<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended September 30, 1995
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 0-14181
- -------------------------------------------------------------------------------
PACIFIC HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its Charter)
Delaware 33-0064895
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
5995 Plaza Drive, Cypress, California 90630-5028
(Address of principal executive offices, including zip code)
(Registrant's telephone number, including area code) (714) 952-1121
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
- -------------------------------------------------------------------------------
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 voting stock held by non-affiliates of the
Registrant on November 1, 1995, was approximately $476,352,000.
The number of shares of Class A Common Stock and Class B Common Stock
outstanding at November 1, 1995, was 12,331,408 and 18,551,697, respectively.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
Portions of the Registrant's definitive Proxy Statement
to be filed by January 29, 1996 Part III
<PAGE>
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 approximately 1,757,000 commercial, Medicare and Medicaid
members. PacifiCare 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 California, Florida, Oklahoma,
Oregon, Texas and Washington, which as of September 30, 1995 had a combined
commercial membership of approximately 1,216,000 members. Through internal
growth and strategic acquisitions, the Company believes it has built a strong
competitive position in California and has expanded operations into new and
existing geographic markets.
The Company, through its Secure Horizons-Registered Trademark- programs,
operates the largest and one of the fastest growing Medicare risk programs in
the United States (as measured by membership) with approximately 481,000 members
enrolled as of September 30, 1995. The Company believes that its Secure
Horizons programs are attractive to Medicare beneficiaries because they provide
a more comprehensive package of benefits than offered under traditional Medicare
and substantially reduce the member's administrative responsibilities.
The Company's commercial and government (Medicare and Medicaid) program
members are provided some or all of the following health care services: primary
and specialty physician care, hospital care, laboratory and radiology services,
prescription drugs, dental and vision care, skilled nursing care, physical
therapy and psychological counseling. 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, Medicare risk management services,
dental and vision services, coordination of managed care products for multi-
region employers, military health care management, workers' compensation managed
care and health promotion.
The Company believes that its ability to provide a comprehensive range of
products and services and its long-term relationships with health care providers
are the major factors that will enable it to respond effectively to changes and
needs in the health care marketplace. The Company believes that it will
continue to be among the nation's leading managed health care services
companies.
THE MANAGED CARE INDUSTRY
Health care costs in the United States have risen from $27 billion in 1960,
comprising five percent of gross domestic product, to more than $1 trillion in
1995 comprising more than 14 percent of gross domestic product. In response to
the rapid increases in health care costs, employers, insurers, government
entities and health care providers have sought alternative health care delivery
systems, such as HMOs, that provide better controls on rising costs without
sacrificing quality. The goal of HMOs is to provide their members with access
to quality health care, while employing a business strategy and management
systems designed to encourage more cost-effective use of health care delivery
systems.
To accomplish these objectives, several basic HMO models have evolved. The
models are distinguishable by the HMO's relationship with its physician
providers and the capital investment required to support its operations. Under
the staff model, the HMO employs the physicians and, ordinarily, provides the
facility in which the physicians see patients. The physicians receive a salary
and/or bonus typically based on the performance of the HMO. Under the group
model, the HMO contracts with one large multi-specialty medical group practice
which typically receives a monthly fixed fee for each HMO member (capitation),
regardless of the medical services provided to each member. The network model
is predicated on an HMO contracting with more than one physician group to
provide services generally on a capitation fee basis. Under an individual
practice association ("IPA") model, the HMO contracts with independent
physicians who are broadly dispersed throughout a community and who see patients
in their own offices in exchange for a monthly capitation fee or on a discounted
fee basis. The Company primarily operates network and group HMOs and, to a
lesser extent, IPA and staff model HMOs. To enhance cost and quality control,
the Company may, in certain instances, expand its current involvement with
health care providers by making investments in their operations or in health
care facilities.
The rate of increase in HMO membership has moderated in recent years in response
to increased competition. Increased managed health care options for commercial,
Medicare and Medicaid programs include point of service ("POS"), preferred
provider organizations ("PPOs") and certain employer self-funded programs. In
addition, in some geographic
2
<PAGE>
markets such as California, large employers have reduced the number of HMO
options offered to their employees. Potential federal legislation may increase
the number of Medicare competitors and various state legislation has changed the
Medicaid market potential (See - "Government Regulation" and "Operations,
Products and Services - Medicaid HMO Programs").
OPERATIONS, PRODUCTS AND SERVICES
HMO Operations
The Company's total membership has grown from approximately 673,000 members
at September 30, 1990 to approximately 1,757,000 members at September 30, 1995,
a 21 percent compound annual growth rate. The Company's membership at September
30, 1995 by state and program is as follows:
<TABLE>
<CAPTION>
GOVERNMENT
(MEDICARE &
COMMERCIAL MEDICAID) TOTAL PERCENT OF TOTAL
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
California 816,554 382,998 1,199,552 68.3%
Florida 53,352 10,104 63,456 3.6
Oklahoma 106,436 16,538 122,974 7.0
Oregon 93,318 45,084 138,402 7.9
Texas 77,532 49,186 126,718 7.2
Washington 68,948 37,082 106,030 6.0
-----------------------------------------------------------
Total Membership 1,216,140 540,992 1,757,132 100.0%
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
COMMERCIAL HMO PROGRAMS
The Company's commercial membership has grown from approximately 546,000
members at September 30, 1990 to approximately 1,216,000 members at September
30, 1995, a 17 percent compound annual growth rate. The Company offers a
comprehensive range of products, including HMOs, PPOs and POS plans, which
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). The Company has historically focused on
the larger employer market, but has recently entered the smaller employer and
individual markets. The Company believes that these markets have lower HMO
penetration levels than the larger employer market and represent significant
growth opportunities.
Commercial members generally join the Company's HMOs through an employer,
which typically offers employees a selection of indemnity insurance and managed
health care plans, pays for all or part of the monthly costs thereof and makes
payroll deductions for any costs payable by the employee. During a designated
annual "open enrollment period," employees may select their desired health care
coverage. New employees make their selection at the time of their employment.
Monthly premium rates are negotiated between the Company and the employer and
are typically fixed for a one-year period, although there is generally no
requirement that the employer offer the Company's services after the expiration
of such period.
For the commercial employer market, the Company offers a range of benefit
plan options that generally vary only in the amount of co-payments required for
physician office visits, inpatient hospitalization and certain other services.
A co-payment is a nominal charge paid by the member, generally at the time of
service. The Company believes that co-payments are useful in helping contain
the costs of health care without providing a barrier to members seeking needed
health care services. In addition, the Company also offers at an additional
premium, specialty managed care products and services, such as prescription
pharmacy benefit management, dental and vision care and behavioral health care
services. These services are generally provided through subcontracting or
referral relationships with other health care providers.
The Company's 25 largest employer groups as of September 30, 1995 accounted
for approximately 34 percent of total commercial membership, with the largest
employer group accounting for approximately eight percent of total commercial
membership. The Company's five largest employer groups, in the aggregate,
accounted for approximately 19 percent of its commercial revenue for the fiscal
year ended September 30, 1995.
3
<PAGE>
SECURE HORIZONS PROGRAMS
Through its Secure Horizons-Registered Trademark- programs, the Company
operates the largest and one of the fastest growing Medicare risk programs in
the United States (as measured by membership). The Company's Medicare
membership has grown from approximately 127,000 members at September 30, 1990 to
approximately 481,000 members at September 30, 1995, a 31 percent compound
annual growth rate. The Company believes the Medicare market offers significant
growth opportunities since only approximately eight percent of the country's
Medicare beneficiaries are enrolled in at-risk HMO programs such as those
offered by the Company. The Company will seek to continue its growth in the
Medicare risk arena by entering into new geographic markets with its Secure
Horizons programs.
The Company has provided health care services to Medicare beneficiaries
through its Secure Horizons programs pursuant to annual contracts with the
Health Care Financing Administration ("HCFA") since 1985. These contracts
entitle the Company to a fixed fee-per-member premium (a "risk contract") and
are subject to periodic unilateral revisions based on certain demographic
information relating to the Medicare population and the cost of providing health
care in a particular geographic area. The Company's Medicare contracts with
HCFA are automatically renewed every 12 months unless the Company or HCFA elects
either not to renew or to terminate them. HCFA may unilaterally terminate the
Company's Medicare contracts if the Company fails to continue to meet compliance
and eligibility standards. Termination of the Company's Medicare contracts
could have a material adverse effect on the Company. The Company, however, has
no reason to believe that such termination will occur.
The Company believes that its Secure Horizons programs are attractive to
Medicare beneficiaries because they provide a more comprehensive package of
benefits than offered under traditional Medicare and because these programs
substantially reduce the member's administrative responsibilities. Secure
Horizons members enroll on an individual basis and may disenroll upon 30 days'
notice. The Company believes that its Secure Horizons programs have one of the
lowest disenrollment rates relative to other Medicare risk plans.
Because the use of health care services by Medicare beneficiaries generally
exceeds the use of services by those who are under the age of 65, the Company's
Medicare contracts generate substantially larger per member revenue than the
Company's commercial and Medicaid programs. Premium revenue for each Secure
Horizons member is more than three times that of a commercial member,
reflecting, in part, the higher medical and administrative costs of serving a
Medicare member. As a result, although members in the Secure Horizons programs
represented approximately 31 percent of the Company's membership at September
30, 1995, they accounted for 57 percent of the consolidated premium revenue for
the fiscal year ended September 30, 1995. The Secure Horizons programs,
however, 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.
The Company's Secure Horizons programs are not permitted, under federal
regulations, to account for more than one-half of the Company's total HMO
members in each of the Company's non-contiguous geographic state markets. This
limitation may constrain the Company's rate of growth in expansion of markets
where the Company is able to add Medicare members at a faster rate than
commercial members. In markets where the Company does not currently operate a
commercial HMO, it has the ability to develop Medicare risk programs through
other arrangements. See - "Specialty Managed Care Products and Services -
Secure Horizons USA, Inc."
Recent legislation passed by the U.S. House of Representatives may have an
impact on the Company's Secure Horizons programs. See "Government Regulation."
The Company is unable to predict the effect, if any, this legislation may have
on the Company's business.
In response to employers' needs to provide cost-effective health care
coverage for their retired employees who may not be currently eligible for
Medicare benefits, the Company developed the Secure Horizons retiree product.
This product takes advantage of PacifiCare's expertise developed in its
traditional Medicare risk programs. The premium and provider networks are the
same as in the Company's Secure Horizons programs. 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 after they
become eligible for Medicare benefits.
4
<PAGE>
MEDICAID HMO PROGRAMS
Since 1993, the Company has arranged for health care services to Medicaid
beneficiaries through certain of its HMO subsidiaries pursuant to annual
contracts with the Department of Health and Human Services ("HHS"). The
Company's Medicaid membership has grown from 1,597 members at September 30, 1993
to 59,586 members at September 30, 1995. Currently, the Company arranges for
the provision of health care services to Medicaid beneficiaries in California,
Florida, Oklahoma, Oregon and Washington and may enroll Medicaid beneficiaries
in other geographic markets. Medicaid is a joint federal and state program
designed to provide health care coverage for the indigent. The Company's
Medicaid programs generally operate similarly to the Company's Secure Horizons
programs with the Company receiving a capitated payment for each Medicaid member
from HHS similar to payments received by the Company from HCFA in connection
with its Secure Horizons programs. The Company's Medicaid contracts are subject
to annual renewal. The Company believes that the risks associated with its
Medicaid managed care programs are similar to the risks associated with its
Secure Horizons programs. The Company believes that its programs are attractive
to Medicaid beneficiaries because these programs provide access to quality
health care providers, continuity of medical care and an introduction into
mainstream managed care.
California's Medicaid ("Medi-Cal") managed care program was recently modified
by the California Department of Health Services ("DHS"). Under the new system,
Medi-Cal beneficiaries can choose between either a county-run program or a
mainstream HMO. Mainstream contracts were awarded by DHS, of which none were
awarded to PacifiCare. Consequently, PacifiCare has decided to discontinue
marketing to Medi-Cal beneficiaries. PacifiCare will continue serving its
approximately 31,000 Medi-Cal members until the members transition to DHS
contracted providers. Once this transition occurs, the Company will no longer
participate in the Medi-Cal program.
In Florida, legislation was recently passed which revised its Medicaid
program. This legislation reduced Medicaid premiums, but did not include an
automatic enrollment procedure for new Medicaid beneficiaries. Because the
costs of marketing to obtain new Medicaid members in Florida is high relative to
the premiums received for a Medicaid member, the Company has decided not to
actively seek Medicaid members in Florida. The Company expects Medicaid members
in Florida to disenroll throughout fiscal 1996. The Company expects to continue
to operate Medicaid managed care programs in Oklahoma, Oregon and Washington.
SPECIALTY MANAGED CARE PRODUCTS AND SERVICES
In addition to its HMO operations, the Company provides a wide range of
specialty managed care products and services. These products and services are
offered to HMOs, insurers, employers, governmental entities, providers and PPOs
through the following affiliated operations:
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.
In January 1995, Prescription Solutions acquired Preferred Solutions, a San
Jose-based pharmacy benefit management company. The acquisition of Preferred
Solutions enables Prescription Solutions to provide fully integrated services,
including mail order distribution, an extensive network of retail pharmacies,
claims processing and sophisticated drug utilization reporting. In addition,
the Company believes the acquisition of Preferred Solutions makes Prescription
Solutions one of the industry's 10 largest pharmacy benefit management companies
covering more than 3.5 million lives.
PACIFICARE LIFE AND HEALTH INSURANCE COMPANY-SM- ("PLHIC") offers 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. PLHIC is a life and health insurance company licensed to operate in
37 states, including California, Florida, Oklahoma, Oregon and Texas.
PACIFICARE BEHAVIORAL HEALTH OF CALIFORNIA, INC., formerly LifeLink, 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.
5
<PAGE>
SECURE HORIZONS-Registered Trademark-USA, INC. ("SHUSA") was formed in March
1993 to take advantage of the Company's expertise in the Medicare risk area.
SHUSA is authorized to license the use of the Secure Horizons service mark,
trade name and systems, in exchange for license fees, to qualified HMOs that
want to engage in Medicare risk contracting. SHUSA provides consulting,
marketing, provider contracting, administrative services and other various
services in support of the operation of a Medicare risk program by such HMOs.
SHUSA is reimbursed for its expenses and receives a percentage of the revenue
derived from each program in the form of license fees. SHUSA may also enter
into joint ventures related to Medicare risk contracting.
In September 1993, SHUSA formed an alliance with Tufts Associated Health
Maintenance Organization, Inc. ("Tufts"). Through this alliance, Tufts operates
Secure Horizons, Tufts Health Plan for Seniors, under a license from and with
the assistance of SHUSA. As of October 1, 1994, Tufts began enrolling Medicare
beneficiaries in Secure Horizons, Tufts Health Plan for Seniors in the Boston
area and, as of September 30, 1995 has approximately 18,000 members. The
Company believes that Secure Horizons, Tufts Health Plan for Seniors will be
ultimately offered throughout Massachusetts and other parts of New England.
Other specialty products and services offered by the Company through various
affiliated operations include: dental and vision care through California Dental
Health Plan, Inc.; coordination of managed care products for multi-region
employers through Covantage, Inc.; military health care management through
PacifiCare Military Health Systems, Inc.; workers' compensation managed care
through COMPREMIER, Inc.; and health promotion through PacifiCare Wellness
Company.
BUSINESS STRATEGY
The Company's business strategy is to solidify its position as one of the
leading managed health care services companies by: marketing a broader range of
managed care products and services; capitalizing on its experience in developing
long-term relationships with health care providers; expanding its Secure
Horizons Medicare programs and selectively expanding into new markets to further
develop its multi-regional servicing capabilities. During its last two fiscal
years, the Company has entered into new markets, including South Florida,
Houston and Dallas, Texas, Seattle, Washington and Central California. Growth
in new markets has resulted from the Company building membership through
expansion of its existing HMOs into additional geographic markets within the
same state and through acquisitions. The Company believes it can continue to
expand its membership through selective acquisitions and by establishing HMOs in
new markets. The strategy of growth through acquisitions will be enhanced
commencing in December 1995 when, for the first time, the Company will have the
ability to use the pooling-of-interests method of accounting in connection with
stock-for-stock acquisitions.
HEALTH CARE PROVIDER RELATIONSHIPS
The Company contracts with more than 381 physician groups for a defined range
of health care services. The Company's HMOs arrange for comprehensive health
care services for their members principally through a capitation payment, based
on a percentage of premium revenue or per-member-per-month fee for each member
assigned to the group. The capitation payment rate is generally negotiated
annually in advance with each physician or physician group and does not
subsequently vary with the nature or extent of the services provided.
Generally, there is no requirement that the provider continue its relationship
with the Company upon expiration of the annual period. The Company has,
however, entered into provider service contracts with terms up to 10 years. The
Company contracts with 560 hospitals for hospital services under a variety of
arrangements including per diem, percentage of premium or per-member-per-month
capitation, discounted fee-for-service, flat fee and fee-for-service
arrangements. The loss of contracts with certain physician groups and with
certain hospitals could have a material adverse effect on the Company's HMO
operations. For the year ended September 30, 1995, fixed fee capitated payments
to providers and hospitals represented 58 percent and 75 percent of total health
care costs for the commercial and government programs, respectively.
