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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 000-21949
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PACIFICARE HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4591529
(State or other jurisdiction (IRS Employer Identification
of incorporation or organization) 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
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, PAR VALUE $0.01
CLASS B COMMON STOCK, PAR VALUE $0.01
PREFERRED STOCK, PAR VALUE $0.01
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K / /
The aggregate market value of common stock held by non-affiliates of the
Registrant on February 28, 1998, was approximately $1,982,670,072.
The number of shares of Class A Common Stock and Class B Common Stock
outstanding at February 28, 1998, was 14,792,144 and 26,814,098, respectively.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
Portions of the Registrant's definitive
Proxy Statement
to be filed by April 30, 1998 Part III
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PART I
ITEM 1. BUSINESS
PacifiCare-Registered Trademark- Health Systems, Inc. (the "Company" or
"PacifiCare") is one of the nation's leading managed health care services
companies, serving nearly 3.8 million HMO members in its commercial and
government product lines as of December 31, 1997. The Company is also a leader
in the management, development and marketing of diversified health maintenance
organization ("HMO") products and related services. The Company operates HMOs in
10 states and Guam, and as of December 31, 1997, had a combined commercial HMO
membership of nearly 2.8 million members. Through internal growth and strategic
acquisitions, the Company believes it has built a strong competitive position in
the western United States and has expanded its operations into new and existing
geographic markets.
The Company's Secure Horizons-Registered Trademark- programs operate the
largest and one of the fastest growing Medicare risk programs in the United
States (as measured by membership and membership growth, respectively) with over
1.0 million members enrolled as of December 31, 1997. The Company believes that
its Secure Horizons programs are attractive to Medicare beneficiaries because
they provide a more comprehensive package of benefits than those available under
traditional Medicare and they substantially reduce the members' administrative
responsibilities.
The Company believes that its ability to offer a comprehensive range of
products and services, combined with its long-term relationships with health
care providers, will enable the Company to respond effectively to the changing
needs of the health care marketplace. The Company anticipates that it will
continue to be among the nation's leading managed health care services
companies.
RECENT DEVELOPMENTS
On February 14, 1997, the Company consummated the acquisition of FHP
International Corporation ("FHP") for a total purchase price, including
transaction costs, of approximately $2.2 billion (the "FHP Acquisition"). With
the FHP Acquisition, the Company conducts business in five additional states and
has experienced an increase in its commercial and government membership. The FHP
Acquisition has been accounted for as a purchase and the Company's consolidated
results of operations include the results of FHP from the date of the FHP
Acquisition (see Note 4 of the Notes to Consolidated Financial Statements).
Also during 1997, the Company consummated the sales of its Florida, Illinois
and New Mexico subsidiaries (see Note 4 of the Notes to Consolidated Financial
Statements). It also announced an exit strategy for its Utah subsidiary,
including its potential sale (see Note 9 of the Notes to Consolidated Financial
Statements).
OPERATIONS, PRODUCTS AND SERVICES
HMO OPERATIONS
The Company's total membership has grown from nearly 1.0 million members at
December 31, 1992 to approximately 3.8 million members at December 31, 1997,
including the impact of the FHP Acquisition,
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a 31 percent compound annual growth rate. The Company's membership at December
31, 1997 by state and program is as follows:
<TABLE>
<CAPTION>
GOVERNMENT
(MEDICARE & PERCENT
COMMERCIAL MEDICAID) TOTAL OF TOTAL
----------- ------------ ---------- -----------
<S> <C> <C> <C> <C>
Arizona.............................................. 109,500 88,700 198,200 5.2%
California........................................... 1,650,000 605,300 2,255,300 59.5
Colorado............................................. 286,700 52,600 339,300 9.0
Guam................................................. 42,800 -- 42,800 1.1
Nevada............................................... 40,700 24,200 64,900 1.7
Ohio................................................. 54,200 13,200 67,400 1.8
Oklahoma............................................. 108,700 26,200 134,900 3.6
Oregon............................................... 116,500 40,600 157,100 4.1
Texas................................................ 128,400 68,600 197,000 5.2
Utah................................................. 154,200 25,000 179,200 4.7
Washington........................................... 98,300 56,700 155,000 4.1
----------- ------------ ---------- -----
Total membership..................................... 2,790,000 1,001,100 3,791,100 100.0%
----------- ------------ ---------- -----
----------- ------------ ---------- -----
</TABLE>
COMMERCIAL PROGRAMS
The Company's commercial membership has grown from approximately 0.7 million
members at December 31, 1992 to approximately 2.8 million members at December
31, 1997, a 30 percent compound annual growth rate. The Company offers a
comprehensive range of products, including HMOs, Preferred Provider Organization
("PPO") and Point of Service ("POS") plans. POS plans combine the features of an
HMO (a defined provider network providing care to members with reduced
deductibles and co-payments) with the features of a traditional indemnity
insurance product (the option to use any physician, with higher deductibles and
co-payments).
For the commercial employer market, the Company offers a range of benefit
plan designs that vary in the amount of member co-payments. The Company believes
that nominal co-payments are useful in helping contain the costs of health care
without providing a barrier to members seeking needed health care services. The
Company offers a variety of specialty managed health care products as either
supplements to its commercial programs or as stand-alone products. These
products include pharmacy benefit management, life and health insurance,
behavioral health services and dental and vision services. These optional
services are generally provided through subcontracting or referral relationships
with other health care providers. The Company is not dependent on any one
employer group or group of employers to sustain its commercial product revenue
stream.
SECURE HORIZONS PROGRAMS
The Company offers health care services to Medicare beneficiaries through
its Secure Horizons programs. The Secure Horizons programs represent the largest
and one of the fastest growing Medicare risk programs in the United States (as
measured by membership and membership growth, respectively). Secure Horizons
membership has grown from approximately 0.2 million members at December 31, 1992
to over 1.0 million members at December 31, 1997, a 34 percent compound annual
growth rate.
The Company believes the Medicare market continues to offer significant
growth opportunities since only approximately 15 percent of the country's
Medicare beneficiaries are enrolled in Medicare risk HMO programs such as those
offered by the Company. The Company anticipates continued growth in the Medicare
risk arena by entering into new geographic markets with its Secure Horizons
programs. Also, recently adopted federal legislation repeals the requirement
that at least half of a Medicare health plan's enrollment be drawn from
commercial contracts (the "50/50 Rule") beginning January 1, 1999, and gives
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the Department of Health and Human Services ("HHS") broad authority to waive the
50/50 Rule for certain plans beginning January 1, 1998. The Company believes
that the repeal of the 50/50 Rule will allow it to develop Medicare risk
programs in markets where it does not have operations through expansion of its
Secure Horizons programs and affiliations between Secure Horizons USA, Inc.
("SHUSA") its Medicare risk management subsidiary and health plans or providers
in such markets (see "Specialty Managed Care Products and Services--Medicare
Risk Management" and "Competition").
The Company has been offering Secure Horizons programs since 1985, pursuant
to annual risk contracts with the Health Care Financing Administration ("HCFA").
HCFA requires that an HMO be federally qualified or meet similar requirements as
a competitive medical plan to be eligible for Medicare risk contracts. These
Medicare risk contracts entitle the Company to a fixed per-member premium, which
is currently based upon the average cost of providing traditional
fee-for-service Medicare benefits to the Medicare population in each county. The
risk contracts are subject to periodic unilateral revisions by HCFA based upon
updated demographic information relating to the Medicare population and the cost
of providing health care in a particular geographic area. Recent legislation has
revised the formula by which Medicare risk premiums will be calculated, which
could result in lower average Medicare premiums paid to the Company. The Company
believes that any reduction in premiums will be offset by other features of this
new legislation which encourages the use of managed care plans by Medicare
beneficiaries (see "Government Regulation"). The Company's Medicare risk
contracts are automatically renewed every 12 months unless the Company or HCFA
elects to terminate them. HCFA may unilaterally terminate the Company's Medicare
risk contracts if the Company fails to continue to meet compliance and
eligibility standards. Termination of the Company's Medicare risk contracts
would have a material adverse effect on the Company. The Company, however, has
no reason to believe that such termination will occur. Each Secure Horizons
member enrolls individually and may disenroll by providing 30 days' notice. The
Company believes that its Secure Horizons programs have one of the lowest
disenrollment rates among Medicare risk plans.
Because the average use of health care services by Medicare beneficiaries
greatly exceeds the use of services by those who are under the age of 65, the
Company's Medicare risk plans generate substantially larger per member revenue
than the Company's commercial plans. Premium revenue for each Secure Horizons
member is usually more than three times that of a commercial member reflecting
in part, the higher medical and administrative cost of serving a Medicare
member. As a result, although membership in the Secure Horizons programs
represented only approximately 26 percent of the Company's membership at
December 31, 1997, it accounted for approximately 58 percent of the consolidated
premium revenue for the year ended December 31, 1997 and an even larger
percentage of the Company's operating profit. The Secure Horizons programs are
subject to certain risks relative to commercial programs, such as higher
comparative medical costs, higher levels of utilization, government and
regulatory reporting requirements, the possibility of reduced or insufficient
government reimbursement in the future and higher marketing and advertising
costs associated with selling to individuals rather than to groups.
In response to the needs of employers to provide cost-effective health care
coverage to their retired employees who may or may not be currently entitled to
Medicare, the Company developed the Secure Horizons retiree product. This
product takes advantage of the Company's expertise in providing health care to
seniors. The provider networks are similar to those offered to the Company's
Secure Horizons enrollees and the premium is based on the revenue requirements
needed to provide services to Secure Horizons enrollees. Moreover, the retiree
product provides the Company with access to individuals who, once familiar with
the Company's services and delivery system, may enroll in Secure Horizons
programs when they become entitled to Medicare benefits.
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SPECIALTY MANAGED CARE PRODUCTS AND SERVICES
In addition to its HMO operations, the Company provides a range of specialty
managed care products and services. These products and services are offered to
HMOs, insurers, employers, governmental entities, providers and PPOs:
MEDICARE RISK MANAGEMENT. The Company formed SHUSA in March 1993 to take
advantage of the Company's expertise in the Medicare risk area. SHUSA provides
management services and best practices to HMOs and health care delivery systems
that want to engage in Medicare risk contracting. SHUSA has approximately 90,000
members under licensure in New Mexico through Presbyterian Healthcare Services
and in New England through Tufts Associated Health Maintenance Organization,
Inc. SHUSA is currently engaged in discussions with a number of health plans and
delivery systems regarding future business development opportunities in the
Medicare risk market.
The Company anticipates that with the repeal of the 50/50 Rule and the drive
to enroll Medicare beneficiaries in HMOs, SHUSA may enter into licensing
arrangements in a variety of geographic areas thereby expanding the Company's
presence in new markets. Recent legislation permits, beginning in 1999, provider
sponsored organizations (networks of doctors, hospitals and providers-"PSOs") to
enter into Medicare risk contracts directly with HCFA (see "Competition"). The
Company believes that PSOs will provide an opportunity for the Company, through
SHUSA, to expand into new Medicare risk markets or alternatively, could become
an additional source of competition for the Company. While the Company currently
expects the opportunities of this legislation to outweigh the potential threats,
HCFA has not adopted final regulations in connection with this legislation and
it is too early to predict the ultimate effect, if any, this legislation will
have on the Company.
PHARMACY BENEFIT MANAGEMENT. Prescription Solutions-Registered Trademark-
was established in May 1993 to offer pharmacy benefit management services.
Clients of Prescription Solutions have access to a pharmacy provider network
that features independent and chain pharmacies, as well as a variety of cost and
quality management capabilities. Prescription Solutions also provides its
clients with an array of fully integrated services, including mail order
distribution, an extensive network of retail pharmacies, claims processing and
sophisticated drug utilization reporting. Prescription Solutions is one of the
industry's largest pharmacy benefit management companies.
LIFE AND HEALTH INSURANCE. PacifiCare Life and Health Insurance
Company-SM-("PLHIC") and PacifiCare Life Assurance Company ("PLAC"), the
Company's life and health insurance subsidiaries, offer employer groups managed
health care insurance products which have been integrated with the Company's
existing HMO products to form multi-option health benefits programs. Together,
PLHIC and PLAC are licensed to operate in the District of Columbia and 38 states
and Guam, including the states in which the Company's HMOs operate.
BEHAVIORAL HEALTH SERVICES. PacifiCare Behavioral Health of California,
Inc. is a licensed specialized health care service plan which provides
behavioral health care services, including chemical dependency benefit programs,
in California directly to corporate customers and indirectly through the
Company's California HMO to its commercial members. Outside of California,
PacifiCare Behavioral Health, Inc. contracts with various HMOs, insurers and
employers to manage their respective mental health and chemical dependency
benefit programs.
DENTAL AND VISION SERVICES. California Dental Health Plan dba PacifiCare
Dental and Vision ("PDV") is a licensed specialized health care service plan
which provides prepaid dental and optometry benefits for individuals, including
members of PacifiCare's California commercial and Secure Horizons programs and
employer groups. PDV continues to market independently of the Company's
California HMO and to provide dental and vision benefits to its members.
Recently, PacifiCare Dental of Colorado, Inc. received approval to offer
stand-alone dental care plans to people in selected areas of Colorado.
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The stand-alone dental care plan works like an HMO and will allow employers to
offer the dental plan to members of any medical carrier.
BUSINESS STRATEGY
The current business strategy of the Company has a strong operational focus.
During 1998, the Company expects to:
- improve commercial gross margins through premium increases and improved
health care cost management through capitated arrangements with strong
provider organizations which align the interest of providers with that of
the Company;
- focus on management tools, including medical and pharmacy management and
effective medical information reporting;
- exit Utah and sell certain specialty businesses which do not fit within
this strategy;
- improve efficiency by further leveraging the Company's economies of scale
to lower the percentage of revenue spent on marketing, general and
administrative expenses;
- continue to integrate FHP's operations to the Company's common
information systems operating platform; and
- increase the quality and service of its basic HMO products measured
through expanded National Committee for Quality Assurance ("NCQA")
accreditation in 1998 (see "Quality Assurance").
The Company continually evaluates opportunities to expand its business
through acquisitions and development of new products. With recent changes in
federal legislation related to Medicare, the Company anticipates expanded growth
in its Secure Horizons Medicare programs and its Medicare risk management
programs into new markets. The Company also evaluates whether certain products
or markets should be discontinued when they do not fit within the Company's core
business strategy. Through the implementation of this business strategy, the
Company believes it can solidify its position as one of the nation's leading
managed health care services companies.
HEALTH CARE PROVIDER RELATIONSHIPS
The profitability of the Company and the success of its long-range business
plans depends upon its ability to attract and retain qualified health care
providers. The Company's ability to expand is dependent, in part, on its ability
to secure cost effective contracts and delivery system models with additional
physicians or to ensure that existing physician groups expand their operations
to accommodate the Company's new HMO membership. Achieving such objectives with
respect to physician contracts is becoming more difficult due to increasing
competition. In addition, increased competition in the health care industry has
resulted in the consolidation of health care providers, resulting in larger
provider groups being created and fewer groups with which the Company can
contract. Contracts with health care providers are commonly negotiated on an
annual basis. Generally, there is no requirement that the provider continue its
relationship with the Company upon expiration of the annual period. To ensure
the quality and stability of the provider network, the Company has entered into
a number of provider service contracts with terms of up to ten years. Some of
the significant provider contracts include multiple five-year contracts with
MedPartners for specified "medical care ratios" (health care expenses as a
percentage of premium revenue) in most of the states where the Company does
business (most significantly, California). MedPartners provides services to over
0.4 million members or 16 percent of the Company's total commercial membership
and approximately 0.1 million or 14 percent of the Company's total government
membership. In addition, the Company has a national letter of intent with FPA
Medical Management ("FPA") that sets forth operating principles between FPA and
the Company for the next ten years. FPA provides health care services to the
Company's members in five states, including California.
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The Company's inability to contract with providers, loss of contracts with
providers, inability of providers to provide adequate care or insolvency of
providers could materially and adversely affect the Company. These contracting
and insolvency risks include: a loss of membership; the incurring of additional
expenses to meet the requirement to continue to arrange for health care
services, among other things, for members; the inability to obtain reimbursement
due the Company from providers; the expenditure of additional funds to maintain
adequate provider networks and the assertion of claims by third parties against
the Company. The effect of these risks could result in the recognition of a
charge in a future period.
HEALTH CARE COSTS
The Company manages health care costs primarily by entering into contractual
arrangements with the majority of its health care providers, including primary
care physicians, specialists, hospitals and other ancillary services providers,
to pay a fixed monthly fee, or capitation payment, for each HMO member
regardless of the services provided to each member. The primary care physician
or group influences medical utilization and cost control in the Company's HMOs
through referrals, hospitalization and other services and is responsible for any
related payments to those referred providers. The Company's HMOs share the risk
of certain health care costs not covered by capitation arrangements and provide
additional incentives to the physicians or groups for appropriate utilization of
hospital inpatient, outpatient surgery and emergency room services. The Company
may also make incentive payments to providers based on performance relative to
budgeted targets. Nearly all of the Company's Medicare contracts are based on a
percentage of premium. Percentage of premium entails provider compensation
fluctuating directly with the amount of premiums paid for Medicare risk
beneficiaries by HCFA.
In certain of the Company's markets, health care providers are not under
capitation arrangements. Fee-for-service contracts increase health care costs
when utilization is not appropriately managed. The Company has or is in the
process of renegotiating these contracts to move the providers to a capitated
payment plan.
The Company also operates a utilization review system, under which routine
hospital admissions and lengths of stay are reviewed by either the Company or
utilization review committees comprised of several physicians at each physician
group. The committees approve non-emergency hospitalizations in advance. After
admission, the committees, together with the Company's medical services
utilization staff, carefully monitor the member's continued stay. The Company,
through its medical services departments, becomes actively involved in the
utilization review of longer, more costly hospitalizations and emergencies.
These departments also become involved in the field to monitor catastrophic
cases in an effort to provide members appropriate medical care and suggest
treatment options that may be more appropriate and cost-effective than a
long-term hospital stay.
QUALITY ASSURANCE
The Company believes that providing access to quality health care services
is an essential ingredient for success. To achieve this goal, the Company has
established a peer review procedure at each HMO, which is implemented by a
Quality Assurance Committee chaired by the HMO's Medical Director and comprised
of physicians and representatives of the physician groups at each HMO. When a
new physician or physician group is considered by one of the Company's HMOs as a
potential provider, the Quality Assurance Committee of the HMO evaluates, among
other things, the quality of the physician or group's medical facilities,
medical records, laboratory and x-ray licenses and the capacity to handle
membership demands. Once selected, a physician or group is periodically reviewed
to monitor whether members are receiving quality medical care.
The Company has developed a comprehensive array of initiatives to improve
the quality of service and clinical outcomes affecting members. Such initiatives
include, among other things, NCQA accreditation,
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Health Plan Employer Data Information Set ("HEDIS") improvements, a
standardized, streamlined specialty referral process, a complaint management
program to coordinate problem resolution, member satisfaction surveys at the
HMO-level, chronic care initiatives, a senior health risk assessment, a smoking
cessation program, sophisticated report cards and a comprehensive information
technology strategy.
Approximately 88 percent of the Company's membership is enrolled in plans
with NCQA accreditation. NCQA is an independent, non-profit organization that
reviews and accredits HMOs. NCQA performs site reviews of standards established
for quality assurance, utilization management, credentialing process, commitment
to members' rights and preventative health services. HMOs that comply with
NCQA's review requirements and quality standards receive NCQA accreditation. The
Company's HMOs in Arizona, California, Colorado, Nevada and Oklahoma have
received full three-year NCQA accreditation status and the Company's HMOs in
Oregon and Utah have received one-year NCQA accreditation status.
RISK MANAGEMENT
In addition to the Company's cost control systems, the use of underwriting
criteria is an integral part of its risk management efforts. Underwriting is the
process by which a health plan assesses the risk of enrolling employer groups
(or individuals) and establishes appropriate or necessary premium rates. The
setting of premium rates directly affects a health plan's profitability and
marketing success (see "Health Care Costs"). Underwriting techniques are not
employed for the Secure Horizons programs because of regulations that require
the Company to accept nearly all Medicare-entitled applicants.
The Company shifts part of the risk of catastrophic losses by maintaining
reinsurance coverage for certain hospital costs incurred in the treatment of
catastrophic illnesses of its members. The Company also maintains general
liability, property and medical malpractice insurance coverage in amounts that
the Company believes are adequate. The Company requires contracting physicians,
physician groups and hospitals to maintain individual malpractice insurance
coverage.
MARKETING
The Company's marketing strategy and implementation is coordinated by the
Company's corporate marketing staff. Primary marketing responsibility for each
of the Company's HMOs and specialty managed care products and services resides
with a marketing director and a direct sales force. Commercial marketing is a
two-step process in which the Company first markets to employer groups and then
provides information directly to employees once the employer has selected the
HMO. The Company solicits new employer groups of various sizes through direct,
personal selling efforts and through contacts with insurance brokers and
consultants. Many employer groups under contract with the Company are
represented by insurance brokers and consultants who work with the employer to
recommend or design employee benefits packages. Brokers are paid on a commission
basis by the Company over the life of the contract, while consultants generally
are paid by the employer. The Company has also developed a marketing strategy to
strengthen and increase its market share by increasing penetration in existing
employer groups and by increasing access to new populations through small group
marketing and expansion of its delivery network to more effectively meet the
needs of multi-state employers. A significant portion of the Company's
commercial membership growth comes from existing employer groups.
During "open enrollment" periods when employees are permitted to change
health care programs, the Company utilizes various techniques to attract
commercial members, including work site presentations, direct mail, medical
group tours and local advertising. Marketing efforts are also supported by an
advertising program that generally includes television, radio, billboard and
print media.
The Company markets the Secure Horizons programs to Medicare beneficiaries
primarily through direct mail, telemarketing, television, radio and cooperative
advertising with participating medical groups. The Company anticipates further
growth opportunities in the Medicare risk program based on the
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Company's current marketing strategies and the growing senior population in the
United States (see "--Operations, Products and Services--Secure Horizons
Programs" and "Specialty Managed Care Products and Services--Medicare Risk
Management"). Most Secure Horizons members deal directly with the plan and
generally without the involvement of insurance brokers except when associated
with an employer group retiree offering.
MANAGEMENT INFORMATION SYSTEMS
The Company uses computer-based management information systems for various
purposes, including marketing and sales tracking, underwriting, billing, claims
processing, utilization management, medical cost and utilization trending,
financial and management accounting, reporting, planning and analysis. These
systems also support member, group and provider service functions, including
on-line access to membership verification, claims and referral status and
information regarding hospital admissions and lengths of stay. In addition,
these systems support extensive analyses of cost and outcome data. The Company
is dependent upon the operations of these systems for sales and marketing,
electronic claims receipt, utilization management authorization processing,
claims adjudication and payment, eligibility verification, bill processing and
general corporate accounting. To preserve its investment in existing systems,
exploit new technologies, improve the cost effectiveness and quality of services
provided and allow for effective new product introduction capabilities, the
Company's computer information systems which support its managed care operations
and specialty managed products are continually being enhanced and upgraded.
System enhancements and upgrades include upgrading mainframe computers,
enhancing existing software functionality, implementing purchased software and
migrating to more suitable software database environments. Following the FHP
Acquisition, the Company has been engaged in an extensive review of its
information systems, including integration of multiple systems. Simplification,
integration and expansion of the systems servicing the Company's business is an
important component of controlling health care and administrative expenses and
improving member and provider satisfaction. To the extent that these systems
fail to operate properly or the integration efforts are not successful, the
Company's financial results may be adversely affected.
YEAR 2000
In 1996, the Company developed and began execution of an enterprise wide
plan to ensure application software and systems compliance for the year 2000.
The Company currently expects the project to be complete by the end of 1998 and
to cost less than $10 million. This estimate includes internal costs, but
excludes the costs to upgrade and replace systems in the normal course of
business. As of December 31, 1997, approximately $2 million had been expensed
related to this project. An additional component of this project is the written
confirmation from all systems vendors ensuring year 2000 compliance in
conjunction with the Company's target deadlines. The Company is currently
assessing the impact, if any, of year 2000 issues it may encounter with entities
with which it electronically interacts, including HCFA. If HCFA or certain other
entities experience significant failures or erroneous applications, it could
have a material adverse effect on the Company's financial position, results of
operations or cash flows.
COMPETITION
The health care industry is highly competitive, both nationally and in the
Company's various markets. Consolidation in the health care industry has
resulted in fewer but larger competitors of the Company including insurance
carriers, other HMOs, employer self-funded programs and PPOs, many of which have
substantially larger enrollments or greater financial resources than the
Company. As a result of this consolidation, the Company has become one of the
largest HMOs in the country. The Company also faces competition from hospitals,
health care facilities and other health care providers who have combined and
formed their own networks to contract directly with employer groups and other
prospective customers for the delivery of health care services. In California,
the largest market in which the Company competes, the
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Company encounters competition from a few large HMOs and to a lesser extent
smaller HMOs, PPOs, self-funded employers and health care providers. In other
markets in which the Company operates, the Company faces competition from local
HMOs, PPOs and other local health care providers as well as other national HMOs
and insurance carriers. In addition, new federal legislation permits for the
first time, beginning in 1999, PSOs to directly contract with HCFA for Medicare
risk contracts. PSOs, if successful, will increase the Company's competition for
new Medicare enrollees (see "Specialty Managed Care Products and
Services--Medicare Risk Management" and "Government Regulation"). Competition
for members in the Company's markets has resulted in an increase in benefits and
price competition. In such an increasingly competitive environment, the Company
believes that a comprehensive range of products and services, along with a
strong provider network, must be provided to remain competitive. Other factors
which the Company believes generally help it in regard to competitors are the
strength of its underwriting and pricing practices and staff, its significant
market position in certain geographic areas, its financial strength, its
experience and its generally favorable marketplace reputation. Increased
competition could result in a decline in revenue or in price reductions, which
could have a material adverse effect on the Company's financial position,
results of operations or cash flows.
GOVERNMENT REGULATION
The Company's HMO subsidiaries are affected by several state and federal
laws and regulations, including the federal Health Maintenance Organization Act
of 1973 (the "HMO Act") and statutes regulating or affecting HMOs in each of the
states in which it does business. As a result, the Company is subject to
extensive regulation regarding the scope of benefits provided to its members,
financial solvency requirements, quality assurance and utilization review
procedures, member grievance procedures, provider contracts, marketing and
advertising. All of the Company's HMO operations are federally qualified or meet
similar requirements as a competitive medical plan.
The Company's Secure Horizons programs are provided under contracts with,
and are subject to regulations by, HCFA and certain state agencies (see
"Operations, Products and Services--HMO Operations-Secure Horizons Programs").
As a result of HCFA's regulations governing the Company's Medicare risk
programs, the medical care ratio, as determined prospectively through formulas
established by HCFA for the Company's Medicare risk contracts in a particular
region, is not allowed to be less than the medical care ratio for the Company's
non-Medicare risk contracts in such regions. If the Company were to fall out of
compliance with these regulations, it would have to provide additional benefits,
reduce the supplemental premiums charged to its Medicare members or accept a
lower payment from HCFA to increase the medical care ratio for the Medicare risk
contracts to the level of the medical care ratio for the non-Medicare contracts.
This regulation could have a material adverse effect on the Company's financial
position, results of operations or cash flows.
Currently, Secure Horizons' premiums are determined through formulas
established by HCFA for the Company's Medicare risk contracts in a particular
region. If these premiums are reduced or if premium rate increases in a
particular region are lower than the rate of increase in health care service
expenses of Secure Horizons members in such region, the Company's operations,
profitability or business prospects could be affected. The Company has mitigated
this risk by paying nearly all of the health care service expenses of the Secure
Horizons programs on a percentage of premium basis.
On August 5, 1997, President Clinton signed into law the Balanced Budget Act
of 1997, which enacted numerous revisions to the Medicare program. The law
replaces the risk contract program with a new "Medicare+Choice" program, which
is intended to increase Medicare enrollment in private health plans. During
1998, HCFA is expected to promulgate regulations that will allow participation
in the Medicare+Choice program by HMOs, preferred provider organizations,
point-of-service plans, PSOs and fee-for-service plans and provide for a new
medical savings accounts demonstration project for Medicare beneficiaries. The
law also revises the formula used by HCFA to calculate payments to Medicare
health plans by establishing minimum payment levels and annual increases and
limiting the overall rate of
10
<PAGE>
payment growth. Further, the law enacts new requirements for risk adjustment,
information disclosure, quality measurement and improvement and beneficiary
enrollment, among other provisions. The Company believes that any slowdown in
the rate of premium growth may be offset by the effect of this new legislation
encouraging managed health care for Medicare beneficiaries. The loss of Medicare
contracts or termination or modification of the HCFA risk-based Medicare program
could have a material adverse effect on the revenue, profitability and business
prospects of the Company.
In 1996, HCFA promulgated regulations ("physician incentive regulations")
enforcing Sections 4204(a) and 4731 of the Omnibus Budget Reconciliation Act of
1990 ("OBRA 90"). OBRA 90 and the physician incentive regulations prohibit HMOs
with Medicare risk contracts from knowingly making incentive payments to
physicians as an inducement to reduce or limit medically necessary services to
Medicare beneficiaries. HCFA requires plans to meet these regulations annually
by submission of consolidated survey responses from contracted physician groups.
Under the physician incentive regulations, HMOs must, among other things,
disclose to HCFA their physician compensation plan in such detail as to allow
HCFA to determine compliance with the regulations, and provide stop-loss
insurance to a physician or physician group, if the HMO places the physician at
"substantial financial risk" for services provided to Medicare beneficiaries.
Revision of the physician incentive regulations in several specific areas is
currently under serious consideration by HCFA. The Company is taking steps to
comply with the physician incentive regulations.
In the normal course of business, the governmental agencies with which
PacifiCare contracts periodically review the premiums paid to the Company under
these programs to detect whether any excess premiums have been paid. If such
agencies discover, in connection with any such review, that excess premiums were
paid to the Company, adjustments to current or future premiums would be made. If
such adjustments were significant, they could materially and adversely affect
the profitability, operations or business prospects of the Company.
PacifiCare's HMOs have commercial contracts with the United States Office of
Personnel Management ("OPM") to provide managed care health services to
employees and retirees of the federal government and their dependents under the
Federal Employees Health Benefit Program ("FEHPB"). 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 and
implemented centralized internal
11
<PAGE>
review processes to reduce the likelihood of liability for contract years
beginning with January 1999. 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 adverse effect
on results of operations or cash flows of a future quarter if resolved
unfavorably.
The Company's HMOs are subject to state regulations which require periodic
financial reports from HMOs licensed to operate in their state and, in certain
cases, impose minimum equity, capital, deposit and/or reserve requirements.
Certain federal and/or state regulatory agencies also require the Company's HMOs
to maintain restricted cash reserves represented by interest-bearing instruments
which are held by trustees or state regulatory agencies. These requirements,
which limit the ability of the Company's subsidiaries to transfer funds to the
Company, may limit the ability of the Company to pay dividends. From time to
time, the Company advances funds, in the form of a loan, to its subsidiaries to
assist them in satisfying federal or state financial requirements.
The National Association of Insurance Commissioners (the "NAIC") has an
effort underway that would impose new minimum capitalization requirements for
HMOs, health care insurance entities and other risk bearing health care
entities. The requirements would take the form of risk-based capital rules
similar to rules for certain non-health care insurance companies. If the
capitalization requirements were enacted, certain of the Company's subsidiaries
would have to increase their capital requirements. If and when the requirements
are enacted, the Company expects to fund the subsidiaries to meet the new
requirements. The Company does not believe that the amount of funds that may be
paid by subsidiaries to the Company will be materially affected after meeting
the new capitalization criteria.
The Company has six insurance subsidiaries, which are subject to regulation
in each jurisdiction in which they are licensed. Regulatory authorities exercise
extensive supervisory power over insurance companies. The Company's insurance
subsidiaries are required to file periodic statutory financial statements in
each jurisdiction in which they are licensed. Additionally, the insurance
departments of the jurisdiction in which they are licensed to do business
periodically examine such subsidiaries.
Certain of the Company's HMOs and each of the Company's insurance
subsidiaries are subject to regulation under state insurance holding company
regulations. Such insurance holding company laws and regulations generally
require registration with the appropriate state department of insurance and the
filing of certain reports describing capital structure, ownership, financial
condition, certain intercompany transactions and general business operations.
Various notice and reporting requirements generally apply to transactions
between companies within an insurance holding company system, depending on the
size and nature of the transactions. Certain state insurance holding company
laws and regulations require prior regulatory approval or, in certain
circumstances, prior notice of certain material intercompany transfers of assets
as well as certain transactions between the regulated companies, their parent
holding companies and affiliates, and acquisitions.
In 1997, the Departments of Health and Human Services, Labor and Treasury
promulgated regulations enforcing the "Health Insurance Portability and
Accountability Act of 1996" which took effect in January 1998. The regulations
require certain guaranteed issuance and renewability of health coverage for
individuals and small groups, limit preexisting condition exclusions and provide
for a demonstration project for medical savings accounts for individuals who
obtain individual medical insurance and small businesses. Regulations were also
promulgated to enforce other federal legislation, which became effective in
January 1998, requiring health plans to provide parity for mental health
benefits and minimum lengths of stay for mothers and their newborns. The Company
is continuing to analyze the operational impact, if any, to the Company of these
regulations; however, the Company believes that these regulations will have an
administrative impact on the Company.
The provision of goods and services to or through certain types of employee
health benefit plans is subject to the Employee Retirement Income Security Act
of 1974 ("ERISA"). ERISA is a complex set of laws and regulations that are
subject to periodic interpretation by the United States Department of Labor.
12
<PAGE>
ERISA places controls on how the Company's health plans and specialty managed
care products and services may do business with employers covered by ERISA,
particularly employers that maintain self-funded plans. The Department of Labor
is engaged in an ongoing ERISA enforcement program which may result in
additional constraints on how ERISA-governed benefit plans conduct their
activities. There have been recent legislative attempts to limit ERISA's
preemptive effect on state laws. If such limitations were to be enacted, they
might increase the Company's liability exposure under state law claims relating
to employee health benefits offered by the Company's health plans and specialty
managed care products and services and may permit greater state regulation of
other aspects of those business operations.
State and federal lawmakers may continue to consider and enact laws and
regulations which could impact the Company, including prohibition or limitation
of capitated arrangements or provider financial incentives, benefit mandates,
limitations on the ability to manage utilization of services, and requirements
for information disclosure, provider contracting and dispute resolution. The
adoption of such legislation or regulations may make it more difficult for the
Company to control health care costs and could adversely affect financial
results. Although the Company intends to maintain its HMOs' federal
qualifications, state licenses and Medicare contracts, there can be no assurance
that it can do so.
STOCK MARKET
The market prices of the Company's Class A Common Stock, par value $0.01 per
share (the "Class A Common Stock"), Class B Common Stock, par value $0.01 per
share (the "Class B Common Stock"), and the Series A Cumulative Preferred Stock,
par value $0.01 per share (the "Series A Preferred Stock") and the market prices
of the publicly traded shares of the Company's competitors have shown
significant volatility and sensitivity to many factors, including legislative or
regulatory actions, health care cost trends, premium pricing trends, levels of
competition, earnings results of industry participants and acquisition activity.
There can be no assurances regarding the stability of the various share prices
of the Company at any time or the impact of these or any other factors on the
share prices of the Company. See Item 5-- "Market for the Company's Equity and
Related Stockholder Matters."
TRADEMARKS
The federally registered service marks PacifiCare-Registered Trademark- and
SecureHorizons-Registered Trademark- are owned by the Company and are material
to its business.
EMPLOYEES
At December 31, 1997, the Company had 9,770 full and part-time employees.
None of the Company's employees are presently covered by a collective bargaining
agreement and the Company has not experienced any work stoppage since its
organization. The Company considers its relations with its employees to be good.
ITEM 2. PROPERTIES
As of December 31, 1997, the Company leased approximately 220,000 aggregate
square feet of space for its principal corporate headquarters and executive
offices in Santa Ana and Costa Mesa, California. In connection with its
operations, as of December 31, 1997, the Company leased approximately 2.2
million aggregate square feet for office space, subsidiary operations, customer
service centers and space for computer facilities. Such space corresponds to
areas in which the Company's HMOs or specialty managed care products and
services operate or where it has satellite administrative offices. The Company's
leases expire at various dates through 2007.
The Company owns 32 buildings encompassing approximately 914,000 aggregate
square feet of space. Six of the buildings, which represent approximately
348,000 aggregate square feet of space are primarily used for administrative
operations and are located in California, Utah and Guam. The remaining 26
13
<PAGE>
buildings are medical office buildings leased under a master lease agreement.
All 26 medical buildings are being marketed for sale. The Company also owns nine
parcels of vacant land for a total of 46 acres, all of which are being marketed
for sale.
The Company considers its facilities to be in good working condition, well
maintained and adequate for its present and anticipated needs. The Company
believes that additional space can be obtained at competitive rates upon the
expiration of current leases or in the event additional space is needed.
ITEM 3. 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 which 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the three
months ended December 31, 1997.
14
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S EQUITY AND RELATED STOCKHOLDER MATTERS
The Class A Common Stock, the Class B Common Stock, and the Series A
Preferred Stock are listed on the Nasdaq National Market under the symbols
PHSYA, PHSYB, and PHSYP, respectively. The following tables set forth, for the
indicated periods, the high and low reported sale prices per share of the Class
A and Class B Common Stock and the Series A Preferred Stock (from February 14,
1997) as furnished by Nasdaq.
<TABLE>
<CAPTION>
CLASS A CLASS B SERIES A
COMMON STOCK COMMON STOCK PREFERRED
STOCK
-------------- -------------- --------------
HIGH LOW HIGH LOW HIGH LOW
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997
First Quarter......................... 85 5/8 68 3/4 89 1/2 72 7/8 34 7/8 32
Second Quarter........................ 83 55 1/2 87 3/4 58 3/4 34 3/8 25 1/8
Third Quarter......................... 71 60 1/4 74 3/4 62 29 5/8 27
Fourth Quarter........................ 71 1/4 48 1/8 72 1/2 50 7/8 28 1/2 20 3/8
TWELVE MONTHS ENDED DECEMBER 31, 1996
First Quarter......................... 98 3/4 75 1/4 99 1/2 78 1/2 -- --
Second Quarter........................ 83 3/4 63 7/8 86 3/4 65 1/4 -- --
Third Quarter......................... 84 3/4 59 5/8 91 59 3/4 -- --
Fourth Quarter........................ 86 1/4 63 1/4 90 1/2 65 3/4 -- --
</TABLE>
The Company has never paid any cash dividends on its common stock and
presently anticipates for the foreseeable future that no cash dividends on its
common stock will be declared and that all of its earnings will be retained for
development of the Company's business. Any dividends will depend upon future
earnings, the financial condition of the Company and regulatory requirements. If
the Company were to decide to make dividend payments, the Company could only
make dividend payments in shares of its common stock pursuant to the
restrictions on dividend payments which exist in the credit facility (see Note 5
of the Notes to Consolidated Financial Statements).
As of December 31, 1997 there were approximately 344 and 364 shareholders of
record of the Company's Class A Common Stock and Class B Common Stock,
respectively. These numbers do not include individual participants in security
position listings. Based on available information, the Company believes there
are at least 15,000 beneficial holders of its Class A and Class B Common Stock.
The authorized preferred stock of the Company includes 11,000,000 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
payable quarterly in arrears 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 Stock 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 the 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
15
<PAGE>
elect two additional directors if the equivalent of six quarterly dividends
payable on the Series A Preferred Stock are in default.
ITEM 6. SELECTED FINANCIAL DATA
In February 1997, PacifiCare's board of directors approved a change in the
Company's fiscal year end from September 30 to December 31. This resulted in a
transition period of October 1, 1996 through December 31, 1996. The following
selected financial and operating data are derived from the audited financial
statements of the Company and its subsidiaries or from the Company's unaudited
internal financial data. For clarity of presentation and comparability, the
following selected financial and operating data includes the unaudited period
for the twelve months ended December 31, 1996. The selected financial and
operating data should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
also with "Item 8. Financial Statements and Supplementary Data."
16
<PAGE>
INCOME STATEMENT DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(TRANSITION
(UNAUDITED) PERIOD)
TWELVE THREE
YEAR ENDED MONTHS ENDED MONTHS ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997(1) 1996(2) 1996 1996(2) 1995 1994(3)
------------ ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenue............ $8,982,680 $ 4,807,856 $ 1,234,875 $ 4,637,305 $ 3,731,022 $ 2,893,252
------------ ------------- ------------- ------------- ------------- -------------
Expenses:
Health care services....... 7,658,879 4,017,383 1,039,345 3,872,747 3,077,135 2,374,258
Other operating expenses... 1,125,299 605,546 154,996 585,081 505,644 398,064
Impairment, disposition,
restructuring and other
charges.................. 154,507 75,840 -- 75,840 -- --
Office of Personnel
Management charge........ -- 25,000 -- 25,000 -- --
------------ ------------- ------------- ------------- ------------- -------------
Operating income............. 43,995 84,087 40,534 78,637 148,243 120,930
Interest income, net......... 16,129 44,696 12,302 44,143 33,857 24,538
------------ ------------- ------------- ------------- ------------- -------------
Income before income taxes
and cumulative effect of a
change in accounting
principle.................. 60,124 128,783 52,836 122,780 182,100 145,468
Provision for income taxes... 81,825 53,052 21,079 50,827 74,005 60,875
------------ ------------- ------------- ------------- ------------- -------------
Income (loss) before
cumulative effect of a
change in accounting
principle.................. (21,701) 75,731 31,757 71,953 108,095 84,593
Cumulative effect on prior
years of a change in
accounting principle....... -- -- -- -- -- 5,658
------------ ------------- ------------- ------------- ------------- -------------
Net income (loss)............ $ (21,701) $ 75,731 $ 31,757 $ 71,953 $ 108,095 $ 90,251
------------ ------------- ------------- ------------- ------------- -------------
------------ ------------- ------------- ------------- ------------- -------------
Preferred dividends.......... (8,792) -- -- -- -- --
------------ ------------- ------------- ------------- ------------- -------------
Net income (loss) available
to common shareholders..... $ (30,493) $ 75,731 $ 31,757 $ 71,953 $ 108,095 $ 90,251
------------ ------------- ------------- ------------- ------------- -------------
Basic earnings (loss) per
share (4).................. $ (0.75) $ 2.43 $ 1.01 $ 2.31 $ 3.69 $ 3.30
------------ ------------- ------------- ------------- ------------- -------------
Diluted earnings (loss) per
share(4)................... $ (0.75) $ 2.39 $ 1.00 $ 2.27 $ 3.62 $ 3.22
------------ ------------- ------------- ------------- ------------- -------------
------------ ------------- ------------- ------------- ------------- -------------
OPERATING STATISTICS
Medical care ratio (health
care services as a
percent of premium
revenue)
Consolidated............. 85.7% 84.5% 85.1% 84.4% 83.6% 83.1%
Commercial............... 85.8% 82.8% 84.4% 83.1% 82.5% 80.5%
Government............... 85.6% 85.6% 85.5% 85.4% 84.3% 85.2%
Marketing, general and
administrative expenses as
a percent of operating
revenue.................... 11.7% 12.4% 12.4% 12.4% 13.4% 13.6%
Operating income............. 0.5% 1.7% 3.3% 1.7% 4.0% 4.2%
Effective tax rate(5)........ 136.1% 41.2% 39.9% 41.4% 40.6% 41.8%
Return on average
shareholders' equity....... (1.5)% 9.3% 3.9% 9.3% 18.9% 24.6%
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1993
-------------
<S> <C>
Operating revenue............ $ 2,221,073
-------------
Expenses:
Health care services....... 1,850,469
Other operating expenses... 283,360
Impairment, disposition,
restructuring and other
charges.................. --
Office of Personnel
Management charge........ --
-------------
Operating income............. 87,244
Interest income, net......... 21,083
-------------
Income before income taxes
and cumulative effect of a
change in accounting
principle.................. 108,327
Provision for income taxes... 45,631
-------------
Income (loss) before
cumulative effect of a
change in accounting
principle.................. 62,696
Cumulative effect on prior
years of a change in
accounting principle....... --
-------------
Net income (loss)............ $ 62,696
-------------
-------------
Preferred dividends.......... --
-------------
Net income (loss) available
to common shareholders..... $ 62,696
-------------
Basic earnings (loss) per
share (4).................. $ 2.30
-------------
Diluted earnings (loss) per
share(4)................... $ 2.25
-------------
-------------
OPERATING STATISTICS
Medical care ratio (health
care services as a
percent of premium
revenue)
Consolidated............. 84.1%
Commercial............... 82.5%
Government............... 85.6%
Marketing, general and
administrative expenses as
a percent of operating
revenue.................... 12.6%
Operating income............. 3.9%
Effective tax rate(5)........ 42.1%
Return on average
shareholders' equity....... 24.2%
</TABLE>
See footnotes described following "Balance Sheet Data"
17
<PAGE>
FINANCIAL STATEMENT CHANGE STATISTICS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997(6) 1996 1995 1994
--------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Operating revenue................................. 86.8% 24.3% 29.0% 30.3%
------ ----- --- ---
Net income (loss)(2,3)............................ (128.7)% (33.4)% 19.8% 44.0%
------ ----- --- ---
Earnings (loss) per share(2,3).................... (131.5)% (37.3)% 12.4% 43.1%
------ ----- --- ---
Total assets...................................... 211.8% (6.2)% 25.3% 59.4%
------ ----- --- ---
Total shareholders' equity........................ 139.8% 12.5% 77.1% 29.5%
------ ----- --- ---
<CAPTION>
YEAR ENDED
SEPTEMBER 30,
1993
-----------------
<S> <C>
Operating revenue................................. 31.7%
---
Net income (loss)(2,3)............................ 43.8%
---
Earnings (loss) per share(2,3).................... 26.4%
---
Total assets...................................... 39.3%
---
Total shareholders' equity........................ 60.5%
---
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1996 1995 1994 1993
------------ ------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
MEMBERSHIP DATA
Commercial.................................. 2,790,000 1,451,500 1,434,500 1,216,100 949,100 806,900
Government (Medicare & Medicaid)............ 1,001,100 593,600 596,200 541,000 409,100 290,100
------------ ------------ ------------- ------------- ------------- -------------
Total membership............................ 3,791,100 2,045,100 2,030,700 1,757,100 1,358,200 1,097,000
------------ ------------ ------------- ------------- ------------- -------------
------------ ------------ ------------- ------------- ------------- -------------
Percent change in membership................ 85.4% 0.7% 15.6% 29.4% 23.8% 14.7%
------------ ------------ ------------- ------------- ------------- -------------
------------ ------------ ------------- ------------- ------------- -------------
BALANCE SHEET DATA
(IN THOUSANDS)
Cash and equivalents and marketable
securities................................ $1,545,382 $ 962,482 $ 700,093 $ 811,525 $ 710,608 $ 437,231
Total assets................................ $4,867,958 $1,561,472 $ 1,299,462 $ 1,385,372 $ 1,105,548 $ 693,646
Medical claims and benefits payable......... $ 715,600 $ 278,800 $ 268,000 $ 288,400 $ 302,900 $ 255,000
Long-term debt, excluding current
maturities................................ $1,011,234 $ 1,370 $ 5,183 $ 11,949 $ 101,137 $ 21,821
Shareholders' equity........................ $2,062,187 $ 860,102 $ 823,224 $ 732,024 $ 413,358 $ 319,294
</TABLE>
- ------------------------
(1) The 1997 results include the results of operations for the FHP Acquisition
from February 14, 1997 (see Note 4 of the Notes to Consolidated Financial
Statements). The 1997 results include $155 million of pretax charges ($129
million or $3.18 diluted loss per share, net of tax) for the impairment of
long-lived assets, restructuring and certain other charges (see Note 9 of
the Notes to Consolidated Financial Statements). Operating income as a
percentage of operating revenue before pretax charges was 2.2 percent.
