<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 September 30, 1997
Commission File Number 0-19506
UNITED WISCONSIN SERVICES, INC.
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1431799
(State of Incorporation) (I.R.S. Employer
Indentification No.)
401 WEST MICHIGAN STREET, MILWAUKEE, WISCONSIN 53203-2896
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 226-6900
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
--- ---
Number of shares of Common Stock outstanding as of October 31, 1997 was
16,480,495.
1
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
ASSETS 1997 1996
------------- -----------
(In thousands)
Investments:
Bonds available for sale, at market $ 390,289 $ 394,615
Bonds held to maturity, at amortized cost 11,884 12,823
---------- ----------
Total bonds 402,173 407,438
Stocks, at market 56,247 59,685
---------- ----------
Total investments 458,420 467,123
Cash and cash equivalents 36,045 51,146
Receivables:
Due from affiliates 3,719 2,641
Other receivables 65,454 74,167
---------- ----------
Total receivables 69,173 76,808
Property and equipment - net 46,142 53,103
Goodwill and other intangibles 140,172 155,458
Other assets 28,293 32,482
---------- ----------
Total assets $ 778,245 $ 836,120
---------- ----------
---------- ----------
See Notes to Interim Consolidated Financial Statements
2
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1997 1996
------------ ------------
(In thousands)
Liabilities:
Medical and other benefits payable $ 191,568 $ 240,338
Advance premiums 47,967 51,514
Due to affiliates 75,736 74,005
Payables and accrued expenses 44,468 50,879
Other liabilities 39,327 49,941
Debt 54,888 55,788
------------ ------------
Total liabilities 453,954 522,465
Shareholders' equity:
Common stock (no par value, $1 stated value,
50,000,000 shares authorized, 16,480,346 and
16,293,995 shares issued and outstanding at
September 30, 1997 and December 31, 1996,
respectively) 16,480 16,294
Paid-in capital 184,673 184,019
Retained earnings 116,502 107,073
Unrealized gains on investments 6,636 6,269
------------ ------------
Total shareholders' equity 324,291 313,655
------------ ------------
Total liabilities and shareholders'
equity $ 778,245 $ 836,120
------------ ------------
------------ ------------
See Notes to Interim Consolidated Financial Statements
3
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------- ---------------------------
1997 1996 1997 1996
------------ ------------ ------------ ------------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Revenues:
Health services revenues:
Premium revenue $ 363,515 $ 261,160 $ 1,131,557 $ 786,929
Other revenue 12,363 7,124 40,005 21,232
Investment results 12,702 9,372 33,910 31,611
------------ ------------ ------------ ------------
Total revenues 388,580 277,656 1,205,472 839,772
Expenses:
Medical and other benefits 292,663 212,743 906,781 650,449
Operating expenses 80,598 53,915 257,458 161,977
Profit sharing on joint ventures 858 2,919 1,960 11,312
Interest expense 2,349 870 6,975 2,609
Amortization of goodwill and other intangibles 2,089 158 6,994 474
------------ ------------ ------------ ------------
Total expenses 378,557 270,605 1,180,168 826,821
------------ ------------ ------------ ------------
Income before income tax expense 10,023 7,051 25,304 12,951
Income tax expense 3,612 2,760 9,960 5,173
------------ ------------ ------------ ------------
Net income $ 6,411 $ 4,291 $ 15,344 $ 7,778
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Earnings per common share $ 0.39 $ 0.34 $ 0.94 $ 0.62
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See Notes to Interim Consolidated Financial Statements
4
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-----------------------
1997 1996
-------- --------
(In thousands)
<S> <C> <C>
Operating activities:
Net income $ 15,344 $ 7,778
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 15,935 1,677
Realized investment gains (11,239) (9,033)
Deferred income tax expense (benefit) (1,958) 2,145
Changes in other operating accounts:
Medical and other benefits payable (48,770) (16,547)
Advance premiums (3,547) 7,746
Due to/from affiliates 653 26,110
Other receivables 8,713 (3,888)
Funds held on behalf of affiliated reinsurers - (22,653)
Other - net (3,317) (5,220)
-------- --------
Net cash used in operating activities (28,186) (11,885)
Investing activities:
Purchases of available for sale investments (359,541) (453,516)
Proceeds from sale of available for sale investments 367,441 471,040
Proceeds from maturity of available for sale investments 13,445 51,125
Purchases of held to maturity investments (1,505) (3,989)
Proceeds from maturity of held to maturity investments 2,430 3,296
Proceeds from sale of property and equipment 1,809 -
Additions to property and equipment (2,606) (758)
Change in investment in unconsolidated affiliates (2,584) (116)
Change in other investments - (336)
-------- --------
Net cash provided by investing activities 18,889 66,746
Financing activities:
Cash dividends paid (5,915) (4,535)
Common stock issued for options exercised 1,010 -
Common stock withheld for taxes on options exercised (1,162) -
Tax benefit of options exercised 1,617 -
Common stock issued for dividend reinvestment 746 -
Repayment of debt (900) (10)
Net borrowings under line of credit agreement (1,200) 667
Repayment of note with affiliate - (65,000)
-------- --------
Net cash used in financing activities (5,804) (68,878)
-------- --------
Cash and cash equivalents:
Decrease during period (15,101) (14,017)
Balance at beginning of year 51,146 38,290
-------- --------
Balance at end of period $ 36,045 $ 24,273
-------- --------
-------- --------
</TABLE>
See Notes to Interim Consolidated Financial Statements
5
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UNITED WISCONSIN SERVICES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The accompanying consolidated financial
statements for United Wisconsin Services, Inc. (the Company) have been
prepared in accordance with generally accepted accounting principles. The
financial information included herein has been prepared by management
without audit by independent certified public accountants.
