<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Mark One)
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended
-----------------------------------------------
or
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from October 1, 1996 to December 31, 1996
-------------------------
Commission File Number 000-21949
PACIFICARE HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4591529
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
5995 Plaza Drive, Cypress, California 90630-5028
(Address of principal executive offices, including zip code)
(Registrant's telephone number, including area code) (714) 952-1121
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
---- ----
As of January 31, 1997, there were 12,385,158 shares of the Registrant's Class A
Common Stock, par value $0.01 per share, outstanding and 18,930,668 shares of
Class B Common Stock, par value $0.01 per share, outstanding.
<PAGE>
PART 1: FINANCIAL INFORMATION
Item 1: FINANCIAL STATEMENTS
PacifiCare Health Systems, Inc.
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, September 30,
(Amounts in thousands, 1996 1996
except per share data) (Unaudited)
- ----------------------- -------------- --------------
<S> <C> <C>
Assets
Current assets:
Cash and equivalents $ 367,748 $ 142,818
Marketable securities 594,734 557,275
Receivables, net 156,212 169,545
Prepaid expenses 8,876 8,274
Deferred income taxes 54,745 56,295
-------------- --------------
Total current assets 1,182,315 934,207
-------------- --------------
Property, plant and equipment, net 91,239 93,816
Marketable securities--restricted 35,399 32,406
Goodwill and intangible assets 227,422 228,834
Other assets 25,097 10,199
-------------- --------------
$ 1,561,472 $ 1,299,462
============== ==============
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ 278,800 $ 268,000
Accounts payable and accrued liabilities 162,882 172,282
Unearned premium revenue 256,416 24,059
Long-term debt due within one year 1,511 6,323
-------------- --------------
Total current liabilities 699,609 470,664
-------------- --------------
Long-term debt due after one year 1,370 5,183
Minority interest 391 391
Shareholders' equity:
Preferred shares, par value $1.00 per share; 20,000
shares authorized; none issued -- --
Class A common shares, par value $0.01 per share; 100,000
shares authorized; 12,380 issued at December 31, 1996 and
September 30, 1996 124 124
Class B common shares, par value $0.01 per share; 100,000
shares authorized; 18,922 and 18,912 issued at
December 31, 1996 and September 30, 1996, respectively 189 189
Additional paid-in capital 373,405 370,442
Unrealized gains on available-for-sale securities, net of taxes 3,451 1,293
Retained earnings 482,933 451,176
-------------- --------------
Total shareholders' equity 860,102 823,224
-------------- --------------
$ 1,561,472 $ 1,299,462
============== ==============
</TABLE>
See accompanying notes.
2
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PacifiCare Health Systems, Inc.
Consolidated Statements of Income (unaudited)
Three months ended
December 31,
(Amounts in thousands, -------------------------
except per share data) 1996 1995
- ---------------------- -------------------------
Revenue:
Commercial premiums $ 498,832 $ 431,074
Government premiums (Medicare and Medicaid) 722,748 621,397
Other income 13,295 11,853
---------- ----------
Total operating revenue 1,234,875 1,064,324
---------- ----------
Expenses:
Health care services:
Medical services 490,792 422,333
Hospital services 419,557 370,696
Other services 128,996 101,680
---------- ----------
Total health care services 1,039,345 894,709
---------- ----------
Marketing, general and administrative expenses 153,135 132,257
Amortization of goodwill and intangible assets 1,861 2,274
---------- ----------
Operating income 40,534 35,084
Interest income 12,652 12,262
Interest expense (350) (513)
---------- ----------
Income before income taxes 52,836 46,833
Provision for income taxes 21,079 18,854
---------- ----------
Net income $ 31,757 $ 27,979
========== ==========
Weighted average common shares and equivalents
outstanding used to calculate earnings per share 31,800 31,648
---------- ----------
Earnings per share $ 1.00 $ 0.88
========== ==========
See accompanying notes.
3
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PacifiCare Health Systems, Inc.