Return on average shareholders' equity before pretax charges was 7.3
percent.
(2) The 1996 results include $101 million of pretax charges ($62 million or
$1.96 and $1.97 diluted loss per share, net of tax for the year ended
September 30 and the twelve months ended December 31, respectively) for the
impairment of long-lived assets, potential government claims, dispositions
and certain restructuring charges (see Note 9 of the Notes to Consolidated
Financial Statements). Operating income as a percentage of operating revenue
before pretax charges for 1996 was 3.8 and 3.9 percent, respectively for the
year ended September 30 and the twelve months ended December 31. Return on
average shareholders' equity before pretax charges for the year ended
September 30, 1996 and the twelve months ended December 31, 1996 was 17.2
percent and 17.0 percent, respectively.
(3) The 1994 results reflect the cumulative effect on prior fiscal years of a
change in accounting principle. Diluted earnings per share before cumulative
effect of a change in accounting principle for the year ended September 30,
1994 was $3.02 per share. The cumulative effect of a change in accounting
principle for the fiscal year ended September 30, 1994 was $0.20 per share.
The fiscal year 1994 changes in net income and earnings per share before
cumulative effect of a change in accounting principle are 34.9 percent and
34.2 percent, respectively.
(4) Earnings per share have been restated to conform with the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share."
Basic earnings per share excludes the effect of all potentially dilutive
securities. Diluted earnings per share includes the effect of the
potentially dilutive securities (see Note 2 of the Notes to Consolidated
Financial Statements). For the years ended September 30, 1993 through
September 30, 1996 and for the three months and twelve months ended December
31, 1996 the current presentation of diluted earnings per share is identical
to the Company's former presentation of primary earnings per share. The
potentially dilutive securities were not included in the calculation of
diluted loss per share for 1997 because they were anti-dilutive.
(5) Effective income tax rate includes the effect of non-deductible pretax
charges.
(6) Changes as compared to the unaudited period for the 12 months ended December
31, 1996.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
In February 1997, PacifiCare's board of directors approved a change in the
Company's fiscal year end from September 30 to December 31. This resulted in a
transition period from October 1, 1996 to December 31, 1996, which has been
audited. However, for clarity of presentation and comparability, the discussion
of results of operations compares the year ended December 31, 1997 to the
unaudited twelve months ended December 31, 1996, followed by a comparison of the
fiscal year ended September 30, 1996 to the fiscal year ended September 30,
1995. For purposes of the comparison of the year ended December 31, 1997 to the
twelve months ended December 31, 1996, the unaudited twelve months ended
December 31, 1996 are referred to as the prior year.
On February 14, 1997 the Company consummated the FHP Acquisition for a total
purchase price including transaction costs of $2.2 billion. The FHP Acquisition
has been accounted for as a purchase. The Company's consolidated results of
operations include the results of FHP from the date of the FHP Acquisition (see
Note 4 of the Notes to Consolidated Financial Statements).
1997 COMPARED WITH 1996
Total operating revenue increased 87 percent to $9.0 billion for the year
ended December 31, 1997 from $4.8 billion for the same period in the prior year.
FHP contributed approximately $3.6 billion or 85 percent of the increase in
revenue. Enrollment gains (net of the FHP Acquisition) in both the government
and commercial programs increased revenue by six percent. Premium increases,
mainly in the government programs, along with the Company's specialty managed
care products and services, contributed the remainder of the increase. Total HMO
membership increased 85 percent to approximately 3.8 million members at December
31, 1997, from approximately 2.0 million members at December 31, 1996, due
primarily to the FHP Acquisition. The Company acquired approximately 1.5 million
and 0.4 million commercial and government members, respectively, as part of the
FHP Acquisition.
Commercial premiums increased 97 percent over the prior year with
approximately 92 percent of the total increase related to the FHP Acquisition.
Enrollment gains in the commercial programs, net of acquisition membership,
accounted for seven percent, while premium rates remained relatively flat.
Excluding the FHP Acquisition, the Company has experienced a decrease in the
rate of membership growth compared to the prior year. This decrease is partly
due to the disposition of the Company's Florida operations. Additionally, the
Company has shifted its focus from one of rapid growth to improved profit
margins through the use of a more disciplined product pricing strategy.
Government premiums increased 85 percent as compared to the twelve months
ended December 31, 1996 with 81 percent of the total increase related to the FHP
Acquisition. On January 1, 1997, the Company received premium rate increases
from HCFA averaging over six percent. Government per member premium rates also
increased as a result of the Company's exit of its Medicaid lines of business in
certain of the Company's markets, which have lower average per member premiums.
These increases were offset slightly by reductions in member paid supplemental
premiums in several of the Company's markets. The combined increases in the per
member premium rates increased revenue by almost 14 percent as compared to the
prior year. Enrollment gains in the government programs, net of acquisition
membership, accounted for an additional five percent of the increase in
government premiums.
The increase in the commercial medical care ratio includes higher cost FHP
provider contracts, increased non-capitated physician costs and increased out of
area emergency room costs as compared to the prior year.
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The government programs' medical care ratio for the year ended December 31,
1997 remained flat as compared to the prior year. This consistency largely
reflects the FHP Acquisition, which had lower cost provider contracts and
generally higher reimbursement for Medicare risk membership. Additionally, the
wind down of the Medicaid business contributed to slight decreases in the
government medical care ratio. These decreases were partially offset by enhanced
prescription drug benefits provided to enrollees combined with lower member paid
supplemental premiums.
As a percentage of operating revenue, marketing, general and administrative
expenses decreased slightly as compared to the prior year, excluding the pretax
charges for 1997 and 1996 as discussed below. The decrease reflects reduced or
eliminated FHP marketing, continued administrative savings, including lower than
expected staffing and greater than expected efficiencies resulting from the
integration of the FHP administrative operations and information systems.
The Company recognized pretax charges totaling $155 million ($129 million or
$3.18 diluted loss per share, net of tax) for the year ended December 31, 1997
and $101 million ($62 million or 1.97 diluted loss per share, net of taxes) for
the twelve months ended December 31, 1996. The 1997 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. The
1996 pretax charges included an impairment of goodwill, a disposition loss
restructuring and OPM charges.
During the fourth quarter of 1997, the Company recognized a $124 million
($111 million or $2.73 diluted loss per share, net of tax) charge for goodwill
and intangible assets which 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 losses 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 which 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.
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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 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.
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.
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 of the
Company's Secure Horizons program. Accordingly, the Company recognized a $59
million ($34 million or $1.10 diluted loss per share, net of tax) charge for the
impairment of goodwill and decided to sell its Florida operations.
Effective June 1, 1996, Florida sold the assets of its staff-model medical
clinics resulting in a pretax loss of $9 million ($8 million or $0.26 diluted
loss per share, net of tax).
During 1996, management approved a plan relating for the discontinuation of
certain specialty heath care products and services that do 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.
In June 1996, a pretax charge was recognized of $25 million ($15 million, or
$0.46 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 FEHBP. 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
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the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claim 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.
Interest income, net of interest expense, decreased approximately $29
million for the year ended December 31, 1997 compared to the prior year due
primarily to increased borrowings to finance the FHP Acquisition.
The majority of the pretax charges the Company recorded in the fourth
quarter of 1997 are not deductible for income tax purposes. Therefore, the
Company did not record an income tax 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 effective income tax rate
without the effect of the pretax charges was approximately 50 percent, which is
an increase over the prior year. This increase reflects the additional goodwill
amortization expense over the prior year related to the FHP Acquisition.
For the year ended December 31, 1997 income excluding the pretax charges
described above was $107 million or $2.43 diluted earnings per share. For the
year ended December 31, 1996 income exclusive of the pretax charges was $138
million or $4.36 diluted earnings per share. The decrease over the prior year
reflects the increase in the commercial medical care ratio, increased
amortization expense, the increase in interest expense related to the FHP
Acquisition and an increase in the shares used to calculate earnings per share.
For the year ended December 31, 1997 the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS")No. 128, "Earnings Per
Share". This statement requires a dual presentation of earnings per share, basic
and diluted and restatement of earnings per share for prior years. The adoption
of this statement did not materially change the Company's calculation of
earnings (loss) per share for any reported period.
Due mainly to the pretax charges in the fourth quarter, and the high
effective tax rate which resulted in the Company reporting a net loss per share,
the convertible preferred stock and stock options or potentially dilutive
securities included in the calculation of diluted loss per share in the fourth
quarter and for 1997 were anti-dilutive. Since the potentially dilutive
securities were anti-dilutive, the calculation of the diluted loss per share is
identical to the basic loss per share.
The Class A Common Stock, Class B Common Stock and Series A Preferred Stock
issued in conjunction with the FHP Acquisition (see Note 4 of the Notes to
Consolidated Financial Statements) caused a significant increase in the shares
outstanding used in computing earnings per share between the fiscal quarters.
Due to the significant increase in shares outstanding and the anti-dilutive
effect of the potentially dilutive securities during the fourth quarter, the sum
of the quarterly earnings (loss) per share does not equal the 1997 year-to-date
loss per share.
FISCAL YEAR 1996 COMPARED WITH FISCAL YEAR 1995
Total operating revenue increased $906 million to $4.6 billion for the
fiscal year ended September 30, 1996 from $3.7 billion for the same period in
the prior fiscal year. Enrollment gains in both the government and commercial
programs, offset slightly by decreases in commercial premium rates, provided an
increase in total operating revenue of $787 million. The remaining operating
revenue increase was contributed by the incremental operations of acquisitions
described in Note 4 of the Notes to Consolidated Financial Statements and the
Company's specialty managed care products and services.
Commercial premiums increased $355 million or 23 percent to $1.9 billion for
the fiscal year ended September 30, 1996 from $1.5 billion in fiscal 1995.
Commercial HMO membership increased by 0.2 million to 1.4 million due to
continued growth in all markets except Florida. Commercial HMO membership growth
provided $281 million of the increase, more than offsetting average premium rate
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decreases of one percent, primarily in California. The effects of acquisitions
described above and the commercial specialty managed care products and services
provided the remainder of the increase in commercial premiums.
Government premiums rose $550 million or 25 percent to $2.7 billion for the
fiscal year ended September 30, 1996 from $2.2 billion in fiscal 1995.
Enrollment gains, predominantly in the Secure Horizons programs, accounted for
$430 million or 78 percent of the increase. The remainder of the premium
increase is attributable to incremental acquisitions and premium rate increases
averaging four percent.
The increase in the commercial medical care ratio for the fiscal year ended
September 30, 1996 was primarily attributable to increased PPO and indemnity
costs of the Company's specialty managed care products and services combined
with higher physician and prescription drug costs in the Company's HMOs.
Exclusive of the Company's PPO and indemnity products, the commercial medical
care ratio decreased slightly through improved contracting arrangements. Many of
the Company's newer markets experienced more membership growth than the Company
as a whole. However, with provider networks less sophisticated in managed care,
these newer markets contributed to a higher medical care ratio. The more mature
commercial markets experienced slightly improved medical care ratios from fiscal
year 1995.
The increase in the medical care ratio for the government programs reflected
increased physician and hospital costs on a per member basis due to higher
membership growth in areas with higher provider costs combined with lower member
supplemental premiums and enhanced benefits to enrollees. These increased costs
are partially offset by January 1, 1996 HCFA premium rate increases.
Marketing, general and administrative expenses increased $78 million to $576
million for the fiscal year ended September 30, 1996 from $498 million for
fiscal year 1995. However, as a percentage of operating revenue, marketing,
general and administrative expenses decreased by one percent. The decrease was
primarily attributable to the Company's reduction of performance based employee
incentives due to current fiscal year operating results not meeting anticipated
fiscal year 1996 targets. Additionally, the Company realized the benefit derived
from prior investments in the Company's infrastructure which have proven
adequate to support the growth in membership.
As discussed previously, the Company recognized pretax charges for the
fiscal year ended September 30, 1996 totaling $101 million ($62 million or $1.96
diluted loss per share, net of tax) (see Note 9 of the Notes to Consolidated
Financial Statements).
Net interest income increased by approximately $10 million compared to the
prior fiscal year primarily due to increased cash available for investment
purposes at higher interest rates than fiscal year 1995 and lower interest
expense associated with decreased debt service.
The increased consolidated effective income tax rate for the fiscal year
ended September 30, 1996 was attributable to the charges for the disposition and
goodwill impairment described in Note 9 of the Notes to Consolidated Financial
Statements, some of which are not deductible for income tax purposes.
Income exclusive of the impairment, disposition, restructuring and OPM
charges described above was $134 million or a 24 percent increase over fiscal
year 1995. Diluted earnings per share before impairment, disposition,
restructuring and OPM charges, increased 17 percent or $0.61 to $4.23 for the
fiscal year ended September 30, 1996. The increases reflect membership growth in
both the commercial and government programs and lower marketing, general and
administrative costs, partially offset by increases in health care service
expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company has significant short-term liquidity with 1997 year-end cash,
equivalents and marketable securities of $1.5 billion, a 61 percent increase
from December 31, 1996 primarily attributable to the FHP Acquisition and results
of operations. The Company's cash flow requirements for 1997 were met by funds
provided from operations. Financing activities, including the issuance of common
and preferred equity
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securities, provided funds for the FHP Acquisition. The Company issued 2,339,402
shares of Class A Common Stock, 7,352,965 shares of Class B Common Stock and
10,517,044 shares of Series A Preferred Stock in connection with the FHP
Acquisition.
Net cash used in investing activities included $1.0 billion, $5 million and
$135 million for acquisitions and $68 million, $23 million and $25 million for
property, plant and equipment purchases in 1997, fiscal 1996 and fiscal 1995,
respectively. In 1997, net cash provided by financing activities included $1.1
billion in borrowings under its $1.5 billion credit facility. Cash payments of
$210 million reduced the credit facility balance to $910 million at December 31,
1997 (see Note 5 of the Notes to Consolidated Financial Statements). The cash
received from the sale of the Talbert stock in 1997 substantially offset the
capital contributions made to Talbert (see Note 4 of the Notes to Consolidated
Financial Statements). Cash received for the issuance of common stock provided
cash in 1997, fiscal 1996 and fiscal 1995 of $44 million, $13 million and $201
million, respectively. The Company issued 991,813 shares, 381,418 shares and
338,608 shares of common stock for benefit plans in 1997, fiscal 1996 and fiscal
1995, respectively. The Company paid approximately $9 million of preferred stock
dividends in 1997.
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 the credit facility to increase the maximum amount of
repurchases permitted to $500 million. The Company will purchase stock using
cash flows from operations and additional borrowings under its credit facility.
Shares repurchased will be available for reissuance in connection with the
Company's employee benefit plans or for other corporate purposes. As of February
28, 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.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued several
pronouncements regarding disclosure that the Company will adopt in 1998.
SFAS No. 129, "Disclosure of Information about Capital Structure,"
consolidates the existing guidance relating to an entity's capital structure.
The required capital structure disclosures include liquidation preferences of
preferred stock, information about the pertinent rights and privileges of the
outstanding equity securities and the redemption amounts of all issues of
capital stock that are redeemable at fixed or determinable prices on fixed or
determinable dates.
SFAS No. 130, "Reporting Comprehensive Income," establishes new rules for
the reporting and display of comprehensive income and its components in a
complete set of general-purpose financial statements as well as in interim
period financial statements.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," significantly changes the way public companies report segment
information in annual financial statements and also requires those companies to
report selected segment information in interim financial reports. Under
Statement 131, public companies will report financial and descriptive
information about their operating segments. Operating segments are
revenue-producing components of the enterprise for which separate financial
information is produced internally and are subject to evaluation by the chief
operating decision maker in deciding how to allocate resources to segments.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants is expected to issue Statement of
Position ("SOP"), "Accounting for the Costs of Computer Software Developed For
or Obtained For Internal-Use." Under the SOP, effective in 1999, certain
computer software costs are required to be capitalized and amortized to income
over the software's estimated useful life. The Company will adopt the SOP in
1999.
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DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward looking statements to encourage companies to provide
prospective information about themselves without fear of litigation so long as
those statements are identified as forward looking and are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those projected in the statements. The
statements contained in this section, and throughout the document, are based on
current expectations. These statements are forward looking and actual results
may differ materially from those projected in the forward looking statements,
which statements involve risks and uncertainties. In addition, past financial
performance is not necessarily a reliable indicator of future performance and
investors should not use historical performance to anticipate results or future
period trends. Shareholders are also directed to the other risks discussed in
other documents filed by the Company with the SEC.
FORWARD LOOKING INFORMATION UNDER THE PRIVATE SECURITIES LITIGATION ACT OF 1995
MEMBERSHIP. The Company's membership for the year ended December 31, 1998
is expected to decline in the commercial program. In accordance with the
Company's strategic focus shifting from one of rapid growth to improved margin
performance, the Company's emphasis is on renewing employer contracts with
sufficient price increases to improve gross margin. Specifically, the Company
has implemented commercial price increases including increases of more than 10
percent in conjunction with open enrollment in all markets, including
concentrated efforts in Utah and Washington which may result in net membership
attrition. In addition to pricing increases, the Company has or intends to exit
certain geographical areas where the premiums are insufficient to support the
cost of health care in that area. Combined with continued increases in
competition and the disposition of its Utah subsidiary which currently has
approximately 154,000 commercial members, the Company expects to see minimal
growth or declines in commercial membership in 1998.
The rate of increase in government membership is expected to decline in 1998
as compared to 1997 as competition increases and the Company continues the
migration of FHP senior members into the Company's benefit structures and the
combined provider network. Additionally, the government membership will decrease
by the approximately 25,000 government members serviced by Utah when the
disposition is complete.
An unforeseen loss of profitable membership could have a material adverse
effect on the Company. Factors which could contribute to the loss of membership
include issues related to the integration of the Company and FHP in retaining
FHP's members as the Company combines the PacifiCare and FHP health plans, sale
of certain managed care operations, failure to obtain new customers or to retain
existing customers, effect of premium increases, reductions in workforce by
existing customers, adverse publicity and news coverage, inability to carry out
marketing and sales plans, or the loss of key executives or key employees.
HEALTH CARE PROVIDER CONTRACTS. The Company's profitability depends, in
part, on its ability to maintain effective control over health care costs while
providing members with quality care. Specifically, capitating providers in Utah,
Nevada and Washington and recontracting with providers in Oregon will be
critical to improved results of operations for those markets. Securing cost
effective contracts with existing and new physician groups is more difficult due
to increased competition. The negotiation of provider contracts, generally as of
January 1, may be impacted by adverse state and federal legislation and
regulation discussed below. Failure to secure cost effective contracts may
result in a loss in membership or a higher medical care ratio. The Company's
inability to contract with providers, loss of contracts with providers,
inability of providers to provide adequate care or insolvency of providers could
materially and adversely affect the Company. These contracting and insolvency
risks include: a loss of membership; incurring additional expenses to meet the
requirement to continue to arrange for health care services,
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among other things, for members; the inability to obtain reimbursement due the
Company from providers; the expenditure of additional funds to maintain adequate
provider networks and assertion of claims by third parties against the Company.
The effect of these risks could result in the recognition of a charge in a
future period.
COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio for the
year ended December 31, 1998 is expected to decrease as compared to 1997. The
Company expects improvements as it continues renegotiation of provider
contracts, implements capitated contracts and implements price increases. Price
increases on a consolidated company basis are expected to increase by an average
of four percent, with increases ranging from zero to over ten percent. Moreover,
higher premium rates offered during open enrollment periods should result in the
elimination of some high medical care ratio membership. During 1998, the Company
will concentrate its efforts on continued renegotiations with providers,
including the acquired FHP contracts. Successful renegotiation of these
contracts should reduce the medical care ratio. Finally, the disposition of
Utah, which currently runs a higher than average medical care ratio, should help
to improve the commercial medical care ratio. These improvements are expected to
be slightly offset by increased prescription drug costs.
GOVERNMENT MEDICAL CARE RATIO. In 1998, the government medical care ratio
is expected to remain consistent with that of 1997. The Company has received
notice from HCFA that in 1998 it will be receiving premium rate increases
ranging from two percent in the Company's largest markets to six percent in
smaller markets resulting in overall weighted average premium rate increases of
a little over two percent. Competitive pressures in the Medicare market may
require enhanced benefits. The implementation of Medicare reform provisions
which curtail program spending and allow the entry of new forms of competitor
plans could further increase competitive pressures (see Legislation and
Regulation below). The 1998 HCFA rate increases and lower FHP government medical
care ratio are expected to be offset by these competitive pressures.
MEDICAL CARE RISK FACTORS. The commercial and government medical care ratio
expectations discussed above could be affected by various uncertainties,
including increases in medical and prescription drug costs which have been
escalating faster than premium increases in recent years, increases in
utilization and costs of medical services and the effect of actions by
competitors or groups of providers, termination of provider contracts or
renegotiation thereof at less cost-effective rates or terms of payment, or the
inability to complete a timely, successful disposition of the Company's Utah
subsidiary. In addition, the commercial and government medical care ratio
expectations for the HMOs acquired in the FHP Acquisition could be impacted by
the conversion to PacifiCare computer systems over the next eighteen months
which may result in reduced timely visibility of actual claims costs.
MARKETING, GENERAL AND ADMINISTRATIVE SUPPORT. In 1998, marketing, general
and administrative expenses as a percentage of operating revenue are expected to
decrease slightly from 1997. The Company expects to experience additional costs
associated with the integration of FHP largely related to upgrading and
converting information systems to maintain and enhance the Company's competitive
edge in information technology. These additional costs are expected to be offset
as the Company realizes the benefits of restructuring and a full year of
synergies as a result of the FHP transaction.
Marketing, general and administrative expenses could be adversely impacted
by the need for additional advertising, marketing, administrative, or management
information systems expenditures and the inability to carry out marketing and
sales plans. The ability of PacifiCare to realize the anticipated benefits and
synergies related to the FHP Acquisition is subject to the following additional
uncertainties, among others: the ability to eliminate duplicative functions
while maintaining acceptable performance levels and the possibility that the
continued integration will result in a loss of providers, employers, members or
key employees.
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1998 DISPOSITIONS. While the Company has previously announced its intention
to dispose of its Utah and workers' compensation operations in 1998, other
dispositions could be announced as the Company continues to evaluate whether
certain subsidiaries or products fit within its core business strategy. There is
no guarantee that the Company will be successful in selling all or a portion of
the Utah or workers' compensation operations at a price sufficient to avoid
disposition losses. Such losses could include restructuring expenses for
severance, lease and contract terminations as well as impairment of long-lived
assets. There can be no assurance that the dispositions will not result in
additional pretax charges. The Company believes, however, that any disposition
operating losses would not materially affect the Company's consolidated
financial position. However, the disposition losses could have a material
adverse effect on the results of operations or cash flows of a future quarter.
IMPAIRMENT OF LONG-LIVED ASSETS. The Company assesses the recoverability of
its long-lived assets (including goodwill and intangibles) on an annual basis or
whenever adverse events or changes in circumstances or the business climate
indicate that expected undiscounted future cash flows for individual business
units may not be sufficient to support the recorded asset. Based on the 1997
annual analysis, certain of the Company's operations will require more frequent
monitoring in 1998. In addition, at December 31, 1997 certain of the Company's
property, plant and equipment was determined to be recoverable because of
long-term operating lease agreements. Should there be a change in the rental
income stream, an impairment for these assets may be necessary. The Company
believes that this impairment would not materially affect the Company's
consolidated financial position. However, the impairment charges could have a
material adverse effect on the results of operations or cash flows.
YEAR 2000. In 1996, the Company developed and began execution of an
enterprise wide plan to ensure application and systems compliance for the year
2000. The Company currently expects the project to be complete by the end of
1998 and to cost less than $10 million. This estimate includes internal costs,
but excludes the costs to upgrade and replace systems in the normal course of
business. As of December 31, 1997, approximately $2 million had been expensed
related to this project. An additional component of this project is the written
confirmation from all systems vendors ensuring year 2000 compliance in
conjunction with the Company's target deadlines. The Company is currently
assessing the impact, if any, of year 2000 issues it may encounter with entities
with which it electronically interacts, including HCFA. If HCFA or certain other
entities experience significant failures or erroneous applications, it could
have a material adverse effect on the Company's financial position, results of
operations or cash flows.
OFFICE OF PERSONNEL MANAGEMENT CONTINGENCIES. The Company intends to
negotiate with OPM and DOJ on all matters to attain a mutually satisfactory
result. While there is no assurance that the negotiations will be concluded
satisfactorily or that additional liability will not be incurred, management
believes that any ultimate liability in excess of amounts accrued, which could
arise upon completion of the audits by OPM of the health plans, would not
materially affect the Company's consolidated financial position. However, such
liability could have a material adverse effect on results of operations or cash
flows of a future quarter if resolved unfavorably (see Note 10 of the Notes to
Consolidated Financial Statements).
LIQUIDITY AND CAPITAL RESOURCES. 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 believes cash flows from operations, existing
cash equivalents, marketable securities and other financing sources will be
sufficient to meet the requirements of the credit facility and will provide
sufficient liquidity for operations in the foreseeable future.
Cash flows could be adversely affected because the Company is subject to
greater operating leverage due to its higher levels of indebtedness as a result
of the FHP Acquisition. The Company's plan to repurchase shares of outstanding
stock may result in the reduction of cash and equivalents or in additional
borrowings on its credit facility. Additional borrowings on the credit facility
may result in the Company
27
<PAGE>
being subject to earlier mandatory reduction of its outstanding balance.
Additionally, should the credit facility be fully drawn, the Company's ability
to make a payment on, or repayment of, its future obligations under the credit
facility and $100 million of senior notes of FHP assumed by the Company will be
significantly dependent upon the receipt of funds from the Company's
subsidiaries. These subsidiary payments represent fees for management services
rendered by the Company to the subsidiaries and cash dividends by the
subsidiaries to the Company. Nearly all of the subsidiaries are subject to HMO
regulations or insurance regulations and may be subject to substantial
supervision by one or more HMO or insurance regulators. Subsidiaries subject to
regulation must meet or exceed various fiscal standards imposed by HMO or
insurance regulations, which may from time to time, impact the amount of funds
that may be paid by subsidiaries to the Company. Additionally, from time to
time, the Company advances funds, in the form of a loan or capital contribution,
to its subsidiaries to assist them in satisfying federal or state financial
requirements. If a federal or state regulator has concerns about the financial
position of a subsidiary, as a result of costs being incurred by such
subsidiary, a regulator may impose additional financial requirements on the
subsidiary which may require additional funding from the Company.
LEGISLATION AND REGULATION. The Company's success is significantly impacted
by federal and state legislation and regulation, including Medicare legislation.
Almost 60 percent of the Company's revenue, and an even greater percentage of
its profit, comes from its government programs, the majority of which is
Medicare risk business. Actual results may differ materially from expected
results discussed throughout this document because of adverse state and federal
legislation and regulation. This includes limitations on premium levels;
increases in minimum capital and reserves and other financial viability
requirements; prohibition or limitation of capitated arrangements or provider
financial incentives; benefit mandates (including mandatory length of stay and
emergency room coverage, many of which are effective in 1998) and limitations on
the ability to manage care and utilization of any willing provider and direct
access laws. It also includes adverse actions of governmental payors, including
unilateral reduction of Medicare premiums payable; discontinuance of or
limitation on governmentally funded programs and recovery by governmental payors
of previously paid amounts; the inability to increase premiums or prospective or
retroactive reductions to premium rates for federal employees; adverse
regulatory determinations resulting in care or limitations of licensure, and
certification or contracts with governmental payors; and consolidation of
operations or other efforts to integrate FHP.
On August 5, 1997, President Clinton signed into law the Balanced Budget Act
of 1997, which enacted numerous revisions to the Medicare program. The law
replaces the risk contract program with a new "Medicare+Choice" program, which
is intended to increase Medicare enrollment in private health plans. During
1998, HCFA is expected to promulgate regulations that will allow participation
in the Medicare+Choice program by HMOs, preferred provider organizations,
point-of-service plans, provider-sponsored organizations and fee-for-service
plans and provide for a new medical savings account demonstration project for
Medicare beneficiaries. The law also revises the formula used by HCFA to
calculate payments to Medicare health plans by establishing minimum payment
levels and annual increases and limiting the overall rate of payment growth.
Further, the law enacts new requirements for risk adjustment, information
disclosure, quality measurement and improvement and beneficiary enrollment,
among other provisions. The Company believes that any slowdown in the rate of
premium growth may be offset by the effect of this new legislation encouraging
managed health care for Medicare beneficiaries. The loss of Medicare contracts
or termination or modification of the HCFA risk-based Medicare program could
have a material adverse effect on the revenue, profitability and business
prospects of the Company.
Additionally, recently adopted federal legislation, among other things,
repeals the requirement that at least half of a Medicare health plan's
enrollment be drawn from commercial contracts (the "50/50 Rule") beginning
January 1, 1999, and gives the Department of Health and Human Services broad
authority to waive the 50/50 Rule for certain plans beginning January 1, 1998.
The Company believes that the repeal of the 50/50 Rule will allow it to develop
Medicare risk programs in markets where it does not have
28
<PAGE>
operations through expansion of the Secure Horizons programs and affiliations
between its Medicare risk management subsidiary and health plans or providers in
such markets.
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 which 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 of a future quarter.
OTHER. Results may differ materially from those projected, forecast,
estimated and budgeted by the Company due to adverse results in ongoing audits
or in other reviews conducted by federal or state agencies or health care
purchasing cooperatives; adverse results in significant litigation matters; and
changes in interest rates causing an increase in interest expense.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Index included at "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in the Registrant's independent auditors or
disagreements with such auditors on accounting principles or practices or
financial statement disclosure within the last two years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is contained in the Company's 1998 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement is
expected to be filed with the Securities and Exchange Commission not later than
120 days subsequent to December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is contained in the Company's 1998 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement is
expected to be filed with the Securities and Exchange Commission not later than
120 days subsequent to December 31, 1997.
29
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is contained in the Company's 1998 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement is
expected to be filed with the Securities and Exchange Commission not later than
120 days subsequent to December 31, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is contained in the Company's 1998 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement is
expected to be filed with the Securities and Exchange Commission not later than
120 days subsequent to December 31, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
<TABLE>
<CAPTION>
PAGE REFERENCE
-----------------
<S> <C> <C>
(a) 1. Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and 1996, and September 30,
1996........................................................................... F-1
Consolidated Statements of Operations for the year ended December 31, 1997, three
months ended December 31, 1996 and the fiscal years ended September 30, 1996
and 1995....................................................................... F-2
Consolidated Statements of Shareholders' Equity for the year ended December 31,
1997, three months ended December 31, 1996 and the fiscal years ended September
30, 1996 and 1995.............................................................. F-3
Consolidated Statements of Cash Flows for the year ended December 31, 1997, three
months ended December 31, 1996 and the fiscal years ended September 30, 1996
and 1995....................................................................... F-4
Notes to Consolidated Financial Statements....................................... F-6
Report of Ernst & Young LLP Independent Auditors................................. F-25
Quarterly Information for 1997 and fiscal 1996 (unaudited)....................... F-26
2. Financial Statement Schedule:
Schedule II--Valuation and Qualifying Accounts................................... F-27
All other schedules have been omitted since the required information is not
present or is not present in amounts sufficient to require submission of the
schedule, or because information required is included in the Financial
Statements and related notes.
3. Exhibits: An "Exhibit Index" has been filed as a part of this Form 10-K beginning
on page E-1 hereof and is incorporate herein by reference.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the three months ended December 31,
1997.
</TABLE>
30
<PAGE>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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.
<TABLE>
<S> <C> <C>
PACIFICARE HEALTH SYSTEMS, INC.
By: /s/ ALAN R. HOOPS
-----------------------------------------
Alan R. Hoops
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
Date: March 19, 1998
Pursuant to the requirements of the Securities Act of 1934, this Report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ TERRY O. HARTSHORN
- ------------------------------ Chairman of the Board March 19, 1998
Terry O. Hartshorn
President, Chief Executive
/s/ ALAN R. HOOPS Officer, and Director
- ------------------------------ (Principal Executive March 19, 1998
Alan R. Hoops Officer)
Executive Vice President
/s/ WAYNE B. LOWELL and Chief Financial
- ------------------------------ Officer (Principal March 19, 1998
Wayne B. Lowell Financial Officer)
Vice President and
/s/ MARY C. LANGSDORF Corporate Controller
- ------------------------------ (Principal Accounting March 19, 1998
Mary C. Langsdorf Officer)
/s/ JACK R. ANDERSON
- ------------------------------ Director March 19, 1998
Jack R. Anderson
/s/ CRAIG T. BEAM
- ------------------------------ Director March 19, 1998
Craig T. Beam
/s/ RICHARD M. BURDGE
- ------------------------------ Director March 19, 1998
Richard M. Burdge
/s/ BRADLEY C. CALL
- ------------------------------ Director March 19, 1998
Bradley C. Call
31
<PAGE>
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ DAVID R. CARPENTER
- ------------------------------ Director March 19, 1998
David R. Carpenter
/s/ GARY L. LEARY
- ------------------------------ Director March 19, 1998
Gary L. Leary
/s/ WARREN E. PINCKERT II
- ------------------------------ Director March 19, 1998
Warren E. Pinckert II
/s/ DAVID A. REED
- ------------------------------ Director March 19, 1998
David A. Reed
/s/ LLOYD E. ROSS
- ------------------------------ Director March 19, 1998
Lloyd E. Ross
/s/ JEAN BIXBY SMITH
- ------------------------------ Director March 19, 1998
Jean Bixby Smith
32
<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.
F-1
<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.
F-2
<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
F-3
<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.
F-4
<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.
F-5
<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
which 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.
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 which 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 which 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
F-6
<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 twenty-five 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.
F-7
<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 which 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
F-8
<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
F-9
<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").
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
---------- ----------- ----------- ------------
</TABLE>
F-10
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. MARKETABLE SECURITIES (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- ------------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C>
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>
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
F-11
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
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
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
F-12
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. ACQUISITIONS AND DISPOSITIONS (CONTINUED)
amortization and income taxes. No adjustment has been made to give effect to any
synergies which 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 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
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
F-13
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT (CONTINUED)
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 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.
F-14
<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>
F-15
<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.
F-16
<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 which 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 which 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 which vest
based on earnings targets that continue to vest based on the original earnings
targets.
F-18
<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>
F-19
<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.
F-20
<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
which 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
F-21
<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 workforce 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 workforce 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
F-22
<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
F-23
<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 Master Lease Agreement
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 which 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 which 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 which 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.
F-24
<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. Our audits also included the financial statement schedule
listed in the Index at Item 14(a)(2). These financial statements and schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and schedule 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. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Los Angeles, California
February 24, 1998
F-25
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
QUARTERLY INFORMATION FOR 1997 AND FISCAL 1996 (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS ENDED
--------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997(1) 1997 1997 1997 1997(2)
- ------------------------------------------------------------ ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Operating revenue........................................... $ 1,843,603 $ 2,381,100 $ 2,401,355 $ 2,356,622
Operating expenses.......................................... 1,772,488 2,338,872 2,343,947 2,483,378
Interest income, net........................................ 7,966 1,673 4,127 2,363
----------- ----------- ----------- -----------
Income (loss) before income taxes........................... 79,081 43,901 61,535 (124,393)
Provision for income taxes.................................. 35,587 25,904 30,767 (10,433)
----------- ----------- ----------- -----------
Net income (loss)........................................... $ 43,494 $ 17,997 $ 30,768 $ (113,960)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Preferred dividends......................................... (904) (2,630) (2,629) (2,629)
----------- ----------- ----------- -----------
Net income (loss) available to common shareholders.......... $ 42,590 $ 15,367 $ 28,139 $ (116,589)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Basic earnings (loss) per share(3).......................... $ 1.17 $ 0.37 $ 0.67 $ (2.78)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted earnings (loss) per share(3)........................ $ 1.12 $ 0.37 $ 0.67 $ (2.78)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Membership(4)............................................... 3,967 3,958 3,834 3,792
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
DEC. 31, MARCH 31, JUNE 30, SEPT. 30,
1996 1995 1996 1996(5) 1996(6)
- -------------------------------------------------------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenue............................................. $ 1,064,324 $ 1,157,170 $ 1,194,718 $ 1,221,093
Operating expenses............................................ 1,029,240 1,115,205 1,185,689 1,228,534
Interest income, net.......................................... 11,749 11,383 9,880 11,131
----------- ----------- ----------- -----------
Income before income taxes.................................... 46,833 53,348 18,909 3,690
Provision for income taxes.................................... 18,854 21,479 10,331 163
----------- ----------- ----------- -----------
Net income.................................................... $ 27,979 $ 31,869 $ 8,578 $ 3,527
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Basic earnings per share...................................... $ 0.91 $ 1.03 $ 0.27 $ 0.11
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted earnings per share.................................... $ 0.89 $ 1.00 $ 0.27 $ 0.11
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Membership(3)................................................. 1,816 1,959 1,996 2,031
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
- --------------------------
(1) The 1997 results include the results of operations for the FHP Acquisition
from February 14, 1997 (see Note 4 of the Notes to Consolidated Financial
Statements).
(2) The December 31, 1997 results include $155 million of pretax charges ($129
million or $3.18 diluted loss per share, net of tax) for the impairment of
long-lived assets, restructuring and certain other charges (see Note 9 of
the Notes to Consolidated Financial Statements). Operating income as a
percentage of operating revenue before pretax charges was 2.2 percent.
(3) Earnings per share have been restated to conform with the provisions of
Statement of Financial Accounting Standards No. 128 "Earnings Per Share."
Basic earnings per share excludes the effect of all potentially dilutive
securities. Diluted earnings per share includes the effect of all
potentially dilutive common securities (see Note 20 of the Notes to
Consolidated Financial Statements). For the each of the quarters of the year
ended September 30, 1996 and March, June and September quarters for 1997,
the current presentation of diluted earnings per share is identical to the
Company's former presentation of primary earnings per share. The potentially
dilutive securities were excluded from the calculation of diluted loss per
share for the fourth quarter of 1997 because they were anti-dilutive. The
Class A Common Stock, Class B Common Stock and Series A Preferred Stock
issued in conjunction with the FHP Acquisition (see Note 4 of the Notes to
Consolidated Financial Statements) caused a significant increase in the
shares outstanding used in computing earnings per share between fiscal 1997
quarters. Due to this significant increase in shares outstanding, and the
anti-dilutive effect of the potentially dilutive securities, the sum of the
quarterly earnings (loss) per share does not equal the year-to-date loss per
share.
(4) Membership as of quarter end.
(5) The June 30, 1996 results include $42 million of pretax charges ($28 million
or $0.88 diluted loss per share, net of tax) for potential government
claims, the disposition of medical clinics and certain restructuring charges
(see Note 9 of the Notes to Consolidated Financial Statements).
(6) The September 30, 1996 results include $59 million of pretax charges ($34
million or $1.08 diluted loss per share, net of tax) for the impairment of
goodwill of the Florida operations (see Note 9 of the Notes to Consolidated
Financial Statements).
F-26
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING FHP COSTS AND OTHER DEDUCTIONS/ END OF
DESCRIPTION OF PERIOD ACQUISITION EXPENSES ACCOUNTS WRITE-OFFS PERIOD
- -------------------------------------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts
Year ended September 30, 1995......... $ 558 -- $ 530 $ 1,498 $ 1,896 $ 690
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Year ended September 30, 1996......... $ 690 -- $ 999 $ (85) $ 714 $ 890
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Three months ended December 31,
1996................................ $ 890 -- $ 296 $ (92) $ (46) $ 1,048
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Year ended December 31, 1997.......... $ 1,048 $ 7,036 $ 5,171 $ 3,620 $ (3,277) $ 13,598
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
</TABLE>
F-27
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
EXHIBIT INDEX
<TABLE>
<C> <S>
3.01 Amended and Restated Certificate of Incorporation of the Registrant.
3.02 Certificate of Amendment of Amended and Restated Certificate of Incorporation of the
Registrant.
3.03 Bylaws of the Registrant [incorporated by reference to Exhibit 3.01 to the
Registrant's Form 10-Q for the quarter ended March 31, 1997].
3.04 First Amendment to Bylaws of the Registrant [incorporated by reference to Exhibit
3.02 to the Registrant's Form 10-Q for the quarter ended March 31, 1997].
4.01 Form of Specimen Certificate for Registrant's Class A Common Stock [incorporated by
reference to Exhibit 4.01 to the Registrant's Form 8-K, dated February 21, 1997].
4.02 Form of Specimen Certificate for Registrant's Class B Common Stock [incorporated by
reference to Exhibit 4.02 to the Registrant's Form 8-K, dated February 21, 1997].
4.03 Form of Specimen Certificate for Registrant's Series A Cumulative Convertible
Preferred Stock [incorporated by reference to Exhibit 4.03 to the Registrant's Form
8-K, dated February 21, 1997].
4.04 First Supplemental Indenture, dated as of February 14, 1997, by and among the
Registrant, FHP International Corporation and The Chase Manhattan Bank, N.A.
[incorporated by reference to Exhibit 4.01 to the Registrant's Form 10-Q for the
quarter ended March 31, 1997].
10.01 Employment Agreement, dated December 1, 1994, between the Registrant and Alan Hoops
[incorporated by reference to Exhibit 10.2 to the Registrant's Form 10-Q for the
quarter ended December 31, 1994].(1)
10.02 Employment Agreement, dated December 12, 1994, between the Registrant and Jeffrey
Folick [incorporated by reference to Exhibit 10.3 to the Registrant's Form 10-Q for
the quarter ended December 31, 1994].(1)
10.03 Employment Agreement, dated February 22, 1990, between the Registrant and Wayne
Lowell, as amended June 5, 1992 [incorporated by reference to Exhibit 28.3 to the
Registrant's Registration Statement on Form S-3 (File No. 33-72012)].(1)
10.04 Form of contract for the period January 1, 1993 through December 31, 1993 between
PacifiCare of California and the Department of Health and Human Services
[incorporated by reference to Exhibit 10.3 to the Registrant's Registration
Statement on Form S-3 (File 33-72012)].