The unaudited financial statements include all adjustments and
accruals consisting only of normal recurring accrual adjustments which are,
in the opinion of management, necessary for a fair presentation of the
consolidated financial position and results of operations for the interim
periods. The results of operations for any interim period are not
necessarily indicative of results for the full year. The unaudited interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto for the year ended
December 31, 1996, incorporated by reference or included in the Company's
Form 10-K, as filed with the Securities and Exchange Commission.
EARNINGS PER COMMON SHARE - Earnings per common share are computed by
dividing net income by the weighted average number of common shares
outstanding. Weighted average common shares outstanding were 16,448,225
and 12,599,715 for the three months ended September 30, 1997 and 1996,
respectively, and 16,403,129 and 12,599,715 for the nine months ended
September 30, 1997 and 1996,respectively.
RECLASSIFICATIONS - Certain reclassifications have been made to the
consolidated financial statements for 1996 to conform with the 1997
presentation.
6
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
OVERVIEW
United Wisconsin Services, Inc. (the Company) is a leading provider of
managed health care services and employee benefit products. The Company's three
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
and Valley; (ii) small group managed care and life products sold through
American Medical Security Holdings, Inc. (AMS), which holds United Wisconsin
Life Insurance Company (UWLIC) and the companies held by the Company's former
joint venture partner, American Medical Security Group, Inc., and (iii)
specialty managed care products and services, including dental, life, disability
and workers' compensation products, managed care consulting, electronic claim
submission, pharmaceutical management and managed behavioral health services.
Operating results and statistics for these three product groups are presented
below for the periods noted.
SUMMARY OF OPERATING RESULTS AND STATISTICS
September 30,
----------------------
1997 1996
------- -------
Membership at end of period:
HMO products 293,817 258,696
AMS medical products 590,214 873,832
------- -------
Total medical products 884,031 1,132,528
AMS life products 266,514 422,119
Specialty managed care
products and services 1,300,416 1,175,683
Three months Nine months
ended September 30, ended September 30,
------------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
Health services revenues (As a
percentage of the total):
HMO products 32.2% 39.2% 30.4% 38.9%
AMS products 60.7 50.4 62.8 50.8
Specialty managed care
products and services 8.2 11.7 7.8 11.3
Intercompany eliminations (1.1) (1.3) (1.0) (1.0)
------ ------ ------ ------
Total 100.0% 100.0% 100.0% 100.0%
------ ------ ------ ------
------ ------ ------ ------
7
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Three months Nine months
ended September 30, ended September 30,
------------------- -------------------
1997 1996 1997 1996
---- ---- ---- ----
Operating statistics:
HMO products:
Medical loss ratio(1) 91.3% 88.7% 90.1% 89.8%
Operating expense ratio(2) 8.8 9.0 9.2 9.1
AMS products:
Medical:
Medical loss ratio(1) 77.5 79.9 78.2 80.9
Operating expense ratio(2) 22.1 23.3 22.4 23.7
Life and other products:
Loss ratio(1) 41.1 29.4 44.0 35.2
Specialty managed care
products and services:
Loss ratio(1) 71.3 73.7 71.6 73.9
Consolidated:
Loss ratio(1) 80.5 81.5 80.1 82.7
Net income margin(3) 1.6 1.5 1.3 0.9
(1) Medical and other benefits as a percentage of premium revenue.
(2) Operating expenses as a percentage of premium revenue.
(3) Net income as a percentage of total revenues.
Reclassifications have been made to the product line amounts shown above
for 1996 to conform with the 1997 presentation. The life products sold by
AMS are now included in the AMS products category; previously, they were
included with specialty products and services. This reclassification was
made in conjunction with the AMS Merger, as discussed further below.
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.
RESULTS OF OPERATIONS
TOTAL REVENUES
Total revenues for the three months ended September 30, 1997 increased
40.0% to $388.6 million from $277.7 million for the three months ended
September 30, 1996. On a year-to-date basis, total revenues increased 43.5%
to $1.2 billion from $839.8 million for the nine months ended September 30,
1996. These increases were due primarily to increased health services
revenues (premium and other revenue) as a result of the AMS Merger, as
discussed further below.
8
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HEALTH SERVICES REVENUES -- HMO health services revenues for the three
months ended September 30, 1997 increased 15.1% to $121.0 million from $105.2
million for the three months ended September 30, 1996. Average HMO medical
premium per member for the three months ended September 30, 1997 increased
1.4% from the same period in the prior year. The average number of HMO
medical members for the three months ended September 30, 1997 increased 13.2%
to 292,000 from 258,000 for the three months ended September 30, 1996.
HMO health services revenues for the nine months ended September 30, 1997
increased 13.1% to $355.8 million from $314.5 million for the same period in
the prior year. Average HMO medical premium per member for the nine months
ended September 30, 1997 increased 2.7% from the same period in the prior
year. The average number of HMO medical members for the nine months ended
September 30, 1997 increased 10.0% to 285,000 from 259,000 for the same
period in the prior year.