The Company's ability to expand is dependent, in part, on competitive premium
pricing and its ability to secure cost effective contracts 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 competitive premium pricing and physician contracts is becoming
difficult due to increasing competition.
6
<PAGE>
CONTROL OF HEALTH CARE COSTS
The Company manages health care costs primarily by entering into contractual
arrangements with health care providers and by sharing the risk of certain
health care costs with the Company's contracting physicians or groups and
hospitals. 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 referral
providers. The primary care physician or group is selected by an HMO member as
the member's personal physician or group. To manage hospital and other health
care costs, the Company provides 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
the physician or physician group based on performance relative to budgeted
targets. The Company believes that these methods of physician reimbursement
encourage efficient utilization of health care services by its providers.
The Company also operates a utilization review system, under which routine
hospital admissions and lengths of stay are reviewed by 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 department, becomes actively involved in the utilization review of
longer, more costly hospitalizations and emergencies. This department also
becomes 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.
The Company's profitability is dependent, in part, on maintaining effective
control over health care costs while providing members with quality care.
Factors such as health care reform, levels of utilization of health care
services, new technologies, hospital costs, major epidemics, competition and
numerous other external factors may affect the ability of the Company to control
health care costs.
QUALITY ASSURANCE
The Company believes that providing access to high 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 evaluates the quality and appropriateness of medical care
provided to its HMO members by performing medical care evaluation and member
satisfaction studies, by reviewing the utilization of certain services and by
responding to member and physician questions and complaints. These evaluations
are based on statistical information compiled by the Company concerning the
utilization of various health care services and on-site reviews of medical
records at the medical groups. In addition, in 1994, the Company began
reporting Health Plan Employer Data Information Sets ("HEDIS"), to test the
ability of health plans to report on indicators of performance in a quantitative
manner. The Company expects that HEDIS will play a larger role in the future as
purchases of managed health care services will be able to use them to compare
health plans on quality and service.
The National Committee for Quality Assurance (the "NCQA") is an independent,
non-profit organization that reviews and accredits HMOs. NCQA assesses an HMO's
quality improvement, 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. At
September 30, 1995, the Company's California HMO received one year accreditation
and the Company's Oklahoma and Florida HMOs were denied accreditation. The
Company's other HMOs have applied for NCQA accreditation and are scheduled for
NCQA site review in 1997. Accreditation in Florida is mandatory and is required
for licensure but is not required in any other state where the Company operates
HMOs. As a result of the accreditation denials in Oklahoma and Florida, the
Company has developed a corrective action process, which is intended to address
the issues identified by the NCQA, and the Company plans to re-
7
<PAGE>
apply for accreditation in the future. The Company believes these denials will
not have a material adverse impact on its operations.
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 and establishes appropriate or necessary premium rates. The setting of
premium rates directly affects a health plan's profitability and marketing
success. Underwriting techniques are not employed with the government programs
because of regulations which require the Company to accept all Medicare and
Medicaid applicants.
The Company shifts part of the risk of catastrophic losses by maintaining
reinsurance coverage for 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
Marketing the Company's HMOs to commercial members generally involves a two-
part sale. The employer must decide to offer the Company's HMO. The employee
then generally must choose from among the Company's HMOs and other health care
coverage options, often including other HMOs.
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. In response to increased HMO penetration of
employer groups in the Southern California service area, the Company has
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 expansion of its delivery network. This strategy
includes implementing a telemarketing program and using extensive market
research. A significant portion of the Company's commercial membership growth
comes from existing employer groups.
The Company utilizes various techniques to attract commercial members during
open enrollment periods, including work site presentations, direct mail, medical
group tours and local advertising. Marketing efforts are also supported by an
advertising program that includes television, radio, billboard and print media.
The Company markets the Secure Horizons programs to Medicare beneficiaries
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 Company's current
marketing strategies and the growing senior population in the United States.
The Company markets the Medicaid programs directly to Medicaid beneficiaries as
various state laws permit.
MANAGEMENT INFORMATION SYSTEMS
The Company uses computer-based management information systems for various
purposes, including underwriting, billing, claims processing, utilization
management, marketing and sales tracking, and financial and management
accounting, reporting, planning and analysis general accounting, medical cost
trending, managed care reporting and financial planning. 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 analysis of cost and outcome data. The Company's computer information
systems which support its managed care operations and specialty managed products
are continually being enhanced and upgraded. Information system development
efforts relating to increased efficiency, capacity and flexibility are ongoing.
The Company is heavily dependent on its information systems and is in the
process of integrating the systems of its recently acquired operations.
8
<PAGE>
COMPETITION
The health care industry is highly competitive, both nationally and in the
Company's various markets. The Company has many competitors, 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. 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. Pending
federal legislation may also increase the number of competitors (See -
"Government Regulation").
California, the largest market in which the Company competes, is served by a
large number of HMOs and is one of the most heavily penetrated markets in the
United States. Competition for members in the Company's markets has resulted in
an increase in benefits and price competition. The Company believes that the
most significant factors which distinguish competing health plans, including
other HMOs, are health care costs to members and employers, access to health
care providers, quality of care, comprehensiveness of coverage and quality of
administrative services. 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.
GOVERNMENT REGULATION
The Company's HMOs are licensed and are subject to state and federal statutes
and regulations which extensively control the activities and licensing of HMOs
and subject the HMOs to periodic examination by governmental agencies. Among
the areas regulated by state and federal law are procedures for quality
assurance, enrollment requirements, the relationship between the HMO and its
health care providers and the HMO's financial condition. The Company believes
that it is currently in compliance in all material respects with the various
federal and state licensing regulations applicable to its current operations.
To maintain such compliance, it may be necessary for the Company's HMOs to make
changes from time to time in their services, procedures, structure and marketing
methods. Some of the changes may be caused by changes in federal and state
statutes and regulations that govern the Company's HMOs. 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. Additional
governmental regulation or future interpretation of existing regulations could
adversely affect the Company's operations, profitability or business prospects.
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.
California legislation requires all HMOs and insurers which offer small group
coverage to accept all small employers who apply for coverage and to guarantee
coverage to their employees seeking coverage regardless of their health status.
The legislation also requires renewal of these small group employer plans,
limits rate renewal increases, mandates community rating and excludes coverage
of pre-existing conditions for six months after enrollment. Compliance with
this legislation has required the Company to make certain changes to its small
group products in California.
One of the most significant federal laws affecting the Company is the Federal
Health Maintenance Organization Act of 1973 (the "HMO Act") and the regulations
promulgated thereunder by the Secretary of Health and Human Services. Among
other things, the HMO Act requires federally qualified HMOs to offer a
comprehensive benefit program and to have quality assurance and educational
programs for both the health care professional utilized by the HMO and its
members. Only HMOs that continue to meet federal criteria may retain their
qualified status. HCFA requires periodic financial reports from qualified HMOs
and imposes net equity, net profitability (or a plan to achieve a net operating
profit within available financial resources), reserve and cash flow
requirements. The Company's HMO operations, except for its Washington HMO and
portions of its California and Oklahoma HMO service areas, are federally
qualified. Lack of federal qualification does not substantially impact the
operations of the Company's HMO subsidiaries or their ability to offer the
Company's Medicare risk program.
9
<PAGE>
The Company's Secure Horizons programs are subject to regulation by HCFA and
various state agencies. HCFA requires that an HMO be federally qualified or
meet similar requirements as a competitive medical plan to be eligible for
Medicare risk contracts. HCFA has the right to audit HMOs operating under
Medicare contracts to determine the quality of care being rendered and the
degree of compliance with HCFA's contract and regulations.
As a result of HCFA's regulations governing the Company's Medicare fixed-fee-
per-member programs, the "medical loss ratio" (health care expenses as a
percentage of premium revenue), as determined prospectively through formulas
established by HCFA for the Company's Medicare contracts in a particular region,
may not be less than the medical loss ratio for the Company's non-Medicare
contracts in such region. 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 loss ratio for the Medicare contracts to the
level of the medical loss ratio for the non-Medicare contracts. This regulation
could affect the operations, profitability or business prospects of the Company.
Secure Horizons' premiums are determined through formulas established by
HCFA for the Company's Medicare 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 approximately 75 percent of the health care service expenses of the
Secure Horizons programs for the year ended September 30, 1995 on a capitated
basis. The Company believes that any slowdown in the rate of premium growth
may be offset by the effect of a proposal 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.
The Company's HMOs which have Medicaid contracts are subject to both federal
and state regulation regarding services to be provided to Medicaid enrollees,
payment for those services and other aspects of the Medicaid program. Both
Medicare and Medicaid have in force and/or have proposed regulations relating to
fraud and abuse, physician incentive plans and provider referrals which may
affect the Company's operations.
Some of the Company's HMOs contract with the United States Office of
Personnel Management ("OPM") to arrange managed health care services under the
Federal Employees Health Benefit Program ("FEHBP"). These contracts are subject
to extensive regulation, including complex rules related to the premiums
charged. OPM has the authority to retroactively audit the rates charged and
frequently seeks premium refunds and other sanctions against health plans
participating in the program. The Company's HMOs which have contracted with OPM
are subject to such audits and may be requested to make such refunds.
The Company has two insurance subsidiaries, one domiciled in Indiana and
licensed in 37 states and one domiciled in Arizona. The Company's insurance
subsidiaries are subject to regulation in each state 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, such subsidiaries are periodically examined
by the insurance departments of the jurisdiction in which they are licensed
to do business.
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 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.
As a result of the continued escalation of health care costs and the
inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been made, and additional
proposals may be introduced in the United State Congress and the legislatures of
the states in which the Company operates or may seek to operate.
10
<PAGE>
The United States Congress recently passed a budget reconciliation package
(the "Budget Package") that included provisions reforming the Medicare
program. Under the Budget Package, Medicare beneficiaries would be offered a
variety of new health care options, including the ability to enroll in
private plans, such as HMOs, PPOs, POS plans, medical savings accounts and
provider-sponsored organizations. A traditional fee-for-service Medicare
program would, however, continue to be offered through HCFA. The Budget
Package would also amend current laws which prohibit physician self-referral,
guard against fraud and abuse and eliminate the requirement that HMOs
participating in the Medicare program have membership which is at least 50
percent non-government program beneficiaries. In addition, HMOs would be
paid a monthly capitation rate that blends local and national costs with
greater weight given to the local component. A floor would be established
for payments to rural areas. The Budget Package has been submitted to
President Clinton and a presidential veto is expected. Accordingly, the
ultimate form in which this legislation will take effect and the impact of
this legislation on the Company's business cannot be predicted. It is
believed that a portion of the managed care provisions will be included in
the final legislation and that programs similar to the Company's Secure
Horizons programs would be favorably impacted by Medicare reform. It may,
however, result in an increase in the number of competitors.
The Budget Package also aims to modify the Medicaid program by converting
the existing Medicaid program from a federal entitlement into a block grant
payment to the states. In addition, federal standards for nursing homes
would be revoked and states would have to establish and maintain their own
standards. As stated above, ultimate passage of this legislation and the
impact of this legislation on the Company's business cannot be predicted.
The Company believes that the current political environment in which it
operates will result in continued legislative scrutiny of health care reform and
may lead to additional legislative initiatives. The Company is unable to
predict the ultimate impact upon the Company of any federal or state
restructuring of the health care delivery or health care financing systems, but
such changes could have a material adverse impact on the operations and
financial condition of the Company.
TRADEMARKS
The federally registered service marks PacifiCare-Registered Trademark- and
Secure Horizons-Registered Trademark- are owned by the Company and are material
to its business.
EMPLOYEES
As of September 30, 1995, the Company had 4,438 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 September 30, 1995 the Company had leases, in the aggregate, for
approximately 1,094,000 square feet of office space for its corporate
headquarters, executive offices, regional offices and subsidiary operations in
California, Florida, Oklahoma, Oregon, Texas and Washington. Of this aggregate
amount, the Company leases approximately 105,000 square feet in Cypress,
California for its corporate headquarters and executive offices.
The Company owns an office building of approximately 216,000 square feet on
approximately 9.2 acres of land in Cypress, California which serves as the
executive and administrative offices of its California HMO operation. The
Company also owns a child care facility on one acre of land in Cypress,
California and an office building of approximately 16,000 square feet on 1.4
acres of land in Tustin, California. The Company considers its facilities to be
in good working condition, well maintained and adequate for its present needs.
11
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in legal actions in the normal course of business,
some of which seek substantial monetary damages, including claims of punitive
damages which are not covered by insurance. After review, including
consultation with counsel, management believes any ultimate liability in excess
of amounts accrued which could arise from the actions would not materially
affect the Company's consolidated financial position, results of operations or
cash flows.
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 September 30, 1995.
12
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND QUARTERLY INFORMATION
The Class A Common Stock, par value $0.01 per share (the "Class A Common
Stock"), and the Class B Common Stock, par value $0.01 per share (the "Class B
Common Stock"), are traded on the over-the-counter market and are quoted on the
Nasdaq National Market under the symbols PHSYA and PHSYB, respectively. The
following tables set forth, for the indicated periods, the high and low last
reported sale prices per share of the Class A and Class B Common Stock as
furnished by Nasdaq.
CLASS A CLASS B
COMMON STOCK COMMON STOCK
------------------ -----------------
HIGH LOW HIGH LOW
------- ------ ------ ------
1994
First Quarter 42 1/4 31 41 1/2 29 7/8
Second Quarter 57 38 1/4 56 3/8 37 3/4
Third Quarter 59 3/4 47 1/2 59 1/2 47 1/2
Fourth Quarter 79 3/16 47 75 46
1995
First Quarter 79 60 3/4 74 3/4 60 1/2
Second Quarter 76 1/4 61 77 62
Third Quarter 75 1/8 44 1/2 76 1/4 44
Fourth Quarter 68 1/2 49 3/4 71 48 1/2
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.
As of September 30, 1995 there were approximately 266 and 211 shareholders of
record of the Company's Class A Common Stock and Class B Common Stock,
respectively. Based upon information available to it, the Company believes that
there are at least 22,000 beneficial holders in the aggregate of the Class A and
Class B Common Stock.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial and operating data are derived from the
audited financial statements of the Company and its subsidiaries. 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."
INCOME STATEMENT DATA
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands, except per share data) 1995(1) 1994(1) 1993 1992 1991
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating revenue $3,731,022 $2,893,252 $2,221,073 $1,686,314 $1,242,357
- ----------------------------------------------------------------------------------------------------------------------
Expenses:
Health care services 3,077,135 2,374,258 1,850,469 1,393,645 1,053,239
Other operating expenses 505,644 398,064 283,360 232,120 159,384
- ----------------------------------------------------------------------------------------------------------------------
Operating income 148,243 120,930 87,244 60,549 29,734
Interest income, net 33,857 24,538 21,083 14,303 14,787
- ----------------------------------------------------------------------------------------------------------------------
Income before income taxes and cumulative
effect of a change in accounting principle 182,100 145,468 108,327 74,852 44,521
Provision for income taxes
74,005 60,875 45,631 31,262 18,819
- ----------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change in
accounting principle 108,095 84,593 62,696 43,590 25,702
Cumulative effect on prior years of a change
in accounting principle -- 5,658 -- -- --
- ----------------------------------------------------------------------------------------------------------------------
Net Income $ 108,095 $ 90,251 $ 62,696 $ 43,590 $ 25,702
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Earnings per share(2) $ 3.62 $ 3.22 $ 2.25 $ 1.78 $ 1.10
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
OPERATING STATISTICS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Medical loss ratio (health care services as a
percent of premium revenue)
Consolidated 83.6% 83.1% 84.1% 83.2% 85.4%
Commercial 82.5% 80.5% 82.5% 80.2% 84.0%
Government 84.3% 85.2% 85.6% 86.6% 87.1%
Marketing, general and administrative
expenses as a percent of operating revenue 13.4% 13.6% 12.6% 13.6% 12.8%
Operating income as a percent of operating
revenue 4.0% 4.2% 3.9% 3.6% 2.4%
Effective tax rate 40.6% 41.8% 42.1% 41.8% 42.3%
Return on average shareholders' equity 18.9% 24.6% 24.2% 29.2% 29.5%
- ----------------------------------------------------------------------------------------------------------------------
(1) The 1995 and 1994 results reflect the effect of several acquisitions.
See Note 5 of Notes to Consolidated Financial Statements, page 28.
(2) Adjusted to reflect the June 1992 Stock Dividend, which had the same
effect on the total number of shares of common stock and equivalents
outstanding as a two-for-one stock split. 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 year ended September 30, 1994 was
$0.20 per share.