10.05 Management Consulting Agreement, dated as of October 1, 1991, between the Registrant
and UniHealth [incorporated by reference to Exhibit 28.6 to the Registrant's
Registration Statement on Form S-3 (File No. 33-52438)].
10.06 1996 Stock Option Plan for Officers and Key Employees of the Registrant [incorporated
by reference to Exhibit 10.05 to Registrant's Form 8-B, dated January 23, 1997].(1)
10.07 1996 Non-Officer Directors Stock Option Plan of the Registrant [incorporated by
reference to Exhibit 10.06 to Registrant's Form 8-B, dated January 23, 1997].(1)
10.08 1996 Management Incentive Compensation Plan of the Registrant [incorporated by
reference to Exhibit 10.07 to Registrant's Form 8-B, dated January 23, 1997].(1)
10.09 1996 Long-Term Performance Incentive Plan of the Registrant [incorporated by
reference to Exhibit 10.08 to Registrant's Form 8-B, dated January 23, 1997].(1)
</TABLE>
E-1
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
EXHIBIT INDEX
<TABLE>
<C> <S>
10.10 Form of 1997 Premium Priced Stock Option Plan of the Registrant.(1)
10.11 Credit Agreement, dated as of October 31, 1996, among Registrant, the several
financial institution from time to time party to the Credit Agreement, The Bank of
New York, The Bank of Nova Scotia, Banque Nationale de Paris, Dai-Ichi Kangyo bank,
Ltd., The Industrial Bank of Japan Limited, RaboBank Nederland, Sanwa Bank of
California, The Sumitomo Bank, Limited and Wells Fargo Bank, N.A., as co-agents,
The Chase Manhattan Bank and CitiCorp USA, Inc. as managing agents, and Bank of
America National Trust and Savings Association, as agent for the Banks
[incorporated by reference to Exhibit 10.01 to the Registrant's Registration
Statement on Form S-4 (File No. 333-16271)].
10.12 First Amendment to Credit Agreement, dated as of August 15, 1997, among the
Registrant, the Banks party to the Credit Agreement, dated as of October 31, 1996,
and Bank of America National Trust and Savings Association, as Agent.
10.13 Second Amendment to Credit Agreement, dated as of December 31, 1997, among the
Registrant, the Banks party to the Credit Agreement, dated as of October 31, 1996,
and Bank of America National Trust and Savings Association, as Agent.
10.14 Contribution and Indemnification Agreement, dated March 16, 1995 between the
Registrant and UniHealth [incorporated by reference to Exhibit 10.01 to the
Registrant's Registration Statement on Form S-3 (File No. 33-57783)].
10.15 PacifiCare Health Systems, Inc. Statutory Restoration Plan.(1)
10.16 PacifiCare Health Systems, Inc. Non-Qualified Deferred Compensation Plan.(1)
10.17 PacifiCare Health Systems, Inc. Stock Unit Deferred Compensation Plan.(1)
10.18 Amended and Restated Agreement and Plan of Reorganization, dated as of November 11,
1996, among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger
Corp., Tree Acquisition Corp. and FHP International Corp. [incorporated by
reference to Exhibit 2.01 to the Registration statement on Form S-4 of N-T
Holdings, Inc. (File No. 333-16271)].
10.19 Employment Agreement, dated December 1, 1994, between the Registrant and Jon Wampler,
as amended March 1, 1996 and October 9, 1997
10.20 Form of Employment Agreement, dated as of February 1, 1996, between FHP International
Corporation and Eric Sipf [incorporated by reference to Exhibit 10.3 to FHP
International Corporation's Form 10-K for the year ended June 30, 1996].
21 List of Subsidiaries.
23 Consent of Ernst & Young LLP Independent Auditors.
27 Financial Data Schedules (filed electronically).
</TABLE>
- ------------------------
(1) Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this Form 10-K pursuant to Item 14(c) of Form 10-K.
E-2
<PAGE>
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION
OF
N-T HOLDINGS, INC.
N-T HOLDINGS, INC., a corporation organized and existing under the General
Corporation Law of the State of Delaware (the "Corporation"), does hereby
certify:
FIRST: The original Certificate of Incorporation was filed with the
Secretary of State of Delaware on August 2, 1996.
SECOND: The Amended and Restated Certificate of Incorporation of N-T
Holdings, Inc. in the form attached hereto as Exhibit A has been duly adopted in
accordance with the provisions of Sections 242 and 245 of the General
Corporation Law of the State of Delaware by the directors and stockholders of
the Corporation.
THIRD: The Amended and Restated Certificate of Incorporation so adopted
reads in full as set forth in Exhibit A attached hereto and is hereby
incorporated herein by this reference.
IN WITNESS WHEREOF, the Corporation has caused this Certificate to be
signed by its President and Secretary on this 14th day of February, 1997.
N-T HOLDINGS, INC.
By: ______________________
Alan R. Hoops, President
ATTEST
By.___________________________
Joseph S. Konowiecki, Secretary
<PAGE>
EXHIBIT A
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
N-T HOLDINGS, INC.
I
The name of this Corporation is: N-T Holdings, Inc.
II
The address of its registered office in the State of Delaware is 1013
Centre Road, County of New Castle, Wilmington, Delaware. The name of its
registered agent at such address is The Prentice-Hall Corporation System, Inc.
III
The nature of business or purposes to be conducted or promoted is to engage
in any lawful act or activity for which corporations may be organized under the
Delaware General Corporation Law.
IV
A. N-T Holdings, Inc. ("Corporation") is authorized to issue three
classes of shares of stock to be designated, respectively, "Class A Common
Shares," "Class B Common Shares," and "Preferred Shares." The total number of
shares of stock which the Corporation shall have authority to issue is two
hundred forty million (240,000,000). The total number of Class A Common Shares
which the Corporation shall have authority to issue is one hundred million
(100,000,000), and the par value of each such Class A Common Share shall be one
cent ($0.01). The total number of Class B Common Shares which the Corporation
shall have authority to issue is one hundred million (100,000,000), and the par
value of each such Class B Common Share shall be one cent ($0.01). The total
number of Preferred Shares which the Corporation shall have the authority to
issue is forty million (40,000,000), and the par value of each such Preferred
Share shall be one cent ($0.01).
B. The powers, preferences and rights of the holders of Class A Common
Shares and Class B Common Shares (collectively, the ''Common Shares"), and the
qualifications, limitations or restrictions thereof, shall be in all respects
identical, except as otherwise required by law or expressly provided in this
Certificate of Incorporation, as amended, and subject to the powers, preferences
and rights of the holders of Preferred Shares, as provided in
1
<PAGE>
or as otherwise determined by the Board of Directors pursuant to paragraph C of
this Article IV.
1. DIVIDENDS. Dividends may be declared and paid to the holders of the
Class A Common Shares and the Class B Common Shares in cash, property, or other
securities of the Corporation out of any funds legally available therefore. If
and when dividends on the Class A Common Shares and the Class B Common Shares
are declared payable from time to time by the Board of Directors, whether
payable in cash, in property or in securities of the Corporation, the holders of
the Class A Common Shares and the holders of the Class B Common Shares shall be
entitled to share equally on a per share basis, in such dividends, except that,
dividends or other distributions payable on the Common Shares in Common Shares
shall be made to all holders of Common Shares and may be made (i) in Class B
Common Shares to the record holders of Class A Common Shares and to the record
holders of Class B Common Shares, (ii) in Class A Common Shares to the record
holders of Class A Common Shares and in Class B Common Shares to the record
holders of Class B Common Shares, or (iii) in any other authorized class or
series of capital stock to the holders of both classes of Common Shares.
2. DISTRIBUTION ON DISSOLUTION, ETC. Upon any liquidation, dissolution
or winding up of the Corporation, whether voluntary or involuntary, the
remaining net assets of the Corporation shall, after payment in full of the
liquidation preference, if any, of any outstanding Preferred Shares, be
distributed pro rata to the holders of the Class A Common Shares and the Class B
Common Shares in accordance with their respective rights and interests.
3. VOTING RIGHTS.
(a) At each annual or special meeting of the shareholders, each holder of
Class A Common Shares shall be entitled to one (1) vote in person or by proxy
for each Class A Common Share standing in his name on the stock transfer records
of the corporation in connection with the election of directors and all other
actions submitted to a vote of shareholders; holders of Class B Common Shares
shall not vote on any matters except as otherwise provided by this Certificate
of Incorporation, as amended, and the Delaware General Corporation Law.
(b) The holders of Class B Common Shares shall be entitled to vote
separately as a group only with respect to (i) proposals to change the par value
of the Class B Common Shares, (ii) amendments to this Certificate of
Incorporation that alter or change the powers, preference or special rights of
the holders of Class B Common Shares so as to affect them adversely, and (iii)
such other matters as may require separate group voting under this Certificate
of Incorporation, as amended, and the Delaware General Corporation Law.
(c) The number of authorized Class B Common Shares may be increased or
decreased (but not below the number of shares then outstanding) by the
affirmative vote of the holders of a majority of the Class A Common Shares
2
<PAGE>
4. Conversion.
(a) All outstanding Class B Common Shares may be converted into Class A
Common Shares on a share-for-share basis by the Board of Directors if, as a
result of the existence of the Class B Common Shares, either the Class A Common
Shares or Class B Common Shares is or both are excluded from trading on the New
York Stock Exchange, the American Stock Exchange and all other principal
national securities exchanges then in use and also is excluded from quotation on
the National Association of Securities Dealers Automated Quotation ("Nasdaq")
National Market and other comparable national quotation systems then in use. In
making such determination, the Board of Directors may conclusively rely on any
information or documentation available to it, including filings made with the
Securities and Exchange Commission, any stock exchange, the National Association
of Securities Dealers, Inc. or any other governmental or regulatory agency or
any written instrument purporting to be authentic.
(b) All outstanding Class B Common Shares shall be converted into Class A
Common Shares on a share-for-share basis if at any time the number of
outstanding Class A Common Shares, as reflected on the stock transfer records of
the Corporation, falls below ten percent (10%) of the aggregate number of
outstanding Class A Common Shares and of Class B Common Shares. For purposes of
the immediately preceding sentence, any Common Shares repurchased and held as
treasury shares or canceled by the Corporation shall no longer be deemed
"outstanding" from and after the date of repurchase.
(c) In the event of any conversion of the Class B Common Shares pursuant
to subparagraph 4(a) or 4(b), certificates which formerly represented,
outstanding shares of Class B Common Shares will thereafter be deemed to
represent a like number of shares of Class A Common Shares and all authorized
Common Shares shall consist of only Class A Common Shares.
5. CLASS B COMMON SHARE PROTECTION PROVISION.
(a) If, after the effective time (the "Effective Time"), of the PacifiCare
Merger (the "PacifiCare Merger"), as that term is defined in the Amended and
Restated Agreement and Plan of Reorganization dated as of November 11, 1996,
among PacifiCare Health Systems, Inc., N-T Holdings, Inc., Neptune Merger Corp.,
Tree Acquisition Corp. and FHP International Corporation, as amended (the
"Reorganization Agreement"), any person or group acting in concert acquires
beneficial ownership of shares representing 10% or more of the then issued and
outstanding Class A Common Shares (excluding the number of shares beneficially
owned by such person or group at or before the Effective Time and other than
upon the issuance or sale by the Corporation, by operation of law, including a
merger, consolidation or reorganization of a beneficial owner, by will or the
laws of descent and distribution, by gift or by foreclosure of a bona fide
loan), and such person or group (a "Significant Shareholder") does not own an
equal or greater percentage of the Class B Common Shares acquired after the
Effective Time, such Significant Shareholder must, within a ninety (90) day
period beginning the day after becoming a Significant Shareholder, make a public
cash tender offer in compliance with all applicable laws and regulations to
acquire additional Class B Common
3
<PAGE>
Shares as provided in this subparagraph B (5) of Article IV (a "Class B
Protection Transaction").
(b) In each Class B Protection Transaction, the Significant Shareholder
must make a public tender offer to acquire that number of Class B Common Shares
determined by (i) multiplying the percentage of outstanding Class A Common
Shares beneficially owned by such Significant Shareholder and acquired after the
Effective Time by such Significant Shareholder by the total number of shares of
Class B Common Shares outstanding on the date such person or group became a
Significant Shareholder, and (ii) subtracting therefrom the total number of
shares of Class B Common Shares beneficially owned on such date and acquired
after the Effective Time by such Significant Shareholder (including shares
acquired on such date at or prior to the time such person or group became a
Significant Shareholder). The Significant Shareholder must acquire all of such
shares validly tendered; provided, however, that if the number of Class B Common
Shares tendered to the Significant Shareholder exceeds the number of shares
required to be acquired pursuant to the formula set forth in this subparagraph
5(b), the number of Class B Common Shares acquired from each tendering holder
shall be pro rata in proportion to the total number of Class B Common Shares
tendered by all tendering holders.
(c) The offer price for any Class B Common Shares required to be purchased
by the Significant Shareholder pursuant to this subparagraph B(5) shall be the
greater of (i) the highest price per share paid by the Significant Shareholder
for any Class A Common Share in the six month period ending on the date such
person or group became a Significant Shareholder or (ii) the highest bid price
of a Class A Common Share or Class B Common Share on the Nasdaq National Market
(or such other exchange or quotation system as is then the principal trading
market for such shares) on the date such person or group became a Significant
Shareholder or (iii) the highest bid price of a Class A Common Share or Class B
Common Share on the Nasdaq National Market (or such other exchange or a
quotation system as is then the principal trading market for such shares) on the
date preceding the date the Significant Shareholder makes the tender offer
required by this subparagraph B(5). For purposes of subparagraph B(5)(d) below,
the applicable date for the calculations required by clauses (i) and (ii) of the
preceding sentence shall be the date on which the Significant Shareholder
becomes required to engage in a Class B Protection Transaction. In the event
that the Significant Shareholder has acquired Class A Common Shares in the six
month period ending on the date such person or group becomes a Significant
Shareholder for consideration other than cash, the value of such consideration
per Class A Common Share shall be as determined in good faith by the Board of
Directors.
(d) A Class B Protection Transaction shall also be required to be effected
by any Significant Shareholder each time that the Significant Shareholder
acquires beneficial ownership of the next higher integral multiple of 5% (e.g.,
15%, 20%, 25%, etc.) of the outstanding Class A Common Shares after the
Effective Time (other than upon the issuance or sale by the Corporation, by
operation of law, including a merger, consolidation or reorganization of a
beneficial owner, by will or the laws of descent and distribution, by gift, or
by foreclosure of a bona fide loan) if such Significant Shareholder does not
then own an equal or greater percentage of the Class B Common Shares acquired
after the Effective Time.
4
<PAGE>
Such Significant Shareholder shall be required to make a public tender offer to
acquire that number of Class B Common Shares prescribed by the formula set forth
in subparagraph B(5)(b) above, and must acquire all shares validly tendered or a
pro rata portion thereof, as specified in subparagraph B(5)(b), at the price
determined pursuant to subparagraph B(5)(c) above
(e) If any Significant Shareholder fails to make an offer required by this
subparagraph B(5) of Article IV, or to purchase shares validly tendered and not
withdrawn (after proration, if any), such Significant Shareholder shall not be
entitled to vote any Class A Common Shares beneficially owned by such
Significant Shareholder unless and until such requirements are compiled with or
unless and until all Class A Common Shares causing such offer requirement to be
effective are no longer beneficially owned by such Significant Shareholder.
(f) The Class B Protection Transaction requirement shall not apply to any
increase in percentage ownership of Class A Common Shares resulting solely from
a change in the total amount of Class A Common Shares outstanding, provided that
any acquisition after such change which resulted in any person or group owning
10% or more of the Class A Common Shares (excluding in the case of the numerator
but not the denominator of the calculation of such percentage, Class A Common
Shares held by such Significant Shareholder immediately after the Effective
Time) shall be subject to any Class B Protection Transaction requirement that
would be imposed with respect to a Significant Shareholder pursuant to this
subparagraph B(5) of Article IV.
(g) All calculations with respect to percentage ownership of issued and
outstanding shares of either class of Common Shares will be based upon the
numbers of issued and outstanding shares reported by the Corporation on the last
to be filed of (i) the Corporation's most recent annual report on Form 10-K,
(ii) its most recent Quarterly Report on Form 10-Q, or (iii) its most recent
Current Report on Form 8-K.
(h) For purposes of this subparagraph B(5) of this Article IV, the term
"person" means a natural person, corporation, partnership, trust, association,
government, or political subdivision, agency or instrumentality of a government,
or other entity. "Beneficial ownership" shall be determined pursuant to Rule
13d-3 promulgated under the Securities Exchange Act of 1934, as amended (the
"1934 Act"), or any successor regulation. The formation or existence of a
"group" shall be determined pursuant to Rule 13d-5(b) under the 1934 Act or any
successor regulation.
6. MERGER OR CONSOLIDATION. In the event of a merger or consolidation of
the Corporation with or into another entity (whether or not the Corporation is
the surviving entity), the holders of Class B Common Shares shall be entitled to
receive the same per share consideration as the per share consideration, if any,
received by any holder of the Class A Common Shares in such merger or
consolidation; provided, however, that this restriction shall not apply to the
PacifiCare Merger.
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7. SPLITS, SUBDIVISIONS, ETC. If the Corporation shall in any manner
split, subdivide or combine the outstanding Class A Common Shares or Class B
Common Shares, the outstanding shares of the other such class of Common Shares
shall be proportionally subdivided or combined in the same manner and on the
same basis as the outstanding shares of the other class of Common Shares have
been split, subdivided or combined.
8. NO PREEMPTIVE RIGHTS. No holder of Class A Common Shares or Class B
Common Shares shall, by reason of such holding, have any preemptive right to
subscribe to any additional issue of stock of any class or series of the
Corporation or to any security of the Corporation convertible into such stock.
9. CONSIDERATION FOR SALE FOR SHARES. The Board of Directors shall have
the power to issue and sell all or any part of any class of stock herein or
hereafter authorized to such persons, firms, associations or corporations, and
for such consideration as the Board of Directors shall from time to time, in its
discretion, determine whether or not greater consideration could be received
upon the issue or sale of the same number of shares of another class, and as
otherwise permitted by law.
10. CONSIDERATION FOR PURCHASE OF SHARES. The Board of Directors shall
have the power to purchase any class of stock herein or hereafter authorized
from such persons, firms, associations or corporations, and for such
consideration as the Board of Directors shall from time to time, in its
discretion, determine, whether or not less consideration could be paid upon the
purchase of the same number of shares of another class, and as otherwise
permitted by law.
C. The Preferred Shares may be issued from time to time in one or more
series. The Board of Directors is hereby authorized, by filing a certificate (a
"Preferred Shares Designation") pursuant to the Delaware General Corporation
Law, to fix or alter from time to time the designation, powers, preferences and
rights of the shares of each such series and the qualifications, limitations or
restriction of any wholly unissued series of Preferred Shares, and to establish
from time to time the number of shares constituting any such series or any of
them; and to increase or decrease the number of shares of any series subsequent
to the issuance of shares of that series, but not below the number of shares of
such series then outstanding. The Board of Directors shall designate each
series to distinguish it from other series and classes of stock of the
Corporation, shall specify the number of shares to be included in the series,
and shall fix the terms, rights, restrictions and qualifications of the shares
of the series, including any preferences, voting powers, dividend rights and
redemption, sinking fund and conversion rights. Subject to the express terms of
any other series of Preferred Shares outstanding at the time, the Board of
Directors may increase or decrease the number of shares or alter the designation
or classify or reclassify any unissued shares of a particular series of
Preferred Stock by fixing or altering in any one or more respects from time to
time before issuing the shares, any terms, rights, restrictions and
qualifications of the shares. In case the number of shares of any series shall
be decreased in accordance with the foregoing sentence, the shares constituting
such decrease shall resume the status that they had prior to the adoption of the
resolution originally fixing the number of shares of such series. The Board of
Directors shall have the power to purchase any of the Preferred Shares herein or
hereafter authorized
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from such persons, firms, or corporations, and for such consideration as the
Board of Directors shall from time to time, in its discretion, determine whether
or not less consideration could be paid upon the purchase of the same number of
shares of another class, and as otherwise permitted by law.
There shall be a series of Preferred Stock designated "Series A Cumulative
Convertible Preferred Shares" (the "Convertible Preferred Shares") which shall
have the powers, preferences and rights as follows:
1. RANK. The Convertible Preferred Shares shall have a par value of
$0.01 per share. The Convertible Preferred Shares will rank, with respect to
dividend rights and rights on liquidation, winding-up and dissolution, (i)
senior to all classes of common stock of the Corporation, as they exist on the
date hereof or as such stock may be constituted from time to time, and each
other class or series of capital stock or preferred stock established by the
Board of Directors to the extent the terms of such stock do not expressly
provide that it ranks senior to or on a parity with the Convertible Preferred
Shares as to dividend rights and rights on liquidation, winding-up and
dissolution collectively, together with the Common Shares, the "Junior
Securities"), (ii) on a parity with each other class or series of capital stock
or of preferred stock issued by the Corporation established by the Board of
Directors to the extent the terms of such stock expressive provide that it will
rank on a parity with the Convertible Preferred Shares as to dividend rights and
rights on liquidation, winding-up and dissolution (collectively, the "Parity
Securities"), and (iii) junior to each other class of capital stock or series of
preferred stock established by the Board to the extent the terms of such stock
expressly provide that it will rank senior to the Convertible Preferred Shares
as to dividend rights and rights on liquidation, winding-up and dissolution
(collectively, the "Senior Securities"). Each share of the Convertible
Preferred Shares shall rank equally in all respect with each other share of the
Convertible Preferred Shares.
2. AUTHORIZED NUMBER. The authorized number of shares constituting the
Convertible Preferred Shares shall be 11,000,000 shares.
3. DIVIDENDS. Holders of Convertible Preferred Shares will be entitled
to receive, when, as and if declared by the Board of Directors out of funds of
the Corporation legally available therefor, cash dividends at an annual rate of
4% of the Stated Value per share of Convertible Preferred Shares, payable
quarterly in arrears on March 15, June 15, September 15, and December 15, of
each year, commencing March 15, 1997, provided that the dividend payable on
March 15, 1997, shall be in an amount determined by assuming that the
Convertible Preferred Shares (a) had been outstanding on December 16, 1996 (the
"Transition Period Commencement Date"), and (b) had been entitled to receive,
when, as and if declared by the Board of Directors out of funds of the
Corporation legally available therefor, cash dividends at an annual rate of (i)
5% of an amount equal to twice the Stated Value per share from such date through
February 14, 1997 (the "Effective Date") and (ii) 4% of the Stated Value per
share from February 15, 1997 through March 15, 1997. Each dividend will be
payable to holders of record as they appear on the books of the Corporation at
the close of business on a record date, not more than 60 nor less than 15 days
before the payment date, fixed by the Board of Directors. Dividends will be
cumulative from the date of original
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issuance of the Convertible Preferred Shares, which will be the Effective Date,
provided that, for purposes of dividends payable on March 15, 1997 in respect of
the period from the Transition Period Commencement Date through the Effective
Date (the "Transition Period"), the Transition Period Commencement Date will be
treated as the issuance date for the Convertible Preferred Shares. Except as
otherwise provided in this subparagraph 3, dividends for each full dividend
period will be computed by dividing the annual dividend rate by four and
dividends payable for any period less than a full dividend period, which may
include, without limitation, dividends payable with respect to the Transition
Period, will be computed on the basis of a 360-day year consisting of twelve
30-day months. The Convertible Preferred Shares will not be entitled to any
dividends, whether payable in cash, property or stock, in excess of full
cumulative dividends. No interest, or sum of money in lieu of interest, will be
payable in respect of any accrued and unpaid dividends. No full dividends may
be declared or paid or funds set apart for the payment of dividends on any
Parity Securities (except dividends on Parity Securities paid in shares of
Junior Securities) for any period unless full cumulative dividends to be paid
hereunder prior to the date thereof shall have been paid, or contemporaneously
are declared and paid, or declared and a sum sufficient for payment thereof is
set apart for such payment on the Convertible Preferred Shares in accordance
with the terms hereof. If full dividends are not so paid, the Convertible
Preferred Shares shall share dividends pro rata with the Parity Securities
according to the amount of dividends due and payable with respect to each. No
dividends may be paid or set apart for such payment, or other distributions made
on Junior Securities (except dividends on Junior Securities paid in additional
shares of Junior Securities), and no Convertible Preferred Shares, Parity
Securities or Junior Securities may be repurchased, redeemed or otherwise
retired nor may funds be set apart for payment with respect thereto, nor shall
the Corporation permit any corporation or entity directly or indirectly
controlled by the Corporation to purchase any Convertible Preferred Shares,
Parity Securities or Junior Securities, if full cumulative dividends to be paid
hereunder prior to the date thereof have not been paid on the Convertible
Preferred Shares. Notwithstanding the foregoing, the Corporation may (i) make
redemptions, purchases or other acquisitions of Convertible Preferred Shares,
Parity Securities or Junior Securities payable in Junior Securities or
repurchases of Convertible Preferred Shares, Parity Securities or Junior
Securities in the ordinary course of business pursuant to the terms of any
current or future employee stock incentive plan or similar plan adopted by the
Board and (ii) make redemptions of Rights (as defined in Section 6 below)
distributed pursuant to a Rights Agreement (as defined in Section 6 below).
4. LIQUIDATION RIGHTS. The Stated Value of each share of Convertible
Preferred Shares shall be $25.00. In the event of any voluntary or involuntary
liquidation, dissolution or winding-up of the Corporation, after satisfaction of
the claims of creditors and any holders of Senior Securities and before any
payment or distribution of assets is made on any Junior Securities, including,
without limitation, the Common Shares, (i) the holders of Convertible Preferred
Shares shall receive a liquidation preference equal to the Stated Value of their
shares, and shall be entitled to receive an amount equal to all accrued and
unpaid dividends through the date of distribution (whether or not declared), and
(ii) the holders of any Parity Securities shall be entitled to receive an amount
equal to the full respective liquidation preferences (including any premium) to
which they are entitled and shall receive an amount equal to all accrued and
unpaid dividends with respect to their respective shares through and
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including the date of distribution (whether or not declared). If upon such a
voluntary or involuntary liquidation, dissolution or winding-up of the
Corporation, the assets of the Corporation are insufficient to pay in full the
amounts described above as payable with respect to the Convertible Preferred
Shares and any Parity Securities, the holders of the Convertible Preferred
Shares and such Parity Securities will share ratably in any distribution of
assets of the Corporation, first in proportion to their respective liquidation
preferences until such preferences are paid in full, and then in proportion to
their respective amounts of accrued but unpaid dividends. After payment of any
such liquidation preference and accrued but unpaid dividends, the Convertible
Preferred Shares will not be entitled to any further participation in any
distribution of assets by the Corporation. Neither the sale or transfer of all
or any part of the assets of the Corporation for cash, securities or other
property, nor the merger or consolidation of the Corporaton into or with any
other corporation or a merger of any other corporation with or into the
Corporation, will be deemed to be a liquidation, dissolution or winding-up of
the Corporation.
5. VOTING RIGHTS.
(a) Except as provided below or as may be required by Delaware law or
provided by the resolution creating any other series of Preferred Shares, the
holders of Convertible Preferred Shares will not be entitled to vote. So long
as any shares of Convertible Preferred Shares are outstanding, the vote or
consent of the holders of 66 2/3% of the outstanding shares of Convertible
Preferred Shares, voting together as a single class, shall be necessary to (i)
increase or decrease the par value of the shares of Convertible Preferred Shares
or (ii) alter or change the powers, preferences, or special rights of the shares
of Convertible Preferred Shares so as to affect them adversely or (iii)
authorize or issue any additional class or series of Parity Securities or Senior
Securities, or any security convertible into Parity Securities or Senior
Securities.
(b) (i) In the event that any accrued dividends (whether or not declared)
on the Convertible Preferred Shares shall not have been paid in an
aggregate amount equal to or greater than six quarterly dividends, the
maximum authorized number of directors of the Corporation will be
automatically increased by two, and holders of Convertible Preferred Shares
shall be entitled to vote their shares of Convertible Preferred Shares,
together with the holders of any Parity Securities upon which like voting
rights have been conferred and are exercisable (the "Voting Parity
Securities"), in accordance with the procedures set forth below, to elect,
as a class, an additional two directors. So long as any shares of
Convertible Preferred Shares shall be outstanding, the holders of shares of
Convertible Preferred Shares shall retain the right to vote and elect, with
the holders of such Voting Parity Securities, as a class, two directors
until all accrued but unpaid dividends on the Convertible Preferred Shares
are paid in full or declared and set aside for payment. The period during
which holders of Convertible Preferred Shares retain such right is referred
to as a "Default Period".
(ii) So long as any shares of Convertible Preferred Shares shall be
outstanding, during any Default Period, the voting right described in
subsection (i) above may be exercised initially at a special meeting called
pursuant to subsection (iii) below or at
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any annual meeting of stockholders. The absence of a quorum of holders of
Common Shares (or any class thereof) shall not affect the exercise of such
voting rights by the holders of Convertible Preferred Shares and Voting
Parity Securities. Holders of Convertible Preferred Shares and Voting
Parity Securities shall be entitled, as among the class of holders of
Convertible Preferred Shares and Voting Parity Securities, to one vote for
each $25.00 of liquidation preference represented by the shares so held.
(iii) Unless the holders of Convertible Preferred Shares and Voting
Parity Securities, if any are then outstanding, have, during an existing
Default Period, previously exercised their right to elect directors, the
Board may, and upon the request of the holders of record of not less than
10% of the aggregate liquidation preference of Convertible Preferred Shares
and Voting Parity Securities, the Board shall, order the calling of a
special meeting of holders of Convertible Preferred Shares and Voting
Parity Securities, if any are then outstanding, which meeting shall,
thereupon be called by the Chairman of the Board, the President, a Vice
President or the Secretary of the Corporation. Notice of such meeting and
of any annual meeting at which holders of Convertible Preferred Shares and
Voting Parity Securities are entitled to vote pursuant to this subsection
(iii) shall be given to each holder of record of Convertible Preferred
Shares by mailing a copy of such notice to such holder at such holder's
last address as it appears on the books of the Corporation. Such meeting
shall be called for a date not later than 90 days after such order or
request, or, in default of the calling of such meeting within 90 days after
such order or request. Such meeting may be called on similar notice by any
stockholder or stockholders owning in the aggregate not less than 10% of
the aggregate liquidation preference of the Convertible Preferred Shares
and Voting Parity Securities. Notwithstanding the provisions of this
subsection (iii), the Corporation shall not be required to call such a
special meeting if such request is received less then 120 days before the
date fixed for the next ensuing annual meeting of stockholders of the
Corporation, at which meeting such newly created directorships shall be
filled by vote of the holders of Convertible Preferred Shares and Voting
Parity Securities.
(iv) During any Default Period, the holders of Class A Common Shares,
and other classes of stock of the Corporation, if applicable, shall
continue to be entitled to elect all of the Directors unless and until the
holders of Convertible Preferred Shares and Voting Parity Securities shall
have exercised their right to elect two Directors voting as a class. After
the exercise of this right (x) the Directors so elected by the holders of
Convertible Preferred Shares and Voting Parity Securities shall continue in
office until the earlier of (A) such time as their successors shall have
been elected by such holders and (B) the expiration of the Default Period,
and (y) any vacancy in the Board of Directors with respect to a
Directorship to be elected pursuant to this subparagraph (b) by the holders
of Convertible Preferred Shares and Voting Parity Securities may be filled
by vote of the remaining Director previously elected by such holders.
References in this subsection (b) to Directors elected by the holders of a
particular class of stock shall include Directors elected by such Directors
to fill vacancies as provided in clause (y) of the foregoing Sentence.
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(v) Immediately upon the expiration of a Default Period, (x) the
right of the holders of Convertible Preferred Shares to elect Directors
pursuant to this subparagraph (b) shall cease, subject to continuing
application of subparagraph (b)(i) upon each and every subsequent
reoccurrence of the event described therein, (y) the term of any Directors
elected by the holders of Convertible Preferred Shares and Voting Parity
Securities pursuant to this subparagraph (b) shall terminate, and (z) the
number of Directors shall be such number as may be provided for in the
Certificate of Incorporation or bylaws irrespective of any increase made
pursuant to subsection (i) of this subparagraph (b) (such number being
subject, however, to subsequent change in any manner provided by law or in
the Certificate of Incorporation or bylaws).
6. CONVERSION.
(a) RIGHT TO CONVERT. Each share of Convertible Preferred Shares will be
convertible (the rights to convert described in this subsection (a) are referred
to as the "Conversion Rights") at the option of the holder thereof, into such
number of fully paid and non-assessable shares of Class B Common Shares
(together with any Rights (as defined in subsection (b)(iii) below) associated
therewith) as is equal to (A) the sum of (i) twice the Stated Value of the
Convertible Preferred Shares plus (ii) accrued but unpaid dividends in arrears
thereon to which the holder converting such shares is entitled, divided by (B)
the Conversion Price then in effect. The initial "Conversion Price" for the
Convertible Preferred Shares shall be $133.62 and shall be subject to adjustment
as described below. The holders of Convertible Preferred Shares at the close of
business on a dividend payment record date shall be entitled to receive the
dividend payable on such shares on the corresponding dividend payment date
notwithstanding the conversion of such Convertible Preferred Shares or the
Corporation's default on payment of the dividend due on such dividend payment
date. However, shares of Convertible Preferred Shares surrendered for conversion
during the period from the close of business on any record date for the payment
of dividends on such shares to the opening of business on the corresponding
dividend payment date (except shares called for redemption to occur during the
period from the record date to the close of business on the payment date
pursuant to Section 7 below) must be accompanied by payment of an amount equal
to the dividend payable on such shares on such dividend payment date. A holder
of Convertible Preferred Shares on a dividend payment record date who (or whose
transferee) tenders shares of Convertible Preferred Shares on a dividend payment
date will be entitled to receive the dividend payable on such shares by the
Corporation on such date, and such converting holder need not include payment in
the amount of such dividend upon surrenderof shares of Convertible Preferred
Shares for conversion. Except as provided above, no payment or adjustment will
be made on account of accrued or unpaid dividends upon the conversion of shares
of Convertible Preferred Shares. Shares of Convertible Preferred Shares called
for redemption will not be convertible after the close of business on the day
preceding the date fixed for redemption, unless the Corporation defaults in
payment of the redemption price.
(b) ANTI-DILUTION PROVISIONS. The Conversion Price is subject to
adjustment after the issuance of the Convertible Preferred Shares from time to
time as follows:
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(i) In case the Corporation shall (1) pay a dividend or make a
distribution on Common Shares in shares of Common Shares, (2) subdivide its
outstanding shares of Common Shares into a greater number of shares or (3)
combine its outstanding shares of any class of Common Shares into a smaller
number of shares, the Conversion Price in effect immediately prior to such
action shall be adjusted (and any other appropriate action taken by the
Corporation) so that the holder of any Convertible Preferred Shares
thereafter surrendered for conversion shall be entitled to receive the
number of shares of Common Shares which such holder would have been
entitled to receive immediately following such action had the holder's
Convertible Preferred Shares been converted immediately prior thereto. An
adjustment made pursuant to this subsection (i) shall become effective
immediately (except as provided in subsection (vi) below) after the record
date in the case of a dividend or distribution and shall become effective
immediately after the effective date in the case of a subdivision or
combination.
(ii) In case the Corporation shall issue rights, options or warrants
to all holders of its outstanding shares of Common Shares, or of its
outstanding shares of any class or series of Common Shares, entitling them,
for a period expiring within 45 days after the record date mentioned below,
to subscribe for or purchase shares of Common Shares at a price per share
less than the Current Market Price per share (as defined in subsection (v)
below) of such offered Common Shares on the record date mentioned below,
then the Conversion Price in effect immediately prior thereto shall be
adjusted so that it shall equal the price determined by multiplying the
Conversion Price in effect immediately prior to the date of issuance of
such rights, options or warrants by a fraction of which
(1) the numerator shall be the sum of (A) the number of shares
of Common Shares outstanding on the date of issuance of such rights,
options or warrants immediately prior to such issuance plus (B) the
number of shares of such offered Common Shares which the aggregate
offering price of the total number of shares so offered would purchase
at such Current Market Price (determined by multiplying such total
number of shares offered for subscription or purchase by the sum of
the exercise price of such rights, options or warrants plus the value
of any consideration per share paid to the Corporation for such
rights, options or warrants and dividing the product so obtained by
such Current Market Price), and
(2) the denominator shall be the sum of (A) the number of shares
of Common Shares outstanding on the date of issuance of such rights,
options or warrants immediately prior to such issuance plus (B) the
number of additional shares of Common Shares which are so offered for
subscription or purchase.
Such adjustment shall be made successively whenever any rights, options or
warrants are issued, and shall become effective immediately (except as provided
in subsection (vi) below) after the record date for the determination of
stockholders entitled to receive such rights, option or warrants; provided,
however, in the event that all the shares of Common
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Shares offered for subscription or purchase are not delivered upon the exercise
of such rights, options or warrants, upon the expiration of such rights, options
or warrants the Conversion Price shall be readjusted to the Conversion Price
which would have been in effect had the numerator and the denominator of the
foregoing fraction and the resulting adjustment been made based upon the number
of shares of Common Shares actually delivered upon the exercise of such rights,
options or warrants rather than upon the number of shares of Common Shares
offered for subscription or purchase. In determining the value of any
consideration received by the Corporation for such rights, options or warrants,
the determination of the Board of Directors in good faith shall be conclusive
and shall be described in a Board resolution.
(iii) Notwithstanding subsection (ii) above, any adjustments to
the Conversion Price to account for the issuance of rights ("Rights") under
a shareholder rights plan or agreement, "poison pill" or similar
arrangement (a "Rights Agreement") adopted subsequent to the date hereof
shall be made when such Rights become exercisable or exchangeable by the
holder thereof for Common Shares (Common Shares issued pursuant to the
exercise of, or exchange by the Corporation for, such Rights are referred
to as "Rights Stock") pursuant to a Rights Agreement at a price per share
less than the Current Market Price per share of such Common Shares on the
date of such exercise or exchange. The Conversion Price in effect
immediately prior to such exercise or exchange shall be adjusted so that it
shall equal the price determined by multiplying the Conversion Price in
effect immediately prior to the date of such exercise or exchange by a
fraction of which
(1) the numerator shall be the sum of (A) the number of shares
of Common Shares of the type issued pursuant to the exercise of, or
exchange by the Corporation for, such Rights outstanding on the date
of issuance of such Rights Stock immediately prior to such issuance
plus (B) the number of shares of Common Shares of the type issued
pursuant to the exercise of, or exchange by the Corporation for, such
Rights which the aggregate consideration received for the total number
of shares of Rights Stock so issued would purchase at such Current
Market Price (determined by multiplying such total number of shares of
Rights Stock by the consideration received per share of such Rights
Stock and dividing the product so obtained by such Current Market
Price), and
(2) the denominator shall be the sum of (A) the number of shares
of Common Shares of the type issued pursuant to the exercise of, or
exchange by the Corporation for, such Rights outstanding on the date
of issuance of such Rights Stock immediately prior to such issuance
plus (B) the number of additional shares of Rights Stock which are so
issued.
Such adjustment shall be made successively whenever any Rights Stock is
issued, and shall become effective immediately (except as provided in subsection
(vi) below) after the issuance of Rights Stock. If after the applicable
"Distribution Date" or a similar date (as defined in a Rights Agreement) holders
converting shares of Convertible Preferred Shares are, for any reason, not
entitled to receive the Rights or similar rights, options or warrants which
would otherwise be attributable (but for the date of conversion) to the shares
of Common
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Shares received upon such conversion), then a reducing adjustment shall be made
in the Conversion Price to reflect the fair market value of the Rights or
similar rights, options or warrants. If such an adjustment is made and the
Rights or similar rights. options or warrants are later exchanged, redeemed,
invalidated or terminated, then a corresponding reversing adjustment shall be
made to the Conversion Price, on an equitable basis, to take account of such
event. However, the Corporation may elect to provide that such shares of Common
Shares issuable upon conversion of the Convertible Preferred Shares, whether or
not issued after the Distribution Date or such similar date for such Rights,
will be accompanied by the Rights which would otherwise be attributable (but for
the date of conversion to such shares of Common Shares, in which event the
preceding two sentences shall not apply).
(iv) In case the Corporation shall distribute to substantially all
holders of Common Shares, or to substantially all holders of its
outstanding shares of any class or series of Common Shares, evidences of
indebtedness, equity securities (including equity interests in the
Corporation's subsidiaries) other than Common Shares or other assets (other
than cash dividends paid out of earned surplus of the Corporation, or if
there shall be no earned surplus, out of net profits for the fiscal year in
which the dividend is made and or the preceding fiscal year), or shall
distribute to substantially all holders of Common Shares or to
substantially all holders of any class or series of Common Shares, rights,
options or warrants to subscribe to securities (other than any rights,
options or warrants referred to in subsection (ii) above or Rights referred
to in subparagraph (iii) above), then in each such case the Conversion
Price shall be adjusted so that it shall equal the price determined by
multiplying the Conversion Price in effect immediately prior to the date of
such distribution by a fraction of which the numerator shall be the Current
Market Price per share of the Common Shares (as determined below) on the
record date mentioned below less the quotient of the then fair market value
of the assets, evidences of indebtedness and equity securities so
distributed, or of such subscription rights, warrants or options, divided
by the number of shares of Common Shares outstanding on such record date,
and of which the denominator shall be such Current Market Price of the
Common Shares. For the purposes of this subsection (iv), in the event of a
distribution of shares of capital stock or other securities of any
subsidiary of the Corporation as a dividend on shares of Common Shares, the
"then fair market value" of the shares or other securities so distributed
shall be the value of such shares or other securities on the record date
mentioned below as determined by the Board of Directors, whose good faith
determination shall be conclusiv evidence of such value, and shall be
described in a Board resolution. Such adjustment shall become effective
immediately (except as provided in subsection (vi) below) after the record
date for the determination of stockholders entitled to receive such
distribution.
(v) For the purpose of any computation under subsection (ii), (iii)
or (iv) above, the "Current Market Price" per share of stock on any date
shall be (A) deemed to be the average of the last sale prices of a share of
such shares for the fifteen consecutive trading days commencing 20 trading
days before the earliest of the date in question and the date before the
"ex date" with respect to the issuance or distribution requiring such
computation, or (B) in each case where the Current Market Price per
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share is to be determined with respect to the two classes or series of
Common Shares considered together, deemed to equal the quotient of (i) the
sum of (a) AvgA multiplied by Na and (b) AvgB multiplied by Nb, divided by
(ii) Nt, where
AvgA = the average of the last sale prices of a share of Class
A Common Shares for the fifteen consecutive trading
days commencing 20 trading days before the earliest of
the date in question and the date before the "ex date"
with respect to the issuance or distribution requiring
such computation,
AvgB = the average of the last sale prices of a share of Class
B Common Shares for the fifteen consecutive trading
days commencing 20 trading days before the earliest of
the date in question and the date before the "ex date"
with respect to the issuance or distribution requiring
such computation,
Na = the average number of shares of Class A Common Shares
outstanding during the fifteen consecutive trading days
commencing 20 trading days before the earliest of the
date in question and the date before the "ex date" with
respect to the issuance or distribution requiring such
computation,
Nb = the average number of shares of Class B Common Shares
outstanding during the fifteen consecutive trading days
commencing 20 trading days before the earliest of the
date in question and the date before the "ex date" with
respect to the issuance or distribution requiring such
computation, and
Nt = the sum of Na and Nb.
For purposes of this subsection (v), the term "ex date," when used with
respect to any issuance or distribution, means the first date on which the
stock trades regular way on the principal national securities exchange on
which the stock is listed or admitted to trading (or if not so listed or
admitted, on Nasdaq, or a similar organization if Nasdaq is no longer
reporting trading information) without the right to receive such issuance
or distribution.
(vi) In any case in which this Section shall require that an
adjustment be made immediately following a record date or immediately
following the exercise of, or exchange of a right, option or warrant, the
Corporation may elect to defer the effectiveness of such adjustment (but in
no event until a date later than the later of the "ex date" as defined
above and the effective date of the event giving rise to such adjustment),
in which case the Corporation shall, with respect to any Convertible
Preferred Shares converted after the date of such exercise or exchange or
such record date, as the case may be, and before such adjustment shall have
become effective (1)
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<PAGE>
defer making any cash payment or issuing to the holder of such Convertible
Preferred Shares the number of shares of Common Shares and other capital
stock of the Corporation issuable upon such conversion in excess of the
number of shares of Common Shares and other capital stock of the
Corporation issuable thereupon only on the basis of the Conversion Price
prior to adjustment, and (2) not later than five business days after such
adjustment shall have become effective, pay to such holder the appropriate
cash payment and issue to such holder the additional shares of Common
Shares and other capital stock of the Corporation issuable on such
conversion.
