- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 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, 1998 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ________. COMMISSION FILE NUMBER: 1-10864 -------------- UNITED HEALTHCARE CORPORATION State of Incorporation: MINNESOTA I.R.S. Employer Identification No: 41-1321939 Principal Executive Offices: 300 OPUS CENTER 9900 BREN ROAD EAST MINNETONKA MN, 55343 Telephone Number: (612) 936-1300 -------------- Indicate by check mark (x) 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 periods 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, par value $.01 per share, outstanding on August 12, 1998, was 195,331,294 - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
UNITED HEALTHCARE CORPORATION INDEX <TABLE> <CAPTION> Page Number ------- <S> <C> PART I. FINANCIAL INFORMATION. ITEM I. FINANCIAL STATEMENTS (UNAUDITED) Condensed Consolidated Balance Sheets at June 30, 1998 and December 31, 1997............................................... 3 Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 1998 and 1997............................................................ 4 Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 1998 and 1997...................... 5 Notes to Condensed Consolidated Financial Statements............ 6 Report of Independent Public Accountants........................ 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.....................10 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................................................15 PART II. OTHER INFORMATION. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...............16 ITEM 5. OTHER INFORMATION.......................................16 ITEM 6. EXHIBITS................................................16 Signatures...........................................................17 </TABLE> 2
UNITED HEALTHCARE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1998 1997 ------- ---------- <S> <C> <C> ASSETS Current Assets Cash and Cash Equivalents......................... $ 663 $ 750 Short-Term Investments............................ 126 506 Accounts Receivable, net (Note 7)................. 1,219 768 Assets Under Management (Note 7).................. 1,069 28 Other Current Assets.............................. 178 141 -------- -------- Total Current Assets........................... 3,255 2,193 Long-Term Investments.................................. 3,280 2,785 Property and Equipment, net............................ 333 364 Goodwill and Other Intangible Assets, net (Note 2)............................................ 2,020 2,281 -------- -------- TOTAL ASSETS........................................... $ 8,888 $ 7,623 -------- -------- -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Medical Costs Payable (Notes 2 and 7)............. $ 2,817 $ 1,565 Other Policy Liabilities (Note 7)................. 460 235 Accounts Payable and Accrued Liabilities (Notes 2 and 6) ................................ 792 495 Unearned Premiums................................. 167 275 -------- -------- Total Current Liabilities...................... 4,236 2,570 Long-Term Obligations.................................. 21 19 Convertible Preferred Stock............................ 500 500 -------- -------- Shareholders' Equity Common Stock, $.01 par value - 500,000,000 shares authorized; 193,440,000 and 191,111,000 issued and outstanding....................................... 2 2 Additional Paid-in Capital........................ 1,449 1,398 Retained Earnings................................. 2,649 3,105 Net Unrealized Holding Gains on Investments Available for Sale, net of income tax effects......................................... 31 29 -------- -------- Total Shareholders' Equity.................... 4,131 4,534 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............. $ 8,888 $ 7,623 -------- -------- -------- -------- </TABLE> See notes to condensed consolidated financial statements 3
UNITED HEALTHCARE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------- ------------------------ 1998 1997 1998 1997 -------- -------- -------- -------- <S> <C> <C> <C> <C> REVENUES Premiums.............................................. $ 3,773 $ 2,501 $ 7,455 $ 4,945 Management Services and Fees.......................... 402 366 773 722 Investment and Other Income........................... 60 64 122 115 -------- -------- -------- -------- Total Revenues..................................... 4,235 2,931 8,350 5,782 -------- -------- -------- -------- OPERATING EXPENSES Medical Costs (Note 2)................................ 3,435 2,119 6,587 4,183 Selling, General and Administrative Expenses.......... 706 592 1,418 1,167 Depreciation and Amortization......................... 48 35 90 69 Operational Realignment Charges (Note 2).............. 725 - 725 - -------- -------- -------- -------- Total Operating Expenses............................ 4,914 2,746 8,820 5,419 -------- -------- -------- -------- EARNINGS (LOSS) BEFORE INCOME TAXES........................ (679) 185 (470) 363 (Provision) Benefit for Income Taxes (Note 3)......... 114 (69) 37 (138) -------- -------- -------- -------- NET EARNINGS (LOSS)........................................ (565) 116 (433) 225 CONVERTIBLE PREFERRED STOCK DIVIDENDS...................... (7) (7) (15) (15) -------- -------- -------- -------- NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS........................................ $ (572) $ 109 $ (448) $ 210 -------- -------- -------- -------- -------- -------- -------- -------- BASIC NET EARNINGS (LOSS) PER COMMON SHARE...................................................... $ (2.96) $ 0.58 $ (2.33) $ 1.13 -------- -------- -------- -------- -------- -------- -------- -------- NET EARNINGS (LOSS) PER COMMON SHARE, ASSUMING DILUTION................................................... $ (2.96) $ 0.57 $ (2.33) $ 1.11 -------- -------- -------- -------- -------- -------- -------- -------- WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING................................................ 193 187 192 186 DILUTIVE EFFECT OF OUTSTANDING STOCK OPTIONS.................................................... - 4 - 4 -------- -------- -------- -------- WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING, ASSUMING DILUTION............................. 193 191 192 190 -------- -------- -------- -------- -------- -------- -------- -------- </TABLE> See notes to condensed consolidated financial statements 4
