<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): June 4, 1998
PACIFICARE HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 000-21949 95-4591529
(State or other jurisdiction of (Commission (IRS Employer
incorporation or organization) File Number) Identification Number)
3120 Lake Center Drive, Santa Ana, California 92704
(Address of principal executive offices, including zip code)
(Registrant's telephone number, including area code) (714) 825-5200
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
ITEM 5. OTHER EVENTS
REDEMPTION OF SERIES A PREFERRED STOCK
On May 22, 1998, PacifiCare Health Systems, Inc. ("PacifiCare" or the
"Company") announced that it would redeem its Series A Cumulative Convertible
Preferred Stock (the "Series A Preferred Stock") on June 23, 1998, at $25.75
per share plus accrued and unpaid dividends (approximately $0.02 per share),
for a total redemption price of approximately $25.77 per share. Each share
is convertible into 0.37419548 shares of the Company's Class B Common Stock
through June 22, 1998.
DEBT SECURITIES REGISTRATION STATEMENT
The Company has filed a registration statement with the U.S. Securities and
Exchange Commission ("SEC") to register $250 million of Debt Securities in
one or more series (collectively, the "Debt Securities"). The Debt
Securities are to be issued under an indenture to be dated as of June 1,
1998, as supplemented from time to time (the "Indenture"), between the
Company and Chase Manhattan Bank and Trust Company, National Association, as
trustee (the "Trustee").
The Company intends to file an amendment to the registration statement
related to the offering of the Debt Securities. The amendment will provide
that the obligations of the Company to pay the principal of, premium, if any,
and interest on the Debt Securities may be guaranteed on a full,
unconditional and joint and several basis by PacifiCare Operations, Inc. and
FHP International Corporation (the "Subsidiary Guarantors"). The guarantees
will be further described in the registration statement (as amended),
including the prospectus and/or prospectus supplement relating to any
particular series of Debt Securities.
In connection with such guarantees, the Company is providing in this filing
additional financial information concerning the Company, the Subsidiary
Guarantors, and the aggregate non-guaranteeing subsidiaries. This additional
financial information is being provided through "Subsequent Events" Note 11
to the consolidated financial statements for the year ended December 31, 1997
and in "Subsequent Events" Note 8 to the condensed consolidated statements
for the quarter ended March 31, 1998. The Company's financial statements for
such periods are included herein but are otherwise unchanged.
The Subsidiary Guarantors are holding companies rather than operating
companies, and most of their subsidiaries are subject to HMO or insurance
regulations. The regulated subsidiaries are generally required to satisfy
minimum equity, capital, deposit and/or reserve requirements. At December
31, 1997, these requirements approximated $195 million. These requirements,
which limit the ability of the regulated subsidiaries to transfer funds to
the Subsidiary Guarantors, may impact the amount of funds that may be paid by
the subsidiaries to the Subsidiary Guarantors. In addition, the rights of
the Subsidiary Guarantors and the rights of their creditors, including
holders of the Debt Securities, to participate in any distribution of the
assets of a subsidiary upon the liquidation or recapitalization of such
subsidiary will be subject to the prior claims of certain of the subsidiary's
creditors, except to the extent that a Subsidiary Guarantor itself may be a
creditor with recognized claims against the subsidiary.
1
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1997 1996 1996
------------ ------------ -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and equivalents............................................... $ 680,674 $ 367,748 $ 142,818
Marketable securities.............................................. 864,708 594,734 557,275
Receivables, net................................................... 301,345 156,212 169,545
Prepaid expenses and other current assets.......................... 32,194 8,876 8,274
Deferred income taxes.............................................. 112,037 54,745 56,295
------------ ------------ -------------
Total current assets............................................. 1,990,958 1,182,315 934,207
------------ ------------ -------------
Property, plant and equipment at cost, net of accumulated
depreciation and amortization...................................... 235,943 91,239 93,816
Marketable securities--restricted.................................... 145,989 35,399 32,406
Goodwill and intangible assets, net.................................. 2,458,463 227,422 228,834
Other assets......................................................... 36,605 25,097 10,199
------------ ------------ -------------
$4,867,958 $1,561,472 $ 1,299,462
------------ ------------ -------------
------------ ------------ -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims and benefits payable................................ $ 715,600 $ 278,800 $ 268,000
Accounts payable................................................... 145,615 15,992 31,082
Accrued liabilities................................................ 205,320 75,284 92,945
Accrued compensation and employee benefits......................... 78,589 52,550 46,930
Income taxes payable............................................... -- 19,056 1,325
Unearned premium revenue........................................... 491,808 256,416 24,059
Long-term debt due within one year................................. 154 1,511 6,323
------------ ------------ -------------
Total current liabilities........................................ 1,637,086 699,609 470,664
------------ ------------ -------------
Long-term debt due after one year.................................... 1,011,234 1,370 5,183
Deferred income taxes................................................ 102,793 -- --
Other liabilities.................................................... 54,283 -- --
Minority interest.................................................... 375 391 391
Commitments and contingencies
Shareholders' equity:
Preferred shares, par value $0.01 per share; 40,000 shares
authorized; 10,517 shares of Series A Convertible Preferred
Stock issued and outstanding at December 31, 1997 ($262,926
aggregate liquidation value)................................... 105 -- --
Class A common shares, par value $0.01 per share; 100,000 shares
authorized; 14,794, 12,380 and 12,380 shares issued at December
31, 1997 and 1996 and September 30, 1996, respectively......... 148 124 124
Class B common shares, par value $0.01 per share; 100,000 shares
authorized; 27,201, 18,922 and 18,912 shares issued at December
31, 1997 and 1996 and September 30, 1996, respectively......... 272 189 189
Additional paid-in capital....................................... 1,599,229 373,405 370,442
Unrealized gains on available-for-sale securities, net of taxes.. 9,993 3,451 1,293
Retained earnings................................................ 452,440 482,933 451,176
------------ ------------ -------------
Total shareholders' equity..................................... 2,062,187 860,102 823,224
------------ ------------ -------------
$4,867,958 $1,561,472 $ 1,299,462
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
See accompanying notes.
2
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995
------------ ------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Revenue:
Commercial premiums................................ $3,728,243 $ 498,832 $ 1,866,830 $ 1,512,080
Government premiums (Medicare and Medicaid)........ 5,206,919 722,748 2,720,698 2,170,885
Other income....................................... 47,518 13,295 49,777 48,057
------------ ------------- ------------- -------------
Total operating revenue.......................... 8,982,680 1,234,875 4,637,305 3,731,022
Expenses:
Health care services:
Commercial services................................ 3,199,885 421,080 1,550,372 1,247,905
Government services................................ 4,458,994 618,265 2,322,375 1,829,230
------------ ------------- ------------- -------------
Total health care services....................... 7,658,879 1,039,345 3,872,747 3,077,135
Marketing, general and administrative
expenses........................................... 1,055,080 153,135 575,928 498,445
Impairment, disposition, restructuring and other
charges............................................ 154,507 -- 75,840 --
Office of Personnel Management charge................ -- -- 25,000 --
Amortization of goodwill and intangible assets....... 70,219 1,861 9,153 7,199
------------ ------------- ------------- -------------
Operating income..................................... 43,995 40,534 78,637 148,243
Interest income...................................... 80,665 12,652 46,237 39,406
Interest expense..................................... (64,536) (350) (2,094) (5,549)
------------ ------------- ------------- -------------
Income before income taxes........................... 60,124 52,836 122,780 182,100
Provision for income taxes........................... 81,825 21,079 50,827 74,005
------------ ------------- ------------- -------------
Net income (loss).................................... $ (21,701) $ 31,757 $ 71,953 $ 108,095
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Preferred dividends.................................. (8,792) -- -- --
------------ ------------- ------------- -------------
Net income (loss) available to common shareholders... $ (30,493) $ 31,757 $ 71,953 $ 108,095
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Basic earnings (loss) per share...................... $ (0.75) $ 1.01 $ 2.31 $ 3.69
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Diluted earnings (loss) per share.................... $ (0.75) $ 1.00 $ 2.27 $ 3.62
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
</TABLE>
See accompanying notes.
3
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED SHARES CLASS A COMMON SHARES
PERIODS ENDED DECEMBER 31, 1997 AND 1996 AND SEPTEMBER 30, ------------------------ -----------------------------
1996 AND 1995 OUTSTANDING AMOUNT OUTSTANDING AMOUNT
- ------------------------------------------------------------- ----------- ----------- -------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balances at September 30, 1994............................... -- $ -- 12,238 $ 122
----------- ----- ------- -----
Issuance of common stock in connection with public
offering................................................... -- -- -- --
Issuance of common stock upon exercise of stock options...... -- -- 93 1
Issuance of common stock under incentive plan................ -- -- -- --
Tax benefit realized upon exercise of stock options.......... -- -- -- --
Cumulative effect of a change in accounting principle, net of
taxes of $2,474............................................ -- -- -- --
Change in unrealized gains, net of taxes of $5,516........... -- -- -- --
Net income................................................... -- -- -- --
----------- ----- ------- -----
Balances at September 30, 1995............................... -- -- 12,331 123
----------- ----- ------- -----
Issuance of common stock upon exercise of stock options...... -- -- 49 1
Issuance of common stock under incentive plan................ -- -- -- --
Tax benefit realized upon exercise of stock options.......... -- -- -- --
Change in unrealized gains, net of taxes of $2,304........... -- -- -- --
Net income................................................... -- -- -- --
----------- ----- ------- -----
Balances at September 30, 1996............................... -- -- 12,380 124
----------- ----- ------- -----
Issuance of common stock upon exercise of stock options...... -- -- -- --
Issuance of common stock under incentive plan................ -- -- -- --
Tax benefit realized upon exercise of stock options.......... -- -- -- --
Change in unrealized gains, net of taxes of $1,337........... -- -- -- --
Net income................................................... -- -- -- --
----------- ----- ------- -----
Balances at December 31, 1996................................ -- -- 12,380 124
----------- ----- ------- -----
Issuance of common stock upon exercise of stock options...... -- -- 75 1
Issuance of common stock under incentive plan................ -- -- -- --
Shares issued in connection with the FHP Acquisition......... 10,517 105 2,339 23
Tax benefit realized upon exercise of stock options.......... -- -- -- --
Change in unrealized gains, net of taxes of $4,035........... -- -- -- --
Net loss..................................................... -- -- -- --
Preferred dividends.......................................... -- -- -- --
----------- ----- ------- -----
Balances at December 31, 1997................................ 10,517 $ 105 14,794 $ 148
----------- ----- ------- -----
----------- ----- ------- -----
<CAPTION>
UNREALIZED
GAINS
(LOSSES) ON
CLASS B COMMON SHARES ADDITIONAL AVAILABLE
PERIODS ENDED DECEMBER 31, 1997 AND 1996 AND SEPTEMBER 30, ----------------------------- PAID-IN FOR-SALE RETAINED
1996 AND 1995 OUTSTANDING AMOUNT CAPITAL SECURITIES EARNINGS
- ------------------------------------------------------------- -------------- ------------- ----------- ----------- ---------
<S> <C>
Balances at September 30, 1994............................... 15,290 $ 153 $ 141,955 $ -- $ 271,128
------- ----- ----------- ----------- ---------
Issuance of common stock in connection with public
offering................................................... 3,000 30 197,602 -- --
Issuance of common stock upon exercise of stock options...... 245 3 3,284 -- --
Issuance of common stock under incentive plan................ 16 -- 1,024 -- --
Tax benefit realized upon exercise of stock options.......... -- -- 3,683 -- --
Cumulative effect of a change in accounting principle, net of
taxes of $2,474............................................ -- -- -- (3,808) --
Change in unrealized gains, net of taxes of $5,516........... -- -- -- 8,752 --
Net income................................................... -- -- -- -- 108,095
------- ----- ----------- ----------- ---------
Balances at September 30, 1995............................... 18,551 186 347,548 4,944 379,223
------- ----- ----------- ----------- ---------
Issuance of common stock upon exercise of stock options...... 347 3 13,338 -- --
Issuance of common stock under incentive plan................ 14 -- 1,172 -- --
Tax benefit realized upon exercise of stock options.......... -- -- 8,384 -- --
Change in unrealized gains, net of taxes of $2,304........... -- -- -- (3,651) --
Net income................................................... -- -- -- -- 71,953
------- ----- ----------- ----------- ---------
Balances at September 30, 1996............................... 18,912 189 370,442 1,293 451,176
------- ----- ----------- ----------- ---------
Issuance of common stock upon exercise of stock options...... 10 -- 612 -- --
Issuance of common stock under incentive plan................ -- -- -- -- --
Tax benefit realized upon exercise of stock options.......... -- -- 2,351 -- --
Change in unrealized gains, net of taxes of $1,337........... -- -- -- 2,158 --
Net income................................................... -- -- -- 31,757
------- ----- ----------- ----------- ---------
Balances at December 31, 1996................................ 18,922 189 373,405 3,451 482,933
------- ----- ----------- ----------- ---------
Issuance of common stock upon exercise of stock options...... 917 9 43,828 -- --
Issuance of common stock under incentive plan................ 9 -- 756 -- --
Shares issued in connection with the FHP Acquisition......... 7,353 74 1,163,393 -- --
Tax benefit realized upon exercise of stock options.......... -- -- 17,847 -- --
Change in unrealized gains, net of taxes of $4,035........... -- -- -- 6,542 --
Net loss..................................................... -- -- -- -- (21,701)
Preferred dividends.......................................... -- -- -- -- (8,792)
------- ----- ----------- ----------- ---------
Balances at December 31, 1997................................ 27,201 $ 272 $ 1,599,229 $ 9,993 $ 452,440
------- ----- ----------- ----------- ---------
------- ----- ----------- ----------- ---------
<CAPTION>
PERIODS ENDED DECEMBER 31, 1997 AND 1996 AND SEPTEMBER 30,
1996 AND 1995 TOTAL
- ------------------------------------------------------------- ------------
Balances at September 30, 1994............................... $ 413,358
------------
Issuance of common stock in connection with public
offering................................................... 197,632
Issuance of common stock upon exercise of stock options...... 3,288
Issuance of common stock under incentive plan................ 1,024
Tax benefit realized upon exercise of stock options.......... 3,683
Cumulative effect of a change in accounting principle, net of
taxes of $2,474............................................ (3,808)
Change in unrealized gains, net of taxes of $5,516........... 8,752
Net income................................................... 108,095
------------
Balances at September 30, 1995............................... 732,024
------------
Issuance of common stock upon exercise of stock options...... 13,342
Issuance of common stock under incentive plan................ 1,172
Tax benefit realized upon exercise of stock options.......... 8,384
Change in unrealized gains, net of taxes of $2,304........... (3,651)
Net income................................................... 71,953
------------
Balances at September 30, 1996............................... 823,224
------------
Issuance of common stock upon exercise of stock options...... 612
Issuance of common stock under incentive plan................ --
Tax benefit realized upon exercise of stock options.......... 2,351
Change in unrealized gains, net of taxes of $1,337........... 2,158
Net income................................................... 31,757
------------
Balances at December 31, 1996................................ 860,102
------------
Issuance of common stock upon exercise of stock options...... 43,838
Issuance of common stock under incentive plan................ 756
Shares issued in connection with the FHP Acquisition......... 1,163,595
Tax benefit realized upon exercise of stock options.......... 17,847
Change in unrealized gains, net of taxes of $4,035........... 6,542
Net loss..................................................... (21,701)
Preferred dividends.......................................... (8,792)
------------
Balances at December 31, 1997................................ $ 2,062,187
------------
------------
</TABLE>
See accompanying notes
4
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995
------------ ------------ ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Operating activities:
Net income (loss)................................... $ (21,701) $ 31,757 $ 71,953 $ 108,095
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Impairment, disposition, restructuring and other
charges........................................... 154,507 -- 75,840 --
Amortization of goodwill and intangible assets...... 70,219 1,861 9,153 7,199
Depreciation and amortization....................... 46,658 5,244 22,949 21,436
Deferred income taxes............................... 25,579 213 (25,783) (2,834)
Loss on disposal of property, plant and equipment
and other......................................... 6,715 191 750 2,147
Provision for doubtful accounts..................... 5,171 296 999 530
Office of Personnel Management charge............... -- -- 25,000 --
Changes in assets and liabilities, net of effects
from acquisitions:
Receivables....................................... 10,621 13,037 (55,971) (27,458)
Prepaid expenses and other assets................. (21,621) (13,745) (5,038) (2,489)
Medical claims and benefits payable............... (4,704) 10,800 (21,261) (19,093)
Accounts payable, accrued liabilities, accrued
compensation and employee benefits and income
taxes payable................................... (93,347) (7,139) 573 35,756
Unearned premium revenue............................ 235,392 232,357 (172,156) 23,934
------------ ------------ ------------- -------------
Net cash flows provided by (used in) operating
activities...................................... 413,489 274,872 (72,992) 147,223
------------ ------------ ------------- -------------
Investing activities:
Acquisitions, net of cash acquired.................. (999,892) (358) (5,403) (134,971)
Proceeds from the dispositions of net assets held
for sale.......................................... 76,500 -- -- --
Purchase of property, plant and equipment........... (68,533) (4,614) (22,728) (25,035)
Purchase of marketable securities--restricted....... (15,475) (2,993) (9,298) (7,114)
Purchase of marketable securities................... (8,795) (33,964) (30,623) (6,395)
Proceeds from the sale of property, plant and
equipment......................................... 3,154 -- -- 3,056
------------ ------------ ------------- -------------
Net cash flows used in investing activities....... (1,013,041) (41,929) (68,052) (170,459)
------------ ------------ ------------- -------------
Financing activities:
Proceeds from borrowings of long-term debt.......... 1,120,000 -- -- 83,335
Principal payments on long-term debt................ (235,166) (8,625) (8,625) (174,483)
Capitalization of Talbert........................... (67,000) -- -- --
Proceeds from sale of Talbert stock................. 59,598 -- -- --
Proceeds from issuance of common stock.............. 43,838 612 13,342 200,920
Preferred dividends paid............................ (8,792) -- -- --
------------ ------------ ------------- -------------
Net cash flows provided by (used in) financing
activities...................................... 912,478 (8,013) 4,717 109,772
------------ ------------ ------------- -------------
Net increase (decrease) in cash and equivalents....... 312,926 224,930 (136,327) 86,536
Beginning cash and equivalents........................ 367,748 142,818 279,145 192,609
------------ ------------ ------------- -------------
Ending cash and equivalents........................... $ 680,674 $ 367,748 $ 142,818 $ 279,145
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
</TABLE>
See accompanying notes.
