-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Bp92ydoOeIBW/gaM90jgVGXFfOLHY4XQvVeB4LeXhshaEymKyIMY22dwbO+S4QCI Qp/UVm3CrZo5QDxuxEhmQg== 0000892569-99-002160.txt : 19990813 0000892569-99-002160.hdr.sgml : 19990813 ACCESSION NUMBER: 0000892569-99-002160 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990812 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFICARE HEALTH SYSTEMS INC /DE/ CENTRAL INDEX KEY: 0001027974 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 954591529 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21949 FILM NUMBER: 99684736 BUSINESS ADDRESS: STREET 1: 3120 LAKE CENTER DRIVE CITY: SANTA ANA STATE: CA ZIP: 92704 BUSINESS PHONE: 7148255200 MAIL ADDRESS: STREET 1: 3120 LAKE CENTER DRIVE CITY: SANTA ANA STATE: CA ZIP: 92704 FORMER COMPANY: FORMER CONFORMED NAME: N T HOLDINGS INC DATE OF NAME CHANGE: 19961204 10-Q 1 FORM 10-Q FOR QUARTER ENDED JUNE 30, 1999 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NUMBER 000-21949 PACIFICARE HEALTH SYSTEMS, INC. - -------------------------------------------------------------------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4591529 ------------------------------- ---------------------- (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 3120 LAKE CENTER DRIVE, SANTA ANA, CALIFORNIA 92704 - -------------------------------------------------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (714) 825-5200 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 [ ] The number of shares of common stock outstanding at July 31, 1999 was approximately 45,910,000. 2 PACIFICARE HEALTH SYSTEMS, INC. FORM 10-Q INDEX
PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998....................... 1 Condensed Consolidated Statements of Operations for the three months ended June 30, 1999 and 1998..... 2 Condensed Consolidated Statements of Operations for the six months ended June 30, 1999 and 1998....... 3 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 1999 and 1998....... 4 Notes to Condensed Consolidated Financial Statements.................................................. 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................. 11 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................................ 22 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES................................................................................. 23 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................... 23 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................................................... 24 SIGNATURES..................................................................................................... 25 EXHIBITS....................................................................................................... 26
i 3 PART I: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 1999 DECEMBER 31, (UNAUDITED) 1998 ----------- ------------ (IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS Current assets: Cash and equivalents .................................... $ 251,194 $ 724,636 Marketable securities ................................... 958,560 875,553 Receivables, net ........................................ 309,450 275,955 Prepaid expenses and other current assets ............... 32,864 24,979 Deferred income taxes ................................... 134,107 132,452 ----------- ----------- Total current assets ................................. 1,686,175 2,033,575 ----------- ----------- Property, plant and equipment at cost, net ................. 168,782 178,520 Marketable securities-restricted ........................... 83,222 82,660 Goodwill and intangible assets, net ........................ 2,279,881 2,313,266 Other assets ............................................... 23,772 22,923 ----------- ----------- $ 4,241,832 $ 4,630,944 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Medical claims and benefits payable ..................... $ 710,300 $ 645,300 Accounts payable and accrued liabilities ................ 430,523 464,170 Unearned premium revenue ................................ 58,779 509,859 Long-term debt due within one year ...................... 21 87 ----------- ----------- Total current liabilities ............................ 1,199,623 1,619,416 ----------- ----------- Long-term debt due after one year .......................... 575,000 650,006 Deferred income taxes ...................................... 118,846 112,056 Other liabilities .......................................... 14,538 11,015 Minority interest .......................................... 333 355 Stockholders' equity: Common stock, $0.01 par value; 200,000 shares authorized; issued 46,802 shares in 1999 and 46,386 shares in 1998 . 468 464 Additional paid-in capital .............................. 1,597,356 1,624,619 Accumulated other comprehensive income (loss) ........... (12,871) 7,359 Retained earnings ....................................... 792,493 649,608 Treasury stock, at cost; 770 shares ..................... (43,954) (43,954) ----------- ----------- Total stockholders' equity ........................... 2,333,492 2,238,096 ----------- ----------- $ 4,241,832 $ 4,630,944 =========== ===========
See accompanying notes. 1 4 PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, ----------------------------- 1999 1998 ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue: Government premiums (Medicare and Medicaid) $ 1,444,823 $ 1,406,509 Commercial premiums ....................... 982,667 961,088 Other income .............................. 27,257 28,662 ----------- ----------- Total operating revenue ................ 2,454,747 2,396,259 ----------- ----------- Expenses: Health care services: Government services ....................... 1,263,762 1,210,407 Commercial services ....................... 799,701 804,651 ----------- ----------- Total health care services ............. 2,063,463 2,015,058 ----------- ----------- Marketing, general and administrative expenses 265,628 275,664 Amortization of goodwill and intangible assets 18,809 19,265 ----------- ----------- Operating income ............................. 106,847 86,272 Net investment income ........................ 20,242 23,850 Interest expense ............................. (9,512) (16,913) ----------- ----------- Income before income taxes ................... 117,577 93,209 Provision for income taxes ................... 48,676 44,338 ----------- ----------- Net income ................................... $ 68,901 $ 48,871 =========== =========== Preferred dividends .......................... -- (2,630) ----------- ----------- Net income available to common stockholders .. $ 68,901 $ 46,241 =========== =========== Basic earnings per share ..................... $ 1.50 $ 1.10 =========== =========== Diluted earnings per share ................... $ 1.49 $ 1.06 =========== ===========
See accompanying notes. 2 5 PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ----------------------------- 1999 1998 ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue: Government premiums (Medicare and Medicaid) $ 2,890,279 $ 2,803,031 Commercial premiums ....................... 1,960,100 1,921,986 Other income .............................. 56,277 53,192 ----------- ----------- Total operating revenue ................ 4,906,656 4,778,209 ----------- ----------- Expenses: Health care services: Government services ....................... 2,520,893 2,420,456 Commercial services ....................... 1,596,490 1,603,103 ----------- ----------- Total health care services ............. 4,117,383 4,023,559 ----------- ----------- Marketing, general and administrative expenses 528,212 557,977 Amortization of goodwill and intangible assets 37,868 37,901 ----------- ----------- Operating income ............................. 223,193 158,772 Net investment income ........................ 40,443 49,154 Interest expense ............................. (19,805) (34,431) ----------- ----------- Income before income taxes ................... 243,831 173,495 Provision for income taxes ................... 100,946 83,278 ----------- ----------- Net income ................................... $ 142,885 $ 90,217 =========== =========== Preferred dividends .......................... -- (5,258) ----------- ----------- Net income available to common stockholders .. $ 142,885 $ 84,959 =========== =========== Basic earnings per share ..................... $ 3.12 $ 2.03 =========== =========== Diluted earnings per share ................... $ 3.10 $ 1.96 =========== ===========
See accompanying notes. 3 6 PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------- 1999 1998 --------- --------- (IN THOUSANDS) Operating activities: Net income ...................................................... $ 142,885 $ 90,217 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Amortization of goodwill and intangible assets .................. 37,868 37,901 Depreciation and amortization ................................... 20,522 25,292 Deferred income taxes ........................................... 16,439 6,058 Loss on disposal of property, plant and equipment and other ..... 3,233 679 Provision for doubtful accounts ................................. 368 1,174 Other noncash items ............................................. (22) (20) Changes in assets and liabilities, net of effects from acquisitions and dispositions: Receivables, net ............................................. (33,863) (6,343) Prepaid expenses and other assets ............................ (8,734) 8,152 Medical claims and benefits payable .......................... 65,000 (51,000) Accounts payable and accrued liabilities ..................... (18,068) 70,581 Unearned premium revenue ..................................... (451,080) (452,310) --------- --------- Net cash flows used in operating activities ................ (225,452) (269,619) --------- --------- Investing activities: Purchase of marketable securities, net .......................... (114,540) (69,253) Purchase of property, plant and equipment ....................... (24,169) (18,176) Proceeds from the sale of property, plant and equipment ......... 10,152 -- Acquisitions .................................................... (4,483) (750) Purchase of marketable securities-restricted .................... (562) (15,411) --------- --------- Net cash flows used in investing activities ................ (133,602) (103,590) --------- --------- Financing activities: Principal payments on long-term debt ............................ (75,072) (230,079) Common stock reclassification payments to UniHealth and others .. (61,920) -- Proceeds from issuance of common and treasury stock ............. 22,604 11,827 Proceeds from borrowings of long-term debt ...................... -- 30,000 Repurchase of common stock ...................................... -- (23,338) Preferred dividends paid ........................................ -- (5,258) Redemption of preferred stock ................................... -- (410) --------- --------- Net cash flows used in financing activities ................ (114,388) (217,258) --------- --------- Net decrease in cash and equivalents ............................... (473,442) (590,467) Beginning cash and equivalents ..................................... 724,636 680,674 --------- --------- Ending cash and equivalents ........................................ $ 251,194 $ 90,207 ========= =========