Health services revenues for AMS products for the three months ended
September 30, 1997 increased 68.7% to $228.1 million from $135.2 million for
the three months ended September 30, 1996. The increase in AMS health
services revenues was due primarily to the acquisition of the 88% of AMS that
the Company did not already own through the merger of the Company and AMS
effective December 3, 1996 (the AMS Merger). Prior to the AMS Merger, the
Company retained 50% of the premium revenue and 50% of the profit (loss) on
small group managed care and life business sold by AMS. Following the AMS
Merger, the Company retained 100% of the health services revenues and 100% of
the profit (loss) on small group managed care and life business sold by AMS.
The additional health services revenues due to the AMS Merger accounted for
$117.1 million of the increase in health services revenues for the three
months ended September 30, 1997. Excluding the effects of the AMS Merger, AMS
health services revenues for the three months ended September 30, 1997
decreased 17.9% to $111.0 million from $135.2 million for the three months
ended September 30, 1996. While average medical premium per member increased
18.7% for the three months ended September 30, 1997, compared with the same
period in the prior year, the average number of small group medical members
outstanding decreased 30.4% for the three months ended September 30, 1997 to
628,000 from 903,000 for the three months ended September 30, 1996. Much of
this membership decline was the result of AMS's efforts to return this block
of business to profitability. These steps included exiting unprofitable
markets in Texas and Kentucky and implementing substantial rate increases for
certain product lines which resulted in membership losses but improved
profitability on renewed business. Major initiatives are underway at AMS in
an effort to reverse this membership decline, including new agency sales
relationships, expansion into new geographic areas, and acquisitions of
blocks of business. On September 30, 1997, the Company announced that it had
acquired substantially all of the small group health insurance business of
Pan-American Life Insurance Company, which represents $125 million in
annualized premium revenue. The Company expects to retain approximately $80
million of this business on an annualized premium basis after exiting certain
unprofitable markets.
9
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Health services revenues for AMS products for the nine months ended
September 30, 1997 increased 79.2% to $736.3 million from $410.9 million for
the nine months ended September 30, 1996. The increase in AMS health
services revenues was due primarily to the acquisition of the 88% of AMS that
the Company did not already own, as previously discussed. The additional
health services revenues due to the AMS Merger accounted for $381.1 million
of the increase in health services revenues for the nine months ended
September 30, 1997. Excluding the effects of the AMS Merger, AMS health
services revenues for the nine months ended September 30, 1997 decreased
13.5% to $355.3 million from $410.9 million for the nine months ended
September 30, 1996. While average medical premium per member increased 15.2%
for the nine months ended September 30, 1997, compared with the same period
in the prior year, the average number of small group medical members
outstanding decreased 24.5% for the nine months ended September 30, 1997 to
705,000 from 934,000 for the nine months ended September 30, 1996. As
previously discussed, this membership decline was the result of AMS's
turnaround strategy, and initiatives are underway at AMS in an effort to
reverse this membership decline.
Health services revenues for specialty managed care products and services
for the three months ended September 30, 1997 decreased 1.3% to $30.9 million
from $31.3 million for the three months ended September 30, 1996. This
decrease was due primarily to a decrease of $2.8 million in premiums assumed
under certain federal and state reinsurance programs. While participation in
these programs added premium revenue to the financial statements of the
Company, their contribution to net income was nominal. Excluding the impact
of the withdrawal from these government-sponsored reinsurance programs,
health services revenues for specialty managed care products and services for
the three months ended September 30, 1997 increased 8.3% to $30.9 million
from $28.5 million for the same period in the prior year. This increase was
due primarily to an increase of $0.9 million in workers' compensation
premiums, an increase of $0.7 million in dental premiums, an increase of $0.5
million in disability premiums, and an increase of $0.4 million in managed
behavioral health revenues. The increases in dental, disability and managed
behavioral health premiums were driven by membership increases, while the
increase in workers' compensation premium was due primarily to a change in
the reinsurance agreement related to this business. In 1996, the Company
ceded 50% of the workers' compensation premiums written by United Heartland,
Inc. to a third-party reinsurer. In 1997, the percentage ceded to the
outside reinsurer was reduced to 40%.
Health services revenues for specialty managed care products and services
for the nine months ended September 30, 1997 increased 0.1% to $91.6 million
from $91.5 million for the nine months ended September 30, 1996, due primarily
to a decrease of $7.5 million in premiums assumed under the aforementioned
reinsurance programs. Excluding the impact of the withdrawal from these
programs, health services revenues for specialty managed care products and
services for the nine months ended September 30, 1997 increased 9.1% to $90.8
million from $83.2
10
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million for the same period in the prior year. This increase was due
primarily to an increase of $2.2 million in workers' compensation premiums,
an increase of $2.1 million in dental premiums, an increase of $2.1 million
in managed behavioral health revenues, and an increase of $1.4 million in
disability premiums. The increases in dental, disability and managed
behavioral health premiums were driven by membership increases, while the
increase in workers' compensation premium was due primarily to the
aforementioned change in the reinsurance agreement related to this business.