UNITED HEALTHCARE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS) (UNAUDITED) <TABLE> <CAPTION> SIX MONTHS ENDED JUNE 30, ------------------------- 1998 1997 ------- ------- <S> <C> <C> OPERATING ACTIVITIES Net Earnings (Loss)................................... $ (433) $ 225 Noncash Items: Depreciation and Amortization...................... 90 69 Deferred Income Taxes.............................. (214) 45 Operational Realignment Charges.................... 725 - Net Change in Other Operating Items: Accounts Receivable and Other Current Assets....... (118) (57) Medical Costs Payable.............................. 200 80 Accounts Payable and Other Current Liabilities...................................... 109 (103) Unearned Premiums.................................. (142) (126) ------- ------- Cash Flows From Operating Activities............ 217 133 ------- ------- INVESTING ACTIVITIES Cash Paid for Acquisition, net of cash assumed and other effects...................................... (86) - Purchases of Property and Equipment and Capitalized Software, net....................................... (90) (90) Purchases of Investments.............................. (1,976) (3,210) Maturities / Sales of Investments..................... 1,867 2,708 ------- ------- Cash Flows Used for Investing Activities......................................... (285) (592) ------- ------- FINANCING ACTIVITIES Proceeds from Stock Option Exercises.................. 73 52 Common Stock Repurchases.............................. (72) - Dividends Paid........................................ (20) (20) ------- ------- Cash Flows (Used for) From Financing Activities.... (19) 32 ------- ------- DECREASE IN CASH AND CASH EQUIVALENTS...................... (87) (427) CASH AND EQUIVALENTS, BEGINNING OF PERIOD.................. 750 1,037 ------- ------- CASH AND EQUIVALENTS, END OF PERIOD........................ $ 663 $ 610 ------- ------- ------- ------- </TABLE> See notes to condensed consolidated financial statements 5
UNITED HEALTHCARE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION Unless the context otherwise requires, the use of the terms the "Company," "we," "us," and "our" in the following refers to United HealthCare Corporation and its subsidiaries. The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting solely of normal recurring adjustments, needed to present the financial results for these interim periods fairly. These financial statements include some amounts that are based on our best estimates and judgments. The most significant estimates relate to medical costs payable and other policy liabilities, intangible asset valuations, integration reserves relating to acquisitions, and reserves relating to our operational realignment activities. These estimates may be adjusted as more current information becomes available, and any adjustment could be significant. Following the rules and regulations of the Securities and Exchange Commission, we have omitted footnote disclosures that would substantially duplicate the disclosures contained in the Company's annual audited financial statements. Read together with the disclosures below, we believe the interim financial statements are presented fairly. However, these unaudited condensed consolidated financial statements should be read together with the consolidated financial statements and the notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 2. SPECIAL OPERATING CHARGES OPERATIONAL REALIGNMENT CHARGES In January 1998, we introduced a significant realignment of our operations into six independent but strategically linked business segments, each focused on performance, growth and shareholder value. In the months that followed, we began to realign our resources and activities; introduce new management processes and policies; evaluate our business units and operations, market positions and customer segments; and assess their strategic fit, operational performance and contribution. We have moved forward to establish more independent identities, brands and market positions for each of these segments. We also have realigned significant personnel and activities from corporate functions to more directly support the operations of our business segments, and we have defined intersegment service arrangements and system platform and process requirements to support each segment's markets and products. In conjunction with these efforts, we developed and approved a comprehensive plan (the Plan) to implement our operational realignment in the second quarter of 1998, and we recognized corresponding charges to operations of $725 million. The charges reflect the estimated costs we will incur principally over the next twelve months under the Plan, including charges associated with disposing or discontinuing business units, product lines, and contracts; transitioning from and eliminating non-core system platforms; and consolidating and eliminating certain processing operations and associated real estate obligations. These activities are anticipated to result in a reduction of more than 4,000 positions, potentially affecting approximately 7,000 people in various locations. The charges do not cover certain aspects of the Plan, including new information systems and employee relocation and training. These costs will be recognized in future periods as incurred. The following table summarizes the components of the operational realignment charges (in millions): <TABLE> <S> <C> Asset write-downs $ 399 Severance and outplacement costs 142 Noncancellable lease obligations 82 Disposition of businesses and other costs 102 ------ $ 725 ------ ------ </TABLE> 6