See accompanying notes. Table continued on next page. 4 7 PACIFICARE HEALTH SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------- 1999 1998 --------- --------- (IN THOUSANDS) Supplemental cash flow information: Cash paid during the year for: Income taxes, net of refunds ................................. $ 77,922 $ 2,083 Interest ..................................................... $ 18,018 $ 31,127 Supplemental schedule of noncash investing and financing activities: Tax benefit associated with exercise of stock options .......... $ 4,943 $ 4,133 Stock-based compensation ....................................... $ 7,113 $ 588 Details of accumulated other comprehensive income: Change in marketable securities ................................. $ (31,533) $ (2,790) Less change in deferred income taxes ............................ 11,303 1,187 --------- --------- Change in stockholders' equity .................................. $ (20,230) $ (1,603) ========= ========= Details of businesses acquired in purchase transactions: Fair value of assets acquired ................................... $ 4,483 $ 750 Liabilities assumed or created .................................. -- -- --------- --------- Cash paid for fair value of assets acquired ........................ $ 4,483 $ 750 ========= =========
See accompanying notes. Table continued from previous page. 5 8 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1999 (UNAUDITED) 1. BASIS OF PRESENTATION PacifiCare Health Systems, Inc. is one of the leading health care services companies in the United States, serving approximately 3.6 million members in the Medicare and commercial lines of business. Following the rules and regulations of the Securities and Exchange Commission ("SEC"), we have omitted footnote disclosures that would substantially duplicate the disclosures contained in the annual audited financial statements. The accompanying unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and the notes included in our December 31, 1998 Annual Report on Form 10-K/A, filed with the SEC in April 1999. The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting solely of normal recurring adjustments, needed to present fairly the financial results for these interim periods. The consolidated results of operations presented for the interim periods are not necessarily indicative of the results for a full year. 2. ACQUISITIONS AND DISPOSITIONS ACQUISITIONS. In June 1999, we entered into a definitive agreement to purchase a health plan in Colorado with approximately 38,000 members. We plan to close the transaction later in 1999, upon regulatory approval and after completion of normal closing conditions. In February 1999, we acquired approximately 15,000 commercial members in Texas for a $4.1 million purchase price. In February 1997, we acquired FHP International Corporation ("FHP"). See the 1997 Form 10-K for additional information. DISPOSITIONS. On September 30, 1998, we sold our Utah health maintenance organization ("HMO") subsidiary. We guaranteed the buyer that the Utah HMO would have a minimum net equity of $10 million, based on the values of the Utah HMO's assets and liabilities as of September 30, 1998. We also extended a $700,000 subordinated loan to the Utah HMO to increase its statutory net equity. We sold all of the issued and outstanding shares of capital stock of the Utah HMO to the buyer for no other consideration. As of September 30, 1998, the Utah HMO served approximately 102,000 commercial and 19,000 government members. On October 31, 1998, we sold our workers' compensation subsidiary for $17 million. We recognized pretax charges of approximately $15 million ($8 million or $0.18 diluted loss per share, net of tax) for these dispositions in the third quarter of 1998. PRO FORMA FINANCIAL STATEMENTS. The pro forma information below presents our consolidated results of operations as if the sale of the Utah HMO occurred on January 1, 1998. This information reflects our actual consolidated operating results before this transaction plus an adjustment for income taxes. Because the purchase of the Texas membership and the sale of the workers' compensation subsidiary were not material to our consolidated results of operations, these transactions were not included in the pro forma information below.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 1998 JUNE 30, 1998 ------------------ ---------------- (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) (UNAUDITED) Total operating revenue............................................. $2,343,749 $4,671,527 Pretax income....................................................... $96,336 $183,965 Net income.......................................................... $50,741 $96,479 Basic earnings per share............................................ $1.14 $2.18 Diluted earnings per share.......................................... $1.10 $2.10
3. LONG-TERM DEBT We have a $1.5 billion credit facility. The terms of this facility require a mandatory step-down payment schedule if the principal balance exceeds certain thresholds. Because the June 30, 1999 balance of $475 million was below the threshold, no step-down payments are required until the final maturity date on January 1, 2002. Interest under the credit facility is variable and is presently based on the London Interbank Offering Rate ("LIBOR") plus a spread, except for $350 million of the outstanding balance that is covered by interest-rate swap agreements. The average fixed interest rate we pay on the existing swap agreements is approximately six percent. The terms of the credit facility contain various covenants, usual for financing 6 9 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 1999 (UNAUDITED) of this type, including a minimum net worth requirement, a minimum fixed charge requirement, leverage ratios and limits on the amount of treasury stock we may purchase. At June 30, 1999, we were in compliance with all such covenants. We also have $100 million in senior notes outstanding that were assumed when we acquired FHP. These notes carry an interest rate of seven percent, are payable semiannually and mature on September 15, 2003. 4. STOCKHOLDERS' EQUITY RECLASSIFICATION OF COMMON STOCK. At our June 24, 1999 annual meeting, our Class A and Class B common stockholders, including UniHealth Foundation ("UniHealth"), a non-profit public benefit corporation and our largest stockholder, approved an amended and restated certificate of incorporation. The amended and restated certificate combined and reclassified PacifiCare's Class A and Class B common stock into a single class of voting common stock. The reclassified common stock has the same rights, powers and limitations as the previously existing Class A common stock. The reclassification of the Class A and Class B common stock had no impact on the total number of our issued and outstanding shares of common stock. Prior to the reclassification of our Class A and Class B common stock, UniHealth owned approximately 40 percent of our Class A common stock and approximately one percent of our Class B common stock. After the reclassification and combination of our common stock, UniHealth owned approximately 13.5 percent of our outstanding common stock. In consideration for UniHealth's vote in favor of the amended and restated certificate of incorporation and in consideration of the agreements and covenants contained in the stock purchase agreement discussed below, we paid UniHealth $60 million on June 24, 1999, the day our stockholders approved the amended and restated certificate of incorporation. We will also incur $1.9 million of expenses related to the reclassification of our common stock and the registration of the shares held by UniHealth. These amounts were recorded as a reduction of stockholders' equity. UNIHEALTH STOCK REPURCHASE AGREEMENT. In May 1999, we entered into a stock purchase agreement with UniHealth to repurchase up to 5.9 million shares of our common stock held by UniHealth. The purchase price for the shares will equal the average fair value of the stock for the 30 trading days preceding the scheduled purchase dates. We are not required to buy if the stock price is greater than $120 per share and UniHealth is not required to sell if the stock price is less than $75 per share ($70 on the initial purchase date in August 1999). The terms of our credit facility permit us to repurchase up to $500 million of our outstanding common stock. Depending on the repurchase prices of the UniHealth shares and other repurchases of our common stock, PacifiCare may need to obtain an amendment under this credit facility. If an amendment cannot be obtained, PacifiCare would be required to negotiate a new credit facility. Depending on the average stock price, PacifiCare may repurchase UniHealth shares on the following dates and in the following installments:
AGGREGATE REPURCHASE PRICE RANGE PER SHARE (IN MILLIONS) ------------ ----------------- APPROXIMATE PURCHASE DATE SHARES LOW HIGH LOW HIGH - ------------------------- --------- --- ---- --- ---- August 9, 1999 1,000,000 $70 $120 $70 $120 November 15, 1999 1,000,000 $75 $120 75 120 February 15, 2000 750,000 $75 $120 56 90 May 15, 2000 750,000 $75 $120 56 90 August 15, 2000 750,000 $75 $120 56 90 November 15, 2000 750,000 $75 $120 56 90 February 15, 2001 909,500 $75 $120 68 109 --------- ---- ---- Repurchase shares 5,909,500 $437 $709 ========= ==== ====
TREASURY STOCK. In January 1998, our board of directors approved a plan for us to repurchase up to ten percent of our outstanding common stock. We are authorized to repurchase up to ten percent of our common stock through the stock 7 10 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 1999 (UNAUDITED) buy-back program and the UniHealth transaction less any shares repurchased in 1998 and 1999. During 1998, we repurchased 784,000 shares totaling $45 million. In July and through August 10, 1999, we repurchased 537,000 shares totaling $37 million. We have repurchased, and may continue to repurchase, our outstanding common stock using cash flows from operations and additional borrowings under the credit facility. Shares repurchased have been, and will be reissued for our employee benefit plans or for other corporate purposes. PREFERRED STOCK REDEMPTION. In May 1998, we announced the redemption of our 10.5 million shares of Series A preferred stock. Substantially all of the preferred shares were converted into 3.9 million shares of common stock as of the June 23, 1998 redemption date. During the six months ended June 30, 1998, we paid approximately $5 million in dividends to our preferred stockholders. 