<PAGE>
UNITED STATES
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended March 31, 1999
Commission File Number 1-14177
UNITED WISCONSIN SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin 39-1931212
(State of incorporation) (I.R.S. Employer
Identification No.)
401 West Michigan Street, Milwaukee, Wisconsin 53203-2896
(Address of principal executive offices) (Zip Code)
(414) 226-6900
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all documents and
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
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date:
Common stock outstanding as of April 30, 1999 was 16,844,998.
<PAGE>
UNITED WISCONSIN SERVICES, INC.
INDEX TO
QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended March 31, 1999
<TABLE>
<CAPTION>
<S> <C>
PART I
Financial Statements and Supplementary Data.................................................................. 3
Management's Discussion and Analysis of Financial Condition and Results of Operations........................11
Quantitative and Qualitative Disclosures about Market Risk...................................................18
PART II
Other Information............................................................................................19
Signature Page...............................................................................................20
</TABLE>
2
<PAGE>
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------- ---------
(In Thousands)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 7,656 $ 26,385
Investments--available for sale 160,526 158,463
Other receivables 71,307 65,464
Prepaid and other current assets 9,234 6,778
--------- ---------
Total Current Assets 248,723 257,090
Investments--held to maturity 7,911 7,710
Property and equipment, net 8,956 8,963
Goodwill and other intangible assets, net 7,613 7,751
Other noncurrent assets 17,896 16,694
--------- ---------
Total Assets $ 291,099 $ 298,208
--------- ---------
--------- ---------
</TABLE>
See Notes to Interim Consolidated Financial Statements.
3
<PAGE>
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------------- ---------------
(IN THOUSANDS)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Medical and other benefits payable $ 62,484 $ 70,659
Advance premiums 29,331 30,584
Note payable to affiliates 70,000 70,000
Due to affiliates - other 10,436 7,513
Payables and accrued expenses 18,053 19,129
Other current liabilities 8,314 10,527
--------------- ---------------
Total Current Liabilities 198,618 208,412
Other noncurrent liabilities 26,303 25,337
--------------- ---------------
Total Liabilities 224,921 233,749
Shareholders' Equity:
Preferred stock (no par value, 1,000,000 shares authorized) - -
Common stock (no par value, no stated value,
50,000,000 shares authorized, 16,844,871 and 16,812,081
issued and outstanding at March 31, 1999
and December 31, 1998, respectively) 13,659 13,378
Retained earnings 52,760 50,088
Unrealized gains (losses) on investments, net of taxes (241) 993
--------------- ---------------
Total Shareholders' Equity 66,178 64,459
--------------- ---------------
Total Liabilities and Shareholders' Equity $ 291,099 $ 298,208
--------------- ---------------
--------------- ---------------
</TABLE>
See Notes to Interim Consolidated Financial Statements.
4
<PAGE>
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------
1999 1998
-------------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C>
Revenues:
Health services revenue:
Premium revenue $ 160,321 $ 148,076
Other revenue 9,325 7,121
Investment results 3,363 3,961
-------------- ---------------
Total Revenues 173,009 159,158
Expenses:
Medical and other benefits 138,936 126,067
Selling, general and administrative expenses 28,696 24,392
Profit (loss) sharing on provider arrangements (130) 1,124
Interest expense 1,184 -
Amortization of goodwill and other intangibles 165 116
-------------- ---------------
Total Expenses 168,851 151,699
-------------- ---------------
Income before Income Taxes 4,158 7,459
Income Tax Expense 1,486 2,743
-------------- ---------------
Net Income $ 2,672 $ 4,716
-------------- ---------------
-------------- ---------------
Diluted Earnings (1998 pro forma) Per
Common Share $ 0.16 $ 0.24
-------------- ---------------
-------------- ---------------
</TABLE>
See Notes to Interim Consolidated Financial Statements.