</TABLE>
14
<PAGE>
FINANCIAL STATEMENT CHANGE STATISTICS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Operating revenue 29.0% 30.3% 31.7% 35.7% 27.3%
Net income 19.8% 44.0% 43.8% 69.6% 45.7%
Earnings per share 12.4% 43.1% 26.4% 61.8% 48.6%
Total assets 25.3% 59.4% 39.3% 54.5% 39.2%
Total shareholders' equity 77.1% 29.5% 60.5% 99.5% 33.7%
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
MEMBERSHIP DATA
(owned and managed)
<TABLE>
<CAPTION>
SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial 1,216,140 949,124 806,918 742,104 567,422
Government (Medicare & Medicaid) 540,992 409,095 290,149 214,110 159,074
- ----------------------------------------------------------------------------------------------------------------------
Total membership 1,757,132 1,358,219 1,097,067 956,214 726,496
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
Percent change in membership 29.4% 23.8% 14.7% 31.6% 7.9%
- ----------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
BALANCE SHEET DATA
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30 1995(1) 1994(1) 1993 1992 1991
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash and equivalents and marketable
securities $ 811,525 $ 710,608 $437,231 $272,135 $205,846
Total assets $1,385,372 $1,105,548 $693,646 $498,082 $322,328
Medical claims and benefits payable $ 288,400 $ 302,900 $255,000 $208,000 $175,700
Long-term debt, excluding current maturities $ 11,949 $ 101,137 $ 21,821 $ 18,488 $ 2,280
Shareholders' equity $ 732,024 $ 413,358 $319,294 $198,884 $ 99,678
- ----------------------------------------------------------------------------------------------------------------------
(1) The 1995 and 1994 results reflect the effect of several acquisitions. See
Note 5 of Notes to Consolidated Financial Statements, page 28. The
1994 results reflect the cumulative effect on prior years of a change in
accounting principle. See Note 2j of Notes to Consolidated Financial
Statements, page 26. The 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.
</TABLE>
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FISCAL YEAR 1995 COMPARED WITH FISCAL YEAR 1994
Total operating revenue increased 29.0 percent or $838 million to $3.7
billion for the year ended September 30, 1995 from $2.9 billion for the same
period in the prior year. Enrollment gains in both the government (Medicare and
Medicaid) and commercial programs, offset slightly by decreases in commercial
premium rates, provided an increase in total operating revenue of $659 million.
Membership growth is expected to continue in both the commercial and government
programs. However, competition for members and the expected Medicaid
disenrollment in California and Florida, combined with a larger membership base
is expected to cause the rate of the membership growth to decline from the 28
percent and 32 percent increases experienced in the commercial and government
programs, respectively, in 1995. Approximately $149 million of the increase in
total operating revenue represents the incremental operations of acquisitions
described in Note 5 of the Notes to Consolidated Financial Statements. The
remaining $30 million was contributed by the Company's specialty managed care
products and services and its joint venture medical groups.
Commercial premiums increased $275 million or 22 percent to $1.5 billion for
the year ended September 30, 1995 from $1.2 billion in 1994. Commercial HMO
membership increased by 267,000 or 28 percent to 1,216,000 due to continued
growth in California, Oregon, Texas and Washington. The increase in membership
includes the effects of acquisitions in California and Washington of 67,000 and
33,000 members, respectively. The Company expects the 1996 membership growth
rate to be lower than 1995 because more competitors are offering consumers more
choices with pricing consistent with 1995 rates. Commercial HMO membership
growth provided $177 million of the increase, more than offsetting average
premium rate decreases of two percent, primarily in California. The effects of
acquisitions described above and the commercial specialty managed care products
and services and joint venture medical groups provided the remainder of the
increase in commercial premiums.
Government premiums rose $553 million or 34 percent to $2.2 billion for the
year ended September 30, 1995 from $1.6 billion in 1994. Enrollment gains,
predominantly in the Secure Horizons programs, accounted for $492 million or 89
percent of the increase. In fiscal 1996, the government membership growth rate
is expected to be less than the 32 percent increase experienced in 1995. The
remainder of the premium increase is attributable to incremental acquisitions
and premium rate increases averaging one percent. In November 1995, the Company
was advised by HCFA that effective January 1996, its HMOs will receive a
weighted average premium rate increase of approximately 5.6 percent. Because
pending federal legislation may change Medicare reimbursement rates, there can
be no assurance that these rate increases will be received.
Total health care services expenses as a percent of premium revenue (the
"medical loss ratio"; See Item 6. Selected Financial Data, page 14) for the
year ended September 30, 1995, increased to 83.6 percent from 83.1 percent in
1994. The commercial medical loss ratio increased to 82.5 percent from 80.5
percent while the government medical loss ratio decreased to 84.3 percent from
85.2 percent.
The increase in the commercial medical loss ratio has been driven by the
Company's entry into new markets, through acquisitions and internal development,
with principally traditional fee-for-service delivery systems. Implementing the
Company's provider contracting approach, shifting the delivery systems from fee-
for-service to capitation and risk-sharing arrangements, and developing the
provider network through education in these markets are expected to decrease the
commercial medical loss ratio by the end of fiscal 1996. Until health care cost
risks are mitigated through contract renewals beginning January 1, 1996 and
later, the commercial medical loss ratio may increase slightly in the first and
second quarter of fiscal 1996. The decrease in the government medical loss
ratio is primarily related to more cost effective physician and hospital
contracts. The government medical loss ratio is expected to increase in 1996 as
competitive pressures increase health care costs and outpace increases in
premium revenue.
For the year ended September 30, 1995, the Company made net positive reserve
adjustments totaling $12 million. These net positive reserve adjustments have
historically been made in the third quarter and result primarily from the
periodic reconciliation of amounts reserved for physician and hospital incentive
programs. For the year ended September 30, 1995, however, net positive reserve
adjustments were made in insignificant amounts throughout the year. For the
year ended September 30, 1994, net positive reserve adjustments of $9 million
were made in the third quarter.
16
<PAGE>
Marketing, general and administrative expenses increased $104 million or 26
percent to $498 million for the year ended September 30, 1995 from $395 million
for 1994. As a percentage of operating revenue, marketing, general and
administrative expenses decreased to 13.4 percent from 13.6 percent. The
decrease is primarily attributable to increased operating revenue and
efficiencies due to process improvements which have offset infrastructure
investments in new markets. Marketing, general and administrative expenses as a
percentage of operating revenue in fiscal 1996 are expected to be comparable to,
or slightly higher than, fiscal 1995 as mature market process improvements are
offset by investments in new markets.
Net interest income increased by approximately $9 million compared to the
prior year primarily due to increased cash available for investment purposes at
higher interest rates than 1994.
For the year ended September 30, 1995, earnings per share increased 20
percent to $3.62 compared to $3.02 for 1994 before the cumulative effect of a
change in accounting principle. The increase is primarily related to membership
growth derived substantially from the government programs predominantly Secure
Horizons. Increases in health care service expenses were partially offset by
decreases in marketing, general and administrative expenses. The results for the
years ended September 30, 1995 and 1994 included approximately $0.24 and $0.18,
respectively, related to the net positive reserve adjustments previously
described. Earnings per share for the year ended September 30, 1994 were $3.22
which included approximately $0.20 due to changes in income tax accounting
principles (see Note 2j of the Notes to Consolidated Financial Statements).
The Company's ability to expand is affected by increasing competition not
only in product choices but also in the number of competitors in the Company's
service areas. Certain large employer groups and other purchasers of health
care services continue to demand minimal premium rate increases or reductions in
premium rates while limiting the number of choices offered to employees. In
addition, securing cost effective contracts with additional physicians is
becoming difficult due to increasing competition among HMOs for physician
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. Factors such as health care reform, levels of utilization of
health care services, new technologies, hospital costs, major epidemics, and
numerous other external influences may affect the Company's operating results.
Accordingly, 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.
FISCAL YEAR 1994 COMPARED WITH FISCAL YEAR 1993
Total operating revenue increased 30 percent or $672 million to $2.9 billion
for the year ended September 30, 1994 from $2.2 billion for the same period in
1993. Enrollment gains in both the government and commercial programs provided
an increase in total operating revenue of $451 million, while an additional $77
million was derived from higher premium rates in both programs. In addition,
approximately $106 million of the increase in total operating revenue
represented the incremental operations of acquisitions described in Note 5 of
the Notes to Consolidated Financial Statements. The Company's specialty managed
care products and services and its joint venture medical groups contributed the
remainder of the increase.
Commercial premiums increased $191 million to $1.2 billion for the year ended
September 30, 1994 from $1 billion in 1993. Excluding the effects of the
acquisitions described above, membership growth provided 46 percent of the
increase in the commercial HMO program. An additional 21 percent of the
increase was attributable to higher premium rates, which rose an average of
three percent. The remainder of the increase in commercial premiums was derived
from commercial specialty managed care products and services and joint venture
medical groups.
Government premiums rose $464 million to $1.6 billion for the year ended
September 30, 1994 from $1.2 billion in 1993. Excluding the effects of
acquisitions described above, enrollment gains predominantly in the Secure
Horizons programs contributed 80 percent of the increase. Average premium rate
increases of two percent accounted for nine percent of the increase. The
remainder of the change was attributable to acquisitions.
The medical loss ratio for the year ended September 30, 1994, decreased to
83.1 percent from 84.1 percent for the same period in 1993. The commercial
medical loss ratio decreased to 80.5 percent from 82.5 percent while the
government medical loss ratio declined slightly to 85.2 percent from 85.6
percent. The decrease in the commercial
17
<PAGE>
medical loss ratio was primarily attributable to lower inpatient hospital
costs. The decrease in the government medical loss ratio was primarily related
to lower hospital expenses and increases in net positive reserve adjustments
described below.
The health care service expenses for the years ended September 30, 1994 and
1993, reflect the impact of net positive reserve adjustments of approximately $9
million and $6 million, respectively. The $3 million increase in net positive
reserve adjustments was primarily attributable to increases in members served
under hospital capitation arrangements and improved contracting. Commercial net
positive reserve adjustments for the year ended September 30, 1994 increased to
$4 million compared to $1 million for the same period in the prior year.
Government net positive reserve adjustments for each of the years ended
September 30, 1994 and 1993 totaled $5 million.
Marketing, general and administrative expenses increased $115 million to $395
million for the year ended September 30, 1994 from $280 million for 1993. As a
percentage of operating revenue, marketing, general and administrative expenses
increased to 13.6 percent from 12.6 percent. These increases were primarily
attributable to higher costs related to developing markets, products and
services in new as well as established geographic areas and incremental expenses
to integrate acquisitions.
For the year ended September 30, 1994, before the cumulative effect of a
change in accounting principle, earnings per share increased 34 percent to $3.02
compared to $2.25 for 1993. The increase was primarily related to membership
growth derived substantially from the government programs. Decreases in health
care service expenses were partially offset by increases in marketing, general
and administrative expenses. The results for the years ended September 30, 1994
and 1993 include approximately $0.18 and $0.12, respectively, related to the net
positive reserve adjustments previously described. Changes in income tax
accounting principles (see Note 2j of the Notes to Consolidated Financial
Statements) increased earnings per share by approximately $0.20, resulting in
earnings per share of $3.22 for the year ended September 30, 1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital as of September 30, 1995 was $321 million, an
increase of $89 million from September 30, 1994. The increase in working
capital is primarily attributable to increases in cash and accounts receivable
offset by increases in accounts payable, accrued liabilities and unearned
premium revenue resulting from growth in operations. Medical claims and
benefits payable decreased from September 30, 1994, reflecting shifting
membership, primarily in the Secure Horizons programs, to capitated
arrangements, coupled with improvements in claims processing that result in
faster payment and fewer claims awaiting adjudication and payment. For the year
ended September 30, 1995, payments for physician and hospital capitation
represented approximately 68 percent of total health care costs, an increase of
four percent over 1994. Redesigned work processes and electronic data interface
technologies resulted in more efficient and prompt payment of claims. While the
expedited claims payment process is expected to reduce interest income, these
operating efficiencies enhance the Company's ability to comply with certain HMO
regulations.
Cash generated from operations was $147 million, principally from net income
and non-cash items including depreciation and amortization. In fiscal 1994,
cash generated from operations of $288 million reflected net income, non-cash
items and a $153 million increase in unearned premium revenue because October
HCFA premiums were received in September. Because fiscal 1995 also reflects
October HCFA premiums received in September, unearned premium revenue increased
slightly over 1994, decreasing cash generated from operations by $141 million.
The Company made acquisitions using $135 million of cash, decreasing the net
purchases of marketable securities. The Company made capital expenditures of
$25 million for the year ended September 30, 1995 primarily for computer
equipment. The Company anticipates that the level of capital expenditures will
increase in 1996 in connection with the Company's ongoing program of updating
and enhancing its management information systems.
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 sold by the Company
and 2,175,000 share were sold by UniHealth. The Company received net proceeds
of approximately $198 million for the sale of the 3,000,000 shares of Class B
Common Stock after deducting underwriting discounts and commissions and expenses
of the offering payable by the Company. The Company used approximately $186
million of the net proceeds to repay the amount outstanding under its line of
credit (see Note 6 -
18
<PAGE>
"Long Term Debt") and to replenish working capital used to pay for certain of
the acquisitions (see Note 5 - "Acquisitions").
The Company believes that its current capital resources, which includes the
$250 million line of credit with B of A, are adequate to fund existing HMO
operations, the introduction of new products and services and the continued
development of its health-care related businesses (see Note 6 - "Long Term Debt"
for a summary of the terms of the B of A Credit Line).