(vii) No adjustment in the Conversion Price shall be required if the
holders of Convertible Preferred Shares are to participate in the
transaction on a basis and with notice that the Board of Directors
determines in good faith to be fair and appropriate in light of the basis
and notice on which holders of Common Shares participate in the
transaction. In addition, no adjustment in the Conversion Price shall be
required unless such adjustment (plus any adjustments not previously made
by reason of this subsection (vii)) would require an increase or decrease
of at least 1% in the Conversion Price; provided, that any adjustments
which by reason of this subsection (vii) are not required to be made shall
be carried forward and taken into account in any subsequent adjustment.
All calculations under this Section shall be made to the nearest cent or to
the nearest one-hundredth of a share, as the case may be.
(viii) whenever the Conversion Price is adjusted as provided above:
(1) the Corporation shall compute the adjusted Conversion Price
and shall promptly file with the stock transfer or conversion agent,
as appropriate, for the Convertible Preferred Shares, a certificate
signed by a principal financial officer of the Corporation setting
forth the adjusted Conversion Price and showing in reasonable detail
the facts upon which such adjustment is based and the computation
thereof; and
(2) a notice stating that the Conversion Price has been adjusted
and setting forth the adjusted Conversion Price shall, as soon as
practicable, be sent by first-class mail to the holders of record of
the Convertible Preferred Shares.
In case:
(A) the Corporation shall take any action which would
require an adjustment to the Conversion Price pursuant to
subsection (iv) above;
(B) the Corporation shall authorize the granting to
the holders of its Common Shares of rights, options or
warrants entitling them to subscribe for or purchase any
shares of capital stock of any class or of any other
rights;
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<PAGE>
(C) of any reorganization or reclassification of the
Common Shares or any class or series of Common Shares
(other than a subdivision or combination of its outstanding
Common Shares), or of any consolidation or merger to which
the Corporation is a party and for which approval of any
stockholders of the Corporation is required, or of the
sale, lease or transfer of all or substantially all the
assets of the Corporation; or
(D) of the voluntary or involuntary liquidation,
dissolution or winding-up of the Corporation;
then the Corporation shall cause to be mailed to the stock transfer or
conversion agent, as appropriate, for the Convertible Preferred Shares and
to the holders of record of Convertible Preferred Shares, at least 20 days
(for 10 days in any case described in subsections (A) or (B) above) prior
to the applicable record date or effective date specified below, a notice
stating (x) the date as of which the holders of record of Common Shares to
be entitled in such dividend, distribution, rights, options or warrants are
to be determined, or (y) the date on which such reorganization,
reclassification, consolidation, merger, sale, lease, transfer,
liquidation, dissolution or winding-up is expected to become effective, and
the date or dates as of which it is expected that holders of record of
Common Shares shall be entitled to exchange their shares for securities or
other property, if any, deliverable upon such reorganization,
reclassification, consolidation, merger, sale, lease, transfer,
liquidation, dissolution or winding-up. Neither the failure to give the
notice required by this subsection (viii), nor any defect therein, to any
particular holder shall affect the sufficiency of the notice or the
legality or validity of any such dividend, distribution, right, option,
warrant, reorganization, reclassification, consolidation, merger, sale,
lease, transfer, liquidation, dissolution or winding-up, or the vote
authorizing any such action with respect to the other holders.
(ix) To the extent permitted by law, the Corporation from time to
time may reduce the Conversion Price by any amount for any period of at
least 20 days (or such other period as may then be required by applicable
law) if the Board of Directors has made a determination in good faith that
such reduction would be in the best interests of the Corporation, which
determination shall be conclusive. No reduction in the Conversion Price
pursuant to this subsection (ix) shall become effective unless the
Corporation shall have mailed a notice, at least 15 days prior to the date
on which such reduction is scheduled to become effective, to each holder of
Convertible Preferred Shares. Such notice shall be given by first-class
mail, postage prepaid, at such holder's address as it appears on the books
of the Corporation. Such notice shall state the amount per share by which
the Conversion Price will be reduced and the period for which such
reduction will be in effect.
(x) At its option, the Corporation may make such reduction in the
Conversion Price, in addition to those otherwise required by this Section
6, as the
17
<PAGE>
Board deems advisable to avoid or diminish any income tax to holders of
Common Shares resulting from any dividend or distribution of stock (or
rights to acquire stock) or from any event treated as such for income tax
purposes; provided that any such reduction shall not be effective until
written evidence of the action of the Board of Directors authorizing such
reduction shall be filed with the Secretary of the Corporation and notice
thereof shall have been given by first-class mail, postage prepaid, to each
holder of Convertible Preferred Shares at such holder's address as it
appears on the books of the Corporation.
(c) CONSOLIDATION, MERGER OR SALE OF ASSETS. If any transaction shall
occur, including without limitation (i) any recapitalization or reclassification
of shares of Common Shares or any class or series of Common Shares (other than a
change in par value, or from par value to no par value, or from no par value to
par value, or as a result of a subdivision or combination of the Common Shares),
(ii) any consolidation or merger of the Corporation with or into another person
or any merger of another person into the Corporation (other than a merger in
which the Corporation is the surviving corporation and that does not result in a
reclassification, conversion, exchange or cancellation of Common Shares, or any
class or series of Common Shares), (iii) any sale, lease or transfer of all or
substantially all of the assets of the Corporation, (iv) any compulsory share
exchange, or (v) any conversion of all of the outstanding Class B Common Shares
into Class A Common Shares, pursuant to any of which holders of Class B Common
Shares shall be entitled to receive other securities, cash or other property,
then appropriate provision shall be made so that the holder of each share of
Convertible Preferred Shares then outstanding shall have the right thereafter to
receive on account of such share only the kind and amount of the securities,
cash or other property that would have been receivable upon such
recapitalization, reclassification, consolidation, merger, sale, lease,
transfer, share exchange or conversion of a holder of the number of shares of
Class B Common Shares issuable upon conversion of such share of Convertible
Preferred Shares immediately prior to such recapitalization, reclassification,
consolidation, merger, sale, lease, transfer or share exchange, and the
Corporation shall not enter into any such merger, consolidation, sale, lease,
transfer or share exchange unless the company formed by such consolidation or
resulting from such merger or that acquires such assets or that acquires the
Corporation's shares, as the case may be, shall make provisions in its
certficate or articles of incorporation or other constituent document or
certificate of merger or other document effecting any such merger,
consolidation, sale, lease, transfer or share exchange to establish such right.
Upon the occurrence of any transaction described in the preceding sentence
(except clause (i) thereof), the Convertible Preferred Shares then outstanding
shall be deemed converted, subject nevertheless to the provisions of Section 8
to the extent applicable.
(d) ACCRUED DIVIDENDS AND FRACTIONAL SHARES. Dividends shall cease to
accrue on shares of the Convertible Preferred Shares surrendered for conversion
into Class B Common Shares pursuant to this Section or Section 8 below. No
fractional shares of Class B Common Shares shall be issued upon conversion of
the Convertible Preferred Shares, and any portion of Convertible Preferred
Shares surrendered for conversion which would otherwise result in a fractional
share of Class B Common Shares shall be redeemed for cash in an amount equal to
the product of such fraction multiplied by the closing price of the Class B
Common Shares on the last business day prior to conversion.
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<PAGE>
(e) MECHANICS OF CONVERSION. Before any holder of Convertible Preferred
Shares shall be entitled to convert such stock into shares of Class B Common
Shares and to receive certificates therefor, such holder shall surrender the
certificate or certificates for the Convertible Preferred Shares to be
converted, duly endorsed, at the office of the Corporation or of any transfer
agent for the Convertible Preferred Shares, and shall give written notice to the
Corporation at such office that such holder elects to convert the same. The
Corporation shall, within 10 days after such delivery issue and deliver at such
office to such holder of the Convertible Preferred Shares (or to any other
person specified in the notice delivered by such holder) a certificate or
certificates for the number of shares of Class B Common Shares to which such
holder shall be entitled as aforesaid and a check payable to the holder for any
cash amounts payable as the result of a conversion into fractional shares of
Class B Common Shares. Such conversion shall be deemed to have been made
immediately prior to the close of business on the date of such surrender of the
shares of Convertible Preferred Shares to be converted, and the Person or
persons entitled to receive the shares of Class B Common Shares issuable upon
such conversion shall be treated for all purposes as the record holder or
holders of such shares of Class B Common Shares on such date. In case any
certificate for shares of the Convertible Preferred Shares shall be surrendered
for conversion of only a part of the shares represented thereby, the Corporation
shall deliver within 10 days at such office to or upon the written order of the
holder thereof, a certificate or certificates for the number of shares of
Convertible Preferred Shares represented by such surrendered certificate which
are not being converted. Notwithstanding the foregoing, the Corporation shall
not be obligated to issue certificates evidencing the shares of Class B Common
Shares issuable upon such conversion unless the certificates evidencing the
Convertible Preferred Shares are either delivered to the Corporation or its
transfer agent or the Corporation or its transfer agent shall have received
evidence satisfactory to it evidencing that such certificates have been lost,
stolen or destroyed and the holder of such Convertible Preferred Shares executes
an agreement satisfactory to the Corporation to indemnify the Corporation from
any loss incurred by it in connection with such certificates. The issuance of
certificates of shares of Class B Common Shares issuable upon conversion of
shares of Convertible Preferred Shares shall be made without charge to the
converting holder for any tax imposed in respect of the issuance thereof;
provided that the Corporation shall not be required to pay any tax which may be
payable with respect to any transfer involved in the issue and delivery of any
certificate in a name other than that of the holder of the shares of Convertible
Preferred Shares being converted.
(f) ADOPTION OF RIGHTS AGREEMENT. The Corporation shall not adopt a
Rights Agreement unless such Rights Agreement shall provide that (i) each holder
of a share of Convertible Preferred Shares shall be entitled to receive
thereunder, upon conversion of such share of Convertible Preferred Shares (in
accordance with the terms hereof), prior to the earlier to occur of the date of
redemption of Rights issued under such Rights Agreement, the date of expiration
of the Rights issued under such Rights Agreement, or the date the Conversion
Price of the Convertible Preferred Shares is adjusted pursuant to subsection
6(b)(iii) above rights for each share of Common Shares issued upon conversion of
such share of Convertible Preferred Shares in an amount equal to the amount of
Rights issued with respect to each outstanding share of Common Shares issued
rights pursuant to such Rights Agreement and (ii) if such Rights are redeemed
prior to the conversion of any share of Convertible
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<PAGE>
Preferred Shares into Common Shares, then, upon conversion of such share of
Convertible Preferred Shares, the holder thereof shall receive an amount in cash
equal to the amount in cash that such holder would have received had he
converted such share of Convertible Preferred Shares prior to such redemption.
7. OPTIONAL REDEMPTION. On or after June 17,1998, the Corporation may,
at its option, redeem all or from time to time any part of the shares of
Convertible Preferred Shares, out of funds legally available therefor, upon
giving a notice of redemption as set forth below, at the following redemption
prices per share (expressed as percentages of the Stated Value thereof), plus an
amount equal to accrued and unpaid dividends, if any (whether or not declared),
up to but excluding the date fixed for redemption, if redeemed during the
twelve-month period commencing on June 17, 1998 of the years indicated below:
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
---- ----------
<S> <C>
1998. . . . . . . . . . 103.0%
1999. . . . . . . . . . 102.5%
2000. . . . . . . . . . 102.0%
2001. . . . . . . . . . 101.5%
2002. . . . . . . . . . 101.0%
2003. . . . . . . . . . 100.5%
2004. . . . . . . . . . 100.0%
</TABLE>
If fewer than all of the outstanding shares of the Convertible Preferred
Shares are to be redeemed, the number of shares to be redeemed shall be
determined by the Board of Directors in good faith and the shares to be redeemed
will be determined pro rata as nearly as practicable, or by such other method as
the Board of Directors may determine to be fair and appropriate. Convertible
Preferred Shares may not be redeemed unless full cumulative dividends have been
paid on the Convertible Preferred Shares for all past dividend periods.
Notice of redemption of Convertible Preferred Shares will be given by (i)
first-class mail, not less than 30 nor more than 60 days prior to the date fixed
for redemption thereof, to each record holder of shares of Convertible Preferred
Shares to be redeemed at the address of such holder in the books of the
Corporation and (ii) publication in THE WALL STREET JOURNAL. On the date such
notices are mailed, the Corporation shall issue a press release announcing the
redemption. The mailed and published notice shall state, as appropriate: (1)
the redemption date and record date for purposes of such redemption; (2) the
number of shares of Convertible Preferred Shares to be redeemed and, if fewer
than all outstanding shares of Convertible Preferred Shares held by any holder
are to be redeemed, the number of shares to be redeemed from such holder; (3)
the place or places at which certificates for such shares are to be surrendered;
(4) the then current redemption price; and (5) that dividends on the Convertible
Preferred Shares to be redeemed shall cease to accrue on such Redemption Date,
except as otherwise provided herein. If such notice of redemption has been
given, from and after the specified redemption date (unless the Corporation
defaults in making payment of the redemption price), dividends on the
Convertible Preferred Shares so called for redemption will
20
<PAGE>
cease to accrue, such shares will no longer be deemed to be outstanding, and all
rights of the holders thereof as stockholders of the Corporation (except the
right to receive the redemption price and any dividends due on a dividend
payment date after the redemption date relating to a dividend record date prior
to such redemption date) will cease.
8. CHANGE IN CONTROL. If there occurs a Change in Control (as defined
below) with respect to the Corporation, then each share of Convertible Preferred
Shares may be converted (the rights to convert described in this Section
referred to as the "Special Conversion Rights"'), at the option of the holder
thereof at any time from the date of such Change in Control until the expiration
of 60 days after the date of the Conversion Notice (as defined below) by the
Corporation to all holders of the Convertible Preferred Shares, into, at its
option, either (A) such number of fully paid and non-assessable shares of Class
B Common Shares as is equal to the Stated Value of the Convertible Preferred
Shares divided by the Special Conversion Price (as defined below) or (B) an
amount in cash equal to the Stated Value of the Convertible Preferred Shares
plus an amount equal to any accrued but unpaid dividends thereon. The "Special
Conversion Price" shall be the closing price of the Class B Common Shares on the
last trading day prior to the date the Corporation gives the Conversion Notice
(as defined below) to the holders of Convertible Preferred Shares.
Within five days after the occurrence of a Change in Control, the
Corporation shall give notice of the occurrence of the Change in Control and of
the Special Conversion Rights set forth herein in accordance with the procedures
set forth below to each holder of Convertible Preferred Shares (the "Conversion
Notice").
Each Conversion Notice shall state:
(a) that a Change in Control has occurred (and shall specify the date of
occurrence), and that the holder's Special Conversion Rights may be exercised in
accordance with this Section;
(b) the expiration date of the Special Conversion Rights;
(c) that a holder of Convertible Preferred Shares, in order to exercise
Special Conversion Rights, must deliver on or before the fifth day prior to the
expiration date of the Special Conversion Rights written notice to the
Corporation of the holder's exercise of those rights, together with the
certificate evidencing such holder's shares with respect to which the rights are
being exercised, duly endorsed for transfer;
(d) the Special Conversion Price and the Conversion Price which would
otherwise be applicable;
(e) a description of the procedure which a holder must follow to exercise
its Special Conversion Rights; and
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<PAGE>
(f) that holders of Convertible Preferred Shares electing to have such
shares converted will be required to surrender the certificates evidencing such
shares for delivery of shares of Class B Common Shares.
The Conversion Notice shall be given by first-class mail, postage paid, to
the holders of record of Convertible Preferred Shares at their respective
addresses as they appear on the books of the Corporation.
No failure of the Corporation to give the Conversion Notice shall limit any
holder's right to exercise its Special Conversion Rights.
Exercise of the Special Conversion Rights by a holder of Convertible
Preferred Shares will be irrevocable. The Corporation shall not enter into any
consolidation, merger or sale of assets, unless in connection therewith the
holders of Convertible Preferred Shares exercising Special Conversion Rights
will be entitled to receive the same consideration as received for the number of
shares of Class B Common Shares into which their shares of Convertible Preferred
Shares would have been converted pursuant to the Special Conversion Rights. The
Special Conversion Rights are in addition to the regular Conversion Rights that
apply to the Convertible Preferred Shares.
The Corporation may, at its option, elect to pay holders of Convertible
Preferred Shares exercising Special Conversion Rights an amount in cash equal to
the Stated Value of the Convertible Preferred Shares plus an amount equal to any
accrued but unpaid dividends thereon.
"Change in Control" means any of the following: (i) the sale, lease,
conveyance or other disposition of all or substantially all of the Corporation's
assets as an entirety or substantially as an entirety to any person or "group"'
(within the meaning of Section 13(d)(3) of the 1934 Act) in one or a series of
transactions, provided that a transaction where the holders of Common Shares
immediately prior to such transaction own, directly or indirectly, 50% or more
of the common stock of such person or group immediately after such transactions
shall not be a Change in Control; (ii) the acquisition by the Corporation and/or
any of its subsidiaries of 50% or more of the aggregate voting power of the
Common Shares in one transaction or a series of related transactions; (iii) the
liquidation or dissolution of the Corporation, provided that a liquidation or
dissolution of the Corporation which is part of a transaction or series of
related transactions that does not constitute a Change in Control under the
"provided" clause of clause (i) above shall not constitute a Change in Control
under this clause (iii); or (iv) any transaction or series of transactions (as a
result of a tender offer, merger, consolidation or otherwise) that results in,
or that is in connection with, (a) any person, including a "group" (within the
meaning of Section 13(d)(3) of the 1934 Act) that includes such person,
acquiring "beneficial ownership" (as defined in Rule 13d-3 under the 1934 Act),
directly or indirectly, of 50% or more of the aggregate voting power of the
Common Shares of the Corporation or any person that possesses "beneficial
ownership" (as defined in Rule 13d-3 under the 1934 Act), directly, of 50% or
more of the aggregate voting Power of the Common Shares, or (b) less than 50%
(measured by the aggregate voting power
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<PAGE>
of all classes) of the Corporation's Common Shares being registered under
Section 12(b) or 12(g) of the 1934 Act.
9. STATUS OF REACQUIRED SHARES. If shares of Convertible Preferred
Shares are converted pursuant to Section 6 hereof or redeemed pursuant to
Section 7 hereof, the shares so converted or redeemed shall, upon compliance
with any statutory requirements, assume the status of authorized but unissued
shares of preferred stock of the Corporation, but may not be reissued as
Convertible Preferred Shares.
10. RESERVED SHARES. So long as any shares of Convertible Preferred
Shares remain outstanding, the Corporation agrees to keep reserved for issuance
in connection with the conversion of the Convertible Preferred Shares at all
times a number of authorized but unissued shares of Class B Common Shares at
least equal to 150% of the number of shares of Class B Common Shares issuable
upon conversion at the Conversion Price of all of the Convertible Preferred
Shares outstanding at such time. The Corporation shall take all action
necessary so that Class B Common Shares so issued will be validly issued, fully
paid and non-assessable. The Corporation shall use its best efforts to list the
Class B Common Shares required to be delivered upon conversion of the shares of
Convertible Preferred Shares, prior to such conversion, upon each national
securities exchange, if any, upon which the outstanding Common Shares are listed
at the time of such delivery.
11. PREEMPTIVE RIGHTS. The Convertible Preferred Shares are not entitled
to any preemptive or subscription rights in respect of any securities of the
Corporation.
12. NOTICES. Except as otherwise provided herein, all notices, requests,
demands, and other communication hereunder shall be in writing and shall be
deemed to have been duly given if delivered by and when sent by telex or
telecopier (with receipt confirmed), provided a copy is also sent by express
(overnight, if possible) courier, addressed (i) in the case of a holder of
Convertible Preferred Shares, to such holder's address as it appears on the
books of the Corporation, and (ii) in the case of the Corporation, to the
Corporation's principal executive offices to the attention of the Corporation's
President,
13. SEVERABILITY OF PROVISIONS. Whenever possible, each provision of this
paragraph C shall be interpreted in a manner as to be effective and valid under
applicable law, but if any provision hereof is held to be prohibited by or
invalid under applicable law, such provision shall be ineffective only to the
extent of such prohibition or invalidity, without invalidating or otherwise
adversely affecting the remaining provisions hereof. If a court of competent
jurisdiction should determine that a provision hereof would be valid or
enforceable if a period of time were extended or shortened or a particular
percentage were increased or decreased, then such court may make such change as
shall be necessary to render the provision in question effective and valid under
applicable law.
V
The number of Directors of the Corporation shall be twelve. The number of
Directors may hereafter be fixed from time to time by bylaw or amendment duly
adopted by the Board
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<PAGE>
of Directors, provided, however, that the number of Directors shall not be more
than twelve nor less than five, except as otherwise may be required to implement
the provisions of paragraph C.5(b) of Article IV hereof.
VI
A. The Board of Directors shall be and is divided in to three classes,
Class I, Class II and Class III. The number of Directors in each class shall be
the whole number contained in the quotient arrived at by dividing the authorized
number of Directors by three, and if a fraction is also contained in such
quotient then if such fraction is one-third (1/3) the extra Director shall be a
member of Class I and if the fraction is two-thirds (2/3) one of the extra
Directors shall be a member of Class I and the other shall be a member of Class
II. Each Director shall serve for a term ending on the date of the third annual
meeting following the annual meeting at which such Director was elected,
provided, however, that the Directors initially appointed to Class I shall serve
for a term ending on the date of the third annual meeting next following the
date hereof, the Directors initially appointed to Class II shall serve for a
term ending on the date of the second annual meeting next following the date
hereof, and the Directors initially appointed to Class III shall serve for a
term ending on the date of the first annual meeting next following the date
hereof.
B. In the event of any increase or decrease in the authorized number of
Directors, (1) each Director then serving as such shall nevertheless continue as
a Director of the class of which he is a member until the expiration of his
current term, or his prior death, resignation or removal, and (2) the newly
created or eliminated Directorships resulting from such increase shall be
apportioned by the Board of Directors to such class or classes as shall, so far
as possible, bring the number of Directors in the respective classes into
conformity with the formula in this Article, as applied to the new authorized
number of Directors.
C. Notwithstanding any of the foregoing provisions of this Article, each
Director shall serve until his successor is elected and qualified or until his
death, resignation or removal. A Director shall not be removed from office
prior to the expiration of his term except by the affirmative vote or written
consent of not less than sixty-six and two-thirds percent (66 2/3%) of the total
votes entitled to be cast in an election of Directors. Should a vacancy occur
or be created, the remaining Directors (even though less than a quorum) may fill
the vacancy for the full term of the class in which the vacancy occurs or is
created.
VII
A. In addition to requirements of any applicable statute, the affirmative
vote or written consent of not less than 66 2/3% of the total votes entitled to
be cast in an election of Directors, considered for purposes of this Article as
one class, shall be required for approval or authorization of any Business
Transaction (as hereinafter defined) between the Corporation and any Control
Person (as hereinafter defined), provided, however, that such additional voting
requirement shall not be applicable if:
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<PAGE>
(1) The Business Transaction was approved by a two-thirds vote of the
Board of Directors of the Corporation prior to the acquisition by the
Control Person, together with its Affiliates and Associates (as hereinafter
defined), of stock of the Corporation, which, in the aggregate, bears the
rights to 10% or more of the total votes entitled to be cast in an election
of Directors; or
(2) The Business Transaction was approved by a two-thirds vote of the
Board of Directors of the Corporation after the acquisition by the Control
Person, together with its Affiliates and Associates, of stock of the
Corporation, which, in the aggregate, bears the rights to 10% or more of
the total votes entitled to be cast in an election of Directors, and such
acquisition by such Control Person and its Affiliates and Associates was
unanimously approved by the Board of Directors of Corporation; or
(3) The Business Transaction is solely between the Corporation and
another corporation, 50% or more of the voting stock of which is owned by
the Corporation and none of which is owned by a Control Person, and each
holder of stock of the Corporation receives the same type of consideration
in proportion to his holdings; or
(4) Both of the following are satisfied:
(a) the cash or fair market value of the property, securities or
other consideration to be received per share in the Business
Transaction by holders of the stock of the Corporation is not less
than the higher of (i) the highest price per share (including
brokerage commissions, soliciting dealers' fees, dealer-management
compensation, and other expenses, including, but not limited to,
newspaper advertisements, printing and attorney's fees) paid by such
Control Person in acquiring any of its holdings of the Corporation's
stock, or (ii) the highest per share market price of the stock of the
Corporation during the 3-month period immediately preceding the date
of the proxy statement described in (c) below; and
(b) a proxy statement responsive to the requirements of the 1934
Act shall be mailed to public stockholders of the Corporation for the
purpose of soliciting stockholder approval of such Business
Transaction and shall contain at the front thereof, in a prominent
place, any recommendations as to the advisability (or inadvisability)
of the Business Transaction which the Continuing Directors, or any of
them, may choose to state, and, if deemed advisable by a majority of
the Continuing Directors, an opinion of a reputable investment banking
firm as to the fairness (or unfairness) of the terms of such Business
Transaction, from the point of view of the remaining public
stockholders of the Corporation (such investment banking firm to be
selected by a majority of the Continuing Directors and to be paid a
reasonable fee for their services by the Corporation upon receipt of
such opinion).
B. For the purposes of this Article:
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(1) The term "Control Person" shall mean and include any individual,
corporation, partnership or other person or entity which, together with its
Affiliates and Associates, "beneficially owns" (as this term is defined on
the date on which this Article becomes effective in Rule 13d-3 of the
General Rules and Regulations under the 1934 Act) in the aggregate, stock
of the Corporation, which bears the rights to 10% or more of the total
votes entitled to be cast in an election of Directors, and any Affiliate or
Associate (as those terms are defined on the date of which this Article is
adopted in Rule 12b-2 of the General Rules and Regulations under the 1934
Act) of any such individual, corporation, partnership or other person or
entity;
(2) The term "Business Transaction" shall mean (a) any merger or
consolidation of the Corporation with or into a Control Person, (b) any
sale, lease, exchange, transfer or other disposition, including without
limitation a mortgage or any other security device, of all or any
Substantial Part (as hereinafter defined) of the assets of the Corporation
(including, without limitation, any voting securities of a subsidiary) or
of a subsidiary, to a Control Person, (c) any merger of consolidation of a
Control Person with or into the Corporation or a subsidiary of the
Corporation, (d) any sale, lease, exchange, transfer or other disposition
of all or any Substantial Part (as hereinafter defined) of the assets of a
Control Person to the Corporation or a subsidiary of the Corporation, (e)
the issuance of any securities of the Corporation or a subsidiary of the
Corporation to a Control Person, (f) the acquisition by the Corporation or
a subsidiary of the Corporation of any securities of a Control Person, (g)
any reclassification or recapitalization (including any reverse stock
split) involving stock of the Corporation, consummated within five (5)
years after a Control Person becomes a Control Person, (h) any plan or
proposal by a Control Person for the dissolution or liquidation of the
Corporation, and (i) any agreement, contract or other arrangement providing
for any of the transactions described in this definition of Business
Transaction;
(3) The term "Continuing Director" shall mean any Director who was
elected by the public stockholders of the Corporation prior to the
acquisition by the Control Person, together with its Affiliates and
Associates, in the aggregate, of stock of the Corporation, which bears the
rights to 10% or more of the total votes entitled to be cast in an election
of Directors, or a person recommended by succeed a Continuing Director by a
majority of Continuing Directors;
(4) The term "Substantial Part" shall mean more than 10% of the total
assets of the Corporation in question as of the end of its most recent
fiscal year ending prior to the time that the termination is being made;
(5) Without limitation, any stock of the Corporation which any
Control Person has the right to acquire at any time pursuant to any
agreement, or upon exercise of conversion rights, warrants or options, or
otherwise, shall be deemed outstanding and beneficially owned by such
Control Person for purposes of this Article only;
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(6) For the purpose of subparagraph 4 of paragraph A of this Article,
the phrase, "other consideration to be received" shall include, without
limitation, stock of the Corporation retained by its existing public
stockholders in the event of a Business Transaction with such Control
Person in which the Corporation is the surviving corporation.
C. The provisions set forth in this Article shall not be repealed or
amended in any respect or in any manner, including any merger of consolidation
of the Corporation with any corporation, unless the surviving corporation's
Certificate of Incorporation contains an Article to the same effect as this
Article, except by the affirmative vote or written consent of not less than 66
2/3% of the total votes entitled to be cast in an election of Directors
attributable to stock owned by persons other than a Control Person.
D. A majority of the Continuing Directors shall have the power and duty
to determine for purposes of this Article on the basis of information known to
them:
(1) Whether any proposed transaction is a Business Transaction and
within the scope of this Article;
(2) Whether a stockholder is a Control Person; and
(3) For the purposes of subparagraph 4 of paragraph A, the per share
market value to be paid to stockholders in the Business Transaction and the
highest per share price paid by the Control Person in acquiring any of its
holdings of the Corporation's stock.
VIII
In furtherance and not in limitation of the powers conferred by statute,
the Board of Directors is expressly authorized to make, alter or repeal the
By-Laws of the Corporation.
IX
No Director shall be personally liable to the corporation or any
stockholder for monetary damages for breach of fiduciary duty as a director,
except for any matter in respect of which such director shall be liable under
Section 174 of Title 8 of the Delaware Code (relating to the Delaware General
Corporation Law) or any amendment thereto or successor provision thereto or
shall be liable by reason that, in addition to any and all other requirements
for such liability, he (i) shall have breached his duty of loyalty to the
corporation or its stockholders, (ii) shall not have acted in good faith, (iii)
shall have acted in a matter involving intentional misconduct or a knowing
violation of law or, in failing to act, shall have acted in a manner involving
intentional misconduct or a knowing violation of law or, (iv) shall have derived
an improper personal benefit. Neither the amendment nor repeal of this Article
Nine, nor the adoption of any provision of the Certificate of Incorporation
inconsistent with this
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Article Nine, shall eliminate or reduce the effect of this Article Nine in
respect of any matter occurring or any cause of action, suit or claim that, but
for this Article Nine would accrue or arise, prior to such amendment, repeal or
adoption of an inconsistent provision.
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CERTIFICATE OF AMENDMENT OF
AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF
N-T HOLDINGS, INC.
N-T Holdings, Inc., a corporation organized and existing under the General
Corporation Law of the State of Delaware (the "Corporation"), does hereby
certify that:
1. At a meeting of the Board of Directors of the Corporation, resolutions
were duly adopted setting forth a proposed amendment of the Amended and Restated
Certificate of Incorporation of the Corporation, declaring such amendment to be
advisable and calling a meeting of the stockholder of the Corporation for
consideration thereof. The resolution setting forth the proposed amendment is
as follows:
RESOLVED, that the Amended and Restated Certificate of Incorporation
be amended by changing Article I, so that, as amended, such Article shall
be and read as follows:
"I
The name of this Corporation is: PacifiCare Health Systems, Inc."
2. Thereafter, pursuant to a resolution of the Board of Directors, the
above amendment was submitted to the stockholder of the Corporation for its
approval in accordance with the provisions of Section 222 of the General
Corporation Law of the State of Delaware at a meeting duly called and held, at
which meeting the necessary number of shares as required by statute were voted
in favor of the amendment.
3. The above amendment was duly adopted in accordance with the provisions
of Section 242 of the General Corporation Law of the state of Delaware.
IN WITNESS WHEREOF, N-T Holdings, Inc. has caused this Certificate of
Amendment to be signed by its President and Secretary this 14th day of February,
1997.
N-T HOLDINGS, INC.
By:
-----------------------------
Alan R. Hoops, President
ATTEST:
By:
-------------------------------
Joseph S. Konowiecki, Secretary
<PAGE>
EXHIBIT 10.10
1997 PREMIUM PRICED STOCK OPTION PLAN
The Company hereby adopts this 1997 Premium Priced Stock Option Plan of
PacifiCare Health Systems, Inc., (the "Plan"), subject to shareholder approval.
The purposes of this Plan are as follows:
(1) To further the growth, development and financial success of the
Company by providing additional incentives to certain of its officers who
have been or will be given responsibility for the management or
administration of the Company's business affairs.
(2) To enable the Company to obtain and retain the services of the
type of professional, technical and managerial personnel considered
essential to the long-range success of the Company by providing and
offering them an opportunity to become owners of capital stock.
ARTICLE I
DEFINITIONS
Whenever the following terms are used in this Plan, they shall have the
meaning specified below unless the context clearly indicates to the contrary.
Section 1.1 - Board
"Board" shall mean the Board of Directors of the Company.
Section 1.2 - Chief Financial Officer
"Chief Financial Officer" shall mean the Chief Financial Officer of the
Company.
Section 1.3 - Class A Common Stock
"Class A Common Stock" shall mean the Class A Common Stock of the Company,
par value $.01 per share.
Section 1.4 - Class B Common Stock
"Class B Common Stock" shall mean the Class B Common Stock of the Company,
par value $.01 per share.
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Section 1.5 - Code
"Code" shall mean the Internal Revenue Code of 1986, as amended from time
to time.
Section 1.6 - Committee
"Committee" shall mean the Committee of the Board of Directors of the
Company as defined in Section 6.1 hereof.
Section 1.7 - Common Stock
"Common Stock" shall mean either or both, as the context requires, the
Class A Common Stock and the Class B Common Stock.
Section 1.8 - Company
"Company" shall mean PacifiCare Health Systems, Inc., a Delaware
corporation.
Section 1.9 - Director
"Director" shall mean a member of the Board.
Section 1.10 - Employee
"Employee" shall mean any employee (as defined in accordance with the
Treasury Regulations and Revenue Rulings then applicable under Section 3401(c)
of the Code) of the Company, or of any corporation which is then a Subsidiary or
a consultant who is providing bona fide services to the Company, whether such
employee is so employed, or such consultant is retained, at the time this Plan
is adopted or becomes so employed or retained subsequent to the adoption of this
Plan.
Section 1.11 - Exchange Act
"Exchange Act" shall mean the Securities Exchange Act of 1934, as amended
from time to time.
Section 1.12 - Fair Market Value
The "Fair Market Value" of a share of the Company's Common Stock on the
date such determination is made shall mean: (i) the closing price of such share
on the principal exchange on which the shares of Common Stock are then trading,
if any, on such date, or, if shares of such stock were not traded on such date,
then on the next preceding trading day during which a sale occurred; or (ii) if
such stock is not traded on an exchange but is quoted on Nasdaq or a successor
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quotation system, (1) the last sales price (if the stock is then listed as a
National Market Issue under the NASD National Market System), or (2) the mean
between the closing representative bid and asked prices (in all other cases) for
the stock on such date as reported by Nasdaq or such successor quotation system;
or (iii) if such stock is not publicly traded on an exchange and not quoted on
Nasdaq or a successor quotation system, the mean between the closing bid and
asked prices for the stock on such date as determined in good faith by the
Committee; or (iv) if the Company's Common Stock is not publicly traded, the
fair market value established by the Committee acting in good faith.
Section 1.13 - Nasdaq
"Nasdaq" shall mean the National Association of Securities Dealers Inc.
Automated Quotation System.
Section 1.14 - Officer
"Officer" shall mean an officer of the Company (including, without
limitation, the Chairman and Vice Chairman of the Board) or any corporation
which is then a Subsidiary, whether such Officer becomes an Officer at the time
this Plan is adopted or subsequent to the adoption of the Plan.
Section 1.15 - Option
"Option" shall mean a non-qualified stock option to purchase shares of the
Class B Common Stock of the Company granted under this Plan.
Section 1.16 - Parent Corporation
"Parent Corporation" shall mean any corporation in an unbroken chain of
corporations ending with the Company if each of the corporations other than the
Company then owns stock possessing 50 percent or more of the total combined
voting power of all classes of stock in one of the other corporations in such
chain.
Section 1.17 - Participant
"Participant" shall mean an Officer who is selected by the Committee to
receive an Option.
Section 1.18 - Plan
"Plan" shall mean this 1997 Premium Priced Stock Option Plan.
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Section 1.19 - Pronouns
The masculine pronoun shall include the feminine and neuter and the
singular shall include plural, where the context so indicates.
Section 1.20 - Regulations
"Regulations" shall mean final, temporary or proposed regulations
promulgated under the Code.
Section 1.22 - Secretary
"Secretary" shall mean the Secretary of the Company.
Section 1.23 - Subsidiary
"Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with the Company if each of the corporations other than
the last corporation in the unbroken chain then owns stock possessing 50 percent
or more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.
Section 1.24 - Termination of Employment
"Termination of Employment" shall mean: (i) the time when the Participant
ceases to be an Employee or Officer of the Company or a Subsidiary for any
reason, including, but not limited to, a termination by resignation, discharge,
death or retirement, and with respect to a Participant who becomes a consultant,
the time when such consultant is no longer retained by the Company or any
Subsidiary of the Company, but excluding terminations where there is a
simultaneous reemployment or reappointment of the Participant as an Employee or
Officer by the Company or a Subsidiary; or (ii) with respect to a Participant
who is an Employee or Officer of a Subsidiary, the time when such Subsidiary
ceases to be a Subsidiary of the Company. The Committee, in its absolute
discretion, shall determine the effect of all other matters and questions
relating to Termination of Employment, including, but not limited to, the
question of whether a Termination of Employment resulted from a discharge for
good cause, and all questions of whether particular leaves of absence constitute
Terminations of Employment.
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ARTICLE II
SHARES SUBJECT TO PLAN
Section 2.1 - Shares Subject to Plan
The shares of stock subject to Options shall be shares of the Company's
Class B Common Stock. The aggregate number of such shares which may be subject
to Options granted under the Plan shall be 2,400,000 shares of Class B Common
Stock.
The maximum number of Options available for grant to any Participant during
any fiscal year shall not exceed 400,000, subject to adjustment as provided
herein.
Section 2.2 - Changes in Company's Shares
In the event that the outstanding shares of Class B Common Stock of the
Company are hereafter changed into or exchanged for a different number or kind
of shares or other securities of the Company, or (subject to Section 7.2 hereof)
of another corporation, by reason of reorganization, merger, consolidation,
recapitalization, reclassification, stock split, stock dividend or combination
of shares, or in the event of extraordinary cash or non-cash dividends being
declared with respect to outstanding shares of Class B Common Stock or similar
transactions, proportionate adjustments shall be made by the Committee in the
number and kind of shares which are subject to Options, including adjustments of
the limitations contained herein on the maximum number and kind of shares which
may be subject to Options under the Plan.
ARTICLE III
GRANTING OF OPTIONS
Section 3.1 - Eligibility
Any Officer or key Employee of the Company or of any corporation which is
then a Subsidiary shall be eligible to be granted Options, except as otherwise
provided herein.
Section 3.2 - Granting of Options
(a) The Committee shall in its absolute discretion:
(i) Determine which Officers or key Employee as in its opinion
should be granted Options;
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(ii) Determine the number of shares to be subject to such Options
granted to such selected Officer or key Employee;
(iii) Determine the terms and conditions of such Options, consistent
with the Plan.
(b) Upon the selection of an Officer or key Employee to be granted an
Option, the Committee shall, by resolution, set forth the terms and conditions
of the Option, and instruct the Secretary or Chief Financial Officer to issue
such Option.
ARTICLE IV
TERMS OF OPTIONS
Section 4.1 - Option Price
The exercise price per share of the shares subject to each Option shall be
set by the Committee; provided, however, that the exercise price per share shall
in all cases be greater than 100 percent of the Fair Market Value of such shares
on the date such Option is granted.
Section 4.2 - Commencement of Exercisability
(a) Except as the Committee may otherwise provide, no Option may be
exercised in whole or in part during the first year after such Option is
granted.
(b) Subject to the provisions of Section 4.2(a), 4.2(c) and 7.2, Options
shall become exercisable in two installments as follows:
(i) The first installment shall consist of 50 percent of the
shares covered by the Option and shall become exercisable if, within three
years from October 6, 1997, the Class B Common Stock achieves a last
reported sales price, as reported by Nasdaq, of at least $92.50 for 20 days
(not necessarily consecutive) during any 12 month period.
(ii) The second installment shall consist of the remaining 50
percent of the shares covered by the Option and shall become exercisable
if, within five years from October 6, 1997, the Class B Common Stock
achieves a last reported sales price, as reported by Nasdaq, of at least
$114.00 for 20 days (not necessarily consecutive) during any 12 month
period.
(c) No portion of an Option which is unexercisable at Termination of
Employment shall thereafter become exercisable.
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(d) The installments provided for in clause (b) shall be cumulative; each
such installment which becomes exercisable pursuant to clause 4.2(b) shall
remain exercisable until such installment becomes unexercisable under Section
4.3.
Section 4.3 - Expiration of Options
(a) Fifty percent of the Options shall expire on October 6, 2000, if the
$92.50 stock price is not achieved for 20 days (not necessarily consecutive) by
such date.
(b) The remaining 50 percent of the Options shall expire on October 6,
2002 if the $114.00 stock price is not achieved for 20 days (not necessarily
consecutive) by such date.
(c) No Option may be exercised to any extent by anyone after the first to
occur of the following events:
(i) The expiration of ten years and one day from the date the
Option was granted;
(ii) The expiration of one year from the date of Participant's
Termination of Employment for any reason other than cause, including
Participant's death or disability;
(iii) Participant's Termination of Employment for cause; or
(iv) The expiration of the Options pursuant to subsection (a) or
(b) above.
For purposes of this Section 4.3, "disabled" shall mean a medically
determinable physical or mental impairment which has lasted or can be expected
to last for a continuous period of not less than 12 months and which renders the
Participant substantially unable to function as an Officer or Employee of the
Company or a Subsidiary.
Section 4.4 - Employment of Participant
Nothing in this Plan or in any stock option agreement shall confer upon any
Participant any right to continue in the employ of, or be retained by the
Company or any Subsidiary or shall interfere with or restrict in any way the
rights of the Company and Subsidiaries, which are hereby expressly reserved, to
discharge any Participant, or to terminate the services of any consultant, at
any time for any reason whatsoever, with or without cause.
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ARTICLE V
EXERCISE OF OPTIONS
Section 5.1 - Person Eligible to Exercise
During the lifetime of the Participant, only he, his guardian, legal
representative or other person approved by the Committee in its sole discretion
and described in the terms of the agreements documenting such Option may
exercise an Option granted to him, or any portion thereof. After the death of
the Participant, any exercisable portion of an Option may, prior to the time
when such portion becomes unexercisable under Article IV or Section 7.2, be
exercised by his personal representative or by any person empowered to do so
under the deceased Participant's will or under the then applicable laws of
descent and distribution.
Section 5.2 - Partial Exercise
At any time and from time to time prior to the time when any Option or
exercisable portion thereof becomes unexercisable under Article IV or Section
7.2, such Option or portion thereof may be exercised in whole or in part;
provided, however, that the Company shall not be required to issue fractional
shares and the Committee may, by the terms of the Option, require any partial
exercise to be with respect to a specified minimum number of shares.
Section 5.3 - Manner of Exercise
An Option, or portion thereof, may be exercised solely by delivery to the
Chief Financial Officer or his office of all of the following prior to the time
when such Option or such portion becomes unexercisable under Section 4.3 or
Section 7.2:
(a) Notice in writing by the Participant or other person then entitled to
exercise such Option or portion, stating that such Option or portion is
exercised, such notice complying with all applicable rules established by the
Committee;
(b) (i) Full payment (in cash or by check) for the shares with respect
to which such Option or portion is thereby exercised;
(ii) With the consent of the Committee, shares of any Class of the
Company's Common Stock owned by the Participant either duly endorsed for
transfer to the Company or duly attested as to ownership with a Fair Market
Value (as determinable under Section 1.12) on the date of delivery equal to
the aggregate Option price of the shares with respect to which such Option
or portion is thereby exercised (which shares shall be owned by the
Participant for more than six months at the time they are delivered);
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(iii) With the consent of the Committee (and provided the use of the
following procedure by a Participant would not violate Rule 16(b) under the
Exchange Act), delivery to the Company of (x) irrevocable instructions to
deliver the stock certificates representing the shares for which the Option
is being exercised directly to a broker, and (y) instructions to the broker
to sell such shares and promptly deliver to the Company the portion of the
sole proceeds equal to the aggregate Option exercise price;
(iv) With the consent of the Committee, any other form of cashless
exercise permitted under Section 5.4 hereof; or
(v) Any combination of the consideration provided in the foregoing
subsections (i), (ii), (iii) and (iv).