TABLE CONTINUED ON NEXT PAGE.
5
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995
------------ ------------- ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Supplemental cash flow information
Cash paid during the year for:
Income taxes...................................... $ 100,202 $ 794 $ 74,092 $ 61,166
Interest.......................................... $ 55,282 $ 241 $ 1,230 $ 2,685
Supplemental schedule of noncash investing and
financing activities:
Tax benefit realized upon exercise of stock
options........................................... $ 17,847 $ 2,351 $ 8,384 $ 3,683
Compensation awarded in Class B Common
Stock............................................. $ 756 $ -- $ 1,172 $ 1,024
Leases capitalized.................................. $ -- $ -- $ 183 $ 392
Details of unrealized gains on marketable securities:
Increase (decrease) in marketable securities........ $ 10,577 $ 3,495 $ (5,955) $ 7,986
Less (increase) decrease in deferred income taxes... (4,035) (1,337) 2,304 (3,042)
------------ ------------- ------------- -------------
Increase (decrease) in shareholders' equity......... $ 6,542 $ 2,158 $ (3,651) $ 4,944
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
Details of businesses acquired in purchase transac-
tions:
Fair value of assets acquired....................... $3,376,241 $ 448 $ 9,906 $ 152,456
Less liabilities assumed or created, including notes
to sellers........................................ (1,168,236) (90) (3,023) (15,909)
Less common and preferred stock consideration....... (1,163,595) -- -- --
------------ ------------- ------------- -------------
Cash paid for acquisitions.......................... 1,044,410 358 6,883 136,547
Cash acquired in acquisitions....................... (44,518) -- (1,480) (1,576)
------------ ------------- ------------- -------------
Net cash paid for acquisitions...................... $ 999,892 $ 358 $ 5,403 $ 134,971
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
</TABLE>
See accompanying notes.
TABLE CONTINUED FROM PREVIOUS PAGE.
6
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE REPORTING ENTITY
A) ORGANIZATION AND OPERATIONS. PacifiCare Health Systems, Inc. (the
"Company" or "PacifiCare") owns and operates federally qualified health
maintenance organizations ("HMOs"), which arrange health care services
principally for a predetermined, prepaid periodic fee to enrolled subscriber
groups through independent health care organizations under contract. The Company
also offers certain specialty products and services to group purchasers and to
other managed care organizations and their beneficiaries, including pharmacy
benefit management, life and health insurance, behavioral health services,
dental and vision services and Medicare risk management services. UniHealth, a
California non-profit public benefit corporation ("UniHealth"), owned
approximately 40 percent of the Company's outstanding shares of Class A Common
Stock, par value $0.01 per share (the "Class A Common Stock") and one percent of
the Company's Class B Common Stock, par value $0.01 per share (the "Class B
Common Stock"), at December 31, 1997.
B) BASIS OF PRESENTATION. The accompanying consolidated financial
statements include the accounts of the Company and all significant subsidiaries
that are more than 50 percent owned and controlled. All significant
intercompany transactions and balances have been eliminated in consolidation.
C) CHANGE OF YEAR END. In February 1997, the Company's board of directors
approved a change in its fiscal year end from September 30 to December 31.
Accordingly, the current year ended on December 31, 1997. The accompanying
financial statements and notes include results for the three-month transition
period ended December 31, 1996, as required by the Securities and Exchange
Commission ("SEC").
2. SIGNIFICANT ACCOUNTING POLICIES
A) CASH AND EQUIVALENTS. Cash and equivalents are defined as cash, money
market funds and certificates of deposit with a maturity, on acquisition date,
of three months or less.
B) MARKETABLE SECURITIES. All marketable securities (which include
municipal bonds, corporate notes, commercial paper and U.S. Treasury
securities), except marketable securities-restricted, are designated as
available-for-sale. Accordingly, marketable securities are carried at fair value
and unrealized gains or losses, net of applicable income taxes, are recorded in
shareholders' equity. Because marketable securities are available for use in
current operations, they are classified as current assets without regard to the
securities' contractual maturity dates.
The Company is required by state regulatory agencies to set aside funds for
the protection of their plan members in accordance with the laws of the various
states in which they operate. Such funds are classified as marketable
securities-restricted (which includes U.S. government securities and
certificates of deposit held by trustees or state regulatory agencies).
Marketable securities-restricted are designated as held-to-maturity since the
Company has the intent and ability to hold such securities to maturity. Held-to-
maturity securities are stated at amortized cost, adjusted for amortization of
premiums and accretion of discounts to maturity, and are classified as
non-current assets.
C) CONCENTRATIONS OF CREDIT RISK. Financial instruments that potentially
subject the Company to concentrations of credit risk consist primarily of
investments in marketable securities and commercial premiums receivable. The
Company's short-term investments in marketable securities are managed by
professional investment managers within guidelines established by the Company's
board of directors, which, as a matter of policy, limit the amounts that may be
invested in any one issuer. Concentrations of credit risk with respect to
commercial premiums receivable are limited due to the large number of
7
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
employer groups comprising the Company's customer base. In management's opinion,
the Company had no significant concentrations of credit risk at December 31,
1997.
D) FAIR VALUE OF FINANCIAL INSTRUMENTS. The Company's consolidated balance
sheets include the following financial instruments: cash and equivalents, trade
accounts and notes receivable, trade accounts payable and long-term obligations.
The Company considers the carrying amounts of current assets and liabilities in
the consolidated financial statements to approximate the fair value for these
financial instruments because of the relatively short period of time between
origination of the instruments and their expected realization. The carrying
value of all long-term obligations approximates the fair value of such
obligations.
E) PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are
recorded at cost; replacements and major improvements are capitalized, while
repairs and maintenance are charged to expense as incurred. Upon sale or
retirement of property, plant and equipment, the costs and related
accumulated depreciation are eliminated from the accounts. Any resulting
gains and losses are included in the determination of net income. Property,
plant and equipment including assets under capital leases are depreciated
using the straight-line method for financial reporting purposes over
estimated useful lives ranging from five to 25 years. Leasehold improvements
are amortized using the straight-line method over the term of the lease or
ten years, whichever is shorter. Accumulated depreciation totaled $129
million, $96 million, and $92 million as of December 31, 1997 and 1996, and
September 30, 1996, respectively.
F) GOODWILL, INTANGIBLE ASSETS AND LONG-LIVED ASSETS. The excess purchase
price over the fair value of net assets acquired has been allocated to goodwill
and identifiable intangible assets including employer group contracts, Medicare
contracts, provider networks and assembled workforce. Goodwill and intangible
assets are amortized on a straight-line basis over periods ranging from four to
40 years. Accumulated amortization totaled $84 million, $23 million and $25
million, as of December 31, 1997 and 1996, and September 30, 1996, respectively.
The Company assesses the recoverability of its goodwill, intangible
assets and long-lived assets on an annual basis or whenever adverse events or
changes in circumstances or business climate indicate that expected
undiscounted future cash flows for individual business units may not be
sufficient to support the recorded goodwill and intangible assets. These
events may include but are not limited to the exiting of certain markets due
to continuous losses or other changes in economic events. If undiscounted
cash flows are not sufficient to support the recorded asset, the Company
completes an analysis of the economic climate of such business units and a
discounted cash flows analysis. If the analysis is insufficient to support
the goodwill, intangible or long-lived assets, an impairment is recognized to
reduce the carrying value. During 1997 and 1996 the Company recorded pretax
charges related to the impairment of goodwill and intangible assets of $124
million and $59 million, respectively (see Note 9--"Impairment, Disposition,
Restructuring and Other Charges").
G) SOFTWARE COSTS. Direct costs associated with the development of
computer software are expensed as incurred. These costs totaled $20 million, $3
million, $13 million and $12 million for the year ended December 31, 1997, the
three months ended December 31, 1996 and the fiscal years ended September 30,
1996 and 1995, respectively.
8
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
H) PREMIUMS AND REVENUE RECOGNITION. Prepaid health care premiums from the
Company's HMOs enrolled groups are reported as revenue in the month in which
enrollees are entitled to receive health care. Premiums received prior to such
period are recorded as unearned premium revenue. Funds received under the
federal Medicare program accounted for approximately 58 percent, 59 percent, 57
percent and 57 percent of total premiums for the year ended December 31, 1997,
the three months ended December 31, 1996, and the fiscal years ended September
30, 1996 and 1995, respectively.
I) HEALTH CARE SERVICES. The Company's HMOs arrange for comprehensive
health care services to their members principally through capitation, a fixed
monthly payment made without regard to the frequency, extent or nature of the
health care services actually furnished. Benefits are provided to enrolled
members generally through the Company's contractual relationships with physician
groups and hospitals. The Company's contracted providers may, in turn, contract
with specialists or referral providers for specific services and are responsible
for any related payments to those referral providers.
The Company's HMOs have various programs that provide incentives to
participating medical groups through the use of risk-sharing agreements and
other programs. Payments are made to medical groups based on their performance
in controlling health care costs while providing quality health care. Expenses
related to these programs, which are based in part on estimates, are recorded in
the period in which the related services are dispensed.
The cost of health care provided is accrued in the period it is dispensed to
the enrolled members, based in part on estimates for hospital services and other
health care costs that have been incurred but not yet reported. The Company has
also recorded reserves, based in part on estimates, to indemnify its members
against potential referral claims related to insolvent medical groups. The
Company's HMOs have stop-loss insurance to cover unusually high costs of care
when incurred beyond a predetermined annual amount per enrollee.
J) PREMIUM DEFICIENCY RESERVES ON LOSS CONTRACTS. The Company assesses the
profitability of its contracts for providing health care services to its members
when current operating results or forecasts indicate probable future losses. The
Company compares anticipated premiums to health care related costs, including
estimated payments for providers, commissions and cost of collecting premiums
and processing claims. If the anticipated future costs exceed the premiums, a
loss contract accrual is recognized (see Note 9--"Impairment, Disposition,
Restructuring and Other Charges").
K) UTILIZATION REVIEW AND CASE MANAGEMENT SERVICES. The Company's HMOs
conduct utilization review and case management programs to ensure that their
providers deliver a consistent quality of care to members. The utilization
review program essentially provides patients with second opinions, while the
case management program assigns nurses to complicated, high-risk or chronic
cases to evaluate and recommend treatment options to the patient and provider.
Exclusive of costs related to the Company's behavioral health product, the HMOs'
costs associated with providing these medical services are recorded in
marketing, general and administrative expenses and totaled $15 million, $3
million, $12 million and $10 million for the year ended December 31, 1997, the
three months ended December 31, 1996 and the fiscal years ended September 30,
1996 and 1995, respectively.
L) ACCOUNTING FOR STOCK-BASED COMPENSATION. The Company accounts for its
stock-based compensation plans under the intrinsic-value method prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (see Note 8--"Employee Benefit Plans"). The intrinsic value
9
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
method requires companies to recognize expense on the issuance of certain
options if the market value of the underlying stock of such options on the date
of grant exceeds the exercise price. Since the exercise price of the Company's
stock options is greater than or equal to the market price of the underlying
stock on the date of grant, no compensation expense is recognized in the
Company's statements of operations.
M) TAXES BASED ON PREMIUMS. Certain states in which the Company does
business require the remittance of excise, per capita or premium taxes based
upon a specified rate for enrolled members or a percentage of billed premiums.
Such taxes may be levied in lieu of a state income tax. These amounts are
recorded in marketing, general and administrative expenses and totaled $13
million, $2 million, $6 million and $4 million for the year ended December 31,
1997, the three months ended December 31, 1996 and the fiscal years ended
September 30, 1996 and 1995, respectively.
N) INCOME TAXES. The Company recognizes deferred income tax assets and
liabilities for the expected future tax consequences of events that have been
included in the financial statements or tax returns. Deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities and are measured by applying enacted tax
rates and laws to taxable years in which such differences are expected to
reverse.
O) EARNINGS PER SHARE. In 1997, the Financial Accounting Standards Board
issued Statement No. 128 ("SFAS 128"), "Earnings per Share." SFAS 128 replaces
the calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options and convertible securities.
