UNH

UnitedHealth Group Inc. - 10-Q Summary (Period Ended June 30, 2006)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2006. The filing is a restated report reflecting significant accounting adjustments related to the Company's historic stock option practices (1994–2005) and the adoption of FAS 123R (Share-Based Payment) effective January 1, 2006. The restatement impacts financial statements for fiscal years 1994 through 2005 and interim periods, including the quarter ended March 31, 2006. The Company is currently subject to regulatory inquiries by the SEC, IRS, and U.S. Attorney regarding these practices.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 57% year-over-year for both the three and six-month periods. Excluding acquisitions, organic revenue growth was approximately 21-22%, driven by the launch of the Medicare Part D program and rate increases.
• Profitability: Net earnings increased 28% for the quarter and 24% for the six-month period compared to the prior year. Diluted EPS rose 21% to $0.70 for the quarter.
• Acquisitions: Results include the full impact of the PacifiCare Health Systems acquisition (closed Dec 2005) and the John Deere Health Care acquisition (closed Feb 2006).
• Medical Care Ratio: The ratio increased to 81.6% (Q2) and 81.8% (YTD) from 80.3% and 80.2% in the prior year, primarily due to the higher medical care ratio of the new Medicare Part D program and PacifiCare.
• Restatement Impact: The restatement resulted in additional stock-based compensation expense. For 2005, the impact was $43 million ($57 million net of tax) under FAS 123R and $304 million ($238 million net of tax) under APB 25.

Guidance, Outlook, Risks, and Unusual Items

• Internal Controls: Management concluded that as of June 30, 2006, the Company had a material weakness in internal control over financial reporting solely relating to stock option plan administration. Disclosure controls and procedures were deemed ineffective for this reason. The weakness was fully remediated as of December 31, 2006.
• Legal and Regulatory Risks: The Company faces formal investigations by the SEC, IRS, and U.S. Attorney regarding historic stock option practices. There are pending shareholder derivative and class-action lawsuits. A notice of default was received regarding $850 million in Senior Unsecured Notes due to delayed filing of the 10-Q; the Company is contesting this in court.
• Credit Ratings: Moody's downgraded the Company's senior debt rating to A3 with a negative outlook in October 2006 due to corporate governance concerns. S&P and Fitch maintained negative outlooks.
• Future Charges: The Company expects to take a charge of approximately $55 million (net of tax) in the first quarter of 2007 related to Section 409A tax costs for certain stock options exercised in 2006.
• Medicare Part D: The Company recognized $3.1 billion in Part D revenues for the six months ended June 30, 2006. Due to the benefit design, the Company incurs disproportionate costs in the first half of the year, resulting in a recorded risk-share receivable of $344 million from CMS.

Investor Verification Checklist

• Verify the status of the declaratory judgment action regarding the $850 million Senior Unsecured Notes default notice.
• Monitor the outcome of the SEC, IRS, and U.S. Attorney investigations into historic stock option practices for potential fines or penalties.
• Review the final settlement of the Medicare Part D risk-share adjustment with CMS, expected six months after the contract year-end.
• Assess the impact of the $55 million Section 409A tax charge anticipated in Q1 2007.
• Confirm the Company's compliance with debt covenants, specifically the debt-to-total-capital ratio, following the credit rating downgrades.