(c) Such representations and documents as the Committee, in its absolute
discretion, deems necessary or advisable to effect compliance with all
applicable provisions of the Securities Act of 1933, as amended, and any other
federal or state securities laws or regulations. The Committee may, in its
absolute discretion, also take whatever additional actions it deems appropriate
to effect such compliance including, without limitation, placing legends on
share certificates and issuing stop-transfer orders to transfer agents and
registrars; and
(d) In the event that an Option or portion thereof shall be exercised
pursuant to Section 5.1 by any person or persons other than the Participant,
appropriate proof of the right of such person or persons to exercise the Option
or portion thereof.
Section 5.4 - Cashless Exercise Procedures
The Company, in its sole discretion, may establish procedures whereby a
Participant, subject to the requirements of Rule 16b-3 under the Exchange Act,
Regulation T issued by the Board of Governors of the Federal Reserve System
pursuant to the Exchange Act, federal income tax laws, and other federal, state
and local tax and securities laws, can exercise an Option or a portion thereof
without making a direct payment of the Option price to the Company. If the
Company so elects to establish a cashless exercise program, the Company shall
determine, in its sole discretion and from time to time, such administrative
procedures and policies as its deems appropriate and such procedures and
policies shall be binding on any participant wishing to utilize the cashless
exercise program.
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Section 5.5 - Conditions to Issuance of Stock Certificates
The shares of stock issuable and deliverable upon the exercise of an
Option, or any portion thereof, may be either previously authorized but unissued
shares or issued shares which have then been reacquired by the Company. The
Company shall not be required to issue or deliver any certificate or
certificates for shares of stock purchased upon the exercise of any Option or
portion thereof prior to fulfillment of all of the following conditions:
(a) The admission of such shares to listing on all stock exchanges on
which such class of stock is then listed;
(b) The completion of any registration or other qualification of such
shares under any state or federal law or under the rulings or regulations of the
Securities and Exchange Commission or any other governmental regulatory body,
which the Committee shall, in its absolute discretion, deem necessary and
advisable;
(c) The obtaining of any approval or other clearance from any state or
federal governmental agency which the Committee shall, in its absolute
discretion, determine to be necessary or advisable;
(d) The payment to the Company of all amounts which it is required to
withhold under federal, state or local law in connection with the exercise of
the Option; and
(e) The lapse of such reasonable period of time following the exercise of
the Option as the Committee may establish from time to time for reasons of
administrative convenience.
Section 5.6 - Rights as Stockholders
The holders of Options shall not be, nor have any of the rights or
privileges of, stockholders of the Company in respect of any shares receivable
upon the exercise of any part of an Option unless and until certificates
representing such shares have been issued by the Company to such holders.
Section 5.7 - Transfer Restrictions
The Committee, in its absolute discretion, may impose such restrictions on
the transferability of the shares receivable upon the exercise of an Option, as
it deems appropriate. Any such restriction shall be set forth in the respective
stock option agreement and may be referred to on the certificates evidencing
such shares.
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ARTICLE VI
ADMINISTRATION
Section 6.1 - Duties and Powers of Committee
(a) The Plan shall be administered by a committee of the Board consisting
of two or more members of the Board, selected by the Board, all of which members
may be both a "Non-Employee Director" as defined in Rule 16b-3(b)(3) (or any
successor provision) promulgated under the Exchange Act, and an "Outside
Director" as defined for purposes of Section 162(m) (or any successor provision)
of the Code and the Regulations promulgated thereunder. It shall be the duty of
the Committee to conduct the general administration of the Plan in accordance
with its provisions. The Committee shall have the power to interpret the Plan
and the Options and to adopt such rules for the administration, interpretation
and application of the Plan as are consistent therewith and to interpret, amend
or revoke any such rules.
(b) No Option granted hereunder shall be exercisable unless and until
evidenced by a written stock option agreement, which shall be executed by the
participant and an authorized Officer of the Company and which shall contain
such terms and conditions as the Committee shall determine, consistent with the
Plan. Each such agreement shall expressly incorporate by reference the
provisions of this Plan (a copy of which shall be made available for inspection
by the Participant during normal business hours at the principal office of the
Company) and shall state that in the event of any inconsistency between the
provisions hereof and the provisions of such agreement, the provisions of this
Plan shall govern.
Section 6.2 - Majority Rule
The Committee shall act by a majority of its members in office. The
Committee may act either by vote at a meeting or by a memorandum or other
written instruments signed by a majority of the Committee.
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Section 6.3 - Compensation; Professional Assistance; Good Faith Actions
Members of the Committee shall not receive compensation for their services
as members but all expenses and liabilities they incur in connection with the
administration of the Plan shall be borne by the Company. The Committee may,
with the approval of the Board, employ attorneys, consultants, accountants,
appraisers, brokers or other persons. The Committee, the Company and its
Officers and Directors shall be entitled to rely upon the advice, opinions or
valuations of any such persons. All actions taken and all interpretations and
determinations made by the Committee in good faith shall be final and binding
upon all Participants, the Company and all other interested persons. No member
of the Committee shall be personally liable for any action, determination or
interpretation made in good faith with respect to the Plan or the Options and
all members of the Committee shall be fully protected by the Company in respect
to any such action, determination or interpretation.
ARTICLE VII
MISCELLANEOUS PROVISIONS
Section 7.1 - Adjustments in Outstanding Options
In the event that the outstanding shares of the stock subject to Options
are changed into or exchanged for a different number or kind of shares of the
Company or other securities of the Company or (subject to Section 7.2 hereof) of
another corporation by reason of reorganization, merger, consolidation,
recapitalization, reclassification, stock split, stock dividend or combination
of shares, or in the event of extraordinary cash or non-cash dividends being
declared with respect to outstanding shares of Common Stock or similar
transactions, the Committee shall make an appropriate and equitable adjustment
in the number and kind of shares as to which all outstanding Options, or
portions thereof then unexercised, shall be exercisable, to the end that after
such event the Participant's proportionate interest shall be maintained as
before the occurrence of such event. Such adjustment in an outstanding Option or
the unexercised portion of an Option (except for any change in the aggregate
price resulting from rounding-off of share quantities or prices) and with any
necessary corresponding adjustment in the exercise price per share, provided,
however, that each such adjustment shall be made in such manner as not to
constitute: (i) a "material modification" to any Option intended to qualify for
treatment as an "existing binding contract" in each case within the meaning of
Section 162(m)(4)(D) of the Code; or (ii) a cancellation and reissuance of a
non-qualified stock option for purposes of 162(m) of the Code, or the
Regulations promulgated thereunder, to the extent that such reissuance would
result in the grant of such Options in excess of the maximum permitted to be
granted to any Participant in any fiscal year. Any such adjustment made by the
Committee shall be final and binding upon all Participants, the Company and all
other interested persons.
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Section 7.2 - Merger, Consolidation, Acquisition, Liquidation or Dissolution
a. Notwithstanding anything to the contrary in Section 4.2(a), Section
4.2(b) or any vesting provisions of any Option, any outstanding under the Plan
which has been held for at least six months shall become exercisable immediately
upon the effective date of a "Change of Control." As used in this Section 7.2,
the term "Change of Control" shall mean the occurrence of any of the following:
(i) a business combination effectuated through the merger or consolidation of
the Company with or into another entity where the Company is not the Surviving
Organization; (ii) any business combination effectuated through the merger or
consolidation of the Company with or into another entity where the Company is
the Surviving Organization and such business combination occurred with an entity
whose market capitalization prior to the transaction was greater than 50 percent
of the Company's market capitalization prior to the transaction; (iii) the sale
in a transaction or series of transactions of all or substantially all of the
Company's assets; (iv) any "person" or "group" (within the meaning of Sections
13(d) and 14(d) of the Exchange Act) other than UniHealth, a California
non-profit public benefit corporation ("UniHealth"), acquires beneficial
ownership (within the meaning of Rule 13d-3 of the Exchange Act), directly or
indirectly, of 20 percent or more of the voting common stock of the Company and
the beneficial ownership of the voting common stock of the Company owned by
UniHealth at that date is less than or equal to the beneficial ownership
interest of voting securities attributable to such other person or group; (v) a
dissolution or liquidation of the Company; or (vi) the Company ceases to be
subject to the reporting requirements of the Exchange Act as a result of a
"going private transaction" (within the meaning of the Exchange Act). For
purposes hereof, "Surviving Organization" shall mean any entity where the
majority of the members of such entity's board of directors are persons who were
members of the Company's board of directors prior to the merger, consolidation
or other business combination, and the senior management of the surviving entity
includes all of the individuals who were the Company's executive management (the
Company's chief executive officer and those individuals who report directly to
the Company's chief executive officer) prior to the merger, consolidation or
other business combination and such individuals are in at least comparable
positions with such entity.
b. The Committee may make such determinations and interpretations and
adopt such rules and conditions as it, in its absolute discretion, deems
appropriate in connection with a Change in Control and acceleration of
exercisability. All such determinations and interpretations by the Committee
shall be conclusive.
c. Each Participant shall receive at least 10 days' notice prior to the
effective date of the Change of Control that their Options will be exercisable
upon the effective date of the Change of Control, and the officers of the
Company shall make adequate provisions to permit all Participants to exercise
their Options as of the effective date of the Change of Control.
- 13 -
<PAGE>
Section 7.3 - Options Not Transferable
Except as otherwise provided by the Committee, no Option or interest or
right therein or part thereof shall be liable for the debts, contracts or
engagements of the Participant or his successors in interest or shall be subject
to disposition by transfer, alienation, anticipation, pledge, encumbrance,
assignment or any other means whether such disposition be voluntary or
involuntary or by operation of law by judgment, levy, attachment, garnishment or
any other legal or equitable proceedings (including bankruptcy) and any
attempted disposition thereof shall be null and void and of no effect; provided,
however, that nothing in this Section 7.3 shall prevent transfers by will or by
the applicable laws of descent and distribution or by other methods to any
approved person pursuant to Section 5.1.
Section 7.4 - Withholding Tax Liability
(a) A holder of an Option granted hereunder may elect to deliver shares to
the Company or have the Company withhold shares otherwise issuable upon the
exercise of an Option in order to satisfy federal and state withholding tax
liability (a "share withholding election"), provided: (i) the Board or, if so
designated, the Committee, shall not have revoked its advance approval of the
holder's share withholding election; and (ii) the share withholding election is
made on or prior to the date on which the amount of withholding tax liability is
determined (the "Tax Date").
(b) A share withholding election shall be deemed made when written notice
of such election, signed by the holder of the Option, has been delivered or
transmitted by registered or certified mail to the Secretary or Chief Financial
Officer of the Company at its then principal office. Delivery of said notice
shall constitute an irrevocable election to have shares withheld.
(c) Upon exercise of an Option by a holder, the Company shall transfer the
total number of shares of Class A Common Stock or Class B Common Stock of the
Company subject to the Option to the holder on the date of exercise, less any
shares the holder elects to withhold.
Section 7.5 - Amendment, Suspension or Termination of the Plan
The Plan may be wholly or partially amended or otherwise modified,
suspended or terminated at any time or from time to time by the Board, but no
amendment may be effective that is not subject to the approval of the
stockholders of the Company if stockholder approval would be required under
Section 162(m) of the Code, or any other law or rule of any governmental
authority, stock exchange or other self-regulatory organization to which the
Company is subject. Neither the amendment, suspension nor termination of the
Plan shall, without the consent of the holder of an Option, impair any rights or
obligations under any Option heretofore granted. No Option may be granted
during any period of suspension nor after termination of the Plan, and in
- 14 -
<PAGE>
no event may any Option be granted under this Plan after the expiration of ten
years from the date the Plan is approved by the Company's stockholders under
Section 7.6. The Committee may amend or otherwise modify any Option (either
individually or as a group) from time to time, but no amendment or modification
shall, without the consent of the holder of such Option, impair any rights or
obligations of such Option.
Section 7.6 - Approval of Plan by Stockholders
The Plan will be submitted for the approval of the Company's stockholders
within 12 months after the date of the Board's initial adoption of the Plan and
as determined necessary or desirable for actions taken pursuant to Section 7.5.
Options may be granted prior to such stockholder approval; provided, however,
that such Options shall not be exercisable prior to the time when the Plan is
approved by the stockholders; provided further, that if such approval has not
been obtained at the end of said 12 month period, all Options previously granted
under the Plan shall thereupon be cancelled and become null and void.
Section 7.7 - Effect of Plan Upon Other Incentive and Compensation Plans
The adoption of this Plan shall not affect any other compensation or
incentive plan in effect for the Company or any Subsidiary. Nothing in this
Plan shall be construed to limit the right of the Company or any Subsidiary:
(i) to establish any other forms of incentives or compensation for
Officers or Employees of the Company or any Subsidiary; or
(ii) to grant or assume Options otherwise than under this Plan in
connection with any proper corporate purpose, including, but not limited
to, the grant or assumption of options or stock appreciation rights in
connection with the acquisition by purchase, lease, merger, consolidation
or otherwise, of the business, stock or assets of any corporation, firm or
association.
Section 7.8 - Titles
Titles are provided herein for convenience only and are not to serve as a
basis for interpretation or construction of the Plan.
- 15 -
<PAGE>
FIRST AMENDMENT TO
CREDIT AGREEMENT
THIS FIRST AMENDMENT TO CREDIT AGREEMENT is made and dated as of August 15,
1997 (the "Amendment") among PACIFICARE HEALTH SYSTEMS, INC., formerly known as
N-T Holdings, Inc., a Delaware corporation (the "Company"), the Banks party to
the Credit Agreement referred to below, and BANK OF AMERICA NATIONAL TRUST AND
SAVINGS ASSOCIATION, a national banking association, as Agent (the "Agent"), and
amends that certain Credit Agreement dated as of October 31, 1996 (the "Credit
Agreement").
RECITALS
WHEREAS, the Company has requested the Agent and the Banks to amend certain
provisions of the Credit Agreement, and the Agent and the Banks are willing to
do so, on the terms and conditions specified herein;
NOW, THEREFORE, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereby agree as follows:
1. TERMS. All terms used herein shall have the same meanings as in the
Credit Agreement unless otherwise defined herein.
2. AMENDMENT. The Credit Agreement is hereby amended as follows:
2.1 AMENDMENTS TO SECTION 1.1. The definitions of the terms
"Applicable Margin" and "Senior Unsecured Debt Rating" in Section 1.1 of the
Credit Agreement are hereby amended and restated to read in their entirety as
follows:
"Applicable Margin" means, in the case of Facility Fees or LIBOR
Committed Loans, a rate per annum determined by reference to the Applicable
Level or Leverage Ratio as follows:
"Applicable Level" means one of the levels set forth below determined
by the Senior Unsecured Debt Rating as follows:
"LEVEL 1" means any period during which the Senior Unsecured Debt
Rating is better than or equal to at least two of the following three
ratings: (i) A- by S&P and/or (ii) A3 by Moody's and/or (iii) A- by
Fitch.
"LEVEL 2" means any period (other than a Level I Period) during
which the Senior Unsecured Debt Rating is better than or equal to at
least two of the following three ratings: (i) BBB+ by S&P and/or (ii)
Baal by Moody's and/or (iii) BBB+ by Fitch.
"LEVEL 3" means any period (other than a Level 1 Period or Level
2 Period) during which the Senior Unsecured Debt Rating is better than
or equal
1
<PAGE>
to at least two of the following three ratings: (i) BBB by S&P and/or
(ii) Baa2 by Moody's and/or (iii) BBB by Fitch.
"LEVEL 4" means any period (other than a Level 1 Period, Level 2
Period or Level 3 Period) during which the Senior Unsecured Debt
Rating is better than or equal to at least two of the following three
ratings: (i) BBB- by S&P and/or (ii) Baa3 by Moody's and/or (iii) BBB-
by Fitch.
"LEVEL 5" means any period (other than a Level 1 Period, Level 2
Period, Level 3 Period or Level 4 Period) during which the Senior
Unsecured Debt Rating is better than or equal to at least two of the
following three ratings: (i) BB+ by S&P and/or (ii) Bal by Moody's
and/or (iii) BB+ by Fitch.
"LEVEL 6" means any period other than a Level I Period, Level 2
Period, Level 3 Period, Level 4 Period or Level 5 Period.
For purposes of the foregoing, (a) if the Senior Unsecured Debt
Ratings fall within different Levels, the Applicable Level shall be based
upon the Level in which the largest number of Senior Unsecured Debt Ratings
fall; PROVIDED that if there shall be no such Level, the highest and the
lowest Level shall be excluded and the Applicable Level shall be the
remaining Level; (b) if only two Senior Debt Ratings exist and they shall
fall within different Levels, the Applicable Level shall be based upon the
higher (numerically lower) of the available Levels unless such Levels are
more than one Level apart, in which case the Applicable Level shall be one
Level higher than the lower Level; (c) if only one Senior Unsecured Debt
Rating exists, the Applicable Level shall be based upon the Level in which
such rating falls and (d) if no Senior Unsecured Debt Rating shall be
available from at least one of S&P, Moody's or Fitch, the Applicable Margin
will be set by reference to the Leverage Ratio so long as the Agent shall
have received the financial statements and Compliance Certificate to be
delivered by the Company pursuant to Section 6.1 and if the Agent shall
have not received such financial statements and Compliance Certificate, in
accordance with Level 6.
"Company" shall mean PacifiCare Health Systems, Inc., formerly known
as N-T Holdings, Inc.
"Fitch" means Fitch Investors Service, Inc.
2.3 AMENDMENT TO SECTION 6.1. Clause (k) of Section 6. 1 of the Credit
Agreement is hereby amended and restated to read in its entirety as follows:
"(k) promptly (but in no case more than five Business Days) after the
Company or either Guarantor receives unsecured long-term debt ratings by
S&P, Moody's or Fitch, a notice of such ratings, and thereafter, promptly
(but in no case more than five Business Days) after any change in such
ratings, a notice of such change;"
2
<PAGE>
3. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to
the Agent and the Banks that, on and as of the date hereof, and after giving
effect to this Amendment:
3.1 AUTHORIZATION. The execution, delivery and performance by the
Company of this Amendment has been duly authorized by all necessary corporate
action, and this Amendment has been duly executed and delivered by the Company.
3.2 BINDING OBLIGATION. This Amendment constitutes the legal, valid
and binding obligations of the Company, enforceable against it in accordance
with its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, or similar laws affecting the enforcement of creditors'
rights generally or by equitable principles relating to enforceability.
3.3 NO LEGAL OBSTACLE TO AMENDMENT. The execution, delivery and
performance by the Company of this Amendment has been duly authorized by all
necessary corporate action, and does not and will not:
(a) contravene the terms of any of the Company's Organization
Documents;
(b) conflict with in any material respect or result in any material
breach or contravention of, or the creation of any Lien under, any document
evidencing any material Contractual Obligation to which the Company is a party
or any order, injunction, writ or decree of any Governmental Authority to which
the Company or its property is subject; or
(c) violate any material Requirement of Law.
3.4 GOVERNMENTAL AUTHORIZATION, No approval, consent, exemption,
authorization, or other action by, or notice to, or filing with, any
Governmental Authority is necessary or required in connection with the
execution, delivery or performance by, or enforcement against the Company of
this Amendment other than that which has been obtained.
3.5 INCORPORATION OF CERTAIN REPRESENTATIONS. The representations
and warranties of the Company set forth in Article V of the Credit Agreement are
true and correct in all respects on and as of the date hereof as though made on
and as of the date hereof, except as to such representations made as of an
earlier specified date.
3.6 DEFAULT. No Default or Event of Default under the Credit
Agreement has occurred and is continuing.
4. MISCELLANEOUS.
4.1 EFFECTIVENESS OF THE CREDIT AGREEMENT AND THE NOTES. Except as
hereby expressly amended, the Credit Agreement and the Notes shall each remain
in full force and effect, and are hereby ratified and confirmed in all respects
on and as of the date hereof.
3
<PAGE>
4.2 WAIVERS. This Amendment is limited solely to the matters
expressly set forth herein and is specific in time and in intent and does not
constitute, nor should it be construed as, a waiver or amendment of any other
term or condition, right, power or privilege under the Credit Agreement or under
any agreement, contract, indenture, document or instrument mentioned therein;
nor does it preclude or prejudice any rights of the Agent or the Banks
thereunder, or any exercise thereof or the exercise of any other right, power or
privilege, nor shall it require the Banks to agree to an amendment, waiver or
consent for a similar transaction or on a future occasion, nor shall any future
waiver of any right, power, privilege or default hereunder, or under any
agreement, contract, indenture, document or instrument mentioned in the Credit
Agreement, constitute a waiver of any other right, power, privilege or default
of the same or, of any other term or provision.
4.3 COUNTERPARTS. This Amendment may be executed in any number of
counterparts, and all of such counterparts taken together shall be deemed to
constitute one and the same instrument. This Amendment shall not become
effective until the Company, the Agent and the Banks shall have signed a copy
hereof and the Agent shall have received acknowledgments and reaffirmations
substantially in the form of EXHIBIT A hereto, duly executed by each of the
Guarantors.
4.4 GOVERNING LAW. This Amendment shall be governed by and construed
in accordance with the laws of the State of California.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed and delivered as of the date first written above.
PACIFICARE HEALTH SYSTEMS, INC.,
formerly known as N-T Holdings, Inc.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, as Agent
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
4
<PAGE>
BANK OF AMERICA NATIONAL TRUST AND
SAVINGS ASSOCIATION, as a Bank
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE CHASE MANHATTAN BANK
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CITICORP USA, INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE BANK OF NEW YORK
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE BANK OF NOVA SCOTIA
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
5
<PAGE>
BANQUE NATIONALE DE PARIS
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE DAI-ICHI KANGYO BANK, LTD., LOS
ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE INDUSTRIAL BANK OF JAPAN, LIMITED,
LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
COOPERATIEVE CENTRALE RAIFFEISEN-
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND" NEW YORK BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
6
<PAGE>
SANWA BANK CALIFORNIA
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE SUMITOMO BANK, LIMITED, LOS ANGELES
BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
WELLS FARGO BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
BANCA COMMERCIALE ITALIANA
LOS ANGELES FOREIGN BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
BANQUE PARIBAS
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
7
<PAGE>
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CIBC INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
COMMERZBANK AKTIENGESELLSCHAFT,
LOS ANGELES BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CREDIT LYONNAIS NEW YORK BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
8
<PAGE>
CREDIT SUISSE FIRST BOSTON
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE FIRST NATIONAL BANK OF CHICAGO
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE FUJI BANK, LIMITED
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE LONG-TERM CREDIT BANK OF JAPAN,
LTD., LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
9
<PAGE>
MELLON BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE MITSUBISHI TRUST AND BANKING
CORPORATION, LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
PNC BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE SAKURA BANK, LTD., LOS ANGELES
AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
SOCIETE GENERALE
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
10
<PAGE>
THE TOKAI BANK, LIMITED,
LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
UNION BANK OF CALIFORNIA, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
11
<PAGE>
SECOND AMENDMENT TO
CREDIT AGREEMENT
THIS SECOND AMENDMENT TO CREDIT AGREEMENT is made and dated as of December
31, 1997 (the "Amendment") among PACIFICARE HEALTH SYSTEMS, INC., formerly known
as N-T Holdings, Inc., a Delaware corporation (the "Company"), the Banks party
to the Credit Agreement referred to below, and BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, a national banking association, as Agent (the "Agent"),
and amends that certain Credit Agreement dated as of October 31, 1996, as
amended by that certain First Amendment to Credit Agreement dated as of August
15, 1997 (as so amended, the "Credit Agreement").
RECITALS
WHEREAS, the Company has requested the Agent and the Banks to amend certain
provisions of the Credit Agreement, and the Agent and the Banks are willing to
do so, on the terms and conditions specified herein;
NOW, THEREFORE, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereby agree as follows:
1. TERMS. All terms used herein shall have the same meanings as in the
Credit Agreement unless otherwise defined herein.
2. AMENDMENT. The Credit Agreement is hereby amended as follows:
2.1 AMENDMENTS TO SECTION 1.1. The definitions of the terms
"Applicable Level" and "Applicable Margin" in Section 1.1 of the Credit
Agreement are hereby amended and restated to read in their entirety as follows:
"Applicable Level" means one of the levels set forth below determined
by the Senior Unsecured Debt Rating as follows:
"LEVEL 1" means any period during which the Senior Unsecured Debt
Rating is better than or equal to at least two of the following three
ratings: (i) A- by S&P and/or (ii) A3 by Moody's and/or (iii) A- by
Fitch.
"LEVEL 2" means any period (other than a Level 1 Period) during
which the Senior Unsecured Debt Rating is better than or equal to at
least two of the following three ratings: (i) BBB+ by S&P and/or (ii)
Baal by Moody's and/or (iii) BBB+ by Fitch.
"LEVEL 3" means any period (other than a Level 1 Period or Level
2 Period) during which the Senior Unsecured Debt Rating is better
than or equal to at least two of the following three ratings: (i) BBB
by S&P and/or (ii) Baa2 by Moody's and/or (iii) BBB by Fitch.
1
<PAGE>
"LEVEL 4" means any period (other than a Level 1 Period, Level 2
Period or Level 3 Period) during which the Senior Unsecured Debt
Rating is better than or equal to at least two of the following three
ratings: (i) BBB- by S&P and/or (ii) Baa3 by Moody's and/or (iii)
BBB- by Fitch.
"LEVEL 5" means any period (other than a Level 1 Period, Level 2
Period, Level 3 Period or Level 4 Period) during which the Senior
Unsecured Debt Rating is better than or equal to at least two of the
following three ratings: (i) BB+ by S&P and/or (ii) Bal by Moody's
and/or (iii) BB+ by Fitch.
LEVEL 6" means any period (other than a Level 1 Period, Level 2
Period, Level 3 Period, Level 4 Period or Level 5 Period) during which
the Senior Unsecured Debt Rating is better than or equal to at least
two of the following three ratings: (i) BB by S&P and/or (ii) Ba2 by
Moody's and/or (iii) BB by Fitch.
"LEVEL 7" means any period (other than a Level 1 Period, Level 2
Period, Level 3 Period, Level 4 Period, Level 5 Period or Level 6
Period) during which the Senior Unsecured Debt Rating is better or
equal to at least two of the following three ratings: (i) BB- by S&P
and/or (ii) Ba3 by Moody's and/or (iii) BB- by Fitch.
"LEVEL 8" means any period other than a Level 1 Period, Level 2
Period, Level 3 Period, Level 4 Period, Level 5 Period, Level 6
Period or Level 7 Period.
For purposes of the foregoing, (a) if the Senior Unsecured Debt
Ratings fall within different Levels, the Applicable Level shall be based
upon the Level in which the largest number of Senior Unsecured Debt Ratings
fall; PROVIDED, that if there shall be no such Level, the highest and the
lowest Level shall be excluded and the Applicable Level shall be the
remaining Level; (b) if only two Senior Debt Ratings exist and they shall
fall within different Levels, the Applicable Level shall be based upon the
higher (numerically lower) of the available Levels unless such Levels are
more than one Level apart, in which case the Applicable Level shall be one
Level higher than the lower Level; (c) if only one Senior Unsecured Debt
Rating exists, the Applicable Level shall be based upon the Level in which
such rating falls and (d) if no Senior Unsecured Debt Rating shall be
available from at least one of S&P, Moody's or Fitch, the Applicable Level
shall be Level 8.
"Applicable Margin" means, in the case of Facility Fees, Base Rate
Committed Loans or LIBOR Committed Loans, a rate per annum determined by
reference to the Applicable Level as follows:
<TABLE>
<CAPTION>
Applicable Base Applicable LIBOR
Applicable Level Rate Margin Rate Margin Facility Fee
---------------- ----------- ----------- ------------
<S> <C> <C> <C>
Level 1 0.0% 0.200% 0.100%
Level 2 0.0% 0.225% 0.125%
Level 3 0.0% 0.250% 0.150%
Level 4 0.0% 0.325% 0.175%
Level 5 0.0% 0.550% 0.200%
2
<PAGE>
Level 6 0.0% 0.775% 0.225%
Level 7 0.250% 1.250% 0.250%
Level 8 0.700% 1.700% 0.300%
</TABLE>
Changes in the Applicable Margin shall take effect (i) in the case of
the Applicable LIBOR Rate Margin for LIBOR Loans, at the beginning of the
following Interest Period and (ii) otherwise, as of the date of public
announcement by S&P. Moody's or Fitch, as applicable.
2.2 AMENDMENTS TO SECTION 2.9. Section 2.9 of the Credit Agreement
is hereby amended by inserting "(a)" immediately after "MANDATORY
COMMITMENT REDUCTIONS" and by adding a new subsection (b) thereto reading
in its entirety as follows:
(b) The aggregate Commitments shall automatically and permanently be
reduced by an amount equal to the first $350,000,000 of the net cash
proceeds received by the Company from the incurrence of any Indebtedness
permitted by Section 7.3(d). Such payments shall be applied to the
mandatory Commitment reductions set forth in clause (a) above in direct
order of application.
2.3 AMENDMENTS TO SECTION 2.11.
(a) Clause (a) of Section 2.11 of the Credit Agreement is hereby
amended by deleting the phrase "(in the case of LIBOR Loans)" from the
fifth and sixth lines thereof.
(b) Clause (c) of Section 2.11 of the Credit Agreement is hereby
amended by inserting "plus the Applicable Base Rate Margin" after the words
"Base Rate" in the ninth line thereof.
2.4 AMENDMENTS TO SECTION 7.7.
(a) Clause (d) of Section 7.7 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(d) from and after December 1, 1997, the Company may repurchase
up to $500,000,000 of its Class A capital stock, its Class B capital
stock or its preferred stock, PROVIDED, that, immediately after giving
effect to such proposed action, there exists no Default or Event of
Default;
(b) Clause (e) of Section 7.7 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(e) Intentionally omitted;"
3
<PAGE>
2.5 AMENDMENT TO SECTION 7.3.
(a) Clause (b) of Section 7.3 of the Credit Agreement is hereby
amended by deleting "on the Closing Date" and substituting therefore "on
December 1, 1997."
(b) Clause (d) of Section 7.3 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(d) Other unsecured Indebtedness incurred by the Company after
December 1, 1997 in an aggregate amount not to exceed $500,000,000;
PROVIDED in no event may such Indebtedness have terms more restrictive than
those set forth in this Agreement nor may the principal payment dates under
such Indebtedness commence prior to March 31, 2002;"
(c) Clause (h) of Section 7.3 of the Credit Agreement is hereby
amended and restated in its entirety to read as follows:
"(h) Additional Indebtedness of the Company and its Subsidiaries up to
but not exceeding an aggregate amount of $100,000,000 at any time
outstanding, with not more than $50,000,000 of such amount being
attributable to Indebtedness of the Company's Subsidiaries to Persons other
than the Company or any other Subsidiary of the Company."
2.6 AMENDMENT TO SECTION 7.7. Clause (a) of Section 7.7 of the Credit
Agreement is hereby amended and restated in its entirety to read as follows:
"(a) the Company may declare and (i) make dividend payments or other -
distributions payable solely in its common stock, and (ii) so long as both
before and after giving effect thereto no Default or Event of Default would
exist and so long as the aggregate amount of such dividend payments in any
Fiscal Year does not exceed $12,000,000, pay current dividends on its
Series A Cumulative Convertible Preferred Stock outstanding as of the
Effective Date;
2.7 AMENDMENT TO SECTION 7.10. Section 7.10 of the Credit Agreement
is hereby amended and restated in its entirety to read as follows:
7.10 FINANCIAL COVENANTS. The Company shall not permit:
(a) its Leverage Ratio, as of the end of any fiscal quarter, to
exceed (i) 3.0 to 1.00 at any time from completion of the FHP
Acquisition through December 31, 1997, (ii) 3.75 to 1.00 from January
1, 1998 through March 31, 1998, (iii) 3.5 to 1.00 from April 1, 1998
through June 30, 1998, (iv) 3.25 to 1.00 from July 1, 1998 through
September 30, 1998, and (v) 3.00 to 1.00 at any time thereafter;
(b) its Fixed Charges Coverage Ratio, as of the end of any
fiscal quarter, to be less than (i) 2.00 to 1.00 at any time from
completion of the FHP Acquisition through December 31, 1997, (ii) 2.5
to 1.00 from January 1, 1998
4
<PAGE>
through December 31, 1998, (iii) 2.75 to 1.00 from January 1, 1999
through December 31, 1999 and (iv) 3.0 to 1.00 at any time thereafter;
or
(c) its Net Worth, as of the end of any fiscal quarter, to be
less than (i) 90% of its Net Worth immediately following completion of
the FHP Acquisition, PLUS (ii) 50% of the consolidated net income
(without giving effect to any consolidated net losses and after the
payment of any dividends on any preferred stock) of the Company and
its Subsidiaries for each fiscal quarter beginning after completion of
the FHP Acquisition, PLUS (iii) 50% of the Net Equity Proceeds from
any equity offering by the Company or any conversion of Series A
Cumulative Convertible Preferred Shares after the date hereof, MINUS
the aggregate purchase price for all of the Company's Class A capital
stock, Class B capital stock and preferred stock repurchased after
December 1, 1997.
The Fixed Charges Coverage Ratio and the Adjusted EBITDA component of
the Leverage Ratio shall be calculated on a Combined Basis for the
quarters ending before the FHP Acquisition and on a consolidated basis
after the FHP Acquisition.
2.8 AMENDMENT TO SCHEDULE 7.3. Schedule 7.3 of the Credit Agreement
is hereby amended and restated to read in its entirety as set forth on Schedule
7.3 attached hereto.
3. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants to
the Agent and the Banks that, on and as of the date hereof, and after giving
effect to this Amendment:
3.1 AUTHORIZATION. The execution, delivery and performance by the
Company of this Amendment has been duly authorized by all necessary corporate
action, and this Amendment has been duly executed and delivered by the Company.
3.2 BINDING OBLIGATION. This Amendment constitutes the legal, valid
and binding obligations of the Company, enforceable against it in accordance
with its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, or similar laws affecting the enforcement of creditors'
rights generally or by equitable principles relating to enforceability.
3.3 NO LEGAL OBSTACLE TO AMENDMENT. The execution, delivery and
performance by the Company of this Amendment has been duly authorized by all
necessary corporate action, and does not and will not:
(a) contravene the terms of any of the Company's Organization
Documents;
(b) conflict with in any material respect or result in any material
breach or contravention of, or the creation of any Lien under, any document
evidencing any material Contractual Obligation to which the Company is a
party or any order, injunction, writ or decree of any Governmental
Authority to which the Company or its property is subject; or
(c) violate any material Requirement of Law.
5
<PAGE>
3.4 GOVERNMENTAL AUTHORIZATION. No approval, consent, exemption,
authorization, or other action by, or notice to, or filing with, any
Governmental Authority is necessary or required in connection with the
execution, delivery or performance by, or enforcement against the Company of
this Amendment other than that which has been obtained.
3.5 INCORPORATION OF CERTAIN REPRESENTATIONS. The representations and
warranties of the Company set forth in Article V of the Credit Agreement are
true and correct in all respects on and as of the date hereof as though made on
and as of the date hereof, except as to such representations made as of an
earlier specified date.
3.6 DEFAULT. No Default or Event of Default under the Credit
Agreement has occurred and is continuing.
4. CONDITIONS, EFFECTIVENESS. The effectiveness of this Amendment shall
be subject to the compliance by the Company with its agreements herein
contained, and to the delivery of the following to Agent in form and substance
satisfactory to Agent:
4.1 AUTHORIZED SIGNATORIES. A certificate, signed by the Secretary
or an Assistant Secretary of the Company and dated the date of this Amendment,
as to the incumbency of the person or persons authorized to execute and deliver
this Amendment and any instrument or agreement required hereunder on behalf of
the Company.
4.2 AUTHORIZING RESOLUTIONS. A certificate, signed by the Secretary
or an Assistant Secretary of the Company and dated the date of the Amendment, as
to the resolutions of the Company's board of directors authorizing the
transactions contemplated by this Amendment.
4.3 AMENDMENT FEE. Payment to the Agent, for the PRO RATA benefit of
each Bank approving this Amendment, of an amendment fee in an amount equal to
.10 % of the aggregate amount of the Commitments held by the Banks approving
this Amendment.
4.4 GUARANTOR AFFIRMATIONS. Acknowledgment and reaffirmation letters
in the form of EXHIBIT A hereto, duly executed by each of the Guarantors.
4.5 OTHER EVIDENCE. Such other evidence with respect to the Company
or any other person as the Agent or any Bank may reasonably request to establish
the consummation of the transactions contemplated hereby, the taking of all
corporate action in connection with this Amendment and the Agreement and the
compliance with the conditions set forth herein.
5. MISCELLANEOUS.
5.1 EFFECTIVENESS OF THE CREDIT AGREEMENT AND THE Notes. Except as
hereby expressly amended, the Credit Agreement and the Notes shall each remain
in full force and effect, and are hereby ratified and confirmed in all respects
on and as of the date hereof.
5.2 WAIVERS. This Amendment is limited solely to the matters
expressly set forth herein and is specific in time and in intent and does not
constitute, nor should it be
6
<PAGE>
construed as, a waiver or amendment of any other term or condition, right, power
or privilege under the Credit Agreement or under any agreement, contract,
indenture, document or instrument mentioned therein; nor does it preclude or
prejudice any rights of the Agent or the Banks thereunder, or any exercise
thereof or the exercise of any other right, power or privilege, nor shall it
require the Banks to agree to an amendment, waiver or consent for a similar
transaction or on a future occasion, nor shall any future waiver of any right,
power, privilege or default hereunder, or under any agreement, contract,
indenture, document or instrument mentioned in the Credit Agreement, constitute
a waiver of any other right, power, privilege or default of the same or of any
other term or provision.
5.3 COUNTERPARTS. This Amendment may be executed in any number of
counterparts, and all of such counterparts taken together shall be deemed to
constitute one and the same instrument.
5.4 GOVERNING LAW. This Amendment shall be governed by and construed
in accordance with the laws of the State of California.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed and delivered as of the date first written above.
PACIFICARE HEALTH SYSTEMS, INC.,
formerly known as N-T Holdings, Inc.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION, as Agent
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
7
<PAGE>
BANK OF AMERICA NATIONAL TRUST AND
SAVINGS ASSOCIATION, as a Bank
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE CHASE MANHATTAN BANK
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CITICORP USA, INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE BANK OF NEW YORK
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE BANK OF NOVA SCOTIA
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
8
<PAGE>
BANQUE NATIONALE DE PARIS
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE DAI-ICHI KANGYO BANK, LTD.,
LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE INDUSTRIAL BANK OF JAPAN,
LIMITED, LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
COOPERATIEVE CENTRALE RAIFFEISEN-
BOERENLEENBANK B.A., "RABOBANK
NEDERLAND" NEW YORK BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
9
<PAGE>
SANWA BANK CALIFORNIA
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE SUMITOMO BANK, LIMITED, LOS
ANGELES BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
WELLS FARGO BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
BANCA COMMERCIALE ITALIANA
LOS ANGELES FOREIGN BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
10
<PAGE>
BANQUE PARIBAS
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CIBC INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
COMMERZBANK AKTIENGESELLSCHAFT, LOS
ANGELES BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
CREDIT LYONNAIS NEW YORK BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
11
<PAGE>
CREDIT SUISSE FIRST BOSTON
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE FIRST NATIONAL BANK OF CHICAGO
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE FUJI BANK, LIMITED
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
MELLON BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE MITSUBISHI TRUST AND BANKING
CORPORATION, LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
12
<PAGE>
PNC BANK, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE SAKURA BANK, LTD., LOS ANGELES
AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
SOCIETE GENERALE
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
THE TOKAI BANK, LIMITED,
LOS ANGELES AGENCY
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
UNION BANK OF CALIFORNIA, N.A.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
13
<PAGE>
THE SANWA BANK, LIMITED,
LOS ANGELES BRANCH
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
14
<PAGE>
PACIFICARE HEALTH SYSTEMS, INC.
STATUTORY RESTORATION PLAN
WHEREAS, PacifiCare Health Systems, Inc., (the "Company") desires to
establish a statutory restoration plan to provide supplemental retirement income
benefits for a select group of management and highly compensated employees
through deferrals of salary and bonuses, effective as of January 1, 1998;
WHEREAS, it is believed that the adoption of this plan providing for
deferral of compensation at the election of each eligible executive will be in
the best interests of the Company;
WHEREAS, it is the intent of the Company that the Plan shall supersede any
other statutory restoration plan, policy or arrangement which the Company or any
of its subsidiaries may have sponsored or made available in the past; and
WHEREAS, the Company intends that this plan shall be maintained as a "top
hat" plan described in Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA;
NOW, THEREFORE, it is hereby declared as follows:
ARTICLE I
DEFINITIONS
Whenever the following words and phrases are used in this Plan, they shall
have the meanings specified below.
Section 1.1 "Accounts" shall mean the accounts maintained by the Committee
for each Participant which includes the Deferral Account, the Matching Account
and the Two Percent Account.
Section 1.2 "Board of Directors" or "Board" means the Board of Directors of
the Company.
Section 1.3 "Bonus" means any cash incentive compensation or sales commission
payable to a Participant in addition to the Participant's Salary, other than the
LTPIP Bonus, moving expenses, sign-on bonuses or bonuses paid in connection with
a promotion, prior to any reduction for deferrals to a plan qualified under
Section 125 or Section 401(k) of the Code.
Section 1.4 "Change of Control" shall have the meaning set forth in Section
7.3.
Section 1.5 "Code" means the Internal Revenue Code of 1986, as amended from
time to time.
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<PAGE>
Section 1.6 "Committee" means the Committee appointed by the Compensation
Committee to administer the Plan in accordance with Article VI.
Section 1.7 "Company" means PacifiCare Health Systems, Inc., a Delaware
corporation, or any successor corporation.
Section 1.8 "Compensation" means for any Participant for any Plan Year his or
her Statutory Compensation for such Plan Year, excluding all reimbursements or
other expense allowances, fringe benefits (cash and noncash), moving expense,
deferred compensation and welfare benefits (including severance benefits).
Section 1.9 "Compensation Committee" shall mean the Compensation Committee of
the Board of Directors of the Company.
Section 1.10 "Deferral Account" shall mean the account maintained by the
Committee for each Participant that is credited with the amounts deferred under
Section 2.2 of this Plan together with any Earnings on such deferred amounts.
Section 1.11 "Disability." A Participant shall be deemed to be incapacitated
or disabled, if such Participant's incapacity or disability prevents a
Participant from fully performing his duties to an Employer for a period in
excess of 90 days and, after such 90-day period, the Company and a physician,
duly licensed and qualified in the specialty of the Participant's incapacity or
disability, decide in their reasonable judgments, that such incapacity or
disability will be permanent or of such continued duration as to prevent a
Participant from resuming the rendition of services to the Employer for at least
an additional six-month period.
Section 1.12 "Earnings" shall mean the amount credited to a Participant's
Account as result of the investment elections made by a Participant pursuant to
Section 3.1.
Section 1.13 "Eligible Employee" means any Employee of an Employer who the
Company has designated to be at an executive salary grade of 15 or above and who
is scheduled to work at least 32 hours per week. Notwithstanding the previous
sentence, any Employee who participated in the Company's predecessor to this
Plan during 1997 shall be an Eligible Employee for Plan Year 1998 and shall
continue to be eligible to participate in this Plan in future Plan Years.
Section 1.14 "Employee" shall mean any employee (as defined in accordance with
the Treasury Regulations and Revenue Rulings then applicable under Section
3401(c) of the Code) of an Employer, whether such employee is so employed at the
time this Plan is adopted or becomes so employed subsequent to the adoption of
this Plan.
Section 1.15 "Employer" means the Company (or any successor by merger,
consolidation or purchase of substantially all of the Company's assets) and any
and all Subsidiaries of the Company.
2
<PAGE>
Section 1.16 "ERISA" shall mean the Employee Retirement Income Security Act of
1974, as amended.
Section 1.17 "Fund" or "Funds" means one or more of the funds selected by the
Committee pursuant to Section 3.1(b).
Section 1.18 "Interest Rate" shall mean, for each Fund, an amount equal to the
net gain or loss on the assets of such Fund during each month.
Section 1.19 "LTPIP" means the Company's Long-Term Performance Incentive Plan,
as it may be amended from time to time.
Section 1.20 "LTPIP Bonus" means incentive compensation payable to a
Participant under the LTPIP.
Section 1.21 "Matching Account" shall mean the account maintained by the
Committee for each Participant that is to be credited with contributions
pursuant to Section 2.4 of this Plan together with the Earnings credited to such
amounts as provided herein.
Section 1.22 "Participant" means, for purposes of this Plan, any Eligible
Employee who satisfies the requirements of Section 2.1.
Section 1.23 "Plan" means this Statutory Restoration Plan of PacifiCare Health
Systems, Inc., as may be amended from time to time.
Section 1.24 "Plan Year" means the 12 consecutive month period beginning on
January 1 and ending on December 31 of the same year.