The asset write-downs consist principally of intangibles and other long-lived assets from businesses we intend to dispose of or discontinue, or markets where we plan to curtail operations or change the nature of our operating presence. The majority of these write-downs relate to businesses acquired after 1994. We prepared a forecast of expected undiscounted cash flows, where appropriate, to determine whether asset impairment existed, and we used fair values to measure the required write-downs. In other instances, we determined the extent of the write-downs based on a determination of the business unit's fair value. Our accompanying financial statements include the operating results of businesses to be disposed of or discontinued in connection with the operational realignment, as follows (in millions): <TABLE> <CAPTION> Three Months Ended Six Months Ended June 30 June 30 ------------------------ ------------------------- 1998 1997 1998 1997 ------- ------- ------- ------- <S> <C> <C> <C> <C> Revenues $ 240 $ 208 $ 475 $ 401 Operating losses before income taxes $ (8) $ (16) $ (23) $ (23) </TABLE> MEDICAL COSTS Medical costs reported in the second quarter of 1998 included $120 million relating to losses in certain underperforming Medicare markets and $55 million related to strengthening our reserves across certain health plan markets, including those where the company may reposition and withdraw its presence, in light of increasing pressure on medical cost trends at the end of the second quarter. We incurred $38 million of these Medicare losses in the second quarter, and accrued $82 million for the losses we expect to incur over the remainder of 1998. 3. INCOME TAXES The income tax benefit associated with the second quarter special operating charges was $196 million. This benefit resulted in an overall effective income tax benefit rate of 17% and 8% for the three and six months ended June 30, 1998. 4. TERMINATED ACQUISITION In May 1998, we entered into an agreement to acquire Humana Inc. (Humana) through the exchange of one share of Company common stock for every two shares of Humana common stock. On August 10, 1998, the Company and Humana mutually terminated the transaction. The costs we incurred associated with the proposed transaction were charged against operations in the second quarter of 1998. 5. STOCK REPURCHASE PROGRAM Under our stock repurchase program, we may purchase up to 10% of our outstanding common stock. Purchases may be made from time to time at prevailing market prices, subject to certain restrictions on volume, pricing, and timing. Repurchased shares will be available for reissuance for employee stock option and purchase plans and for other corporate purposes. During the six-month period ended June 30, 1998, we repurchased 1.2 million shares at an average price of $59 per share. Shares issued under our stock plans over the same period exceeded the number of shares repurchased. 6. CASH AND INVESTMENTS As of June 30, 1998, the amortized cost, gross unrealized holding gains and losses and fair value of cash and investments were as follows (in millions): <TABLE> <CAPTION> GROSS UNREALIZED GROSS UNREALIZED AMORTIZED COST HOLDING GAINS HOLDING LOSSES FAIR VALUE -------------- ---------------- ---------------- ----------- <S> <C> <C> <C> <C> Cash and Cash Equivalents...................... $ 663 $ - $ - $ 663 Investments Available for Sale................. 3,282 50 (2) 3,330 Investments Held to Maturity................... 76 - - 76 -------- ----- ------ ------- Total Cash and Investments.................. $ 4,021 $ 50 $ (2) $ 4,069 -------- ----- ------ ------- -------- ----- ------ ------- </TABLE> 7
7. AMERICAN ASSOCIATION OF RETIRED PERSONS CONTRACT We began providing insurance products and services to the American Association of Retired Persons (AARP) on January 1, 1998. Our portion of the AARP's insurance program represents approximately $3.5 billion in annual net premium revenue from more than 4 million AARP members. We also are developing an array of new products and services designed to complement the insurance offerings under the AARP program. Under the terms of our 10-year agreement with the AARP, we receive monthly fees for claim administrative services and as compensation for assuming the underwriting risk associated with the program. In addition, the AARP has separately contracted with certain vendors to provide marketing and member services. We recognize premium revenues associated with the AARP program net of the administrative fees paid to these vendors. The following assets and liabilities were transferred from the program's previous carrier and are included in our consolidated balance sheet (in millions): <TABLE> <CAPTION> - ---------------------------------------------------------------------------------- Amounts Description Transferred as of Balance as of January 1, 1998 June 30, 1998 - ---------------------------------------------------------------------------------- <S> <C> <C> Assets Under Management $ 959 $ 1,041 Accounts Receivable $ 300 $ 375 Medical Costs Payable $ 1,024 $ 1,074 Other Policy Liabilities $ 192 $ 229 Other Current Liabilities $ 43 $ 79 </TABLE> 8. COMPREHENSIVE INCOME The table below presents comprehensive income, defined as changes in the equity of our business excluding charges resulting from investments by and distributions to our shareholders, for the six-month periods ended June 30, 1998 and 1997 (in millions): <TABLE> <CAPTION> - ------------------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------------------- <S> <C> <C> Net Earnings (Loss) $(433) $225 Change in Net Unrealized Holding Gains on Investments Available for Sale, net of income tax effects 2 9 - ------------------------------------------------------------------------- Comprehensive Income (Loss) $(431) $234 - ------------------------------------------------------------------------- </TABLE> 9. RECENTLY ISSUED ACCOUNTING STANDARDS In the fourth quarter of 1998, we will adopt a new accounting standard (SFAS No. 131) that will require us to report financial and descriptive information about our reportable operating segments. Generally, financial information will be required to be reported on the basis that is used internally to evaluate segment performance and allocate resources to segments. This new standard will not affect how we determine net earnings or shareholders' equity. In June 1998, a new standard on accounting for derivative instruments and hedging activities (SFAS No. 133) was issued. This new standard will not materially affect our financial results or disclosures given our current investment portfolio and investment policies. 8