5. COMMITMENTS AND CONTINGENCIES PROVIDER INSTABILITY AND INSOLVENCY. Provider insolvency charges include write-offs of certain providers' uncollectable receivables and the estimated cost of unpaid health care claims normally covered by our capitation payments. Depending on state laws, we may be held liable for unpaid health care claims that were contractually the responsibility of the capitated provider. The balance of our provider insolvency reserves was $45 million at June 30, 1999 and $58 million at December 31, 1998. The net year-to-date decrease in provider insolvency reserves is attributable to $20 million in payments, primarily to Nevada providers, offset by $7 million in additional provider insolvency reserves. For the first six months of 1998, provider insolvency costs totaled $41 million and were entirely related to the bankruptcy of FPA Medical Management, Inc. The California Department of Corporations ("DOC") entered into a settlement with Alabama-based MedPartners, Inc. regarding its California subsidiary, MedPartners Network ("MPN"). MPN is a provider organization licensed by the DOC that arranges health care services for HMO members through arrangements between HMOs and health care providers, such as hospitals and physician groups. In March 1999, California regulators seized MPN and appointed a conservator to oversee MPN. The conservator placed MPN in bankruptcy. The State of California, the DOC, MPN and MedPartners, Inc. recently entered into an Operations and Settlement Agreement to ensure continuing patient care and to resolve certain claims by and against MPN and MedPartners, Inc. Under this agreement, MedPartners, Inc. agreed to fund MPN's liabilities to its contracted and non-contracted providers in California. As part of the agreement, and subject to certain conditions that have not yet been fulfilled, effective June 1, 1999, we agreed to assume financial responsibility for institutional services that were previously the responsibility of MPN. The agreement requires the institutional provider to offer the same terms to us as MPN had through the earlier of the termination of the provider's contract or December 31, 1999. In addition, our intent is to participate in the agreement, which may require us to waive or subordinate certain claims against MPN in exchange for waivers of claims against us in connection with services provided by MPN. We, along with other HMOs, are participating in discussions about making a loan or loans to MedPartners, Inc. Recent discussions involve a total loan by all the HMOs in the amount of $12 million, with $3 million contributed by us. No final commitment to loan funds to MedPartners, Inc. has been made. MPN is one of our significant provider networks in California. The majority of our insolvency reserves relate to specific providers. However, our reserves also include estimates for potentially insolvent providers, where conditions indicate claims are not being paid or have slowed considerably. Based on information currently available, we believe that any liability in excess of amounts accrued would not materially affect our consolidated financial position. However, our evaluation of the likely impact of claims asserted against us could change in the future and an unfavorable outcome, depending on the amount and timing, could have a material effect on our results of operations or cash flows for a future quarter. OPM. Our HMO subsidiaries have commercial contracts with the United States Office of Personnel Management ("OPM") to provide managed health care services to federal employees, annuitants and their dependents under the Federal Employee Health Benefits Program ("FEHBP"). In the normal course of business, OPM audits health plans with which it contracts mainly to verify that the premiums calculated and charged to OPM are established in compliance with the best price community rating guidelines established by OPM. OPM typically audits plans once every five or six years, with each audit covering a multiple year period. While the government's initial on-site audits are usually followed by a post-audit briefing in which the government indicates its preliminary results, final resolution and settlement of the audits have historically taken three or more years. In July 1999, we received a request for additional information regarding FHP's OPM contracts from 1990 to present. The majority of these contract years have been audited but are not yet settled. We intend to comply with OPM's request. 8 11 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 1999 (UNAUDITED) In addition to claims made by the OPM auditors as part of the normal audit process, OPM may also refer their results to the United States Department of Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ has the authority to file a claim under the False Claims Act if it believes that the health plan knowingly overcharged the government or otherwise submitted false documentation or certifications. In False Claims Act actions, the government may impose trebled damages and a civil penalty of not less than $5,000 nor more than $10,000 for each separate alleged false claim. In November 1997, we were notified that the 1990 through 1995 audit of the operations of our Oklahoma HMO subsidiary had been referred to the DOJ. In the third quarter of 1998 we recorded an additional reserve of approximately $4 million ($2 million, or $0.04 diluted loss per share, net of tax) for potential OPM claims bringing the September 30, 1998 balance for the 1990-1995 audits to $17 million. In January 1999, we preliminarily agreed to settle the 1990-1995 Oklahoma OPM audits for $9 million. As a result of this settlement and other changes in estimate, we recognized a pretax OPM credit of $8 million ($4 million or $0.10 diluted income per share, net of tax) in the fourth quarter of 1998, bringing the December 31, 1998 reserve balance for the 1990-1995 audits down to $9 million. In June 1999, we paid $9 million to the DOJ as final settlement for the 1990-1995 Oklahoma OPM audits. In connection with the sales of our health plans in New Mexico, Illinois and Utah, we have agreed to indemnify the buyers for potential OPM liabilities that relate to the years in which we owned these plans. In addition to indemnified OPM reserves, we establish reserves based upon best estimates for OPM audits not yet settled. We intend to negotiate with OPM on any existing or future unresolved matters to attain a mutually satisfactory result. There can be no assurance that any ongoing and future negotiations will be concluded satisfactorily, that additional audits will not be referred to the DOJ, or that additional, possibly material, liability will not be incurred. We believe that any ultimate liability in excess of amounts accrued would not materially affect our consolidated financial position. However, such liability could have a material effect on results of operations or cash flows of a future quarter if resolved unfavorably. LEGAL PROCEEDINGS. In 1997, we were served with several purported class action suits alleging violations of federal securities laws by PacifiCare and by certain of our officers and directors. The complaints related to the period from the date of the FHP acquisition through our November 1997 announcement that earnings for the fourth quarter of 1997 would be lower than expected. These complaints primarily alleged that we previously omitted and/or misrepresented material facts with respect to our costs, earnings and profits. We have filed a motion to dismiss the entire complaint. No discovery has been taken, and all discovery has been stayed pending the resolution of our motion to dismiss. We believe we have good defenses to the claims in these suits and are contesting them vigorously. We are also involved in legal actions in the normal course of business, some of which seek monetary damages, including claims of punitive damages that are not covered by insurance. Based on current information and review with our lawyers, management believes any ultimate liability which may arise from these actions (including the purported class actions), would not materially affect our consolidated financial position, results of operations or cash flows. However, management's evaluation of the likely impact of these actions could change in the future and an unfavorable outcome, depending upon the amount and timing, could have a material effect on our results of operations or cash flows for a future quarter. 6. EARNINGS PER SHARE We calculated the denominators for the computation of basic and diluted earnings per share as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------- 1999 1998 1999 1998 ------ ------ ------ ------- (AMOUNTS IN THOUSANDS) Shares outstanding at the beginning of the period ............... 45,664 41,720 45,616 41,995 Weighted average number of shares issued: Stock options exercised ...................................... 203 68 134 150 Treasury stock acquired, net of shares issued ................ -- 9 -- (405) Conversion of Series A preferred stock ....................... -- 348 -- 175 ------ ------ ------ ------- Denominator for basic earnings per share ........................ 45,867 42,145 45,750 41,915 Employee stock options and other dilutive potential common shares 419 507 353 341 Assumed conversion of Series A preferred stock .................. -- 3,582 -- 3,755 ------ ------ ------ ------- Denominator for diluted earnings per share ...................... 46,286 46,234 46,103 46,011 ====== ====== ====== =======
9 12 PACIFICARE HEALTH SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued) JUNE 30, 1999 (UNAUDITED) 7. COMPREHENSIVE INCOME Comprehensive income represents PacifiCare's net income plus changes in its equity, other than those changes resulting from investments by, and distributions to PacifiCare's stockholders. Such changes include unrealized gains or losses on our available-for-sale securities. PacifiCare's comprehensive income totaled $55 million for the three months ended June 30, 1999 and $123 million for the six months ended June 30, 1999. Comprehensive income totaled $49 million for the three months ended June 30, 1998 and $89 million for the six months ended June 30, 1998. 8. FUTURE APPLICATION OF ACCOUNTING STANDARDS Derivatives. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard requires companies to record all derivatives on the balance sheet as either assets or liabilities and measure those instruments at their fair value. The manner in which companies record gains or losses resulting from changes in the values of those derivatives depends on the use of the derivative and whether it qualifies for hedge accounting. This standard is effective for our consolidated financial statements beginning January 1, 2001, although early adoption is permitted. Based on current derivatives held, we believe that the adoption of this statement will not have a material impact to our consolidated financial position or results of operations. 10 13 PART I: FINANCIAL INFORMATION ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS OVERVIEW. PacifiCare sells HMO and HMO-related products primarily to members in two groups: the Secure Horizons program for Medicare beneficiaries and the commercial programs for members of employer groups and individuals. Our specialty managed care HMOs and HMO-related products and services supplement our commercial and Secure Horizons programs. These include pharmacy benefit management, life and health insurance, behavioral health services, dental and vision services and Medicare+Choice management services. Events significant to our business in 1999 include: o In May 1999, we entered into a stock purchase agreement with UniHealth to repurchase up to 5.9 million shares of our common stock held by UniHealth. See Note 4 of the Notes to the Condensed Consolidated Financial Statements. o At our June 24, 1999 annual meeting, our Class A and Class B common stockholders approved an amended and restated certificate of incorporation, which combined and reclassified PacifiCare's Class A and Class B common stock into a single class of voting common stock. We paid UniHealth $60 million when our stockholders approved the amended and restated certificate of incorporation on June 24, 1999. This payment was recorded as a reduction of stockholders' equity. See Note 4 of the Notes to Condensed Consolidated Financial Statements. o In June 1999, we submitted our year 2000 proposed Secure Horizons benefit plan changes to HCFA for their approval. These changes include exiting Secure Horizons operations in 12 counties in Ohio, Washington, Oregon and California effective January 1, 2000. This will affect approximately 16,400 Secure Horizons members, or less than two percent of our 996,000 members. In addition, we plan to increase our members' monthly premiums and co-payments and reduce benefits where the government provides insufficient reimbursement. See "Forward Looking Information." o The California Department of Corporations ("DOC") entered into a settlement with Alabama-based MedPartners, Inc. regarding its California subsidiary, MPN. See Note 5 of the Notes to Condensed Consolidated Financial Statements and "Consolidated Medical Care Ratio and Provider Insolvency Reserves" below. 1999 COMPARED WITH 1998 The information below includes both the Medicare and Medicaid lines of business as part of the government program for the 1998 period presented. MEMBERSHIP. Total membership decreased two percent to approximately 3.6 million members at June 30, 1999 from approximately 3.7 million members at June 30, 1998, with the majority of the decrease resulting from the disposition of Utah.