5
<PAGE>
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
-----------------------------
1999 1998
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Operating Activities:
Net Income $ 2,672 $ 4,716
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 833 632
Realized investment gains (968) (1,379)
Deferred income tax expense (benefit) 705 (310)
Changes in operating accounts:
Other receivables (5,127) (346)
Due from clinics and providers (839) 982
Medical and other benefits payable (7,059) 190
Advance premiums (1,253) 5,342
Due to/from affiliates 2,157 1,415
Other, net (6,269) 1,100
------------ ------------
Net Cash Provided by (Used in) Operating Activities (15,148) 12,342
Investing Activities:
Purchases of available for sale investments (54,457) (51,966)
Proceeds from sale of available for sale investments 42,532 47,056
Proceeds from maturity of available for sale investments 8,650 -
Purchases of held to maturity investments (204) (239)
Proceeds from maturity of held to maturity investments - 195
Additions to property and equipment (540) (999)
------------ ------------
Net Cash Used in Investing Activities (4,019) (5,953)
Financing Activities:
Issuances of common stock 1 -
Proceeds from line of credit 490 -
Repayment of debt (53) -
Decrease in investments by and advances from AMSG - (7)
------------ ------------
Net Cash Provided by (Used in) Financing Activities 438 (7)
Cash and Cash Equivalents:
Increase (decrease) during period (18,729) 6,382
Balance at beginning of year 26,385 17,033
------------ ------------
Balance at End of Period $ 7,656 $ 23,415
------------ ------------
------------ ------------
</TABLE>
See Notes to Interim Consolidated Financial Statements.
6
<PAGE>
UNITED WISCONSIN SERVICES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
March 31, 1999
Note A. Basis of Presentation
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments (consisting of only normal recurring adjustments) considered
necessary for a fair presentation have been included. Operating results for
the three-month periods ended March 31, 1999 and 1998 are not necessarily
indicative of the results that may be expected for the years ending December
31, 1999 and 1998. These interim consolidated financial statements should be
read in conjunction with the audited consolidated financial statements for
the year ended December 31, 1998 and footnotes thereto included in United
Wisconsin Services, Inc. (the "Company") Form 10-K, as filed with the
Securities and Exchange Commission.
The accompanying unaudited interim consolidated financial statements present the
consolidated financial position, consolidated results of operations and cash
flows as if the Company had been an independent, publicly owned company for all
periods presented prior to the spin off ("Spin off" or "Distribution") from
American Medical Security Group, Inc. ("AMSG", formerly United Wisconsin
Services, Inc.) on September 25, 1998 ("Spin off date"). Certain estimates,
assumptions and allocations were made to facilitate the preparation of the
unaudited interim consolidated financial statements.
Note B. Net Income Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per
common share are computed by dividing net income by the weighted average number
of common shares outstanding, adjusted for the effect of dilutive securities for
employee stock options.
The following table provides a reconciliation of the number of weighted average
basic and diluted shares outstanding:
<TABLE>
<CAPTION>
Three months ended
March 31, 1999
----------------------
<S> <C>
Weighted average common shares outstanding 16,823,387
Potentially dilutive stock options 11,566
----------------------
Weighted average common and potentially
dilutive shares outstanding 16,834,953
----------------------
----------------------
</TABLE>
Options to purchase 2,690,034 shares during the three months ended March 31,
1999 were not included in the computation of earnings per diluted common share
price since the options' exercise prices were greater than the average market
price of the outstanding common shares.
7
<PAGE>
Note C. Pro Forma Financial Information
In conjunction with the distribution of assets pursuant to the Spin off, the
Company assumed a $70 million note obligation to Blue Cross & Blue Shield United
of Wisconsin ("BCBSUW"). The assumption of debt was effective September 11,
1998. The unaudited pro forma results presented on the interim consolidated
statement of income and below, have been prepared for informational purposes
only. These results include the adjustment to historical results, based on
additional interest expense for the quarter ended March 31, 1998, net of related
income tax. Pro forma calculations for dilutive securities for the first quarter
of 1998, assume that the price of the stock and the strike price of the options
is the same during the period.
The following unaudited pro forma information presents a summary of the effect
on net income as if the Spin off had occurred at the beginning of the period:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1998
------------------------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C>
Net income as reported $4,716
Pro forma adjustment - interest expense, net of taxes 792
------------------------
Pro forma net income $3,924
------------------------
------------------------
Pro forma diluted weighted average common shares 16,515,874
Pro forma diluted earnings per common share $0.24
------------------------
------------------------
</TABLE>
The unaudited pro forma financial information presented on the consolidated
statement of income and above, do not purport to be indicative of the results of
operations which actually would have resulted had the transactions occurred at
the beginning of the periods presented or of the future results of operations.