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To United HealthCare Corporation: We have reviewed the accompanying condensed consolidated balance sheet of United HealthCare Corporation (a Minnesota corporation) and Subsidiaries as of June 30, 1998 and the related condensed consolidated statements of operations and cash flows for the three and six month periods ended June 30, 1998 and 1997. These financial statements are the responsibility of the Company's management. We conducted our review 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, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated financial statements of United HealthCare Corporation and Subsidiaries as of and for the year-ended December 31, 1997 (not presented herein), and, in our report dated February 12, 1998, we expressed an unqualified opinion on those statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Arthur Andersen LLP Minneapolis, Minnesota, August 6, 1998 9
UNITED HEALTHCARE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Unless the context otherwise requires, the use of the terms the "Company," "we," "us," and "our" in the following refers to United HealthCare Corporation and its subsidiaries. On January 1, 1998, we began delivering Medicare supplement insurance and other medical insurance coverage for the American Association of Retired Persons (AARP) to more than 4 million AARP members. In the second quarter of 1998, we recorded special operating charges related to our operational realignment activities ($725 million) and certain medical cost items. The significance of the AARP business and the special charges affects the year-to-year comparability of our consolidated financial position and results of operations. The Summary Operating Information below should be read together with the narrative portions of Management's Discussion and Analysis that more fully describe the specific effects of the AARP business and the special charges. The following discussion should be read together with the accompanying condensed consolidated financial statements and notes. In addition, the following discussion should be considered in light of a number of factors that affect the Company, the industry in which we operate, and business generally. These factors are described in Exhibit 99 to this Quarterly Report. SUMMARY OPERATING INFORMATION <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------------- ------------------------------- Operating Results (IN MILLIONS, EXCEPT PER PERCENT PERCENT SHARE DATA) 1998 1997 CHANGE 1998 1997 CHANGE - ------------------------------------------ ------- -------- ------- ------ -------- ------- <S> <C> <C> <C> <C> <C> <C> Total Revenues..................................... $ 4,235 $ 2,931 44% $8,350 $ 5,782 44% Earnings (Loss) from Operations................... $ (679) $ 185 (467)% $ (470) $ 363 (229)% Net Earnings (Loss)................................ $ (565) $ 116 (587)% $ (433) $ 225 (292)% Net Earnings (Loss) Per Common Share, Assuming Dilution.................................. $ (2.96) $ 0.57 (619)% $(2.33) $ 1.11 (310)% Medical Costs to Premium Revenues.................. 91.0% (a) 84.7% 88.4% (a) 84.6% SG&A Expenses to Total Revenues.................... 16.7% 20.2% 17.0% 20.2% </TABLE> <TABLE> <CAPTION> JUNE 30, JUNE 30, PERCENT Enrollment by Product (IN THOUSANDS) 1998 1997 CHANGE - ------------------------------------ -------- -------- ------- <S> <C> <C> <C> Health Plan Products Commercial......................................... 5,719 (b) 5,139 (b) 11% Medicare........................................... 427 286 49% Medicaid........................................... 511 483 6% ------ ------ --- Total Health Plan Products...................... 6,657 5,908 13% Other Network-Based Products............................ 4,906 (b) 4,594 (b) 7% Indemnity Products...................................... 1,639 2,492 (34)% ------ ------ --- Total Enrollment................................ 13,202 12,994 2% ------ ------ --- ------ ------ --- <CAPTION> JUNE 30, JUNE 30, PERCENT Enrollment by Funding Arrangement (IN THOUSANDS) 1998 1997 CHANGE - ------------------------------------------------ -------- -------- ------- <S> <C> <C> <C> Fully Insured Health Plan Products............................... 5,693 5,042 13% Other Network-Based Products....................... 503 496 1% Indemnity Products................................. 319 492 (35)% ------ ------ --- Total Fully Insured............................. 6,515 6,030 8% ------ ------ --- Self-Funded Health Plan Products............................... 964 866 11% Other Network-Based Products....................... 4,403 4,098 7% Indemnity Products................................. 1,320 2,000 (34)% ------ ------ --- Total Self Funded............................... 6,687 6,964 (4)% ------ ------ --- Total Enrollment.............................. 13,202 12,994 2% ------ ------ --- ------ ------ --- </TABLE> (a) Includes $120 million related to certain Medicare markets and $55 million related to reserve strengthening associated with increasing pressure on medical cost trends. (b) In conjunction with the realignment of our operations, small group and middle market point-of-service membership, previously classified as other network based products, are now being presented with our commercial health plan products (867,000 members at June 30, 1998 and 756,000 members at June 30, 1997). 10
