<PAGE> 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.
<PAGE> 2
PACIFICARE HEALTH SYSTEMS, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
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
</TABLE>
i
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
1999 DECEMBER 31,
(UNAUDITED) 1998
----------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
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
=========== ===========
</TABLE>
See accompanying notes.
1
<PAGE> 4
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JUNE 30,
-----------------------------
1999 1998
----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
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
=========== ===========
</TABLE>
See accompanying notes.
2
<PAGE> 5
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------------
1999 1998
----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
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
=========== ===========
</TABLE>
See accompanying notes.
3
<PAGE> 6
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------------
1999 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
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
========= =========
</TABLE>
See accompanying notes.
Table continued on next page.
4
<PAGE> 7
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-------------------------
1999 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
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
========= =========
</TABLE>
See accompanying notes.
Table continued from previous page.
5
<PAGE> 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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1998
------------------ ----------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) (UNAUDITED)
<S> <C> <C>
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
</TABLE>
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
<PAGE> 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:
<TABLE>
<CAPTION>
AGGREGATE
REPURCHASE PRICE
RANGE
PER SHARE (IN MILLIONS)
------------ -----------------
APPROXIMATE PURCHASE DATE SHARES LOW HIGH LOW HIGH
- ------------------------- --------- --- ---- --- ----
<S> <C> <C> <C> <C> <C>
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
========= ==== ====
</TABLE>
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
<PAGE> 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
<PAGE> 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ -------------------
1999 1998 1999 1998
------ ------ ------ -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
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
====== ====== ====== =======
</TABLE>
9
<PAGE> 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
<PAGE> 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.
<TABLE>
<CAPTION>
AT JUNE 30, 1999 AT JUNE 30, 1998
---------------------------------- -----------------------------------
MEMBERSHIP DATA GOVERNMENT COMMERCIAL TOTAL GOVERNMENT COMMERCIAL TOTAL
- --------------- ---------- ---------- --------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
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
======= ========= ========= ======= ========= =========
</TABLE>
- -------------
(1) At June 30, 1998, Utah had approximately 9,800 Medicaid members.
11
<PAGE> 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 JUNE 30, 1999
------------------ ----------------
(AMOUNTS IN MILLIONS)
<S> <C> <C>
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
==== ====
</TABLE>
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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1999 JUNE 30, 1999
------------------ ----------------
(AMOUNTS IN MILLIONS)
<S> <C> <C>
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
==== =====
</TABLE>
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
<PAGE> 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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
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%
</TABLE>
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:
<TABLE>
<CAPTION>
QUARTER GOVERNMENT COMMERCIAL TOTAL
------- ---------- ---------- -----
<S> <C> <C> <C>
First ......... $ 3 $ 3 $ 6
Second ........ 25 10 35
--- --- ---
Total ........ $28 $13 $41
=== === ===
</TABLE>
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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Marketing, general and administrative expenses as a
percent of operating revenue ......................... 10.8% 11.5% 10.8% 11.7%
</TABLE>
13
<PAGE> 16
OPERATING INCOME. The drivers of this growth are discussed above.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ------------------
1999 1998 1999 1998
------ ------ ------ ------
<S> <C> <C> <C> <C>
Operating income as a percentage of operating revenue ... 4.4% 3.6% 4.5% 3.3%
</TABLE>
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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
------------------ ----------------
<S> <C> <C>
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
===== =====
</TABLE>
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
<PAGE> 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
<PAGE> 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.
<TABLE>
<CAPTION>
AT JUNE 30, 1999 AT MARCH 31, 1999
------------------------------------- --------------------------------------
MEMBERSHIP DATA GOVERNMENT COMMERCIAL TOTAL GOVERNMENT COMMERCIAL TOTAL
- --------------- ---------- ---------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
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
======= ========= ========= ======= ========= =========
</TABLE>
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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 1999 MARCH 31, 1999
------------------ ------------------
<S> <C> <C>
Medical care ratio:
Consolidated................. 85.0% 84.8%
Government................... 87.5% 87.0%
Commercial .................. 81.4% 81.5%
</TABLE>
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
<PAGE> 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------
<S> <C>
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
======
</TABLE>
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
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 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
<PAGE> 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.
<TABLE>
<CAPTION>
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE
----- --- ------- ------- ---------------
<S> <C> <C> <C> <C>
A 13,344,147 11,067 4,311 689,158
B 20,903,958 83,776 17,140 --
</TABLE>
(2) The stockholders approved the election of the nominees to PacifiCare's
board of directors.
<TABLE>
<CAPTION>
WITHHOLD
CLASS DIRECTOR FOR AUTHORITY
----- -------- --- ---------
<S> <C> <C> <C>
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
</TABLE>
(3) The stockholders approved performance objectives for, and maximum
awards under the 1996 Management Incentive Compensation Plan.
<TABLE>
<CAPTION>
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE
----- --- ------- ------- ---------------
<S> <C> <C> <C> <C>
A 14,018,500 23,558 6,625 --
</TABLE>
(4) The stockholders approved amendments to the 1996 Stock Option Plan for
Officers and Key Employees.
<TABLE>
<CAPTION>
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE
----- --- ------- ------- ---------------
<S> <C> <C> <C> <C>
A 11,045,926 2,994,017 8,740 --
</TABLE>
23
<PAGE> 26
(5) The stockholders approved the Amended and Restated 1996 Non-Officer
Directors Stock Option Plan.
<TABLE>
<CAPTION>
CLASS FOR AGAINST ABSTAIN BROKER NON-VOTE
----- --- ------- ------- ---------------
<S> <C> <C> <C> <C>
A 11,394,850 2,646,475 7,358 --
</TABLE>
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
<PAGE> 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
<PAGE> 28
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<C> <S>
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)
</TABLE>
<PAGE> 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
<PAGE> 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
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
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.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 251,194
<SECURITIES> 958,560
<RECEIVABLES> 315,470
<ALLOWANCES> 6,020
<INVENTORY> 0
<CURRENT-ASSETS> 1,686,175
<PP&E> 292,299
<DEPRECIATION> 123,517
<TOTAL-ASSETS> 4,241,832
<CURRENT-LIABILITIES> 1,199,623
<BONDS> 0
0
0
<COMMON> 468
<OTHER-SE> 2,333,024
<TOTAL-LIABILITY-AND-EQUITY> 4,241,832
<SALES> 0
<TOTAL-REVENUES> 4,906,656
<CGS> 0
<TOTAL-COSTS> 4,117,383
<OTHER-EXPENSES> 565,712
<LOSS-PROVISION> 368
<INTEREST-EXPENSE> 19,805
<INCOME-PRETAX> 243,831
<INCOME-TAX> 100,946
<INCOME-CONTINUING> 142,885
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 142,885
<EPS-BASIC> 3.12
<EPS-DILUTED> 3.10
</TABLE>