Diluted earnings per share is very similar to the previously reported fully
diluted earnings per share. All earnings per share amounts reported for the
years ended September 30, 1996 and 1995 have been presented, and where
necessary, were restated to conform to the SFAS 128 requirements. Restated
amounts did not vary materially from amounts previously stated. The following
table sets forth the computation of the denominator for basic and diluted
earnings per share.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995
------------- ------------- ------------- -------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Shares outstanding at the beginning of the
period.................................... 31,301 31,292 30,882 27,528
Weighted average number of shares issued:
FHP Acquisition........................... 8,498 -- -- --
Exercise of stock options................. 724 3 209 1,750
------ ------ ------ ------
Denominator for basic earnings per share.... 40,523 31,295 31,091 29,278
Employee stock options...................... -- 505 580 586
------ ------ ------ ------
Denominator for diluted earnings per
share..................................... 40,523 31,800 31,671 29,864
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
The Company's Series A Preferred Stock is convertible to approximately 3.9
million shares of Class B Common Stock. Additionally, the Company has
outstanding stock options under its employee and director
10
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
stock option plans. However, since the Company reported a net loss, these
potentially dilutive securities were not included in the calculation of the 1997
loss per share because they were anti-dilutive (see Note 6--"Shareholders'
Equity" and Note 8--"Employee Benefit Plans").
P) USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS. The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates. Principal
areas requiring the use of estimates include: determination of allowances for
doubtful accounts receivable, medical claims and benefits payable, professional
and general liability, reserves relating to the United States Office of
Personnel Management ("OPM") contract and certain other reserves (see Note
10--"Commitments and Contingencies").
11
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MARKETABLE SECURITIES
The following tables summarize marketable securities as of the dates
indicated:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Marketable securities:
U.S. government and agency......................... $ 427,728 $ 9,936 $ (399) $ 437,265
State, municipal and state and local agency........ 244,130 5,773 (731) 249,172
Corporate debt and other securities................ 176,543 1,941 (213) 178,271
---------- ----------- ----------- ------------
Total marketable securities.......................... 848,401 17,650 (1,343) 864,708
---------- ----------- ----------- ------------
Marketable securities--restricted:
U.S. government and agency......................... 110,555 1,106 (1,021) 110,640
Municipal and local agency......................... 8,898 45 (42) 8,901
Corporate debt and other securities................ 26,536 39 (39) 26,536
---------- ----------- ----------- ------------
Total marketable securities--restricted.............. 145,989 1,190 (1,102) 146,077
---------- ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1997......................... $ 994,390 $ 18,840 $ (2,445) $ 1,010,785
---------- ----------- ----------- ------------
---------- ----------- ----------- ------------
Marketable securities:
U.S. government and agency......................... $ 120,683 $ 2,635 $ (183) $ 123,135
State, municipal and state and local agency........ 211,871 3,879 (240) 215,510
Corporate debt and other securities................ 256,171 1,055 (1,137) 256,089
---------- ----------- ----------- ------------
Total marketable securities.......................... 588,725 7,569 (1,560) 594,734
---------- ----------- ----------- ------------
Marketable securities--restricted:
U.S. government and agency......................... 9,637 -- -- 9,637
State, municipal and state and local agency........ 8,400 -- -- 8,400
Corporate debt and other securities................ 17,362 -- -- 17,362
---------- ----------- ----------- ------------
Total marketable securities--restricted.............. 35,399 -- -- 35,399
---------- ----------- ----------- ------------
BALANCE AT DECEMBER 31, 1996......................... $ 624,124 $ 7,569 $ (1,560) $ 630,133
---------- ----------- ----------- ------------
---------- ----------- ----------- ------------
Marketable securities:
U.S. government and agency......................... $ 165,789 $ 988 $ (827) $ 165,950
State, municipal and state and local agency........ 205,321 2,986 (207) 208,100
Corporate debt and other securities................ 184,134 662 (1,571) 183,225
---------- ----------- ----------- ------------
Total marketable securities.......................... 555,244 4,636 (2,605) 557,275
---------- ----------- ----------- ------------
Marketable securities--restricted:...................
U.S. government and agency......................... 15,842 -- -- 15,842
Municipal and local agency......................... 8,020 -- -- 8,020
Corporate debt and other securities................ 8,544 -- -- 8,544
---------- ----------- ----------- ------------
Total marketable securities--restricted.............. 32,406 -- -- 32,406
---------- ----------- ----------- ------------
BALANCE AT SEPTEMBER 30, 1996........................ $ 587,650 $ 4,636 $ (2,605) $ 589,681
---------- ----------- ----------- ------------
---------- ----------- ----------- ------------
</TABLE>
12
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MARKETABLE SECURITIES (CONTINUED)
As of December 31, 1997 the contractual maturities of the Company's
marketable securities were as follows:
<TABLE>
<CAPTION>
MARKETABLE
SECURITIES--
MARKETABLE SECURITIES RESTRICTED
---------------------- ----------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
Due in one year or less................................ $ 198,354 $ 199,396 $ 61,661 $ 60,816
Due after one year through five years.................. 204,336 202,985 31,660 31,594
Due after five years through ten years................. 255,746 271,186 26,445 26,811
Due after ten years.................................... 189,965 191,141 26,223 26,856
---------- ---------- ---------- ----------
$ 848,401 $ 864,708 $ 145,989 $ 146,077
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
During the year ended December 31, 1997, three months ended December 31,
1996, and fiscal year ended September 30, 1996, proceeds from sales and
maturities of marketable securities were $3.4 billion, $507 million and $1.4
billion, respectively. Gross realized gains and gross realized losses are
included in interest income under the specific identification method.
4. ACQUISITIONS AND DISPOSITIONS
A) FHP ACQUISITION--1997. On February 14, 1997, FHP International
Corporation ("FHP") was acquired by the Company. Pursuant to the FHP
Acquisition, each outstanding share of FHP common stock was exchanged for $17.50
in cash, 0.056 shares of the Company's Class A Common Stock and 0.176 shares of
the Company's Class B Common Stock. Each outstanding share of FHP's preferred
stock was exchanged for $14.113 in cash and one-half of one share of the
Company's Series A Preferred Stock. The Company paid approximately $1.0 billion
in cash to holders of FHP common and preferred stock. The terms of the FHP
Acquisition also required FHP to contribute $67 million to Talbert Medical
Management Corporation ("Talbert"), a wholly owned subsidiary of FHP, which
increased its net worth to approximately $60 million on February 14, 1997. Also
at that time, FHP sold its investment in Talbert in exchange for a $60 million
non-recourse promissory note and rights to purchase shares of Talbert common
stock.
As part of the FHP Acquisition, each former FHP shareholder received Talbert
rights. Holders of Talbert rights were able to purchase one share of Talbert
common stock for each Talbert right for the subscription price of $21.50 per
share. Holders of Talbert rights were entitled to subscribe for all, or any
portion of, the shares of Talbert common stock underlying their Talbert rights
as well as to subscribe for any unallocated additional shares. In May 1997,
Talbert successfully completed its rights offering and shares of Talbert common
stock were distributed. Proceeds from the Talbert rights offering were used to
repay the non-recourse promissory note issued to FHP.
The FHP Acquisition has been accounted for as a purchase. Total
consideration of approximately $2.2 billion, including $18 million of
transaction costs, has been allocated to the assets acquired and liabilities
assumed based on estimates of their fair values. The Company recorded fair value
increases and decreases in tangible assets and liabilities acquired. Fair value
decreases included a $76 million decrease to property, plant and equipment
including real property write downs based on appraised values and the
13
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
abandonment of capitalized software and equipment. The Company also recognized
certain liabilities in connection with the acquisition as follows:
- $62 million of contractual obligations and commitments to conform all of
FHP's multiple information systems to one uniform system which will be
abandoned upon the final conversion to the Company's operating platform
(these costs are direct, incremental and are not related to the
development of new software systems that will have future economic
benefit);
- $33 million of severance benefits for the involuntary termination of FHP
employees (approximately $23 million had been paid as of December 31,
1997);
- $33 million of FHP OPM claims (see Note 10--"Commitments and
Contingencies"); and
- $14 million for the estimated lease termination costs of FHP facilities
abandoned.
The fair value of assets acquired and liabilities assumed were $0.9 billion
and $1.1 billion, respectively. A total of $2.4 billion, net of related deferred
taxes, representing the excess of the purchase price over the fair values of the
net assets acquired, has been allocated to goodwill and other acquired
intangible assets and is being amortized over a four to 40 year period.
Identified intangibles of $365 million include commercial employer group
contracts, Medicare contracts, provider networks and assembled workforce.
B) FLORIDA DISPOSITION--1997. In February 1997, the Company sold the
outstanding common stock of its Florida subsidiary, at which time the buyer
assumed the daily operations. The sales price, which approximated net book
value, totaled $9 million. The close of the sale was completed in July 1997 when
the Company received regulatory approval from the state of Florida.
C) PRO FORMA FINANCIAL STATEMENTS. The Company's consolidated results of
operations include FHP from February 14, 1997 and its Florida subsidiary through
February 1997. The pro forma information below presents combined results of
operations as if the FHP Acquisition, as well as the sale of the Company's
Florida subsidiary, had occurred at the beginning of 1996. The pro forma
information gives effect to actual operating results prior to the acquisition
and adjustments to interest expense, goodwill amortization and income taxes. No
adjustment has been made to give effect to any synergies that may be realized
as a result of the FHP Acquisition.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
(UNAUDITED)
(AMOUNTS IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C>
Total operating revenue.................................................... $9,541,105 $2,334,094
Pretax income.............................................................. $ 45,987 $ 66,465
Net income (loss).......................................................... $ (33,977) $ 34,558
------------ ------------
Basic earnings (loss) per share............................................ $ (0.80) $ 0.77
------------ ------------
Diluted earnings (loss) per share.......................................... $ (0.80) $ 0.76
------------ ------------
------------ ------------
</TABLE>
D) DISPOSITION OF FHP SUBSIDIARIES--1997. In February 1997, the Company
announced its intention to sell the Illinois and New Mexico subsidiaries of FHP.
The Company classified the subsidiaries as net
14
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
assets held for sale and assigned carrying values at the net realizable value.
FHP of Illinois was sold in October 1997 to The Principal Financial Group. FHP
of New Mexico was sold in November 1997 to Presbyterian Healthcare Services. Net
losses from the date of the FHP Acquisition through disposition totaling $15
million, and disposition gains totaling $46 million, have been treated as part
of the purchase price allocation. The pro forma financial information has not
been adjusted for these dispositions because the effects of these dispositions
were not significant.
E) FISCAL 1996 AND 1995 ACQUISITIONS. In January 1996, the Company
acquired Psychology Systems, Inc., a California-based managed care behavioral
health and employee assistance program company. During fiscal year 1995, the
Company acquired Preferred Solutions, a San Jose-based pharmacy benefit
management company; ValuCare, a Fresno, California-based HMO; and Pacific Health
Plans, a Washington-based HMO. The total purchase price for these acquisitions,
including contingent purchase payments, was approximately $131 million. Based on
the fair values of the assets and liabilities of the acquired companies, the
excess purchase price was approximately $126 million. The acquisitions were
accounted for as purchases and the operating results of each completed
acquisition were included in the consolidated financial statements from the date
of purchase. Amortization of excess purchase price is made over a period not to
exceed 40 years. Pro forma results of operations have not been presented because
the effects of these acquisitions were not significant.
5. LONG-TERM DEBT
In October 1996, the Company entered into a $1.5 billion credit facility
under which it borrowed $1.1 billion in February 1997 to pay $1.0 billion in
cash consideration to former holders of FHP common and preferred stock and to
make other acquisition-related payments. Through December 31, 1997, the Company
repaid $210 million of its borrowings under the credit facility, resulting in
$910 million outstanding. The Company's credit facility requires mandatory
reductions of the outstanding principal balance beginning January 1999 and is
required to be paid in full by January 1, 2002. As of December 31, 1997, the
outstanding balance on the credit facility would not require a reduction until
July 1, 2001. The Company is required to reduce the outstanding balance to $800
million by July 1, 2001 and pay the remaining balance by January 1, 2002.
Additional borrowings on the credit facility may result in the Company being
subject to earlier mandatory reduction of its outstanding balance. Interest
under the credit facility is presently based on the London Interbank Offering
Rate ("LIBOR") plus a spread, except for $350 million of the outstanding balance
which is covered by interest-rate swap agreements. The average fixed interest
rate paid by the Company on the existing swap agreements is approximately six
percent. The terms of the credit facility contain various covenants usual for
financing of this type, including a minimum net worth requirement, a minimum
fixed charge requirement and leverage ratios. At December 31, 1997, the Company
was in compliance with all such covenants. On February 14, 1997, the Company
assumed $100 million in FHP senior notes which carry an interest rate of seven
percent. Interest is payable semiannually and the notes mature on September 15,
2003. Maturities of long-term debt for the next five years are $0.2 million in
1998, $0.1 million in 1999, none in 2000, $910.0 million in 2001, $1.0 million
in 2002 and $100.0 million in 2003.
6. SHAREHOLDERS' EQUITY
The authorized Preferred Stock of the Company includes 11,000,000 authorized
shares of Series A Preferred Stock. Each share of Series A Preferred Stock
entitles its owner to convert it at any time to 0.374
15
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. SHAREHOLDERS' EQUITY (CONTINUED)
shares of Class B Common Stock, assuming no unpaid accrued dividends in arrears.
Series A Preferred Stock shareholders also have a preference of $25.00 per share
over the Common Stock in the event of involuntary or voluntary liquidation.
Dividends on the Series A Preferred Stock accrue at an annual rate of $1.00 per
share, are cumulative and payable quarterly when, as and if declared by the
board of directors. During 1997, the Company paid $9 million in dividends to its
preferred shareholders. There were no unpaid dividends on the Series A Preferred
shares at December 31, 1997.
On or after June 17, 1998, the Series A Preferred Stock may be redeemed at
the option of the Company for cash plus unpaid dividends. The redemption price
ranges from 103 percent to 100 percent of the stated value of Series A Preferred
Stock, or $25.00 per share, in one-half percent decrements for each successive
anniversary of June 17, 1998 through 2004. Series A Preferred Stock ranks senior
to the Class A and B Common Stock with respect to dividend and liquidation
rights, and holders of Series A Preferred Stock generally have no voting rights;
however, there are certain exceptions including the right to elect two
additional directors if the equivalent of six quarterly dividends payable on the
Series A Preferred Stock are in default.
In March 1995, the Company completed a public offering of 5,175,000 shares
of its Class B Common Stock, of which 3,000,000 shares were issued and sold by
the Company and 2,175,000 shares were sold by UniHealth. The Company received
net proceeds of approximately $198 million from the sale after deducting
underwriting discounts and commissions and expenses of the offering payable by
the Company. The Company did not receive any of the proceeds from the sale of
shares of Class B Common Stock by UniHealth.