RESULTS OF OPERATIONS SPECIAL OPERATING CHARGES OPERATIONAL REALIGNMENT CHARGES In November 1997, we embarked on a course to realign our business operationally. Many factors, both strategic and operational, drove this decision. Among them was a recognition that we have grown significantly over the last several years and, as a result, have redundant systems, offices and enterprises that are no longer core to our future strategy. We concluded that an operational realignment would be required to improve our customer support and reduce our cost structure. In January 1998, we introduced a significant realignment of our operations into six independent but strategically linked business segments, each focused on performance, growth and shareholder value. In the months that followed, we began to realign our resources and activities; introduce new management processes and policies; evaluate our business units and operations, market positions and customer segments; and assess their strategic fit, operational performance and contribution. We have moved forward in establishing more independent identities, brands and market positions for each of these segments. We also have realigned significant personnel and activities from corporate functions to more directly support the operations of our business segments, and have defined intersegment service arrangements and system platform and process requirements to support each segment's markets and products. In conjunction with these efforts, we developed and introduced a comprehensive plan (the Plan) to implement our operational realignment in the second quarter of 1998, and we recognized corresponding charges to operations of $725 million. The charges reflect the estimated costs we will incur principally over the next twelve months under the Plan, including charges associated with disposing or discontinuing business units, product lines, and contracts; transitioning from and eliminating non-core system platforms; and consolidating and eliminating certain processing operations and associated real estate obligations. These activities are anticipated to result in a reduction of more than 4,000 positions potentially affecting approximately 7,000 people in various locations. We believe the aggregate reduction in our overall cost structure from our realignment will reach an annual run rate of approximately $300 million. We expect to realize $125 to $150 million of these reductions by the end of 1999 and $225 million to $250 million by the end of year 2000. The charges do not cover certain aspects of the Plan, including new information systems and employee relocation and training. These costs will be recognized in future periods as incurred. MEDICAL COSTS During the second quarter, we considered many factors influencing medical cost trends. On balance, we believe that we can respond to factors that increase medical cost trends and price our products and services sufficient to realize satisfactory margins. While half of our Medicare business remains solidly profitable, certain of our markets are not profitable. This unprofitable Medicare business generally resides in newer markets where we have been unable to achieve the scale necessary to achieve profitability. As a result of these factors, medical costs reported in the second quarter of 1998 included $120 million relating to losses in certain underperforming Medicare markets and $55 million related to strengthening our reserves across certain health plan markets, including those where the company may reposition and withdraw its presence, in light of increasing pressure on medical cost trends at the end of the second quarter. We incurred $38 million of these Medicare losses in the second quarter, and accrued $82 million for the losses we expect to incur over the remainder of 1998. PREMIUM REVENUES Premium revenues in the second quarter of 1998 totaled $3.8 billion, an increase of $1.3 billion, or 51%, over the second quarter of 1997. For the six months ended June 30, 1998, premium revenues of $7.5 billion increased $2.5 billion, or 51% over the same period in 1997. On January 1, 1998, we began delivering Medicare supplement insurance and other medical insurance coverage for the American Association of Retired Persons (AARP) to more than 4 million AARP members. Premium revenues from our portion of the AARP insurance offerings during the first six months of 1998 were $1.8 billion. Excluding the AARP business, second quarter 1998 premium revenues totaled $2.9 billion, an increase of 16% over second quarter 1997. For the six months ended June 30, 1998, premium revenues excluding the AARP business were $5.7 billion, an increase of 15% over the same period in 1997. This increase is primarily the result of growth in year-over-year same-store health plan premium revenues of $898 million, or 22%, through the second quarter of 1998. Increases in the health plan premium revenue reflect same-store enrollment growth of 13% and an average year-over-year premium rate increase on renewing commercial groups exceeding 6%. Growth in our Medicare programs also contributed to the increase in premium revenues. The total health plan same- store enrollment growth of 13% includes a year-over-year same-store increase of 49% in Medicare enrollment. Significant growth in Medicare enrollment affects 11
year-over-year comparability of premium revenues. The Medicare product generally has per member premium rates three to four times higher than average commercial premium rates because Medicare members typically use proportionately more medical care services. The six-month year-over-year increase in premium revenues from health plan operations was partially offset by an expected decrease in premium revenues from fully insured non-network-based indemnity products of $82 million. Nearly $60 million of this decrease is because we discontinued our relationship with a broker who sold and administered small group indemnity business on our behalf, which led to the loss of 30,000 indemnity members effective July 1, 1997. The remaining decrease is from declining enrollment in these products, due to rate increases averaging 10% to 20% in 1997 and into 1998, as well as other business factors. We expect enrollment in the non-network-based indemnity products will continue to decline through 1998. To the extent possible, we will try to convert these members to our network-based managed care products. MEDICAL COSTS Medical costs reported in the second quarter of 1998 include $175 million of charges. Of this amount $120 million relates to losses we expect to incur related to 13 of our 22 Medicare health plans which contribute half of our annualized Medicare premiums of $2.3 billion. We incurred $38 million of these losses in the second quarter, and accrued $82 million for the losses we expect to incur over the