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Balance Sheets . . . . . . . . . . . . . . 20
Consolidated Statements of Income . . . . . . . . . . . 21
Consolidated Statements of Shareholders' Equity . . . . 22
Consolidated Statements of Cash Flows . . . . . . . . . 23
Notes to Consolidated Financial Statements. . . . . . . 25
Report of Ernst & Young LLP Independent Auditors. . . . 35
Quarterly Information for Fiscal Years 1995 and 1994
(Unaudited). . . . . . . . . . . . . . . . . . . . . . 36
</TABLE>
19
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30
(in thousands, except per share data) 1995 1994
- ------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 279,145 $ 192,609
Marketable securities 532,380 517,999
Receivables, net 112,408 73,976
Prepaid expenses 9,469 8,883
Deferred income taxes 28,207 28,415
- ------------------------------------------------------------------------------------------
Total current assets 961,609 821,882
- ------------------------------------------------------------------------------------------
Property, plant and equipment at cost, net of accumulated
depreciation and amortization 99,276 97,018
Marketable securities - restricted 23,108 15,994
Goodwill and intangible assets 295,794 167,085
Other assets 5,585 3,569
- ------------------------------------------------------------------------------------------
$1,385,372 $1,105,548
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims and benefits payable:
Medical claims payable $ 192,800 $ 203,900
Incentives payable to participating medical groups 80,600 83,700
Future life and annuity policy benefits 15,000 15,300
- ------------------------------------------------------------------------------------------
Total medical claims and benefits payable 288,400 302,900
- ------------------------------------------------------------------------------------------
Accounts payable 21,699 17,000
Accrued liabilities 74,685 47,110
Accrued compensation and employee benefits 45,415 37,737
Income taxes payable 7,404 6,748
Unearned premium revenue 195,413 170,970
Long-term debt due within one year 7,978 8,175
- ------------------------------------------------------------------------------------------
Total current liabilities 640,994 590,640
- ------------------------------------------------------------------------------------------
Long-term debt due after one year 11,949 101,137
Minority interest 405 413
Commitments and contingencies
Shareholders' equity:
Preferred shares, par value $1.00 per share; 10,000 shares
authorized; none issued -- --
Class A common shares, par value $0.01 per share; 30,000
shares authorized; 12,331 and 12,238 shares issued in 1995
and 1994, respectively 123 122
Class B common shares, par value $0.01 per share; 60,000
shares authorized; 18,551 and 15,290 shares issued in 1995
and 1994, respectively 186 153
Additional paid-in capital 347,548 141,955
Unrealized gain on marketable securities net of taxes 4,944 --
Retained earnings 379,223 271,128
- ------------------------------------------------------------------------------------------
Total shareholders' equity 732,024 413,358
- ------------------------------------------------------------------------------------------
$1,385,372 $1,105,548
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
20
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands, except per share data) 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue:
Commercial premiums $1,512,080 $1,237,411 $1,046,186
Government premiums 2,170,885 1,618,145 1,153,964
Other income 48,057 37,696 20,923
- ------------------------------------------------------------------------------------------------------------
Total operating revenue 3,731,022 2,893,252 2,221,073
- ------------------------------------------------------------------------------------------------------------
Expenses:
Health care services:
Medical services 1,453,289 1,127,785 867,157
Hospital services 1,264,002 968,605 766,770
Other services 359,844 277,868 216,542
- ------------------------------------------------------------------------------------------------------------
Total health care services 3,077,135 2,374,258 1,850,469
Marketing, general and administrative expenses 498,445 394,620 279,865
Amortization of intangibles 7,199 3,444 3,495
- ------------------------------------------------------------------------------------------------------------
Operating income 148,243 120,930 87,244
Interest income 39,406 28,588 23,459
Interest expense (5,549) (4,050) (2,376)
- ------------------------------------------------------------------------------------------------------------
Income before income taxes and cumulative effect of a
change in accounting principle 182,100 145,468 108,327
Provision for income taxes 74,005 60,875 45,631
- ------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change in
accounting principle 108,095 84,593 62,696
Cumulative effect on prior years of a change in
accounting principle -- 5,658 --
- ------------------------------------------------------------------------------------------------------------
Net income $ 108,095 $ 90,251 $ 62,696
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Weighted average common shares and equivalents
outstanding used to calculate earnings per share 29,864 28,004 27,847
- ------------------------------------------------------------------------------------------------------------
Earnings per share:
Before cumulative effect of a change in accounting
principle $ 3.62 $ 3.02 $ 2.25
Cumulative effect on prior years of a change in
accounting principle -- .20 --
- ------------------------------------------------------------------------------------------------------------
Earnings per share $ 3.62 $ 3.22 $ 2.25
- ------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
21
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30, 1995, 1994 AND 1993
UNREALIZED
CLASS A COMMON SHARES CLASS B COMMON SHARES ADDITIONAL GAIN ON
--------------------- --------------------- PAID-IN MARKETABLE RETAINED
(in thousands) OUTSTANDING AMOUNT OUTSTANDING AMOUNT CAPITAL SECURITIES EARNINGS TOTAL
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at September 30, 1992 11,946 $119 13,671 $137 $ 80,447 $ -- $118,181 $198,884
- ---------------------------------------------------------------------------------------------------------------------------------
Issuance of 1,600 shares of
common stock in connection
with public offering -- -- 1,600 16 59,276 -- -- 59,292
Issuance of common stock upon
exercise of stock options 186 2 112 1 1,536 -- -- 1,539
Issuance of common stock upon
conversion of convertible
debentures 1 -- 1 -- 20 -- -- 20
Tax benefit realized upon
exercise of stock options -- -- -- -- 5,038 -- -- 5,038
Purchase and retirement of
common stock -- -- (261) (3) (8,172) -- -- (8,175)
Net income -- -- -- -- -- -- 62,696 62,696
- ---------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 1993 12,133 121 15,123 151 138,145 -- 180,877 319,294
- ---------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock upon
exercise of stock options 105 1 181 2 2,323 -- -- 2,326
Issuance of common stock
under incentive plan -- -- 21 -- 849 -- -- 849
Tax benefit realized upon
exercise of stock options -- -- -- -- 1,715 -- -- 1,715
Purchase and retirement of
common stock -- -- (35) -- (1,077) -- -- (1,077)
Net income -- -- -- -- -- -- 90,251 90,251
- ---------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 1994 12,238 122 15,290 153 141,955 -- 271,128 413,358
- ---------------------------------------------------------------------------------------------------------------------------------
Issuance of 3,000 shares of
common stock in connection
with public offering -- -- 3,000 30 197,602 -- -- 197,632
Issuance of common stock upon
exercise of stock options 93 1 245 3 3,284 -- -- 3,288
Issuance of common stock
under incentive plan -- -- 16 -- 1,024 -- -- 1,024
Tax benefit realized upon
exercise of stock options -- -- -- -- 3,683 -- -- 3,683
Cumulative effect of a change
in accounting principle, net
of taxes of $2,474 -- -- -- -- -- (3,808) -- (3,808)
Change in unrealized gains
(losses), net of taxes of $5,516 -- -- -- -- -- 8,752 -- 8,752
Net income -- -- -- -- -- -- 108,095 108,095
- ---------------------------------------------------------------------------------------------------------------------------------
Balances at September 30, 1995 12,331 $123 18,551 $186 $347,548 $4,944 $379,223 $732,024
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
22
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands) 1995 1994 1993
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net income $ 108,095 $ 90,251 $62,696
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 21,436 17,913 11,916
Amortization of intangibles 7,199 3,444 3,495
Loss on disposal of property, plant and equipment 2,033 642 1,337
Deferred income taxes (2,834) (9,411) 1,275
Provision for doubtful accounts 530 532 1,650
Cumulative effect of a change in accounting principle -- (5,658) --
Other 114 45 (407)
Changes in assets and liabilities net of effects from
acquisitions:
Accounts receivable (27,458) (15,607) (16,433)
Prepaid and other assets (2,489) 9,774 (5,715)
Medical claims and benefits payable (19,093) 29,043 47,000
Accounts payable (153) (5,819) 1,768
Accrued liabilities 27,575 8,336 18,736
Accrued compensation and employee benefits 7,678 9,249 994
Income taxes payable 656 2,372 4,428
Unearned premium revenue 23,934 153,387 2,378
- ------------------------------------------------------------------------------------------------
Net cash flows provided by operating activities 147,223 288,493 135,118
- ------------------------------------------------------------------------------------------------
Investing activities:
Acquisitions, net of cash acquired (134,971) (69,589) --
Purchase of property, plant and equipment (25,035) (24,979) (19,577)
Purchase of marketable securities (6,395) (113,415) (161,971)
Purchase) sale of marketable securities -- restricted (7,114) 450 (206)
Proceeds from sale of property, plant and equipment 3,056 -- 32
- ------------------------------------------------------------------------------------------------
Net cash flows used in investing activities (170,459) (207,533) (181,722)
- ------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from issuance of common stock 200,920 2,326 60,831
Principal payments on long-term debt (174,483) (5,212) (2,927)
Proceeds from borrowings of long-term debt 83,335 82,350 --
Purchase and retirement of common stock -- (1,077) (8,175)
- ------------------------------------------------------------------------------------------------
Net cash flows provided by financing activities 109,772 78,387 49,729
- ------------------------------------------------------------------------------------------------
Net increase in cash and equivalents 86,536 159,347 3,125
Beginning cash and equivalents 192,609 33,262 30,137
- ------------------------------------------------------------------------------------------------
Ending cash and equivalents $ 279,145 $ 192,609 $33,262
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
23
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands) 1995 1994 1993
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Supplemental cash flow information
Cash paid during the year for:
Income taxes $ 61,166 $ 66,510 $40,295
Interest $ 2,685 $ 2,466 $ 1,865
- ------------------------------------------------------------------------------------------------
Supplemental schedule of noncash investing and
financing activities:
Tax benefit realized upon exercise of stock options $ 3,683 $ 1,715 $ 5,038
Compensation awarded in Class B Common Stock $ 1,024 849 $ --
Leases capitalized $ 392 $ 4,063 $ 8,658
Capital leases terminated $ -- $ 1 $ 45
Conversion of 7.50% subordinated convertible debentures $ -- $ -- $ 20
- ------------------------------------------------------------------------------------------------
Details of unrealized gain on marketable securities:
Marketable securities $ 7,986 $ -- $ --
Deferred taxes $ 3,042 $ -- $ --
- ------------------------------------------------------------------------------------------------
Increase in shareholders' equity $ 4,944 $ -- $ --
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
Details of businesses acquired in purchase transactions:
Fair value of assets acquired $ 152,456 $ 130,323 $ --
Less liabilities assumed or created, including
notes to seller 15,909 42,587 --
- ------------------------------------------------------------------------------------------------
Cash paid for acquisitions 136,547 87,736 --
Cash acquired in acquisitions 1,576 18,147 --
- ------------------------------------------------------------------------------------------------
Net cash paid for in acquisitions $ 134,971 $ 69,589 $ --
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE REPORTING ENTITY
a) Organization and Operations. PacifiCare Health Systems, Inc. (the
"Company") 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, Medicare risk
management services and vision services, coordination of managed care products
for multi-region employers, military health care management, workers'
compensation managed care and health promotion. UniHealth, a California non-
profit public benefit corporation owned approximately 44 percent and two percent
of the Company's outstanding shares of Class A and Class B Common Stock,
respectively, at September 30, 1995.
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.
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 of three months or
less.
b) Marketable Securities. As of October 1, 1994, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." In connection with the
adoption of SFAS No. 115, the Company determined that all marketable
securities (which are comprised of municipal bonds, corporate notes,
commercial paper and U.S. Treasury securities) held as of that date are
available for sale. Accordingly, such securities are carried at fair value
and unrealized gains or losses, net of applicable income taxes, are recorded
in shareholders' equity. The Company also determined that these marketable
securities are available for use in current operations and, accordingly,
classified such securities as current assets without regard to the
securities' contractual maturity dates. Prior to the adoption of SFAS No.
115, the Company carried marketable securities at cost, unless there was a
permanent impairment of value. The adoption of SFAS No. 115 had no effect on
net income, but decreased marketable securities as of October 1, 1994 by $6.3
million, decreased shareholders' equity by $3.8 million and increased
deferred tax assets by $2.5 million.
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 included in marketable securities-
restricted (which are comprised of U.S. government securities and certificates
of deposit held by trustees or state regulatory agencies). The Company
determined that all marketable securities-restricted are held-to-maturity since
the Company has the intent and ability to hold the securities to maturity.
Held-to-maturity securities continue to be stated at amortized cost, adjusted
for amortization of premiums and accretion of discounts to maturity, and are
classified as noncurrent assets.
c) 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
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.
d) Goodwill and Intangible Assets. Goodwill and intangible assets represent
principally the unamortized excess of the cost of acquiring subsidiary companies
over the fair values of such companies' net tangible assets at the dates of
acquisition. Goodwill and intangible assets are amortized on a straight-line
basis over periods not exceeding forty years. Net intangible assets totaling
$0.8 million were written off in 1993, reducing earnings per
25
<PAGE>
share by approximately $0.03. These assets, which were related to the Company's
life and health insurance subsidiary, were determined to have no continuing
value. As of September 30, 1995 and 1994, accumulated amortization totaled
$16.0 and $8.8 million, respectively.
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which
requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. The statement also addresses the accounting for long-lived
assets that are expected to be disposed of. The Company will adopt SFAS No. 121
on October 1, 1996 and, based on current circumstances, does not believe the
effect of the adoption will be material.
e) Software Costs. Direct costs associated with the development of computer
software are expensed as incurred. These costs totaled $12.1 million, $9.6
million and $7.0 million in 1995, 1994 and 1993, respectively.
f) 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 programs accounted for approximately 57 percent of the
Company's premium revenue for each of the years ended September 30, 1995 and
1994 and 52 percent for the year ended September 30, 1993.
g) 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.
h) 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.
The costs associated with providing these medical services are recorded in
general and administrative expenses and totaled $14.6 million, $10.9 million and
$8.9 million for the fiscal years ended September 30, 1995, 1994 and 1993,
respectively.
i) Earnings Per Share. Earnings per share are computed on the weighted
average number of common shares outstanding each year. Outstanding stock
options are common stock equivalents and are included in earnings per share
computations.
j) Taxes Based on Premiums and Income. 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 general and administrative expenses and totaled $4.3
million, $4.0 million and $3.3 million for the fiscal years ended
September 30, 1995, 1994 and 1993.
26
<PAGE>
As of October 1, 1993, the Company adopted SFAS No. 109, "Accounting for
Income Taxes" and recorded a benefit for the cumulative effect prior to October
1, 1993 of the change in accounting principle of $5.7 million or approximately
$0.20 per share.
3. MARKETABLE SECURITIES
The following table summarizes marketable securities as of September 30,
1995:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
(amounts in thousands) COST GAINS LOSSES FAIR VALUE
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Marketable securities:
U.S. Government and agency $120,756 $3,396 $ (63) $124,089
State and state agency 107,483 1,454 (237) 108,700
Municipal and local agency 117,221 3,140 - 120,361
Corporate debt and other securities 178,934 1,498 (1,202) 179,230
- ----------------------------------------------------------------------------------------------------------
Total marketable securities 524,394 9,488 (1,502) 532,380
- ----------------------------------------------------------------------------------------------------------
Marketable securities - restricted:
U.S. Government and agency 5,595 11 - 5,606
Corporate debt and other securities 17,513 - - 17,513
- ----------------------------------------------------------------------------------------------------------
Total marketable securities - restricted 23,108 11 - 23,119
- ----------------------------------------------------------------------------------------------------------
Total marketable securities $547,502 $9,499 $(1,502) $555,499
- ----------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------
</TABLE>
As of September 30, 1995, the contractual maturities of the Company's
marketable securities were as follows:
<TABLE>
<CAPTION>
MARKETABLE SECURITIES-
MARKETABLE SECURITIES RESTRICTED
AMORTIZED AMORTIZED
(amounts in thousands) COST FAIR VALUE COST FAIR VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $118,332 $118,011 $21,655 $21,661
Due after one year through five years 259,938 261,575 1,453 1,458
Due after five years through ten years 120,301 126,120 - -
Due after ten years 25,823 26,674 - -
- ------------------------------------------------------------------------------------------------
$524,394 $532,380 $23,108 $23,119
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
</TABLE>
During the year ended September 30, 1995, proceeds from sales and maturities
of marketable securities were $2.7 billion, resulting in gross realized gains of
$6.0 million and realized losses of $6.8 million. Realized gains and losses are
included in investment income under the specific identification method.
27
<PAGE>
4. PROPERTY, PLANT AND EQUIPMENT
The following table summarizes the components of property, plant and
equipment:
<TABLE>
<CAPTION>
SEPTEMBER 30
(in thousands) 1995 1994
- --------------------------------------------------------------------------
<S> <C> <C>
Land $12,060 $14,533
Buildings and improvements 33,994 30,087
Furniture, fixtures and equipment 91,304 74,148
Leasehold improvements 15,620 10,509
Capital leases 18,357 17,526
Construction in progress 1,082 2,717
- --------------------------------------------------------------------------
172,417 149,520
Less accumulated depreciation and amortization 73,141 52,502
- --------------------------------------------------------------------------
Net property, plant and equipment $ 99,276 $ 97,018
- --------------------------------------------------------------------------
- --------------------------------------------------------------------------
</TABLE>
5. ACQUISITIONS
The Company completed several acquisitions in the years ended September 30,
1995 and 1994. During fiscal 1995, the Company made the following acquisitions
(the "1995 Acquisitions"): (i) Preferred Solutions, a San Jose-based pharmacy
benefit management company, in January 1995; (ii) ValuCare, a Fresno,
California-based HMO with approximately 67,000 members in March 1995; and (iii)
the membership of Pacific Health Plans, a Washington-based HMO, with
approximately 33,000 members in March 1995.
During fiscal 1994, the Company made the following acquisitions (the "1994
Acquisitions"): (i) Freedom Plan, Inc., a Santa Barbara, California-based HMO,
with approximately 14,000 members in October 1993; (ii) California Dental Health
Plan, Inc., a southern California-based dental HMO and its affiliate, Dental
Plan Administrators, a third party administrator, in November 1993; (iii)
Advantage Health Plans, Inc., a southern Florida-based HMO, with approximately
20,000 members in December 1993; (iv) Network Health Plan, Inc., a Washington-
based health care service contractor, with approximately 28,000 members in
February 1994; and (v) Pasteur Health Plans, Inc., a southern Florida-based HMO,
with approximately 50,000 members in August 1994. The 1994 and the 1995
Acquisitions shall together be referred to herein as the "Acquisitions" and the
companies acquired through the Acquisitions shall be referred to as the
"Acquired Companies."
The total purchase price for the Acquisitions, including contingent purchase
payments, was approximately $220.0 million. Based on the fair values of the
assets and liabilities of the Acquired Companies, the preliminary estimate of
excess purchase price is approximately $220.4 million. A final allocation of
purchase price will be determined when appraisals and other studies are
completed. The Acquisitions have been accounted for as purchases and the
operating results of each completed acquisition are included in the consolidated
financial statements from the date of purchase.
The following table summarizes the unaudited pro forma consolidated results
of the Company as though the Acquisitions had occurred at the beginning of the
periods presented giving effect to the interest income foregone, the costs
associated with the integration of the operations into those of the Company and
the amortization of the excess of the purchase price over the fair value of the
assets acquired. The unaudited pro forma information is not necessarily
indicative of the actual consolidated results of operations that would have
occurred had the Acquisitions occurred at the beginning of the period and is not
intended to be indicative of results which may occur in the future.
28
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(Unaudited)
(Amounts in thousands, except per share amounts) 1995 1994
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Premium revenue $3,752,959 $3,067,329
Total operating revenue $3,801,684 $3,112,121
Pretax income $177,925 $ 129,334
Net income (1) $105,100 $ 78,862
Earnings per share (1) $ 3.52 $ 2.82
- ----------------------------------------------------------------------------------------
</TABLE>
(1) The unaudited pro forma income before cumulative effect of a change in
accounting principle for the year ended September 30, 1994 was $73.2
million or $2.62 per share. The unaudited pro forma cumulative effect
on prior years of a change in accounting principle for the year ended
September 30, 1994 is $5.7 million or $0.20 per share (see Note 2j of the
Notes to Consolidated Financial Statements).