Section 1.25 "Qualified Plan" shall mean the Amended and Restated PacifiCare
Health Systems, Inc. Savings and Profit-Sharing Plan.
Section 1.26 "Retirement" or "Retire" shall mean the retirement of a
Participant under the normal or disability provisions of the Qualified Plan.
Section 1.27 "Statutory Compensation" means for any Participant for any Plan
Year his or her total taxable remuneration received from an Employer in that
Plan Year for service rendered as an Employee (including those items not
reported on Form W-2 as determined under Treas. Reg. Section
1.415-2(d)(2)(iii)-(vi)) and including any elective deferrals as defined in Code
Section 402(g)(3) and any amounts not includable in gross income by reason of
the Code Section 125 (cafeteria plan) or Code Section 457 (deferred compensation
plan of state and local governments and tax-exempt organizations) and excluding
3
<PAGE>
(a) Employer contributions to a deferred compensation plan (to the
extent includable in the Participant's gross income solely by reason of
Code Section 415) or to a simplified employee pension plan (to the extent
deductible by the Participant) and any distribution from a deferred
compensation plan (other than an unfunded, non-qualified plan);
(b) amounts realized from the exercise of a non-qualified stock
option or taxable by reason of restricted property becoming freely tradable
or free of a substantial risk of forfeiture as described in Code Section
83;
(c) amounts realized from the sale, exchange, or other disposition of
stock acquired under a qualified stock option; and
(d) other amounts which receive special tax benefits such as Employer
contributions toward the purchase of an annuity contract described in Code
Section 403(b) (whether or not excludable form the Participant's gross
income).
Section 1.28 "Statutory Limits" shall mean the limitations on contributions
imposed by Sections 415, 401(a)(17) and 402(g) of the Code.
Section 1.29 "Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with the Company if each of the corporations other than
the last corporation in the unbroken chain then owns stock possessing 50 percent
or more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.
Section 1.30 "Two Percent Contribution Account" shall mean the account
maintained by the Committee for each Participant which is to be credited with
contributions made pursuant to Section 2.3 of this Plan together with the
Earnings credited thereon as provided herein.
ARTICLE II
CONTRIBUTIONS TO PLAN
SECTION 2.1 ELECTION TO PARTICIPATE.
a. Except as provided in Section 2.5, to be eligible to participate in
this Plan, an Eligible Employee must be participating in the Qualified Plan and
be contributing to the Qualified Plan the maximum elective deferral allowed
under the Qualified Plan.
b. An Eligible Employee shall become a Participant in this Plan through
either (1) an election to defer a portion of his or her Salary in accordance
with
4
<PAGE>
subsection 2.1 (c) or (2) a contribution by the Company to an Employee's Two
Percent Account.
c. The Compensation Committee shall determine the Eligible Employees who
may participate in this Plan for the next Plan Year at least 60 days prior to
the beginning of the next Plan Year and the Committee shall notify each Employee
of his prospective eligibility to participate in this Plan at least 30 days
prior to the time he must file an application for participation. To be eligible
to defer Salary and/or Bonus paid during any Plan Year, an Eligible Employee
must file a written application with the Committee no later than December 15 of
the preceding Plan Year. Notwithstanding the foregoing, the Committee may, in
its sole and absolute discretion, permit an Eligible Employee to file an
application on or after December 15 if, in its judgment, his or her failure to
do so prior to said date was due to reasonable cause, but in no event may such
application be filed after December 31. The application for participation shall
signify the Eligible Employee's acceptance of the terms of this Plan and the
portion of Salary and/or Bonus that he elects to defer in accordance with
Section 2.2 of this Plan. Elections by Eligible Employees to defer Salary
and/or Bonus for a Plan Year shall be irrevocable.
SECTION 2.2 AMOUNT OF DEFERRAL.
A Participant may elect to defer all or a portion of the amount of his
Salary and/or Bonus that he could defer under the terms of the Qualified Plan,
except for the application of the Statutory Limits. If a Participant so elects,
any such excess deferral will be credited to that Participant's Deferral Account
under this Plan. Upon an election to defer Salary and/or Bonus, each
Participant's Salary and/or Bonus will be reduced by the amount deferred.
SECTION 2.3 AMOUNT OF TWO PERCENT CONTRIBUTION.
Any excess two percent contribution that would have been contributed on
behalf of a Participant under the terms of the Qualified Plan, except for the
application of the Statutory Limits, will be credited to that Participant's Two
Percent Account under this Plan.
SECTION 2.4 AMOUNT OF MATCHING CONTRIBUTION.
Any excess Company matching contribution that would have been contributed
on behalf of a Participant under the terms of the Qualified Plan, except for the
application of the Statutory Limits, will be credited to that Participant's
Matching Account under this Plan. Such matching contributions shall be
determined assuming that such Participant's Salary and/or Bonus deferrals under
this Plan would have been made under the Qualified Plan.
5
<PAGE>
SECTION 2.5 CONTRIBUTIONS PRIOR TO QUALIFIED PLAN ELIGIBILITY.
Prior to being eligible to participate in the Qualified Plan, an Eligible
Employee who has been granted expressed authorization by the Compensation
Committee to participate in this Plan may participate in this Plan subject to
the following provisions:
a. Amount of Deferral. A Participant may elect to defer all or a portion
of the amount of his or her Salary and/or Bonus that he could defer under the
terms of the Qualified Plan, except for the application of the eligibility
requirements of the Qualified Plan and the Statutory Limits. If a Participant
who satisfies this Section 2.5 so elects, any such deferral will be credited to
the Participant's Deferral Account under this Plan. Such Participant shall
agree to contribute the maximum elective deferral under the Qualified Plan upon
becoming eligible to participate in the Qualified Plan.
b. Amount of Two Percent Contribution. Any Two Percent Contribution that
would have been contributed on behalf of a Participant under the terms of the
Qualified Plan, except for the application of the eligibility requirements of
the Qualified Plan and the Statutory Limits, will be credited to that
Participant's Two Percent Account under this Plan.
c. Amount of Matching Contribution. Any Company matching contribution
that would have been contributed on behalf of a Participant under the terms of
the Qualified Plan, except for the application of the eligibility requirements
of the Qualified Plan and the Statutory Limits, will be credited to that
Participant's Matching Account under this Plan. Such matching contributions
shall be determined assuming that such Participant's Salary and/or Bonus
deferrals under this Plan would have been made under the Qualified Plan.
SECTION 2.6 DESIGNATION OF BENEFICIARY.
For purposes of this Plan, a Participant's Beneficiary or Beneficiaries
will be the individual(s) designated as such under the Qualified Plan. The
Employer and the Committee may rely on the designation of the Beneficiary or
Beneficiaries last filed in accordance with the terms of the Qualified Plan. In
the case of an Eligible Employee who is participating in this Plan through the
provisions of Section 2.5 prior to becoming eligible to participate in the
Qualified Plan, such Participant's Beneficiary or Beneficiaries shall be the
individual(s) designated as such for life insurance purposes. Upon
participation in the Qualified Plan, the Participant's Beneficiary or
Beneficiaries will be the person designated under the Qualified Plan.
SECTION 2.7 ADMINISTRATION.
Any amounts credited to a Participant's Account under this Plan will be
administered by the Committee.
6
<PAGE>
ARTICLE III
ACCRUAL OF BENEFITS
SECTION 3.1 INVESTMENT ELECTIONS.
a. At the time of making the deferral elections described in Section 2.2,
the Participant shall designate, on a form provided by the Committee, the types
of funds the Participant's Accounts will be deemed to be invested in for
purposes of determining the amount of Earnings to be credited to his or her
Account. Examples of the types of funds that may be available for investment
are: (i) Money Market Fund; (ii) Common Stock Fund; (iii) International Equity
Fund; (iv) Balanced Fund; (v) Growth Fund; (vi) Aggressive Growth Fund; (vii)
Bond Fund; and (viii) Global Equity Fund.
In making the designation pursuant to this Section 3.1, a Participant may
specify that all or any multiple of a Participant's Account (at least 10
percent) be deemed to be invested in one or more funds. Effective as of the end
of any calendar month, a Participant may change the designation made under this
Section 3.1 with respect to amounts contained in his or her Accounts or amounts
to be credited to his Accounts by current or future deferrals by filing an
election, on a form provided by the Committee, at least 30 days prior to the end
of such month. If a Participant fails to elect a type of fund under this
Section 3.1, he or she shall be deemed to have elected a fund similar to a Money
Market Fund.
b. Although the Participant may designate the type of funds in subsection
(a) above, the Committee shall select from time to time, in its sole discretion,
a commercially available fund similar to the types described in subsection (a)
above to be the Funds. The Interest Rate of such commercially available fund or
contract shall be used to determine the amount of Earnings to be credited to
Participants' Accounts under Section 4.4.
SECTION 3.2 DEFERRAL ACCOUNT.
The Committee shall establish and maintain an Account for each Participant
under the Plan. Each Participant's Accounts shall be further divided into
separate subaccounts ("fund subaccounts"), each of which corresponds to a fund
elected by the Participant pursuant to Section 3.1(a). A Participant's Accounts
shall be credited as follows:
a. As of the last day of each month, the Committee shall credit the fund
subaccounts of the Participant's Accounts with an amount equal to Salary
deferred by the Participant during each pay period ending in that month in
accordance with the Participant's election under Section 3.1(a); that is, the
portion of the Participant's deferred Salary that the Participant has elected to
be deemed to be invested in a certain type of fund shall be credited to the fund
subaccount corresponding to that fund.
7
<PAGE>
b. As of the last day of the month in which the Bonus or partial Bonus
would have been paid, the Committee shall credit the fund subaccounts of the
Participant's Accounts with an amount equal to the portion of the Bonus deferred
by the Participant's election under Section 3.1(a); that is, the portion of the
Participant's deferred Bonus that the Participant has elected to be deemed to be
invested in a particular type of fund shall be credited to the fund subaccount
corresponding to that fund.
c. As of the last day of each month, each fund subaccount of a
Participant's Accounts shall be credited with earnings or losses in an amount
equal to that determined by multiplying the balance credited to such fund
subaccount as of the last day of the preceding month by the Interest Rate for
the corresponding Fund selected by the Company pursuant to Section 3.1(b) with
the assumption that all dividends or interest is reinvested at the fair market
value of the Fund at the end of the day in which it would be paid.
SECTION 3.3 VESTING.
The interest of each Participant in any benefit accrued hereunder shall be
vested in accordance with the vesting provisions of the Qualified Plan. In the
event of death or Disability, the Participant will become 100 percent vested.
ARTICLE IV
DISTRIBUTION OF ACCOUNTS
SECTION 4.1 PAYMENT UPON RETIREMENT
If a Participant terminates employment with all Employers due to Retirement
(or thereafter), the amount of a Participant's Accounts distributable to the
Participant (determined pursuant to Section 3.1) as of the date of such
Retirement shall be paid to the Participant in the manner selected by
Participant not less than one year in advance of the Participant's Retirement.
At that time, the Participant may elect to have his or her Accounts paid: (i)
in a single lump sum cash payment as soon as practicable after the last day of
the calendar quarter (the "Valuation Date") following the Participant's
Retirement Date; or (ii) in equal quarterly installments over a period not
greater than 15 years.
SECTION 4.2 PAYMENT UPON TERMINATION OF EMPLOYMENT.
If a Participant terminates employment with all Employers by reason of
death, or any other reason other than Retirement, the amount of a Participant's
Accounts distributable to the Participant (determined pursuant to Section 3.1)
as of the date of termination shall be distributed to the Participant in a
single lump sum cash payment as soon as practicable after the Valuation Date
following such termination.
8
<PAGE>
SECTION 4.3 PAYMENT UPON A CHANGE OF CONTROL
a. If a Change of Control occurs, the amount of a Participant's Accounts
distributable to the Participant (determined pursuant to Section 3.1) as of the
date of such Change of Control shall be paid by the Trustee of the Trust (as
defined herein) to the Participant in a single lump sum cash payment, as soon as
practicable after the Valuation Date following the effective date of such Change
of Control.
b. In the event of a Change in Control, no changes in the Plan and no
adjustments, determinations or other exercises of discretion by the Plan
Administrator, the Committee, the Compensation Committee or the Board of
Directors that were made at the effective time of, or subsequent to the Change
in Control and that would have the effect of diminishing a Participant's rights
or payments under this Plan or this Section shall be effective.
SECTION 4.4 AMOUNT DISTRIBUTABLE.
The amount of a Participant's Accounts distributable to a Participant or
any designated Beneficiary or Beneficiaries as of any date specified in this
Plan shall be an amount equal to the vested balance credited to the
Participant's Accounts as of the Valuation Date immediately following said date.
ARTICLE V
TRUST
SECTION 5.1 TRUST.
a. The Company shall cause the payment of benefits under this Plan to be
made in whole or in part by the Trustee of the PacifiCare Health Systems, Inc.
Rabbi Trust (the "Trust") in accordance with the provisions of this Section 5.1.
As soon as practicable after the end of each Plan Year (but no later than the
tax return due date of the Company for such year), each Employer shall
contribute to the Trust for each Participant an amount equal to the amount
deferred by the Participant for the Plan Year and an amount equal to the Two
Percent and Company Matching Contributions for such Participant for such Plan
Year. Notwithstanding anything contained herein, contributions to the Trust by
each Employer may be made throughout the Plan Year.
b. The Committee shall direct the Trustee to pay the Participant or his
beneficiary at the time and in the amount described in Article IV. In the event
the amounts held under the Trust are not sufficient to provide the full amount
payable to the Participant, the Employers shall pay for the remainder of such
amount at the time set forth in Article IV.
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ARTICLE VI.
ADMINISTRATION
SECTION 6.1 COMMITTEE.
A number of individuals shall be appointed by, and serve at the pleasure
of, the Compensation Committee as a committee to administer this Plan (the
"Committee"). The number of members comprising the Committee shall be determined
by the Compensation Committee, which may from time to time vary the number of
members. A member of the Committee may resign by delivering a written notice of
resignation to the Compensation Committee. The Compensation Committee may
remove any member by delivering a certified copy of its resolution of removal to
such member. Vacancies in the membership of the Committee shall be filled
promptly by the Compensation Committee.
SECTION 6.2 COMMITTEE ACTION.
The Committee shall act at meetings by affirmative vote of a majority of
the members of the Committee. Any action permitted to be taken at a meeting may
be taken without a meeting if, prior to such action, a written consent to the
action is signed by all members of the Committee and such written consent is
filed with the minutes of the proceedings of the Committee. A member of the
Committee shall not vote or act upon any matter, which relates solely to himself
or herself as a Participant. The Chairman or any other member or members of the
Committee designated by the Chairman may execute any certificate or other
written direction on behalf of the Committee.
SECTION 6.3 POWERS AND DUTIES OF THE COMMITTEE.
a. The Committee, on behalf of the Participants and their Beneficiaries,
shall enforce the Plan in accordance with its terms, shall be the "Plan
Administrator" charged with the general administration of the Plan, and shall
have all discretionary authority and powers necessary to accomplish its
purposes, including, but not by way of limitation, the following:
i. To select the funds or contracts to be the Funds in accordance
with Section 3.1(b);
ii. To construe and interpret the terms and provisions of this
Plan;
iii. To compute and certify the amount and kind of benefits payable
to Participants and their beneficiaries;
iv. To maintain all records that may be necessary for the
administration of the Plan;
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v. To provide for the disclosure of all information and the filing
or provision of all reports and statements to Participants, beneficiaries
or governmental agencies as shall be required by law;
vi. To make and publish such rules for the regulation of this Plan
and procedures for the administration of this Plan as are not inconsistent
with the terms hereof;
vii. To appoint a plan administrator or any other agent, and to
delegate to them such powers and duties in connection with the
administration of the Plan as the Committee may from time to time
prescribe; and
viii. To take all actions set forth in the Trust agreement, including
determining whether to hold or discontinue the policies.
SECTION 6.4 CONSTRUCTION AND INTERPRETATION.
The Committee shall have full discretion to construe and interpret the
terms and provisions of this Plan, which interpretation or construction shall be
final and binding on all parties, including but not limited to the Company and
any Participant or beneficiary. The Committee shall administer such terms and
provisions in a uniform and nondiscriminatory manner and in full accordance with
any and all laws applicable to this Plan.
SECTION 6.5 INFORMATION.
To enable the Committee to perform its functions, the Employers shall
supply full and timely information to the Committee on all matters relating to
the Compensation of all Participants, their death or other cause of termination
and such other pertinent facts as the Committee may require.
SECTION 6.6 COMPENSATION, EXPENSES AND INDEMNITY.
a. The members of the Committee shall serve without compensation for
their services hereunder.
b. The Committee is authorized at the expense of the Company to employ
such legal counsel as it may deem advisable to assist in the performance of its
duties hereunder. Expenses and fees in connection with the administration of the
Plan shall be paid by the Company.
c. To the extent permitted by applicable state law, the Company shall
indemnify and hold harmless the Committee and each member thereof, the Board of
Directors, the Compensation Committee and any delegate of the Committee who is
an employee of the Company against any and all expenses, liabilities and claims,
including
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legal fees to defend against such liabilities and claims arising out of their
discharge in good faith of responsibilities under or incident to this Plan,
other than expenses and liabilities arising out of bad faith or willful
misconduct. This indemnity shall not preclude such further indemnities as may be
available under insurance purchased by the Company or provided by the Company
under any bylaw, agreement or otherwise, as such indemnities are permitted under
state law.
SECTION 6.8 QUARTERLY STATEMENTS.
Under procedures established by the Committee, a Participant shall receive
a statement with respect to such Participant's Accounts on a quarterly basis as
of each March 31, June 30, September 30 and December 31.
SECTION 6.9 CLAIM PROCEDURES.
a. Claim. A person who believes that he or she is being denied a benefit
to which he or she is entitled under this Plan (hereinafter referred to as
"Claimant") may file a written request for such benefit with the Plan
Administrator, setting forth his or her claim.
b. Claim Decision. Upon receipt of a claim, the Plan Administrator shall
advise the Claimant that a reply will be forthcoming within 90 days and shall,
in fact, deliver a reply within such period. The Plan Administrator may,
however, extend the reply period for an additional 90 days for special
circumstances.
If the claim is denied in whole or in part, the Plan Administrator shall
inform the Claimant in writing, using language calculated to be understood by
the Claimant, setting forth: (A) the specified reason or reasons for such
denial; (B) the specific reference to pertinent provisions of this Plan on which
such denial is based; (C) a description of any additional material or
information necessary for the Claimant to perfect his or her claim and an
explanation of why such material or such information is necessary; (D)
appropriate information as to the steps to be taken if the Claimant wishes to
submit the claim for review; and (E) the time limits for requesting a review
under subsection 6.9(c).
c. Request for Review. Within 60 days after the receipt by the Claimant
of the written opinion described above, the Claimant may request in writing that
the Committee review the determination of the Plan Administration. The Claimant
or his or her duly authorized representative may, but need not, review the
pertinent documents and submit issues and comments in writing for consideration
by the Committee. If the Claimant does not request a review within such 60 day
period, he or she shall be barred and estopped from challenging the Plan
Administrator's determination.
d. Review of Decision. Within 60 days after the Committee's receipt of a
request for review, after considering all materials presented by the Claimant,
the
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Committee will inform the Participant in writing, in a manner calculated to be
understood by the Claimant, of its decision setting forth the specific reasons
for the decision and containing specific references to the pertinent provisions
of this Agreement on which the decision is based. If special circumstances
require that the 60 day time period be extended, the Committee will so notify
the Claimant and will render the decision as soon as possible, but no later than
120 days after receipt of the request for review.
ARTICLE VII
MISCELLANEOUS
SECTION 7.1 UNSECURED GENERAL CREDITOR.
Participants and their beneficiaries, heirs, successors, and assigns shall
have no legal or equitable rights, claims, or interest in any specific property
or assets of any Employer. Any and all of the assets of each Employer shall be,
and remain, the general unpledged, unrestricted assets of such Employer. Each
Employer's obligation under this Plan shall be merely that of an unsecured
promise of such Employer to pay money in the future, and the rights of the
Participants and beneficiaries shall be no greater than those of unsecured
general creditors. It is the intention of the Company that this Plan (and the
Trust described in Article V) be unfunded for purposes of the Code and for
purposes of Title I of ERISA.
SECTION 7.2 RESTRICTION AGAINST ASSIGNMENT.
The Employers shall pay all amounts payable hereunder only to the person or
persons designated by the Plan and not to any other person or corporation. No
part of a Participant's Accounts shall be liable for the debts, contracts, or
engagements of any Participant, his or her beneficiary, or successors in
interest, nor shall a Participant's Accounts be subject to execution by levy,
attachment, or garnishment or by any other legal or equitable proceeding, nor
shall any such person have any right to alienate, anticipate, sell, transfer,
commute, pledge, encumber, or assign any benefits or payments hereunder in any
manner whatsoever. If any Participant, beneficiary or successor in interest is
adjudicated bankrupt or purports to anticipate, alienate, sell, transfer,
commute, assign, pledge, encumber or charge any distribution or payment from the
Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel
such distribution or payment (or any part thereof) to or for the benefit of such
Participant, beneficiary or successor in interest in such manner as the
Committee shall direct.
SECTION 7.3 CHANGE OF CONTROL.
For purposes of this Plan, "Change of Control" means the occurrence of any
of the following: (i) a business combination effectuated through the merger or
consolidation of the Company with or into another entity where the Company is
not the
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Surviving Organization; (ii) any business combination effectuated through the
merger or consolidation of the Company with or into another entity where the
Company is the Surviving Organization and such business combination occurred
with an entity whose market capitalization prior to the transaction was greater
than 50 percent of the Company's market capitalization prior to the transaction;
(iii) the sale in a transaction or series of transactions of all or
substantially all of the Company's assets; (iv) any "person" or "group" (within
the meaning of Sections 13(d) and 14(d) of the Securities Exchange Act of 1934,
as amended (the "Exchange Act")) other than UniHealth, a California non-profit
public benefit corporation ("UniHealth"), acquires beneficial ownership within
the meaning of Rule 13d-3 of the Exchange Act, directly or indirectly, of 20
percent or more of the voting common stock of the Company and the beneficial
ownership of the voting common stock of the Company owned by UniHealth at that
date is less than or equal to the beneficial ownership interest of voting
securities attributable to such other person or group; (v) a dissolution or
liquidation of the Company; or (vi) the Company ceases to be subject to the
reporting requirements of the Exchange Act as a result of a "going private
transaction" (within the meaning of the Exchange Act). For purposes hereof,
"Surviving Organization" shall mean any entity where the majority of the members
of such entity's board of directors are persons who were members of the
Company's board of directors prior to the merger, consolidation or other
business combination and the senior management of the surviving entity includes
all of the individuals who were the Company's executive management (the
Company's chief executive officer and those individuals who report directly to
the Company's chief executive officer) prior to the merger, consolidation or
other business combination and such individuals are in at least comparable
positions with such entity. The Committee may make such determinations and
interpretations and adopt such rules and conditions as it, in its absolute
discretion, deems appropriate in connection with a Change in Control. All such
determinations and interpretations by the Committee shall be conclusive.
SECTION 7.4 WITHHOLDING.
There shall be deducted from each payment made under the Plan or any other
compensation payable to the Participant (or beneficiary) all taxes which are
required to be withheld by the Company in respect to such payment or this Plan.
The Company shall have the right to reduce any payment (or compensation) by the
amount of cash sufficient to provide the amount of said taxes.
SECTION 7.5 AMENDMENT, MODIFICATION, SUSPENSION OR TERMINATION.
The Compensation Committee may amend, modify, suspend or terminate the Plan
in whole or in part, except that no amendment, modification, suspension or
termination shall have any retroactive effect to reduce any amounts allocated to
a Participant's Accounts. In the event that this Plan is terminated, the
amounts allocated to a Participant's Accounts (regardless of whether such
amounts had become vested)
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shall be distributed to the Participant or, in the event of his or her death,
his or her beneficiary in a lump sum within 30 days following the date of
termination.
SECTION 7.6 GOVERNING LAW.
This Plan shall be construed, governed and administered in accordance with
the laws of the United States and to the extent not preempted by such law by the
laws of the State of California.
SECTION 7.7 RECEIPT OR RELEASE.
Any payment to a Participant or the Participant's Beneficiary in accordance
with the provisions of the Plan shall to the extent thereof, be in full
satisfaction of all claims for benefits under this Plan against the Committee
and the Company. The Committee may require such Participant or beneficiary, as
a condition precedent to such payment, to execute a receipt and release to such
effect.
SECTION 7.8 EFFECTIVE DATE.
This Plan shall be effective as of January 1, 1998.
IN WITNESS WHEREOF, this Plan is adopted as of January 1, 1998.
PACIFICARE HEALTH SYSTEMS, INC.
------------------------------------
By:
Title:
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PACIFICARE HEALTH SYSTEMS, INC.
NON-QUALIFIED DEFERRED COMPENSATION PLAN
WHEREAS, PacifiCare Health Systems, Inc., (the "Company") desires to
establish a non-qualified deferred compensation plan to provide supplemental
retirement income benefits for a select group of management and highly
compensated employees through deferrals of salary and bonuses, effective as of
December 18, 1997;
WHEREAS, it is believed that the adoption of this plan providing for
deferral of compensation at the election of each executive will be in the best
interests of the Company;
WHEREAS, it is the intent of the Company that this Plan shall supersede
any other non-qualified deferred compensation plan, policy or arrangement which
the Company or any of its subsidiaries may have sponsored or made available in
the past; and
WHEREAS, the Company intends that this plan shall be maintained as a
"top hat" plan described in Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA;
NOW, THEREFORE, it is hereby declared as follows:
ARTICLE I
DEFINITIONS
Whenever the following words and phrases are used in this Plan, they
shall have the meanings specified below.
Section 1.1 "Beneficiary" or "Beneficiaries" for purposes of this Plan shall
have the meaning set forth in Section 6.4.
Section 1.2 "Board of Directors" or "Board" means the Board of Directors of
the Company.
Section 1.3 "Bonus" means any cash incentive compensation or sales
commissions payable to a Participant in addition to the Participant's Salary,
other than the LTPIP Bonus, moving expenses, sign-on bonuses or bonuses paid in
connection with a promotion, prior to any reduction for deferrals to a plan
qualified under Section 125 or Section 401 (k) of the Code.
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Section 1.4 "Change of Control" shall have the meaning set forth in Section
6.3.
Section 1.5 "Class B Common Stock" means the Company's Class B Common Stock,
par value $0.01 per share.
Section 1.6 "Code" means the Internal Revenue Code of 1986, as amended from
time to time.
Section 1.7 "Committee" means the Committee appointed by the Compensation
Committee to administer the Plan in accordance with Article V.
Section 1.8 "Company" means PacifiCare Health Systems, Inc., a Delaware
corporation, or any successor corporation.
Section 1.9 "Compensation Committee" shall mean the Compensation Committee
of the Board of Directors of the Company.
Section 1.10 "Deferral Account" shall mean the amount of Salary and Bonus
deferred under Article III of this Plan, the Interest Rate or Rates credited to
such deferred amounts and the LTPIP Stock Accounts.
Section 1.11 "Disability." A Participant shall be deemed to be incapacitated
or disabled, if such Participant's incapacity or disability prevents a
Participant from fully performing his duties to an Employer for a period in
excess of 90 days and, after such 90-day period, the Company and a physician,
duly licensed and qualified in the specialty of the Participant's incapacity or
disability, decide in their reasonable judgments, that such incapacity or
disability will be permanent or of such continued duration as to prevent a
Participant from resuming the rendition of services to the Employer for at least
an additional six-month period.
Section 1.12 "Distributable Amount" shall mean having the meaning set forth
in Section 3.8(a).
Section 1.13 "Eligible Employee" shall mean those Employees who satisfy any
of the requirements of Section 2.1.
Section 1.14 "Employee" shall mean any employee (as defined in accordance
with the Treasury Regulations and Revenue Rulings then applicable under Section
3401 (c) of the Code) of an Employer, whether such employee is so employed at
the time this Plan is adopted or becomes so employed subsequent to the adoption
of this Plan.
Section 1.15 "Employer" means the Company (or any successor by merger,
consolidation or purchase of substantially all of the Company's assets) and any
and all Subsidiaries of the Company.
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Section 1.16 "ERISA" shall mean the Employee Retirement Income Security Act
of 1974, as amended from time to time.
Section 1.17 "Exchange Act" shall mean the Securities Exchange Act of 1934,
as amended from time to time.
Section 1.18 "Fund" or "Funds" means one or more of the funds selected by the
Committee pursuant to Section 3.3(b).
Section 1.19 "Initial Election Period'' for an Eligible Employee means the
30-day period following the later of November 15, 1997 or the receipt by an
Eligible Employee of enrollment material for this Plan.
Section 1.20 "Interest Rate" shall mean, for each Fund, an amount equal to
the net gain or loss on the assets of such Fund during each month.
Section 1.21 "LTPIP" means the Long-Term Performance Incentive Compensation
Plan of the Company, as it may be amended from time to time.
Section 1.22 "LTPIP Bonus" means incentive compensation payable to a
Participant under the LTPIP in addition to the Participant's Salary prior to any
reduction for deferrals to a plan qualified under Section 125 or Section 401(k).
Section 1.23 "LTPIP Stock Account" shall have the meaning specified in
Section 3.5.
Section 1.24 "Participant" means for purposes of this Plan, any Eligible
Employee who satisfies the requirements of Section 3.1.
Section 1.25 "Payment Eligibility Date" means the first day of the month
following the end of the calendar quarter in which a Participant terminates
employment for any reason with all Employers or dies.
Section 1.26 "Plan" means this Non-Qualified Deferred Compensation Plan of
PacifiCare Health Systems, Inc., as it may be amended from time to time.
Section 1.27 "Plan Year" means the 12 consecutive month period beginning on
January 1 and ending on December 31 of the same year.
Section 1.28 "Retirement" or "Retire" for purposes of this Plan means
termination of a Participant's employment from all Employers, which occurs after
the sum of the following two factors meet or exceed 55: (i) the Participant's
age and (ii) the Participant's number of years of service with all Employers.
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Section 1.29 "Salary" shall mean the Participant's salary prior to any
reduction for deferrals to a plan qualified under Section 125 or Section 401 (k)
of the Code.
Section 1.30 "Social Security Wage Base" means contributions and benefits
base under Section 230 of the Social Security Act in effect for the Plan Year.
Section 1.31 "Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with the Company if each of the corporations other than
the last corporation in the unbroken chain then owns stock possessing 50 percent
or more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.
ARTICLE II
ELIGIBILITY
SECTION 2.1 ELIGIBILITY.
a. At the effective date of this Plan, an Employee of an Employer
will be eligible to defer payments of Salary and/or Bonus pursuant to the
provisions of this Plan if at the time when an election may be made he or she is
an Employee who the Company has designated to be in one of the five highest
executive pay bands and is scheduled to work at least 32 hours per week.
Notwithstanding any other provisions of this Plan, all Employees who participate
in this Plan for Plan Year 1998 shall continue to be eligible to participate in
this Plan in future Plan Years.
b. Subsequent to the effective date of this Plan, a new Employee of
an Employer will be eligible to defer payments of Salary and/or Bonus pursuant
to the provisions of this Plan if at the time when an election may be made: (i)
he or she has an annual base salary of at least $80,000 and is scheduled to work
at least 32 hours per week; or (ii) he or she is an Employee scheduled to work
at least 32 hours per week designated by the Committee to be eligible to
participate in this Plan so long as such designation does not make this Plan not
eligible for "top hat" plan status.
An Employee who satisfies the requirements of subsection (a) or (b)
shall be an "Eligible Employee."
ARTICLE III
DEFERRAL OF COMPENSATION
SECTION 3.1 PARTICIPATION.
a. An Eligible Employee shall become a Participant in this Plan by
(1) electing to defer a portion of his or her Salary and/or Bonus in accordance
with Section
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3.2, and (2) filing a life insurance application form along with his or her
deferral election form.
b. During any Plan Year, a Participant who is scheduled to work
more than 20 hours but less than 32 hours per week shall not trigger a
distribution event; provided, however, such Participant will not be able to
continue making deferrals or be eligible to make new deferrals under this Plan
until such time the Participant is scheduled to work at least 32 hours per week.
Any amounts previously deferred by such Participant will continue to be credited
with the Interest Rate or Rates according to the provisions of this Plan. If a
Participant subsequently is scheduled to work at least 32 hours per week, the
Participant may make an election to defer Salary and/or Bonus for the next Plan
Year.
SECTION 3.2 ELECTIONS TO DEFER COMPENSATION.
a. INITIAL ELECTION PERIOD. Subject to Article II and Section 3.1,
each Eligible Employee may elect to defer Salary and/or Bonus by filing with the
Committee, on a form provided by the Committee, an election that conforms to the
requirements of this Section 3.2, no later than the last day of his or her
Initial Election Period.
b. GENERAL RULE. The amount of compensation which an Eligible
Employee may elect to defer is as follows:
(i) Any whole percentage of Salary up to and including 50
percent of Salary and/or
(ii) Any whole percentage of Bonus up to 100 percent.
c. MINIMUM DEFERRALS. For each Plan Year during which an Eligible
Employee is a Participant, the minimum amount that may be elected to be deferred
under Section 3.2(b) is $5,000. Such minimum may be satisfied by deferring
Salary and/or the Bonus or LTPIP Bonus payable for services rendered for such
Plan Year (even though it may not be paid until the next Plan Year); provided
that if Salary is deferred, the minimum Salary deferral is $5,000. Accordingly,
if no Salary is deferred for a Plan Year and the total amount of the Bonus or
LTPIP Bonus elected to be deferred with respect to that Plan Year is in fact
less than $5,000, then no portion of the Bonus or LTPIP Bonus shall be deferred.
d. EFFECT OF INITIAL ELECTION. For Participants who are Employees
of an Employer on the effective date of this Plan, an election to defer Salary
and/or Bonus during the Initial Election Period shall be effective with respect
to Salary and/or Bonus earned during the first pay period beginning after the
end of the Initial Election Period.
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For Participants who become Employees of an Employer subsequent to the effective
date of this Plan, an election to defer Salary and/or Bonus during the Initial
Election Period shall be effective with respect to Salary and/or Bonus earned
after the first day of the calendar quarter beginning after the end of the
Initial Election Period.
e. DURATION OF DEFERRAL ELECTION. Any Salary and/or Bonus deferral
election made under subsection (a) or subsection (f) of this Section 3.2 shall
be irrevocable and shall apply only to the Salary payable during the Plan Year
and/or Bonus payable with respect to services performed during the Plan Year.
For each subsequent Plan Year, an Eligible Employee may make a new election,
subject to the limitations set forth in this Section 3.2, to defer a percentage
of his or her Salary and/or Bonus. Such election shall be on forms provided by
the Committee and shall be made on or before the December 15 preceding the Plan
Year for which the election is to apply. Notwithstanding the foregoing, the
Committee may, in its absolute discretion, permit an Eligible Employee to file
an election to defer on or after December 15, if, in its judgment, his or her
failure to do so prior to said date was due to reasonable cause, but in no event
may such election be filed after December 31. All elections, once made, are
irrevocable.
f. ELECTIONS OTHER THAN ELECTIONS DURING THE INITIAL ELECTION
PERIOD. Subject to the minimum deferral requirement of subsection (c) above, any
Eligible Employee who fails to elect to defer Salary and/or Bonus during his or
her Initial Election Period may subsequently become a Participant, and any
Eligible Employee who has terminated a prior Salary deferral election may elect
to again defer Salary and/or Bonus, by filing an election, on a form provided by
the Committee, to defer Salary and/or Bonus as described in this Section 3.2.
An election to defer Salary and/or Bonus must be filed on or before each
December 15 and will be effective for Salary paid after the following January 1
and the Bonus payable with respect to services performed in the Plan Year
beginning on the following January 1.
g. LTPIP BONUS. One year in advance of the end of a LTPIP
performance cycle, an Eligible Employee may elect in writing, to defer receipt
of all or a portion of the LTPIP Bonus, which may be earned under the LTPIP for
that performance cycle.
h. REDUCTION OF SALARY AND/OR BONUS. Upon an election to defer
Salary and/or Bonus, each Participant's Salary, Bonus and/or LTPIP Bonus will be
reduced by the amount elected to be deferred.
SECTION 3.3 INVESTMENT ELECTIONS.
a. At the time of making the deferral elections described in
Section 3.2, the Participant shall designate, on a form provided by the
Committee, the types of funds the Participant's Deferral Account will be deemed
to be invested in for purposes of determining the amount of Interest Rate or
Rates to be credited to his or her Account.
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Examples of the types of funds that may be available for investment are: (i)
Money Market Fund; (ii) Common Stock Fund; (iii) International Equity Fund; (iv)
Balanced Fund; (v) Growth Fund; (vi) Aggressive Growth Fund; (vii) Bond Fund;
and (viii) Global Equity Fund.
In making the designation pursuant to this Section 3.3, the Participant
may specify that all or any whole percentage of his Deferral Account (at least
10 percent) be deemed to be invested in one or more funds. Effective as of the
end of any calendar month, a Participant may change the designation made under
this Section 3.3 with respect to amounts contained in his or her Deferral
Accounts or amounts to be credited to his or her Deferral Accounts by current or
future deferrals by filing an election, on a form provided by the Committee, at
least 30 days prior to the end of such month. If a Participant fails to elect a
type of fund under this Section 3.3, he or she shall be deemed to have elected a
fund similar to a Money Market Fund.
b. Although the Participant may designate the type of funds in
subsection (a) above, the Committee shall select from time to time, in its sole
discretion, a commercially available fund similar to the types described in
subsection (a) above to be the Funds. The Interest Rate of such commercially
available fund or contract shall be used to determine the amount of earnings or
losses to be credited to Participants' Deferral Accounts under Section 3.4.
SECTION 3.4 DEFERRAL ACCOUNT.
The Committee shall establish and maintain a Deferral Account for each
Participant under the Plan. Each Participant's Deferral Account shall be further
divided into separate subaccounts ("fund subaccounts"), each of which
corresponds to a fund elected by the Participant pursuant to Section 3.3(a). A
Participant's Deferral Account shall be credited as follows:
a. As of the last day of each month, the Committee shall credit the
fund subaccounts of the Participant's Deferral Account with an amount equal to
Salary deferred by the Participant during each pay period ending in that month
in accordance with the Participant's election under Section 3.3(a); that is, the
portion of the Participant's deferred Salary that the Participant has elected to
be deemed to be invested in a certain type of fund shall be credited to the fund
subaccount corresponding to that fund.
b. As of the last day of the month in which the Bonus or partial
Bonus would have been paid, the Committee shall credit the fund subaccounts of
the Participant's Deferral Account with an amount equal to the portion of the
Bonus deferred by the Participant's election under Section 3.3(a); that is, the
portion of the Participant's deferred Bonus that the Participant has elected to
be deemed to be invested
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in a particular type of fund shall be credited to the fund subaccount
corresponding to that fund.
c. As of the last day of each month, each fund subaccount of a
Participant's Deferral Account shall be credited with earnings or losses in an
amount equal to that determined by multiplying the balance credited to such fund
subaccount as of the last day of the preceding month by the Interest Rate for
the corresponding Fund selected by the Committee pursuant to Section 3.2(b) with
the assumption that all dividends or interest is reinvested at the fair market
value of the Fund at the end of the day in which it would be paid.
d. All amounts in a Participant's Deferral Account shall be 100
percent vested at all times.
SECTION 3.5 CREATION OF DEFERRED LTPIP STOCK ACCOUNTS.
If a Participant elects to defer all or any portion of the LTPIP Bonus,
60 percent of the amount deferred will be credited to the Deferral Account and
approximately 40 percent of the amount defined will be credited to the LTPIP
Stock Account (as defined herein). The LTPIP Stock Account will be credited
with stock units (the "LTPIP Stock Units") equal to the number of shares of
Class B Common Stock into which the amount deferred is converted based on the
closing price of the Class B Common Stock as of the time the LTPIP Bonus would
have been paid, but for the election to defer under this Plan. The LTPIP Stock
Units shall be credited to a bookkeeping account, established for this purpose
in the Participant's name (the "LTPIP Stock Account") as of the last day of the
LTPIP performance cycle for which the LTPIP Bonus is earned. The number of
LTPIP Stock Units shall remain constant over the deferral period except as
adjusted pursuant to Section 3.7. The number of shares of Class B Common Stock
to be distributed shall equal the number of LTPIP Stock Units credited to the
LTPIP Stock Account at the time the LTPIP Bonus was originally awarded.
SECTION 3.6 ROLLOVERS.
a. Participants of the FHP International Corporation Deferred
Compensation Plan, as amended (the "FHP Plan"), who have a positive account
balance, as of December 31, 1997, in the FHP Plan shall have such positive
account balance transferred to and added to an account balance under this Plan;
provided, however, that individuals who are not employees of an Employer as of
December 31, 1997 shall receive a lump sum distribution of any and all amounts
contained in their account balance under the FHP Plan as soon as practicable but
no later than April 1, 1998; provided further, however, that notwithstanding the
preceding provisions, individuals who are receiving salary continuation payments
pursuant to the terms of an employment agreement or through arrangements with an
Employer shall have their
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account balances under the FHP Plan transferred to and added to an account in
this Plan. Participant's account balances transferred to this Plan shall be
governed by the terms and conditions of this Plan and shall be referred to as
the "FHP Rollover Amount" and shall be credited to such Participant's Deferral
Account as of December 31, 1997.
b. Participants of any existing deferred compensation plan
administered by the Company, who have a positive account balance in such plan as
of December 31, 1997 and who are employed by an Employer as of December 31, 1997
shall have such positive account balance transferred to and added to an account
balance under this Plan provided that individuals who are not employees of an
Employer as of December 31, 1997 shall receive a lump sum distribution of any
and all amounts contained in their account balances; provided further, however,
that notwithstanding the preceding provisions, individuals who are receiving
salary continuation payments pursuant to the terms of an employment agreement or
through arrangements with an Employer shall have their account balances under
the Company's existing deferred compensation plan transferred to and added to an
account in this Plan. Participant's account balances transferred to this Plan
pursuant to this subsection (b) shall be governed by the terms and conditions of
this Plan, shall be referred to as the "Existing PHS Rollover Amount" and shall
be credited to such Participant's Deferral Account as of December 31, 1997.
SECTION 3.7 CHANGE IN COMPANY SHARES.
If the outstanding shares of Class B Common Stock are hereafter changed
into or exchanged for a different number or kind of shares or other securities
of the Company, or of another company, by reason of reorganization, merger,
consolidation, recapitalization, reclassification, stock split, stock dividend
or combination of shares, or if the Company distributes a cash or non-cash
dividend to holders of Class B Common Stock or engages in another similar
transaction, the Committee shall make an appropriate and equitable adjustment in
the number and kind of units credited to the LTPIP Stock Account. Any such
adjustment made by the Committee shall be final and binding upon a Participant,
the Company and all other interested persons.
SECTION 3.8 DISTRIBUTION OF DEFERRED COMPENSATION.
(a) In the case of a Participant who terminates employment with all
Employers on or after Retirement or who terminates as a result of a Disability,
the aggregate amount credited to the Deferral Account (the "Distributable
Amount") shall be paid to the Participant (and after his death to his or her
Beneficiary) in the form of substantially equal quarterly installments over 15
years beginning within 30 days of his or her Payment Eligibility Date.
Notwithstanding the foregoing, a Participant described in the preceding sentence
may elect one of the following optional forms of distribution
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provided that his or her election is filed with the Committee at least one year
prior to his or her termination of employment with all Employers:
(i) a single lump sum cash payment payable on the
Participant's Payment Eligibility Date; or
(ii) substantially equal quarterly installments over five or
ten years beginning on the Participant's Payment Eligibility Date.
Any such election filed less than one year prior to termination of
employment shall not become effective.
Notwithstanding this subsection, if the Distributable Amount is $25,000
or less, the Distributable Amount shall automatically be distributed in the form
of a single lump sum cash payment within 30 days of the Participant's Payment
Eligibility Date. The Participant's Deferral Accounts shall continue to be
credited monthly with Interest Rate or Rates pursuant to Section 3.4 of this
Plan until all amounts credited to his or her Deferral Accounts under this Plan
have been distributed. For all purposes under this Plan, a Participant shall not
be considered terminated from employment with all Employers if the Participant
remains employed by an entity that is an Employer. However, if the Employee is
employed by an Employer and such Employer ceases to be an Employer as a result
of a sale or other corporate reorganization, such sale or other corporate
reorganization shall be treated as termination of employment with all Employers
unless immediately following such event and without any break in employment the
Participant remains employed by an Employer or the former Employer assumes
liability for the benefit of the Participant.