Consolidated Statements of Cash Flows (unaudited)
<TABLE>
<CAPTION>
Three months ended
December 31,
------------------------
(Amounts in thousands) 1996 1995
- --------------------- --------- ---------
<S> <C> <C>
Operating activities:
Net income $ 31,757 $ 27,979
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 5,244 5,701
Amortization of goodwill and intangible assets 1,861 2,274
Provision for doubtful accounts 296 93
Deferred income taxes 213 812
Loss on disposal of equipment 191 --
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable 13,037 (2,511)
Prepaid, intangible and other assets (13,745) 1,759
Medical claims and benefits payable 10,800 36,000
Accounts payable and accrued liabilities (7,139) (959)
Unearned premium revenue 232,357 18,929
--------- ---------
Net cash flows provided by operating activities 274,872 90,077
--------- ---------
Investing activities:
Purchase of marketable securities (33,964) (2,981)
Purchase of property, plant and equipment (4,614) (5,597)
Purchase of marketable securities - restricted (2,993) (824)
Acquisitions, net of cash acquired (358) (46)
--------- ---------
Net cash flows used in investing activities (41,929) (9,448)
--------- ---------
Financing activities:
Principal payments on long-term debt (8,625) (5,178)
Proceeds from issuance of common stock 612 2,694
--------- ---------
Net cash flows used in financing activities (8,013) (2,484)
--------- ---------
Net increase in cash and equivalents 224,930 78,145
Beginning cash and equivalents 142,818 279,145
--------- ---------
Ending cash and equivalents $ 367,748 $ 357,290
========= =========
</TABLE>
See accompanying notes.
4
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PacifiCare Health Systems, Inc.
Consolidated Statements of Cash Flows (unaudited)
<TABLE>
- --------------------------------------------------------------------------------------------------------
<CAPTION>
Three months ended
December 31,
------------------------
(Amounts in thousands) 1996 1995
- --------------------- --------- ---------
<S> <C> <C>
Supplemental cash flow information
Cash paid during the period for:
Income taxes $ 794 $ 4,020
Interest $ 241 $ 757
--------- ---------
Supplemental schedule of noncash investing
and financing activities:
Tax benefit realized upon exercise of stock options $ 2,351 $ 1,594
Disposition of equipment under sales-type lease $ 1,755 $ --
Leases capitalized $ -- $ 120
--------- ---------
Details of unrealized gains on available-for-sale securities:
Increase in marketable securities $ 3,495 $ 5,656
Increase in deferred taxes (1,337) (2,166)
--------- ---------
Increase in shareholders' equity $ 2,158 $ 3,490
========= =========
Details of businesses acquired in purchase transactions:
Fair value of assets acquired $ 448 $ 55
Less liabilities assumed or created, including
notes to seller 90 9
--------- ---------
Net cash paid for acquisitions $ 358 $ 46
========= =========
</TABLE>
See accompanying notes.
5
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PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
(unaudited)
NOTE 1 - BASIS OF PRESENTATION
The interim condensed consolidated financial statements included herein
have been prepared by PacifiCare Health Systems, Inc. (the "Company") without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission (the "SEC"). Certain information and footnote disclosures,
normally included in the financial statements prepared in accordance with
generally accepted accounting principles, have been condensed or omitted
pursuant to such SEC rules and regulations; nevertheless, the management of
the Company believes that the disclosures herein are adequate to make the
information presented not misleading. It is suggested that these condensed
consolidated financial statements be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
most recent Annual Report on Form 10-K/A, filed with the SEC in January 1997.
In the opinion of management, all adjustments, consisting only of normal
recurring adjustments necessary to present fairly the consolidated financial
position of the Company with respect to the interim condensed consolidated
financial statements, and the consolidated results of its operations and its
cash flows for the interim periods then ended, have been included. The
results of operations for the interim periods are not necessarily indicative
of the results for the full year.
NOTE 2 - PROPOSED FHP MERGER
On December 31, 1996, the shareholders of the Company and FHP
International Corporation ("FHP"), the Fountain Valley, California-based
health care services company, approved the transaction whereby the Company
will acquire FHP for a total purchase price expected to be approximately $2.2
billion (the "FHP Transaction"). FHP is a diversified health care services
company which, through its HMO subsidiaries, serves approximately 1.9 million
members in 11 states and Guam. FHP reported revenues of $4.2 billion and net
income of $44.2 million for the fiscal year ended June 30, 1996. FHP also
operates a health indemnity insurer, a workers' compensation insurer and a
national preferred provider organization. FHP is one of the largest providers
of health care services for Medicare beneficiaries in the United States. The
FHP Transaction will result in the current operations of the Company in
California, Florida, Oklahoma, Oregon, Texas and Washington being expanded to
include operations in Arizona, Colorado, Illinois, Indiana, Kentucky, New
Mexico, Nevada, Ohio, Utah and Guam. The FHP Transaction will be accounted
for as a purchase, when the business combination is completed, and is
designed to qualify as a tax-free exchange for the stock portion.
As a result of the FHP Transaction, the Company and FHP will become
wholly owned subsidiaries of N-T Holdings, Inc. ("PacifiCare Holding").
Shortly after the FHP Transaction becomes effective, it is the intention of
PacifiCare Holding to change its name to PacifiCare Health Systems, Inc. and
the Company will change its name to PacifiCare Operations Systems, Inc.
Accordingly, PacifiCare Holding, on a going forward basis, will be the
publicly held entity and thereby the registrant for SEC purposes.