remainder of 1998. These plans are generally located in newer markets where we have been unable to achieve the scale of operations necessary to achieve profitability. An additional $55 million related to strengthening our reserves across certain health plan markets, including those where the company may reposition or withdraw its presence, in light of increasing pressure on medical cost trends at the end of the second quarter. Our medical care ratio (the percent of premiums expensed as medical costs) increased from 84.7% in the second quarter of 1997, and 85.6% in the first quarter of 1998, to 91.0% in the second quarter of 1998. The year-over-year increase includes the effects of the AARP business on our medical care ratio. We report a medical care ratio of nearly 92% related to our portion of the AARP insurance offerings, which we began delivering on January 1, 1998. The increase in the medical care ratio over the first quarter reflects the medical cost adjustments discussed above. Lower margins in our nine other Medicare health plans also adversely affected the medical core ratio. While these plans are profitable, average Medicare premium rate increases of 2.5% in these plans were more than offset by increased medical utilization, reflected mostly in inpatient hospital costs. Performance in a few of our commercial health plans lagged behind the performance of our remaining commercial health plans and modestly contributed to the increased medical care ratio. We are addressing the medical cost trend by altering benefit designs, recontracting with providers and further enhancing disease specific and local medical management programs. We are also accelerating and intensifying the contemporaneous and retrospective claim management activities that we have in place. We are continuing to evaluate the markets we serve and products we offer and will curtail activities or exit markets where we believe near term prospects are unacceptable. We believe these efforts will help us to maintain an aggregate medical cost trend in the 3.5% to 4.5% range in the face of a rising national cost trend that could exceed 5.0% in 1999. We have considered known and anticipated medical inflation in our product pricing for 1998 and 1999. MANAGEMENT SERVICES AND FEE REVENUES Management services and fee revenues during the three months and six months ended June 30, 1998, totaled $402 million and $773 million, which represented increases of $36 million and $51 million, respectively, over management services and fee revenues for the same periods in 1997. These revenues are primarily generated from self-funded products where we receive a fee for administrative services and generally assume no financial responsibility for health care costs. In 12
addition, we generate fee revenues from administrative services we perform on behalf of managed health plans and for services provided by our specialty businesses. The overall increase in management services and fee revenues is due to enrollment growth within our managed health plans and an increase in individuals served by our specialty services operations, most notably in United Behavioral Health and Optum-Registered Trademark-, our telephone- and Internet-based health information and personal care management business. These increases are partially offset by the effects of our June 30, 1997 sale of our subsidiary, United HealthCare Administrators, Inc., which resulted in a $24 million decrease in these revenues for the first six months of 1998, compared to 1997. OPERATING EXPENSES Selling, general and administrative expenses as a percent of total revenues (the SG&A ratio) decreased from 20.2 % during the second quarter of 1997 to 17.3% during the first quarter of 1998, and decreased again to 16.7% during the second quarter of 1998. The improvement in the SG&A ratio reflects the operating leverage we gained with the addition of the AARP business, as well as our diligence in managing these expenses. On an absolute dollar basis, selling, general and administrative costs through the first half of 1998 increased $251 million, or 22%, over the comparable period in 1997. This increase reflects the additional costs to support the corresponding $2.6 billion increase in revenues, as well as our additional investment in future growth platforms. GOVERNMENT REGULATION Our primary business, offering health care coverage and health care management services, is heavily regulated at the federal and state levels. We strive to comply in all respects with applicable regulations and may need to make changes from time to time in our services, products, marketing methods or organizational or capital structure. Regulatory agencies generally have broad discretion to issue regulations and interpret and enforce laws and rules. Changes in applicable laws and regulations are continually being considered, and the interpretation of existing laws and rules also may change from time to time. These changes could affect our operations and financial results. Certain proposed changes in Medicare and Medicaid programs may improve opportunities to enroll people under products developed for these populations. Other proposed changes could limit available reimbursement and increase competition in those programs, with adverse affects on our financial results. Also, it could be more difficult for us to control medical costs if federal and state bodies continue to consider and enact significant and onerous managed care laws and regulations. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) may represent the most significant federal reform of employee benefit law since the enactment of the Employee Retirement Income Security Act (ERISA) in 1974. Some of HIPAA's significant provisions include guaranteeing the availability of health insurance for certain employees and individuals, limits on the use of preexisting condition exclusions, prohibitions against discriminating on a basis of health status, and requirements that make it easier to continue coverage in cases where a person is terminated or changes employers. Under HIPAA and other similar state laws, medical cost control through amended provider contracts and improved preventive and chronic care management may become more important. We believe our experience in these areas will allow us to compete effectively. Health care fraud and abuse has become a top priority for the nation's law enforcement entities, which have focused on participants in federal government health care programs such as Medicare, Medicaid and the Federal Employees Health Benefits Program (FEHBP). We participate extensively in these programs. We also are subject to governmental investigations and enforcement actions. Included are actions relating to ERISA, which regulates insured and self- insured health coverage plans offered by employers; 13