Note D. Related Party
The Company continues to negotiate with BSBSUW for the possible purchase by
BCBSUW of approximately 2,750,000 shares of the Company's common stock to be
issued in a privately negotiated transaction. This purchase is part of the
previously disclosed plan for BCBSUW to increase its ownership in the Company to
allow Compcare Health Services Insurance Company, a wholly owned subsidiary of
the Company, to use the Blue Cross and Blue Shield brand on its products.
Note E. Comprehensive Income
A reconciliation from net income reported in the Statement of Income and
comprehensive income from operations is stated below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1999 1998
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Net income per Statement of Income $ 2,672 $4,716
Unrealized gains (losses) on investments, net of taxes (1,234) 927
----------- -----------
Comprehensive income $ 1,438 $5,643
----------- -----------
----------- -----------
</TABLE>
8
<PAGE>
Comprehensive income is defined therein as all changes in equity during the
period except those resulting from shareholder equity contributions and
distributions. Accumulated effect of comprehensive income (loss) was $(0.2)
million and $1.0 million as of March 31, 1999 and December 31, 1998,
respectively.
Note F. Segment Reporting
The Company has two reportable business segments: Health Maintenance
Organization ("HMO") products sold primarily in Wisconsin, and specialty managed
care products and services, including dental, life, disability and workers'
compensation products, managed care consulting, electronic claim submission,
pharmaceutical management, managed behavioral health services, case management
and receivables management sold throughout the United States.
"Other Operations" includes operations not directly related to the business
segments, unallocated corporate items (i.e. corporate interest expense on
corporate debt, amortization of goodwill and intangibles and unallocated
overhead expenses) and intercompany eliminations. The Company evaluates segment
performance based on profit or loss from operations before income taxes. The
accounting policies of the reportable segments are the same as those described
in the December 31, 1998 audited financial statements in the summary of
significant accounting policies.
Financial data by segment is as follows:
<TABLE>
<CAPTION>
Three months ended March 31,
------------------------------------
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Health services revenue:
HMO products $136,898 $126,636
Specialty managed care products and services 36,709 32,468
Other operations (3,961) (3,907)
------------------------------------
Total consolidated $169,646 $155,197
------------------------------------
------------------------------------
Investment results:
HMO products $1,982 $1,593
Specialty managed care products and services 1,363 2,232
Other operations 18 136
------------------------------------
Total consolidated $3,363 $3,961
------------------------------------
------------------------------------
Income (loss) before income tax expense:
HMO products $2,503 $3,775
Specialty managed care products and services 3,189 4,006
Other operations (1,534) (322)
------------------------------------
Total consolidated $4,158 $7,459
------------------------------------
------------------------------------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Total assets:
HMO products $138,333 $138,272
Specialty managed care products and services 153,287 151,845
Other operations (521) 8,091
------------------------------------
Total consolidated $291,099 $298,208
------------------------------------
------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Three months ended March 31,
1999 1998
------------------------------------
(IN THOUSANDS)
<S> <C> <C>
Health services revenue from transactions with other operating segments:
HMO products $ 460 $ 481
Specialty managed care products and services 3,669 3,766
</TABLE>
Note G. Reclassifications
Certain reclassifications have been made to the consolidated financial
statements for 1998 to conform with the 1999 presentation.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
United Wisconsin Services, Inc. (the "Company") is a Wisconsin corporation
organized in May of 1998 for the purpose of owning and operating the managed
care companies and specialty businesses of the Company's predecessor, American
Medical Security Group, Inc. ("AMSG") (formerly United Wisconsin Services,
Inc.). On September 25, 1998, the Company was spun off (the "Spin off") from its
former parent AMSG.
The Company is a leading provider of managed health care services and
employee benefit products. The Company's two primary product lines are: (i)
Health Maintenance Organization ("HMO") products, including Compcare Health
Services Insurance Corporation ("Compcare"), Valley Health Plan, Inc.
("Valley"), Unity Health Plans Insurance Corporation ("Unity") and certain
point-of-service ("POS") and other related products managed by Compcare, Valley
and Unity, and (ii) specialty managed care products and services, including
dental, life, disability and workers' compensation products, managed care
consulting, electronic claim submission, pharmaceutical management, managed
behavioral health services, case management and receivables management, sold
throughout the United States. Operating results and statistics for these product
groups are presented below for the periods indicated.
The following Management's Discussion and Analysis should be read in
conjunction with the audited consolidated financial statements for the year
ended December 31, 1998 and footnotes thereto included in the Company's Form
10-K.