AT JUNE 30, 1999 AT JUNE 30, 1998 ---------------------------------- ----------------------------------- MEMBERSHIP DATA GOVERNMENT COMMERCIAL TOTAL GOVERNMENT COMMERCIAL TOTAL - --------------- ---------- ---------- --------- ---------- ---------- --------- Arizona ........... 81,200 100,300 181,500 88,400 105,400 193,800 California ........ 613,900 1,665,200 2,279,100 600,300 1,561,000 2,161,300 Colorado .......... 67,300 292,200 359,500 55,500 295,200 350,700 Guam .............. -- 42,100 42,100 -- 40,400 40,400 Nevada ............ 22,600 36,200 58,800 24,700 43,700 68,400 Ohio .............. 19,800 42,700 62,500 15,000 46,800 61,800 Oklahoma .......... 27,700 84,500 112,200 26,700 100,700 127,400 Oregon ............ 38,600 115,300 153,900 38,700 116,200 154,900 Texas ............. 60,000 126,700 186,700 68,600 141,800 210,400 Utah (1) .......... -- -- -- 22,200 113,300 135,500 Washington ........ 64,900 76,200 141,100 59,500 95,600 155,100 ------- --------- --------- ------- --------- --------- Total membership 996,000 2,581,400 3,577,400 999,600 2,660,100 3,659,700 ======= ========= ========= ======= ========= =========
- ------------- (1) At June 30, 1998, Utah had approximately 9,800 Medicaid members. 11 14 Government membership decreased slightly at June 30, 1999 as compared to the same period in the prior year due to: o Membership decreases resulting from the disposition of Utah and our exit from certain rural markets; partially offset by o Membership increases due primarily to competitor exits in markets in which Secure Horizons will remain. Commercial membership decreased approximately three percent at June 30, 1999 as compared to the same period in the prior year due to: o Membership decreases resulting from the disposition of Utah and our continued focus on renewing commercial contracts with sufficient price increases to improve gross margin; partially offset by o Membership increases primarily in California due to improved sales efforts. GOVERNMENT PREMIUMS. Government premiums increased three percent or $38 million for the three months and $87 million for the six months ended June 30, 1999 as compared to the same periods in the prior year as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 1999 JUNE 30, 1999 ------------------ ---------------- (AMOUNTS IN MILLIONS) Premium rate increases that averaged approximately two percent for the three months and three percent for the six months ended June 30, 1999 ........................ $ 34 $ 86 Net membership increases (excluding Utah), primarily due to competitors' exits in markets in which Secure Horizons will remain .................................. 21 35 Membership losses resulting from the disposition of Utah (17) (34) ---- ---- Increase over prior year ............................... $ 38 $ 87 ==== ====
Government premium rate increases were higher than the published Health Care Financing Administration ("HCFA") rate increase due to changes in membership mix, higher retiree supplemental premiums and the exit of the Utah Medicaid business. COMMERCIAL PREMIUMS. Commercial premiums increased two percent or $22 million for the three months and $38 million for the six months ended June 30, 1999 compared to the same periods in the prior year as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 1999 JUNE 30, 1999 ------------------ ---------------- (AMOUNTS IN MILLIONS) Premium rate increases that averaged approximately six percent for both the three and six months ended June 30, 1999 ............................................. $ 52 $ 114 Net membership increases (excluding Utah), primarily in California ........................................... 9 12 Membership losses resulting from the disposition of Utah ................................................. (33) (69) Discontinued indemnity and workers' compensation products ............................................. (6) (19) ---- ----- Increase over prior year .............................. $ 22 $ 38 ==== =====
OTHER INCOME. Other income decreased for the three months ended June 30, 1999 compared to the same period in the prior year, primarily due to lower SHUSA revenues and rental income due to the sale of certain rental property owned in 1998. Other income increased for the six months ended June 30, 1999 compared to the same period in the prior year. The increase was primarily due to increased mail-service revenues from our pharmacy benefit management company, where we, rather than the network retail pharmacies, collect the member copayments. 12 15 CONSOLIDATED MEDICAL CARE RATIO AND PROVIDER INSOLVENCY RESERVES. The consolidated medical care ratio (health care services as a percentage of premium revenue) declined for the three and six months ended June 30, 1999, compared to the same periods in the prior year.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ------------------ 1999 1998 1999 1998 ------ ------ ------ ------ Medical care ratio: Consolidated ... 85.0% 85.1% 84.9% 85.2% Government ..... 87.5% 86.1% 87.2% 86.4% Commercial ..... 81.4% 83.7% 81.4% 83.4%
The improved consolidated medical care ratio performance is primarily related to lower 1999 provider reserves compared to 1998. Provider reserves for the six months ended June 30, 1998 were as follows:
QUARTER GOVERNMENT COMMERCIAL TOTAL ------- ---------- ---------- ----- First ......... $ 3 $ 3 $ 6 Second ........ 25 10 35 --- --- --- Total ........ $28 $13 $41 === === ===
Provider insolvency charges include the write-off of the providers' uncollectable receivables and estimated cost of unpaid health care claims covered by our capitation payment. Depending on state law, we may be liable for unpaid health care claims that were the responsibility of the capitated provider. During the second quarter of 1998, the provider insolvency reserves were partially offset by approximately $15 million of unrelated favorable provider settlements. Excluding net provider reserves, the increase in the 1999 consolidated medical care ratio for the three and six months ended June 30, 1999 compared to 1998 was primarily due to higher hospital utilization and costs and increased pharmacy costs due to benefit enhancements for Secure Horizons members. GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio increased for the three and six months ended June 30, 1999 compared to the prior year due to: o Higher hospital utilization and costs; o Increased pharmacy utilization as a result of pharmacy benefit enhancements and higher prescription drug costs; partially offset by o Premium rate increases. COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the specialty HMOs and indemnity insurance results. The commercial medical care ratio for the three and six months ended June 30, 1999 decreased due to: o A favorable premium pricing environment; o The sale of our Utah HMO and workers' compensation subsidiaries; and o Improved specialty product performance. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and administrative expenses as a percentage of operating revenue decreased for the three and six months ended June 30, 1999 as compared to the prior year because of: o The Utah HMO disposition; o The introduction of new technologies; o The improved efficiencies of our regional customer service operations; and o The realization of a full year of synergies from the FHP acquisition.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ------------------ 1999 1998 1999 1998 ------ ------ ------ ------ Marketing, general and administrative expenses as a percent of operating revenue ......................... 10.8% 11.5% 10.8% 11.7%
13 16 OPERATING INCOME. The drivers of this growth are discussed above.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ------------------ 1999 1998 1999 1998 ------ ------ ------ ------ Operating income as a percentage of operating revenue ... 4.4% 3.6% 4.5% 3.3%
NET INVESTMENT INCOME. Net investment income decreased approximately 15 percent for the three months ended and approximately 18 percent for the six months ended June 30, 1999 compared to the same periods in the prior year. Interest income decreased because we had fewer realized gains on sales of marketable securities in the current year, interest rates are lower and we have shifted more portfolio holdings to tax exempt investments. INTEREST EXPENSE. Interest expense decreased approximately 44 percent for the three months ended and approximately 43 percent for the six months ended June 30, 1999 compared to the same periods in the prior year due to continued repayment of our credit facility and declining interest rates. PROVISION FOR INCOME TAXES. The effective income tax rate was 41.4 percent for the three and six months ended June 30, 1999, compared with 47.6 percent for the three months ended and 48.0 percent for the six months ended June 30, 1998. The rate declined significantly because: o Nondeductible goodwill amortization was a smaller percentage of pretax income; o We benefited from certain tax strategies, in particular the legal reorganization of the Company and its subsidiaries; o The 1998 effective tax rate included an increase related to the dispositions of Utah and the workers' compensation subsidiaries; and o 1999 investment strategies to date have resulted in an increase in tax-exempt earnings. DILUTED EARNINGS PER SHARE. For the three months ended June 30, 1999, net income was $69 million or $1.49 diluted earnings per share, compared to net income of $49 million or $1.06 diluted earnings per share for the same period in the prior year. For the six months ended June 30, 1999, net income was $143 million or $3.10 diluted earnings per share. For the six months ended June 30, 1998, net income was $90 million or $1.96 diluted earnings per share. The increases in diluted earnings per share from the prior periods were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30 JUNE 30 ------------------ ---------------- Diluted earnings per share - June 30, 1998 $1.06 $1.96 Improved operations: Commercial gross margin performance ... 0.34 0.57 Government gross margin performance ... (0.19) (0.17) MG&A .................................. 0.13 0.38 Other income performance .............. (0.02) 0.04 ----- ----- Total improved operations ........... 0.26 0.82 ----- ----- Net investment income and interest expense 0.05 0.07 Income tax rate decrease ................. 0.12 0.25 ----- ----- Diluted earnings per share - June 30, 1999 $1.49 $3.10 ===== =====
