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MINNETONKA, Minn.Embattled health insurer UnitedHealth Group Inc. is making headway in moving past its stock-option backdating problems, though it's not out of the woods, analysts say.
The company's completion last week of a $1.5 billion restatement was a big step toward recovery from the backdating scandal that has plagued the health insurer since last year, they say. But, the prospect of future legal battleswith federal regulators as well as company shareholdersstill leaves a big question mark.
Minnetonka, Minn.-based UnitedHealth's restatement consisted largely of noncash charges to earnings to fix errors in stock-based compensation expenses over a 12-year period ending Dec. 31, 2005. The cumulative pretax effect of those errors was a total of $1.53 billionin line with the company's December 2006 estimate of $1.5 billion to $1.7 billion.
The only cash payment the company will record is approximately $100 million for additional corporate income taxes due for historical periods, and a charge of $55 million in the first quarter of 2007 for a settlement with the Internal Revenue Service relating to employees who exercised certain options in 2006.
As part of the restatement, UnitedHealth posted higher 2006 earnings; net income grew 35% to $4.16 billion from $3.08 billion in 2005, which the company said in a statement was partly due to a boost in revenues stemming from its 2005 acquisition of PacifiCare Health Systems Inc.
"Becoming current in our financial filings is a significant step forward for UnitedHealth Group, and it comes as the board and the company have advanced substantial improvements in our governance processes and administrative business practices," said Stephen J. Hemsley, UnitedHealth's president and chief executive officer, in a statement. Mr. Hemsley succeeded longtime company head Dr. William McGuire following his departure in the wake of an independent review that found evidence of backdating of stock option grants at UnitedHealth (BI, Oct. 23, 2006).
That report, conducted by a special committee of UnitedHealth's board of directors and its independent counsel, Wilmer Cutler Pickering Hale & Dorr L.L.P., focused on 29 distinct option grants made by the company from 1994 through 2006, comprising nearly 85% of the options issued by UnitedHealth during that period.
Among other things, the report said that the measurement dates used by the company for most of the 29 options grants "were not correct, and many of these grants were likely backdated," and option grants made to newly hired employees and employees receiving promotions "were backdated as a matter of policy." The report alsoÝsaid UnitedHealth's internal controls related to option grants were "inadequate," and senior management "failed to ensure that option granting practices were appropriate."
The practice of so-called backdating involves turning back the clock toÝdeliberately grantÝstock options on the most favorable date for a recipient, to boost the value of the option.
As part of its 10-K filing, UnitedHealth noted that it has "fully remediated" its previously reported material weakness in internal control as of Dec. 31, 2005, relating to stock option plan administration and accounting for and disclosure for stock option grants.
"We are pleased to have resolved the financial reporting and control-related issues stemming solely from historic stock option programs," said Mike Mikan, UnitedHealth's chief financial officer, in the statement. "We have used this process to create a stronger enterprise in all aspects of administration, including our governance, control environment and commitment to modern corporate social responsibility."
"It's a big first stepÖthey needed to get the statements current and resolve the accounting issues," related to its historical stock option program, said Stephen Zaharuk, vp and senior analyst for Moody's Investors Service Inc. in New York. "Now they can move on with running the business."
Becoming current in their financial filings will permit UnitedHealth to go back to things it could not do before, for example, "deploying capital back into the business," or engage in mergers and acquisitions, noted Carl McDonald, an analyst with CIBC World Markets in New York.
"We anticipate that (UnitedHealth) will immediately begin its share repurchase program," said Morgan Stanley analyst Christine Arnold in a research note. The company has more than $1.9 billion in available cash on hand.
From a financial perspective, the restatement was "largely meaningless for the company, the reason being is that it's just an accounting charge, it doesn't impact the company's cash flow," Mr. McDonald said.
"The bigger issue was the amount of cash they would have to use to pay the IRS for underreporting taxes," he said. "That amount turned out to be $100 millionÖthe market's expectation was that it would be in the $200 to $300 million range," Mr. McDonald said.
The total $155 million in extra taxes and charges for employees who exercised options "is a big numberÖbut it's a very big company and they are able to absorb that," noted Moody's Mr. Zaharuk.
Additionally, "we thought (the stock-options issues) might be a distraction and it might hurt their earnings in 2006 but that hasn't proved to be the case," he said.
However, "issues still remain with what the ramifications of legal settlements will be," Mr. Zaharuk said.
The SEC's enforcement division in December 2006 notified UnitedHealth of a formal investigation into the company's historic stock options practices, and the company has also received related document requests from the U.S. Attorney for the Southern District of New York, U.S. Congressional committees and the Minnesota Attorney General. The company further faces consolidated shareholder derivative litigation.
"The last question is going to be what is going to be the impact on the company as far as the customers go," Mr. Zaharuk said. "If (the legal issues) get ugly and messy and are in the press a lot, there may be some pressure for providers in the network to leave," he said, but that is probably "unlikely."