16
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES
Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30,
1997 1996 1996
------------- ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Current deferred tax assets (liabilities):
Future benefit from goodwill impairment................. $ -- $ 22,433 $ 22,637
Accrued health care costs............................... 59,938 15,334 14,477
Accrued compensation.................................... 14,939 12,687 11,025
Accrued expenses........................................ 37,819 5,198 5,107
Other assets............................................ 14,447 4,803 2,550
Depreciation............................................ -- 917 2,137
State franchise taxes................................... 3,852 (1,543) 1,779
Prepaid expenses........................................ (2,381) (1,476) (1,451)
Unrealized gains on marketable securities............... (6,550) (2,075) (738)
Pharmacy rebate......................................... (11,190) -- --
Other................................................... 1,163 (1,533) (1,228)
------------- ------------ -------------
$ 112,037 $ 54,745 $ 56,295
------------- ------------ -------------
------------- ------------ -------------
Non-current deferred tax assets (liabilities):
Future benefits from goodwill impairment................ $ 3,569 $ -- $ --
Accrued health care costs............................... 6,314 -- --
Accrued expenses........................................ 22,922 -- --
Identifiable intangibles................................ (132,067) -- --
Depreciation............................................ (7,374) -- --
Other................................................... 3,843 -- --
------------- ------------ -------------
$ (102,793) $ -- $ --
------------- ------------ -------------
------------- ------------ -------------
</TABLE>
17
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
The provision for income taxes consists of the following components for the
periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995
------------ ------------ ------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current:
Federal................................... $ 46,810 $ 17,337 $ 62,781 $ 62,912
State..................................... 9,436 3,529 13,829 13,927
------------ ------------ ------------- -------------
Total current............................. 56,246 20,866 76,610 76,839
Deferred:
Federal................................... 18,754 163 (22,172) (2,444)
State..................................... 6,825 50 (3,611) (390)
------------ ------------ ------------- -------------
Total deferred............................ 25,579 213 (25,783) (2,834)
------------ ------------ ------------- -------------
Provision for income taxes................ $ 81,825 $ 21,079 $ 50,827 $ 74,005
------------ ------------ ------------- -------------
------------ ------------ ------------- -------------
</TABLE>
The following table summarizes significant differences between the provision
for income taxes and the amount computed by applying the statutory federal
income tax rate to income before income taxes:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS YEAR ENDED YEAR ENDED
DECEMBER 31, ENDED DECEMBER SEPTEMBER 30, SEPTEMBER 30,
1997 31, 1996 1996 1995
--------------- --------------- ----------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Computed expected provision............... 35.0% 35.0% 35.0% 35.0%
State taxes, net of federal benefit....... 16.9 4.4 4.4 4.9
Tax exempt interest....................... (6.3) (2.0) (3.6) (2.2)
Impairment of non-deductible goodwill..... 54.6 -- 1.8 --
Amortization of intangibles............... 29.7 0.9 1.5 1.1
Other, net................................ 6.2 1.6 2.3 1.8
----- --- --- ---
Provision for income taxes................ 136.1% 39.9% 41.4% 40.6%
----- --- --- ---
----- --- --- ---
</TABLE>
The majority of the goodwill impairment charges (see Note 9--"Impairment,
Disposition, Restructuring and Other Charges") recorded in the fourth quarter of
1997 are not deductible for income tax purposes. Therefore, the Company did not
record a benefit for most of these charges. The magnitude of these charges, in
conjunction with the inability to record a related income tax benefit, resulted
in the Company reporting a disproportionately high effective income tax rate.
The 1997 effective income tax rate without the effect of the impairment charges
was approximately 50 percent. Excluding the impact of non-deductible goodwill
impairment and amortization, the impact of state taxes, net of federal
benefit, would have been 5.3 percent for 1997.
18
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT PLANS
A) SAVINGS AND PROFIT-SHARING PLANS. Substantially all full-time employees
of the Company are eligible to participate in a savings and profit-sharing plan.
Under the plan, participants may defer up to 12 percent of their annual
compensation with the Company matching one-half of the deferral, up to a maximum
of three percent of annual compensation per employee. Additionally, the Company
automatically contributes two percent of annual compensation per employee to the
plan, and at the discretion of the Company's board of directors, an additional
amount may be contributed to each participant generally based on a percentage of
pretax income. Contributions to the plan totaled $7 million, $3 million, $14
million and $14 million for the year ended December 31, 1997, three months ended
December 31, 1996 and the fiscal years ended September 30, 1996 and 1995,
respectively.
FHP had an Employee Stock Ownership Plan that covered substantially all FHP
employees. The FHP plan consisted of three separate parts: an employee stock
ownership plan (the "ESOP"); a 401(k) plan; and a payroll-based tax credit
employee stock ownership plan. Effective February 14, 1997, the payroll-based
tax credit employee stock ownership plan was spun off into a separate plan and
was terminated. The ESOP portion and the 401(k) portion were continued as part
of the FHP plan which, effective February 14, 1997, was converted to a
profit-sharing plan (the "FHP Savings Plan"). The FHP Savings Plan was amended
to eliminate certain provisions to discontinue distributions in shares of FHP
common stock. FHP employees participated in the FHP Savings Plan until December
31, 1997, at which time they became eligible to participate in the Company's
plan. In 1998 all eligible participants' balances will be transferred to the
Company's plan and The FHP Savings Plan will be merged into the Company's plan.
The Company will be making contributions to the FHP Savings Plan for 1997 during
1998.
FHP maintained a defined contribution pension plan to which it ceased making
contributions effective January 1996. All participants in the pension plan
vested as of December 31, 1995. The pension plan was terminated effective
December 31, 1997, with participants to receive distributions in early 1998.
B) STOCK OPTION PLANS. The Company has three stock option plans: the 1996
Employee Plan, the 1996 Director Plan and the 1997 Premium Plan. Under the 1996
Employee Plan, officers and key employees are granted options to purchase shares
of the Company's common stock at exercise prices equal or greater than the
market price on the date of grant. Stock appreciation rights and stock payments
may also be awarded under the 1996 Employee Plan. No stock appreciation rights
have been awarded under the 1996 Employee Plan. Options granted under the 1996
Employee Plan generally vest over a four-year period with 25 percent of the
options vesting each year. During 1997, the Company granted options that vest
upon achievement of certain earnings targets. Vested options may be exercised at
any time during the ten years subsequent to the date of grant, except upon the
death, disability, retirement or termination of employment of the optionee.
Options granted under the stock option plans expire ten years from the date of
grant. At December 31, 1997, approximately 0.9 million shares were available for
awards under the 1996 Employee Plan.
In 1997, certain holders of the Company's stock options received additional
stock options in exchange for waiving the accelerated vesting provision of their
options triggered by the FHP Acquisition. Also during 1997, certain stock
options were canceled and new options were granted with exercise prices equal to
the Company's stock price on the grant date. The new options have a four-year
vesting schedule commencing on the date of grant, except for options that vest
based on earnings targets that continue to vest based on the original earnings
targets.
19
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT PLANS (CONTINUED)
The 1996 Director Plan provides for the automatic annual grant of options to
purchase 5,000 shares of the Company's common stock to each eligible non-officer
director of the Company. Options granted under the 1996 Director Plan have a
four-year vesting schedule with 25 percent of the options vesting each year
after the date of grant.
In October 1997, the compensation committee adopted the 1997 Premium Priced
Stock Option Plan, subject to shareholder approval. Under the 1997 Premium Plan,
certain officers of the Company were granted options to purchase shares of the
Company's common stock. No participant may receive options to purchase more than
400,000 shares per year. Currently, the maximum number of shares available to
grant under this plan is 2.4 million. Fifty percent of the options granted under
the 1997 Premium Plan vest within three years of the date of grant if the price
of the Company's Class B Common Stock reaches $92.50, which is the exercise
price. The remaining 50 percent vest if the price of the Company's Class B
Common Stock reaches $114.00 within five years, with the exercise price equal to
$114.00. The first 50 percent of the options expire in 2000 if the $92.50 stock
price is not achieved and the remaining 50 percent expire in 2002 if the $114.00
stock price is not achieved. During 1997 nearly 2.4 million options were granted
under the 1997 Premium Plan.
Effective with the FHP Acquisition, stock options to purchase shares of FHP
common stock were exchanged for options to purchase shares of the Company's
Class B Common Stock, along with Talbert rights (see Note 4--"Acquisitions and
Dispositions"). Non-qualified stock option activity for the periods indicated
was as follows:
<TABLE>
<CAPTION>
NON-QUALIFIED STOCK OPTIONS
----------------------------------------------------------
CLASS A WEIGHTED AVERAGE CLASS B WEIGHTED AVERAGE
STOCK EXERCISE PRICE STOCK EXERCISE PRICE
--------- ----------------- ---------- ----------------
<S> <C> <C> <C> <C>
OUTSTANDING AT SEPTEMBER 30, 1995........... 357,084 $ 7.77 1,692,311 $ 46.38
Granted at market price..................... -- -- 402,150 $ 71.34
Exercised................................... (48,250) $ 9.58 (333,168) $ 35.93
Canceled.................................... -- -- (114,172) $ 64.93
--------- ----- ---------- -------
OUTSTANDING AT SEPTEMBER 30, 1996........... 308,834 $ 7.49 1,647,121 $ 53.21
Granted at market price..................... -- -- 358,300 $ 80.92
Exercised................................... -- -- (9,722) $ 62.91
Canceled.................................... -- -- (210,561) $ 80.25
--------- ----- ---------- -------
OUTSTANDING AT DECEMBER 31, 1996............ 308,834 $ 7.49 1,785,138 $ 55.79
Granted at market price..................... -- -- 1,948,100 $ 70.98
Granted in excess of market price........... -- -- 1,187,500 $ 92.50
Granted in excess of market price........... -- -- 1,187,500 $ 114.00
Exchanged for FHP stock options............. -- -- 933,594 $ 51.83
Exercised................................... (74,784) $ 5.85 (903,029) $ 46.98
Canceled.................................... -- -- (470,347) $ 75.04
--------- ----- ---------- -------
OUTSTANDING AT DECEMBER 31, 1997............ 234,050 $ 8.02 5,668,456 $ 75.51
--------- ----- ---------- -------
--------- ----- ---------- -------
</TABLE>
20
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT PLANS (CONTINUED)
The following is a summary of stock options exercisable as of the dates
indicated:
<TABLE>
<CAPTION>
NON-QUALIFIED STOCK OPTIONS
-----------------------------------------------------------
CLASS A WEIGHTED AVERAGE CLASS B WEIGHTED AVERAGE
STOCK EXERCISE PRICE STOCK EXERCISE PRICE
--------- ----------------- ---------- -----------------
<S> <C> <C> <C> <C>
Exercisable at September 30, 1995........... 342,984 $ 7.36 395,114 $ 21.23
Exercisable at September 30, 1996........... 308,834 $ 7.49 435,474 $ 35.57
Exercisable at December 31, 1996............ 308,834 $ 7.49 728,316 $ 45.73
Exercisable at December 31, 1997............ 234,050 $ 8.02 1,268,710 $ 54.62
</TABLE>
The following is a summary of information about options outstanding and
options exercisable at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- --------------------------------- ----------- --------------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
CLASS A STOCK:
$1.63 - $19.75................... 234,050 3 $ 8.02 234,050 $ 8.02
----------- --- ------------- ---------- ------
----------- --- ------------- ---------- ------
CLASS B STOCK:
$ 0.48 - $19.75.................. 75,312 4 $ 9.21 75,312 $ 9.21
$29.75 - $43.34.................. 393,662 6 $ 39.14 374,809 $ 39.36
$44.75 - $67.00.................. 1,664,326 9 $ 64.65 572,114 $ 62.97
$68.88 - $92.50.................. 2,347,656 9 $ 82.84 246,475 $ 72.32
$114.00.......................... 1,187,500 10 $ 114.00 -- --
----------- ----------
5,668,456 1,268,710
----------- ----------
----------- ----------
</TABLE>
C) PRO FORMA STOCK OPTION DISCLOSURE. Pro forma net earnings and earnings
per share information, as required by Statement of Financial Accounting
Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation," has
been determined as if the Company had accounted for employee stock options under
SFAS 123's fair value method. The fair value of these options was estimated at
grant date using a Black-Scholes option pricing model with the following
weighted-average assumptions for fiscal 1997 and 1996, respectively: risk-free
interest rate of six percent; dividend yield of zero percent; weighted average
expected option life of three years; and volatility of the expected market price
of the Company's common stock of 43 percent.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period of the options. The
Company's pro forma net income (loss) for the year ended December 31, 1997,
three months ended December 31, 1996 and fiscal year ended September 30, 1996
was $(48) million, $31 million and $69 million, respectively, the pro forma
basic earnings (loss) per share were $(1.19), $0.99 and $2.24 and pro forma
diluted earnings (loss) per share were $(1.19), $0.97 and $2.19 respectively.
These pro forma amounts include amortized fair values attributable to options
granted after October 1, 1995 only, and therefore are not representative of
future pro forma amounts.
21
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT PLANS (CONTINUED)
The weighted-average fair values on the grant date for options granted at
market values for the year ended December 31, 1997, three months ended December
31, 1996 and the fiscal year ended September 30, 1996, were $71.95, $80.95 and
$71.53, respectively. The weighted-average fair value on the grant date for
options granted in excess of market value during 1997 was $68.63.
9. IMPAIRMENT, DISPOSITION, RESTRUCTURING AND OTHER CHARGES
A) YEAR ENDED DECEMBER 31, 1997. The Company recognized pretax charges for
the year ended December 31, 1997 totaling $155 million ($129 million or $3.18
diluted loss per share, net of tax). The pretax charges included fourth quarter
write-offs associated with the impairment of goodwill in certain of the
Company's markets, restructuring charges and certain other charges.
IMPAIRMENT. The Company recognized a $124 million ($111 million or $2.73
diluted loss per share, net of tax) charge for goodwill and intangible assets
that were impaired and no longer recoverable from future operations. These
pretax charges relate to the following markets and products:
- $63 million for the Utah HMO;
- $40 million for the Washington health plan; and
- $21 million primarily for discontinued workers' compensation products.
As discussed in the second quarter, Utah's operating loses were related to
lower than expected 1997 premium rate increases coupled with a shift of
membership from capitated to non-capitated health care providers as a
significant health care provider contract switched from capitation to
fee-for-service. The Company agreed to continue this contract to ensure an
adequate infrastructure to service the Utah membership. At the same time, the
Utah information systems migrated to the standard FHP system in anticipation of
the conversion of the FHP system into the Company's common system. As a result,
increased utilization under the new fee-for-service contract was not visible
until the fourth quarter of 1997 when conversion reconciliations discovered
significant unpaid claims as well as claims paid inaccurately. The Company
expects that economic and competitive conditions in Utah will continue to
minimize premium increases and will make provider capitation contracting
difficult. Because the 1997 losses and the cash flow analysis did not support
the recoverability of goodwill, the Company recorded an impairment charge and
announced that it will exit or otherwise dispose of the Utah operations.
Since its acquisition, the Washington market has had a history of operating
losses. While capitated contracts have been implemented, claims payment issues
continue as most providers are not able to administer the claims process.
Utilization also continues to be higher than expected. The Company determined
that goodwill and intangibles were no longer recoverable and recorded an
impairment charge in light of the historical and increasing losses in the market
and expected future cash flows.
The Company owns a subsidiary that provides workers' compensation benefits.
In developing its 1998 business plan, the Company determined that California
legislation did not allow workers' compensation products to be priced at a
competitive rate that would result in the required return on investment. Without
a profitable California revenue stream, the remaining business did not support
the recoverability of the goodwill and the impairment was recorded.
The Company is committed to the successful integration of FHP and as part of
that process continually assesses the efficiency of its operations and
determines whether duplicative functions or
22
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. IMPAIRMENT, DISPOSITION, RESTRUCTURING AND OTHER CHARGES (CONTINUED)
facilities exist. As a result of that commitment, the Company identified
opportunities to restructure and streamline operations which resulted in
recording a restructuring charge in the fourth quarter of 1997 in the amount of
$15 million ($9 million or $0.22 diluted loss per share, net of tax). The
restructuring charges include work force reductions, facility consolidation and
other related cost accruals. To improve efficiency and reduce costs, the Company
experienced a work force reduction. Work force costs of $8 million primarily
include employee severance related to involuntary termination programs. Lease
terminations of $5 million pretax were associated with the consolidation of
administrative and operations office space. Other related charges totaled $2
million, pretax. Cash flows from operations are expected to fund all of the
restructuring charges. The restructuring should be complete by December 1998.