INVESTMENT RESULTS -- Investment results include investment income and
realized gains (losses) on investments. Investment results for the three
months ended September 30, 1997 increased 35.5% to $12.7 million from $9.4
million for the three months ended September 30, 1996. On a year-to-date
basis, investment results increased 7.3% to $33.9 million from $31.6 million
for the same period in the prior year. Average annual investment yields,
excluding net realized gains, were 6.2% for both the three months ended
September 30, 1997 and 1996. On a year-to-date basis, average annual
investment yields, excluding net realized gains, were 6.1% and 5.9% for the
nine months ended September 30, 1997 and 1996, respectively. Investment
gains are realized in the normal investment process in response to market
opportunities. Average invested assets for the three months ended September
30, 1997 decreased 2.3% to $496.2 million from $507.7 million for the three
months ended September 30, 1996. On a year-to-date basis, average invested
assets decreased 4.6% to $498.0 million from $522.3 million for the nine
months ended September 30, 1996. The decrease in average invested assets is
due primarily to the decrease in medical and other benefits payable resulting
from the membership decline for AMS products over the past year.
EXPENSE RATIOS
LOSS RATIO -- The consolidated loss ratio represents the ratio of medical
and other benefits to premium revenue for the Company on a consolidated
basis, and is therefore a blended ratio for medical, life, dental, disability
and other product lines. The consolidated loss ratio improved to 80.5% for
the third quarter of 1997, compared with 81.5% for the third quarter of 1996.
On a year-to-date basis, the consolidated loss ratio improved to 80.1% for
the first nine months of 1997, compared with 82.7% for the first nine months
of 1996. The consolidated loss ratio is influenced by the component loss
ratios for each of the Company's primary product lines, as discussed below.
The medical loss ratio for HMO products for the three months ended September
30, 1997 was 91.3%, compared with 88.7% for the same period in the prior year.
On a year-to-date basis, the medical loss ratio for HMO products was 90.1%,
compared with 89.8% for the same period in the prior year. The increase in the
medical loss ratio for HMO products is due primarily to higher loss experience
in the southeastern Wisconsin HMO market, due in
11
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part to certain high-cost claims, an increase in the drug cost component and
an increase in outpatient utilization.
The medical loss ratio for AMS products for the three months ended
September 30, 1997 was 77.5%, compared with 79.9% for the same period in
1996. On a year-to-date basis, the medical loss ratio for AMS products was
78.2%, compared with 80.9% for the same period in 1996. The lower loss
ratios in 1997 reflect improvements in medical cost trends and pricing
changes achieved by AMS since the first quarter of 1996. AMS continues to
re-price its products and eliminate unprofitable business.
The loss ratio for AMS life and other products for the three months ended
September 30, 1997 was 41.1%, compared with 29.4% for the same period in
1996. On a year-to-date basis, the loss ratio for AMS life and other products
was 44.0%, compared with 35.2% for the same period in 1996. This product
category also includes accidental death and dismemberment (AD&D) coverage.
The increased loss ratio in 1997 is due to higher AD&D loss experience on
AMS's Texas occupational accident business. AMS began exiting that product
line in January 1997.
The loss ratio for specialty managed care products and services for the
three months ended September 30, 1997 was 71.3%, compared with 73.7% for the
same period in 1996. On a year-to-date basis, the loss ratio for specialty
managed care products and services decreased to 71.6%, compared with 73.9%
for the same period in 1996. The lower loss ratios in 1997 are due primarily
to the Company's withdrawal from the government-sponsored reinsurance
programs discussed previously, which were recorded at a near-100% loss ratio.
OPERATING EXPENSE RATIO - The operating expense ratio includes
commissions, administrative expenses, and premium taxes and other
assessments. The operating expense ratio for HMO products decreased to 8.8%
for the third quarter of 1997, compared with 9.0% for the third quarter of
1996. On a year-to-date basis, the operating expense ratio for HMO products
increased slightly to 9.2% from 9.1% for the nine months ended September 30,
1996.
The operating expense ratio for AMS medical products decreased to 22.1% for
the three months ended September 30, 1997 from 23.3% for the three months ended
September 30, 1996, due primarily to a decrease in commissions as a percentage
of premium revenue. On a year-to-date basis, the operating expense ratio for
AMS medical products decreased to 22.4% for the nine months ended September 30,
1997 from 23.7% for the nine months ended September 30, 1996. The operating
expense ratio for AMS life products declined to 29.3% for the third quarter of
1997, compared with 31.1% for the same period in the prior year. On a year-to-
date basis, the operating expense ratio for AMS life products also declined to
29.7% for the nine months ended September 30, 1997, compared with 31.7% for the
same period in the prior year. AMS products are sold exclusively through
12
<PAGE>
independent agents who are compensated through commissions. Over time,
renewal business has gradually represented a larger proportion of the total
AMS medical and life business. Since renewal commissions are typically lower
than commissions on new sales, this has contributed to the decrease in the
ratios. AMS also continues to focus on efforts to improve operating
efficiency through process re-engineering and to reduce staff commensurate
with the decline in gross premium revenue.
Operating expenses related to specialty managed care products and
services increased 5.8% for the three months ended September 30, 1997 to
$14.7 million from $13.9 million for the same period in the prior year. On a
year-to-date basis, operating expenses related to specialty managed care
products and services increased 14.3% for the nine months ended September 30,
1997 to $43.3 million from $37.9 million for the same period in the prior
year. Increases in operating expenses are tied to health services revenues
which increased 8.3% for the three months ended September 30, 1997 over the
same period in 1996 and 9.1% for the nine months ended September 30, 1997
over the same period in 1996, excluding the impact of the decrease in assumed
premiums related to certain federal and state reinsurance programs. Of the
remaining increase in operating expenses that is not due to growth in health
services revenues, the majority is due to higher expenses for services
rendered by behavioral health providers related to the Company's managed
behavioral health business.