RESULTS OF OPERATIONS
TOTAL REVENUES
Total revenues for the three months ended March 31, 1999 increased 8.7% to
$173.0 million from $159.2 million for the three months ended March 31, 1998.
These increases were due primarily to increased membership in all the major
product lines and general premium increases.
HEALTH SERVICES REVENUES -- HMO health services revenues for the three
months March 31, 1999 increased 8.1% to $136.9 million from $126.6 million for
the three months ended March 31, 1998. Average insured HMO medical premium per
member for the three months ended March 31, 1999 increased 4.2% from the same
period in the prior year. The average number of insured HMO medical members for
the three months ended March 31, 1999 increased 3.7% to 297,609 from 286,891 for
the three months ended March 31, 1998.
Health services revenues for specialty managed care products and services
for the three months ended March 31, 1999 increased 12.9% to $36.7 million from
$32.5 million for the three months ended March 31, 1998. This increase was due
primarily to an increase in covered lives and additional revenue of $1.3 million
in the first quarter of 1999 from the acquisitions of Intercare Network, Inc.
("Intercare") and Ladd Enterprises, Inc. ("Ladd") which occurred during the
second half of 1998. This increase was partially offset by the Company's exit
from the vision business in the first quarter of 1999. Premium revenues for the
vision business were $0.6 million for the three months ended March 31, 1998.
NET INVESTMENT RESULTS -- Investment results include investment income and
realized gains on investments. Investment results for the three months ended
March 31, 1999 decreased 15.0% to $3.4 million from $4.0 million for the three
months ended March 31, 1998. Average annual investment yields, excluding net
realized gains, were 5.2% for the three months ended March 31, 1999 and 5.8% for
the three months ended March 31, 1998. The decreased yields were representative
of economic trends in the financial markets.
Average invested assets for the three months ended March 31, 1999
increased 1.2% to $185.1 million from $182.9 million for the three months ended
March 31, 1998.
11
<PAGE>
Investment gains are realized in the normal investment process in response
to market opportunities. Realized gains for the three months ended March 31,
1999 were $1.0 million compared to $1.4 million for the three months ended March
31, 1998.
EXPENSE RATIOS
LOSS RATIO -- The consolidated loss ratio represents the ratio of medical
and other benefits to premium revenue on a consolidated basis, and is therefore
a blended ratio for medical, life, dental, disability and other product lines.
The consolidated loss ratio was 86.7% for the first quarter of 1999 compared
with 85.1% for the first quarter of 1998. The consolidated loss ratio is
influenced by the component loss ratio for each of the Company's primary product
lines, as discussed below.
The medical loss ratio for HMO products for the three months ended March
31, 1999 was 89.4%, compared with 88.4% for the three months ended March 31,
1998. The increase is principally due to increased claims on out-of-area health
services provided to Compcare and Valley members. This out-of-area component had
premium and incurred claims of $2.2 million and $3.4 million for the first
quarter of 1999, compared to $2.3 million and $1.6 million for the first quarter
of 1998, respectively.
The loss ratio for the risk products within specialty managed care
products and services for the three months ended March 31, 1999 was 74.1%
compared with 71.4% for the three months ended March 31, 1998. The loss ratios
principally relate to the life, disability, workers' compensation and dental
product lines of business. These products represent relatively small blocks of
business, and as a result, the loss ratio can exhibit significant volatility due
to varying levels of claim frequency and severity. Generally, the anticipated
aggregate loss ratio for the four products should range between 70% and 75%.
United Heartland, Inc. workers' compensation block of business had achieved
better than expected results during 1998, while the first quarter of 1999
results represent an increased loss ratio which is more in line with industry
and targeted results.
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSE RATIO -- The selling, general
and administrative ("SGA") expense ratio includes commissions, administrative
expenses, and premium taxes and other assessments. The SGA expense ratio for HMO
products for the first quarter of 1999 was 10.3%, compared with 9.0% for the
first quarter of 1998. Substantially all of the increase in the SGA expense
ratio relates to the Company's implementation of its Year 2000 readiness program
for the Compcare HMO business. The additional costs associated with the
conversion to the upgraded computer system will continue into the second quarter
of 1999, but at a lower level and should not have an impact beyond the end of
the second quarter.