the FEHBP; federal and state fraud and abuse laws; and laws relating to care management and health care delivery. Government actions could result in assessment of damages, civil or criminal fines or penalties, or other sanctions, including exclusion from participation in government programs. We currently are involved in various government investigations and audits, but we do not believe the results will have a material adverse effect on our financial position or results of operations. INFLATION Although the general rate of inflation has remained relatively stable and health care cost inflation has stabilized in recent years, the national health care cost inflation rate still exceeds the general inflation rate. We use various strategies to mitigate the negative effects of health care cost inflation, including setting commercial premiums based on anticipated health care costs, risk-sharing arrangements with various health care providers, and other health care cost containment measures. Specifically, health plans try to control medical and hospital costs through contracts with independent providers of health care services. Through these contracted care providers, our health plans emphasize preventive health care and appropriate use of specialty and hospital services. While we currently believe our strategies to mitigate health care cost inflation will continue to be successful, competitive pressures, new health care product introductions, demands from health care providers and customers, applicable regulations or other factors may affect our ability to control the impact of health care cost increases. In addition, certain non-network-based products do not have health care cost containment measures similar to those in place for network-based products. As a result, there is added health care cost inflation risk with these products. FINANCIAL CONDITION AND LIQUIDITY Cash and investments at June 30, 1998, were $4.1 billion, a $28 million increase from December 31, 1997 and a $71 million increase from March 31, 1998. Through the second quarter of 1998, we generated cash from operations of $217 million and realized proceeds from stock option exercises and the sale of property and equipment of $103 million. In the same period, we used nearly $300 million in cash for capital expenditures, acquisitions, common stock repurchases, and dividends. Under applicable government regulations, several subsidiaries are required to maintain specific capital levels to support their operations. After taking these regulations and certain business considerations into account, we had $856 million in cash and investments available for general corporate use at June 30, 1998. The National Association of Insurance Commissioners is expected to adopt rules which, if implemented by the states, would require new minimum capitalization limits for health care coverage provided by insurance companies, HMOs and other risk-bearing health care entities. The requirements would take the form of risk-based capital rules. Depending on the nature and extent of the new minimum capitalization requirements ultimately adopted, there could be an increase in the capital required for certain of our subsidiaries. We do not expect a significant increase in the overall capital required by our regulated entities. Any increase would be funded from our corporate usable cash reserves. The new requirements are expected to be effective December 31, 1998. We are in the process of modifying our computer systems to accommodate the Year 2000. We currently expect these modifications to be completed well in advance of the Year 2000 with no adverse effect on our operations. We expect to incur associated expenses of approximately $20 million in 1998 and $15 million in 1999 to complete this effort. Our inability to complete Year 2000 modifications on a timely basis or the inability of other companies with which we do business to complete their Year 2000 modifications on a timely basis could adversely affect our operations. Under our stock repurchase program, we may purchase up to 10% of our outstanding common stock. Purchases may be made from time to time at prevailing market prices, subject to certain restrictions relating to volume, pricing and timing. The repurchased shares will be available for reissuance 14
through employee stock option and purchase plans and for other corporate purposes. During the first six months of 1998, we repurchased 1.2 million shares at an average price of $59 per share. Shares issued under our stock plans over the same period have exceeded the number of shares repurchased. In January 1998, we filed a shelf registration statement with the Securities and Exchange Commission to sell as much as $200 million of debt securities, and preferred shares or common shares. The shelf filing registers the securities and allows us to sell them from time to time in the event we need financing. Proceeds from sales of these securities may be used for a variety of general corporate purposes, including working capital, securities repurchases and acquisitions. Effective October 1, 1998, we have the right to redeem in whole or in part the 500,000 outstanding shares of our 5.75% Series A Convertible Preferred Stock (the Preferred Stock) at certain defined redemption rates. The initial aggregate redemption price of the Preferred Stock would be $520 million, or $1,040 per share. In June 1998, we agreed to acquire HealthPartners of Arizona, Inc. for $235 million in cash, subject to regulatory approvals. We expect the transaction will close in the third quarter of 1998. In the