Terms of the FHP Transaction call for holders of FHP common stock to
receive a package of consideration equal to approximately $37 per share to be
paid in cash totaling $17.50 per FHP share and a combination of PacifiCare
Holding Class A Common Stock, par value $0.01 ("Class A"), and PacifiCare
Holding Class B Common Stock, par value $0.01 ("Class B") to equal a fixed
total of .232 fractional shares of PacifiCare Holding common stock. The
exchange ratios of Class A and Class B, based on the current number of
outstanding shares of FHP common stock are 0.056 and 0.176, respectively.
The number of
6
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shares to be issued in Class A is fixed at 2,350,000 total shares, therefore,
the amount of shares of Class B and the exchange ratio split between Class A
and Class B may vary based on the number of outstanding shares of FHP common
stock at the time of the close of the FHP Transaction. In addition,
stockholders of FHP common stock will receive rights to purchase the common
stock of Talbert Medical Management Holdings Corporation, as soon as such
rights can be legally distributed.
On October 31, 1996, PacifiCare Holding entered into a credit agreement
with Bank of America as Agent, and a syndicate of financial institutions
(collectively, the "Banks") whereby the Banks are obligated to provide a
five-year unsecured, revolving credit facility in an aggregate amount of $1.5
billion (the "Credit Facility"). The Company and FHP will provide guarantees
under the Credit Facility. PacifiCare Holding may borrow the full amount of
the Credit Facility to fund the cash portion of the consideration being paid
to FHP shareholders and to pay a portion of the fees and expenses incurred in
connection with the FHP Transaction. Thereafter, the Credit Facility will
remain available for general corporate purposes. Interest on the borrowing
under the Credit Facility will be based on any of the London Interbank
Offering Rate, a base rate or competitive bid. The Credit Facility is
subject to, among other things, various covenants usual for financing of this
type, with financial covenants including a minimum net worth requirement, a
fixed charge coverage ratio and a leverage ratio.
The FHP Transaction has received most of the necessary regulatory
approval and is currently awaiting two state regulatory approvals, most
notably from the California Department of Corporations. The FHP Transaction
is expected to close in February 1997. For additional information regarding
the FHP Transaction, please refer to the Registration Statement on Form S-4
of PacifiCare Holding filed with the Securities and Exchange Commission on
November 18, 1996.
NOTE 3 - LONG-TERM DEBT
Subsequent to establishing the Credit Facility (See Note 2 - "Proposed
FHP Merger"), the Company's existing $250.0 million revolving line of credit
with Bank of America National Trust and Savings Association and a syndicate
of banks was terminated. There were no outstanding borrowings under the
Credit Facility as of December 31, 1996.
In anticipation of the close of the FHP Transaction, the Company paid
$7.8 million to retire the remaining outstanding balance of its 8.8 percent
privately placed senior debt in December 1996.
Upon consummation of the FHP Transaction, PacifiCare Holding will assume
$100 million senior notes of FHP (the "FHP Notes") by entering into a
supplemental indenture, which will be dated as of the closing date of the FHP
Transaction, with Chase Manhattan Bank. The FHP Notes carry an interest rate
of 7.0 percent and mature on September 15, 2003.
NOTE 4 - SHAREHOLDERS' EQUITY
In March 1996, the shareholders of the Company approved an amendment (the
"Amendment") to the Company's Certificate of Incorporation, as amended, to
increase the total number of authorized shares of stock which the Company has
the authority to issue to 220,000,000. The Amendment increased the number of
shares of the Class A Common Stock, par value $0.01 per share, which the
Company is authorized to issue from 30,000,000 to 100,000,000, increased the
number of shares of the Class B Common Stock, par value $0.01 per share,
which the Company is authorized to issue from 60,000,000 to 100,000,000 and
increased the total number of shares of preferred stock, par value $1.00 per
share, which the Company is authorized to issue from 10,000,000 to 20,000,000.
7
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NOTE 5 - CONTINGENCIES
The Company is involved in legal actions in the normal course of
business, some of which seek substantial monetary damages, including claims
for punitive damages which are not covered by insurance. Additionally, the
Company's programs, including services provided to government employees, are
subject to retrospective audits by the respective regulating agencies in the
normal course of business. After review, including consultation with counsel,
management believes any ultimate liability in excess of amounts accrued which
could arise from audits or legal actions would not materially affect the
Company's consolidated financial position, results of operations or cash
flows.
The Company has set aside reserves in anticipation of negotiations
relating to potential governmental claims for contracts with the United
States Office of Personnel Management ("OPM"). The Company's HMO
subsidiaries which provide managed health care services under the Federal
Employees Health Benefits Program are subject to audit, in the normal course
of business, by OPM. Currently, OPM audits for multiple periods are in
various stages of completion for several of the Company's HMO subsidiaries.