6. LONG-TERM DEBT
Long-term debt consists of the following components:
<TABLE>
<CAPTION>
SEPTEMBER 30
(in thousands) 1995 1994
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
8.80% privately placed senior debt, due in annual installments of
$3,750 through November 1997 $11,250 $ 15,000
Capitalized lease obligations 5,655 9,745
Revolving line of credit - 82,350
Other long-term debt 3,022 2,217
- ------------------------------------------------------------------------------------------------------
19,927 109,312
Less amounts due within one year 7,978 8,175
- ------------------------------------------------------------------------------------------------------
Long-term debt due after one year $11,949 $101,137
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
</TABLE>
In November 1994, the Company established a $250.0 million revolving line
of credit with Bank of America National Trust and Saving Association and a
syndicate of banks (the "B of A Credit Line"). The B of A Credit Line has a
five year term with interest payable at a rate per annum equal to the London
Interbank Offered Rate plus a margin. The B of A Credit Line is subject to,
among other things, certain financial covenants, including a fixed charge ratio
and a leverage ratio. The B of A Credit Line may be extended beyond its five
year term but not beyond November 30, 2001. In November 1994, the Company
borrowed $82.3 million under the B of A Credit Line to pay the balance owed on
the syndicated $130.0 million credit line with The Chase Manhattan Bank, N.A.
The amount outstanding under the B of A Credit Line was repaid in March 1995
from the proceeds of the sale of the Company's Class B Common Stock, par value
$0.01 per share (the "Class B Common Stock") (see Note 7 - "Shareholders'
Equity").
As of September 30, 1995, the maturities of long-term debt for the years
following 1995 are as follows:
<TABLE>
<CAPTION>
YEARS ENDING SEPTEMBER 30
(in thousands)
- -----------------------------------------------------------------------------
<S> <C>
1996 $7,978
1997 6,264
1998 4,112
1999 111
2000 32
Thereafter 1,430
- -----------------------------------------------------------------------------
$19,927
- -----------------------------------------------------------------------------
- -----------------------------------------------------------------------------
</TABLE>
29
<PAGE>
Capitalized leases relate to equipment included in the accompanying
consolidated balance sheets at a cost of $18.4 million and $17.5 million at
September 30, 1995 and 1994, respectively. Accumulated amortization related to
this equipment totaled $12.8 million and $8.2 million at September 30, 1995 and
1994, respectively. These leases require future payments including interest
totaling $8.4 million at September 30, 1995 through the end of the lease terms.
7. SHAREHOLDERS' EQUITY
The authorized capital stock of the Company consists of 30 million shares of
the Class A Common Stock, par value $0.01 per share (the "Class A Common
Stock"), 60 million shares of the Class B Common Stock and 10 million shares of
Preferred Stock, par value $1.00 per share (the "Preferred Stock"). As of
November 1, 1995, there were 12,331,408 shares of the Class A Common Stock
outstanding, 18,551,697 of the Class B Common Stock outstanding and no shares of
Preferred Stock outstanding. Holders of the Class A Common Stock have one vote
per share while holders of the Class B Common Stock have no voting rights other
than as required by Delaware law. Holders of the Class A Common Stock and
Class B Common Stock are entitled to equal per share cash and stock dividends,
if any, distributions upon liquidation of the Company and consideration in a
merger or consolidation of the Company.
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 sale of 4,500,000
shares of the Class B Common Stock closed on March 23, 1995 with the sale of the
additional 675,000 shares of the Class B Common Stock occurring on
March 29, 1995 pursuant to the exercise of the underwriters' over-allotment
option.
The Company received net proceeds of approximately $197.6 million from the
sale of the 3,000,000 shares of Class B Common Stock 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. The Company used approximately
$186.0 million of the net proceeds to repay the amount outstanding under its B
of A Credit Line and to replenish working capital used to pay for certain of the
Acquisitions (see Note 5 - "Acquisitions").
In December 1994, the Company completed a public offering of 90,000 shares of
its Class B Common Stock to certain physician groups which currently contract
with the Company. Each group has entered into an irrevocable obligation to
purchase a fixed number of shares of the Class B Common Stock over a five year
period beginning May 1, 1996 at $64.88 per share.
On December 13, 1993, UniHealth completed a public offering of 575,000 shares
of the Company's Class A Common Stock. The Company did not receive any of the
proceeds from this offering.
In November 1992, the Company completed a public offering of 3,200,000 shares
of Class B Common Stock, of which 1,600,000 shares were sold by the Company and
1,600,000 shares were sold by UniHealth. The net proceeds received by the
Company were approximately $59 million after deducting underwriting discounts
and commissions, and expenses of the offering.
8. TRANSACTIONS WITH RELATED PARTIES
The Company purchased health care services from hospitals owned and managed
by UniHealth totaling $70.6 million, $61.5 million and $55.5 million for the
years ended September 30, 1995, 1994 and 1993, respectively. Under the terms of
a management arrangement with UniHealth, the Company paid $0.7 million, $0.8
million and $1.2 million for management fees, payroll processing services and
other services in the years ended September 30, 1995, 1994 and 1993,
respectively.
UniHealth purchased health care coverage from the Company in the amounts of
$12.0 million, $10.0 million and $7.3 million for the years ended September 30,
1995, 1994 and 1993, respectively. Amounts receivable from UniHealth were $0.9
million and $1.0 million at September 30, 1995 and 1994, respectively.
30
<PAGE>
Joseph S. Konowiecki, the secretary and general counsel of the Company, is
the sole shareholder of Joseph S. Konowiecki, Inc., a California professional
corporation, which is a partner of the law firm of Konowiecki & Rank. The
Company purchased legal services from Konowiecki & Rank in the amounts of $3.2
million, $3.1 million and $2.3 million for the years ended September 30, 1995,
1994 and 1993, respectively. The amount payable to Konowiecki & Rank was $0.2
million at September 30, 1995 and 1994.
9. 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>
SEPTEMBER 30
(IN THOUSANDS) 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Accrued health care costs $15,147 $ 8,363
Accrued compensation 8,682 9,574
Accrued expenses 4,761 5,644
State franchise taxes 3,121 2,758
Capital leases 708 2,974
Depreciation 693 --
Other assets 485 1,434
- --------------------------------------------------------------------------------
Total deferred tax assets 33,597 30,747
Deferred tax liabilities:
Unrealized gain on marketable securities (3,042) --
Prepaid expense (1,445) --
Other liabilities (903) (741)
Depreciation -- (1,591)
- --------------------------------------------------------------------------------
Net deferred tax assets $28,207 $28,415
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
The provision for income taxes for the years ended September 30, 1995,
1994 and 1993, consists of the following components:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands) 1995 1994 1993
<S> <C> <C> <C>
Current:
Federal $62,912 $58,036 $35,324
State 13,927 12,250 9,032
- ---------------------------------------------------------------------------------------
Total current 76,839 70,286 44,356
Deferred:
Federal (2,444) (9,349) 1,275
State (390) (62) --
- ---------------------------------------------------------------------------------------
Total deferred (2,834) (9,411) 1,275
- ---------------------------------------------------------------------------------------
Provision for income taxes $74,005 $60,875 $45,631
- ---------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
</TABLE>
31
<PAGE>
The following table summarizes significant differences between the
provision for income taxes and the amount computed by applying the statutory
federal income tax rates to income before income taxes:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands) 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed expected provision 35.0% 35.0% 34.8%
State taxes, net of federal benefit 4.9 5.4 5.4
Tax exempt interest (2.2) (1.9) (1.7)
Amortization of intangibles 1.1 0.7 1.0
Changes in unrecognized deferred tax benefits 0.2 (0.3) 2.2
Other, net 1.6 2.9 0.4
- --------------------------------------------------------------------------------
Provision for income taxes 40.6% 41.8% 42.1%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
The Company and its subsidiaries file a consolidated Federal income tax
return. The Company also files a combined California franchise tax return
with its subsidiaries.
Prior to the change in accounting principle, the sources of deferred tax
items and the corresponding tax effects during the year ended September 30, 1993
were as follows:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
(in thousands) 1993
- --------------------------------------------------------------------------------
<S> <C>
Depreciation $ 2,803
Medical claims and benefits payable 1,482
Performance incentives 942
State franchise taxes (141)
Capital leases (2,322)
Other, net (1,489)
- --------------------------------------------------------------------------------
$ 1,275
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
</TABLE>
10. EMPLOYEE BENEFIT PLANS
a) Savings and Profit-Sharing Plan. The Company has an employee profit-
sharing plan (the "Plan") covering substantially all full-time employees, which
provides for annual contributions by the Company of two percent of the annual
compensation of employees and additional amounts determined by the Board of
Directors which are generally based upon a percentage of pretax income.
Employees may defer up to twelve percent of their annual compensation under the
Plan, with the Company matching one-half of the deferred amount, up to a maximum
of three percent of annual compensation. Amounts charged to expense applicable
to the Plan were $14.3 million, $10.3 million and $7.8 million for the years
ended September 30, 1995, 1994 and 1993, respectively.
b) Stock Option Plans. The Company has granted stock options for employees
and Directors under various plans including the Stock Option Plan for Executive
and Key Employees, as amended (the "1985 Plan"), the Second Amended and
Restated 1989 Stock Option Plan for Officers and Key Employees, as amended (the
"1989 Employee Plan"), the 1989 Non-Officer Directors Stock Option Plan (the
"1989 Director Plan") and the 1992 Non-Officer Directors Stock Option Plan (the
"1992 Director Plan").
Grants under the 1985 Plan and 1989 Director Plan were suspended. The total
number of shares of common stock which may be granted as incentive stock
options, non-qualified stock options ("NQSOs"), stock appreciation rights
("SARs") and stock payments under the 1989 Employee Plan is approximately
653,500. Options may be granted for a term of up to ten years at a price not
less than 100 percent of the fair market value of the common stock at the time
of grant.
The 1992 Director Plan provides for a maximum of 140,000 shares of Class B
Common Stock issuable upon the exercise of NQSQs granted to eligible non-officer
Directors of the Company. Non-officer Directors of the Company who are not
eligible to receive options under the 1989 Employee Plan are eligible to receive
NQSQs under the 1992 Director Plan.
32
<PAGE>
The following table summarizes the activity in NQSQs under the 1985 Plan, the
1989 Employee Plan, the 1989 Director Plan and the 1992 Director Plan for the
years ended September 30, 1995 and 1994:
<TABLE>
<CAPTION>
NON-QUALIFIED STOCK OPTIONS
- -------------------------------------------------------------------------------------------------------------------
YEARS ENDED SEPTEMBER 30, CLASS A CLASS B
1995 AND 1994 STOCK EXERCISE PRICE STOCK EXERCISE PRICE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OUTSTANDING AT SEPTEMBER 30, 1993 560,059 $ 1.63 - $19.75 922,089 $ 1.63 - $44.75
Granted -- $ -- - $ -- 588,400 $37.75 - $53.75
Exercised 104,649 $ 1.63 - $17.25 180,645 $ 1.63 - $40.25
Canceled 4,126 $17.25 - $17.25 25,005 $17.25 - $40.50
- -------------------------------------------------------------------------------------------------------------------
OUTSTANDING AT SEPTEMBER 30, 1994 451,284 $ 1.63 - $19.75 1,304,839 $ 1.63 - $53.75
Granted -- $ -- - $ -- 743,700 $65.56 - $66.75
Exercised 93,375 $ 1.63 - $19.75 245,233 $ 1.63 - $53.75
Canceled 825 $17.25 - $19.75 110,995 $17.25 - $66.75
- -------------------------------------------------------------------------------------------------------------------
OUTSTANDING AT SEPTEMBER 30, 1995 357,084 $ 1.63 - $19.75 1,692,311 $ 1.63 - $66.75
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
At September 30, 1995, approximately 2,049,575 shares were reserved for
issuance upon the exercise of outstanding options. As of that date, options
were exercisable for 342,984 shares of Class A Common Stock at exercise prices
of $1.63 - $19.75 per share and 394,289 shares of Class B Common Stock at
exercise prices of $1.63 - $66.75. No SARs have been awarded under the 1989
Employee Plan.
c) Performance Incentive Programs. The Company has a long-term performance
incentive program, under which all executive officers of the Company and certain
officers and key employees of the Company and its subsidiaries are eligible to
participate. Incentive compensation is based on the achievement of objectives
established by the Compensation Committee (the "Committee") of the Board of
Directors and approved by the shareholders of the Company. For fiscal years
ended September 30, 1995, 1994 and 1993, the incentive compensation expense for
this program was $3.0 million, $2.5 million and $1.9 million, respectively.
The Company also has an annual incentive compensation program. All executive
officers of the Company or any subsidiary of the Company are eligible to
participate and any officer or full-time employee of the Company or any
subsidiary of the Company, determined by the Committee to have a direct,
significant and measurable impact on the attainment of the Company's or
subsidiary's annual growth and profitability objectives is eligible to
participate. Amounts charged to expense for the annual compensation program
were $2.7 million, $7.0 million and $2.2 million for the years ended September
30, 1995, 1994 and 1993, respectively.
11. COMMITMENTS AND CONTINGENCIES
a) Lease Commitments. The Company leases office space and equipment under
various non-cancelable operating leases. Rental expense for the years ended
September 30, 1995, 1994 and 1993 totaled $18.3 million, $10.2 million and $8.1
million, respectively. Future minimum lease payments under operating leases at
September 30, 1995 are as follows:
<TABLE>
<CAPTION>
YEARS ENDING SEPTEMBER 30
(in thousands)
- ------------------------------------------------------------------------------
<S> <C>
1996 $20,658
1997 17,275
1998 10,359
1999 5,706
2000 4,159
Thereafter 5,169
- ------------------------------------------------------------------------------
$63,326
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
</TABLE>
33
<PAGE>
b) Employment Agreements. The Company has entered into employment
agreements with the President 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) would be approximately $7.4 million at
September 30, 1995.
c) Litigation. The Company is involved in legal actions in the normal
course of business, some of which seek substantial monetary damages, including
claims for punitive damages which are not covered by insurance. After review,
including consultation with counsel, management believes any ultimate liability
in excess of amounts accrued which could arise from the actions would not
materially affect the Company's consolidated financial position, results of
operations or cash flows.
12. INTEREST RATE SWAP AGREEMENTS
The Company has entered into interest rate swaps to reduce the impact of
changes in interest rates on a portion of its investments in marketable
securities. Interest rate swaps are contractual agreements between the Company
and third parties to exchange floating interest rate payments periodically over
the life of the agreements without the exchange of the underlying principal
amounts ("notional amounts"). At September 30, 1995, the total notional amount
of such agreements with off-balance sheet risk was $150.0 million. At September
30, 1995, the fair value of such agreements, representing the estimated amount
the Company would receive to terminate the agreement based on current interest
rates, was not significant.
13. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations
of credit risk consist primarily of investments in marketable securities,
interest rate swap agreements and commercial premiums receivable. The Company's
short-term investments in marketable securities are managed by professional
investment managers within guidelines established by the 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 employer groups comprising the
Company's customer base. The interest rate swap agreements contain an element
of risk that the counter parties may be unable to meet the terms of the
agreement. However, the Company minimizes such risk exposure for interest rate
swap agreements by limiting the counterparties to major financial institutions.
As of September 30, 1995, in Management's opinion, the Company had no
significant concentrations of credit risk.
34
<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 September 30, 1995 and 1994, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended September 30, 1995. 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. as of September 30, 1995 and 1994, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended September 30, 1995 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.
As discussed in Note 2 to the Consolidated Financial Statements, as of
October 1, 1994 the Company changed its method of accounting for marketable
securities.
ERNST & YOUNG LLP
Los Angeles, California
November 10, 1995
35
<PAGE>
QUARTERLY INFORMATION FOR FISCAL YEARS 1995 AND 1994 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------
(in thousands, except per share amounts) DEC. 31 MARCH 31 JUNE 30 SEPT. 30
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
YEAR ENDED SEPTEMBER 30, 1995
- ---------------------------------------------------------------------------------------------------------
Operating revenue $821,614 $912,766 $981,236 $1,015,406
Operating expenses 790,748 875,318 941,650 975,063
Interest income, net 3,217 8,594 11,281 10,765
- ---------------------------------------------------------------------------------------------------------
Income before income taxes 34,083 46,042 50,867 51,108
Provision for income taxes 14,026 18,683 20,619 20,677
- ---------------------------------------------------------------------------------------------------------
Net income $20,057 $27,359 $30,248 $30,431
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Earnings per share(1) $ 0.71 $ 0.96 $ 0.97 $ 0.98
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Membership(2) 1,405 1,526 1,682 1,757
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
YEAR ENDED SEPTEMBER 30, 1994
- ---------------------------------------------------------------------------------------------------------
Operating revenue $645,748 $714,424 $752,259 $780,821
Operating expenses 625,411 683,591 713,234 750,086
Interest income, net 5,603 5,777 6,617 6,541
- ---------------------------------------------------------------------------------------------------------
Income before income taxes and
cumulative effect of a change in
accounting principle 25,940 36,610 45,642 37,276
Provision for income taxes 11,201 15,766 18,846 15,062
- ---------------------------------------------------------------------------------------------------------
Income before cumulative effect of a
change in accounting principle 14,739 20,844 26,796 22,214
Cumulative effect on prior years of a
change in accounting principle 5,658 -- -- --
- ---------------------------------------------------------------------------------------------------------
Net income $20,397 $20,844 $26,796 $22,214
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Earnings per share:
Before cumulative effect of a change in
accounting principle $ 0.53 $ 0.75 $ 0.95 $ 0.79
Cumulative effect on prior years of a
change in accounting principle 0.20 -- -- --
- ---------------------------------------------------------------------------------------------------------
Earnings per share(1) $ 0.73 $ 0.75 $ 0.95 $ 0.79
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
Membership(2) 1,149 1,227 1,255 1,358
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(1) The results for the quarter ended June 30, 1994 includes $0.18 of positive
reserve adjustments which are described in Management's Discussion and
Analysis on page 16.