(b) In the case of a Participant who terminates employment with all
Employers prior to Retirement or for reasons other than a Disability, the
Distributable Amount shall be paid to the Participant in the form of a single
lump sum cash payment within 30 days of a Participant's Payment Eligibility
Date; provided, however, that notwithstanding the preceding provision,
individuals who are receiving salary continuation payments pursuant to the terms
of an employment agreement or through arrangements with an Employer shall
continue to be eligible to participate in this Plan until termination of salary
continuation. Upon termination of salary continuation, the Distributable Amount
shall be paid to such Participate in the form of a single lump cash payment
within 30 days of the Payment Eligibility Date.
(c) In the case of a Participant who dies while employed by an
Employer, the Participant's Beneficiary will be paid one and one-half times the
Participant's Deferral Account balance in a single lump sum cash payment. If a
Participant dies after terminating employment with all Employers and while
receiving installment payments
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of his or her Deferral Account balance, the Participant's Deferral Account
balance will continue to be paid in the same form to the Participant's
Beneficiary.
(d) A Participant who has not terminated employment with all
Employers may change his or her form of payment applicable to the portion of the
Deferral Account balance attributable to one or more Plan Years to one of the
payment forms permitted by the Plan at least one year prior to his or her
termination of employment with all Employers and, in the case of scheduled early
distributions elected pursuant to Section 3.10, may defer the Scheduled Payment
Dates in accordance with Section 3.10. Any such election to change form of
payment less than one year prior to termination of employment shall not become
effective. The Participant's payment election with respect to a given Plan Year
may not be changed after payment of that portion of the Deferral Account balance
has been made or has begun.
(e) In the case of a Participant who becomes a Participant in this
Plan as a result of a FHP Rollover and who is receiving salary continuation, the
Distributable Amount of such Participant upon termination of salary continuation
shall be paid to such Participant in the form of a single lump sum cash payment;
provided, however, if such Participant can be deemed to be Retired, then the
Distributable Amount shall be paid to such Participant in accordance with his or
her elections to defer.
SECTION 3.9 UNSCHEDULED EARLY DISTRIBUTIONS.
A Participant shall be permitted to elect to withdraw amounts from his
or her Deferral Accounts prior to termination of employment with all Employers
("Early Distributions"), subject to the following restrictions:
a. The election to take an Early Distribution shall be made by
filing a form provided by and filed with the Committee prior to the end of any
calendar month.
b. The amount of the Early Distribution shall in all cases equal 85
percent of the Distributable Amount as of the end of the calendar month in which
the distribution is to be made.
c. The amount described in subsection 3.9(b) above shall be paid in
a single lump sum cash payment as soon as practicable after the end of the
calendar month in which the Early Distribution election is made.
d. If a Participant receives an Early Distribution pursuant to this
Section 3.9, 15 percent of the Distributable Amount shall be permanently
forfeited and the Company shall have no obligation to the Participant or any
Beneficiary with respect to such forfeited amount.
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e. If a Participant receives an Early Distribution, the Participant
will be ineligible to participate in this Plan for the balance of the Plan Year
and for the following Plan Year.
SECTION 3.10 SCHEDULED EARLY DISTRIBUTIONS.
Participants may elect to have their Salary and/or Bonus deferred during
a given Plan Year be paid on a future date while still employed, provided the
payment date (the "Scheduled Payment Date") is at least two years from the last
day of such Plan Year. This election shall apply to the Salary and/or Bonus
deferred for the Plan Year specified by the Participant on his or her payment
election and the Interest Rate or Rates credited thereto until the Scheduled
Payment Date. A Participant may elect a different Payment Date for Salary
and/or Bonus deferred for each Plan Year. In addition, Scheduled Payment Dates
elected pursuant to this Section 3.10 may be deferred by at least one year, by
filing with the Committee written notice at least one year prior to the
Scheduled Payment Date. A Participant may elect to defer a Scheduled Payment
Date selected by this Section 3.10 once every two years. A distribution
pursuant to this Section 3.10 of less than the Participant's entire interest in
the Deferral Account shall be made pro rata from his or her investment fund
subaccounts according to the balances in such subaccounts. All early
distributions pursuant to this Section 3.10 shall be made in a single lump sum
cash payment. Notwithstanding the foregoing, if a Participant terminates
employment with all Employers for any reason prior to the date on which a
payment is scheduled to be made pursuant to this Section 3.10, the Participant's
entire Deferral Account balance will be paid pursuant to the provisions of
Section 3.8.
SECTION 3.11 FINANCIAL HARDSHIP WITHDRAWALS.
The Committee may, pursuant to rules adopted by it and applied in a
uniform manner, accelerate the date of distribution of all or any portion of a
Participant's Deferral Account balance, including amounts in the LTPIP Stock
Account, because of a financial hardship. A financial hardship means an
unforeseeable, severe financial emergency resulting from (a), a sudden and
unexpected illness or accident of the Participant or his or her dependent (as
defined in Section 152(a) of the Code); (b) loss of the Participant's property
due to casualty; or (c) other similar extraordinary and unforeseeable
circumstances arising out of an event beyond the control of the Participant,
which may not be relieved through other available resources of the Participant,
as determined by the Committee in accordance with uniform rules adopted by it.
Distribution pursuant to this Section 3.11 of less than the Participant's entire
interest in the Plan shall be made pro rata from his or her investment fund
subaccounts according to the balances in such subaccounts. Subject to the
foregoing, payment of any amount with respect to which a Participant has filed a
request under this Section 3.11 shall be made in a single lump sum cash payment
as soon as practicable after
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approval of such request by the Committee and shall be limited to the amount
necessary to satisfy the financial hardship. Distributions made pursuant to
this Section 3.11 shall be without penalty.
SECTION 3.12 INABILITY TO LOCATE PARTICIPANT.
In the event that the Committee is unable to locate a Participant or
Beneficiary within two years following the Participant's Payment Eligibility
Date, the amount allocated to the Participant's Deferral Account shall be
forfeited. If, after such forfeiture, the Participant or Beneficiary later
claims such benefit, such benefit shall be reinstated without interest or
earnings.
SECTION 3.13 DISTRIBUTIONS UPON A CHANGE OF CONTROL.
a. If a Change of Control occurs, the Deferral Account balance of
each Participant will be paid by the Trustee of the Trust (as defined herein) to
the Participant (or Beneficiary) in accordance with such Participants' deferral
election.
b. Following a Change in Control, no changes in the Plan, or in any
documents evidencing an election to defer compensation, and no adjustments,
determinations or other exercises of discretion by the Compensation Committee,
the Committee or the Company's board of directors that were made subsequent to
the Change in Control and that would have the effect of diminishing a
Participant's rights or payments under this Plan or this Section 3.13, or of
causing a Participant to recognize income (for federal income tax purposes) with
respect to a Participant's Deferral Account prior to the actual distribution to
a Participant of such Deferral Account, shall be effective.
ARTICLE IV
TRUST
SECTION 4.1 TRUST.
a. The Company shall cause the payment of benefits under this Plan
to be made in whole or in part by the Trustee of the PacifiCare Health Systems,
Inc. Rabbi Trust (the "Trust") in accordance with the provisions of this Section
4.1. As soon as practicable after the end of each Plan Year (but no later than
the tax return due date of the Company for such year), the Employers shall
contribute to the Trust for each Participant an amount equal to the amount
deferred by the Participant for the Plan Year. Notwithstanding anything
contained herein, contributions to the Trust by each Employer may be made
throughout the Plan Year.
b. The Committee shall direct the Trustee to pay the Participant or
his or her Beneficiary at the time and in the amount described in the Article
III. In the event
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the amounts held under the Trust are not sufficient to provide the full amount
(excluding amounts described in Section 3.8(c)) payable to the Participant, the
Employers shall pay for the remainder of such amount at the times set forth in
Section 3.8, (excluding amounts described in Section 3.8(c)).
ARTICLE V
ADMINISTRATION
SECTION 5.1 COMMITTEE.
A number of individuals shall be appointed by, and serve at the pleasure
of, the Compensation Committee as a committee to administer this Plan (the
"Committee"). The number of members comprising the Committee shall be determined
by the Compensation Committee, which may from time to time vary the number of
members. A member of the Committee may resign by delivering a written notice of
resignation to the Compensation Committee. The Compensation Committee may remove
any member by delivering a certified copy of its resolution of removal to such
member. Vacancies in the membership of the Committee shall be filled promptly by
the Compensation Committee.
SECTION 5.2 COMMITTEE ACTION.
The Committee shall act at meetings by affirmative vote of a majority of
the members of the Committee. Any action permitted to be taken at a meeting may
be taken without a meeting if, prior to such action, a written consent to the
action is signed by all members of the Committee and such written consent is
filed with the minutes of the proceedings of the Committee. A member of the
Committee shall not vote or act upon any matter, which relates solely to himself
or herself as a Participant. The Chairman or any other member or members of the
Committee designated by the Chairman may execute any certificate or other
written direction on behalf of the Committee.
SECTION 5.3 POWERS AND DUTIES OF THE COMMITTEE.
a. The Committee, on behalf of the Participants and their
Beneficiaries, shall enforce the Plan in accordance with its terms, shall be the
"Plan Administrator" charged with the general administration of the Plan, and
shall have all discretionary authority and powers necessary to accomplish its
purposes, including, but not by way of limitation, the following:
i. To select the funds or contracts to be the Funds in
accordance with Section 3.3(b);
ii. To construe and interpret the terms and provisions of
this Plan;
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iii. To compute and certify to the amount and kind of benefits
payable to Participants and their Beneficiaries;
iv. To maintain all records that may be necessary for the
administration of the Plan;
v. To provide for the disclosure of all information and the
filing or provision of all reports and statements to Participants,
Beneficiaries or governmental agencies as shall be required by law;
vi. To make and publish such rules for the regulation of this
Plan and procedures for the administration of this Plan as are not
inconsistent with, the terms hereof;
vii. To appoint a plan administrator or any other agent, and
to delegate to them such powers and duties in connection with the
administration of this Plan as the Committee may from time to time
prescribe; and
viii. To take all actions set forth in the Trust agreement,
including determining whether to hold or discontinue the policies.
SECTION 5.4 CONSTRUCTION AND INTERPRETATION.
The Committee shall have full discretion to construe and interpret the
terms and provisions of this Plan, which interpretation or construction shall be
final and binding on all parties, including but not limited to the Company and
any Participant or Beneficiary. The Committee shall administer such terms and
provisions in a uniform and nondiscriminatory manner and in full accordance with
any and all laws applicable to the Plan.
SECTION 5.5 INFORMATION.
To enable the Committee to perform its functions, the Employers shall
supply full and timely information to the Committee on all matters relating to
the compensation of all Participants, their death or other cause of termination,
and such other pertinent facts as the Committee may require.
SECTION 5.6 COMPENSATION, EXPENSES AND INDEMNITY.
a. The members of the Committee shall serve without compensation
for their services hereunder.
b. The Committee is authorized at the expense of the Company to
employ such legal counsel, as it may deem advisable to assist in the performance
of its duties
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hereunder. Expenses and fees in connection with the administration of the Plan
shall be paid by the Company.
c. To the extent permitted by applicable state law, the Company
shall indemnify and hold harmless the Committee and each member thereof, the
Board of Directors, the Compensation Committee and any delegate of the Committee
who is an employee of the Company against any and all expenses, liabilities and
claims, including legal fees to defend against such liabilities and claims
arising out of their discharge in good faith of responsibilities under or
incident to this Plan, other than expenses and liabilities arising out of bad
faith willful misconduct. This indemnity shall not preclude such further
indemnities as may be available under insurance purchased by the Company or
provided by the Company under any bylaw, agreement or otherwise, as such
indemnities are permitted under state law.
SECTION 5.7 QUARTERLY STATEMENTS.
Under procedures established by the Committee, a Participant shall
receive a statement with respect to such Participant's Deferral Accounts on a
quarterly basis as of each March 31, June 30, September 30 and December 31.
SECTION 5.8 SUSPENSION OF DEFERRALS.
At the request of a Participant, the Committee may at its sole
discretion, pursuant to rules adopted by it and applied in a uniform manner,
suspend an election to defer Salary made pursuant to Article III during the Plan
Year for which the election to defer was made because of circumstances arising
out of an event beyond the control of the Participant, as determined by the
Committee in accordance with uniform rules adopted by it. If the Committee
permits the suspension of an election to defer, a Participant will be ineligible
to participate in this Plan for the balance of the Plan Year and for the
following Plan Year.
SECTION 5.9 CLAIM PROCEDURES.
a. Claim. A person who believes that he or she is being denied a
benefit to which he or she is entitled under this Plan (hereinafter referred to
as "Claimant") may file a written request for such benefit with the Plan
Administrator, setting forth his or her claim.
b. Claim Decision. Upon receipt of a claim, the Plan Administrator
shall advise the Claimant that a reply will be forthcoming within 90 days and
shall, in fact, deliver such reply within such period. The Plan Administrator
may, however, extend the reply period for an additional 90 days for special
circumstances.
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If the claim is denied in whole or in part, the Plan Administrator shall
inform the Claimant in writing, using language calculated to be understood by
the Claimant, setting forth: (A) the specified reason or reasons for such
denial; (B) the specific reference to pertinent provisions of this Plan on which
such denial is based; (C) a description of any additional material or
information necessary for the Claimant to perfect his or her claim and an
explanation why such material or such information is necessary; (D) appropriate
information as to the steps to be taken if the Claimant wishes to submit the
claim for review; and (E) the time limits for requesting a review under
subsection 5.9(c).
c. Request for Review. Within 60 days after the receipt by the
Claimant of the written opinion described above, the Claimant may request in
writing that the Committee review the determination of the Plan Administrator.
The Claimant or his or her duly authorized representative may, but need not,
review the pertinent documents and submit issues and comments in writing for
consideration by the Committee. If the Claimant does not request a review within
such 60 day period, he or she shall be barred and estopped from challenging the
Plan Administrator's determination.
d. Review of Decision. Within 60 days after the Committee's
receipt of a request for review, after considering all materials presented by
the Claimant, the Committee will inform the Participant in writing, in a manner
calculated to be understood by the Claimant, of its decision setting forth the
specific reasons for the decision and containing specific references to the
pertinent provisions of this Plan on which the decision is based. If special
circumstances require that the 60 day time period be extended, the Committee
will so notify the Claimant and will render the decision as soon as possible,
but no later than 120 days after receipt of the request for review.
ARTICLE VI
MISCELLANEOUS
SECTION 6.1 UNSECURED GENERAL CREDITOR.
Participants and their Beneficiaries, heirs, successors, and assigns
shall have no legal or equitable rights, claims, or interest in any specific
property or assets of any Employer. Any and all of the assets of each Employer
shall be, and remain, the general unpledged, unrestricted assets of such
Employer. Each Employer's obligation under this Plan shall be merely that of an
unsecured promise to pay money in the future, and the rights of the Participants
and Beneficiaries shall be no greater than those of unsecured general creditors.
It is the intention of the Company that this Plan (and the Trust described in
Article VI) be unfunded for purposes of the Code and for purposes of Title I of
ERISA.
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SECTION 6.2 RESTRICTION AGAINST ASSIGNMENT.
The Employers shall pay all amounts payable hereunder only to the person
or persons designated by the Plan and not to any other person or corporation. No
part of a Participant's Deferral Account shall be liable for the debts,
contracts, or engagements of any Participant, his or her Beneficiary, or
successors in interest, nor shall a Participant's Deferral Account be subject to
execution by levy, attachment, or garnishment or by any other legal or equitable
proceeding, nor shall any such person have any right to alienate, anticipate,
sell, transfer, commute, pledge, encumber, or assign any benefits or payments
hereunder in any manner whatsoever. If any Participant, Beneficiary or successor
in interest is adjudicated bankrupt or purports to anticipate, alienate, sell,
transfer, commute, assign, pledge, encumber or charge any distribution or
payment from the Plan, voluntarily or involuntarily, the Committee, in its
discretion, may cancel such distribution or payment (or any part thereof) to or
for the benefit of such Participant, Beneficiary or successor in interest in
such manner as the Committee shall direct.
SECTION 6.3 CHANGE OF CONTROL.
For purposes of this Plan, "Change of Control" means the occurrence of
any of the following: (i) a business combination effectuated through the merger
or consolidation of the Company with or into another entity where the Company is
not the Surviving Organization; (ii) any business combination effectuated
through the merger or consolidation of the Company with or into another entity
where the Company is the Surviving Organization and such business combination
occurred with an entity whose market capitalization prior to the transaction was
greater than 50 percent of the Company's market capitalization prior to the
transaction; (iii) the sale in a transaction or series of transactions of all or
substantially all of the Company's assets; (iv) any "person" or "group" (within
the meaning of Sections 13(d) and 14(d) of the Exchange Act) other than
UniHealth, a California non-profit public benefit corporation ("UniHealth"),
acquires beneficial ownership (within the meaning of Rule 13d-3 of the Exchange
Act), directly or indirectly, of 20 percent or more of the voting common stock
of the Company and the beneficial ownership of the voting common stock of the
Company owned by UniHealth at that date is less than or equal to the beneficial
ownership interest of voting securities attributable to such other person or
group; (v) a dissolution or liquidation of the Company; or (vi) the Company
ceases to be subject to the reporting requirements of the Exchange Act as a
result of a "going private transaction" (within the meaning of the Exchange
Act). For purposes hereof, "Surviving Organization" shall mean any entity where
the majority of the members of such entity's board of directors are persons who
were members of the Company's board of directors prior to the merger,
consolidation or other business combination and the senior management of the
surviving entity includes all of the individuals who were the
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Company's executive management (the Company's chief executive officer and those
individuals who report directly to the Company's chief executive officer) prior
to the merger, consolidation or other business combination and such individuals
are in at least comparable positions with such entity. The Committee may make
such determinations and interpretations and adopt such rules and conditions as
it, in its absolute discretion, deems appropriate in connection with a Change in
Control. All such determinations and interpretations by the Committee shall be
conclusive.
SECTION 6.4 BENEFICIARY.
For purposes of the this Plan, "Beneficiary" or "Beneficiaries" mean the
person or persons, including a trustee, personal representative or other
fiduciary, last designated in writing by a Participant in accordance with
procedures established by the Committee to receive the benefits specified
hereunder in the event of the Participant's death. No beneficiary designation
shall become effective until it is filed with the Committee. If there is no
such designation or if there is no surviving designated Beneficiary, then the
Participant's surviving spouse shall be the Beneficiary. If there is no
surviving spouse to receive any benefits payable in accordance with the
preceding sentence, the participant's estate shall be the Beneficiary. In the
event any amount is payable under the Plan to a minor, payment shall not be made
to the minor, but instead be paid (a) to that person's living parent(s) to act
as custodian, (b) if that person's parents are then divorced, and one parent is
the sole custodial parent, to such custodial parent, or (c) if no parent of that
person is then living, to a custodian selected by the Committee to hold the
funds for the minor under the Uniform Transfers or Gifts to Minors Act in effect
in the jurisdiction in which the minor resides. If no parent is living and the
Committee decides not to select another custodian to hold the funds for the
minor, then payment shall be made to the duly appointed and currently acting
guardian of the estate for the minor or, if no guardian of the estate for the
minor is duly appointed and currently acting within 60 days after the date the
amount becomes payable, payment shall be deposited with the court having
jurisdiction over the estate of the minor.
SECTION 6.5 WITHHOLDING.
There shall be deducted from each payment made under this Plan or any
other compensation payable to the Participant (or Beneficiary) all taxes which
are required to be withheld by the Company in respect to such payment under this
Plan. The Company shall have the right to reduce any payment (or compensation)
by the amount of cash sufficient to provide the amount of said taxes.
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SECTION 6.6 AMENDMENT, MODIFICATION, SUSPENSION OR TERMINATION.
The Compensation Committee may amend, modify, suspend or terminate this
Plan in whole or in part, except that no amendment, modification, suspension or
termination shall have any retroactive effect to reduce any amounts allocated to
a Participant's Deferral Accounts (neither the policies themselves, nor the
death benefit described in Section 3.8(c) shall be treated as allocated to
Deferral Accounts). In the event that this Plan is terminated, the amounts
allocated to a Participant's Deferral Accounts shall be distributed to the
Participant or, in the event of his or her death, his or her Beneficiary in a
lump sum within 30 days following the date of termination.
SECTION 6.7 GOVERNING LAW.
This Plan shall be construed, governed and administered in accordance
with the laws of the United States and to the extent not preempted by such law
by the laws of the State of California.
SECTION 6.8 RECEIPT OR RELEASE.
Any payment to a Participant or the Participant's Beneficiary in
accordance with the provisions of this Plan shall to the extent thereof, be in
full satisfaction of all claims for benefits under this Plan against the
Committee and the Company. The Committee may require such Participant or
Beneficiary, as a condition precedent to such payment, to execute a receipt and
release to such effect.
SECTION 6.9 EFFECTIVE DATE.
This Plan shall be effective as of December 18, 1997.
IN WITNESS WHEREOF, this Plan is adopted as of December 18, 1997.
PACIFICARE HEALTH SYSTEMS, INC.
---------------------------------
By:
Title:
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PACIFICARE HEALTH SYSTEMS, INC.
STOCK UNIT DEFERRED COMPENSATION PLAN
WHEREAS, PacifiCare Health Systems, Inc., (the "Company") desires to
establish a non-qualified stock unit deferred compensation plan to provide
supplemental retirement income benefits for a select group of management and
highly compensated employees through deferrals of salary and bonuses, effective
as of December 18, 1997;
WHEREAS, it is believed that the adoption of this plan providing for
deferral of compensation at the election of each executive will be in the best
interests of the Company; and
WHEREAS, the Company intends that this plan shall be maintained as a "top
hat" plan described in Sections 201(2), 301(a)(3) and 401(a)(1) of ERISA:
NOW, THEREFORE, it is hereby declared as follows:
ARTICLE I
DEFINITIONS
Whenever the following words and phrases are used in this Plan, they shall
have the meanings specified below.
Section 1.1 "Beneficiary" or "Beneficiaries" for purposes of this Plan shall
have the meaning set forth in Section 4.5.
Section 1.2 "Board of Directors" or "Board" means the Board of Directors of
the Company.
Section 1.3 "Bonus" means any cash incentive compensation payable to a
Participant in addition to the Participant's Salary, other than the bonus paid
under the LTPIP, moving expenses, sign-on bonuses or bonuses paid in connection
with a promotion, prior to any reduction for any deferrals to a plan qualified
under Section 125 or Section 401 (k) of the Code.
Section 1.4 "Change of Control" shall have the meaning set forth in Section
4.3.
Section 1.5 "Class B Common Stock" means the Company's Class B Common Stock,
par value $0.01 per share.
Section 1.6 "Code" means the Internal Revenue Code of 1986, as amended from
time to time.
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Section 1.7 "Committee" means the Committee appointed by the Compensation
Committee to administer the Plan in accordance with Article III.
Section 1.8 "Company" means PacifiCare Health Systems, Inc., a Delaware
corporation, or any successor corporation.
Section 1.9 "Compensation Committee" shall mean the Compensation Committee of
the Board of Directors of the Company.
Section 1.10 "Disability." A Participant shall be deemed to be incapacitated
or disabled, if such Participant's incapacity or disability prevents a
Participant from fully performing his or her duties to an Employer for a period
in excess of 90 days and, after such 90-day period, the Company and a physician,
duly licensed and qualified in the specialty of the Participant's incapacity or
disability, decide in their reasonable judgments, that such incapacity or
disability will be permanent or of such continued duration as to prevent a
Participant from resuming the rendition of services to the Employer for at least
an additional six-month period.
Section 1.11 "Eligible Employee" means any Employee of an Employer who the
Company has designated to be in executive salary grade of 15 or above, is a
member of the Company's Senior Council and is scheduled to work at least 32
hours per week.
Section 1.12 "Employee" shall mean any employee (as defined in accordance with
the Treasury Regulations and Revenue Rulings then applicable under Section 3401
(c) of the Code) of an Employer, whether such employee is so employed at the
time this Plan is adopted or becomes so employed subsequent to the adoption of
this Plan.
Section 1.13 "Employer" means the Company (or any successor by merger,
consolidation or purchase of substantially all of the Company's assets) and any
and all Subsidiaries of the Company.
Section 1.14 "ERISA" shall mean the Employee Retirement Income Security Act of
1974, as amended from time to time.
Section 1.15 "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended from time to time.
Section 1.16 "LTPIP" means the Company's Long-Term Performance Incentive
Compensation Plan, as amended from time to time.
Section 1.17 "Participant" means for purposes of this Plan, any Eligible
Employee who satisfies the requirements of Section 2.1.
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Section 1.18 "Payment Eligibility Date" means the first day of the month
following the end of the calendar quarter in which a Participant terminates
employment for any reason with all Employers or dies.
Section 1.19 "Plan" means this Stock Unit Deferred Compensation Plan of
PacifiCare Health Systems, Inc., as may be amended from time to time.
Section 1.20 "Plan Year" means the 12 consecutive month period beginning on
January 1 and ending on December 31 of the same year.
Section 1.21 "Retirement" or "Retire", for purposes of this Plan, mean
termination of a Participant's employment from all Employers, which occurs after
the sum of the following two factors meet or exceed fifty-five (55): (i) the
Participant's age and (ii) the Participant's number of years of service with all
Employers.
Section 1.22 "Salary" shall mean the Participant's Salary prior to any
reduction for deferrals to a plan qualified under Section 125 or Section 401 (k)
of the Code.
Section 1.23 "Stock Unit" means a unit representing the right to receive a
share of Class B Common Stock in accordance with the terms of this Plan.
Section 1.24 "Stock Unit Account" is the cumulative number of Stock Units
assigned to a Participant in accordance with Section 2.2.
Section 1.25 "Subsidiary" shall mean any corporation in an unbroken chain of
corporations beginning with the Company if each of the corporations other than
the last corporation in the unbroken chain then owns stock possessing 50 percent
or more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.
ARTICLE II
DEFERRAL OF COMPENSATION
SECTION 2.1 ELIGIBILITY.
a. The Company's Chief Executive Officer (the "CEO") may elect to
defer (on a pre-tax basis) all, or a portion, of his or her Salary to be paid
during a Plan Year by filing an election to participate in this Plan on a form
provided by the Committee and filed with the Committee no later than December 15
of the preceding Plan Year. The election form filed by the CEO shall signify
the CEO's acceptance of the terms of this Plan and the portion of Salary that he
elects to defer. Notwithstanding the foregoing, the Committee may, in its sole
and absolute discretion, permit the Chief Executive Officer to file an
application on or after December 15 if, in its judgment, his or her failure to
do so prior to said date was due to reasonable cause, but in no event
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may such application be filed after December 31. All elections, once made, are
irrevocable.
b. The Compensation Committee shall determine at least 60 days prior
to the beginning of each Plan Year, the Eligible Employees, including the CEO,
who may defer all or a portion of Bonus pursuant to the provisions of this Plan
for the next Plan Year. The Committee shall notify each Eligible Employee of
his or her eligibility to participate in this Plan at least 30 days prior to the
time he or she must file an application for participation. The CEO and any
Eligible Employee must file a written application with the Committee no later
than December 15 of the preceding Plan Year to participate in this Plan for the
next succeeding Plan Year. Notwithstanding the foregoing, the Committee may, in
its sole and absolute discretion, permit an Eligible Employee to file an
application on or after December 15 if, in its judgment, his or her failure to
do so prior to said date was due to reasonable cause, but in no event may such
application be filed after December 31. All elections, once made, are
irrevocable.
SECTION 2.2 STOCK ACCOUNT.
a. Any amount of Salary deferred by the CEO pursuant to Section 2.1
(a) shall be converted into Stock Units of the Company's Class B Common Stock.
The number of shares of Class B Common Stock into which the deferred amount
shall be converted shall equal the amount of Salary deferred by the CEO
multiplied by a risk premium (the "Risk Premium") determined by the Compensation
Committee at least 45 days prior to the beginning of the next Plan Year, divided
by the closing price of the Class B Common Stock as quoted on Nasdaq on a date
selected by the Committee. The Stock Units deferred pursuant to this provision
shall be credited to a bookkeeping account established for this purpose (the
"Stock Unit Account") in the name of the CEO. The number of Stock Units
established by deferrals of Salary under this Plan shall remain constant over
the deferral period, except as provided in Section 4.4.
b. Any amount of Bonus deferred pursuant to this Section 2.2 by any
Participant shall be converted into Stock Units of the Company's Class B Common
Stock. The number of shares of Class B Common Stock into which the deferred
amount shall be converted shall equal the amount of Bonus deferred multiplied by
the Risk Premium divided by the closing price of the Class B Common Stock as
quoted on Nasdaq on a date selected by the Committee. The Stock Units deferred
pursuant to this provision shall be credited to the Stock Unit Account in the
name of each Participant. The number of Stock Units established by deferrals of
Bonus and Salary under this Plan shall remain constant over the deferral period,
except as provided in Section 4.4.
c. No fractional shares shall be deferred under this Plan.
Accordingly, if the conversion of Salary and/or a Bonus into Stock Units results
in fractional shares, such unit shall be rounded up to the next highest round
number.
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SECTION 2.3 DISTRIBUTION OF DEFERRED COMPENSATION.
(a) In the case of a Participant who terminates employment with all
Employers on or after Retirement or who terminates as a result of death or a
Disability, the aggregate amount credited to the Stock Unit Account (the
"Distributable Amount") shall be paid to the Participant (and after his death
to his or her Beneficiary) in the form of substantially equal quarterly
installments over five years beginning within 30 days from his or her Payment
Eligibility Date. Notwithstanding the foregoing, a Participant described in the
preceding sentence may elect one of the following optional forms of distribution
provided that his or her election is filed with the Committee at least one year
prior to his or her termination of employment with all Employers:
(i) a lump sum of the Distributable Amount payable within 30
days from the Participant's Payment Eligibility Date; or
(ii) substantially equal quarterly installments over three years
beginning within 30 days from the Participant's Payment Eligibility
Date.
For all purposes under this Plan, a Participant shall not be considered
terminated from employment with all Employers if the Participant remains
employed by an entity that is an Employer. However, if the Employee is employed
by an Employer and such Employer ceases to be an Employer as a result of a sale
or other corporate reorganization, such sale or other corporate reorganization
shall be treated as termination of employment with all Employers unless
immediately following such event and without any break in employment the
Participant remains employed by an Employer.
(b) In the case of a Participant who terminates employment with all
Employers prior to Retirement for reasons other than a Disability, the
Distributable Amount shall be paid to the Participant in a lump sum on the
Participant's Payment Eligibility Date.
(c) A Participant who has not terminated employment with all
Employers may change his or her form of payment applicable to the portion of the
Stock Unit Account balance attributable to one or more Plan Years to one of the
payment forms permitted by this Plan at least one year prior to the payment date
to be deferred. The Participant's payment election with respect to a given Plan
Year may not be changed after payment of that portion of the Stock Unit Account
balance has been made or has begun.
SECTION 2.4 SCHEDULED EARLY DISTRIBUTIONS.
Participants may elect to have Salary and/or Bonus deferred during a given
Plan Year be paid on a future date while still employed, provided the payment
date (the "Scheduled Payment Date") is at least two years from the last day of
such Plan Year.
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This election shall apply to the compensation deferred for the Plan Year
specified by the Participant on his or her payment election. A Participant may
elect a different Payment Date for compensation deferred for each Plan Year. In
addition, Scheduled Payment Dates elected pursuant to this Section 2.4 may be
deferred by at least one year, by filing with the Committee written notice at
least one year prior to the Scheduled Payment Date. A Participant may elect to
defer a Scheduled Payment Date selected by this Section 2.4 once every two
years. A distribution pursuant to this Section 2.4 of less than the
Participant's entire interest in the Stock Unit Account shall be made pro rata
from his or her Stock Unit Accounts. All early distributions pursuant to this
Section 2.4 shall be made in a lump sum payment. Notwithstanding the foregoing,
if a Participant terminates employment with the all Employers for any reason
prior to the date on which a payment is scheduled to be made pursuant to this
Section 2.4, the Participant's entire Stock Unit Account balance will be paid
pursuant to the provisions of Section 2.3.
SECTION 2.5 DISTRIBUTIONS UPON A CHANGE OF CONTROL.
a. If a Change of Control occurs, the Stock Unit Account balance of
each Participant will be paid to the Participant (or Beneficiary) in a lump sum
within 30 days after such Change of Control.
b. Following a Change in Control, no changes in the Plan, or in any
documents evidencing an election to defer compensation, and no adjustments,
determinations or other exercises of discretion by the Compensation Committee,
the Committee or the Company's board of directors that were made subsequent to
the Change in Control and that would have the effect of diminishing a
Participant's rights or payments under this Plan or this Section 2.5, or of
causing a Participant to recognize income (for federal income tax purposes) with
respect to a Participant's Stock Unit Account prior to the actual distribution
to a Participant of such Stock Unit Account, shall be effective.
SECTION 2.6. FORM OF DISTRIBUTION
Upon the occurrence of any event giving rise to a distribution, amounts
deferred under this Plan shall be distributed in shares of Class B Common Stock
equal to the number of Stock Units of Class B Common Stock converted on the date
of deferral as determined by Article II. Such shares shall be distributed as
provided in Sections 2.3, 2.4, 2.5 and 2.7.
SECTION 2.7 FINANCIAL HARDSHIP WITHDRAWALS.
The Committee may, pursuant to rules adopted by it and applied in a uniform
manner, accelerate the date of distribution of all or any portion of a
Participant's Stock Unit Account, because of a financial hardship. A financial
hardship means an unforeseeable, severe financial emergency resulting from (a) a
sudden and unexpected
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illness or accident of the Participant or his or her dependent (as defined in
Section 152(a) of the Code); (b) loss of the Participant's property due to
casualty; or (c) other similar extraordinary and unforeseeable circumstances
arising out of event beyond the control of the Participant, which may not be
relieved through other available resources of the Participant, as determined by
the Committee in accordance with uniform rules adopted by it. Payment of any
amount with respect to which a Participant has filed a request under this
Section 2.7 shall be made as soon as practicable after approval of such request
by the Committee, but shall be limited to the amount necessary to satisfy the
financial hardship. Distributions made pursuant to this Section 2.7 shall be
without penalty.
SECTION 2.8 ROLLOVERS
Participants of any existing CEO Stock Unit Deferred Compensation Plan
administered by the Company, who have a positive account balance in such plan as
of December 31, 1997 and who are employed by an Employer as of December 31, 1997
shall have such positive account balance transferred to and added to a Stock
Unit Account under this Plan. Participant's account balances transferred to
this Plan pursuant to this Section 3.8 shall be governed by the terms and
conditions of this Plan, shall be referred to as the "Existing PHS Rollover
Amount" and shall be credited to such Participant's Stock Unit Account as of
December 31, 1997.
ARTICLE III
ADMINISTRATION
SECTION 3.1 COMMITTEE.
A number of individuals shall be appointed by, and serve at the pleasure
of, the Compensation Committee as a committee to administer the Plan (the
"Committee"). The number of members comprising the Committee shall be determined
by the Compensation Committee, which may from time to time vary the number of
members. A member of the Committee may resign by delivering a written notice of
resignation to the Compensation Committee. The Compensation Committee may
remove any member by delivering a certified copy of its resolution of removal to
such member. Vacancies in the membership of the Committee shall be filled
promptly by the Compensation Committee.
SECTION 3.2 COMMITTEE ACTION.
The Committee shall act at meetings by affirmative vote of a majority of
the members of the Committee. Any action permitted to be taken at a meeting may
be taken without a meeting if, prior to such action, a written consent to the
action is signed by all members of the Committee and such written consent is
filed with the minutes of the proceedings of the Committee. A member of the
Committee shall not vote or act upon any matter, which relates solely to himself
or herself as a Participant. The Chairman or
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any other member or members of the Committee designated by the Chairman may
execute any certificate or other written direction on behalf of the Committee.
SECTION 3.3 POWERS AND DUTIES OF THE COMMITTEE.
a. The Committee, on behalf of the Participants and their
Beneficiaries, shall enforce the Plan in accordance with its terms, shall be the
"Plan Administrator" charged with the general administration of the Plan, and
shall have all discretionary authority and powers necessary to accomplish its
purposes, including, but not by way of limitation, the following:
i. To construe and interpret the terms and provisions of this
Plan;
ii. To compute and certify to the amount and kind of benefits
payable to Participants and their Beneficiaries;
iii. To maintain all records that may be necessary for the
administration of the Plan;
iv. To provide for the disclosure of all information and the
filing or provision of all reports and statements to Participants,
Beneficiaries or governmental agencies as shall be required by law;
v. To make and publish such rules for the regulation of this
Plan, and procedures for the administration of this Plan, as are not
inconsistent with the terms hereof; and
vi. To appoint a plan administrator or any other agent, and to
delegate to them such powers and duties in connection with the
administration of this Plan as the Committee may from time to time
prescribe.
SECTION 3.4 CONSTRUCTION AND INTERPRETATION.
The Committee shall have full discretion to construe and interpret the
terms and provisions of this Plan, which interpretation or construction shall be
final and binding on all parties, including but not limited to the Company and
any Participant or Beneficiary. The Committee shall administer such terms and
provisions in a uniform and nondiscriminatory manner and in full accordance with
any and all laws applicable to the Plan.
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SECTION 3.5 INFORMATION.
To enable the Committee to perform its functions, the Employers shall
supply full and timely information to the Committee on all matters relating to
the Compensation of all Participants, their death or other cause of termination,
and such other pertinent facts as the Committee may require.
SECTION 3.6 COMPENSATION, EXPENSES AND INDEMNITY.
a. The members of the Committee shall serve without compensation for
their services hereunder.
b. The Committee is authorized at the expense of the Company to
employ such legal counsel as it may deem advisable to assist in the performance
of its duties hereunder. Expenses and fees in connection with the administration
of the Plan shall be paid by the Company.
c. To the extent permitted by applicable state law, the Company
shall indemnify and hold harmless the Committee and each member thereof, the
Board of Directors, Compensation Committee and any delegate of the Committee who
is an employee of the Company against any and all expenses, liabilities and
claims, including legal fees to defend against such liabilities and claims
arising out of their discharge in good faith of responsibilities under or
incident to this Plan, other than expenses and liabilities arising out of bad
faith or willful misconduct. This indemnity shall not preclude such further
indemnities as may be available under insurance purchased by the Company or
provided by the Company under any bylaw, agreement or otherwise, as such
indemnities are permitted under state law.
SECTION 3.7 QUARTERLY STATEMENTS.
Under procedures established by the Committee, a Participant shall receive
a statement with respect to such Participant's Stock Unit Accounts on a
quarterly basis as of each March 31, June 30, September 30 and December 31.
SECTION 3.8 CLAIM PROCEDURES.
a. Claim. A person who believes that he or she is being denied a
benefit to which he or she is entitled under this Plan (hereinafter referred to
as "Claimant") may file a written request for such benefit with the Plan
Administrator, setting forth his or her claim.
b. Claim Decision. Upon receipt of a claim, the Plan Administrator
shall advise the Claimant that a reply will be forthcoming within 90 days and
shall, in fact, deliver such reply within such period. The Plan Administrator
may, however, extend the reply period for an additional 90 days for special
circumstances. If the claim is
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denied in whole or in part, the Plan Administrator shall inform the Claimant in
writing, using language calculated to be understood by the Claimant, setting
forth: (A) the specified reason or reasons for such denial; (B) the specific
reference to pertinent provisions of this Plan on which such denial is based;
(C) a description of any additional material or information necessary for the
Claimant to perfect his or her claim and an explanation why such material or
such information is necessary; (D) appropriate information as to the steps to be
taken if the Claimant wishes to submit the claim for review; and (E) the time
limits for requesting a review under subsection 3.9(c).
c. Request for Review. Within 60 days after the receipt by the
Claimant of the written opinion described above, the Claimant may request in
writing that the Committee review the determination of the Plan Administrator.
The Claimant or his or her duly authorized representative may, but need not,
review the pertinent documents and submit issues and comments in writing for
consideration by the Committee. If the Claimant does not request a review within
such 60 day period, he or she shall be barred and estopped from challenging the
Plan Administrator's determination.
d. Review of Decision. Within 60 days after the Committee's receipt
of a request for review, after considering all materials presented by the
Claimant, the Committee will inform the Participant in writing, in a manner
calculated to be understood by the Claimant, of its decision, setting forth the
specific reasons for the decision and containing specific references to the
pertinent provisions of this Agreement on which the decision is based. If
special circumstances require that the 60 day time period be extended, the
Committee will so notify the Claimant and will render the decision as soon as
possible, but no later than 120 days after receipt of the request for review.
ARTICLE IV
MISCELLANEOUS
SECTION 4.1 UNSECURED GENERAL CREDITOR.
Participants and their Beneficiaries, heirs, successors, and assigns shall
have no legal or equitable rights, claims, or interest in any specific property
or assets of any Employer. Any and all of the assets of each Employer shall be,
and remain, the general unpledged, unrestricted assets of such Employer. Each
Employer's obligation under this Plan shall be merely that of an unfunded and
unsecured promise of such Employer to pay money in the future, and the rights of
the Participants and Beneficiaries shall be no greater than those of unsecured
general creditors. It is the intention of the Company that this Plan (and the
Trust described in Article VI) be unfunded for purposes of the Code and for
purposes of Title I of ERISA.
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SECTION 4.2 RESTRICTION AGAINST ASSIGNMENT.
The Employers shall pay all amounts payable hereunder only to the person or
persons designated by this Plan and not to any other person or corporation. No
part of a Participant's Account shall be liable for the debts, contracts, or
engagements of any Participant, his or her Beneficiary, or successors in
interest, nor shall a Participant's Account be subject to execution by levy,
attachment, or garnishment or by any other legal or equitable proceeding, nor
shall any such person have any right to alienate, anticipate, sell, transfer,
commute, pledge, encumber, or assign any benefits or payments hereunder in any
manner whatsoever. If any Participant, Beneficiary or successor in interest is
adjudicated bankrupt or purports to anticipate, alienate, sell, transfer,
commute, assign, pledge, encumber or charge any distribution or payment from the
Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel
such distribution or payment (or any part thereof) to or for the benefit of such
Participant, Beneficiary or successor in interest in such manner as the
Committee shall direct.
SECTION 4.3 CHANGE OF CONTROL.
For purposes of this Plan, "Change of Control" means the occurrence of any
of the following: (i) a business combination effectuated through the merger or
consolidation of the Company with or into another entity where the Company is
not the Surviving Organization; (ii) any business combination effectuated
through the merger or consolidation of the Company with or into another entity
where the Company is the Surviving Organization, and such business combination
occurred with an entity whose market capitalization prior to the transaction was
greater than 50 percent of the Company's market capitalization prior to the
transaction; (iii) the sale in a transaction or series of transactions of all or
substantially all of the Company's assets; (iv) any "person" or "group" (within
the meaning of Sections 13(d) and 14(d) of the Exchange Act) other than
UniHealth, a California non-profit public benefit corporation ("UniHealth"),
acquires beneficial ownership (within the meaning of Rule 13d-3 of the Exchange
Act), directly or indirectly, of 20 percent or more of the voting common stock
of the Company and the beneficial ownership of the voting common stock of the
Company owned by UniHealth at that date is less than or equal to the beneficial
ownership interest of voting securities attributable to such other person or
group; (v) a dissolution or liquidation of the Company; or (vi) the Company
ceases to be subject to the reporting requirements of the Exchange Act as a
result of a "going private transaction" (within the meaning of the Exchange
Act). For purposes hereof, "Surviving Organization" shall mean any entity where
the majority of the members of such entity's board of directors are persons who
were members of the Company's board of directors prior to the merger,
consolidation or other business combination and the senior management of the
surviving entity includes all of the individuals who were the Company's
executive management (the Company's chief executive officer and those
individuals who report directly to the Company's chief executive officer) prior
to the merger, consolidation or other business combination and such individuals
are in at least
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comparable positions with such entity. The Committee may make such
determinations and interpretations and adopt such rules and conditions as it, in
its absolute discretion, deems appropriate in connection with a Change in
Control. All such determinations and interpretations by the Committee shall be
conclusive.
SECTION 4.4 CHANGE IN COMPANY SHARES.
If the outstanding shares of Class B Common Stock are hereafter changed
into or exchanged for a different number or kind of shares or other securities
of the Company, or of another company, by reason of reorganization, merger,
consolidation, recapitalization, reclassification, stock split, stock dividend
or combination of shares, or if the Company distributes a cash or non-cash
dividend to holders of Class B Common Stock or engages in another similar
transaction, the Compensation Committee shall make an appropriate and equitable
adjustment in the number and kind of units credited to the Stock Unit Account.
Any such adjustment made by the Compensation Committee shall be final and
binding upon the a Participant, the Company and all other interested persons.
SECTION 4.5 BENEFICIARY.