second quarter of 1998, we recognized special charges to operations of $725 million associated with the implementation of our operational realignment and certain medical cost adjustments of $175 million. We believe our after tax cash outlay associated with these charges will be in the range of $225 million to $275 million over the next twelve months. We expect our available cash resources will be sufficient to meet our current operating requirements and internal development and realignment initiatives. In addition, based on our current financial condition and results of operations, we should be able to finance additional cash requirements in the public or private markets, if necessary. Currently, we do not have any other material definitive commitments that require cash resources; however, we continually evaluate opportunities to expand our operations. This includes internal development of new products and programs and may include acquisitions. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Since the date of the Company's Quarterly Report filed on Form 10-Q for the quarter ended March 31, 1998, no material changes have occurred in the Company's exposure to market risk associated with the Company's investments in market risk sensitive financial instruments. The Company does not believe that its risk of a loss in future earnings, fair values or cash flow attributable to such investments is material. 15
UNITED HEALTHCARE CORPORATION PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS The Company exchanged 210,675 shares of its common stock for all of the outstanding capital stock of Insite Clinical Trials, LLC in a transaction that closed on May 1, 1998. The Company issued these shares in reliance on Section 4(2) of the Securities Act of 1933. The Company made inquiries of the recipients of securities in this transaction and obtained representations from such persons to establish that such issuance qualified for an exemption from the registration requirements. ITEM 5. OTHER INFORMATION The Company and Humana Inc. ("Humana") announced on August 10, 1998 the mutual agreement to terminate the previously announced merger of the two companies. The termination of the merger was approved by the boards of directors of the Company and Humana. The Termination Agreement, dated August 9, 1998, by and among the Company, UH-1 Inc., a wholly owned subsidiary of the Company, and Humana, is included as Exhibit 10e to this Form 10-Q. ITEM 6. EXHIBITS (a) The following exhibits are filed in response to Item 601 of Regulation S-K. <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION - ------------- ------------------------------------------------------------- <S> <C> Exhibit 10(a) - First Amendment to the AARP Health Insurance Agreement by and among American Association of Retired Persons, Trustees of the AARP Insurance Plan and United HealthCare Insurance Company effective January 1, 1998.* Exhibit 10(b) - Second Amendment to the AARP Health Insurance Agreement by and among American Association of Retired Persons, Trustees of the AARP Insurance Plan and United HealthCare Insurance Company effective January 1, 1998.* Exhibit 10(c) - Employment Agreement, dated as of May 20, 1998, between United HealthCare Services, Inc. and R. Channing Wheeler. Exhibit 10(d) - Employment Agreement, dated as of May 19, 1998, between United HealthCare Services, Inc. and Arnold H. Kaplan. Exhibit 10(e) - Termination Agreement, dated August 9, 1998, by and among the Company, UH-1 Inc., a wholly owned subsidiary of the Company, and Humana. Exhibit 15 - Letter Re Unaudited Interim Financial Information Exhibit 99 - Cautionary Statements. </TABLE> * Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, portions of these amendments have been omitted and filed separately with the Securities and Exchange Commission in connection with a confidential treatment request. (b) The Company filed the following reports on Form 8-K during the three month period ended June 30, 1998. 1. Form 8-K Dated May 29, 1998. The items reported were items 5 and 7 concerning the announcement of the Agreement and Plan of Merger entered into by and among the Company, Humana Inc. and UH-1 Inc., a wholly owned subsidiary of the Company. 2. Form 8-K Dated June 11, 1998. The items reported were items 5 and 7 concerning the announcement of the agreement entered into between the Company and HealthPartners of Arizona, Inc., pursuant to which the Company will acquire HealthPartners. 16
UNITED HEALTHCARE CORPORATION 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. UNITED HEALTHCARE CORPORATION /s/ STEPHEN J. HEMSLEY Chief Operating Dated: August 14, 1998 - ------------------------------- Officer Stephen J. Hemsley /s/ GREGORY J. SPRINGER Chief Accounting Dated: August 14, 1998 - ------------------------------- Officer Gregory J. Springer 17
UNITED HEALTHCARE CORPORATION EXHIBITS <TABLE> <CAPTION> EXHIBIT NUMBER DESCRIPTION - ------------- ------------------------------------------------------------- <S> <C> Exhibit 10(a) - First Amendment to the AARP Health Insurance Agreement by and among American Association of Retired Persons, Trustees of the AARP Insurance Plan and United HealthCare Insurance Company effective January 1, 1998.* Exhibit 10(b) - Second Amendment to the AARP Health Insurance Agreement by and among American Association of Retired Persons, Trustees of the AARP Insurance Plan and United HealthCare Insurance Company effective January 1, 1998.* Exhibit 10(c) - Employment Agreement, dated as of May 20, 1998, between United HealthCare Services, Inc. and R. Channing Wheeler. Exhibit 10(d) - Employment Agreement, dated as of May 19, 1998, between United HealthCare Services, Inc. and Arnold H. Kaplan. Exhibit 10(e) - Termination Agreement, dated August 9, 1998, by and among the Company, UH-1 Inc., a wholly owned subsidiary of the Company, and Humana. Exhibit 15 - Letter Re Unaudited Interim Financial Information Exhibit 99 - Cautionary Statements. </TABLE> * Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended, portions of these amendments have been omitted and filed separately with the Securities and Exchange Commission in connection with a confidential treatment request. 18