LIQUIDITY AND CAPITAL RESOURCES OPERATING CASH FLOWS. PacifiCare's consolidated cash, equivalents and marketable securities decreased to $1.2 billion at June 30, 1999 from $1.6 billion at December 31, 1998. The combined decrease in cash, equivalents and marketable securities occurred because the January 1999 Medicare payment from HCFA was prepaid in December 1998 while the July 1999 HCFA payment was paid in July 1999. Cash flows from operations, excluding the impact of deferred revenue, were $226 million at June 30, 1999 and $183 million at June 30, 1998, and were primarily attributable to increased net income. 14 17 INVESTING ACTIVITIES. For the six months ended June 30, 1999, we used $134 million of cash for investing activities, compared to $104 million used for the first half of 1998. We purchased more marketable securities in 1999, resulting in the majority of the $30 million net increase over the prior year. FINANCING ACTIVITIES. Net cash used in financing activities was $114 million for the six months ended June 30, 1999 and $217 million for the six months ended June 30, 1998. We paid $75 million on our credit facility for the six months ended June 30, 1999, and $230 million for the six months ended June 30, 1998. In May 1999, we entered into a stock purchase agreement with UniHealth to repurchase up to 5.9 million shares of our common stock held by UniHealth. In addition, in consideration for UniHealth's vote for the reclassification of our stock and in consideration for the agreements and covenants contained in the stock purchase agreement between us and UniHealth, we paid UniHealth $60 million on June 24, 1999, when our stockholders approved the amended and restated certificate of incorporation. See Note 4 of the Notes to Condensed Consolidated Financial Statements. In January 1998, our board of directors approved a plan for us to repurchase up to ten percent of our outstanding common stock. We are authorized to repurchase up to ten percent of our common stock through the stock buy-back program and the UniHealth transaction less any shares repurchased in 1998 and 1999. During 1998, we repurchased 784,000 shares of our common stock for $45 million. In July and through August 10, 1999, we repurchased 537,000 shares totaling $37 million. During 1998, we borrowed $30 million under the credit facility to repurchase shares of our outstanding common stock, and as of June 30, 1998, we had repurchased 448,000 shares of our common stock for an aggregate amount of $23 million. Cash received for the issuance of common stock provided $23 million in 1999 and $12 million in 1998. We paid approximately $5 million of preferred stock dividends in 1998. OTHER BALANCE SHEET CHANGE EXPLANATIONS RECEIVABLES, NET. Receivables, net increased by $33 million from December 31, 1998, primarily from providers. We administer claims payments for some of our capitated providers. For this service we hold back, or withhold, a percentage of capitation payments due to the providers. At June 30, 1999, claims paid have exceeded capitation withheld, but are expected to be recovered through capitation withhold adjustments and settlement negotiations through the remainder of the year. GOODWILL AND INTANGIBLE ASSETS, NET. Goodwill and intangible assets decreased by $33 million from 1998 as follows: o $38 million of goodwill and intangible amortization expense; partially offset by o $5 million increase primarily related to the acquisition of approximately 15,000 commercial members in Texas. MEDICAL CLAIMS AND BENEFITS PAYABLE. Medical claims and benefits payable increased by $65 million from December 31, 1998 as follows: o $48 million increase primarily due to increased amounts withheld for claims administration, both our risk and claims administered on behalf of providers; o $15 million increase in claims incurred but not yet reported for increased membership and utilization under shared risk arrangements; o $15 million increase in provider capitation and incentive liabilities; offset by o $13 million net decrease in provider insolvency reserves, consisting of $7 million in additional provisions and $20 million in payments, primarily to Nevada providers. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES. Accounts payable and accrued liabilities decreased $34 million from December 31, 1998. The income taxes payable decreased by $46 million due to estimated tax payments partially offset by the tax provision for 1999. This decrease was partially offset by an increase in pharmacy rebates payable to external clients. MATERIAL COMMITMENTS. In May 1999, we committed to repurchase up to 5.9 million of our shares of common stock from UniHealth in installments during 1999 through February 2001. We expect to repurchase up to 2 million shares during 1999 at a price equal to the average closing price for the 30 trading days preceding the repurchase. However, we are not required to buy if the stock price is greater than $120 per share and UniHealth is not required to sell if the stock price is less than $75 per share ($70 on the initial purchase date in August 1999). See Note 4 of the Notes to Condensed Consolidated Financial Statements. NEW ACCOUNTING PRONOUNCEMENTS. See Note 8 of the Notes to Condensed Consolidated Financial Statements for a discussion of future application of accounting standards. 15 18 THREE MONTHS ENDED JUNE 30, 1999 COMPARED WITH THREE MONTHS ENDED MARCH 31, 1999 The following presents our results of operations for the three months ended June 30, 1999 in comparison to the results of operations for the three months ended March 31, 1999. We are presenting this information to assist in the understanding of our discussions about our operating trends, our outlook on future performance and the risks affecting our future performance discussed below in Forward Looking Information under the Private Securities Litigation Act of 1995. MEMBERSHIP. Total membership decreased slightly at June 30, 1999 from March 31, 1999.
AT JUNE 30, 1999 AT MARCH 31, 1999 ------------------------------------- -------------------------------------- MEMBERSHIP DATA GOVERNMENT COMMERCIAL TOTAL GOVERNMENT COMMERCIAL TOTAL - --------------- ---------- ---------- --------- ---------- ---------- ---------- Arizona ........... 81,200 100,300 181,500 83,300 103,500 186,800 California ........ 613,900 1,665,200 2,279,100 611,200 1,657,000 2,268,200 Colorado .......... 67,300 292,200 359,500 65,400 292,700 358,100 Guam .............. -- 42,100 42,100 -- 41,500 41,500 Nevada ............ 22,600 36,200 58,800 22,300 40,200 62,500 Ohio .............. 19,800 42,700 62,500 18,900 43,900 62,800 Oklahoma .......... 27,700 84,500 112,200 27,300 87,600 114,900 Oregon ............ 38,600 115,300 153,900 38,500 114,000 152,500 Texas ............. 60,000 126,700 186,700 60,700 134,500 195,200 Washington ........ 64,900 76,200 141,100 64,000 78,800 142,800 ------- --------- --------- ------- --------- --------- Total membership 996,000 2,581,400 3,577,400 991,600 2,593,700 3,585,300 ======= ========= ========= ======= ========= =========
Government membership increased slightly at June 30, 1999 from March 31, 1999 due primarily to competitor exits in markets in which Secure Horizons will remain. Commercial membership decreased slightly at June 30, 1999 from March 31, 1999 due to second quarter employer group terminations because of our continued focus on renewing commercial contracts with sufficient price increases to improve gross margin and provider network changes. GOVERNMENT PREMIUMS. Government premiums for the three months ended June 30, 1999 were comparable to the three months ended March 31, 1999. COMMERCIAL PREMIUMS. Commercial premiums increased approximately one percent or $5 million for the three months ended June 30, 1999 compared to the three months ended March 31, 1999. The increase was primarily due to premium rate increases. OTHER INCOME. Other income decreased for the three months ended June 30, 1999 compared to the three months ended March 31, 1999 primarily due to lower SHUSA revenues. CONSOLIDATED MEDICAL CARE RATIO. The consolidated medical care ratio increased for the three months ended June 30, 1999 compared to the three months ended March 31, 1999. The increase was primarily due to higher hospital utilization and costs and increased pharmacy utilization for Secure Horizons members.