SGA expense ratio related to the risk products within specialty managed
care products and services for the first quarter of 1999 was 23.5%, compared
with 24.3% for the first quarter of 1998. This decrease was primarily due to an
expense credit of approximately $0.2 million in the first quarter of 1999,
related to the Company's participation in a reinsurance pool for the State of
Wisconsin group life insurance program. Such expense credits or offsetting
expense charges may continue throughout 1999. The Company does not expect such
credits to continue beyond 1999.
The operating expense ratio related to the service products within
specialty managed care products and services for the first quarter of 1999 was
89.0%, compared with 91.2% for the first quarter of 1998. This improvement is
primarily related to the receipt of additional profit sharing from Virginia
Surety Company, which is reported as increased revenue in the Company's workers'
compensation block of business. In addition, during the second half of 1998 the
Company acquired Ladd and Intercare, which have lower than average operating
expense ratios.
12
<PAGE>
OTHER EXPENSES
Profit (loss) sharing on joint ventures was $(0.1) million for the three
months ended March 31, 1999 compared with $1.1 million for the three months
ended March 31, 1998. These balances are related to the Unity and Valley
provider arrangements and reflect the relative profitability of these entities.
Amortization of goodwill and other intangibles for the three months ended
March 31, 1999 was $0.2 million compared with $0.1 million for the three months
ended March 31, 1998. The increase is due to goodwill arising from the
acquisitions of Intercare and Ladd during the second half of 1998.
Interest expense for the three months ended March 31, 1999 was primarily
related to the $70 million note obligations to BCBSUW which was assumed on
September 11, 1998 in conjunction with the Spin off.
NET INCOME FROM OPERATIONS
Net income from operations for the three months ended March 31, 1999
decreased 42.6% to $2.7 million from $4.7 million for the three months ended
March 31, 1998.
The Company's effective tax rate was 35.7% for the three months ended
March 31, 1999 compared with 36.8% for the three months ended March 31, 1998.
This rate fluctuates based upon the relative profitability of the Company's two
product lines and the differing effective tax rate for each of those product
lines. The effective tax rate by product line ranges from 34% to 43%. In
addition to the impact from the mix of earnings, favorable adjustments relating
to prior periods totaling approximately $0.2 million were recorded during the
first quarter of 1999.
SUMMARY OF OPERATING RESULTS AND STATISTICS
Operating results and statistics for the two primary product groups are
presented below for the periods indicated.
<TABLE>
<CAPTION>
March 31,
------------------------------
1999 1998
-------------- --------------
<S> <C> <C>
Members at end of period:
HMO members by business unit:
Compcare 175,656 169,532
Valley 41,953 40,319
Unity 86,491 84,294
-------------- --------------
Total HMO members 304,100 294,145
-------------- --------------
-------------- --------------
HMO members by product type:
Commercial 184,414 185,945
Point of Service 73,300 63,434
Medicaid 39,894 38,935
-------------- --------------
Total insured members 297,608 288,314
Self-insured members 6,492 5,831
-------------- --------------
Total HMO members 304,100 294,145
-------------- --------------
-------------- --------------
Specialty managed care products and services:
UWG Life/AD&D 159,776 140,091
Dental - HMO 172,000 167,901
UWG Dental 12,696 12,448
Disability 112,056 91,142
Behavioral Health 961,774 898,222
Workers' Compensation 54,142 53,280
-------------- --------------
Total Specialty managed care
products and services members 1,472,444 1,363,084
-------------- --------------
-------------- --------------
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Health services revenues (as a percentage of the total):
HMO products 80.7% 81.6%
Specialty managed care products and services
Service Products 7.5 6.8
Risk Products 14.1 14.1
Intercompany eliminations (2.3) (2.5)
----------- -----------
Total 100.0% 100.0%
----------- -----------
----------- -----------
Operating statistics:
HMO products:
Medical loss ratio (1) 89.4% 88.4%
Selling, general, & administrative
expense ratio (2) 10.3 9.0
Combined loss and expense ratio 99.7 97.4
Specialty managed care products and services:
Service products:
Operating expense ratio* 89.0% 91.2%
Risk products:
Loss ratio (1) 74.1 71.4
Selling, general, & administrative
expense ratio (2) 23.5 24.3
Combined loss and expense ratio 97.6 95.7
Consolidated:
Loss ratio (1) 86.7% 85.1%
Net income margin (3) 1.5 3.0
</TABLE>
(1) Medical and other benefits as a percentage of premium revenue.
(2) Selling, general and administrative expenses as a percentage of premium
revenue.
(3) Net income as a percentage of total revenues.