The Company intends to negotiate with OPM on all matters to attain a mutually
satisfactory result. While there is no assurance that the negotiations will
be concluded satisfactorily or that additional liability will not be
incurred, management believes that any ultimate liability in excess of
amounts accrued which could arise upon completion of the audits by OPM of the
health plans, would not materially affect the Company's consolidated
financial position, results of operations or cash flows; however, such
liability could be material to net income of a future quarter if resolved
unfavorably.
NOTE 6 - SUBSEQUENT EVENTS
On January 22, 1997, the Company signed a definitive agreement to sell
the outstanding stock of its PacifiCare of Florida ("PCFL") subsidiary to
Total Health Choice, a newly formed Florida subsidiary of Total Health Care,
Inc. The terms of the agreement call for a purchase price which approximates
the net book value of PCFL. Closing of the sale of PCFL is subject to
various federal and state regulatory approvals. As of December 31, 1996,
PCFL served approximately 35,000 commercial and Medicaid members.
NOTE 7 - CHANGE IN FISCAL YEAR
On February 27, 1996, the Company determined to change its fiscal year
end from September 30 to December 31. Accordingly, the Company's next fiscal
year will end on December 31, 1997. The Company will include audited
financial statements for the October 1, 1996 to December 31, 1996 transition
period in its Annual Report on Form 10-K for the year ended December 31, 1997.
8
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table presents membership data by region and by consumer type as
of the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
GOVERNMENT GOVERNMENT
(MEDICARE & (MEDICARE &
MEMBERSHIP DATA COMMERCIAL MEDICAID) TOTAL COMMERCIAL MEDICAID) TOTAL
- --------------- -------- ------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
California 979,696 416,264 1,395,960 842,427 393,283 1,235,710
Florida 33,077 2,365 35,442 53,452 8,307 61,759
Oklahoma 116,683 23,432 140,115 106,462 19,949 126,411
Oregon 113,428 38,351 151,779 96,913 44,406 141,319
Texas 117,425 62,707 180,132 86,662 52,485 139,147
Washington 91,187 50,494 141,681 71,779 40,307 112,086
--------- ------- --------- --------- -------- ---------
Total membership 1,451,496 593,613 2,045,109 1,257,695 558,737 1,816,432
========= ======= ========= ========= ======== =========
</TABLE>
THREE MONTHS ENDED
DECEMBER 31,
-------------------
OPERATING STATISTICS 1996 1995
- -------------------- ------ -------
Medical loss ratio (health care services as a
percent of premium revenue)
Consolidated 85.1% 85.0%
Commercial 84.4% 85.8%
Government (Medicare and Medicaid) 85.5% 84.4%
Marketing, general and administrative expenses
as a percent of operating revenue 12.4% 12.4%
Operating income as a percent of operating revenue 3.3% 3.3%
Effective tax rate 39.9% 40.3%
====== ======
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1996
COMPARED TO THE
THREE MONTHS ENDED DECEMBER 31, 1995
Total operating revenue increased 16 percent to $1.2 billion for the
three months ended December 31, 1996 from $1.1 billion for the same period in
the prior year. Enrollment gains in the HMOs' commercial and government
programs, offset slightly by decreases in commercial premium rates,
contributed 15 percent of the increase in total operating revenue. The
Company's specialty managed care products and services contributed the
remainder of the increase in operating revenue.
For the three months ended December 31, 1996, commercial HMO premiums
increased $68 million to $499 million as compared to the same period in the
prior year. Commercial HMO membership at December 31, 1996 increased 15
percent, as compared to December 31, 1995, to approximately 1,451,500
9
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members due to continued growth in all states except Florida. Commercial HMO
membership growth provided the increase in commercial premiums, more than
offsetting premium rate decreases averaging 1.4 percent. The Company's
specialty managed care products and services contributed the remainder of the
increase in operating revenue.
Government premiums rose $102 million to $723 million for the three
months ended December 31, 1996 from $621 million in the same period of fiscal
year 1996. Enrollment gains in the Medicare programs, which offset losses in
Medicaid membership, accounted for 47 percent of the increase for the three
month period ended December 31, 1996. The remainder of the premium increase
was attributable to average premium rate increases of 8.3% for the three
months ended December 31, 1996 as compared to the same period in the prior
year which reflect reductions in member paid supplemental premiums and the
Company's continued withdrawal from low premium Medicaid programs.
The decrease in the commercial medical loss ratio for the three months
ended December 31, 1996 was primarily due to the implementation of more
effective physician contracts, mainly in California. Additionally, the
Company is experiencing improved performance in its PPO, indemnity and other
specialty managed care products and services. Lower physician and specialty
managed care costs were partially offset by increases in prescription drug
costs.