THREE MONTHS ENDED THREE MONTHS ENDED JUNE 30, 1999 MARCH 31, 1999 ------------------ ------------------ Medical care ratio: Consolidated................. 85.0% 84.8% Government................... 87.5% 87.0% Commercial .................. 81.4% 81.5%
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio increased for the three months ended June 30, 1999 compared to the three months ended March 31, 1999 due to: o Higher hospitalization utilization and costs; o Increased pharmacy utilization and costs; partially offset by o Premium rate increases. 16 19 COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the specialty HMOs and indemnity insurance results. The commercial medical care ratio for the three months ended June 30, 1999 was comparable to the commercial medical care ratio for the three months ended March 31, 1999. MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and administrative expenses as a percentage of operating revenue was 10.8 percent for the three months ended June 30, 1999 and was comparable to 10.7 percent for the three months ended March 31, 1999. OPERATING INCOME. Operating income as a percentage of operating revenue was 4.4 percent for the three months ended June 30, 1999 and was 4.7 percent for the three months ended March 31, 1999. The drivers of this sequential decline are discussed above. NET INVESTMENT INCOME AND INTEREST EXPENSE. Net investment income for the three months ended June 30, 1999 is comparable to the three months ended March 31, 1999. Interest expense decreased for the three months ended June 30, 1999 compared to the three months ended March 31, 1999 due to a lower average balance outstanding on the credit facility during the current quarter. PROVISION FOR INCOME TAXES. The effective income tax rate was 41.4 percent for the three months ended June 30, 1999 and March 31, 1999. DILUTED EARNINGS PER SHARE. For the three months ended June 30, 1999, net income was $69 million or $1.49 diluted earnings per share compared to net income of $74 million or $1.61 diluted earning per share for the three months ended March 31, 1999. The change was due to the following:
THREE MONTHS ENDED ------------------ Diluted earnings per share - March 31, 1999 $ 1.61 Change attributable to operations: Commercial gross margin performance............ 0.03 Government gross margin performance............ (0.09) MG&A and amortization.......................... (0.05) Other income performance....................... (0.02) ------ Total change attributable to operations...... (0.13) Net investment income and interest expense........ 0.01 ------ Diluted earnings per share - June 30, 1999 $ 1.49 ======
FORWARD LOOKING INFORMATION UNDER THE PRIVATE SECURITIES LITIGATION ACT OF 1995 The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. The Act was designed to encourage companies to provide prospective information about themselves without fear of litigation. The prospective information must be identified as forward looking and must be accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statements. The statements about our plans, strategies, intentions, expectations and prospects contained throughout the document are based on current expectations. These statements are forward looking and actual results may differ materially from those predicted as of the date of this report in the forward looking statements, which involve risks and uncertainties. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. Stockholders are also directed to the other risks discussed in other documents filed by PacifiCare with the Securities and Exchange Commission. DILUTED EARNINGS PER SHARE. We estimate that 1999 diluted earnings per share will be 40 to 45 percent greater than 1998 diluted earnings per share of $4.40. We expect our earnings per share for the last six months of 1999 to be comparable to the six months ended June 30, 1999. The drivers of our expectations are discussed below. MEMBERSHIP. We expect government membership to increase one to three percent by December 31, 1999 compared to December 31, 1998. We continue to expand our membership retention programs and target group retiree members in our existing markets. These increases will be partially offset by our exit from certain rural markets. In the year 2000, we expect membership decreases because we will not renew Medicare risk contracts in 12 counties in Ohio, Washington, Oregon and 17 20 California effective January 1, 2000. Approximately 16,400 Secure Horizons members or less than two percent of our 996,000 members, will be impacted. We also could lose members if we decide to exit additional unprofitable markets. We expect commercial membership for the year ended December 31, 1999 to increase one to two percent compared to 1998. The majority of the growth will be in California where we plan to focus our marketing efforts on membership renewal and national accounts. PREMIUMS. We expect premium rate increases of three percent for Medicare and six percent for commercial for the six months ended June 30, 1999 to be sustained for the remainder of 1999. Our emphasis continues to be on renewing commercial employer contracts with price increases sufficient to maintain or improve margin performance. Effective January 1, 2000, we expect to increase Secure Horizons member paid supplemental premiums for approximately 57 percent of our Secure Horizons members, increase office visit copayments for approximately 60 percent of our Secure Horizons members and decrease pharmacy benefits for approximately 75 percent of our Secure Horizons members. In determining our benefit changes for 2000, our strategy is to err on the side of margin protection. We recognize that we can only reduce benefits once a year but, if necessary, we can add Secure Horizons benefits back at any time. MEMBERSHIP AND PREMIUM RISK FACTORS. An unforeseen loss of profitable membership could negatively affect our financial position, results of operations and cash flows. Factors that could contribute to the loss of membership include: o Our failure to obtain new customers or retain existing customers; o The effect of premium increases, benefit changes and member paid supplemental premiums and copayments; o Our exit from certain markets; o Reductions in work force by existing customers; o Negative publicity and news coverage; o Inability of our marketing and sales plans to attract new customers; or o Our loss of key executives or key employees. OTHER INCOME. In 1999, we expect other income to be comparable to or slightly higher than 1998. HEALTH CARE COSTS. Our profitability depends, in part, on our ability to control health care costs while providing quality care. Our primary focus is securing cost-effective physician, hospital and other health care provider contracts to maintain our qualified and financially stable network of providers in each geographic area we serve. Whether our contracts are physician and hospital capitated or some form of medical risk sharing, comprehensive medical management is one way we control health care costs. Currently we estimate that providers representing approximately six percent of our members are moving to shared risk arrangements. As a result, we expect to increase our medical management focus in the last half of 1999. We continue to evaluate the financial stability of our providers, focusing on providers with significant membership in key geographic areas and providers that have been identified as a poor risk. We are also seeking to improve 1999 provider stability over 1998 by taking steps to minimize insolvency risk. This includes developing contingency plans to shift membership to other providers, supplementing utilization management review personnel of the provider group and reviewing operational and financial plans to increase financial stability. We believe our June 30, 1999 provider insolvency reserves are adequate. These reserves are intended to pay for June 1999 and prior health care services that may not be paid by insolvent or unstable providers. Prescription drug costs increased 11 to 12 percent from 1998 driven by drug utilization, cost per prescription and benefit enhancements. We provide contracted medical groups with prescription drug formularies as a way of controlling health care costs. Formularies are lists of physician recommended drugs in different therapeutic classes that have been reviewed for safety, efficacy and value. These lists help ensure that members get the right prescription at the right time in the right dose, avoiding potential adverse effects. Formularies also ensure that the price is right; if two medications have the same effect, the less expensive option (often a generic alternative) is recommended. Medically necessary drugs not included in the formulary can be obtained through our authorization process. We continue to conduct member and physician education programs to provide information on the appropriate use of generic drugs, over the counter drugs and antibiotics. Many of our medical groups share the financial risk for prescription drugs to find the most effective and cost-efficient treatments for our members. Prescription drug benefit changes are expected in 2000 as a way of controlling this health care cost component and will be announced in the fall of 1999. 18 21 GOVERNMENT MEDICAL CARE RATIO. We expect the 1999 government medical care ratio to increase 60 to 100 basis points from 86.5 percent in 1998. Higher provider costs (both capitated and shared risk) and pharmacy costs will increase the 1999 medical care ratio. These will be partially offset by premium rate increases, improvements in hospital utilization management and our exit of rural markets in certain states plus the disposition of Utah. COMMERCIAL MEDICAL CARE RATIO. We expect the 1999 commercial medical care ratio improvements made to date to continue for the remainder of the year. Moreover, higher premium rates offered during the summer renewal period should continue to result in the elimination of some high medical care ratio business. MEDICAL CARE RATIO RISK FACTORS. Increases in the Medicare and/or commercial medical care ratio could have an adverse effect on our profitability. Uncertainties that could have a negative impact on our medical care ratio include: o Medical and prescription drug costs that rise faster than premium increases; o Increases in utilization and costs of medical and hospital services; o The effect of federal and/or state legislation on our ability to secure cost-effective contracts with providers; o The effect of actions by competitors or groups of providers; o Termination of provider contracts, provider insolvency or renegotiation of such contracts at less favorable rates or terms of payment; o Legislation that gives physicians collective bargaining power; or o The expected September 1999 announcement of drug benefit changes effective January 1, 2000 that could result in increased pharmacy utilization during the fourth quarter of 1999. We have and may continue to incur additional health care costs. The effect of these risks and the need for additional provider insolvency reserves could have a material effect on our results of operations or cash flows. We believe, however, that such reserves would not materially affect our consolidated financial position. MARKETING, GENERAL AND ADMINISTRATIVE SUPPORT. In 1999, marketing, general and administrative expenses as a percentage of operating revenue are expected to decline compared to the 1998 rate of 11.4 percent because we expect to realize continued efficiencies from the FHP acquisition and new technologies that are implemented. The California HMO's final conversion from FHP information systems to PacifiCare systems was completed in June 1998, so 1999 will be the first full year of integrated operations. MARKETING, GENERAL AND ADMINISTRATION RISK FACTORS. The following factors