profitability in 1998 via increased membership,
rate increases and further reductions in medical and general and administrative
expenses. The Company is also aggressively pursuing balances due from commercial
customers in accordance with contractual stipulations to more closely match the
collection of premium with the payment of provider capitation fees and fees for
service. A significant portion of premiums receivable are due from governmental
agencies relating to the Medicaid program, some of which relate to 1996 and
1997. Approximately $850,000 has been collected through April 1998, and the
remainder is anticipated to be collected in the second and third quarters of
1998. The collection of these balances will have a positive impact on the
Company's cash flow.
In March 1998, the Company engaged Bear, Stearns & Co. Inc. to assist the
Company in exploring its strategic opportunities. This could include joint
venture, merger or sale of all or a portion of the Company.
Additionally, cash is expected from the proceeds upon the anticipated exercise
of the Investor's option to merge with the Buyer, as discussed in Note 3 or if
another buyer is found. There can be no assurance that any transaction will
occur. Management believes that the Company will have sufficient funds available
from the above sources to maintain its planned level of operations and programs
for 1998.
At March 31, 1998, the Company had total mortgage indebtedness of $5.8 million
outstanding on five of its office buildings, of which approximately $0.8 million
is due February 1, 1999, approximately $4.0 million is due January 1, 2000,
approximately $0.7 million is due March 1, 2000, and approximately $0.3 million
is due March 1, 2001.
INFLATION
Medical costs have been rising at a higher rate than consumer goods as a whole.
The Company believes its premium increases, capitation arrangements and other
cost controls measures mitigate, but do not wholly offset, the effects of
medical cost inflation on its operations and its inability to increase premiums
could negatively impact the Company's future earnings.
Part II - OTHER INFORMATION
Item 1 Legal Proceedings
Between April and June 1996, the Company, its former President and Chief
Executive Officer, and its former Vice President of Finance and Chief Financial
Officer were named as defendants in twelve separate actions filed in Federal
Court (the "Securities Litigations"). An additional three directors were also
named in one of these actions. Plaintiffs sought to recover damages allegedly
caused by the Company's defendants' violations of
25
<PAGE>
federal securities laws with regard to the preparation and dissemination to the
investing public of false and misleading information concerning the Company's
financial condition.
In July 1996, the Securities Litigations were consolidated in the United States
District Court for the Northern District of New York, and an amended
consolidated complaint (the "Complaint") was served in August 1996. The
complaint did not name the three additional directors. The Company's auditor,
however, was named as an additional defendant. In October 1996, the Company
filed a motion to dismiss the consolidated amended complaint against the Company
as well as the individual defendants. The Company's auditor likewise filed its
own motion to dismiss. By Memorandum Decision and Order (the "Order"), entered
in April 1997, the Court (i) granted the auditor's motion to dismiss and ordered
that the claims against the auditors be dismissed with prejudice; and (ii)
denied the motion to dismiss brought by the individual defendants. Because the
Order did not specifically address the Company's motion to dismiss, in May 1997,
the Company moved for reconsideration of its motion to dismiss and dismissal of
all claims asserted against it. On reconsideration, the judge clarified his
previous ruling expanding it to include a denial of the Company's motion as
well. Following the Court's decision, the Company filed its answer and defense
to the Complaint. In September 1997, the plaintiff's class was certified and the
parties are currently actively engaged in the discovery process of the
litigation.
Although management is unable to predict the likelihood of success on the merits
of the consolidated class action, it has instructed its counsel to vigorously
defend its interests. To date, the Company has indemnified both former officers
who are defendants for costs incurred in defending the Securities Litigations.
The Company has insurance in effect which may, at least in part, offset any
costs to be incurred in these litigations.
The Company and certain of its subsidiaries, including WellCare of New York,
Inc. have responded to subpoenas issued in April and August 1997 from the United
States District Court for the Northern District of New York through the office
of the United States Attorney for that District. These subpoenas sought the
production of various documents concerning financial and accounting systems,
corporate records, press releases and other external communications. While the
United States Attorney has not disclosed the purpose of its inquiry, the Company
has reason to believe that neither its current management nor its current
directors are subjects or targets of the investigation. The Company has,
however, informed the government that it will continue to cooperate fully in any
way that it can in connection with the ongoing investigation.