The increase in the medical loss ratio for the government programs
reflects increased physician costs due to membership growth in areas with
higher physician costs combined with lower member paid supplemental premiums
and enhanced benefits provided to enrollees. These lower supplemental
premiums and increased costs were partially offset by the average premium
rate increases.
Marketing, general and administrative expenses increased $21 million to
$153 million for the three months ended December 31, 1996 from $132 million
for the same period in fiscal year 1996. As a percentage of operating
revenue, marketing, general and administrative expenses remained consistent
with the same quarter in the prior year. Continued administrative
efficiencies have allowed the Company to control its overhead, as well as
continue investments in medical management systems.
Net income increased 14 percent to $32 million for the quarter ended
December 31, 1996 compared to $28 million in the same period in the prior
fiscal year. Earnings per share of $1.00 were 14 percent higher than the
prior year's quarterly earnings per share of $0.88.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital at December 31, 1996 was $483 million, an
increase of $19 million from September 30, 1996. Cash flows provided by
operations increased primarily due to advanced receipt of the January 1997
Health Care Financing Administration ("HCFA") Medicare premium payment.
In October 1996, the Company established a $1.5 billion revolving credit
facility with Bank of America National Trust and Savings Association and a
syndicate of banks to finance the cash portion of the FHP Transaction.
Subsequent to establishing the Credit Facility, the Company's existing $250.0
million revolving line of credit with Bank of America National Trust and
Savings Association and a syndicate of banks was terminated. Additionally,
the Company paid $7.8 million to retire the remaining outstanding balance of
its 8.8 percent privately placed senior debt in December 1996. (See Notes 2
and 3 of the Notes to the Condensed Consolidated Financial Statements.) The
Company has paid approximately $11 million in Credit Facility fees in the
quarter ended December 31, 1996, which have been recorded in noncurrent
assets and will be amortized over the term of the loan.
10
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Upon consummation of the FHP Transaction, PacifiCare Holding the FHP
Notes by entering into a supplemental indenture, which will be dated as of
the close of the FHP Transaction, with Chase Manhattan Bank. The Notes carry
an interest rate of 7.0 percent and mature on September 15, 2003 (see Note 3
of the Notes to the Condensed Consolidated Financial Statements).
As of October 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which
requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted
cash flows estimated to be generated by those assets are less than the
assets' carrying amounts. The statement also addresses the accounting for
long-lived assets that are expected to be disposed of. The adoption did not
materially affect the Company's consolidated financial position, results of
operations or cash flows.
On October 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation," which provides an alternative to Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS No. 123 encourages, but does not require recognition of
compensation expense for grants of stock, stock options and other equity
instruments to employees based on the fair value. The statement also allows
companies to continue to measure compensation cost using the intrinsic value
method of accounting prescribed by APB Opinion No. 25. While recognition for
employee stock-based compensation is not mandatory, SFAS No. 123 requires
companies that choose not to adopt the new fair value accounting rules to
disclose pro forma net income and earnings per share under the new method.
The Company will continue with the intrinsic value based method prescribed by
APB Opinion No. 25 and make pro forma disclosures of net income and EPS, as
if the fair value based method of accounting defined in SFAS No. 123 had been
applied beginning on October 1, 1996.
FORWARD LOOKING INFORMATION UNDER THE PRIVATE SECURITIES LITIGATION ACT OF
1995
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward looking statements to encourage companies to provide
prospective information about themselves without fear of litigation so long
as those statements are identified as forward looking and are accompanied by
meaningful cautionary statements identifying important factors that could
cause actual results to differ materially from those projected in the
statements. The statements contained in this section, and throughout the
document, are based on current expectations. These statements are forward
looking and actual results may differ materially from those projected in the
forward looking statements, which statements involve risks and uncertainties.
In addition, past financial performance is not necessarily a reliable
indicator of future performance and investors should not use historical
performance to anticipate results or future period trends. Shareholders are
also directed to the other risks discussed in other documents filed by the
SEC.
The following forward looking statements, except where specifically
noted, exclude the potential impact of the integration of FHP into the
Company subsequent to the FHP Transaction (see Note 2 of the Notes to the
Condensed Consolidated Financial Statements). The impact of FHP has been
excluded because the Company believes that it has insufficient information to
make any projections and that disclosure of any potential impact would be
premature.
INDUSTRY COMPETITION AND CONSOLIDATION. The Company's business strategy
is to solidify its position as one of the leading managed health care
services companies. The pending FHP Transaction is consistent with this
strategy as it offers significant synergies creating a combined company that
would be better able to respond to the needs of consumers and customers, the
increased competitiveness of the health care industry and the opportunities
that changes in the health care industry might bring. While the Company
believes that the acquisition will be successfully completed, the regulatory
approvals required, including various state approvals, may not be obtained.