(2) Membership as of quarter-end.
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.
36
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is contained in the Company's 1995 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement shall
be filed with the Securities and Exchange Commission not later than 120 days
subsequent to September 30, 1995.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is contained in the Company's 1995 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement shall
be filed with the Securities and Exchange Commission not later than 120 days
subsequent to September 30, 1995.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is contained in the Company's 1995 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement shall
be filed with the Securities and Exchange Commission not later than 120 days
subsequent to September 30, 1995.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is contained in the Company's 1995 Proxy
Statement and is incorporated herein by reference. Such Proxy Statement shall
be filed with the Securities and Exchange Commission not later than 120 days
subsequent to September 30, 1995.
37
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K
The following documents are filed as part of this report. Consolidated
financial statements and notes thereto are included in Part II, Item 8 of this
Report:
<TABLE>
<CAPTION>
PAGE REFERENCE
<C> <S> <C>
(a)1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1995 and 1994...............20
Consolidated Statements of Income for the years ended
September 30, 1995, 1994 and 1993.........................................21
Consolidated Statements of Shareholders' Equity for the years
ended September 30, 1995, 1994 and 1993...................................22
Consolidated Statements of Cash Flows for the years ended
September 30, 1995, 1994 and 1993.........................................23
Notes to Consolidated Financial Statements..................................25
Report of Ernst & Young LLP Independent Auditors............................35
Quarterly Information for Fiscal Years 1995 and 1994 (Unaudited)............36
2. Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts...........................42
</TABLE>
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.
<TABLE>
<C> <C> <S>
3. Exhibits:
3.1 Certificate of Incorporation and amendments thereto
[incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-2 (File No. 33-31541)].
3.2 Amendment to the Certificate of Incorporation [incorporated by
reference to Exhibit 2.1 to the Company's Registration
Statement on Form 8-A, dated May 20, 1992].
3.3 Amendment to the Certificate of Incorporation [incorporated by
reference to Exhibit 3.1 to the Company's Form 10-Q for the
quarter ended March 31, 1994].
3.4 Bylaws of the Company [ incorporated by reference to Exhibit
3.4 to the Company's Form 10-K for the year ended September
30, 1994].
3.5 First Amendment to the Bylaws of the Company [incorporated by
reference to Exhibit 3.5 to the Company's Form 10-K for the
year ended September 30, 1994].
4.1 Specimen of the Company's Class A Common Shares [incorporated
by reference to Exhibit 1 to the Company's Form 8, dated May
20, 1992].
4.2 Specimen of the Company's Class B Common Shares [incorporated
by reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A, dated May 20, 1992].
</TABLE>
38
<PAGE>
<TABLE>
<C> <C> <S>
10.1 Employment Agreement, dated as of April 1, 1993, between the
Company and Terry Hartshorn [incorporated by reference to
Exhibit 10.2 to the Company's Form 10-Q for the quarter ended
March 31, 1994].
10.2 Employment Agreement, dated December 1, 1994, between the
Company and Alan Hoops [incorporated by reference to Exhibit
10.2 to the Company's Form 10-Q for the quarter ended December
31, 1994].(1)
10.3 Employment Agreement, dated December 12, 1994, between the
Company and Jeffrey Folick [incorporated by reference to
Exhibit 10.3 to the Company's Form 10-Q for the quarter ended
December 31, 1994].(1)
10.4 Employment Agreement, dated February 22, 1990, between the
Company and Wayne Lowell, as amended June 5, 1992
[incorporated by reference to Exhibit 28.3 to the Company's
Registration Statement on Form S-3 (File No. 33-52438)].(1)
10.5 Employment Agreement, dated as of October 16, 1992, between
the Company and Roger Taylor [incorporated by reference to
Exhibit 10.1 to the Company's Registration Statement on Form
S-3 (File No. 33-72012)].(1)
10.6 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 Company's Registration
Statement on Form S-3 (File No. 33-72012)].
10.7 Management Consulting Agreement, dated as of October 1, 1991,
between the Company and UniHealth [incorporated by reference
to Exhibit 28.6 to the Company's Registration Statement on
Form S-3 (File No. 33-52438)].
10.8 Second Amended and Restated 1989 Stock Option Plan for
Officers and Key Employees, as amended [incorporated by
reference to Exhibit A to the Company's Proxy Statement, dated
January 26, 1992.(1)
10.9 1992 Non-Officer Directors Stock Option Plan [incorporated by
reference to Exhibit 4.2 to the Company's Registration
Statement on Form S-8 (File No. 33-48543)].(1)
10.10 Amended Long-Term Performance Incentive Plan, as amended
[incorporated by reference to Exhibit 10.4 to the Company's
Form 10-Q for the quarter ended March 31, 1994].(1)
10.11 Amended Management Incentive Compensation Plan, as amended
[incorporated by reference to Exhibit 10.5 to the Company's
Form 10-Q for the quarter ended March 31, 1994].(1)
10.12 Credit Agreement, dated as of November 30, 1994, among
PacifiCare Health Systems, Inc., the financial institutions
named therein, The Chase Manhattan Bank, Citicorp USA, Inc.
and Nationsbank of Texas, N.A., as Co-Agents and Bank of
America, National Trust and Savings Association, as
Administrative Agent [incorporated by reference to Exhibit
10.1 to the Company's Form 10-Q for the quarter ended December
31, 1994].
10.13 Contribution and Indemnification Agreement, dated March 16,
1995 between the Company and UniHealth [incorporated by
reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-3 (File No. 33-57783)].
</TABLE>
39
<PAGE>
<TABLE>
<C> <C> <S>
10.14 The PacifiCare Health Systems, Inc. Statutory Restoration
Plan.(1)
10.15 PacifiCare Health Systems, Inc. Nonemployee Director
Compensation and Retirement Plan.(1)
11A Computation of Earnings Per Share - Primary
11B Computation of Earnings Per Share - Fully Diluted
21 List of Subsidiaries
23 Consent of Ernst & Young LLP Independent Auditors
27 Financial Data Schedules
</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.
(b) Reports on Form 8-K:
None.
40
<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.
PACIFICARE HEALTH SYSTEMS, INC.
Date: November 22, 1995 By /s/ ALAN HOOPS
---------------------------------------------
Alan Hoops, President
and Chief Executive Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE 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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ TERRY HARTSHORN Chairman of the Board November 22, 1995
- -----------------------------------
Terry Hartshorn
President,
Chief Executive Officer,
and Director
/s/ ALAN HOOPS (Principal Executive Officer) November 22, 1995
- -----------------------------------
Alan Hoops
Executive Vice President,
Chief Administrative Officer
and Chief Financial Officer
/s/ WAYNE LOWELL (Principal Financial Officer) November 22, 1995
- -----------------------------------
Wayne Lowell
Senior Vice President and
Corporate Controller
/s/ FRED V. RYDER, JR. (Principal Accounting Officer) November 22, 1995
- -----------------------------------
Fred V. Ryder, Jr.
/s/ JEAN BIXBY SMITH Director November 22, 1995
- -----------------------------------
Jean Bixby Smith
/s/ DAVID R. CARPENTER Director November 22, 1995
- -----------------------------------
David R. Carpenter
/s/ GARY L. LEARY Director November 22, 1995
- -----------------------------------
Gary L. Leary
/s/ WARREN E. PINCKERT II Director November 22, 1995
- -----------------------------------
Warren E. Pinckert II
/s/ DAVID A. REED Director November 22, 1995
- -----------------------------------
David A. Reed
/s/ LLOYD ROSS Director November 22, 1995
- -----------------------------------
Lloyd Ross
</TABLE>
41
<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 COSTS AND OTHER DEDUCTIONS/ END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS PERIOD
- ------------------------------------------------------------------------------------------------------------
<S> <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, 1994 $1,155 $ 532 $ 263 $1,392 $ 558
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
Year ended
September 30, 1993 $1,698 $1,650 $ 546 $2,739 $1,155
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------
</TABLE>
42
<PAGE>
EXHIBIT 10.15
PACIFICARE HEALTH SYSTEMS, INC.
_____________________________________________________________________________
RESTORATION PLAN
<PAGE>
TABLE OF CONTENTS PAGE
- ------------------------------------------------------------------
ARTICLE I Definitions. . . . . . . . . . . . . . . . . . . . 1
1.1 Accounts . . . . . . . . . . . . . . . . . . . . . 1
1.2 Administrative Committee . . . . . . . . . . . . . 1
1.3 Beneficiary. . . . . . . . . . . . . . . . . . . . 1
1.4 Board of Directors . . . . . . . . . . . . . . . . 1
1.5 Compensation . . . . . . . . . . . . . . . . . . . 1
1.6 Deferral Account . . . . . . . . . . . . . . . . . 1
1.7 Earnings . . . . . . . . . . . . . . . . . . . . . 2
1.8 Effective Date . . . . . . . . . . . . . . . . . . 2
1.9 Eligible Employee. . . . . . . . . . . . . . . . . 2
1.10 Employer . . . . . . . . . . . . . . . . . . . . . 2
1.11 Matching Account . . . . . . . . . . . . . . . . . 2
1.12 Participant. . . . . . . . . . . . . . . . . . . . 2
1.13 Plan . . . . . . . . . . . . . . . . . . . . . . . 2
1.14 Plan Year. . . . . . . . . . . . . . . . . . . . . 2
1.15 Profit-Sharing Account . . . . . . . . . . . . . . 3
1.16 Qualified Plan . . . . . . . . . . . . . . . . . . 3
1.17 Retirement . . . . . . . . . . . . . . . . . . . . 3
1.18 Statutory Limits . . . . . . . . . . . . . . . . . 3
1.19 Valuation Date . . . . . . . . . . . . . . . . . . 3
ARTICLE II Contributions to the Plan. . . . . . . . . . . . . 4
2.1 Amount of Deferral . . . . . . . . . . . . . . . . 4
2.2 Amount of Profit-Sharing Contribution. . . . . . . 4
2.3 Amount of Matching Contribution. . . . . . . . . . 4
2.4 Amount of Discretionary Company Contribution . . . 4
2.5 Filing of Applications . . . . . . . . . . . . . . 4
2.6 Designation of Beneficiary . . . . . . . . . . . . 5
2.7 Administration . . . . . . . . . . . . . . . . . . 5
ARTICLE III Accrual of Benefits. . . . . . . . . . . . . . . . 6
3.1 Earnings of Accounts . . . . . . . . . . . . . . . 6
3.2 Vesting. . . . . . . . . . . . . . . . . . . . . . 6
(i)
<PAGE>
TABLE OF CONTENTS PAGE
- ------------------------------------------------------------------
ARTICLE IV Distribution of Accounts . . . . . . . . . . . . . 7
4.1 Payment upon Retirement. . . . . . . . . . . . . . 7
4.2 Payment upon Termination of Employment . . . . . . 7
4.3 Amount Distributable . . . . . . . . . . . . . . . 7
ARTICLE V The Administrative Committee . . . . . . . . . . . 8
5.1 Administrative Committee . . . . . . . . . . . . . 8
5.2 Rights and Duties. . . . . . . . . . . . . . . . . 8
5.3 Information. . . . . . . . . . . . . . . . . . . . 10
5.4 Compensation, Indemnity and Liability. . . . . . . 10
ARTICLE VI Amendment and Discontinuance . . . . . . . . . . . 11
6.1 Amendments . . . . . . . . . . . . . . . . . . . . 11
6.2 Discontinuance of Plan . . . . . . . . . . . . . . 11
ARTICLE VII Miscellaneous. . . . . . . . . . . . . . . . . . . 12
7.1 No Interest in Assets. . . . . . . . . . . . . . . 12
7.2 Limitation of Rights of Employees. . . . . . . . . 12
7.3 Restriction against Assignment . . . . . . . . . . 12
7.4 Receipt or Release . . . . . . . . . . . . . . . . 12
7.5 Payment on Behalf of Minor . . . . . . . . . . . . 13
7.6 Forfeiture . . . . . . . . . . . . . . . . . . . . 13
7.7 Withholding. . . . . . . . . . . . . . . . . . . . 13
7.8 California Law Governs . . . . . . . . . . . . . . 13
7.9 Interpretation . . . . . . . . . . . . . . . . . . 13
7.10 Instrument in Counterparts . . . . . . . . . . . . 13
7.11 Successors and Assigns . . . . . . . . . . . . . . 14
(ii)
<PAGE>
1.
PACIFICARE HEALTH SYSTEMS, INC.
RESTORATION PLAN
THIS PLAN evidences the terms of the PacifiCare Health Systems, Inc.
Restoration Plan for certain executive employees.
WITNESSETH:
ARTICLE I
DEFINITIONS
Any terms defined in the Qualified Plan will have the same definition in this
Plan unless such term is expressly redefined in this Article I.
1.1 ACCOUNTS. "Accounts" shall mean the accounts maintained by the
Administrative Committee for each Participant, which includes the
Deferral Account, the Profit- Sharing Account, and the Matching Account.
1.2 ADMINISTRATIVE COMMITTEE. The "Administrative Committee" shall mean the
committee of at least three persons appointed by the Employer to perform
the duties detailed in Article V.
1.3 BENEFICIARY. "Beneficiary" or "Beneficiaries" shall mean the person or
persons (including, without limitation, any trustee) last designated by a
Participant to receive the benefits specified hereunder, in the event of
the Participant's death, or if there is no designated Beneficiary or
surviving Beneficiary, the Participant's estate.
14. BOARD OF DIRECTORS. "Board of Directors" shall mean the Board of Directors
of PacifiCare Health Systems, Inc.
1.5 COMPENSATION. "Compensation" shall mean Compensation as defined in the
Qualified Plan, without application of the "Pay Cap" defined in Section
1.18(a) of this Plan.
1.6 DEFERRAL ACCOUNT. "Deferral Account" shall mean the Account maintained by
the Administrative Committee for each Participant that is to be credited
with the
<PAGE>
2.
amounts of the Participant's Compensation that are deferred pursuant to
this Plan, together with the Earnings credited thereon as provided herein.
1.7 EARNINGS. "Earnings" shall mean the amounts credited to a Participant's
Accounts as investment growth. The rate of growth credited to the
Accounts will be set by, and at the sole discretion of, the Administrative
Committee. The rate will be determined for each ensuing quarter and will be
communicated to Participants prior to the beginning of such quarter.
1.8 EFFECTIVE DATE. "Effective Date" shall mean January 1, 1993.
1.9 ELIGIBLE EMPLOYEE. "Eligible Employee" shall mean any employee of the
Employer whose job classification is Senior Vice President or a higher
classification.
1.10 EMPLOYER. "Employer" or "Company" shall mean PacifiCare Health Systems,
Inc. and wholly-owned subsidiaries.
1.11 MATCHING ACCOUNT. "Matching Account" shall mean the Account maintained by
the Administrative Committee for each Participant that is to be credited
with:
(a) The amount of Company Matching (50% of deferrals to a maximum of 3%
of Compensation) contribution pursuant to this Plan;
(b) The amount of discretionary Company contributions contributed pursuant
to this Plan;
(c) Earnings credited to such contributions as provided herein.
1.12 PARTICIPANT. "Participant" shall mean any Eligible Employee who actually
participates in this Plan in any Plan Year and who is entitled to a benefit
hereunder.
1.13 PLAN. This Plan shall be known as the "PacifiCare Health Systems, Inc.
Restoration Plan," as now adopted or hereafter amended.
1.14 PLAN YEAR. "Plan Year" shall mean the 12-month period commencing on
January 1 and ending on December 31.
<PAGE>
3.
1.15 PROFIT-SHARING ACCOUNT. "Profit-Sharing Account" shall mean the Account
maintained by the Administrative Committee for each Participant which is
to be credited with the 2% of Compensation contributions made pursuant to
this Plan, together with the earnings credited thereon as provided herein.
1.16 QUALIFIED PLAN. "Qualified Plan" shall mean the PacifiCare Health
Systems, Inc. Savings and Profit-Sharing Plan for Employees of PacifiCare
Health Systems, Inc.
1.17 RETIREMENT. "Retirement" shall mean the retirement of a Participant
under the normal or disability retirement provisions of the Qualified Plan.
1.18 STATUTORY LIMITS. "Statutory Limits" shall mean the following:
(a) The maximum recognizable compensation under Internal Revenue
Code (IRC) Section 401(a)(17) -- the "Pay Cap;"
(b) The maximum contributions or other additions permitted under
IRC Section 415(c) -- the "415 Limit;"
(c) The exclusion of excess deferrals under IRC Section 402(g)(1) --
the "Deferral Limit"
(d) The limit on contributions for highly compensated employees
under IRC Sections:
401(k)(3) -- the "ADP Test," and
401(m)(2) -- the "ACP Test."