On July 31, 1996 and October 3, 1996 the Securities and Exchange Commission
issued subpoenas to the Company for the production of various financial and
medical claims information. The Company fully complied with both of these
subpoenas on August 21, 1996 and October 31, 1996. It is management'
understanding that the Securities and Exchange Commission investigation is
continuing.
Item 2 Changes in Securities
Not Applicable
26
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Item 3 Defaults Upon Senior Securities
During 1997, the Company was in default of certain provisions of the Note
Purchase Agreement and the 1997 Amendment between the Company and The 1818 Fund
II, L.P. (see Note 5). In January 1998, The 1818 Fund II, L.P., as part of the
1998 Amendment to the Note, waived any existing defaults known to it under the
loan documents.
Item 4 Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5 Other Information
On March 10, 1998, the Company named Adele Reiter, Esq. as Vice President, Legal
and Governmental Affairs.
On April 3, 1998, Jack Sizer, M.D. resigned as Chief Medical Director.
On April 24, 1998, Howard B. Lorch resigned as Vice President and Chief
Financial Officer.
On May 1, 1998, the Company named Craig S. Dupont as Chief Financial Officer.
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 10.49a Copy of Amendment to Quota Share Reinsurance Agreement
between Registrant and Allianz Life Insurance Company of
North America dated March 20, 1998
Exhibit 11 Computation of Net Income Per Share of Common Stock
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
Not Applicable
27
<PAGE>
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.
The WellCare Management Group, Inc.
By: /s/ Joseph R. Papa
- -----------------------------------
Joseph R. Papa
President, Chief Executive Officer
and Chief Operating Officer
(Principal Executive Officer)
By: /s/ Edward J. Halas
- -----------------------------------
Chief Financial Accounting Officer
(Principal Accounting Officer)
Date: May 15, 1998
28
<PAGE>
INDEX TO EXHIBITS
All exhibits below are filed with this Quarterly Report of Form 10-Q:
EXHIBIT NUMBER
- --------------
10.49a Copy of Amendment to Quota Share Reinsurance Agreement between
Registrant and Allianz Life Insurance Company of North America
dated March 20, 1998
11 Computation of Net Income Per Share of Common Stock
27 Financial Data Schedule
29
Exhibit 10.49a Copy of Revised Quota Share Reinsurance Agreement
between Registrant and Allianz Life Insurance Company of
North America
AMENDMENT TO
QUOTA SHARE REINSURANCE AGREEMENT
BETWEEN
THE WELLCARE MANAGEMENT GROUP, INC.
AND
ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA
THIS AGREEMENT is made and entered into as of this 20th day of March, 1998
by and between The WellCare Management Group, Inc., a New York corporation
(hereinafter referred to as "WellCare") and Allianz Life Insurance Company of
North American (hereinafter referred to as "Allianz").
WHEREAS, WellCare and Allianz have entered into a Quota Share Reinsurance
Agreement dated September 1, 1995 (hereinafter referred to as "The Agreement")
by the terms of which Allianz has reinsured a quota share of the contractual
risks and rewards of WellCare's Medicare Risk Contract program (more commonly
known as WellCare's "Senior Health" program); and
WHEREAS, WellCare and Allianz wish to amend the terms of The Agreement as
set forth below.
NOW, THEREFORE, the parties agree that The Agreement shall be amended as
follows:
I. Subject to Article II and Article III hereof, quota share reinsurance
under Article 1 and Article 3 of The Agreement shall cease for any and all
reinsurance premium liabilities incurred on or after January 1, 1998; provided,
however, that WellCare shall continue to account for and report to Allianz all
of WellCare's gross revenue, Claim Expenses and Administrative Expenses pursuant
to Articles 1 and 3 of The Agreement through December 31, 2000, as if there has
been no amendment to The Agreement.