For additional information regarding the FHP Transaction, please refer to the
11
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Registration Statement on Form S-4 of PacifiCare Holding filed with the SEC
on November 18, 1996. Increased competition could result in a decline in
revenue or in price reductions. Factors which could influence increased
competition include larger competitors being created through consolidation,
intensification of price competition and the formation of new products by new
and existing competitors, especially with respect to Medicare products.
MEMBERSHIP GROWTH. Excluding the effects of the FHP Transaction, the
Company's membership growth is expected to continue in 1997 in both the
commercial and government programs but decline from the overall 15 percent
growth rate experienced in the quarter ended December 31, 1996 as competition
continues to increase and the Company shifts its emphasis from rapid growth
to improved margin performance. The rate of membership growth is also
expected to decline in 1997 with approximately 35,000 of expected membership
losses with the Company's exit from the Florida market and additional losses
as the Company continues to exit the Medicaid business in all markets. If
the FHP Transaction is successfully completed, membership is expected to
double solely as a result of the combination of the two companies. Had the
business combination been closed as of December 31, 1996, total membership
would have been approximately 3.9 million, an increase of 93 percent.
Commercial and government membership would have been 2.9 million and 1.0
million, respectively. An unforeseen loss of membership could have a
material adverse effect on the Company. Factors which could contribute to
the loss of membership include without limitation, failure to obtain new
customers or to retain existing customers, reductions in workforce by
existing customers, adverse publicity and news coverage, inability to carry
out marketing and sales plans, loss or retirement of key executives or key
employees or denial of accreditation by independent quality accrediting
agencies.
HEALTH CARE PROVIDER CONTRACTS. The Company's profitability depends, in
part, on its ability to maintain effective control over health care costs
while providing members with quality care. Securing cost effective contracts
with existing and new physician groups is more difficult due to increased
competition. The negotiation of provider contracts, generally as of January
1, may be impacted by adverse state and federal legislation and regulation
discussed below. Factors which could impact the Company's ability to secure
contracts with providers include the inability to renegotiate contracts or
entering into contracts with less cost-effective rates or terms of payment
and factors affecting increased competition as discussed above.
COMMERCIAL MEDICAL LOSS RATIO. The 1997 commercial medical loss ratio is
expected to be lower than fiscal year 1996. The Company expects commercial
premium rates to increase slightly as competitive pressures continue to ease
and the Company pursues its strategic focus from membership growth to product
performance, resulting in premium rate stabilization or increases for its HMO
and PPO indemnity products. Without compromising its strategic focus on
product performance, the Company continues to work with certain large
employer groups and other purchasers of commercial health care services which
continue to demand minimal premium rate increases or reductions in premium
rates while limiting the number of choices offered to employees. Premium
increases are expected to be slightly offset by the rate of increases in
health care costs including prescription drugs. Increased provider experience
in the newer markets, combined with continual renegotiation of current
contracts in all markets, should begin to slightly decrease physician costs,
improving the commercial medical loss ratio. Additionally, the pending sale
of PCFL should contribute to a further decrease in the commercial medical
loss ratio.
GOVERNMENT MEDICAL LOSS RATIO. In September 1996, the Company was
advised by HCFA that effective January 1997, its HMOs will receive a weighted
average premium rate increase of approximately 6.1 percent. The Company
expects to receive these rates barring any adverse federal legislation
change. The 1997 medical loss ratio for the government programs is expected
to be moderately higher than the fiscal year 1996 rate as competitive
pressures in the Medicare market, requiring enhanced benefits with lower
supplemental premiums, offset HCFA rate increases.
12
<PAGE>
The commercial and government medical loss ratio expectations discussed
above could be affected by various uncertainties, including increases in
medical and prescription drug costs, increases in utilization and costs of
medical services and the effect of actions by competitors or groups of
providers and termination of provider contracts or renegotiation thereof at
less cost-effective rates or terms of payment. In addition, price increases
in health care costs including prescription drug costs, which have been
escalating faster than premium increases in recent years, as well as price
increases for durable medical equipment and other covered items plus other
factors, as discussed below, could also affect expectations.