OTHER EXPENSES
Profit sharing on joint ventures was $0.9 million for the three months
ended September 30, 1997, compared with $2.9 million for the three months
ended September 30, 1996. Of these balances, $0.9 million and $0.7 million
for the three months ended September 30, 1997 and 1996, respectively,
represented profit sharing expenses related primarily to the Unity and Valley
joint ventures. The remaining $2.2 million for the three months ended
September 30, 1996 was due to investment income and realized investment gains
on funds held by the Company on behalf of an insurance subsidiary of AMS.
Following the AMS Merger, the reinsurance agreement, which gave rise to this
funds held balance, was terminated effective December 31, 1996. On a
year-to-date basis, profit sharing on joint ventures was $2.0 million for the
nine months ended September 30, 1997 and $11.3 million for the nine months
ended September 30, 1996. Of these balances, $2.0 million and $2.2 million
for the nine months ended September 30, 1997 and 1996, respectively,
represented profit sharing expenses related primarily to the Unity and Valley
joint ventures. The remaining $9.1 million for the nine months ended
September 30, 1996 was due to investment income and realized investment gains
on funds held by the Company on behalf of an insurance subsidiary of AMS, as
previously discussed.
13
<PAGE>
Interest expense increased to $2.3 million for the three months ended
September 30, 1997, compared with $0.9 million for the same period in the
prior year. Interest expense increased to $7.0 million for the nine months
ended September 30, 1997, compared with $2.6 million for the same period in
the prior year. The increase is due primarily to interest expense on the
$70.0 million of borrowings from Blue Cross & Blue Shield United of Wisconsin
(BCBSUW) to fund the cash portion of the consideration for the AMS Merger.
In conjunction with the AMS Merger, the Company also recorded $150.0 million
of goodwill and other intangibles and $22.2 million of related deferred
taxes. Amortization of goodwill and other intangibles for the third quarter
of 1997 totaled $2.1 million, including $2.0 million related to the AMS
Merger, compared with $0.2 million of amortization expense for the three
months ended September 30, 1996. On a year-to-date basis, amortization of
goodwill and other intangibles totaled $7.0 million, including $6.6 million
related to the AMS Merger, compared with $0.5 million of amortization expense
for the nine months ended September 30, 1996.
NET INCOME
Consolidated net income for the three months ended September 30, 1997
increased to $6.4 million or $0.39 per share from $4.3 million or $0.34 per
share for the three months ended September 30, 1996. Consolidated net income
for the nine months ended September 30, 1997 increased to $15.3 million or
$0.94 per share from $7.8 million or $0.62 per share for the nine months
ended September 30, 1996. The results for 1997 reflect 100% of the profit on
the small group managed care and life business sold by AMS, compared with 50%
in 1996. The 1997 earnings per share calculation also reflects the new
shares issued in conjunction with the AMS Merger of approximately 3.7 million
shares.
The Company's effective tax rate was 36.0% for the three months ended
September 30, 1997, compared with 39.1% for the three months ended September
30, 1996. Excluding the impact of non-deductible goodwill related to the AMS
Merger and other acquisitions, the Company's effective tax rate for the three
months ended September 30, 1997 and 1996 was 34.0% and 38.5%, respectively.
On a year-to-date basis, the Company's effective tax rate was 39.4% for the
nine months ended September 30, 1997, compared with 39.9% for the nine months
ended September 30, 1996. Excluding the impact of non-deductible goodwill
related to the AMS merger and other acquisitions, the Company's effective tax
rate for the nine months ended September 30, 1997 and 1996 was 36.5% and
38.9%, respectively. Deferred tax benefits have been recognized for
identified intangibles related to the AMS Merger. The decrease in the
effective tax rates in 1997 is due primarily to a higher proportion of the
Company's income being generated by AMS's insurance subsidiaries, which
record lower effective tax rates than the Company's other subsidiaries due to
reduced state income tax liabilities.
14
<PAGE>
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.
Historically, the Company has generated positive cash flow from
operations. For the nine months ended September 30, 1997 and 1996, however,
net cash used in operating activities amounted to a use of $28.2 million and
$11.9 million, respectively. The decrease in cash flow is due primarily to
the decrease in medical and other benefits payable resulting from the
membership decline for AMS products over the past year. Due to periodic cash
flow requirements of certain subsidiaries, the Company made borrowings under
its bank line of credit ranging up to $8.5 million during the first nine
months of 1997 to meet short-term cash needs. No balance was outstanding at
September 30, 1997.
The Company's investment portfolio consists primarily of investment grade
bonds and has a limited exposure to equity securities. At December 31, 1996,
$407.4 million or 87.2% of the Company's total investment portfolio was
invested in bonds. At September 30, 1997, $402.2 million or 87.7% of the
Company's total investment portfolio was invested in bonds. The bond
portfolio had an average quality rating of Aa3 at December 31, 1996 and a
rating of A1 at September 30, 1997 by Moody's Investor Service, and the
majority of the bond portfolio was classified as available for sale. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 115,
bonds classified as available for sale are recorded on the Company's balance
sheet at market value. The market value of the total investment portfolio,
which includes stocks and bonds, exceeded amortized cost by $10.1 million and
$10.5 million at December 31, 1996 and September 30, 1997, respectively.