could have an adverse impact on marketing, general and administrative expenses: o The need for additional advertising, marketing, administrative or management information systems expenditures; o The inability of marketing and sales plans to attract new customers; and o The need for increased claims administration for capitated providers. FUTURE DISPOSITIONS AND IMPAIRMENTS. Dispositions could be announced as we continue to evaluate whether certain subsidiaries or products fit within our core business strategy. We review long-lived assets for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. We consider assets to be impaired and write them down to fair value if we determine that the realizable value of long-lived assets such as property and equipment, real estate and goodwill, is less than the value carried on the consolidated financial statements. There can be no assurances that the dispositions and impairments will not result in additional pretax charges. We believe that any disposition or impairment operating losses would not materially affect our consolidated financial position. However, the disposition or impairment losses could have a material effect on the results of operations or cash flows of a future period. EFFECTIVE TAX RATE. The 1998 effective tax rate was 47.5 percent. We expect the 1999 effective tax rate to be between 41 and 42 percent because: o Nondeductible goodwill amortization is expected to be a smaller percentage of pretax income. As a result, the effective tax rate will decrease by approximately one to two percent. o A full year's benefit of certain tax strategies, in particular our legal reorganization will be realized in 1999. These tax strategies are expected to reduce the effective tax rate by two to three percent. o The 1998 effective tax rate included a more than one percent increase related to the dispositions of Utah and the workers' compensation subsidiary. This is not expected to reoccur. 19 22 o 1999 investment strategies to date have resulted in an increase in tax-exempt earnings, which are expected to decrease the effective tax rate on a year to date basis by approximately one percent. There can be no assurance that these tax strategies will be successful, that pretax income will increase as projected or that future business decisions will not impact the current effective tax rate. YEAR 2000. PacifiCare has implemented a Year 2000 compliance program to address all major computing information systems, including core application systems, networks, desktop systems, infrastructure, and critical information supply chains. In addition to all major information systems, we are verifying that all date fields and calculations used in critical business processes will be Year 2000 compliant. Under the program we are also addressing our external Year 2000 related risks which arise from the year 2000 readiness of third parties with whom we maintain ongoing relationships. The Year 2000 compliance program includes the following phases for our internal systems, which are listed in logical order, but are being addressed concurrently as appropriate: o Awareness and Communication. We have undertaken an ongoing company-wide communication and education effort to ensure that there is a clear understanding of the Year 2000 problem and associated risks. o Inventory and Assessment. We have completed a company-wide inventory of all internal computer information systems and their components, including infrastructure equipment and hardware, software applications and information supply chains. Through the inventory, we have assessed the business risks and Year 2000 compliance status of each system component. For components that are not Year 2000 compliant, a preliminary remediation plan has been developed that includes the Year 2000 remediation, action required and the time and resources needed to accomplish it. We have established priorities based on the relative business critical function of each system component. o Remediation, Testing, and Certification. We have tested each computer information system and component for Year 2000 compliance, using industry standards. If actual test results are acceptable, we certify the tested system or component as Year 2000 compliant. If the test identifies any issues, we take steps to correct the system or component and then retest the corrected system or component as necessary to achieve certified compliance. To date, we have tested and certified as Year 2000 compliant substantially all of our internal systems and components other than the FHP systems described below. We expect to complete the few remaining tasks (except the FHP systems) by October 31, 1999. o Implementation and Close. A final review is in process and confirmation that the remediated systems and components have met all Year 2000 compliance objectives. The program incorporates a regular reporting process, which helps us to monitor and measure our progress toward Year 2000 compliance against defined goals. Through this reporting process we can focus resources on any Year 2000 issue as necessary. When our Year 2000 compliance program was first established in 1996, we focused on existing systems and did not contemplate acquisitions of other companies. These core computing programs became Year 2000 compliant in 1998. Prior to 1999 the total cost to make our pre-FHP core computing information systems Year 2000 compliant was approximately $6 million. Amounts spent during the second quarter of 1999 are insignificant. With the February 1997 FHP acquisition, we originally expected the Arizona, Colorado, Nevada and Ohio HMOs to shift to our pre-FHP core computing information systems throughout 1998 and 1999 as providers moved to delegated capitation arrangements. In the second quarter of 1998, we determined that while we had successfully moved some of these providers to capitation arrangements, the provider networks did not have sufficient infrastructure to administer the claims under a fully delegated capitated arrangement. We concluded that our HMOs in these states will need to continue to administer claims on behalf of providers. Because the claims-based FHP core systems function more effectively than our core computing systems for claims administration on behalf of non-delegated delivery systems, we decided to maintain the FHP systems. As a result, the scope of our Year 2000 compliance activities was expanded to include the FHP computer system. We have a detailed project plan for modifying the FHP systems to be Year 2000 compliant by October 1999. Based upon an outside consultant's recommendations and internal analysis, we estimate that the total cost to make the FHP systems Year 2000 compliant ranges from $5 to $9 million. Through June 30, 1999, our costs for remedying the FHP systems have been approximately $2 million. Prior to 1999, our costs incurred were approximately $2 million. We have also contacted our third party vendors, provider and hospital networks, business partners, contractors, and service providers, including HCFA, to assess their Year 2000 level of readiness. In some cases, we sought reasonable assurances 20 23 with respect to Year 2000 compliance. Our priority was to assess the readiness of our providers with delegated responsibility and other third parties with which we electronically exchange data or interact. Because we do not control the products, services, or systems of our providers, vendors or customers, we cannot ensure their Year 2000 compliance. We have developed business process contingency plans for critical third party sources that appear to be at risk. These plans, which vary by third party entity, include contingencies for replacement, outsourcing, or manual processing. If HCFA or certain other third parties experience significant failures or erroneous applications, it could have a material effect on our financial position, results of operations, cash flows, and business prospects. For example, if HCFA, OPM, or our commercial customers experience system failures, this could cause a delay in our receipt of payments from these customers, including a significant HCFA payment due in January 2000. Therefore, we have developed a cash contingency plan that includes using available cash and lines of credit to cover any significant shortfalls in cash receipts. We also could have difficulties processing Medicare and other claims within required periods, collecting accurate claims and other data on which we depend, or enrolling new members. Further, our marketing, general and administrative expenses could increase due to Year 2000 compliance expenditures. Because some risks are beyond our control, we have developed business contingency plans to mitigate these risks. These business contingency plans were developed for each critical business function and cover contingencies such as the loss of a facility, loss of system(s), or loss of a key vendor. We may also have members who are concerned about prescription drug availability in light of the "millennium bug." This could lead to over ordering of drugs and result in increased pharmacy utilization in the fourth quarter of 1999. OFFICE OF PERSONNEL MANAGEMENT CONTINGENCIES. OPM generally audits health plans which it contracts with every five or six years, with each audit covering a multiple year period. We currently have several audits with OPM that are in various stages. We intend to negotiate with OPM's request for information on any existing or future unresolved matters to attain a mutually satisfactory result. There can be no assurance that any ongoing and future negotiations will be concluded satisfactorily, that additional audits will not be referred to the DOJ, or that additional, possibly material, liability will not be incurred. We believe that any ultimate liability in excess of amounts accrued would not materially affect our consolidated financial position. However, such liability could have a material effect on results of operations or cash flows of a future quarter if resolved unfavorably. LIQUIDITY AND CAPITAL RESOURCES. We have a $1.5 billion credit facility under which we had $475 million in borrowings outstanding as of June 30, 1999. Additional borrowings on our credit facility may be necessary if: o We repurchase additional shares of outstanding stock, including the repurchase of up to 5.9 million shares held by UniHealth. See Note 4 of the Notes to Condensed Consolidated Financial Statements; or o HCFA and OPM are unable to remit funds as a result of Year 2000 compliance issues. The terms of our credit facility permit us to repurchase up to $500 million of our outstanding common stock. Depending on the repurchase prices of the UniHealth shares and other repurchases of our common stock, we may need to obtain an amendment under the credit facility. If an amendment cannot be obtained, we would be required to negotiate a new credit facility. Should the credit facility be drawn, we could be subject to earlier mandatory reductions of the outstanding balance. Our ability to repay amounts owed under the credit facility and other long-term debt will also depend on cash receipts from our subsidiaries' restricted cash reserves. These subsidiary receipts represent cash dividends by the subsidiaries to us. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO or insurance regulators. Subsidiaries subject to regulation must meet or exceed various capital standards imposed by HMO or insurance regulations, which may from time to time impact the amount of funds the subsidiaries can pay to us. Additionally, from time to time, we advance funds in the form of a loan or capital contribution to our subsidiaries to assist them in satisfying federal or state financial requirements. If a federal or state regulator has concerns about the financial position of a subsidiary, a regulator may impose additional financial requirements on the subsidiary, which may require additional funding from us. We believe that cash flows from operations, existing cash equivalents, marketable securities and other financing sources will be sufficient to meet the requirements of the credit facility, our business and the UniHealth transaction. RISK-BASED CAPITAL REQUIREMENTS. The National Association of Insurance Commissioners has proposed that states adopt risk-based capital standards that, if implemented, would require new minimum capitalization limits for health care coverage provided by HMOs and other risk-bearing health care entities. To date, Washington is the only state where we have HMO operations that has adopted these standards. We do not expect this legislation to have a material impact on our consolidated financial position in 21 24 the near future if other states where we operate HMOs adopt these standards. We believe that cash flows from operations will be sufficient to fund any additional 1999 risk-based capital requirements. Furthermore, borrowings under the credit facility could be used for risk based capital requirements, if necessary. LEGISLATION AND REGULATION. Changes in state and federal legislation may negatively impact our financial and operating results. These changes may increase our medical care ratios, decrease our membership or otherwise adversely affect our revenues and our profitability. As of June 30, 1999, approximately 59 percent of our revenue and an even greater percentage of our profit came from our government programs, the majority of which was Medicare business. Changes that could affect us materially include: o Limitations on premium levels; o Increases in minimum capital, reserves, and other financial viability requirements; o Prohibition or limitation of capitated arrangements or provider financial incentives; o New benefit mandates (including mandatory length of stay and emergency room coverage, many of which become effective in 1999); o Limitations on the ability to manage care and utilization due to willing provider and direct access laws; and o Adoption on the federal and/or state level of legislation that holds HMOs liable for malpractice. Legislation and regulation could also include adverse actions of governmental payors, including reduced Medicare premiums; discontinuance of, or limitation on, governmentally funded programs; recovery by governmental payors of previously paid amounts; the inability to increase premiums or prospective or retroactive reductions to premium rates for federal employees; and adverse regulatory actions. OTHER. Results may differ materially from those projected, forecast, estimated and budgeted by us due to adverse results in ongoing audits or in other reviews conducted by federal or state agencies or health care purchasing cooperatives; adverse results in significant litigation matters; and changes in interest rates causing changes in interest expense and net investment income. ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The principal objective of our asset/liability management activities is to maximize net investment income, while managing levels of interest rate risk and facilitating our funding needs. Our net investment income and interest expense are subject to the risk of interest rate fluctuations. To mitigate the impact of fluctuations in interest rates, we manage the structure of the maturity of debt investments and derivatives. We use derivative financial instruments, primarily interest rate swaps, with maturities that correlate to balance sheet financial instruments. This results in a modification of existing interest rates to levels deemed appropriate based on our current economic outlook. 22 25 PART II: OTHER INFORMATION ITEM 1: LEGAL PROCEEDINGS No changes. ITEM 2: CHANGES IN SECURITIES At our June 24, 1999 annual meeting, our Class A and Class B common stockholders approved an amended and restated certificate of incorporation. This amended and restated certificate combined and reclassified PacifiCare's Class A and B common stock into a single class of voting common stock. The reclassified common stock has the same rights, powers and limitations as the previously existing Class A common stock. The reclassification of the Class A and B common stock had no impact on the total number of our issued and outstanding shares of common stock. See Note 4 of the Notes to Condensed Consolidated Financial Statements. ITEM 3: DEFAULTS UPON SENIOR SECURITIES None. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We held our Annual Meeting of Stockholders on June 24, 1999. On May 24, 1999, the record date for our annual meeting, there were 14,838,711 shares of Class A common stock issued, outstanding and entitled to vote and 31,108,146 shares of Class B common stock issued, outstanding and entitled to vote. The Class B stockholders were entitled to vote only on the amended and restated certificate of incorporation while the Class A stockholders were entitled to vote on all matters. The following is a brief description of each matter voted on at the meeting and a statement of the number of votes cast for, against or withheld, the number of abstentions, and broker non-votes with respect to each matter. (1) The stockholders approved the amended and restated certificate of incorporation of PacifiCare, which combined and reclassified PacifiCare's two classes of common stock into a single class of voting common stock.
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE ----- --- ------- ------- --------------- A 13,344,147 11,067 4,311 689,158 B 20,903,958 83,776 17,140 --
(2) The stockholders approved the election of the nominees to PacifiCare's board of directors.
WITHHOLD CLASS DIRECTOR FOR AUTHORITY ----- -------- --- --------- A Bradley C. Call 14,037,696 10,987 A David R. Carpenter 14,037,969 10,714 A David A. Reed 14,038,071 10,612 A Lloyd E. Ross 14,037,971 10,712
(3) The stockholders approved performance objectives for, and maximum awards under the 1996 Management Incentive Compensation Plan.
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE ----- --- ------- ------- --------------- A 14,018,500 23,558 6,625 --
(4) The stockholders approved amendments to the 1996 Stock Option Plan for Officers and Key Employees.
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE ----- --- ------- ------- --------------- A 11,045,926 2,994,017 8,740 --
23 26 (5) The stockholders approved the Amended and Restated 1996 Non-Officer Directors Stock Option Plan.
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE ----- --- ------- ------- --------------- A 11,394,850 2,646,475 7,358 --
ITEM 5: OTHER INFORMATION None. ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Index Exhibit 3.1 -- Amended and Restated Certificate of Incorporation of PacifiCare Health Systems, Inc. [incorporated by reference to Exhibit 99.1 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. Exhibit 3.2 -- Bylaws of PacifiCare Health Systems, Inc. [incorporated by reference to Exhibit 99.2 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. Exhibit 10.1 -- Stock Purchase Agreement, dated May 4, 1999, between PacifiCare Health Systems, Inc. and UniHealth Foundation [incorporated by reference to Exhibit 99.3 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. Exhibit 10.2 -- Registration Rights Agreement, dated May 4, 1999, between PacifiCare Health Systems, Inc. and UniHealth Foundation [incorporated by reference to Exhibit 99.4 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. Exhibit 15 -- Letter re: Unaudited Interim Financial Information Exhibit 20 -- Independent Accountants' Review Report Exhibit 27 -- Financial Data Schedule (filed electronically) (b) We did not file any reports on Form 8-K during the quarter ended June 30, 1999. 24 27 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. PACIFICARE HEALTH SYSTEMS, INC. (Registrant) Date: August 12, 1999 By: /s/ ALAN R. HOOPS ------------------------ --------------------------------- Alan R. Hoops Chairman of the Board and Chief Executive Officer Date: August 12, 1999 By: /s/ ROBERT B. STEARNS ------------------------ --------------------------------- Robert B. Stearns Executive Vice President and Chief Financial Officer 25 28 EXHIBIT INDEX
Exhibit Number Description - ------ ----------- 3.1 Amended and Restated Certificate of Incorporation of PacifiCare Health Systems, Inc. [incorporated by reference to Exhibit 99.1 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. 3.2 Bylaws of PacifiCare Health Systems, Inc. [incorporated by reference to Exhibit 99.2 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. 10.1 Stock Purchase Agreement, dated May 4, 1999, between PacifiCare Health Systems, Inc. and UniHealth Foundation [incorporated by reference to Exhibit 99.3 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. 10.2 Registration Rights Agreement, dated May 4, 1999, between PacifiCare Health Systems, Inc. and UniHealth Foundation [incorporated by reference to Exhibit 99.4 to PacifiCare's Registration Statement on Form S-3 (File No. 333-83069)]. 15 Letter re: Unaudited Interim Financial Information 20 Independent Accountants' Review Report 27 Financial Data Schedule (filed electronically)
EX-15 2 LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION 1 EXHIBIT 15 LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION The Board of Directors PacifiCare Health Systems, Inc. We are aware of the incorporation by reference in the Registration Statement (Form S-8 number 333-21713) and related Prospectus pertaining to the 1996 Stock Option Plan for Officers and Key Employees and the related Prospectus pertaining to the 1996 Non-Officer Directors Stock Option Plan of PacifiCare Health Systems, Inc. and in the Registration Statement (Form S-8 number 333-48377) and related Prospectus pertaining to the 1997 Premium Priced Stock Option Plan and the related Prospectus pertaining to the Amendment and Restatement of the PacifiCare Health Systems, Inc. Savings and Profit-Sharing Plan of PacifiCare Health Systems, Inc. of our report dated July 26, 1999 relating to the unaudited condensed consolidated interim financial statements of PacifiCare Health Systems, Inc. that are included in its Form 10-Q for the quarters ended June 30, 1999 and 1998. ERNST & YOUNG LLP Los Angeles, California July 26, 1999 EX-20 3 INDEPENDENT ACCOUNTANTS' REVIEW REPORT 1 EXHIBIT 20 INDEPENDENT ACCOUNTANTS' REVIEW REPORT The Board of Directors PacifiCare Health Systems, Inc. We have reviewed the accompanying condensed consolidated balance sheets of PacifiCare Health Systems, Inc. as of June 30, 1999, and the related condensed consolidated statements of operations for the three and six-month periods ended June 30, 1999 and 1998, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 1999 and 1998. These financial statements are the responsibility of the Company's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of PacifiCare Health Systems, Inc. as of December 31, 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for the year then ended [not presented herein] and in our report dated February 9, 1999, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1998, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. ERNST & YOUNG LLP Los Angeles, California July 26, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from PacifiCare Health Systems, Inc.'s condensed consolidated balance sheets as of June 30, 1999 and related consolidated statments of operations for the six months ended June 30, 1999 and is qualified in its entirety by reference to such financial statements. 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 251,194 958,560 315,470 6,020 0 1,686,175 292,299 123,517 4,241,832 1,199,623 0 0 0 468 2,333,024 4,241,832 0 4,906,656 0 4,117,383 565,712 368 19,805 243,831 100,946 142,885 0 0 0 142,885 3.12 3.10
-----END PRIVACY-ENHANCED MESSAGE-----