MARKETING, GENERAL AND ADMINISTRATIVE SUPPORT INVESTMENTS. Marketing,
general and administrative expenses as a percentage of operating revenue in
1997 are expected to be slightly higher than fiscal year 1996. The Company
plans to increase its investment in medical management to improve its medical
loss ratios and expects increased investments in information services to
maintain and enhance its current competitive advantage in information
technology. In addition, employee incentives will be realigned with 1997
targets. Marketing, general and administrative expenses as a percentage of
operating revenue for 1997 are expected to increase from fiscal year 1996
levels as the Company invests in the integration of FHP. Although the
Company anticipates that the FHP Transaction will yield increased operating
income partly resulting from a combination of reductions in marketing,
general and administrative expenses, there can be no assurances that the
anticipated benefits and synergies will be obtained. The ability of the
Company to realize the anticipated benefits and synergies is subject to the
following additional uncertainties, among others: the ability to integrate
the Company's and FHP's management and information systems, on a timely
basis, if at all; the ability to eliminate duplicative functions while
maintaining acceptable performance levels; and the possibility that the
integration of FHP will result in the loss of providers, employers, members
or key employees of PacifiCare, FHP or their subsidiaries. Additionally,
marketing, general and administrative expenses could be adversely impacted by
the need for additional advertising, marketing, administrative, or management
information systems expenditures and the inability to carry out marketing and
sales plans.
OFFICE OF PERSONNEL MANAGEMENT CONTINGENCIES. The Company intends to
negotiate with the OPM on all matters to attain a mutually satisfactory
result. While there is no assurance that the negotiations will be concluded
satisfactorily or that additional liability will not be incurred, management
believes that any ultimate liability in excess of amounts accrued which could
arise upon completion of the audits by OPM of the health plans would not
materially affect the Company's consolidated financial position, results of
operations or cash flows; however, such liability could be material to net
income of a future quarter if resolved unfavorably (see Note 5 of the Notes
to the Condensed Consolidated Financial Statements).
LIQUIDITY AND CAPITAL RESOURCES. The Company believes that cash flows
from operations, the Credit Facility, existing cash and equivalents and
marketable securities and other financing sources will provide sufficient
liquidity for operations in the foreseeable future. However, cash flows
could be adversely affected by changes in interest rates causing an increase
in interest expense and the fact that the Company will be subject to greater
operating leverage due to its higher levels of indebtedness if the FHP
Transaction is consummated. Additionally, should the Credit Facility be fully
drawn to fund the FHP Transaction or other business purpose, the Company's
ability to make a payment on, or repayment of, its future obligations under
the Credit Facility and the Notes will be significantly dependent upon the
receipt of funds from the Company's subsidiaries. These subsidiary payments
represent fees for management services rendered by the Company to the
subsidiaries and cash dividends by the subsidiaries to the Company. Nearly
all of the subsidiaries are subject to HMO regulations or insurance
regulations and may be subject to substantial supervision by one or more HMO
or insurance regulators. Subsidiaries subject to regulation must meet or
exceed various fiscal standards imposed by HMO or insurance regulations.
These fiscal standards may, from time to time, impact the amount of funds
paid by subsidiaries to the Company.
LEGISLATION AND REGULATION. The Company's success is significantly
impacted by federal and state legislation and regulation. Actual results may
differ materially from expected results discussed throughout this
13
<PAGE>
document because of adverse state and federal legislation and regulation.
This includes limitations on premium levels; increases in minimum capital and
reserves and other financial viability requirements; prohibition or
limitation of capitated arrangements or provider financial incentives;
benefit mandates (including mandatory length of stay and emergency room
coverage) and limitations on the ability to manage care and utilization of
any willing provider or pharmacy laws. It also includes adverse actions of
governmental payors, including unilateral reduction of Medicare and Medicaid
premiums payable; discontinuance of or limitation on governmentally funded
programs and recovery by governmental payors of previously paid amounts; the
inability to increase premiums or prospective or retroactive reductions to
premium rates for federal employees notwithstanding increases in medical
costs due to competition, government regulation or other factors; adverse
regulatory determinations resulting in loss or limitations of licensure,
certification or contracts with governmental payors; and increase by
regulatory authorities of minimum capital, reserve and other financial
viability requirements.
OTHER. Results may differ materially from those projected, forecast,
estimated and budgeted by the Company due to adverse results in ongoing
audits or in other reviews conducted by federal or state agencies or health
care purchasing cooperatives; adverse results in significant litigation
matters; and changes in interest rates causing an increase in interest
expense.
14
<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
The Company held a Special Meeting of Stockholders on December 31,
1996. The following is a brief description of each matter voted upon at
the meeting and a statement of the number of votes cast for or against, and
the number of abstentions with respect to each matter. All proposals were
approved by the stockholders.
(a) The stockholders approved the Amended and Restated Agreement and Plan
of Reorganization, dated as of November 11, 1996, among the Company,
N-T Holdings, Inc., Neptune Merger Corp., Tree Acquisition Corp., and
FHP International Corporation.
FOR AGAINST ABSTAINED
--- ------- ---------
9,948,938 13,427 2,811
(b) The stockholders approved an amendment to the Certificate of
Incorporation of the Company.