Unrealized holding gains and losses on bonds classified as available for sale
are included as a component of shareholders' equity, net of applicable
deferred taxes. 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.
Prior to the AMS Merger the Company owned 12% of the common stock of AMS,
which was recorded at cost of $1.4 million. Effective December 3, 1996, the
Company acquired the remaining 88% interest in AMS that it did not already own.
The acquisition was accomplished through the merger of AMS with and into the
Company pursuant to the terms of an Agreement and Plan of Merger dated July 31,
1996, by and between AMS, BCBSUW, the Company and the two principal AMS
shareholders (individually and as trustees under a voting trust for the other
AMS shareholders). The
15
<PAGE>
Company was the surviving corporation in the merger. The aggregate
consideration for the merger was cash of $71.8 million, including expenses,
and $98.7 million representing the market value of 3,694,280 newly issued
shares of Company common stock and options to purchase Company common stock.
Most of the cash came from $70.0 million borrowed from BCBSUW, which, after
the merger, owns approximately 38% of the Company's common stock.
Effective October 1, 1997, the Company acquired substantially all of the
small group health insurance business of Pan-American Life Insurance Company.
The Company expects to record one-time charges against earnings in the fourth
quarter of approximately $4 million in conjunction with this transaction. The
Pan-American business operations will be consolidated with AMS operations in
Green Bay, Wisconsin, which is expected to reduce operating expenses related
to the new business.
As of September 30, 1997, AMS had minority ownership interests in three
HMOs and a majority ownership in one HMO. In October 1997, AMS sold its
interest in one of the minority-owned HMOs. The Company is reviewing its
strategy with respect to the remaining HMOs.
In December 1995, United Wisconsin Insurance Company (UWIC) borrowed
$65.0 million from BCBSUW under a Surplus Note Agreement, which was
guaranteed by the Company. The Surplus Note provided UWIC with regulatory
capital needed to replace capital paid to the Company in the form of a
dividend in December 1995. The dividend and Surplus Note were part of a
capital restructuring plan designed to transfer capital from UWIC to UWLIC to
support UWLIC's retention of the AMS medical business beginning in 1996. The
Company repaid $25.0 million in each of the first and second quarters of 1996
and the remainder was repaid in the third quarter of 1996.
The Company's anticipated expansion of its business requires capital
levels sufficient to support premium growth. The Company's compound annual
growth rate in premium revenue for the five years ended December 31, 1996 was
28.8%, due principally to the growth of AMS products. While the future rate
of growth is uncertain, growth in premium revenue is expected to continue.
From time to time, the Company makes capital contributions to its
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 September 30, 1997,
statutory capital and surplus for each of these insurance subsidiaries
exceeded required levels.
16
<PAGE>
In compliance with applicable state insurance regulations, certain
insurance subsidiaries have deposited securities with various states
aggregating $6.2 million at September 30, 1997. In addition, HMOs are
required to maintain a deposit with the State of Wisconsin for future
assessments for HMO insolvencies. As of September 30, 1997, the aggregate
deposit for the Company's consolidated HMOs was $4.9 million. States in
which the insurance subsidiaries are licensed to do business independently
establish deposit requirements. Increases in deposit levels, resulting in
the segregation of certain investments, may adversely affect the Company's
liquidity.
The National Association of Insurance Commissioners (NAIC) has adopted
risk-based capital guidelines for both life and health insurers and for
property and casualty insurers. These guidelines currently apply only to
certain of the Company's subsidiaries. Those subsidiaries exceed the company
action level for NAIC risk-based capital guidelines. The NAIC is also
developing risk-based capital guidelines for health organizations, which
would apply to the Company's HMO subsidiaries. In addition, the Office of
the Commissioner of Insurance of the State of Wisconsin (OCI) and other state
regulators have the authority to establish capital and surplus requirements
for individual companies and may propose stricter capital and surplus
requirements.
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 other bank borrowings, as market
conditions may permit or dictate.
FORWARD LOOKING STATEMENTS
This report contains certain forward looking statements with respect to
the financial condition, results of operations and business of the Company.
Such forward looking statements are subject to inherent risks and
uncertainties that may cause actual results to differ materially from those
contemplated by such 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, business
conditions and competition in the managed care industry, developments in
health care reform and other regulatory issues.
17
<PAGE>
PART II. OTHER INFORMATION
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
(a) Exhibits
10.1 Supplemental Compensation Agreement (A portion of this
exhibit has been omitted pursuant to a request for
confidential treatment filed with the Securities and
Exchange Commission. The omitted portion has been filed
separately with the Commission).
11 Statement regarding computation of per share earnings.
(See Note 1 of Notes to Interim Consolidated Financial
Statements).
(b) Reports on Form 8-K
None
18
<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: 11/11/97
------------------------------
UNITED WISCONSIN SERVICES, INC.
/s/ C. Edward Mordy
---------------------------------------------
C. Edward Mordy
Vice President and Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
19
<PAGE>
UNITED WISCONSIN SERVICES, INC.
INDEX TO EXHIBITS
Sequential
Exhibit Page
Number Document Description Number
- ------- -------------------- ------
10.1 Supplemental Compensation Agreement (A portion 21
of this exhibit has been omitted pursuant to a
request for confidential treatment filed with
the Securities and Exchange Commission. The
omitted portion has been filed separately with
the Commission).