OTHER. Approximately $16 million ($9 million, or $0.23 diluted loss per
share, net of tax) of other charges were recorded for contracts for which the
anticipated future health care costs exceed the premiums. Approximately $13
million ($8 million, or $0.19 diluted loss per share, net of tax) related to
PacifiCare of Utah due to the continuing losses anticipated by the plan. The
remaining charge for loss contract accruals pertains to a workers' compensation
insurance company and an HMO plan.
B) YEAR ENDED SEPTEMBER 30, 1996. The Company recognized pretax
impairment, disposition, restructuring and OPM charges for the year ended 1996
totaling $101 million ($62 million or $1.96 diluted loss per share, net of tax).
IMPAIRMENT. During 1996, the Company decided that its PacifiCare of Florida
("Florida") subsidiary would not launch the Secure Horizons program and withdrew
its HCFA application after considering the effects of enhanced state regulation,
reduced Medicaid reimbursement, and continued losses experienced in the Florida
market. The business strategy for Florida profitability was based on launching
the Company's Secure Horizons program. Accordingly, the Company recognized a $59
million ($34 million or $1.08 diluted loss per share, net of tax) charge for the
impairment of goodwill and decided to sell its Florida operations.
DISPOSITION OF MEDICAL CLINICS. Effective June 1, 1996, the Company sold
the assets of its Florida subsidiary's staff-model medical clinics resulting in
a pretax loss of $9 million ($8 million or $0.26 diluted loss per share, net of
tax).
RESTRUCTURING. During 1996, management approved a plan relating to the
discontinuation of certain specialty heath care products and services that
did not meet the Company's strategic and economic return objectives,
including a reduction in work force and the establishment of regional
customer service centers. A restructuring charge of $8 million ($5 million or
$0.15 diluted loss per share, net of tax) was recognized which included
employee severance related to an involuntary work force reduction of
approximately $4 million, write-offs of assets designated for disposition of
approximately $3 million, and other related costs of approximately $1
million. The restructuring was financed by cash flows from operations and
actual expenditures did not differ materially from amounts accrued.
OTHER. In June 1996, a pretax charge was recognized of $25.0 million ($15
million, or $0.47 diluted loss per share, net of tax) for an increase of
reserves in anticipation of negotiations relating to potential governmental
claims for contracts with OPM. The Company's HMO subsidiaries have commercial
contracts with OPM to provide managed health care services to members under the
Federal Employees Health Benefits Program ("FEHBP"). OPM, as a normal course of
business, audits health plans with which it contracts to, among other things,
verify that premiums charged under OPM contracts are
23
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. IMPAIRMENT, DISPOSITION, RESTRUCTURING AND OTHER CHARGES (CONTINUED)
established in compliance with community rating and other requirements under the
FEHBP. Currently, OPM audits for multiple periods are in various stages of
completion for the majority of the Company's HMO subsidiaries.
10. COMMITMENTS AND CONTINGENCIES
A) OPM. The Company's HMO subsidiaries have commercial contracts with OPM
to provide managed health care services to members under FEHBP for federal
employees, annuitants and their dependents. In the normal course of business,
OPM audits health plans with which it contracts to, among other things, verify
that the premiums calculated and charged to OPM are established in compliance
with the best price community rating guidelines established by OPM. OPM
typically audits plans once every five or six years and each audit covers the
prior five or six year period. Depending on the type of contract the Company has
with OPM, OPM will audit one or more health plans at the same time. OPM has
notified PacifiCare of its intent to audit or has recently completed an audit of
the majority of the Company's health plans. While the government's initial
on-site audits are usually followed by a post-audit briefing in which the
government indicates its preliminary results, final resolution and settlement of
the audits have historically taken a minimum of three to five years.
In addition to claims made by the auditors as part of the normal audit
process, the OPM may also refer their results to the United States Department of
Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ
has the authority to file a claim under the False Claims Act if it believes that
the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claims Act actions, the
government may impose trebled damages and a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim. In November
1997, the Company was notified that the 1995 audit of the operations of the
Company's Oklahoma HMO subsidiary had been referred to the DOJ. The Company is
negotiating to settle this matter with the DOJ.
PacifiCare intends to negotiate with OPM and the DOJ on all matters to
attain a mutually satisfactory result. There can be no assurance, however, that
these negotiations will be concluded satisfactorily, that additional audits will
not be referred to the DOJ, or that additional, possibly material, liability
will not be incurred. The Company has also entered into discussions with OPM.
The Company believes that any ultimate liability in excess of amounts accrued
would not materially affect the Company's consolidated financial position.
However, such liability could have a material effect on results of operations or
cash flows of a future quarter if resolved unfavorably.
B) LEASE COMMITMENTS. The Company leases office space and equipment under
various non-cancelable operating leases. Rental expense totaled $48 million, $5
million, $29 million and $18 million for the year ended December 31, 1997, the
three months ended December 31, 1996 and the fiscal years ended September 30,
1996 and 1995, respectively.
For the years ending December 31, 1998 through 2002, future minimum lease
payments total $51 million, $38 million, $26 million, $18 million and $15
million, respectively. Minimum lease payments after December 31, 2002 will be
$35 million.
The Company has entered into a real estate and equipment master transfer
agreement to provide for the lease, sublease or assignment by the Company of
facilities and equipment that are either owned or leased by the Company. The net
book value of such facilities and equipment at December 31, 1997 was
24
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
approximately $83 million. The leases are accounted for as operating leases,
and subleases are accounted for as rental income. The agreement has been
amended to include extensions, at prevailing market rates, of the existing
terms of the individual leases to December 31, 2005 and two five-year
extension options at prevailing market rates, exercisable solely at the
lessee's discretion; and a right of first offer for the lessee to purchase
the furniture, fixtures and equipment. The parties have also agreed to enter
into a separate lease agreement with respect to furniture, fixtures and
equipment that will expire on December 31, 2000.
C) EMPLOYMENT AGREEMENTS. The Company has entered into employment
agreements with the president and chief executive officer of the Company and
certain other executive officers. The agreements contain provisions that
would entitle each to receive severance benefits that are payable if
employment is terminated for various reasons, including termination following
a change of ownership or control of the Company as defined by the agreements.
The maximum contingent liability for severance payments that the Company
would be required to make under the employment agreements (excluding amounts
that may be payable under incentive plans and the value of certain benefits)
is approximately $10 million at December 31, 1997.
D) LEGAL PROCEEDINGS. The Company has been served with several purported
class action suits alleging violations of federal securities laws by the Company
and by certain of its officers and directors. The complaints relate to the
period from the date of the FHP Acquisition through the Company's November 25,
1997 announcement that earnings for the fourth quarter of 1997 would be lower
than expected. These complaints primarily allege that the Company previously
omitted and/or misrepresented material facts with respect to its costs, earnings
and profits. These suits are at a very early stage and no discovery has
occurred. The Company believes it has good defenses to the claims in these suits
and is contesting them vigorously.
The Company is also involved in legal actions in the normal course of
business, some of which seek monetary damages, including claims of punitive
damages which are not covered by insurance. After review, including
consultation with counsel, based on current information, management believes
any ultimate liability in excess of amounts accrued that would likely arise
from these actions (including the purported class actions) would not
materially affect the Company's consolidated financial position, results of
operations or cash flows. However, management's evaluation of the likely
impact of these actions could change in the future and an unfavorable
outcome, depending upon the amount and timing, could have a material adverse
effect on the Company's results of operations or cash flows for a future
quarter.
25
<PAGE>
11. SUBSEQUENT EVENTS
REDEMPTION OF SERIES A PREFERRED STOCK
On May 22, 1998, the Company announced that it would redeem its Series A
Preferred Stock on June 23, 1998, at $25.75 per share plus accrued and unpaid
dividends (approximately $0.02 per share), for a total redemption price of
approximately $25.77 per share. Each share of Series A Preferred Stock is
convertible into 0.37419548 shares of the Company's Class B Common Stock
through June 22, 1998.
DEBT SECURITIES REGISTRATION STATEMENT
The Company has filed a registration statement with the SEC to register $250
million of debt securities in one or more series (the "Debt Securities").
The Company intends to file an amendment to the registration statement
related to the offering of the Debt Securities. The amendment will provide
that the obligations of the Company to pay the principal of, and interest on
the Debt Securities may be guaranteed on a full, unconditional and joint and
several basis by PacifiCare Operations, Inc. and FHP International
Corporation (the "Subsidiary Guarantors"). The Subsidiary Guarantors are
each a direct, wholly owned subsidiary of the Company.
The Subsidiary Guarantors are holding companies rather than operating
companies, and most of their subsidiaries are subject to HMO or insurance
regulations. The regulated subsidiaries are generally required to satisfy
minimum equity, capital, deposit and/or reserve requirements. At December
31, 1997 these requirements approximated $195 million. These requirements,
which limit the ability of the regulated subsidiaries to transfer funds to
the Subsidiary Guarantors, may impact the amount of funds that may be paid by
the subsidiaries to the Subsidiary Guarantors. In addition, the rights of the
Subsidiary Guarantors and the rights of their creditors, including holders of
the Debt Securities, to participate in any distribution of the assets of a
subsidiary upon the liquidation or recapitalization of such subsidiary will
be subject to the prior claims of certain of the subsidiary's creditors,
except to the extent that a Subsidiary Guarantor itself may be a creditor
with recognized claims against the subsidiary.
In accordance with SEC requirements, the Company has prepared consolidating
condensed financial statements to quantify the assets, operations and cash
flows of the Subsidiary Guarantors. The following consolidating condensed
balance sheets, consolidating condensed statements of operations and
consolidating condensed statements of cash flows present financial
information for:
PARENT - PacifiCare Health Systems, Inc. on a stand-alone basis (carrying
investments in subsidiaries under the equity method); the Company became the
parent on February 14, 1997 effective with the FHP Acquisition (See Note 4
- -"Acquisitions and Dispositions").
GUARANTOR SUBSIDIARIES - PacifiCare Operations, Inc. (formerly PacifiCare
Health Systems, Inc.) and FHP International Corporation on a stand-alone
basis (carrying investments in subsidiaries under the equity method).
Effective with the FHP Acquisition, both companies ceased to be parent
companies. Prior to the FHP Acquisition, PacifiCare Operations, Inc. was the
ultimate parent company and borrower; there were no guarantor subsidiaries.
NON-GUARANTOR SUBSIDIARIES - Represents all other directly or indirectly
wholly owned subsidiaries of the Guarantor Subsidiaries on a consolidated
basis.
ELIMINATIONS - Entries eliminating investment in subsidiaries and
intercompany balances and transactions.
THE COMPANY - The financial information for PacifiCare Health Systems, Inc.
on a condensed consolidated basis.
PROVISION FOR INCOME TAXES - The Company and its Non-Guarantor Subsidiaries
record the provision for income taxes in accordance with an intercompany
tax-sharing agreement. Income tax benefits available to a Non-Guarantor
Subsidiary which arise from net operating losses can only be used to offset
the Non-Guarantor Subsidiary's taxable income in future periods. Accordingly,
the tax benefit is excluded from the Non-Guarantor Subsidiary's operating
results.
26
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED BALANCE SHEETS SUBSIDIARY NON-GUARANTOR
DECEMBER 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Assets
Current assets:
Cash and equivalents $ - $ 24,119 $ 656,555 $ - $ 680,674
Marketable securities - 118,902 745,806 - 864,708
Receivables, net - 4,987 292,271 4,087 301,345
Intercompany (78,230) (239,847) 318,077 - -
Prepaid expenses and other current assets 176 5,001 27,017 32,194
Deferred income taxes (1,323) 64,930 48,430 - 112,037
- ------------------------------------------------------------------------------------------------------------------------
Total current assets (79,377) (21,908) 2,088,156 4,087 1,990,958
- ------------------------------------------------------------------------------------------------------------------------
Property, plant and equipment, net - 64,699 171,244 - 235,943
Marketable securities - restricted - 100 145,889 - 145,989
Investment in subsidiaries 2,551,394 1,397,882 (89,962) (3,859,314) -
Goodwill and intangibles, net - 1,156,660 1,301,803 - 2,458,463
Other assets 9,831 176,540 11,352 (161,118) 36,605
- ------------------------------------------------------------------------------------------------------------------------
$2,481,848 $2,773,973 $3,628,482 $(4,016,345) $4,867,958
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ - $ - $ 711,513 $ 4,087 $ 715,600
Accounts payable and accrued liabilities 18,175 105,176 306,173 - 429,524
Unearned premium revenue - - 491,808 - 491,808
Long-term debt due within one year - - 154 - 154
- ------------------------------------------------------------------------------------------------------------------------
Total current liabilities 18,175 105,176 1,509,648 4,087 1,637,086
- ------------------------------------------------------------------------------------------------------------------------
Long-term debt due after one year 910,000 100,000 162,352 (161,118) 1,011,234
Deferred income taxes - 4,796 97,997 - 102,793
Other liabilities - - 54,283 - 54,283
Minority interest - - 375 - 375
Shareholders' equity:
Capital stock 525 659 59,508 (60,167) 525
Additional paid-in capital 1,599,229 2,079,138 1,626,490 (3,705,628) 1,599,229
Unrealized gain on available-for-sale
securities, net of taxes - 1,595 8,398 - 9,993
Retained (deficit) earnings (46,081) 482,609 109,431 (93,519) 452,440
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 1,553,673 2,564,001 1,803,827 (3,859,314) 2,062,187
- ------------------------------------------------------------------------------------------------------------------------
$2,481,848 $2,773,973 $3,628,482 $(4,016,345) $4,867,958
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
27
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED BALANCE SHEETS NON-GUARANTOR
DECEMBER 31, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and equivalents $26,561 $341,187 $ - $367,748
Marketable securities 115,356 479,378 - 594,734
Receivables, net 2,434 149,109 4,669 156,212
Intercompany 107,427 (107,427) - -
Prepaid expenses and other current assets 1,328 7,548 - 8,876
Deferred income taxes 34,262 20,483 - 54,745
- ------------------------------------------------------------------------------------------------------
Total current assets 287,368 890,278 4,669 1,182,315
- ------------------------------------------------------------------------------------------------------
Property, plant and equipment, net 25,755 65,484 - 91,239
Marketable securities - restricted - 35,399 - 35,399
Investment in subsidiaries 458,932 88,382 (547,314) -
Goodwill and intangibles, net 4,885 222,537 - 227,422
Other assets 135,292 8,679 (118,874) 25,097
- ------------------------------------------------------------------------------------------------------
$912,232 $1,310,759 $(661,519) $1,561,472
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ - $274,671 $ 4,129 $278,800
Accounts payable and accrued liabilities 53,521 108,821 540 162,882
Unearned premium revenue - 256,416 - 256,416
Long-term debt due within one year 1,404 107 - 1,511
- ------------------------------------------------------------------------------------------------------
Total current liabilities 54,925 640,015 4,669 699,609
- ------------------------------------------------------------------------------------------------------
Long-term debt due after one year 76 120,168 (118,874) 1,370
Minority interest - 391 - 391
Shareholders' equity:
Capital stock 313 50,303 (50,303) 313
Additional paid-in capital 373,405 315,569 (315,569) 373,405
Unrealized gain on available-for-sale
securities, net of taxes 580 2,871 - 3,451
Retained earnings 482,933 181,442 (181,442) 482,933
- ------------------------------------------------------------------------------------------------------
Total stockholders' equity 857,231 550,185 (547,314) 860,102
- ------------------------------------------------------------------------------------------------------
$912,232 $1,310,759 $(661,519) $1,561,472
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED BALANCE SHEETS NON-GUARANTOR
SEPTEMBER 30, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and equivalents $ 18,807 $ 124,011 $ - $ 142,818
Marketable securities 157,000 400,275 - 557,275
Receivables, net 3,269 162,760 3,516 169,545
Intercompany 88,081 (88,081) - -
Prepaid expenses and other current assets 2,201 6,073 - 8,274
Deferred income taxes 35,496 20,799 - 56,295
- ----------------------------------------------------------------------------------------------------------
Total current assets 304,854 625,837 3,516 934,207
- ----------------------------------------------------------------------------------------------------------
Property, plant and equipment, net 25,336 68,480 - 93,816