1.19 VALUATION DATE. "Valuation Date" shall mean the last day of each
calendar quarter or, in the Administrative Committee's discretion, such
other dates on which the Administrative Committee undertakes to determine
the value of each Participant's Accounts.
<PAGE>
4.
ARTICLE II
CONTRIBUTIONS TO THE PLAN
2.1 AMOUNT OF DEFERRAL. A Participant may elect to defer all or a portion
of the amount of his Compensation 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.
2.2 AMOUNT OF PROFIT-SHARING CONTRIBUTION. Any excess profit-sharing
contribution that would be 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 Profit-Sharing
Account under this Plan.
2.3 AMOUNT OF MATCHING CONTRIBUTION. Any excess Company matching
contribution that would be 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.
2.4 AMOUNT OF DISCRETIONARY COMPANY CONTRIBUTION. Any excess discretionary
Company contribution that would be 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.
2.5 FILING OF APPLICATIONS. To be eligible to defer Compensation that is
paid as part of a Participant's regular wages paid during any Plan Year, an
Eligible Employee must file a written application with the Administrative
Committee no later than December 15 of the preceding Plan Year. The
Administrative Committee shall notify each employee of his prospective
eligibility to participate in the Plan at least thirty (30) days prior to
the time he must file an application for participation. Notwithstanding
the foregoing, the Administrative 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 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
Compensation that he elects to defer in accordance with Section 2.1 of
this Plan.
<PAGE>
5.
Notwithstanding the above, no further application shall be required from
any Eligible Employee who elects to defer Compensation hereunder until such
Eligible Employee wishes to change the amount to be deferred in accordance
with the next succeeding paragraph.
A Participant may elect, with at least fifteen (15) days' advance
written notification to the Administrative Committee, to terminate his
deferrals under this Plan with respect to Compensation in subsequent years.
A Participant shall be permitted to resume participation in the Plan or
change his deferral amount subject to the limitation specified in Section
2.1 as of the first day of a Plan year if he files an application pursuant
to this Section 2.5.
2.6 DESIGNATION OF BENEFICIARY. The Beneficiary or Beneficiaries under this
Plan will be the individual(s) designated as such under the Qualified Plan.
The Employer and the Administrative Committee may rely on the designation
of the beneficiary or beneficiaries last filed in accordance with the terms
of the Qualified Plan.
2.7 ADMINISTRATION. Any amounts credited to a Participant's Accounts under
this Plan will be administered by the Administrative Committee.
<PAGE>
6.
ARTICLE III
ACCRUAL OF BENEFITS
3.1 EARNINGS OF ACCOUNTS. There shall be credited to each Participant's
Accounts as of the end of each calendar quarter Earnings on the balance(s)
credited thereto. Such Earnings, determined pursuant to Section 1.7,
shall be credited as though the amount allocated to the hypothetical
Participant's Accounts pursuant to Article II was contributed on the date
deemed to be the date such amount would have been invested, if the amount
were available for contribution under the Qualified Plan.
3.2 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 permanent and total disability,
the Participant becomes 100% vested.
<PAGE>
7.
ARTICLE IV
DISTRIBUTION OF ACCOUNTS
4.1 PAYMENT UPON RETIREMENT. If a Participant terminates employment due to
Retirement (or thereafter), the amount distributable to the Participant
(determined pursuant to Section 4.3) as of the date of such Retirement,
plus Earnings, shall be paid to the Participant in a single sum as soon as
practicable after the Valuation Date following such Retirement.
4.2 PAYMENT UPON TERMINATION OF EMPLOYMENT. If a Participant terminates
employment with the Employer by reason of death, or any other reason other
than Retirement, the amount distributable to the Participant (determined
pursuant to Section 4.3) as of the date of termination shall be distributed
to the Participant in a single sum as soon as practicable after the
Valuation Date following such termination.
4.3 AMOUNT DISTRIBUTABLE. The amount 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.
<PAGE>
8.
ARTICLE V
THE ADMINISTRATIVE COMMITTEE
5.1 ADMINISTRATIVE COMMITTEE. The Administrative Committee (appointed by
the Board of Directors) shall keep all records and documents pertaining to
the Committee's administration of the Plan. Any action of the
Administrative Committee shall be taken pursuant to a majority vote, or
with the written consent of a majority of its members, and such action
shall constitute the action of the Administrative Committee and be binding
the same as if all members had joined therein. A quorum of the
Administrative Committee shall consist of two members. A member of the
Administrative Committee shall not vote or act on any matter that relates
solely to such member as a Participant. Any member may execute any
certificate or other written direction on behalf of the Administrative
Committee. Third persons dealing with the Administrative Committee may
conclusively rely on any certificate or other written direction signed by
a member that purports to have been duly authorized by the Administrative
Committee.
5.2 RIGHTS AND DUTIES. The Administrative Committee, on behalf of the
Participants and their Beneficiaries, shall enforce the Plan in accordance
with its terms, shall be charged with the general administration of the
Plan, and shall have all powers necessary to accomplish those purposes,
including, but not by way of limitation, the following:
(a) To determine all questions relating to the eligibility of employees to
participate;
(b) To maintain or to designate any person or entity to maintain all the
necessary records for the administration of the Plan;
(c) To make and publish such rules for the regulation of the Plan as are
not inconsistent with the terms hereof;
(d) To provide for disclosure of all information and filing or provision
of all reports and statements to Participants or Beneficiaries under
this Plan or to governmental bodies as may be required by ERISA; and
(e) To establish claims procedures consistent with regulations of the
Secretary of Labor for presentation of claims by Participants and
Beneficiaries for Plan
<PAGE>
9.
benefits, consideration of such claims, review of claim denials, and
issuance of decisions on review. Such claims procedures at a minimum
shall consist of the following:
(1) The Administrative Committee shall notify Participants and, where
appropriate, Beneficiaries, of their right to claim benefits
under the claims procedures, shall make forms available for
filing of such claims, and shall provide the name of the person
or persons with whom such claims should be filed.
(2) The Administrative Committee shall establish procedures for
action on claims initially made and the communication of a
decision to the claimant promptly and, in any event, not later
than sixty (60) days after the date of the claim; the claim may
be deemed by the claimant to have been denied for purposes of
further review described below in the event a decision is not
furnished to the claimant within a 60-day period. Every claim
for benefits that is denied shall be denied by written notice
setting forth in a manner calculated to be understood by the
claimant (1) the specific reason or reasons for the denial, (2)
specific reference to any provisions of this Plan on which denial
is based, (3) description of any additional material or
information necessary for the claimant to perfect his claim with
an explanation of why such material or information is necessary,
and (4) an explanation of the procedure for further reviewing the
denial of the claim under the Plan.
(3) The Administrative Committee shall establish a procedure for
review of claim denials, with such review to be undertaken by the
Committee. The review given after denial of any claim shall be a
full and fair review, with the claimant or his duly authorized
representative having sixty (60) days after receipt of denial of
his claim to request such review, and having the right to review
all pertinent documents and the right to submit issues and
comments in writing.
(4) The Administrative Committee shall establish a procedure for
issuance of a decision by the Committee not later than sixty (60)
days after receipt of a request for review from a claimant unless
special circumstances, such as the need to hold a hearing,
require a longer period of time, in which
<PAGE>
10.
case a decision shall be rendered as soon as possible but not
later than one hundred twenty (120) days after receipt of the
claimant's request for review. The decision on review shall be
in writing and shall include specific reasons for the decision
written in a manner calculated to be understood by the claimant,
with specific reference to any provision of the Plan on hich the
decision is based.
All action of the Administrative Committee shall be conclusive on all
persons interested in the Plan, except to the extent otherwise specifically
indicated herein. The Administrative Committee may appoint a plan
administrator and other agents, and delegate thereto such powers and duties
in connection with the administration of the Plan as the Administrative
Committee may from time to time prescribe.
5.3 INFORMATION. To enable the Administrative Committee to perform its
functions, the Employer shall supply full and timely information to such
Committee on all matters relating to the payment of Compensation of all
Participants, their employment, their retirement, death, or the cause for
termination of employment, and such other pertinent facts as the
Administrative Committee may require.
5.4 COMPENSATION, INDEMNITY AND LIABILITY. The members of the
Administrative Committee shall serve without bond, except as otherwise
required by law, and without compensation for their services hereunder.
All expenses of the Administrative Committee shall be paid by the Employer,
and the Employer shall furnish the Administrative Committee with such
clerical and other assistance as is necessary in the performance of its
duties.
No member of the Administrative Committee shall be liable for any act or
omission of any other member of the Administrative Committee nor for any
act or omission on his own part, excepting only his own willful misconduct
or gross negligence. The Employer shall indemnify and save harmless each
member of the Administrative Committee against any and all expenses and
liabilities arising out of his membership on the Administrative Committee,
excepting only expenses and liabilities arising out of his own willful
misconduct or gross negligence.
<PAGE>
11.
ARTICLE VI
AMENDMENT AND DISCONTINUANCE
6.1 AMENDMENTS. The Board of Directors shall have the right to amend this Plan
from time to time or to cancel any amendments.
6.2 DISCONTINUANCE OF PLAN. It is the expectation of the Employer that this
Plan will be continued indefinitely, but continuance of the Plan is not
assumed as a contractual obligation of the Employer, and the right is
reserved by the Employer at any time to reduce, suspend, or discontinue
this Plan; provided, however, the Employer shall in no event have the power
to reduce the amount already paid or credited to a Participant's Deferral
Account.
<PAGE>
12.
ARTICLE VII
MISCELLANEOUS
7.1 NO INTEREST IN ASSETS. No Participant or any other person shall have
any interest in any fund or in any specific asset of the Employer by reason
of any amount credited to him hereunder, nor any right to receive any
distribution under the Plan except as and to the extent expressly provided
in the Plan. There shall be no funding of any benefits that may become
payable hereunder. No trust shall be created in connection with or by the
execution or adoption of this Plan. Any benefits that become payable
hereunder shall be paid from the general assets of the Employer. Nothing in
the Plan shall be deemed to give any officer or any employee of the
Employer any right to participate in the Plan, except in accordance with
the provisions of the Plan.
7.2 LIMITATION ON RIGHTS OF EMPLOYEES. Neither the adoption nor the
amendment of the Plan, nor any action of the Board of Directors of the
Employer, shall be held or construed to confer on any person any legal
right to be continued as an employee of the Employer, to receive any
particular level of compensation, or to be employed in any particular job
or job classification.
7.3 RESTRICTION AGAINST ASSIGNMENT. The Employer shall pay all amounts
payable hereunder only to the person(s) designated by the 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
Beneficiaries, or successors in interest, nor shall it 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, commute, pledge, encumber, or assign any benefits or payments
hereunder in any manner whatsoever.
Notwithstanding the above, nothing herein shall be deemed a waiver of the
Employer's right of offset as set forth in the laws of the State of
California.
7.4 RECEIPT OR RELEASE. Any payment to any Participant or his Beneficiary
in accordance with the provisions of this Plan shall, to the extent
thereof, be in full satisfaction of all claims against the Committee and
the Employer, and the Committee may require such Participant or
Beneficiary, as a condition precedent to such payment, to execute a receipt
and release to such effect.
<PAGE>
13.
7.5 PAYMENT ON BEHALF OF MINOR. In the event any amount becomes payable
under the Plan to a minor or a person who, in the sole judgment of the
Committee, is considered by reason of physical or mental condition to be
unable to give a valid receipt therefor, the Committee may direct that such
payment be made to any person found by the Committee, in its sole judgment,
to have assumed the care of such minor or other person. Any payment made
pursuant to such determination shall constitute a full release and
discharge of the Committee and the Employer.
7.6 FORFEITURE. Any payment or distribution to a Participant under the Plan
that is not claimed by the Participant, Beneficiary, or other person
entitled thereto within three years after becoming payable shall be
forfeited and canceled and shall remain with the Employer, and no other
person shall have any right thereto or interest therein. The Employer shall
not have any duty to give notice that amounts are payable under the Plan to
any person other than the Participant and the designated Beneficiary or
Beneficiaries.
7.7 WITHHOLDING. The Employer shall deduct from the amount of all
distributions under the Plan any taxes required to be withheld by the
federal or any state or local government.
7.8 CALIFORNIA LAW GOVERNS. This Plan shall be construed, regulated, and
administered under the laws of the State of California. If any provision
of this instrument shall be held by a court of competent jurisdiction to be
invalid or unenforceable, the remaining provisions thereof shall continue
to be fully effective.
7.9 INTERPRETATION. Headings and subheadings in the Plan are inserted for
convenience only and are not to be considered in the construction of the
provisions thereof. Singular nouns may include the plural and plural nouns
may include the singular where appropriate. The masculine gender may mean
the feminine and/or neuter gender where appropriate.
7.10 INSTRUMENT IN COUNTERPARTS. This Plan has been executed in several
counterparts, each of which shall be deemed an original, and said
counterparts shall constitute but one and the same instrument, which may
be sufficiently evidenced by one counterpart.
<PAGE>
14.
7.11 SUCCESSORS AND ASSIGNS. This Plan shall inure to the benefit of, and be
binding on, the parties hereto and their successors and assigns.
Executed at ____________________, California, on the ____ day of
________________, 1992.
PacifiCare Health Systems, Inc.
By /s/ SAMUEL J. TIBBETTS
-------------------------------
Title CHAIRMAN
-------------------------------
By
-------------------------------
Title
-------------------------------
Approved as to form:
___________________________
Counsel for Employer
<PAGE>
EXHIBIT 10.16
PACIFICARE HEALTH SYSTEMS, INC.
NONEMPLOYEE DIRECTOR
COMPENSATION AND RETIREMENT PLAN
PacifiCare Health Systems, Inc., a corporation organized under the laws
of the State of Delaware (the "Company"), hereby adopts this PacifiCare
Health Systems, Inc. Nonemployee Director Compensation and Retirement Plan.
1. PURPOSE OF THE PLAN
The purpose of this Plan is to enhance the growth, development and
financial success of the Company and its ability to attract and retain the
services of qualified and experienced Nonemployee Directors by providing such
Nonemployee Directors annual cash compensation, retirement benefits and stock
options, subject to the conditions and limitations of the Plan.
2. DEFINITIONS
When used herein, the following terms shall have the respective meanings
set forth below:
(a) "Affiliate" shall mean any corporation or entity which directly, or
indirectly through one or more intermediaries, controls, is controlled by or
is under common control with the Company. Affiliates of the Company shall
include UniHealth America and its affiliates.
(b) "Annual Retainer" means the retainer compensation established by
the Board and paid to a qualified Nonemployee Director pursuant to Section 4
hereof.
(c) "Board" means the Board of Directors of the Company.
(d) "Board Meeting Fee" shall mean the fee established by the Board and
paid to each Nonemployee Director for attending a meeting of any committee of
the Board pursuant to Section 5 hereof.
(e) "Committee Meeting Fee" shall mean the fee established by the Board
and paid to each Nonemployee Director for attending a meeting of any
committee of the Board pursuant to Section 5 hereof.
(f) "Company" means PacifiCare Health Systems, Inc., a Delaware
corporation, and any successor corporation.
(g) "Director" means any person who is duly elected or appointed to the
Board.
1
<PAGE>
(h) "Employee" means any full-time employee (as defined in Section
31.340(c)-1 of the Internal Revenue Code of 1986, as amended) of the Company
or any of its Affiliates.
(i) "Meeting Fees" shall mean the Board Meeting Fee and the Committee
Meeting Fee.
(j) "Nonemployee Director" or "Participant" means any Director who is
not an Employee and who is otherwise eligible to accrue or receive benefits
under the Plan.
(k) "Plan" means the Company's Nonemployee Director Compensation and
Retirement Plan as set forth herein, as it may be amended from time to time.
(l) "Plan Committee" shall mean the committee of the Board of Directors
of the Company as defined in Section 3(a) hereof.
(m) "Retire" or "Retirement" shall mean the termination of service of a
Nonemployee Director as a Director by resignation, expiration of office
without reelection, or for any other reason except death or removal of the
Nonemployee Director for "cause."
(n) "Retirement Benefits" shall mean the retirement benefits payable to
Nonemployee Directors under Section 7 hereof.
(o) "Stock Options" shall mean options to purchase shares of the
Company's common stock granted to Nonemployee Directors under the Company's
1989 Stock Option Plan for Officers and Key Employees and the 1989 Stock
Option Plan for Non-Officer Directors.
(p) "Year(s) of Service" shall mean the number of full years (i.e., 365
days) of service of a Director as a Nonemployee Director for the Company and,
prior to November, 1983, for the Company's predecessors, PacifiCare Health
Systems, a California corporation, PacifiCare, Inc., a California
corporation, and PacifiCare, Inc., a California nonprofit corporation.
3. ADMINISTRATION OF THE PLAN
(a) GENERAL ADMINISTRATION; POWERS OF ADMINISTRATION. The Plan shall
be generally administered by the Board. The Board may delegate the general
administration of the Plan to a committee of the Board (the "Plan
Committee"). The Company shall pay all costs of administration of the Plan.