11 Statement regarding computation of per share
earnings. (See Note 1 of Notes to Interim
Consolidated Financial Statements).
20
<PAGE>
EXHIBIT 10.1
<PAGE>
TEXT OF THIS EXHIBIT HAS BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIAL
TREATMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. SUCH OMITTED
TEXT HAS BEEN FILED SEPARATELY WITH THE COMMISSION.
071497
SUPPLEMENTAL COMPENSATION AGREEMENT
This Supplemental Compensation Agreement (the "Agreement") between United
Wisconsin Services, Inc., a Wisconsin corporation (the "Company"), and Thomas
R. Hefty ("Employee") is made this 22nd day of September, 1997.
P R E M I S E S:
WHEREAS, Employee, during his employment with Company, has consistently
demonstrated outstanding skills as a chief executive officer.
WHEREAS, the Company has consulted with Hewitt Associates regarding,
among other things, Employee's compensation and the comparison of Employee's
compensation against a peer group with which the Company competes for
executive talent.
WHEREAS, the Company believes it is in its best interest to continue to
retain the services of Employee.
WHEREAS, the Company believes it is in the Company's best interests to
provide an incentive arrangement for Employee whereby Employee is recognized
and compensated for any increase in shareholder value created as a result of
the Company's ownership of American Medical Security Holdings, Inc. ("AMS").
WHEREAS, the Company desires to provide such compensation by providing
Employee with phantom shares ("Phantom Shares"), the value of which is based
on the value of Company common stock, no par value ("UWS Shares").
AGREEMENT
Now, therefore, the Company and Employee agree, for the consideration
identified herein and in consideration of Employee's continued employment
with the Company, as follows:
1. PHANTOM SHARE AWARD.
(a) AWARD OF PHANTOM SHARES. Upon a Triggering Event (as defined
in Section 1(b) hereof) Employee shall be awarded
<PAGE>
Phantom Shares, subject to the terms and conditions herein in the following
amounts:
Transaction Value Phantom Shares Awarded
- ----------------- ----------------------
Less than $*********** 0
$***********-$*********** 35,000 - .01($*********** - TRANSACTION VALUE)
------------------------------------
$28
More than $*********** 35,000 + .02(TRANSACTION VALUE - $***********)(1)
---------------------------------------
$28
(b) TRIGGERING EVENTS. Phantom Shares shall be awarded pursuant to
Section 1(a) hereof on the occurrence of one or more of the following events
("Triggering Events") prior to the termination of the Agreement pursuant to
Section 7 hereof:
(i) the sale of some or all of any capital stock of AMS;
(ii) the sale of some or all of the assets of AMS;
(iii) an initial public offering ("IPO") of the stock of AMS;
(iv) the merger of AMS and an unrelated party in which UWS
receives cash or stock in a publicly traded corporation;
(v) a spinoff of some or all of the outstanding stock of AMS;
(vi) a dividend of AMS stock to shareholders of the Company;
(vii) Employee's attainment of age 55; or
(viii) any other transaction which the Board determines to be
similar to the transactions identified in (i) through (vii)
above.
(c) TRANSACTION VALUE. The value to the Company resulting from a
Triggering Event (the "Transaction Value") shall be:
(i) in the event that cash or other property is received by
the Company, the fair market value
- -----------------------------
(1) "*" Indicates text which has been omitted pursuant to a confidential
treatment request.
-2-
<PAGE>
thereof as determined by the Board of Directors
in good faith;
(ii) in the event of an IPO, spinoff or other public
distribution of AMS stock to Company shareholders, the value
of AMS stock determined by multiplying the average closing
price of AMS stock for the 30 days following such spinoff
or distribution times the total number of shares of AMS
stock outstanding;
(iii) in the event of Employee's attainment of age 55 prior to
any other Triggering Event, the value of AMS, as determined
by the Board of Directors in good faith.
The Transaction Value shall be reduced by the fair market value (as
determined by the Board of Directors in good faith) of any AMS liabilities
transferred to or assumed by the Company in connection with the Triggering
Event. The Transaction Value shall be determined before any income taxes
payable by the Company or its shareholders.
2. RIGHTS WITH RESPECT TO PHANTOM SHARES. Each Phantom Share awarded
shall entitle Employee to a cash payment equal to the value of one UWS Share
plus any dividends which are declared with respect to a UWS Share from the
date of the Triggering Event until the date Employee receives payment of the
Phantom Share award. Such dividends shall also accrue interest from and
after their payment date at 60% of the prime rate as reported in THE WALL
STREET JOURNAL and shall be held in the United Wisconsin Services, Inc.
Deferred Compensation Trust. All such dividends and interest shall be
subject to the vesting schedule of Section 3 hereof and shall be distributed
in accordance with Section 5 hereof. Employee shall not be entitled to any
voting rights with respect to the Phantom Shares.
3. VESTING. If Employee's employment terminates prior to the date he
attains age 55, the number of Phantom Shares to which Employee is entitled
(and the dividends and interest payable with respect to such Shares) shall be
reduced by 7% for each full or partial year between Employee's termination
date and the date he would have attained age 55.