CLASS A
FOR AGAINST ABSTAINED
--- ------- ---------
10,026,490 13,085 3,392
CLASS B
FOR AGAINST ABSTAINED
--- ------- ---------
13,290,051 11,200 13,048
(c) The stockholders approved the Second Amended 1992 Non-Officer
Directors Stock Option Plan of PacifiCare Health Systems, Inc.
FOR AGAINST ABSTAINED
--- ------- ---------
9,931,343 538,475 8,107
15
<PAGE>
Item 5: Other Information
On February 27, 1996, the Company determined to change its fiscal year
end from September 30 to December 31. Accordingly, the Company's next
fiscal year will end on December 31, 1997. The Company will include audited
financial statements for the October 1, 1996 to December 31, 1996
transition period in its Annual Report on Form 10-K for the year ended
December 31, 1997.
On February 14, 1997, the Registrant's Commission File Number and IRS
Employer Identification Number changed as a result of a corporate
reorganization. The identifying numbers on page one of this transition
report on Form 10-Q/A, therefore, are different from those presented on the
Registrant's initial quarterly report on Form 10-Q for the period ended
December 31, 1996, originally filed on February 7, 1997. In the original
filing, the Registrant's Commission File Number and IRS Employer
Identification Number were 0-14181 and 33-0064895, respectively.
Item 6: Exhibits and Reports
a) Exhibit Index
Exhibit 11A Computation of Net Income per Share of Common
Stock - Primary
Exhibit 11B Computation of Net Income per Share of Common
Stock - Fully Diluted
Exhibit 27 Financial Data Schedules (filed
electronically)
b) No reports on Form 8-K were filed during the quarter for which
this report is filed.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACIFICARE HEALTH SYSTEMS, INC.
(Registrant)
Date: February 28, 1997 By: /s/ ALAN HOOPS
------------------------- -------------------------
Alan Hoops
President,
Chief Executive Officer
and Director
Date: February 28, 1997 By: /s/ WAYNE LOWELL
------------------------- -------------------------
Wayne Lowell
Executive Vice President,
Chief Administrative Officer and
Chief Financial Officer
17
<PAGE>
EXHIBIT 11A
PACIFICARE HEALTH SYSTEMS, INC.
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK -
PRIMARY
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
DECEMBER 31,
---------------------
1996 1995
-------- -------
<S> <C> <C>
Shares outstanding at the beginning of the period 31,292 30,945
Weighted average number of shares issued during the period in
connection with the exercise of stock options 3 39
Dilutive shares issuable, net of shares assumed to have been
purchased (at the average market price) for treasury with
assumed proceeds from the contingent exercise of stock
options and registered equity purchase contracts 505 664
------- -------
Total shares -- primary 31,800 31,648
======= =======
Net income $31,757 $27,979
======= =======
Primary earnings per share $ 1.00 $ 0.88
======= =======
</TABLE>
<PAGE>
EXHIBIT 11B
PACIFICARE HEALTH SYSTEMS, INC.
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK -
FULLY DILUTED
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
DECEMBER 31,
---------------------
1996 1995
-------- -------
<S> <C> <C>
Shares outstanding at the beginning of the period 31,292 30,945
Weighted average number of shares issued during the period in
connection with the exercise of stock options 3 39
Dilutive shares issuable, net of shares assumed to have been
purchased (at the greater of ending or average market price)
for treasury with assumed proceeds from the contingent
exercise of stock options and registered equity purchase
contracts 549 703
------- -------
Total shares -- fully diluted 31,844 31,687
======= =======
Net income $31,757 $27,979
======= =======
Fully diluted earnings per share $ 1.00 $ 0.88
======= =======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
PacifiCare Health Systems, Inc.'s consolidated balance sheet as of
December 31, 1996, and the related consolidated statement of income
for the three months ended December 31, 1996, 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> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 367,748
<SECURITIES> 594,734
<RECEIVABLES> 157,089
<ALLOWANCES> 877
<INVENTORY> 0
<CURRENT-ASSETS> 1,182,315
<PP&E> 186,880
<DEPRECIATION> 95,641
<TOTAL-ASSETS> 1,561,472
<CURRENT-LIABILITIES> 699,609
<BONDS> 0
0
0
<COMMON> 313
<OTHER-SE> 859,789
<TOTAL-LIABILITY-AND-EQUITY> 1,561,472
<SALES> 0
<TOTAL-REVENUES> 1,234,875
<CGS> 0
<TOTAL-COSTS> 1,039,345
<OTHER-EXPENSES> 154,996
<LOSS-PROVISION> 296
<INTEREST-EXPENSE> 350
<INCOME-PRETAX> 52,836
<INCOME-TAX> 21,079
<INCOME-CONTINUING> 31,757
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 31,757
<EPS-PRIMARY> 1.00
<EPS-DILUTED> 1.00
</TABLE>