II. All WellCare Senior Health claims with dates of service in 1996 and
1997 which have not been paid and, therefore, have not yet been accounted for in
calculating the reinsurance premium as of January 1, 1998, will be accounted for
and settled in accordance with Articles 1 and 3 of The Agreement as such claims
are paid between January 1, 1998 and December 31, 2000. WellCare will continue
to report the development of these liabilities on a cash and accrual basis as
has been reported throughout the term of The Agreement.
III. In the event quota share reinsurance premiums are calculated and due
to Allianz pursuant to Articles 1 and 3 of The Agreement, WellCare shall pay to
Allianz such quota share reinsurance premiums under The Agreement for each of
the years 1998, 1999 and 2000, up to a maximum cumulative total of $500,000.00.
30
<PAGE>
Such quota share reinsurance premiums, if any, shall be accounted for by
WellCare beginning on January 1, 1998, and a preliminary settlement amount shall
be paid to Allianz on or about April 15 following the year being accounted for.
Such preliminary settlement amount will be calculated on a cash basis for claims
paid through March 31, and adjustments to the preliminary settlement amount will
be calculated on a cash basis until all claims for the years 1998, 1999 and 2000
are paid. WellCare will provide Allianz with quarterly reports stating the
adjustments to the preliminary settlement amounts and the amount of quota share
reinsurance recovery payment due, if any, from Allianz. Allianz shall pay any
and all quota share reinsurance recovery payments within 30 days of receipt of
the reported adjustments.
IV. The payments due to WellCare on April 1, 1998, July 1, 1998 and October
1, 1998, pursuant to Article 2 of The Agreement shall be accelerated and shall
be due and payable by Allianz upon execution of this Agreement.
IN WITNESS THEREOF, the parties have executed this Agreement as of the date
first above written.
THE WELLCARE MANAGEMENT ALLIANZ LIFE INSURANCE COMPANY
GROUP, INC. OF NORTH AMERICA
By:/s/ Joseph R. Papa By: /s/ Kenneth P. Schrapp
------------------ ------------------------
Joseph R. Papa Print Name: KENNETH P. SCHRAPP
President & CEO ------------------
Signed: March 20, 1998 Signed: March 26, 1998
31
THE WELLCARE MANAGEMENT GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
---- ----
Loss before income taxes $ (1,218) $(13,002)
Provision for income taxes -- --
--------- --------
Net Loss $ (1,218) $(13,002)
========= ========
LOSS PER SHARE - BASIC $ (0.19) $ (2.06)
========= ========
Weighted average shares of
Common Stock outstanding 6,299 6,298
========= ========
LOSS PER SHARE - DILUTED $ (0.19) $ (2.06)
========= ========
Weighted average shares of Common
Stock and Common Stock equivalents Not Not
outstanding Applicable Applicable
32
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet of The WellCare Management Group, Inc. and
Subsidiaries as of March 31, 1998, and the related Statement of Operations for
the quarter ended March 31, 1998, and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 1,970
<SECURITIES> 103
<RECEIVABLES> 9,821
<ALLOWANCES> 2,753
<INVENTORY> 0
<CURRENT-ASSETS> 22,703
<PP&E> 17,965
<DEPRECIATION> 6,857
<TOTAL-ASSETS> 51,389
<CURRENT-LIABILITIES> 29,476
<BONDS> 0
0
0
<COMMON> 63
<OTHER-SE> (3,132)
<TOTAL-LIABILITY-AND-EQUITY> 51,389
<SALES> 35,019
<TOTAL-REVENUES> 35,564
<CGS> 0
<TOTAL-COSTS> 28,509
<OTHER-EXPENSES> 8,273
<LOSS-PROVISION> 836
<INTEREST-EXPENSE> 432
<INCOME-PRETAX> (1,218)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,218)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,218)
<EPS-PRIMARY> (0.19)
<EPS-DILUTED> (0.19)
</TABLE>