The Board or, if applicable, the Plan Committee, shall have and may exercise
such powers and authority as may be necessary or appropriate to carry out the
administration of the Plan. Without limiting the generality of the
foregoing, the Board or, if applicable, the Plan Committee shall have full
power and authority (i) to
2
<PAGE>
determine all questions of fact and law that may arise under the Plan, (ii)
to interpret the Plan and to make all other determinations necessary or
advisable for the administration of the Plan, and (iii) to prescribe, amend,
and rescind rules and regulations relating to the Plan, including, without
limitation, any rules which the Board or, if applicable, the Plan Committee
determines are necessary or appropriate, as the case may be, to ensure that
the Company complies with all applicable provisions of any federal, state, or
local law, including laws relating to the withholding of tax, including both
prospective and retroactive changes in tax laws. All interpretations,
determinations, and actions by the Board or Plan Committee, as the case may
be, shall be final, conclusive, and binding upon all Participants.
(b) PLAN COMMITTEE. The Plan Committee shall consist of at least three
(3) members. The Plan Committee shall only act by a majority vote of its
members. The Plan Committee may act either by a vote at a meeting or by
memorandum or other written instrument signed by a majority of the Plan
Committee members.
(c) LIABILITY. All actions taken and all interpretations and
determinations made by the Board or the Plan Committee, as the case may be,
in good faith shall be final and binding upon all Participants, the Company
and all other interested persons. No member of the Board or the Plan
Committee, as the case may be, shall be personally liable for damages, costs
or expenses resulting from any action, failure to act, determination or
interpretation made in good faith with respect to the Plan and all members of
the Board and Plan Committee shall be fully protected by the Company in
respect to any such action, determination or interpretation.
(d) NONAPPLICABILITY TO STOCK OPTIONS. Notwithstanding anything
contained herein, any action, determination, or interpretation with respect
to Stock Options, including, but not limited to, the administration of or
grants of Stock Options under the Company's 1989 Stock Option Plan for
Officers and Key Employees and the 1989 Stock Option Plan for Non-Officer
Directors, as the case may be, shall be governed exclusively by the terms and
conditions of said stock option plans.
(e) COMPENSATION AND RETIREMENT AGREEMENTS. The Board or Plan
Committee, as the case may be, in its sole and absolute discretion, shall
cause the Company to enter into a written compensation and retirement
agreement with each eligible Nonemployee Director which agreement shall be
executed by the Nonemployee Director and an authorized Officer of the Company
and which shall contain such terms and conditions as the Board or Plan
Committee, as the case may be, shall determine, consistent with the Plan.
Each such agreement shall expressly incorporate
3
<PAGE>
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.
4. ANNUAL RETAINER
(a) AMOUNT. The amount of the Annual Retainer payable by the Company
to each eligible Nonemployee Director other than the Chairman of the Board of
the Company shall be $10,000 per year. In recognition of his additional
administrative duties and responsibilities, the amount of the Annual Retainer
for an eligible Nonemployee Director who is also the Chairman of the Board of
the Company shall be equal to one hundred fifty percent (150%) of the Annual
Retainer amount payable to all other eligible Nonemployee Directors. The
Board may change the amount of the Annual Retainer at any time by a duly
adopted resolution.
(b) ELIGIBILITY. A Nonemployee Director shall be eligible to receive
the Annual Retainer only if he or she has been duly elected as a Director and
serving in such capacity on April 1 of the particular year for which the
Annual Retainer is payable by the Company.
(c) PAYMENT DATE. Each eligible Nonemployee Director shall be paid the
Annual Retainer on April 1 of each year commencing on April 1, 1991.
5. MEETING FEES
(1) AMOUNT.
(i) The amount of the Board Meeting Fee for eligible Nonemployee
Directors other than the Chairman of the Board of the Company shall be $1,000
per Board meeting. In recognition of his additional administrative duties
and responsibilities, the amount of the Board Meeting Fee for an eligible
Nonemployee Director who is also the Chairman of a Board Committee shall be
equal to one hundred fifty percent (150%) of the Board Meeting Fee amount
applicable to all other eligible Nonemployee Directors.
(ii) The amount of the Committee Meeting Fee for eligible
Nonemployee Directors other than the Chairman of each respective committee of
the Board shall be $750 per Board committee meeting. In recognition of his
or her additional administrative duties and responsibilities, the amount of
the Committee Meeting Fee for an eligible committee chairman shall be equal
to one hundred fifty percent (150%) of the Board Meeting
4
<PAGE>
Fee amount applicable to all other eligible Nonemployee Directors.
(iii) The Board may change the amount of the Board Meeting Fee and
the Committee Meeting Fee at any time by a duly adopted resolution.
(b) ELIGIBILITY. A Nonemployee Director shall be eligible to receive a
Board Meeting Fee and/or Committee Meeting Fee only if he or she attends the
Board meeting or Board committee meeting, as the case may be, to which the
Board Meeting Fee or Committee Meeting Fee, as the case may be, applies.
(c) PAYMENT DATE. Each eligible Nonemployee Director shall be paid the
applicable Board Meeting Fee or Committee Meeting Fee, as the case may be, at
the commencement of the Board meeting or Board committee meeting to which the
Board Meeting Fee or Committee Meeting Fee applies.
6. DEFERRAL OF ANNUAL RETAINER AND MEETING FEES
A Nonemployee Director may elect to defer all or a portion of the Annual
Retainer or Meeting Fees payable to such Nonemployee Director by the Company.
In the event that a Nonemployee Director elects to defer all or a portion of
the Annual Retainer or Meeting Fees, he or she shall enter into a written
agreement with the Company, which agreement shall contain such terms and
conditions of the deferral arrangement as the Board or Plan Committee, as the
case may be, shall determine, consistent with the Plan.
7. RETIREMENT BENEFITS
(a) ELIGIBILITY.
(i) Upon Retirement, a Nonemployee Director shall be eligible to
receive Retirement Benefits under the Plan if such Nonemployee Director has
at least five (5) consecutive Years of Service as a Nonemployee Director
(I.E., without any break in service for any reason). The amount and the
manner of payment of such Retirement Benefits will be as provided below in
Section 7(c).
(ii) A Nonemployee Director who serves or has at anytime served
(before or after the effective date of the Plan) as any Employee shall not be
eligible to receive Retirement Benefits under the Plan if such Nonemployee
Director is eligible to receive retirement benefits under a Defined Benefit
Plan (as such plans are defined by the Employee Retirement Income Security
Act (ERISA)) established by the Company.
5
<PAGE>
(b) DISQUALIFICATION. A Nonemployee Director shall not be entitled to
receive Retirement Benefits under the Plan if he or she is removed for
"cause" from the Board even if such Nonemployee Director otherwise satisfies
the requirements for receiving Retirement Benefits and even if Retirement
Benefits have already accrued.
(c) AMOUNT OF RETIREMENT BENEFITS.
(i) If a Nonemployee Director Retires, the Company shall pay the
Nonemployee Director Retirement Benefits equal to the average of the Annual
Retainer paid to such Nonemployee Director for the three (3) year period
immediately preceding Retirement or the average of the Annual Retainer paid
to such Nonemployee Director if the Annual Retainer has been paid by the
Company for less than three (3) years. Unless an eligible Nonemployee
Director becomes ineligible, disqualified or his or her Retirement Benefits
terminate as provided herein, the payment of Retirement Benefits by the
Company shall be made annually for the number of Years of Service accumulated
by an eligible Nonemployee Director at the time of his Retirement. Each
Nonemployee Director shall be fully liable for payment of any local, state or
federal income or other taxes associated with the receipt of Retirement
Benefits.
(ii) If a Nonemployee Director Retires and later resumes
Nonemployee Director status, payments of Retirement Benefits shall be
automatically suspended as of the date of resumption of Nonemployee Director
status and until such time as the Nonemployee Director again Retires and is
eligible to receive Retirement Benefits. If the Nonemployee Director again
Retires, the Company shall pay the Nonemployee Director Retirement Benefits
equal to the average Annual Retainer paid to such Nonemployee Director for
the immediately preceding three (3) year period, or the average of the Annual
Retainer paid to such Nonemployee Director if such has been paid for less
than three (3) years, provided such Nonemployee Director remains eligible to
receive Retirement Benefits. Unless an eligible Nonemployee Director becomes
ineligible, disqualified or his or her Retirement Benefits terminate as
provided herein, payment of Retirement Benefits shall be made by the Company
annually for the number of Years of Service accumulated by the Nonemployee
Director (less any period of time for which payments of Retirement Benefits
were previously made under the Plan) at the time of his or her Retirement,
including Years of Service which may have accrued since the resumption of
Nonemployee Director as a Director or in any other capacity for any period of
time or at a particular retainer or other rate of compensation, as conferring
upon any Participant any legal or other right to continue as a Director or in
any other capacity, or as limiting, interfering with or otherwise affecting
the right to terminate a
6
<PAGE>
Participant in his or her capacity as a Director or otherwise at any time for
any reason, with or without cause, and without regard to the effect that such
termination might have upon him or her as a Participant under the Plan.
10. COMPLIANCE WITH GOVERNMENT REGULATIONS
Neither the Plan nor the Company shall be obligated to make any payments
pursuant to the Plan at any time unless and until all applicable requirements
under federal and state laws, rules, and regulations, or by any regulatory
agencies, have been fully met.
11. NONTRANSFERABILITY OF RIGHTS
No Participant may assign the right to receive Retirement Benefits under
the Plan or any other right or interest under the Plan, contingent or
otherwise, or to cause or permit any encumbrance, pledge, or charge of any
nature to be imposed on any such right or interest.
12. AMENDMENT AND TERMINATION OF PLAN
The Board shall have the power, in its discretion, to amend, suspend, or
terminate the Plan at any time, provided that no amendment, suspension, or
termination of the Plan will, without the consent of the Participant, alter,
terminate, or reduce any benefits which have accrued under the Plan, unless
such amendment, suspension, or termination is required by applicable law.
13. GOVERNING LAW
The laws of the State of Delaware shall govern and control the
interpretation and application of the terms of the Plan.
14. EFFECTIVE DATE AND DURATION OF THE PLAN
This Plan will become effective as of April 1, 1991. Nonemployee
Directors who have Retired prior to such date shall not be entitled to
receive Retirement Benefits under the Plan.
7
<PAGE>
Exhibit 11A
PACIFICARE HEALTH SYSTEMS, INC.
Computation of Net Income per Share of Common Stock - Primary
(dollars and shares in thousands, except per share amounts)
<TABLE>
<CAPTION>
Years ended September 30
---------------------------------------
1995 1994 1993
---------------------------------------
<S> <C> <C> <C>
Shares outstanding at the beginning of the period 27,528 27,256 25,617
Weighted average number of shares issued during the period
in connection with a public offering, compensation
awarded in stock and exercise of stock options 1,750 155 1,694
Shares repurchased (weighted) - (33) (88)
Dilutive shares issuable, net of shares assumed to have been
purchased (at the average market price) for treasury with
assumed proceeds from contingent exercise of stock options
586 626 624
---------------------------------------
Total primary shares 29,864 28,004 27,847
---------------------------------------
---------------------------------------
Income before cumulative effect of a change in
accounting principle $ 108,095 $ 84,593 $ 62,696
Cumulative effect on prior years of a change in
accounting principle - 5,658 -
---------------------------------------
Net income $ 108,095 $ 90,251 $ 62,696
---------------------------------------
---------------------------------------
Primary earnings per share:
Before cumulative effect of a change in
accounting principle $ 3.62 $ 3.02 $ 2.25
Cumulative effect on prior years of a change in
accounting principle - 0.20 -
---------------------------------------
Earnings per share - primary $ 3.62 $ 3.22 $ 2.25
---------------------------------------
---------------------------------------
</TABLE>
<PAGE>
Exhibit 11B
PACIFICARE HEALTH SYSTEMS, INC.
COMPUTATION OF NET INCOME PER SHARE OF COMMON STOCK - FULLY DILUTED
(dollars and shares in thousands, except per share amounts)
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30
----------------------------------------
1995 1994 1993
----------------------------------------
<S> <C> <C> <C>
Shares outstanding at the beginning of the period 27,528 27,256 25,617
Weighted average number of shares issued during the period
in connection with a public offering, compensation
awarded in stock and exercise of stock options 1,750 155 1,694
Shares repurchased (weighted) - (33) (88)
Dilutive shares issuable, net of shares assumed to have
been purchased (at the higher of average or ending
market price) for treasury with assumed proceeds from:
Contingent exercise of stock options 608 766 624
Registered equity purchase contracts 4 - -
----------------------------------------
Total fully diluted shares 29,890 28,144 27,847
----------------------------------------
----------------------------------------
Income before cumulative effect of a change in
accounting principle $ 108,095 $ 84,593 $ 62,696
Cumulative effect on prior years of a change in
accounting principle - 5,658 -
----------------------------------------
Net income $ 108,095 $ 90,251 $ 62,696
Decrease in interest expense applicable to subordinated
convertible debentures, net of income tax effect - - 1
----------------------------------------
Net income as adjusted $ 108,095 $ 90,251 $ 62,697
----------------------------------------
----------------------------------------
Fully diluted earnings per share:
Earnings before cumulative effect of a change in
accounting principle $ 3.62 $ 3.00 $ 2.25
Cumulative effect on prior years of a change in
accounting principle - 0.20 -
----------------------------------------
Earnings per share - fully diluted $ 3.62 $ 3.20 $ 2.25
----------------------------------------
----------------------------------------
</TABLE>
<PAGE>
Exhibit 21
PACIFICARE HEALTH SYSTEMS, INC.
LIST OF SUBSIDIARIES
NAME OF SUBSIDIARY STATE OF INCORPORATION
------------------ ----------------------
Advanced Delivery Systems Management Company California
Barbis Advertising, Inc. Florida
California Dental Health Plan California
Clinica Pasteur, Inc. Florida
Clinica Pasteur Laguna & Sweetwater, Inc. Florida
COMPREMIER, Inc. California
Covantage, Inc. Delaware
CRM Insurance Services, Inc. California
Dental Plan Administrators California
Health in Dade, Inc. Florida
Health in Miami Beach, Inc. Florida
Health Managers of Oklahoma, Inc. Oklahoma
Health Managers of Texas, Inc. Texas
Interstate Medical Equipment, Inc. Florida
Ismael Hernandez, M.D. & Associates, P.A. Florida
MediCor, Inc. Texas
Optica Pasteur, Inc. Florida
Oregon Health Management Company California
PacifiCare Administrative Services, Inc. California
PacifiCare Administrative Services of Florida, Inc. Florida
PacifiCare Behavioral Health, Inc. Delaware
PacifiCare Behavioral Health of California, Inc. Delaware
PacifiCare Benefit Administrators, Inc. Washington
PacifiCare Life and Health Insurance Company Indiana
PacifiCare Life Insurance Company Arizona
PacifiCare Military Health Systems, Inc. Delaware
PacifiCare of California California
PacifiCare of Florida, Inc. Florida
PacifiCare of Oklahoma, Inc. Oklahoma
PacifiCare of Oregon, Inc. Oregon
PacifiCare of Texas, Inc. Texas
PacifiCare of Washington, Inc. Washington
PacifiCare Pharmacy Centers, Inc. California
PacifiCare Ventures, Inc. California
PacifiCare Wellness Company California
PacifiClinic, P.C. Oregon
PC-CWD Vista Associates California
Pasteur Delivery Systems, Inc. Florida
Pasteur Pharmacy, Inc. Florida
Pasteur Systems, Inc. Florida
Secure Horizons USA, Inc. California
West Dade Professional Services, Inc. Florida
<PAGE>
Exhibit 23
CONSENT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(S-8 number 33-82204) and related Prospectus pertaining to the Amended and
Restated 1989 Stock Option Plan for Officers and Key Employees, as amended, and
in the Registration Statement (S-8 number 48543) and related Prospectus
pertaining to the 1992 Non-Officer Directors Stock Option Plan, of PacifiCare
Health Systems, Inc. of our report dated November 10, 1995 with respect to the
consolidated financial statements and schedule of PacifiCare Health Systems,
Inc. included in this Annual Report (Form 10-K) for the year ended September 30,
1995.
ERNST & YOUNG LLP
Los Angeles, California
November 21, 1995
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1995
<PERIOD-START> OCT-01-1994
<PERIOD-END> SEP-30-1995
<CASH> 279,145
<SECURITIES> 532,380
<RECEIVABLES> 113,098
<ALLOWANCES> 690
<INVENTORY> 0
<CURRENT-ASSETS> 961,609
<PP&E> 172,417
<DEPRECIATION> 73,141
<TOTAL-ASSETS> 1,385,372
<CURRENT-LIABILITIES> 640,994
<BONDS> 11,949
<COMMON> 309
0
0
<OTHER-SE> 732,024
<TOTAL-LIABILITY-AND-EQUITY> 1,385,372
<SALES> 0
<TOTAL-REVENUES> 3,731,022
<CGS> 0
<TOTAL-COSTS> 3,077,135
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 530
<INTEREST-EXPENSE> 5,549
<INCOME-PRETAX> 182,100
<INCOME-TAX> 74,005
<INCOME-CONTINUING> 108,095
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 108,095
<EPS-PRIMARY> 3.62
<EPS-DILUTED> 3.62
</TABLE>