* This business does not have insurance related risk associated with it.
The Company's revenues are derived primarily from premiums, while medical
benefits constitute the majority of expenses. Profitability is directly affected
by many factors including, among others, premium rate adequacy, estimates of
medical benefits, health care utilization, effective administration of benefit
payments, operating efficiency, investment returns and federal and state laws
and regulations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of health services
revenues and investment income. The primary uses of cash include medical and
other benefits and operating expense payments. Positive cash flows are invested
pending future payments of medical and other benefits and other operating
expenses. The Company's investment policies are designed to maximize yield,
preserve principal and provide liquidity to meet anticipated payment
obligations.
14
<PAGE>
The Company has typically generated positive cash flow from operations in
prior years. For the three months ended March 31, 1999, net cash was used in
operating activities in the amount of $15.1 million, compared with net cash
provided by operating activities of $12.3 million for the three months ended
March 31, 1998. The decrease in cash flows from operations in 1999 was due
primarily to an increase in premiums receivables and reductions in medical and
other benefits payable and other liabilities. Due to periodic cash flow
requirements of certain subsidiaries, the Company made borrowings under its bank
line of credit ranging up to $8.9 million during the first three months of 1999
and $10.0 million during the first three months of 1998 to meet short-term cash
needs. The outstanding balance on the line of credit at March 31, 1999 was $0.5
million compared with no outstanding balance at March 31, 1998.
The Company's investment portfolio consists primarily of investment grade
bonds and Government securities, and has a limited exposure to equity
securities. At March 31, 1999, $126.7 million or 75.1% of the Company's total
investment portfolio was invested in bonds compared with $132.8 million or 79.8%
at December 31, 1998. The bond portfolio had an average quality rating by
Moody's Investor Service of Aa3 at March 31, 1999 and December 31, 1998,
respectively. The majority of the bond portfolio was classified as available for
sale. The market value of the total investment portfolio, which includes stocks
and bonds, was less than amortized cost by $0.3 million at March 31, 1999 and
greater than amortized cost by $1.9 million at December 31, 1998. The Company
has no investments in mortgage loans, non-publicly traded securities (except for
principal-only strips of U. S. Government securities), real estate held for
investment or financial derivatives.
From time to time, capital contributions are made to the subsidiaries to
assist them in maintaining appropriate levels of capital and surplus for
regulatory and rating purposes. Insurance subsidiaries are required to maintain
certain levels of statutory capital and surplus. In Wisconsin, where a large
percentage of the Company's premium is written, these levels are based upon the
amount and type of premiums written and are calculated separately for each
subsidiary. As of the balance sheet dates presented, statutory capital and
surplus for each of these insurance subsidiaries exceeded required levels.
In conjunction with the Spin off, the Company assumed a $70 million note
obligation to BCBSUW that matures on October 30, 1999. The assumption of debt
was effective September 11, 1998.
In addition to internally generated funds and periodic borrowings on its
bank line of credit, the Company believes that additional financing to
facilitate long-term growth could be obtained through equity offerings, debt
offerings, financings from BCBSUW or bank borrowings, as market conditions may
permit or dictate.
YEAR 2000 ISSUES
GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE
YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software or embedded chips may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
The Company has identified required modifications or replacements of its
software and certain hardware so that those systems will properly utilize dates
beyond December 31, 1999. The Company presently believes that with these
modifications or replacements of existing software and certain hardware, the
Year 2000 Issue can be mitigated and will not pose significant operational
problems. However, if such modifications and conversions are not made or are not
completed timely, the Year 2000 Issue could have a material impact on the
operations of the Company.
15
<PAGE>
The Company's plan to resolve the Year 2000 Issue involves the following
four phases: assessment, remediation, testing, and implementation. To date, the
Company has fully completed its assessment of all systems that could be
significantly affected by the Year 2000 Issue. The completed assessment
indicated that most of the Company's significant information technology systems
could be affected, particularly the general ledger, billing and processing of
medical claims. That assessment also indicated that software and hardware
(embedded chips) used in building operations and office equipment (hereafter
referred to as non-IT systems) are at risk. The Company does not believe that
the Year 2000 Issue presents a material exposure as it relates to the Company's
non-IT systems. In addition, the Company has inquired and gathered information
about the Year 2000 readiness status of its significant suppliers and vendors
and continues to monitor their readiness.
STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR
COMPLETION OF EACH REMAINING PHASE
As of March 31, 1999, the Company was approximately 90% complete with the
remediation phase for its information technology exposures. Once software is
reprogrammed or replaced for a system, the Company will begin testing and
implementation. These phases are expected to run concurrently for different
systems. For all systems where the Company has completed the remediation phase,
the Company has also completed the testing and implementation phases. For those
systems where remediation is still underway, the Company expects to complete
remediation, testing and implementation by September 30, 1999.
The remediation phase of non-IT systems is nearly complete. Testing of
remediated non-IT systems is approximately 90% complete. Once testing is
complete, the non-IT systems are expected to be ready for immediate use. The
Company expects to complete its remediation efforts, testing and implementation
of affected non-IT systems by May 31, 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE TO THE YEAR
2000
The Company outsources and relies extensively on third party systems to
process selected payroll, membership and claims processing functions, among
others. The Company is in the process of working with third party vendors to
ensure that their systems are Year 2000 ready. Several third party systems are
currently not Year 2000 ready. Compcare utilizes a membership system that is
expected to complete its upgrades and testing by May 31, 1999. United Wisconsin
Group, which includes the Company's wholly owned subsidiaries United Wisconsin
Insurance Company and United Heartland Life Insurance Company, is expected to be
Year 2000 ready by September 30, 1999 for its administrative, claims and billing
systems. Based on discussions with these key vendors, the Company is of the
understanding that the vendor systems utilized are or will be Year 2000 ready.
The Company has initiated formal communications with its systems
processing vendors, government agencies and all large customers and providers
using electronic interfaces to determine the extent to which the Company's
interface systems are vulnerable to the failure of third parties to remediate
Year 2000 Issues. The Company is not aware of any significant interface issues.
The Company has surveyed its significant suppliers and subcontractors
(external agents) that do not share information systems with the Company. To
date, the Company is not aware of any external agent with a Year 2000 Issue that
would materially impact the Company's results of operations, liquidity or
capital resources. However, the Company has no means of ensuring that external
agents will be Year 2000 ready. The inability of external agents to complete
their Year 2000 resolution process in a timely fashion could materially impact
the Company. The effect of non-compliance by external agents is not
determinable.
16
<PAGE>
COST OF THE YEAR 2000 PROJECT
The Company has utilized both internal and external resources to reprogram
or replace, test and implement the software and non-IT systems for the Year 2000
modifications. The total direct costs of the Year 2000 project is estimated at
$1.5 million and is being funded through operating cash flows. To date, the
Company has incurred $1.0 million of identifiable costs related to all phases of
the Year 2000 project. Remaining costs, to be incurred to complete the Year 2000
project, are estimated to approximate $0.5 million. In addition, the Company has
capitalized $2.7 million related to other functionality enhancing system
upgrades which also provide Year 2000 readiness. A number of other modifications
to current systems are covered by existing maintenance agreements and by normal
upgrades and do not present incremental additional expense.
BCBSUW leases the claims, membership and general ledger software programs
and subleases the use of these systems to the Company under the service
agreement. BCBSUW capitalized $16.5 million of implementation and system
enhancement costs that were incurred to replace these systems primarily as a
result of a service agreement expiration and for improved functionality. These
replacements also included Year 2000 readiness but were not the result of
acceleration due to Year 2000 Issues. Approximately 24% of the amortized costs
are allocated to the Company.
Costs related to maintenance of existing computer hardware and software
are expensed as incurred. Purchases of new hardware or software in replacement
of non-compliant hardware or software and reprogramming costs are being
capitalized in accordance with the Company's standard accounting practices.
RISKS ASSOCIATED WITH YEAR 2000
Company management believes it has an effective program in place to
resolve the Year 2000 Issue in a timely manner. As noted above, the Company has
not yet completed all necessary phases of the Year 2000 program. In the event
that the Company is unable to complete the remaining phases, the Company would
selectively be unable to bill and collect premiums, adjudicate medical and other
claims, manage the utilization of medical services or perform actuarial
determinations. In addition, disruptions in the economy generally resulting from
Year 2000 issues could also materially adversely affect the Company. The Company
could be subject to litigation on a loss of business in the event it failed to
complete certain of the remaining remediation and implementation steps. The
amount of any potential liability and lost revenue cannot be reasonably
estimated at this time. No provision for any such liability or lost revenue has
been recorded.