Marketable securities - restricted - 32,406 - 32,406
Investment in subsidiaries 312,833 88,381 (401,214) -
Goodwill and intangibles, net 4,612 224,222 - 228,834
Other assets 223,723 7,399 (220,923) 10,199
- ----------------------------------------------------------------------------------------------------------
$871,358 $1,046,725 $(618,621) $1,299,462
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ - $265,024 $2,976 $ 268,000
Accounts payable and accrued liabilities 39,476 132,266 540 172,282
Unearned premium revenue - 24,059 - 24,059
Long-term debt due within one year 5,680 643 - 6,323
- ----------------------------------------------------------------------------------------------------------
Total current liabilities 45,156 421,992 3,516 470,664
- ----------------------------------------------------------------------------------------------------------
Long-term debt due after one year 3,865 222,241 (220,923) 5,183
Deferred income taxes - - - -
Other liabilities - - - -
Minority interest - 391 - 391
Shareholders' equity:
Capital stock 313 50,303 (50,303) 313
Additional paid-in capital 370,442 199,850 (199,850) 370,442
Unrealized gains on available-for-sale
securities, net of taxes 406 887 - 1,293
Retained earnings 451,176 151,061 (151,061) 451,176
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 822,337 402,101 (401,214) 823,224
- ----------------------------------------------------------------------------------------------------------
$871,358 $1,046,725 $(618,621) $1,299,462
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS SUBSIDIARY NON-GUARANTOR
FOR THE YEAR ENDED DECEMBER 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ---------------------------------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C> <C>
Operating revenue $(15,912) $(13,949) $9,122,774 $(110,233) $8,982,680
Health care services - -- 7,798,803 (139,924) 7,658,879
Marketing, general and administrative
expenses 98 (18,538) 1,073,843 (323) 1,055,080
Impairment, disposition, restructuring
and other charges - 11,246 143,261 - 154,507
Amortization of goodwill and intangible assets - 25,986 44,233 - 70,219
- ---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (16,010) (32,643) 62,634 30,014 43,995
Interest income (expense), net (56,894) 178 72,845 - 16,129
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (72,904) (32,465) 135,479 30,014 60,124
Provision (benefit) for income taxes (35,615) (32,141) 149,581 - 81,825
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(37,289) $ (324) $ (14,102) $ 30,014 $ (21,701)
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS
OF OPERATIONS NON-GUARANTOR
FOR THE THREE MONTHS ENDED DECEMBER 31, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- --------------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C>
Operating revenue $30,402 $1,263,277 $(58,804) $1,234,875
Health care services - 1,065,739 (26,394) 1,039,345
Marketing, general and administrative
expenses 6,624 148,541 (2,030) 153,135
Amortization of goodwill and intangible assets 86 1,775 - 1,861
- --------------------------------------------------------------------------------------------------------------
Operating income 23,692 47,222 (30,380) 40,534
Interest income, net 3,874 8,428 - 12,302
- --------------------------------------------------------------------------------------------------------------
Income before income taxes 27,566 55,650 (30,380) 52,836
Provision (benefit) for income taxes (4,191) 25,270 - 21,079
- --------------------------------------------------------------------------------------------------------------
Net income $31,757 $30,380 $(30,380) $31,757
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF
OPERATIONS NON-GUARANTOR
FOR THE YEAR ENDED SEPTEMBER 30, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- --------------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C>
Operating revenue $13,949 $4,744,173 $(120,817) $4,637,305
Health care services - 3,969,162 (96,415) 3,872,747
Marketing, general and administrative
expenses (14,246) 600,796 (10,622) 575,928
Impairment, disposition, restructuring
and other charges - 75,840 - 75,840
Office of Personnel Management charge - 25,000 - 25,000
Amortization of goodwill and intangible assets 342 8,811 - 9,153
- --------------------------------------------------------------------------------------------------------------
Operating income 27,853 64,564 (13,780) 78,637
Interest income, net 14,064 30,079 - 44,143
- --------------------------------------------------------------------------------------------------------------
Income before income taxes 41,917 94,643 (13,780) 122,780
Provision (benefit) for income taxes (30,036) 80,863 - 50,827
- --------------------------------------------------------------------------------------------------------------
Net income $71,953 $13,780 $(13,780) $71,953
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS NON-GUARANTOR
FOR THE YEAR ENDED SEPTEMBER 30, 1995 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IN THOUSANDS
Operating revenue $ 97,212 $3,817,500 $(183,690) $3,731,022
Health care services - 3,150,715 (73,580) 3,077,135
Marketing, general and administrative
expenses (5,180) 516,069 (12,444) 498,445
Amortization of goodwill and intangible assets 342 6,857 - 7,199
- ---------------------------------------------------------------------------------------------------------------------
Operating income 102,050 143,859 (97,666) 148,243
Interest income, net 6,275 26,932 650 33,857
- ---------------------------------------------------------------------------------------------------------------------
Income before income taxes 108,325 170,791 (97,016) 182,100
Provision for income taxes 230 73,775 - 74,005
- ---------------------------------------------------------------------------------------------------------------------
Net income $108,095 $ 97,016 $ (97,016) $ 108,095
- ---------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
31
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS SUBSIDIARY NON-GUARANTOR
FOR THE YEAR ENDED DECEMBER 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income (loss) $ (37,289) $ (324) $ (14,102) $ 30,014 $ (21,701)
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Impairment, disposition, restructuring,
and other charges -- 11,246 143,261 -- 154,507
Amortization of goodwill and intangible assets -- 25,986 44,233 -- 70,219
Depreciation and amortization -- 14,152 32,506 -- 46,658
Deferred income taxes 1,323 3,854 20,402 -- 25,579
Loss on disposal of property, plant and equipment -- 367 6,348 -- 6,715
Provision for doubtful accounts -- -- 5,171 -- 5,171
Changes in assets and liabilities net of effects
from acquisition:
Receivables -- 5,601 5,020 -- 10,621
Prepaid expenses and other assets (10,007) (23,655) 12,041 -- (21,621)
Intercompany 82,645 280,861 (333,492) (30,014) --
Medical claims and benefits payable -- -- (4,704) -- (4,704)
Accounts payable and accrued liabilities 18,174 (256,707) 145,186 -- (93,347)
Unearned premium revenue -- -- 235,392 -- 235,392
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by operating
activities 54,846 61,381 297,262 -- 413,489
- ------------------------------------------------------------------------------------------------------------------------------
Investing activities:
Acquisitions, net of cash acquired (999,892) -- -- -- (999,892)
Proceeds from the disposition of net assets
held for sale -- 76,500 76,500
Purchase of property, plant and equipment -- (34,344) (34,189) -- (68,533)
Purchase of marketable securities - restricted -- (100) (15,375) -- (15,475)
Purchase of marketable securities -- (1,420) (7,375) -- (8,795)
Proceeds from sale of property,
plant and equipment -- -- 3,154 -- 3,154
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in)
investing activities (999,892) (35,864) 22,715 -- (1,013,041)
- ------------------------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from borrowings of long-term debt 1,120,000 -- -- -- 1,120,000
Principal payments on long-term debt (210,000) (20,557) (4,609) -- (235,166)
Capitalization of Talbert -- (67,000) -- -- (67,000)
Proceeds of sale from Talbert stock -- 59,598 -- -- 59,598
Proceeds from issuance of common stock 43,838 -- -- -- 43,838
Preferred dividends paid (8,792) -- -- -- (8,792)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in)
financing activities 945,046 (27,959) (4,609) -- 912,478
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents -- (2,442) 315,368 -- 312,926
Beginning cash and equivalents -- 26,561 341,187 -- 367,748
- ------------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $ -- $ 24,119 $ 656,555 $ -- $ 680,674
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
32
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS NON-GUARANTOR
FOR THE THREE MONTHS ENDED DECEMBER 31, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income $ 31,757 $ 30,380 $ (30,380) $ 31,757
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 2,470 2,774 - 5,244
Amortization of goodwill and intangible assets 86 1,775 - 1,861
Provision for doubtful accounts - 296 - 296
Deferred income taxes 1,113 (900) - 213
Loss on disposal of property, plant and equipment 36 155 - 191
Changes in assets and liabilities net of effects from
acquisition:
Receivables 835 12,202 - 13,037
Prepaid expenses and other assets 89,304 (103,049) - (13,745)
Intercompany (165,696) 135,316 30,380 -
Medical claims and benefits payable - 10,800 - 10,800
Accounts payable and accrued liabilities 16,646 (23,785) - (7,139)
Unearned premium revenue - 232,357 - 232,357
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating activities (23,449) 298,321 - 274,872
- --------------------------------------------------------------------------------------------------------------------------
Investing activities:
Sale (purchase) of marketable securities 41,939 (75,903) - (33,964)
Purchase of property, plant and equipment (2,925) (1,689) - (4,614)
Purchase of marketable securities - restricted - (2,993) - (2,993)
Acquisitions, net of cash acquired (358) - - (358)
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities 38,656 (80,585) - (41,929)
- --------------------------------------------------------------------------------------------------------------------------
Financing activities:
Principal payments on long-term debt (8,065) (560) - (8,625)
Proceeds from issuance of common stock 612 - - 612
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows used in financing activities (7,453) (560) - (8,013)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 7,754 217,176 - 224,930
Beginning cash and equivalents 18,807 124,011 - 142,818
- --------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $ 26,561 $ 341,187 $ - $367,748
- --------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
33
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS NON-GUARANTOR
FOR THE YEAR ENDED SEPTEMBER 30, 1996 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income $ 71,953 $ 13,780 $ (13,780) $ 71,953
Adjustments to reconcile net income to net
cash used in operating activities:
Impairment, disposition, restructuring and other charges - 75,840 - 75,840
Deferred income taxes (26,541) 758 - (25,783)
Office of Personnel Management charge - 25,000 - 25,000
Depreciation and amortization 10,475 12,474 - 22,949
Amortization of goodwill and intangible assets 342 8,811 - 9,153
Provision for doubtful accounts - 999 - 999
Loss on disposal of property, plant and equipment 188 562 - 750
Changes in assets and liabilities net of effects from
acquisition:
Receivables 2,568 (58,539) - (55,971)
Prepaid expenses and other assets (182,904) 177,866 - (5,038)
Intercompany 124,193 (137,973) 13,780 -
Medical claims and benefits payable - (21,261) - (21,261)
Accounts payable and accrued liabilities (2,779) 3,352 - 573
Unearned premium revenue - (172,156) - (172,156)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating activities (2,505) (70,487) - (72,992)
- ---------------------------------------------------------------------------------------------------------------------------
Investing activities:
Sale (purchase) of marketable securities 8,957 (39,580) - (30,623)
Purchase of property, plant and equipment (7,600) (15,128) - (22,728)
Purchase of marketable securities - restricted - (9,298) - (9,298)
Acquisitions, net of cash acquired - (5,403) - (5,403)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) investing activities 1,357 (69,409) - (68,052)
- ---------------------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from issuance of common stock 13,342 - - 13,342
Principal payments on long-term debt (7,483) (1,142) - (8,625)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities 5,859 (1,142) - 4,717
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents 4,711 (141,038) - (136,327)
Beginning cash and equivalents 14,096 265,049 - 279,145
- ---------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $18,807 $ 124,011 $ - $142,818
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
34
<PAGE>
11. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS NON-GUARANTOR
FOR THE YEAR ENDED SEPTEMBER 30, 1995 PARENT SUBSIDIARIES ELIMINATIONS COMPANY
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income $ 108,095 $ 97,016 $(97,016) $108,095
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 11,262 10,174 - 21,436
Amortization of goodwill and intangible assets 342 6,857 - 7,199
Deferred income taxes 4,790 (7,624) - (2,834)
Loss on disposal of property, plant and equipment 24 2,123 - 2,147
Provision for doubtful accounts - 530 - 530
Changes in assets and liabilities net of effects from
acquisition:
Receivables (3,512) (23,946) - (27,458)
Prepaid expenses and other assets (39,072) 36,583 - (2,489)
Intercompany (184,701) 87,685 97,016 -
Medical claims and benefits payable - (19,093) - (19,093)
Accounts payable and accrued liabilities 19,624 16,132 - 35,756
Unearned premium revenue - 23,934 - 23,934
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating activities (83,148) 230,371 - 147,223
- ---------------------------------------------------------------------------------------------------------------------------
Investing activities:
Acquisitions, net of cash acquired - (134,971) - (134,971)
Purchase of property, plant and equipment (10,399) (14,636) - (25,035)
Purchase of marketable securities - restricted - (7,114) - (7,114)
Purchase of marketable securities (2,598) (3,797) - (6,395)
Proceeds from sale or property, plant and equipment 3,056 - 3,056
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows used in investing activities (12,997) (157,462) - (170,459)
- ---------------------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from issuance of common stock 200,920 - - 200,920
Principal payments on long-term debt (173,513) (970) - (174,483)
Proceeds from long-term borrowings, net of expenses 83,000 335 - 83,335
- ---------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities 110,407 (635) - 109,772
- ---------------------------------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 14,262 72,274 - 86,536
Beginning cash and equivalents (166) 192,775 - 192,609
- ---------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $ 14,096 $ 265,049 $ - $ 279,145
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
35
<PAGE>
REPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
The Board of Directors and Shareholders
PacifiCare Health Systems, Inc.
We have audited the accompanying consolidated balance sheets of
PacifiCare Health Systems, Inc. as of December 31, 1997 and 1996, and as of
September 30, 1996, and the related consolidated statements of operations,
shareholders' equity and cash flows for the year ended December 31, 1997,
the three months ended December 31, 1996 and each of the years in the two-
year period ended September 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of PacifiCare Health Systems, Inc. at December 31, 1997 and 1996,
and at September 30, 1996, and the consolidated results of its operations
and its cash flows for the year ended December 31, 1997, the three months
ended December 31, 1996 and each of the years in the two-year period ended
September 30, 1996 in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Los Angeles, California
February 24, 1998, except for Note 11,
as to which the date is June 2, 1998
36
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETSw
<TABLE>
<CAPTION>
MARCH 31,
1998 DECEMBER 31,
(UNAUDITED) 1997
------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C>
Assets
Current assets:
Cash and equivalents...................................... $ 235,693 $ 680,674
Marketable securities..................................... 926,652 864,708
Receivables, net.......................................... 326,343 301,345
Prepaid expenses and other current assets................. 32,213 32,194
Deferred income taxes..................................... 111,401 112,037
---------- ----------
Total current assets.............................. 1,632,302 1,990,958
---------- ----------
Property, plant and equipment, net.......................... 229,145 235,943
Marketable securities -- restricted......................... 157,596 145,989
Goodwill and intangible assets, net......................... 2,440,577 2,458,463
Other assets................................................ 35,261 36,605
---------- ----------
$4,494,881 $4,867,958
========== ==========
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable....................... $ 708,700 $ 715,600
Accounts payable and accrued liabilities.................. 460,421 429,524
Unearned premium revenue.................................. 43,034 491,808
Long-term debt due within one year........................ 152 154
---------- ----------
Total current liabilities......................... 1,212,307 1,637,086
---------- ----------
Long-term debt due after one year........................... 1,041,195 1,011,234
Deferred income taxes....................................... 103,174 102,793
Other liabilities........................................... 54,155 54,283
Minority interest........................................... 355 375
Shareholders' equity:
Preferred shares, par value $0.01 per share; 40,000 shares
authorized; 10,517 shares of Series A Convertible
Preferred Stock issued and outstanding at March 31,
1998 and December 31, 1997 ($262,926 aggregate
liquidation value)..................................... 105 105
Class A common shares, par value $0.01 per share; 100,000
shares authorized; 14,860 and 14,794 issued and
outstanding at March 31, 1998 and December 31, 1997,
respectively........................................... 148 148
Class B common shares, par value $0.01 per share; 100,000
shares authorized; 27,307 and 27,201 issued and
outstanding at March 31, 1998 and December 31, 1997,
respectively........................................... 273 272
Additional paid-in capital................................ 1,607,518 1,599,229
Accumulated other comprehensive income.................... 7,832 9,993
Retained earnings......................................... 491,157 452,440
Treasury shares, at cost: Class A common shares -- 42;
Class B common shares -- 406........................... (23,338) --
---------- ----------
Total shareholders' equity........................ 2,083,695 2,062,187
---------- ----------
$4,494,881 $4,867,958
========== ==========
</TABLE>
See accompanying notes.