4. TERMINATION PRIOR TO TRIGGERING EVENT. If Employee is terminated
because of death, Disability or following a Change in Control of the Company,
Employee (or his beneficiary) shall be entitled, if a Triggering Event occurs
in the two year period from the date of such termination, to receive the
Phantom Shares, if any, which he would have received if he had remained an
employee of the Company during such two year period. For purposes of this
Agreement, Disability means the complete inability, due to injury
-3-
<PAGE>
or illness, of Employee to perform with reasonable continuity any of his
material and substantial duties as President and Chief Executive Officer.
A "Change in Control" shall be deemed to occur on the earlier of (A) the
acquisition by any entity, person or group, as that term is defined in Rule
13d-3 under the Securities Exchange Act of 1934, other than Blue Cross & Blue
Shield United of Wisconsin ("BCBSU") of more than 30% of the outstanding
capital stock of the Company; (B) the commencement by any entity, person or
group (other than the Company or BCBSU) of a tender offer or an exchange
offer for more than 20% of the outstanding stock of the Company; (C) the
effective time of (i) a merger or consolidation of the Company with one or
more other corporations as a result of which the holders of the outstanding
stock of the Company immediately prior to such merger or consolidation hold
less than 50% of the voting stock of the surviving or resulting corporation
or (ii) a transfer of substantially all of the property of the Company other
than to an entity of which the Company owns at least 80% of the voting stock;
or (D) the election to the Board of Directors of the Company, without the
recommendation or approval of the incumbent Board of Directors of the
Company, of directors constituting a majority of the number of directors of
the Company then in office.
5. DISTRIBUTION OF PHANTOM SHARES, DIVIDENDS AND INTEREST. The value
of any Phantom Shares awarded to Employee pursuant to this Agreement, any
dividends payable with respect to such Phantom Shares and any interest
payable with respect to such dividends shall be paid to Employee (or his
beneficiary in the event of his death) as soon as practicable after the date
Employee ceases to be a Covered Employee under Section 162(m) of the Internal
Revenue Code (or, if later, as soon as practicable after the date of the
Triggering Event if the Triggering Event occurs after Employee's termination
of employment and Employee or his beneficiary remains entitled to payments
pursuant to Section 4 hereof). The value of Phantom Shares, dividends and
interest shall be paid in cash.
6. FORFEITURE FOR CAUSE. If Employee is terminated for Cause, all
Phantom Shares granted to him pursuant to this Plan, dividends and interest
(whether or not such Phantom Shares, dividends and interest are vested) shall
be forfeited. Cause shall mean (A) a criminal violation involving personal
dishonesty or fraud; (B) breach of fiduciary duty involving personal profit;
or (C) willful misconduct in the performance of his duties which materially
injures the Company.
7. TERMINATION AND AMENDMENT. This Agreement may be terminated by
the Board in its sole discretion, after December 31, 1999 on one year's
written notice to Employee, provided however, this Agreement may not be
terminated either: (A) following a Triggering Event; or (B) less than two
years after Employee's termination following a Change in Control (as defined
in Section 4
-4-
<PAGE>
hereof) or his death or Disability. This Agreement may also be terminated or
amended in writing on the mutual consent of Employee and the Company.
8. MISCELLANEOUS.
(a) NO EMPLOYMENT CONTRACT. Nothing contained herein should be
interpreted as an employment contract or to confer upon Employee the right to
be retained in the service of the Company or to limit the right of the
Company to terminate Employee.
(b) ADJUSTMENT FOR CAPITAL CHANGES. In the event of any change
in the outstanding UWS Shares by reason of any stock dividend or split,
recapitalization, merger, consolidation, spin-off, reorganization,
combination or exchange of UWS Shares or any similar corporate change, or
other increase or decrease in such UWS Shares effected without the payment or
receipt of consideration by the Company, the Phantom Shares granted pursuant
to Section 1(a) hereof shall be adjusted by the Company to prevent dilution
or enlargement of the rights granted to Employee.
(c) NONTRANSFER AND NONASSIGNMENT. Except as set forth in
Section 8(d) herein, Employee may not transfer, assign or encumber his rights
under this Agreement.
(d) BENEFICIARY DESIGNATION. Employee may designate any person to
be the beneficiary of his rights under this Agreement in the event of his
death. Such person or persons shall be designated in writing. In the absence
of such a designation Employee's beneficiary shall be his surviving spouse,
if any, or if none, his estate.
(e) WITHHOLDING. The Company may withhold from any payment or
distribution made under this Plan a sufficient amount of cash to cover any
applicable withholding or employment taxes.
Dated at Milwaukee, Wisconsin this 22nd day of September, 1997.
ON BEHALF OF UNITED WISCONSIN
SERVICES, INC.
By: /s/ James L. Forbes
-------------------------------
/s/ Thomas R. Hefty
-----------------------------------
Thomas R. Hefty
-5-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 1997 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 390,289
<DEBT-CARRYING-VALUE> 11,884
<DEBT-MARKET-VALUE> 12,038
<EQUITIES> 56,247
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 458,420
<CASH> 36,045
<RECOVER-REINSURE> 0
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<TOTAL-ASSETS> 778,245
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 47,967
<POLICY-OTHER> 191,568
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<NOTES-PAYABLE> 54,888
0
0
<COMMON> 16,480
<OTHER-SE> 307,811
<TOTAL-LIABILITY-AND-EQUITY> 778,245
1,131,557
<INVESTMENT-INCOME> 33,910
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<INCOME-CONTINUING> 15,344
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<NET-INCOME> 15,344
<EPS-PRIMARY> .94
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