CONTINGENCY PLANS
The Company is developing contingency plans for certain critical
applications and is working on such plans with major data center vendors. These
contingency plans are being developed in the event the system conversions and
their functionality or the readiness of Year 2000 are not completed on a timely
basis. These contingency plans involve, among other actions, manual workarounds,
reducing claim inventories prior to December 31, 1999, and adjusting staffing
strategies.
FORWARD LOOKING STATEMENTS
This report contains certain forward looking statements with respect to
the financial condition, results of operation and business of the Company. Such
forward looking statements are subject to inherent risks and uncertainties that
may cause actual results or events to differ materially from those contemplated
by such forward looking statements. Forward-looking statements may include, but
are not limited to, projections of revenues, income or losses, capital
expenditures, plans for future operations, financing needs or plans, compliance
with financial covenants in loan agreements, plans relating to products or
services of the Company, assessments of materiality, predictions of future
events, the ability to obtain additional financing, the Company's ability to
meet obligations as they become due, as well as assumptions relating to the
foregoing. In addition, when used in this discussion, the words "anticipates,"
"believes," "estimates,"
17
<PAGE>
"expects," "intends," "plans" and similar expressions are intended to identify
forward-looking statements. Factors that may cause actual results to differ
materially from those contemplated by such forward looking statements include,
among others, rising health care costs, economic and business conditions and
competition in the managed care industry, development of claims reserves,
developments in health care reform and other regulatory issues.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is provided under the caption
`Liquidity and Capital Resources' under Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Because of the Company's investment policies, the primary market risks
associated with the Company's portfolio are interest rate risk, credit risk, and
the risk related to fluctuations in equity prices. With respect to interest rate
risk, a reasonably near-term rise in interest rates could negatively affect the
fair value of the Company's bond portfolio; however, because the Company
considers it unlikely that the Company would need to choose to substantially
liquidate its portfolio, the Company believes that such an increase in interest
rates would not have a material impact on future earnings or cash flows. In
addition, the Company is exposed to the risk of loss related to changes in
credit spreads. Credit spread risk arises from the potential that changes in an
issuer's credit rating or credit perception may affect the value of financial
instruments.
The overall goal of the investment portfolios is to support the ongoing
operations of the Company's business units. The Company's philosophy is to
actively manage assets to maximize total return over a multiple-year time
horizon, subject to appropriate levels of risk. The Company manages these risks
by establishing gain and loss tolerances, targeting asset-class allocations,
diversifying among assets classes and segments within various asset classes, and
using performance measurement and reporting.
The Company uses a sensitivity model to assess the inherent rate risk of
its fixed income investments. The model includes all fixed income securities
held and incorporates assumptions regarding the impact of changing interest
rates on expected cash flows for certain financial assets with prepayment
features, such as callable bonds and mortgage-backed securities. No significant
changes have occurred in the determination of the reduction in the fair value of
the Company's modeled financial assets as a result of a hypothetical
instantaneous 100 basis point increase since last reported as of December 31,
1998.
18
<PAGE>
PART II. OTHER INFORMATION
UNITED WISCONSIN SERVICES, INC.
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None
19
<PAGE>
SIGNATURE
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.
DATE: 5/13/99
-------
UNITED WISCONSIN SERVICES, INC.
/s/ C. Edward Mordy
----------------------------------
C. Edward Mordy
Vice President and Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT MARCH 31, 1999 (UNAUDITED) AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED) AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 7,656
<SECURITIES> 168,437
<RECEIVABLES> 71,307
<ALLOWANCES> 0<F1>
<INVENTORY> 0
<CURRENT-ASSETS> 248,723
<PP&E> 18,755
<DEPRECIATION> 9,799
<TOTAL-ASSETS> 291,099
<CURRENT-LIABILITIES> 198,618
<BONDS> 0
0
0
<COMMON> 13,659
<OTHER-SE> 52,519
<TOTAL-LIABILITY-AND-EQUITY> 291,099
<SALES> 169,646
<TOTAL-REVENUES> 173,009
<CGS> 167,632
<TOTAL-COSTS> 167,632
<OTHER-EXPENSES> 35
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,184
<INCOME-PRETAX> 4,158
<INCOME-TAX> 1,486
<INCOME-CONTINUING> 2,672
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,672
<EPS-PRIMARY> 0.16
<EPS-DILUTED> 0.16
<FN>
<F1>Included in #13 (Receivables)
</FN>
</TABLE>