For purposes of this Plan, "Beneficiary" or "Beneficiaries" mean the person
or persons, including a trustee, personal representative or other fiduciary,
last designated in writing by a Participant in accordance with procedures
established by the Committee to receive the benefits specified hereunder in the
event of the Participant's death. No beneficiary designation shall become
effective until it is filed with the Committee. If there is no such designation
or if there is no surviving designated Beneficiary, then the Participant's
surviving spouse shall be the Beneficiary. If there is no surviving spouse to
receive any benefits payable in accordance with the preceding sentence, the
participant's estate shall be the Beneficiary. In the event any amount is
payable under the Plan to a minor, payment shall not be made to the minor, but
instead be paid (a) to that person's living parent(s) to act as custodian, (b)
if that person's parents are then divorced, and one parent is the sole custodial
parent, to such custodial parent, or (c) if no parent of that person is then
living, to a custodian selected by the Committee to hold the funds for the minor
under the Uniform Transfers or Gifts to Minors Act in effect in the jurisdiction
in which the minor resides. If no parent is living and the Committee decides
not to select another custodian to hold the funds for the minor, then payment
shall be made to the duly appointed and currently acting guardian of the estate
for the minor or, if no guardian of the estate for the minor is duly appointed
and currently acting within 60 days after the date the amount becomes payable,
payment shall be deposited with the court having jurisdiction over the estate of
the minor.
SECTION 4.6 WITHHOLDING.
There shall be deducted from each payment made under the Plan or any other
compensation payable to the Participant (or Beneficiary) all taxes which are
required to
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be withheld by the Company in respect to such payment or this Plan. The Company
shall have the right to reduce any payment (or compensation) by the amount of
cash sufficient to provide the amount of said taxes.
SECTION 4.7 AMENDMENT, MODIFICATION, SUSPENSION OR TERMINATION.
The Compensation Committee may amend, modify, suspend or terminate this
Plan in whole or in part, except that no amendment, modification, suspension or
termination shall have any retroactive effect to reduce any amounts allocated to
a Participant's Stock Account. In the event that this Plan is terminated, the
amounts allocated to a Participant's Stock Account shall be distributed to the
Participant or, in the event of his or her death, his or her Beneficiary in a
lump sum within 30 days following the date of termination.
SECTION 4.8 GOVERNING LAW.
This Plan shall be construed, governed and administered in accordance with
the laws of the United States and, to the extent not preempted by such law, by
the laws of the State of California.
SECTION 4.9 RECEIPT OR RELEASE.
Any payment to a Participant or the Participant's Beneficiary in accordance
with the provisions of the Plan shall to the extent thereof, be in full
satisfaction of all claims for benefits under this Plan against the Committee
and the Company. The Committee may require such Participant or Beneficiary, as a
condition precedent to such payment, to execute a receipt and release to such
effect.
SECTION 4.10 EFFECTIVE DATE.
This Plan shall be effective as of December 18, 1997.
IN WITNESS WHEREOF, this Plan is adopted as of December 18, 1997.
PACIFICARE HEALTH SYSTEMS, INC.
------------------------------------
By:
Title:
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EMPLOYMENT AGREEMENT
This EMPLOYMENT AGREEMENT (this "Agreement") is made and entered into as
of the 1st day of December, 1994, by and between PACIFICARE HEALTH SYSTEMS,
INC., a Delaware corporation (the "Company"), with its principal place of
business located at 5995 Plaza Drive, Cypress, California 90630 and Jon
Wampler ("Executive"), residing at 1501 Lincoln Lane, Newport Beach,
California 92660.
RECITALS
WHEREAS, the Company desires to employ Executive in the capacity of
Regional Vice President of the West and President and Chief Executive Officer
of PacifiCare of California.
WHEREAS, the Company and Executive are entering into this Agreement to
establish the terms and conditions of the desired employment relationship.
NOW, THEREFORE, in consideration of the following covenants, conditions
and promises contained herein, and other good and valuable consideration, the
Company and Executive hereby agree as follows:
1. EMPLOYMENT
1.1 EXECUTIVES' GENERAL DUTIES. The Company hereby employees Executive
and Executive hereby agrees to serve the company in the capacity of Regional
Vice President of the West and President and Chief Executive Officer of
PacifiCare of California having such usual and customary duties and authority
as an officer of similar capacity in a corporation of comparable size,
holdings, and business as that of the Company.
Executive shall do and perform all services, acts, or things necessary
or advisable to manage and conduct the business of the Company and shall
preside over such other areas of corporate activity as specified from time to
time by the Board of Directors of the Company. During the term of this
Agreement, Executive shall perform such additional or different duties, and
accept the election or appointment to such other offices or positions, as are
mutually agreed upon by Executive and the Company.
1.2 DEVOTION OF EXECUTIVE. During the term of this Agreement,
Executive shall devote his entire productive time, ability, and attention to
the business of the Company. Executive shall use his best efforts, skills,
and abilities to promote the general welfare and interests of the Company and
to preserve, maintain, and foster the Company's business and business
relationships with all persons and entities associated therewith, including,
without limitation, employer groups, medical service providers, shareholders,
affiliates, officers, employees, and banks and other financial institutions.
The Company shall give Executive a reasonable opportunity to perform his
duties and shall neither expect Executive to devote more
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time, nor assign more duties or functions to Executive, than are customary
and reasonable for an executive in Executive's position.
2. TERM AND TERMINATION
2.1 TERM. The term of Executive's employment under this Agreement
shall commence on December 1, 1994, and shall continue unless terminated as
provided Section 2.2.
2.2 TERMINATION. This Agreement shall be terminated upon the
occurrence of any one of the following events:
a. The death of the Executive.
b. Executive becomes incapacitated or disabled, which incapacity or
disability prevents Executive from fully performing his duties to the
Company for a period in excess of 90 days and, after such 90-day period,
the Company and a physician, duly licensed and qualified in the specialty
of Executive's incapacity, decide in their reasonable judgments, that such
incapacity will be permanent or of such continued duration as to prevent
Executive from resuming the rendition of services to the Company for at
least an additional six-month period. For purposes of this Agreement,
Executive shall be deemed permanently disabled, and this Agreement
terminated upon the date Executive receives written notice from the
Company that such determination has been made.
c. Executive habitually neglects his duties to the Company or
engages in gross misconduct during the term of this Agreement. For the
purposes of this Agreement, "gross misconduct" shall mean Executive's
conviction of any criminal offense, misappropriation of funds, securities
fraud, insider trading, unauthorized possession of corporate property or
the sale, distribution, possession or use of a controlled substance
(whether or not such felony or criminal offense is committed in connection
with Executive's duties hereunder or in the course of his employment with
the Company). In such event, Executive's termination shall be effective
immediately upon receipt of written notice from the Company.
d. Either party hereto may terminate this Agreement, with or
without cause, upon 30 days prior written notice to the other party.
Executive's termination shall be effective 90 days after receipt of such
notice.
2.3 EFFECT OF TERMINATION. No termination of this Agreement shall
affect or impair any rights or obligations of the parties respecting certain
compensation accruing prior thereto or continuing thereafter in accordance
with the terms set forth in Section 3.2 and Section 4.
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3. COMPENSATION
3.1 Compensation During the Term of this Agreement
a. As long as Executive satisfactorily performs all of his
obligations hereunder, the Company shall pay Executive an annual base
salary, as determined by the compensation committee of the board of
directors, payable in equal installments on the Company's regular payroll
dates, which as of the date hereof is $275,000. On an annual basis, the
Company's compensation committee shall review Executive's salary, but
shall be under no obligation to increase Executive's salary.
Executive authorizes the Company to take such deductions and withholdings
from his salary as are required by law, directed by Executive, or as
reasonably directed by the Company for its employees, which deductions
shall include, without limitation, withholding for federal and state
income taxes and social security.
b. Executive shall be entitled to fully participate in all of the
employee benefit plans and programs available to other high-level
executives of the Company, including, without limitation, health, dental,
and life insurance benefits for Executive and Executive's dependents,
pension and profit sharing programs, and vacation and sick leave benefits.
However, the terms of this Agreement shall not restrict the Company's
right to change, amend, modify, or terminate any existing benefit plan or
program, or to change any insurance company or modify any insurance policy
adopted incident to such existing benefit plan and program.
c. The Company shall provide Executive with a $400 per month
automobile allowance. The Company shall furnish Executive's automobile
with a cellular car telephone. Executive shall provide and maintain
automobile insurance for Executive's car including collision,
comprehensive liability, personal and property damage, and uninsured and
underinsured motorist coverage in amounts customarily obtained to cover
such contingencies in California. Executive shall provide proof of such
coverage to the Company upon the Company's request.
d. The Company shall pay for or reimburse Executive for all other
reasonable travel, entertainment, and other business expenses incurred or
paid for by Executive in connection with the performance of his services
under this Agreement. The Company shall not be obligated to make any such
reimbursement unless Executive presents corresponding expense statements
or vouchers and such other supporting information as the Company may from
time to time reasonably request. The Company reserves the right to place
subsequent limitations or restrictions on business expenses to be incurred
or reimbursed.
e. Executive shall be entitled to participate fully in the
Company's Long-Term Performance Incentive Plan, as amended (the "LTPIP"),
as from time to time
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may be amended, modified or replaced, in accordance with the terms
and conditions set forth herein and therein.
f. Executive shall be entitled to participate fully in the
Company's Annual Incentive Plan, as amended (the "AIP"), as may be
amended, modified, or replaced, in accordance with the terms and
conditions set forth herein and therein.
g. Executive shall be entitled to participate in the Amended and
Restated 1989 Stock Option Plan for Officers and Key Employees of
PacifiCare Health Systems, Inc., as amended (the "1989 Stock Option
Plan"), as such plan from time to time may be amended, modified or
replaced, in accordance with the terms and conditions set forth herein and
therein.
h. During the term of this Agreement, the Company shall insure
Executive under its general liability insurance for all conduct committed
in good faith while acting in the capacity as Regional Vice President of
the West and President and Chief Executive Officer of PacifiCare of
California or in any other capacity to which Executive may be appointed or
elected.
i. In the event Executive is involuntarily terminated, without
cause, except in the case of death or incapacity or disability, the
Company shall provide outplacement services to Executive to assist
Executive in securing a position comparable to the one from which he was
terminated. The Company shall be obligated to provide those outplacement
services as customarily provided by companies of similar size and holdings
as those of the Company to executives with comparable responsibility and
longevity as Executive and for reasonable cost as approved by the Company.
The Company's provision of such outplacement services shall not limit,
restrict, or reduce, in any manner, any and all other compensation to
which Executive is entitled hereunder.
j. As part of the compensation for services rendered under this
Agreement, Executive shall be entitled to participate in the PacifiCare
Health Systems, Inc. Savings and Profit-Sharing Plan, and the trust
agreement implemented pursuant thereto, adopted as of June 1, 1985, as
from time to time may be amended modified, or replaced, in accordance with
the terms and conditions set forth therein.
k. Executive shall be entitled to the benefits provided under the
Company's Statutory Restoration Plan, as such plan from time to time may
be amended, modified or replaced, in accordance with the terms set forth
herein and therein. A copy of a summary of the current plan is attached
hereto as Exhibit E and incorporated herein by this reference.
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3.2 Compensation Following Termination
a. In the event that this Agreement is terminated by reason of
Executive's death, Executive's estate or legal representative shall be
entitled to receive the following:
1. Payment of benefits under the life insurance policy
purchased by the Company on Executive's behalf, if any;
2. Payments of benefits under the LTPIP and the AIP set forth
in Sections 3.1(e) and 3.1(f), respectively, which will be deemed to
have accrued as of the date of Executive's death; and
3. Executive's legal representative shall be permitted to
exercise any vested and unexercised options under the 1989 Stock
Option Plan set forth in Section 3.1(g) and shall be permitted to
exercise any other vested and unexercised options granted under any
other stock option plans of the Company ("Prior Stock Option Plans")
in accordance with their terms for a period of one year following
Executive's death. The 1989 Stock Option Plan and the Prior Stock
Option Plans shall together be referred to herein as the "Stock
Option Plans."
b. In the event that Executive is terminated because of an
incapacity or disability, the Company shall provide Executive with the
following:
1. Payment of benefits under the disability insurance policy
maintained by the Company on Executive's behalf, if any;
2. Payment of benefits under the LTPIP and the AIP set forth
in Sections 3.1(e) and 3.1(f), respectively, which will be deemed to
have accrued as of the effective date of such termination;
3. The right to exercise any vested and unexercised options
under the Stock Option Plans in accordance with the terms stated
therein; and
4. Payment of the automobile allowance as provided under
Section 3.1(c) for a period of 24 months following the effective date
of such termination.
c. In the event this Agreement is terminated because of Executive's
habitual neglect or gross misconduct pursuant to Section 2.2(c) or because
of Executive's voluntary termination, the Company shall be relieved from
any and all further or future obligations to compensate Executive;
provided, however, that Executive shall be able to exercise any vested and
unexercised awards under the Stock Option Plans in accordance with the
terms set forth therein.
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d. In the event that the Company terminates Executive, for any
reason other than Executive's incapacity or disability or misconduct as
described in Sections 2.2(b) and 2.2(c), respectively, Executive shall be
entitled to the following severance compensation:
1. Executive's then current annual salary under Section 3.1(a)
for a period of 24 months following the effective date of such
termination;
2. Payment of benefits under the LTPIP and the AIP set forth
in Sections 3.1(e) and 3.1.(f), respectively, which will be deemed to
have accrued as of the effective date of such termination;
3. The right to exercise any vested and unexercised options
under the Stock Option Plans in accordance with their terms within
one year of the effective date of such termination;
4. Notwithstanding the foregoing, in the event Executive
engages in employment with a competitor of the Company during the
24 month benefit period, the severance compensation available to
Executive under this Section 3.2(d) shall be reduced by the amount of
any and all gross earnings Executive earns while engaged in
employment with any such competitor or competitors. For the purposes
of this Section 3.2(d)(5), a "competitor of the Company" shall
include, without limitation, an health maintenance organization,
competitive medical plan, or preferred provider organization, or
health or life insurance company which owns a managed care plan or
program. Executive agrees to provide immediate notice to Company
upon receipt of any gross earnings received by Executive from a
competitor of Company;
5. Payment of the automobile allowance as provided in Section
3.1-C- for a period of 24 months following the effective date of such
termination; and
6. The Company shall provide to Executive the outplacement
services described in Section 3.1(i).
e. Notwithstanding anything which may be expressed in, or inferred
from the provisions expressed in, or inferred from the provisions of this
Section 3.2 or Section 4.1, this Agreement should not be construed to
limit, restrict, or deny Executive any benefits to which he otherwise may
be entitled to under the LTPIP, the AIP, the Stock Option Plans, the
Company's pension plan or otherwise which arise from circumstances not
addressed in this Agreement.
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4. TERMINATION AS A RESULT OF A CHANGE OF CONTRO OR FOR GOOD CAUSE
4.1 EXECUTIVE'S RIGHTS. In the event that, during the term of this
Agreement, the Company undergoes a "change of ownership or control," as that
term is defined in Section 4.3, Executive shall be entitled to the following
compensation if within 24 months after the consummation of such change
Executive is involuntarily terminated, except as provided in Section 4.2, or
Executive voluntarily terminates his employment for "good cause" as defined in
Section 4.4:
a. Executive's then current annual salary under Section 3.1(a) for
a period of 24 months following the effective date of such termination;
b. Payment of health insurance premiums under the Consolidated
Omnibus Budget Reconciliation Act of 1985, as amended, for Executive and
Executive's dependents for a period of 18 months following the effective
date of such termination;
c. Annual payment of benefits under the LTPIP set forth in Section
3.1(e) for each performance period of the LTPIP for a period of 24 months
following the effective date of such termination;
d. Annual payment of benefits under the AIP set forth in Section
3.1(f), for a period of 24 months following the effective date of such
termination;
e. The right to exercise any and all granted and unexercised stock
options, under the Stock Option Plans in accordance with their terms
(whether or not such options are actually vested), as if all such
unexercised stock options are fully vested within one year of the
effective date of such termination;
f. Payment of the automobile allowance as provided under Section
3.1(c) for a period of 24 months following the effective date of such
termination; and
g. The Company shall provide to Executive the outplacement services
described in Section 3.1(i).
4.2 LIMITATION OF BENEFITS. In the event that Executive is terminated
within 12 months after a change of ownership or control of the Company, and
such termination results from either Executive's incapacity or disability or
habitual neglect or gross misconduct, then, notwithstanding anything in this
Section 4 to the contrary, Executive shall receive only that compensation, if
any, to which he is entitled to under Sections 3.2(b) and 3.2(c), respectively.
In no event shall the aggregate amount of all compensation which Executive may
receive pursuant to the provisions of this Section 4, including without
limitation, any salary, bonuses, stock options, employee benefits and all other
cash and in-kind compensation exceed an amount (the "Maximum Compensation
Amount") which would give rise to an "excess
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parachute payment" as determined by Section 280G of the Internal Revenue Code
of 1986, as amended, and any regulations promulgated thereunder. In the
event that this Section 4 would entitle Executive to sums in excess of the
Maximum Compensation Amount, the Company shall use its sound discretion, in
good faith, to furnish Executive with a post-termination compensation package
which is substantially equal to the Maximum Compensation Amount.
4.3 CHANGE OF CONTROL. As used in this Section 4, the term "change of
ownership or control" means and refers to:
a. any merger, consolidation, or sale of the Company such that any
individual, entity or group (within the meaning of Section 13(d)(3) or
14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) acquires beneficial ownership, within the meaning of Rule 13d-3 of
the Exchange Act, of 20 percent or more of the voting common stock of the
Company and the ownership interest of the voting common stock owned by
UniHealth America is less than or equal to the ownership interest of the
voting common stock of such individual, entity or group;
b. any transaction in which the Company sells substantially all of
its material assets;
c. a dissolution or liquidation of the Company; or
d. the Company becomes a non-publicly held company.
4.4 GOOD CAUSE. As used in this Section 4, "good cause" for Executive to
terminate his employment shall be deemed to exist if Executive voluntarily
terminates his employment for any of the following reasons:
a. Without Executive's express prior written consent, Executive:
(i) is assigned duties materially inconsistent with Executive's
position, duties, responsibilities, or status with the Company which
substantially varies from that which existed immediately prior to
such change of ownership or control;
(ii) experiences a change in his reporting level, titles, or
business location (to a point more than 50 miles outside of Orange
County, California) which substantially varies from that which
existed immediately prior to the change of ownership or control; or
(iii) with respect to any position held immediately prior to
the change of ownership or control, is removed or fails to obtain
reelection, which removal or failure to reelect is not directly
related to Executive's incapacity or disability, habitual neglect,
gross misconduct or death;
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b. Without Executive's express prior written consent, Executive's
salary is reduced below that which existed immediately prior to the change
of ownership or control and such change is not otherwise applied to others
in the Company with at least Executive's position or title;
c. Without Executive's express prior written consent, any employee
benefit, business expense reimbursement or allotment, incentive bonus
program, or any other manner or form of compensation available to
Executive immediately prior to the change of ownership or control is
reduced or eliminated and such change is not otherwise applied to others
in the Company with at least Executive's position or title;
d. The Company fails to obtain from any successor, before the
succession takes place, a written commitment obligating the successor, to
perform this Agreement in accordance with all of its terms and conditions;
or
e. The Company or any successor thereto, purports to terminate
Executive without first giving Executive prior written notice thereof, in
accordance with the provisions of Section 2.2(d), that specifies: (i) the
exact provision of Section 2.2 relied upon; and (ii) the facts and
circumstances, in reasonable detail, serving as the basis for Executive's
termination.
6. NOTICES
All notices shall be given in writing and sent by either personal
delivery, overnight delivery, or United States registered or certified mail,
return receipt requested, all of which shall be properly addressed with
postal or delivery charges prepaid, to the parties at their respective
addresses set forth below, or to such other addresses as either party may
designate to the other in accordance with this Section 5:
If to the Company: PacifiCare Health Systems, Inc.
5995 Plaza Drive
Cypress, California 90630
Attn: President and
Chief Executive Officer
If to Executive: Jon Wampler
1501 Lincoln Lane
Newport Beach, California 92660
All notices sent by personal delivery shall be deemed given when actually
received. All notices sent by overnight delivery shall be deemed given on the
next business day. All other notices sent via United States mail shall be
deemed given no later than two business days after mailing.
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GENERAL PROVISIONS
6.1 ASSIGNABILITY. This Agreement shall inure to the benefit of, and
shall be binding upon the heirs, executors, administrators, successors, and
legal representatives of Executive and shall inure to the benefit of, and be
binding upon the Company and its successors and assigns. Executive shall not
assign, delegate, subdelegate, transfer, pledge, encumber, hypothecate, or
otherwise dispose of this Agreement, or any rights, obligations, or duties
hereunder, and any such attempted delegation or disposition shall be null and
void and without any force or effect; provided however, that nothing
contained herein shall prevent Executive from designating beneficiaries for
insurance, death, or retirement benefits.
6.2 ENTIRE AGREEMENT. This Agreement is a fully integrated document
and contains any and all promises, covenants, and agreements between the
parties hereto with respect to Executive's employment. This Agreement
supersedes any and all other, prior or contemporaneous, discussions,
negotiations, representations, warranties, covenants, conditions, and
agreements, whether written or oral, between the parties hereto. Except as
expressed herein, the parties have not exchanged any other representations,
warranties, inducements, promises, or agreements respecting Executive's
employment with the Company.
6.3 SEVERABILITY. In the event any one or more of the provisions of
this Agreement shall be rendered by a court of competent jurisdiction to be
invalid, illegal, or unenforceable, in any respect, such invalidity,
illegality, or unenforceability shall not affect or impair the remainder of
this Agreement which shall remain in full force and effect and enforced
accordingly.
6.4 AMENDMENT. This Agreement shall not be changed, amended, or
modified, nor shall any performance or condition hereunder be waived, in
whole or in part, except by written instrument signed by the party against
whom enforcement or waiver is sought. The waiver of any breach of any term
or condition of this Agreement shall not be deemed to constitute the waiver
of any other or subsequent breach of the same or any other term or condition
of this Agreement.
6.5 GOVERNING LAW. This Agreement shall be governed by, enforced
under, and construed in accordance with the laws of the State of California.
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IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the
date first written above.
The Company: PACIFICARE HEALTH SYSTEMS, INC.,
a Delaware corporation
________________________________
By: Alan R. Hoops
Title: President and
Chief Executive Officer
Executive: ________________________________
Jon Wampler
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FIRST AMENDMENT
EXECUTIVE EMPLOYMENT AGREEMENT
This First Amendment, dated as of March 1, 1996 (the "Amendment"), to
the Executive Employment Agreement, dated as of December 1, 1994 (the
"Agreement"), between PacifiCare Health Systems, Inc., a Delaware
corporation, and Jon Wampler, an individual ("Executive"), hereby amends the
Agreement as follows:
1. AMENDMENT TO SECTION 3.1 (a). Section 3.1(a) shall hereby be
amended by adding the following sentence to the end of the first paragraph of
Section 3.1(a):
In addition, Executive shall receive an advance to his annual base salary
in the amount of $120,000 (the "Advance"). If Executive does not continue
his employment with the Company for a sufficient period of time in order
to earn the Advance, Executive shall be required to repay the Advance as
follows:
(i) if Executive leaves the Company prior to January 3, 1997,
Executive shall be required to repay $80,000 of the Advance;
(ii) if Executive leaves the Company prior to January 3, 1998,
Executive shall be required to repay $40,000 of the Advance; and
(iii) if Executive leaves the Company subsequent to January 3, 1998,
Executive shall be deemed to have earned the Advance in full and shall not
be required to repay the Advance.
2. AMENDMENT TO SECTION 3.1(e). Section 3.1(e) is hereby amended by
adding the following sentence to the end of Section 3.1(e):
Beginning with the 1995 through 1997 performance cycle and for each
successive performance cycle, the target bonus award which Executive may
be eligible to receive under the LTPIP, if the performance objectives for
the performance cycle are achieved, shall be 35 percent of the average of
Executive's annual base salary for the three years of the performance
cycle up to a maximum bonus award of 70 percent of the average of
Executive's annual base salary for the three years of the performance
cycle. If the percentage of salary for the target and maximum award
under the LTPIP is changed, such change shall be reflected on SCHEDULE I
attached hereto.
3. AMENDMENT TO SECTION 3.1(f). Section 3.1(f) is hereby amended by
adding the following sentence to the end of Section 3.1(f):
During the term of this Agreement, the target bonus award which Executive
may be eligible to receive under the MICP, if the performance objectives
for the fiscal year are achieved, shall be 35 percent of Executive's
annual base salary applicable at the end of the fiscal year preceding the
payment of the award up to a maximum bonus award of 70 percent of
Executive's annual base salary applicable at the end of the fiscal year
preceding the payment of the award. If the percentage of salary for the
target and maximum award under the MICP is changed, such change shall be
reflected on SCHEDULE I attached hereto.
4. AMENDMENT TO SECTION 3.2 (a). Section 3.2(a) is hereby amended by
adding the following subparagraph to Section 3.2(a):
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4. If Executive's death occurs prior to January 3, 1998,
Executive's estate or legal representative will not be required to repay
any amount of the Advance, which but for this subparagraph, Executive's
estate or legal representative would be required to be repay pursuant to
the provisions of Section 3.1(a).
5. AMENDMENT TO SECTION 3.2 (b). Section 3.2(b) is hereby amended by
adding the following subparagraph to Section 3.2(b):
5. If Executive is disabled or incapacitated prior to January 3,
1998, Executive will not be required to repay any amount of the Advance,
which but for this subparagraph, Executive would be required to repay
pursuant to the provisions of Section 3.1(a).
6. AMENDMENT TO SECTION 3.2 (c). Section 3.2(c) shall hereby be amended
by adding the following sentence to the end of Section 3.3(c):
In addition, if this Agreement is terminated pursuant to the provisions
contained in this Section 3.2(c) prior to January 3, 1998, Executive will
be required to repay any amount of the Advance, which continues to be
subject to reimbursement pursuant to the provisions of Section 3.1(a).
7. AMENDMENT TO SECTION 3.2 (d). Section 3.2(d) is hereby amended by
adding the following subparagraph to Section 3.2(d):
7. If Executive's termination occurs prior to January 3, 1998,
Executive will not be required to repay any amount of the Advance, which
but for this subparagraph, Executive would be required to repay pursuant
to the provisions of Section 3.1(a).
8. AMENDMENT TO SECTION 4.1. Section 4.1 is hereby amended by adding
the following subparagraph to Section 4.1:
h. If Executive's termination is a result of a Change of Control or
Executive voluntarily terminates for "good cause" and such termination
occurs prior to January 3, 1998, Executive will not be required to repay
any amount of the Advance, which but for this subparagraph, Executive
would be required to repay pursuant to the provisions of Section 3.1(a).
9. ADDITION OF SCHEDULE I. By this Amendment, Schedule I attached
hereto shall hereby be deemed to be attached to the Agreement.
10. LIMITATION OF AMENDMENTS. Except as expressly provided herein, no
terms or provision of any agreement or instrument are modified or changed by
this Amendment and the terms and provisions of the Agreement, as amended by
this Amendment, shall continue in full force and effect.
11. GOVERNING LAW. This Amendment shall be construed, interpreted and
enforced in accordance with, and governed by California law.
12. CAPITALIZED TERMS. Capitalized terms not defined herein shall have
the meanings ascribed to them in the Agreement.
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13. DUPLICATE ORIGINALS; EXECUTION IN COUNTERPART. Two or more duplicate
originals of this Amendment may be signed by the parties, each of which shall
be an original but all of which together shall constitute one and the same
instrument.
14. WAIVERS AND AMENDMENTS. Neither this Amendment nor any term hereof
may be changed, waived, discharged or terminated orally, or by any action or
inaction, but only by an instrument in writing signed by the party against
which enforcement of the change, waiver, discharge or termination is sought.
15. SECTION HEADINGS. The titles of the sections hereof appear as a
matter of convenience only, do not constitute a part of this Amendment and
shall not affect the construction hereof.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of
the date first written above.
PACIFICARE HEALTH SYSTEMS, INC.,
a Delaware corporation
________________________________
By: Alan R. Hoops
Title: President and
Chief Executive Officer
________________________________
Jon Wampler
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SCHEDULE I
LTPIP TARGET AND MAXIMUM BONUS AWARD CHANGES
Target Maximum
------ -------
MICP TARGET and MAXIMUM BONUS AWARD CHANGES
Target Maximum
------ -------
(i)
<PAGE>
SECOND AMENDMENT
EXECUTIVE EMPLOYMENT AGREEMENT
This Second Amendment, dated as of October 9, 1997 (the "Amendment"), to
the Executive Employment Agreement, dated as of December 1, 1994 (the
"Agreement"), between PacifiCare Health Systems, Inc., a Delaware corporation,
and Jon Wampler, an individual ("Executive"), hereby amends the Agreement as
follows:
1. AMENDMENT TO SECTION 1.1. Section 1.1 is hereby amended as follows:
a. Executive agrees to serve the Company in the capacity of Regional Vice
President of the West through December 31, 1997;
b. Effective October 9, 1997, Executive resigns as President and Chief
Executive Officer of PacifiCare of California; and
c. Effective October 9, 1997, Executive shall assume new duties as
Executive Consultant, reporting to the Senior Vice President of Public Affairs,
PacifiCare Health Systems, Inc.
d. In addition to those duties specified in the Agreement, Executive may
become responsible for special projects involving Public Affairs Department
activities in Sacramento and Washington D.C. Executive may also be required to
assist the Department in its efforts to build strong partnerships with key
targeted audiences who potentially could impact the Public Affairs objectives
and goals of the Company and the managed care industry as a whole.
2. AMENDMENT TO SECTION 2.1. Section 1.1 is hereby amended to read as
follows:
2.1. The term of Executive's employment under this Agreement
shall commence on December 1, 1994, and shall terminate without
cause, pursuant to Section 2.2.d of the Agreement on October 9, 1998,
unless extended by a new Amendment to this Agreement or Executive and
Company enter into a new employment arrangement. If Executive is
terminated without cause pursuant to Section 2.2.d of the Agreement
on October 9, 1998, in addition to the severance benefits to which
Executive will be entitled under Section 3.2.d of the Agreement,
arrangements will be made so that, for a period of two years
commencing October 9, 1998, Executive may continue to make
contributions to PacifiCare's Profit Sharing Plan and Executive's
stock options will continue to vest and remain exercisable.
3. AMENDMENT TO SECTION 3.1. Section 3.1, subsection d, is amended by the
addition of the following:
d. [....] The Company will continue to pay Executive's dues and
related fees that support Executive's current memberships at both the
Santa Ana
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Country Club and the Pacific Club during calendar year 1998 in
an amount not to exceed $8,500.00. Additional expenses shall be
reimbursed in accordance with this subsection d, if properly
documented as business expenses that support Executive's new duties.
Section 3.1, subsections e, f, and g are amended to read as follows:
e. Executive shall be entitled to receive payments, if any,
under the Company's Long Term Performance Incentive Plan, (the
"LTPIP"), as from time to time may be amended, modified or replaced,
in accordance with the terms and conditions set forth herein and
therein, for the 1995-1997, 1996-1998 and 1997-1999 cycles of the
LTPIP. Commencing January 1, 1998, Executive shall no longer be
eligible to participate in new cycles of the LTPIP.
f. Executive shall be entitled to receive payment, if any, by
PacifiCare of California, under the Company's Management Incentive
Compensation Plan (the "MICP"), as may be amended, modified, or
replaced, in accordance with the terms and conditions set forth
herein and therein, through December 31, 1997. Commencing January 1,
1998, Executive shall no longer be eligible to participate in the
MICP.
g. Executive current options shall be continue to vest and
shall remain exercisable under in accordance with the terms and
conditions of such options, except that commencing with the date of
this Amendment, Executive shall no longer be eligible to receive
additional stock options.
4. AMENDMENT TO SECTION 3.2.d Section 3.2.d, is amended as follows:
Section 3.2.d.2 is deleted, and replaced with the following:
3.2.d.2. Executive shall not have any right to participate in
the LTPIP or the MICP.
Section 3.2.d.3 is deleted, and replaced with the following:
3.2.d.3. The right to vest options and to exercise any vested
and unexercised options in accordance with their terms within two
years of the effective date of such termination.
5. LIMITATION OF AMENDMENTS. Except as expressly provided herein, no terms or
provision of any agreement or instrument are modified or changed by this
Amendment and the terms and provisions of the Agreement, as amended by this
Amendment, shall continue in full force and effect.
6. GOVERNING LAW. This Amendment shall be construed, interpreted and enforced
in accordance with, and governed by California law.
2
<PAGE>
7. CAPITALIZED TERMS. Capitalized terms not defined herein shall have the
meanings ascribed to them in the Agreement.
8. DUPLICATE ORIGINALS; EXECUTION IN COUNTERPART. Two or more duplicate
originals of this Amendment may be signed by the parties, each of which shall
be an original but all of which together shall constitute one and the same
instrument.
9. WAIVERS AND AMENDMENTS. Neither this Amendment nor any term hereof may be
changed, waived, discharged or terminated orally, or by any action or inaction,
but only by an instrument in writing signed by the party against which
enforcement of the change, waiver, discharge or termination is sought.
10. SECTION HEADINGS. The titles of the sections hereof appear as a matter of
convenience only, do not constitute a part of this Amendment and shall not
affect the construction hereof.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of
the date first written above.
PACIFICARE HEALTH SYSTEMS, INC.,
a Delaware corporation
____________________________________
By: Alan R. Hoops
Title: President and
Chief Executive Officer
____________________________________
Jon Wampler
3
<PAGE>
Exhibit 21
PACIFICARE HEALTH SYSTEMS, INC.
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION/PARTNERSHIP
- ------------------ ----------------------------------
<S> <C>
California Dental Health Plan California
Covantage, Inc. Delaware
CRM Insurance Services, Inc. California
Dental Plan Administrators California
FHP Financial Corporation Delaware
FHP International Corporation Delaware
FHP of Colorado, Inc. Colorado
FHP of Tennessee, Inc. Tennessee
FHP Reinsurance Limited Bermuda
Great States Administrators, Inc. Delaware
Great States Insurance Company California
Health Maintenance Life, Inc. Guam
Oregon Health Management Company California
PacifiCare Administrative Services, Inc. California
PacifiCare Behavioral Health of California, Inc. Delaware
PacifiCare Behavioral Health, Inc. Delaware
PacifiCare Benefit Administrators, Inc. Washington
PacifiCare Credentialing, Inc. California
PacifiCare Dental of Colorado, Inc. Colorado
PacifiCare Health Option, Inc. Utah
PacifiCare Health Plan Administrators, Inc. Indiana
PacifiCare Life and Health Insurance Company Indiana
PacifiCare Life Assurance Company California
PacifiCare Life Insurance Company Arizona
PacifiCare Military Health Systems, Inc. Delaware
PacifiCare of Arizona, Inc. Arizona
PacifiCare of California California
PacifiCare of Nevada, Inc. Nevada
PacifiCare of Ohio, Inc. Ohio
PacifiCare of Oklahoma, Inc. Oklahoma
PacifiCare of Oregon, Inc. Oregon
PacifiCare of Texas, Inc. Texas
PacifiCare of Utah, Inc. Utah
PacifiCare of Washington, Inc. Washington
PacifiCare Operations, Inc. Delaware
PacifiCare Pharmacy Centers, Inc. California
PacifiCare Ventures, Inc. California
PacifiClinic Company Oregon
PC-CWD Vista Associates California
Providers Protective Insurance Company Guam
Secure Horizons USA, Inc. California
TakeCare Insurance Company Colorado
</TABLE>
<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 with
respect to the consolidated financial statements and schedule of PacifiCare
Health Systems, Inc. included in the Annual Report on Form 10-K for the year
ended December 31, 1997.
ERNST & YOUNG LLP
Los Angeles, California
March ??, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
PacifiCare Health Systems, Inc's consolidated balance sheet as of
December 31, 1997 and related consolidated statement of income for the
year ended December 31, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 680,674
<SECURITIES> 864,708
<RECEIVABLES> 314,943
<ALLOWANCES> 13,598
<INVENTORY> 0
<CURRENT-ASSETS> 1,990,958
<PP&E> 365,382
<DEPRECIATION> 129,439
<TOTAL-ASSETS> 4,867,958
<CURRENT-LIABILITIES> 1,637,086
<BONDS> 1,011,234
0
105
<COMMON> 420
<OTHER-SE> 2,061,662
<TOTAL-LIABILITY-AND-EQUITY> 4,867,958
<SALES> 0
<TOTAL-REVENUES> 8,982,680
<CGS> 0
<TOTAL-COSTS> 7,658,879
<OTHER-EXPENSES> 1,279,806
<LOSS-PROVISION> 5,171
<INTEREST-EXPENSE> 64,536
<INCOME-PRETAX> 60,124
<INCOME-TAX> 81,825
<INCOME-CONTINUING> (21,701)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (21,701)
<EPS-PRIMARY> (0.75)
<EPS-DILUTED> (0.75)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHED CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFICARE
HEALTH SYSTEMS, INC'S CONSOLIDATED BALANCE SHEET AS OF DEC 31, 1996, SEPT
30, 1996 & 1995, & RELATED CONSOLIDATED STATEMENT OF INCOME FOR THE
TRANSITION PERIOD DEC 31, 1996 & FISCAL YEARS ENDED SEPT 30, 1996 & 1995,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> SEP-30-1997 SEP-30-1996 SEP-30-1995
<PERIOD-START> OCT-01-1996 OCT-01-1995 OCT-01-1994
<PERIOD-END> DEC-31-1996 SEP-30-1996 SEP-30-1995
<CASH> 367,748 142,818 279,145
<SECURITIES> 594,734 557,275 532,380
<RECEIVABLES> 157,089 170,435 113,098
<ALLOWANCES> 877 890 690
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 1,182,315 934,207 961,609
<PP&E> 186,880 186,087 172,417
<DEPRECIATION> 95,641 92,271 73,141
<TOTAL-ASSETS> 1,561,472 1,229,462 1,385,372
<CURRENT-LIABILITIES> 699,609 470,664 640,994
<BONDS> 0 5,183 11,949
0 0 0
0 0 0
<COMMON> 313 313 309
<OTHER-SE> 859,789 822,911 731,715
<TOTAL-LIABILITY-AND-EQUITY> 1,561,472 1,299,462 1,385,372
<SALES> 0 0 0
<TOTAL-REVENUES> 1,234,875 4,637,305 3,731,022
<CGS> 0 0 0
<TOTAL-COSTS> 1,039,345 3,872,747 3,077,135
<OTHER-EXPENSES> 154,996 685,921 505,644
<LOSS-PROVISION> 296 999 530
<INTEREST-EXPENSE> 350 2,094 5,549
<INCOME-PRETAX> 52,836 122,180 182,100
<INCOME-TAX> 21,079 50,827 74,005
<INCOME-CONTINUING> 31,757 71,953 108,095
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 31,757 71,953 108,095
<EPS-PRIMARY> 1.01 2.31 3.69
<EPS-DILUTED> 1.00 2.27 3.62
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFICARE
HEALTH SYSTEMS, INC.'S CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 1997, JUNE 30,
1997, SEPTEMBER 30, 1997 AND RELATED CONSOLIDATED STATEMENT OF INCOME FOR THE
QUARTERS ENDED MARCH 31, 1997, JUNE 30, 1997 AND SEPTEMBER 30, 1997, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<CASH> 228,915 238,661 186,946
<SECURITIES> 776,845 804,870 810,075
<RECEIVABLES> 348,950 278,723 343,100
<ALLOWANCES> 489 6,088 13,492
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 1,580,304 1,497,531 1,499,740
<PP&E> 319,912 316,830 333,347
<DEPRECIATION> 101,582 114,001 116,177
<TOTAL-ASSETS> 4,729,255 4,604,031 4,592,860
<CURRENT-LIABILITIES> 1,255,058 1,188,598 1,172,738
<BONDS> 0 0 0
0 0 0
105 105 105
<COMMON> 417 419 420
<OTHER-SE> 2,101,796 2,134,889 2,171,394
<TOTAL-LIABILITY-AND-EQUITY> 4,729,255 4,604,031 4,592,860
<SALES> 0 0 0
<TOTAL-REVENUES> 1,843,603 4,224,703 6,626,058
<CGS> 0 0 0
<TOTAL-COSTS> 1,547,655 3,597,373 5,648,362
<OTHER-EXPENSES> 224,833 513,987 806,945
<LOSS-PROVISION> 1,690 2,435 2,212
<INTEREST-EXPENSE> 9,719 28,414 46,483
<INCOME-PRETAX> 79,081 122,982 184,517
<INCOME-TAX> 35,587 61,491 92,258
<INCOME-CONTINUING> 43,494 61,491 92,259
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 43,494 61,491 92,259
<EPS-PRIMARY> 1.17 1.48 2.15
<EPS-DILUTED> 1.12 1.44 2.11
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFICARE
HEALTH SYSTEMS, INC'S CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1995, MARCH
31, 1996, JUNE 30, 1996 AND RELATED CONSOLIDATED STATEMENT OF INCOME FOR THE
QUARTERS ENDED DECEMBER 31, 1995, MARCH 31, 1996, JUNE 30, 1996, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> SEP-30-1996 SEP-30-1996 SEP-30-1996
<PERIOD-START> OCT-01-1995 OCT-01-1995 OCT-01-1995
<PERIOD-END> DEC-31-1995 MAR-31-1996 JUN-30-1996
<CASH> 357,290 190,207 154,461
<SECURITIES> 541,017 527,007 522,061
<RECEIVABLES> 115,672 141,669 140,255
<ALLOWANCES> 846 891 761
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 1,046,825 895,765 849,497
<PP&E> 178,074 183,086 184,159
<DEPRECIATION> 78,782 83,914 88,889
<TOTAL-ASSETS> 1,468,456 1,323,053 1,264,657
<CURRENT-LIABILITIES> 689,207 510,773 446,012
<BONDS> 11,063 10,105 5,555
0 0 0
0 0 0
<COMMON> 310 312 312
<OTHER-SE> 767,471 801,471 812,386
<TOTAL-LIABILITY-AND-EQUITY> 1,468,456 1,323,053 1,264,657
<SALES> 0 0 0
<TOTAL-REVENUES> 1,064,324 2,221,494 3,416,212
<CGS> 0 0 0
<TOTAL-COSTS> 849,709 1,859,836 2,855,936
<OTHER-EXPENSES> 134,531 284,609 474,198
<LOSS-PROVISION> 93 30 561
<INTEREST-EXPENSE> 513 1,342 1,737
<INCOME-PRETAX> 46,833 100,181 119,090
<INCOME-TAX> 18,854 40,333 50,664
<INCOME-CONTINUING> 27,979 59,848 68,426
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 27,979 59,848 68,426
<EPS-PRIMARY> 0.90 1.93 2.20
<EPS-DILUTED> 0.88 1.89 2.16
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFICARE
HEALTH SYSTEMS, INC'S CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1994, MARCH
31, 1995, JUNE 30, 1995 AND RELATED CONSOLIDATED STATEMENT OF INCOME FOR THE
QUARTERS ENDED DECEMBER 31, 1994, MARCH 31, 1995, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> SEP-30-1995 SEP-30-1995 SEP-30-1995
<PERIOD-START> OCT-01-1994 OCT-01-1994 OCT-01-1994
<PERIOD-END> DEC-31-1994 MAR-31-1995 JUN-30-1995
<CASH> 218,590 213,639 280,219
<SECURITIES> 532,735 622,349 507,790
<RECEIVABLES> 73,883 87,860 108,763
<ALLOWANCES> 163 331 690
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 864,441 955,053 922,853
<PP&E> 155,743 161,073 169,324
<DEPRECIATION> 57,346 62,373 67,670
<TOTAL-ASSETS> 1,158,551 1,375,617 1,346,252
<CURRENT-LIABILITIES> 630,876 698,719 633,487
<BONDS> 97,590 13,403 12,287
0 0 0
0 0 0
<COMMON> 276 307 308
<OTHER-SE> 429,396 662,775 699,765
<TOTAL-LIABILITY-AND-EQUITY> 1,158,551 1,375,617 1,346,252
<SALES> 0 0 0
<TOTAL-REVENUES> 821,614 1,734,380 2,715,616
<CGS> 0 0 0
<TOTAL-COSTS> 676,299 1,426,148 2,238,504
<OTHER-EXPENSES> 114,449 239,918 369,212
<LOSS-PROVISION> 90 1,187 392
<INTEREST-EXPENSE> 1,684 3,694 4,723
<INCOME-PRETAX> 34,083 80,125 130,992
<INCOME-TAX> 14,026 32,709 53,328
<INCOME-CONTINUING> 20,057 47,416 77,664
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 20,057 47,416 77,664
<EPS-PRIMARY> 0.73 1.71 2.70
<EPS-DILUTED> 0.71 1.67 2.64
</TABLE>