37
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------
1998 1997
-------------- --------------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C>
Revenue:
Commercial premiums....................................... $ 960,898 $ 756,927
Government premiums (Medicare and Medicaid)............... 1,396,522 1,074,995
Other income.............................................. 24,530 11,681
---------- ----------
Total operating revenue........................... 2,381,950 1,843,603
---------- ----------
Expenses:
Health care services:
Commercial services....................................... 798,452 629,793
Government services....................................... 1,210,049 917,862
---------- ----------
Total health care services........................ 2,008,501 1,547,655
---------- ----------
Marketing, general and administrative expenses.............. 282,313 214,514
Amortization of goodwill and intangible assets.............. 18,636 10,319
---------- ----------
Operating income............................................ 72,500 71,115
Interest income............................................. 25,304 17,685
Interest expense............................................ (17,518) (9,719)
---------- ----------
Income before income taxes.................................. 80,286 79,081
Provision for income taxes.................................. 38,940 35,587
---------- ----------
Net income.................................................. $ 41,346 $ 43,494
========== ==========
Preferred dividends......................................... (2,629) (904)
---------- ----------
Net income available to common shareholders................. $ 38,717 $ 42,590
========== ==========
Basic earnings per share.................................... $ 0.93 $ 1.17
========== ==========
Diluted earnings per share.................................. $ 0.90 $ 1.12
========== ==========
</TABLE>
See accompanying notes.
38
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------
1998 1997
--------- ----------
(IN THOUSANDS)
<S> <C> <C>
Operating activities:
Net income................................................ $ 41,346 $ 43,494
Adjustments to reconcile net income to net cash used in
operating activities:
Amortization of goodwill and intangible assets......... 18,636 10,319
Depreciation and amortization.......................... 12,627 9,141
Deferred income taxes.................................. 2,368 911
Provision for doubtful accounts........................ 136 1,690
Other noncash items.................................... (22) --
Loss on disposal of property, plant and equipment...... -- 2,966
Changes in assets and liabilities, net of effects from
acquisitions:
Receivables.......................................... (25,134) (27,234)
Prepaid expenses and other assets.................... 1,325 (6,205)
Medical claims and benefits payable.................. (6,900) (29,000)
Accounts payable and accrued liabilities............. 33,017 31,857
Unearned premium revenue............................. (448,774) (213,630)
--------- ----------
Net cash flows used in operating activities....... (371,375) (175,691)
--------- ----------
Investing activities:
Sale (purchase) of marketable securities.................. (65,456) 57,862
Sale (purchase) of marketable securities -- restricted.... (11,607) 393
Purchase of property, plant and equipment................. (5,827) (8,673)
Acquisitions, net of cash acquired........................ (750) (980,646)
--------- ----------
Net cash flows used in investing activities....... (83,640) (931,064)
--------- ----------
Financing activities:
Proceeds from long-term borrowing, net of expenses........ 30,000 1,105,639
Repurchase of common stock................................ (23,338) --
Proceeds from issuance of common stock.................... 6,042 29,912
Cash dividends paid to preferred shareholders............. (2,629) (904)
Principal payments on long-term debt...................... (41) (99,725)
Capitalization of Talbert................................. -- (67,000)
--------- ----------
Net cash flows provided by financing activities... 10,034 967,922
--------- ----------
Net decrease in cash and equivalents........................ (444,981) (138,833)
Beginning cash and equivalents.............................. 680,674 367,748
--------- ----------
Ending cash and equivalents................................. $ 235,693 $ 228,915
========= ==========
</TABLE>
See accompanying notes.
Table Continued on Next Page
39
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
------- -----------
(IN THOUSANDS)
<S> <C> <C>
Supplemental cash flow information:
Cash paid during the period for:
Income taxes........................................... $ 360 $ 45,092
Interest............................................... $16,086 $ 2,437
Supplemental schedule of noncash investing and financing
activities:
Tax benefit realized upon exercise of stock options....... $ 2,216 $ 14,858
Compensation awarded in Class B Common Stock.............. $ 32 $ 721
Details of businesses acquired in purchase transactions:
Fair value of assets acquired............................. $ 750 $ 3,384,154
Liabilities assumed or created, including notes to
sellers................................................ -- (1,194,988)
Preferred and common consideration........................ -- (1,161,893)
------- -----------
Cash paid for acquisitions................................ 750 1,027,273
Cash acquired in acquisitions............................. -- (46,627)
------- -----------
Net cash paid for acquisitions............................ $ 750 $ 980,646
======= ===========
Details of unrealized changes in marketable securities:
Decrease in marketable securities......................... $(3,512) $ (7,530)
Less decrease in deferred income taxes.................... 1,351 2,882
------- -----------
Decrease in shareholders' equity.......................... $(2,161) $ (4,648)
======= ===========
</TABLE>
See accompanying notes.
Table continued from Previous Page
40
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
PacifiCare Health Systems, Inc. (the "Company" or "PacifiCare") is one of
the leading health care services companies in the United States, serving
approximately 3.7 million members in the commercial, Medicare and Medicaid lines
of business. The interim condensed consolidated financial statements included
herein have been prepared by 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, 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 December 31, 1997 Annual Report on Form 10-K, filed with the SEC in
March 1998.
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 -- ACQUISITIONS AND DISPOSITIONS
In February 1997, FHP International Corporation ("FHP") was acquired by the
Company (the "FHP Acquisition"), which was accounted for as a purchase. Total
consideration of approximately $2.2 billion was allocated to the assets acquired
and liabilities assumed based on estimates of their fair values. The fair values
of the assets acquired and liabilities assumed were $0.9 billion and $1.1
billion, respectively. A total of $2.4 billion, net of related deferred taxes,
representing the excess of the purchase price over the estimated fair values of
the net assets acquired, was allocated to goodwill and other acquired intangible
assets and is being amortized over a four to 40 year period.
In February 1997, the Company sold the outstanding common stock of its
Florida subsidiary, at which time the buyer assumed the daily operations. The
sales price, which approximated net book value, totaled $9 million. The close of
the sale was completed in July 1997 when the Company received regulatory
approval from the state of Florida.
41
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The pro forma information below presents combined results of operations as
if the FHP Acquisition and the sale of the Company's Florida subsidiary had
occurred at the beginning of 1997. The pro forma information gives effect to
actual operating results prior to the acquisition and adjustments to interest
expense, goodwill amortization and income taxes. No adjustment has been made to
give effect to synergies that may be realized as a result of the FHP
Acquisition.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1997
------------------
(UNAUDITED)
(IN THOUSANDS,
EXCEPT
PER SHARE AMOUNTS)
<S> <C>
Total operating revenue............................ $2,396,482
Pretax income...................................... $ 69,501
Net income......................................... $ 35,243
==========
Basic earnings per share........................... $ 0.79
==========
Diluted earnings per share......................... $ 0.77
==========
</TABLE>
NOTE 3 -- LONG-TERM DEBT
The Company has a $1.5 billion credit facility under which it had $940
million in borrowings outstanding as of March 31, 1998. The credit facility
requires mandatory step-down payments beginning on January 1, 1999 with final
maturity on January 1, 2002. The outstanding balance on the credit facility, as
of March 31, 1998, would not require a reduction until July 1, 2001. Interest
under the credit facility is presently based on the London Interbank Offering
Rate ("LIBOR") plus a spread, except for $350 million of the outstanding balance
which is covered by interest-rate swap agreements. The average fixed interest
rate paid by the Company on the existing swap agreements is approximately six
percent. The terms of the credit facility contain various covenants usual for
financing of this type, including a minimum net worth requirement, a minimum
fixed charge requirement and leverage ratios. At March 31, 1998, the Company was
in compliance with all such covenants. In 1997, the Company assumed $100 million
in senior notes of FHP which carry an interest rate of seven percent, payable
semiannually, and mature on September 15, 2003.
NOTE 4 -- SHAREHOLDERS' EQUITY
In January 1998, the Company's board of directors approved a plan to
repurchase shares of the Company's equity instruments. The Company successfully
renegotiated terms of its credit facility to increase the maximum amount of
repurchases permitted to $500 million. The Company has and may repurchase its
equity instruments using cash flows from operations and additional borrowings
under its credit facility. See "Liquidity and Capital Resources." Shares
repurchased will be available for reissuance in connection with the Company's
employee benefit plans or for other corporate purposes. As of March 31, 1998,
the Company had repurchased 42,000 shares of its Class A Common Stock and
406,000 shares of its Class B Common Stock for an aggregate amount of $23
million.
The Company's Preferred Stock includes 11,000,000 authorized shares of
Series A Preferred Stock. Each share of Series A Preferred Stock entitles its
owner to convert it at any time to 0.374 shares of Class B Common Stock,
assuming no unpaid accrued dividends in arrears. Series A Preferred Stock
shareholders also have a preference of $25.00 per share over the Common Stock in
the event of involuntary or voluntary liquidation. Dividends on the Series A
Preferred Stock accrue at an annual rate of $1.00 per share, are cumulative and
are payable quarterly when, as and if declared by the board of directors. In
March 1998, the Company paid $0.25 per share or approximately $3 million in
dividends to preferred shareholders of record as of February 27, 1998. Unpaid
cumulative dividends earned were $0.4 million on the 10,517,044 Series A
Preferred shares outstanding at March 31, 1998.
42
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
On or after June 17, 1998, the Series A Preferred Stock may be redeemed at
the option of the Company for cash plus unpaid dividends. The redemption price
ranges from 103 percent to 100 percent of the stated value of Series A Preferred
Stock, or $25.00 per share, in one-half percent decrements for each successive
anniversary of June 17, 1998 through 2004. Series A Preferred Stock ranks senior
to the Class A and B Common Stock with respect to dividend and liquidation
rights. Holders of Series A Preferred Stock generally have no voting rights;
however, there are certain exceptions including the right to elect two
additional directors if the equivalent of six quarterly dividends payable on the
Series A Preferred Stock are in default.
NOTE 5 -- CONTINGENCIES
OPM. The Company's HMO subsidiaries have commercial contracts with the
United States Office of Personnel Management ("OPM") to provide managed health
care services to members under the Federal Employees Health Benefit Program
("FEHBP") for federal employees, annuitants and their dependents. In the normal
course of business, OPM audits health plans with which it contracts to, among
other things, verify that the premiums calculated and charged to OPM are
established in compliance with the best price community rating guidelines
established by OPM. OPM typically audits plans once every five or six years, and
each audit covers the prior five or six year period. Depending on the type of
contract the Company has with OPM, OPM will audit one or more health plans at
the same time. OPM has notified the Company of its intent to audit or has
recently completed an audit of the majority of the Company's health plans. While
the government's initial on-site audits are usually followed by a post-audit
briefing in which the government indicates its preliminary results, final
resolution and settlement of the audits have historically taken a minimum of
three to five years.
In addition to claims made by the auditors as part of the normal audit
process, OPM may also refer their results to the United States Department of
Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ
has the authority to file a claim under the False Claims Act if it believes that
the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claims Act actions, the
government may impose trebled damages and a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim. In November
1997, the Company was notified that the 1995 audit of the operations of the
Company's Oklahoma HMO subsidiary had been referred to the DOJ. The Company is
negotiating to settle this matter with the DOJ.
PacifiCare intends to negotiate with OPM and the DOJ on all matters to
attain a mutually satisfactory result. There can be no assurance that these
negotiations will be concluded satisfactorily, that additional audits will not
be referred to the DOJ, or that additional, possibly material, liability will
not be incurred. The Company has also entered into discussions with OPM. The
Company believes that any ultimate liability in excess of amounts accrued would
not materially affect the Company's consolidated financial position. However,
such liability could have a material effect on results of operations or cash
flows of a future quarter if resolved unfavorably.
Legal Proceedings. The Company has been served with several purported class
action suits alleging violations of federal securities laws by the Company and
by certain of its officers and directors. The complaints relate to the period
from the date of the FHP Acquisition through the Company's November 25, 1997
announcement that earnings for the fourth quarter of 1997 would be lower than
expected. These complaints primarily allege that the Company previously omitted
and/or misrepresented material facts with respect to its costs, earnings and
profits. These suits are at a very early stage and no discovery has occurred.
The Company believes it has good defenses to the claims in these suits and is
contesting them vigorously.
The Company is also involved in legal actions in the normal course of
business, some of which seek substantial monetary damages, including claims of
punitive damages that are not covered by insurance. After review, including
consultation with counsel, based on current information, management believes any
ultimate liability in excess of amounts accrued that would likely arise from
these actions (including the purported class
43
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
actions) would not materially affect the Company's consolidated financial
position, results of operations or cash flows.
NOTE 6 -- EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No.
128 ("SFAS 128"), "Earnings per Share." SFAS 128 replaces the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. Earnings per share amounts reported for the three months
ended March 31, 1997 were restated to conform to the SFAS 128 requirements,
and did not vary materially from amounts previously stated. The following
table sets forth the computation of the denominator for basic and diluted
earnings per share for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31,
---------------
1998 1997
------ ------
(IN THOUSANDS)
<S> <C> <C>
Shares outstanding at the beginning of the period........... 41,995 31,301
Weighted average number of shares issued (repurchased):
Repurchases............................................... (370) --
Exercise of stock options................................. 58 217
FHP Acquisition........................................... -- 4,842
------ ------
Denominator for basic earnings per share.................... 41,683 36,360
Assumed conversion of Series A Preferred Stock.............. 3,955 1,987
Employee stock options...................................... 250 634
------ ------
Denominator for diluted earnings per share.................. 45,888 38,981
====== ======
</TABLE>
NOTE 7 -- COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income."
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, its adoption had no impact on the Company's
net income or shareholders' equity for the quarter ended March 31, 1998. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities to be included in other comprehensive income. These amounts were
reported separately in shareholders' equity prior to adoption. Prior year
financial statements have been conformed to the reporting requirements of SFAS
130. During each of the quarters ended March 31, 1998 and 1997, comprehensive
income totaled $39 million.
44
<PAGE>
NOTE 8. SUBSEQUENT EVENTS
REDEMPTION OF SERIES A PREFERRED STOCK
On May 22, 1998, the Company announced that it would redeem its Series A
Preferred Stock on June 23, 1998, at $25.75 per share plus accrued and unpaid
dividends (approximately $0.02 per share), for a total redemption price of
approximately $25.77 per share. Each share of Series A Preferred Stock is
convertible into 0.37419548 shares of the Company's Class B Common Stock
through June 22, 1998.
DEBT SECURITIES REGISTRATION STATEMENT
The Company has filed a registration statement with the SEC to register $250
million of debt securities in one or more series (the "Debt Securities").
The Company intends to file an amendment to the registration statement
related to the offering of the Debt Securities. The amendment will provide
that the obligations of the Company to pay the principal of, and interest on
the Debt Securities may be guaranteed on a full, unconditional and joint and
several basis by PacifiCare Operations, Inc. and FHP International
Corporation (the "Subsidiary Guarantors"). The Subsidiary Guarantors are
each a direct, wholly owned subsidiary of the Company.
The Subsidiary Guarantors are holding companies rather than operating
companies, and most of their subsidiaries are subject to HMO or insurance
regulations. The regulated subsidiaries are generally required to satisfy
minimum equity, capital, deposit and/or reserve requirements. At December
31, 1997 these requirements approximated $195 million. These requirements,
which limit the ability of the regulated subsidiaries to transfer funds to
the Subsidiary Guarantors, may impact the amount of funds that may be paid by
the subsidiaries to the Subsidiary Guarantors. In addition, the rights of the
Subsidiary Guarantors and the rights of their creditors, including holders of
the Debt Securities, to participate in any distribution of the assets of a
subsidiary upon the liquidation or recapitalization of such subsidiary will
be subject to the prior claims of certain of the subsidiary's creditors,
except to the extent that a Subsidiary Guarantor itself may be a creditor
with recognized claims against the subsidiary.
In accordance with SEC requirements, the Company has prepared consolidating
condensed financial statements to quantify the assets, operations and cash
flows of the Subsidiary Guarantors. The following consolidating condensed
balance sheets, consolidating condensed statements of operations and
consolidating condensed statements of cash flows present financial
information for:
PARENT - PacifiCare Health Systems, Inc. on a stand-alone basis (carrying
investments in subsidiaries under the equity method); the Company became the
parent on February 14, 1997 effective with the FHP Acquisition (See Note 4
- -"Acquisitions and Dispositions").
GUARANTOR SUBSIDIARIES - PacifiCare Operations, Inc. (formerly PacifiCare
Health Systems, Inc.) and FHP International Corporation on a stand-alone
basis (carrying investments in subsidiaries under the equity method).
Effective with the FHP Acquisition, both companies ceased to be parent
companies. Prior to the FHP Acquisition, PacifiCare Operations, Inc. was the
ultimate parent company and borrower; there were no guarantor subsidiaries.
NON-GUARANTOR SUBSIDIARIES - Represents all other directly or indirectly
wholly owned subsidiaries of the Guarantor Subsidiaries on a consolidated
basis.
ELIMINATIONS - Entries eliminating investment in subsidiaries and
intercompany balances and transactions.
THE COMPANY - The financial information for PacifiCare Health Systems, Inc.
on a condensed consolidated basis.
PROVISION FOR INCOME TAXES - The Company and its Non-Guarantor Subsidiaries
record the provision for income taxes in accordance with an intercompany
tax-sharing agreement. Income tax benefits available to a Non-Guarantor
Subsidiary which arise from net operating losses can only be used to offset
the Non-Guarantor Subsidiary's taxable income in future periods. Accordingly,
the tax benefit is excluded from the Non-Guarantor Subsidiary's operating
results.
45
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED BALANCE SHEETS SUBSIDIARY NON-GUARANTOR
MARCH 31, 1998 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Assets
Current assets:
Cash and equivalents $ - $ 47,167 $ 188,526 $ - $ 235,693
Marketable securities - 156,767 736,420 33,465 926,652
Receivables, net - 2,905 294,860 28,564 326,343
Intercompany (110,605) (183,965) 294,570 - -
Prepaid expenses and other current assets (233) 5,700 26,742 4 32,213
Deferred income taxes (7,384) 65,127 (39,131) 92,789 111,401
- --------------------------------------------------------------------------------------------------------------------------------
Total current assets (118,222) 93,701 1,501,987 154,822 1,632,302
- --------------------------------------------------------------------------------------------------------------------------------
Property, plant and equipment, net - 63,533 165,612 - 229,145
Marketable securities - restricted - 100 157,496 - 157,596
Investment in subsidiaries 2,647,704 2,476,685 1,143,416 (6,267,791) -
Goodwill and intangibles, net - 1,149,884 1,290,693 - 2,440,577
Other assets 10,421 173,963 43,163 (192,286) 35,261
- --------------------------------------------------------------------------------------------------------------------------------
$2,539,903 $3,957,866 $4,302,367 $(6,305,255) $ 4,494,881
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ - $ 74 $ 680,069 $ 28,557 $ 708,700
Accounts payable and accrued liabilities (24,238) 165,177 319,482 - 460,421
Unearned premium revenue - - 43,034 - 43,034
Long-term debt due within one year - - 152 - 152
- --------------------------------------------------------------------------------------------------------------------------------
Total current liabilities (24,238) 165,251 1,042,737 28,557 1,212,307
- --------------------------------------------------------------------------------------------------------------------------------
Long-term debt due after one year 940,000 100,000 160,005 (158,810) 1,041,195
Deferred income taxes - 4,795 5,590 92,789 103,174
Other liabilities - - 54,155 - 54,155
Minority interest - - 355 - 355
Shareholders' equity:
Capital stock 526 - 52,495 (52,495) 526
Additional paid-in capital 1,607,518 3,121,926 2,728,476 (5,850,402) 1,607,518
Accumulated other comprehensive income - 1,568 6,264 - 7,832
Retained earnings 39,435 564,326 252,290 (364,894) 491,157
Treasury shares (23,338) - - - (23,338)
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 1,624,141 3,687,820 3,039,525 (6,267,791) 2,083,695
- --------------------------------------------------------------------------------------------------------------------------------
$2,539,903 $3,957,866 $4,302,367 $(6,305,255) $4,494,881
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
46
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED BALANCE SHEETS SUBSIDIARY NON-GUARANTOR
DECEMBER 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Assets
Current assets:
Cash and equivalents $ - $ 24,119 $ 656,555 $ - $ 680,674
Marketable securities - 118,902 745,806 - 864,708
Receivables, net - 4,987 292,271 4,087 301,345
Intercompany (78,230) (239,847) 318,077 - -
Prepaid expenses and other current assets 176 5,001 27,017 - 32,194
Deferred income taxes (1,323) 64,930 48,430 - 112,037
- ------------------------------------------------------------------------------------------------------------------------
Total current assets (79,377) (21,908) 2,088,156 4,087 1,990,958
- ------------------------------------------------------------------------------------------------------------------------
Property, plant and equipment, net - 64,699 171,244 - 235,943
Marketable securities - restricted - 100 145,889 145,989
Investment in subsidiaries 2,551,394 1,397,882 (89,962) (3,859,314) -
Goodwill and intangibles, net - 1,156,660 1,301,803 - 2,458,463
Other assets 9,831 176,540 11,352 (161,118) 36,605
- ------------------------------------------------------------------------------------------------------------------------
$2,481,848 $2,773,973 $ 3,628,482 $(4,016,345) $4,867,958
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Medical claims and benefits payable $ - $ - $ 711,513 $ 4,087 $ 715,600
Accounts payable and accrued liabilities 18,175 105,176 306,173 - 429,524
Unearned premium revenue - - 491,808 - 491,808
Long-term debt due within one year - - 154 - 154
- ------------------------------------------------------------------------------------------------------------------------
Total current liabilities 18,175 105,176 1,509,648 4,087 1,637,086
- ------------------------------------------------------------------------------------------------------------------------
Long-term debt due after one year 910,000 100,000 162,352 (161,118) 1,011,234
Deferred income taxes - 4,796 97,997 - 102,793
Other liabilities - - 54,283 - 54,283
Minority interest - - 375 - 375
Shareholders' equity:
Capital stock 525 659 59,508 (60,167) 525
Additional paid-in capital 1,599,229 2,079,138 1,626,490 (3,705,628) 1,599,229
Accumulated other comprehensive income - 1,595 8,398 - 9,993
Retained (deficit) earnings (46,081) 482,609 109,431 (93,519) 452,440
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 1,553,673 2,564,001 1,803,827 (3,859,314) 2,062,187
- ------------------------------------------------------------------------------------------------------------------------
$2,481,848 $2,773,973 $3,628,482 $(4,016,345) $4,867,958
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS SUBSIDIARY NON-GUARANTOR
FOR THE THREE MONTHS ENDED MARCH 31, 1998 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ---------------------------------------------------------------------------------------------------------------------------------
IN THOUSANDS
<S> <C> <C> <C> <C> <C>
Operating revenue $49,511 $ 59,260 $2,430,338 $(157,159) $2,381,950
Health care services - - 2,051,465 (42,964) 2,008,501
Marketing, general and administrative
expenses 169 4,180 283,387 (5,423) 282,313
Amortization of goodwill and intangible assets - 6,776 11,860 - 18,636
- ---------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 49,342 48,304 83,626 (108,772) 72,500
Interest income, net (15,372) 1,207 21,951 - 7,786
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 33,970 49,511 105,577 (108,772) 80,286
Provision (benefit) for income taxes (7,376) - 46,316 - 38,940
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $41,346 $49,511 $59,261 $(108,772) $41,346
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS SUBSIDIARY NON-GUARANTOR
FOR THE THREE MONTHS ENDED MARCH 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Operating revenue $36,248 $45,177 $1,874,844 $ (112,666) $1,843,603
Health care services - - 1,576,405 (28,748) 1,547,657
Marketing, general and administrative
expenses - (14,430) 231,473 (2,531) 214,512
Amortization of goodwill and intangible assets - 2,467 7,852 - 10,319
- ------------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) 36,248 57,140 59,114 (81,387) 71,115
Interest income, net (8,342) (1,692) 18,000 - 7,966
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes 27,906 55,448 77,114 (81,387) 79,081
Provision for income taxes - 3,613 31,974 - 35,587
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $27,906 $ 51,835 $ 45,140 $ (81,387) $ 43,494
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
49
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS SUBSIDIARY NON-GUARANTOR
FOR THE THREE MONTHS ENDED MARCH 31, 1998 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income (loss) $ 41,346 $ 49,511 $ 59,261 $ (108,772) $ 41,346
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of goodwill and intangible assets - 6,776 11,860 - 18,636
Depreciation and amortization - 4,457 8,170 - 12,627
Deferred income taxes 6,061 (133) (3,560) - 2,368
Provision for doubtful accounts - - 136 - 136
Other noncash charges to income - 40 (62) - (22)
Changes in assets and liabilities net of effects from
acquisition:
Receivables - 2,082 (27,216) - (25,134)
Prepaid expenses and other assets (181) 1,878 (372) - 1,325
Intercompany (17,136) (60,350) (31,286) 108,772 -
Medical claims and benefits payable - (156) (6,744) - (6,900)
Accounts payable and accrued liabilities (40,165) 60,231 12,951 - 33,017
Unearned premium revenue - - (448,774) - (448,774)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating activities (10,075) 64,336 (425,636) - (371,375)
- ------------------------------------------------------------------------------------------------------------------------------------
Investing activities:
Sale (purchase) of marketable securities - (37,957) (27,499) - (65,456)
Sale (purchase) of marketable securities - restricted - - (11,607) - (11,607)
Purchase of property, plant and equipment - (3,331) (2,496) - (5,827)
Acquisitions, net of cash acquired - - (750) - (750)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash flows used in investing activities - (41,288) (42,352) - (83,640)
- ------------------------------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from long-term borrowings, net of expenses 30,000 - - - 30,000
Repurchase of common stock (23,338) - - - (23,338)
Proceeds from issuance of common stock 6,042 - - - 6,042
Preferred dividends paid (2,629) - - - (2,629)
Principal payments on long-term debt - - (41) - (41)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) financing activities 10,075 - (41) - 10,034
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents - 23,048 (468,029) - (444,981)
Beginning cash and equivalents - 24,119 656,555 - 680,674
- ------------------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $ - $ 47,167 $ 188,526 $ - $ 235,693
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
50
<PAGE>
NOTE 8. SUBSEQUENT EVENT (Continued)
<TABLE>
<CAPTION>
PACIFICARE HEALTH SYSTEMS, INC.
CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS SUBSIDIARY NON-GUARANTOR
FOR THE THREE MONTHS ENDED MARCH 31, 1997 PARENT GUARANTORS SUBSIDIARIES ELIMINATIONS COMPANY
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IN THOUSANDS
Operating activities:
Net income $ 27,906 $ 51,835 $ 45,140 $ (81,387) $ 43,494
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of goodwill and intangible assets -- 2,467 7,852 -- 10,319
Depreciation and amortization -- 3,298 5,843 -- 9,141
Loss on disposal of property, plant and equipment -- -- 2,966 -- 2,966
Provision for doubtful accounts -- -- 1,690 -- 1,690
Deferred income taxes -- (438) 1,349 -- 911
Changes in assets and liabilities net of effects
from acquisition:
Receivables -- 1,414 (28,648) -- (27,234)
Prepaid expenses and other assets (146) (32,833) 26,774 -- (6,205)
Intercompany (109,595) 65,809 (37,601) 81,387 --
Medical claims and benefits payable -- -- (29,000) -- (29,000)
Accounts payable and accrued liabilities 8,475 10,842 12,540 -- 31,857
Unearned premium revenue -- -- (213,630) -- (213,630)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in) operating
activities (73,360) 102,394 (204,725) -- (175,691)
- ------------------------------------------------------------------------------------------------------------------------------
Investing activities:
Acquisitions, net of cash acquired (980,646) -- -- -- (980,646)
Sale of marketable securities -- 37,134 20,728 -- 57,862
Purchase of property, plant and equipment -- (4,848) (3,825) -- (8,673)
Sale of marketable securities - restricted -- -- 393 -- 393
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in)
investing activities (980,646) 32,286 17,296 -- (931,064)
- ------------------------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from long-term borrowings,
net of expenses 1,105,639 -- -- -- 1,105,639
Principal payments on long-term debt (80,000) (19,649) (76) -- (99,725)
Capitalization of Talbert -- (67,000) -- -- (67,000)
Proceeds from issuance of common stock 29,912 -- -- -- 29,912
Preferred dividends paid (904) -- -- -- (904)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash flows provided by (used in)
financing activities 1,054,647 (86,649) (76) -- 967,922
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents 641 48,031 (187,505) -- (138,833)
Beginning cash and equivalents -- 26,561 341,187 -- 367,748
- ------------------------------------------------------------------------------------------------------------------------------
Ending cash and equivalents $ 641 $ 74,592 $ 153,682 $ -- $ 228,915
- ------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
51
<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: June 4, 1998 By: /s/ ALAN R. HOOPS
--------------------------------
Alan R. Hoops
President
Chief Executive Officer
and Director
Date: June 4, 1998 By: /s/ WAYNE B. LOWELL
--------------------------------
Wayne B. Lowell
Executive Vice President
and Chief Financial Officer
<PAGE>
Exhibit 23
CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 number 333-21713) and related Prospectus pertaining
to the 1996 Stock Option Plan for Officers and Key Employees, and related
Prospectus pertaining to the 1996 Non-Officer Directors Stock Option Plan,
of PacifiCare Health Systems, Inc. of our report dated February 24, 1998
(except for Note 11, as to which the date is June 2, 1998) with respect
to the consolidated financial statements of PacifiCare Health Systems, Inc.
included in the Current Report on Form 8-K for the year ended December 31,
1997.
ERNST & YOUNG LLP
Los Angeles, California
May 29, 1998
